Recent Risk Alert from the SEC’s Division of Examinations
On July 21, 2021, the SEC’s Division of Examinations released a Risk Alert addressing their observations from examinations of investment advisers managing wrap fee programs. The SEC focused on this topic due to the growing amount of retail client assets participating in such programs.
Based on the Risk Alert, the SEC was specifically looking at the conflicts of interest for advisers and the risks to investors participating in such programs. Based on their examination of 100 advisers, the Risk Alert focuses on the following deficiencies noted with advisers serving as portfolio managers, sub-adviser or sponsors of wrap programs:
The most frequently cited deficiencies were related to: (1) compliance and oversight, including policies and procedures regarding the tracking and monitoring of the wrap fee programs; and (2) disclosures, including disclosures regarding conflicts, fees, and expenses. In some instances the staff questioned the appropriateness of recommendations of wrap fee programs for clients, particularly when the clients had no or low trading volume in their accounts.
Here is what the SEC highlighted as deficiencies:
- Advisers did not monitor the trading activity in clients’ accounts or their monitoring activities were ineffective. (Any trading-away? Any undisclosed fees? Infrequent trading?)
- Advisers did not have a reasonable basis to believe that the wrap fee programs were in the clients’ best interests. (SEC expects initial and on-going analysis of this.)
- Inconsistent disclosures regarding the same topic in various documents. For example: The staff identified inconsistencies across advisers’ Part 2A of Form ADV (the firm brochure), sponsors’ Part 2A Appendix 1 of Form ADV (the wrap fee program brochure), advisory agreements, and other account documents and agreements for wrap fee clients.
- Conflicts of interest which were not disclosed: For example, the advisers recommending wrap fee programs to their clients did not disclose that accounts with low trading volumes, high cash balances, or significant fixed income weightings may be able to receive similar services at a lower cost outside of a wrap fee program.
- Compliance programs were weak and could be improved: citing advisers did not adopt policies and procedures to address the initial and on-going best interest reviews when recommending wrap fee programs. Risk inventories did not address managing client portfolios within wrap programs. (RISK MATRIX)
Does your firm manage client assets in one of these wrap fee programs, either as the sponsor, adviser, or sub-adviser? If so, then here is what the SEC wants advisers participating in wrap fee programs to do:
- Conduct reviews of wrap fee programs – both initially and periodically thereafter – to assess whether the programs recommended to clients are in the best interests of clients, using information obtained directly from clients (e.g., through interviews, discussions, IPS and/or questionnaires).
- Communicate with clients to educate them on the programs available, such as wrap and non-wrap platforms. This should include the assessments of the fees, expenses, and other costs involved.
- Provide clients with disclosures regarding the advisers’ conflicts of interest related to transactions executed within the wrap fee programs.
- Make sure you address the topic of wrap fee programs in your risk matrix.
For those advisers managing or involved in these types of programs, now is the time to perform a thorough review of your policies, procedures and ADV disclosure.
For more information or to speak with a regulatory expert, please email firstname.lastname@example.org.