SEC Examiners: Advisers Should Review Policies and Procedures for Calculating Advisory Fees

SEC examiners have recommended that investment advisers “review routinely, refine, and improve, as appropriate, their fee billing policies, procedures, and practices and address new risks as they are identified” to ensure that they are calculating advisory fees correctly. They also should review their disclosures to confirm that clients are aware of all fees and expenses and related material conflicts of interest, examiners have suggested.

Examiners made the recommendations after identifying deficiencies related to the advisory fees charged by most of the approximately 130 investment advisers that it examined in a nationwide initiative. The deficiencies “often resulted in financial harm to clients,” which were predominantly retail investors, according to an SEC risk alert regarding investment advisers’ fee calculations.

The SEC cited deficiencies such as advisory fee calculation errors and not properly crediting certain fees due to clients, as well as fee-related compliance and disclosure issues. It also warned that advisers may violate their fiduciary duties and the Investment Advisers Act of 1940, including its anti-fraud provisions, if they fail to adhere to the terms of their agreement and disclosures, or otherwise engage in inappropriate fee billing and expense practices.

“It is important for clients to receive timely and accurate information regarding fees and expenses when hiring an investment adviser because every dollar an investor pays in fees and expenses is a dollar not invested for the investor’s benefit,” examiners wrote in the risk alert, in explaining the SEC’s advisory fees initiative.

“Advisory fee calculation and billing has been, and continues to be, an area that warrants routine review during investment adviser examinations. The staff’s observations and examination findings often lead to advisers returning money owed to clients due to fee billing and calculation errors, or to the improvement of advisers’ compliance programs, policies, and procedures that foster prevention of future advisory fee issues,” examiners wrote.

Deficiencies in calculating and disclosing advisory fees

Examiners cited “notable deficient practices” related to advisory fee calculations; false, misleading, or omitted disclosures; missing or inadequate policies and procedures; and inaccurate financial statements.

Advisory Fee Calculations

  • Advisers charged advisory fees inaccurately “due to a variety of errors,” including:
    • Inaccurate percentages being used to calculate advisory fees
    • Advisory fees being double-billed
    • Breakpoint or tiered billing rates not being calculated correctly
    • Householding of client accounts not being calculated correctly
    • Incorrect client account valuations being used
  • Advisers either did not refund prepaid fees on terminated accounts or did not assess fees for new accounts on a pro-rata basis.

False, Misleading, or Omitted Disclosures

  • Advisers had disclosure issues related to incomplete or misleading Form ADV Part2 brochures and/or other disclosures, including disclosure that:
  • Did not reflect current fees charged or whether fees were negotiable;
  • Did not accurately describe how fees would be calculated or billed; and
  • Was inconsistent across advisory documents.
  • Some advisers did not have written agreements or documentation establishing the client-fee amount.

Missing or Inadequate Policies and Procedures

“Many” advisers did not maintain written policies and procedures addressing advisory fee billing, monitoring of fee calculations and billing, or both, according to examiners. Examples of practices that examiners noted should be captured in written policies and procedures included:

  • Policies and procedures that specifically address fee calculations
  • Policies and procedures to address material advisory fee components

Inaccurate Financial Statements

Advisers had issues or inaccuracies with financial statements related to advisory fees, including not properly recording pre-paid advisory fees as liabilities or maintaining financial statements. Examples included:

  • Not recording all advisory fee income, administrative fee revenue, and compensation expenses in general ledgers and on financial statements
  • Using a cash and modified cash basis of accounting, but preparing financial statements on an accrual basis of accounting

Disclosing and calculating advisory fees compliantly

After detailing the deficiencies that they observed, examiners offered the following examples of policies and practices that help advisers address their legal and regulatory obligations related to the compliance issues raised in the risk alert.

  • Adopting and implementing written policies and procedures addressing advisory fee billing processes and validating fee calculations
  • Centralizing fee billing and validating that the fees charged to clients are consistent with compliance procedures, advisory contracts, and disclosures
  • Using the resources and tools provided for reviewing fee calculations
  • Recording all advisory expenses and fees assessed to and received from clients, including those paid directly to advisory personnel

“Examiners have indicated that advisers should be more deliberate in how they calculate advisory fees and disclose them,” said Margie Webber, director of compliance for RegEd. “They have also noted that policies and procedures and disclosure practices are not one-time efforts. Rather, they should be regularly reviewed and revised as needed to maintain compliance.”

RegEd’s Policies and Procedures Management solution assists firms with compliance by ensuring that critical compliance information is synchronized with current rules and regulations. It also streamlines preparedness for regulatory audits and market conduct exams with strong documentation and detailed evidence of compliance. For more information, please schedule a consultation.

About RegEd

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Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.

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