The SEC Division of Examinations (Exams) recently published a Risk Alert discussing observations on investment adviser fee calculations resulting from a review of approximately 130 firms. This 2021 Risk Alert supplements a prior alert on the same topic that Exams (then, the Office of Compliance Inspections and Examinations) published in 2018. Policing fee calculation practices continues to be a priority for the SEC staff because returning fees in cases of overcharges or miscalculations has a direct – and quantifiable – financial benefit for retail investors. At the same time, errors are not uncommon because advisory fee calculations involve a great deal of operational complexity. This is particularly the case where advisers manage many different fee schedules, breakpoints, householding requirements, rebates, and offsets. Given these multiple fee tiers and adjustments, it is not surprising that the Exams reports that “most” of the examinations conducted as part of this “Advisory Fee Initiative” resulted in deficiencies in advisory fee calculations.
The Risk Alert listed the following types of deficiencies related to fee calculations:
- Inaccurate fee calculations, including situations where the fees charged were different from contractually agreed-upon rates; the incorrect fee schedule was applied; advisers failed to convert all clients to a new or updated fee schedule; or there were errors in fee percentages manually entered into portfolio management systems.
- Advisory fees were double-billed, generally due to inadvertent errors such as when a system is not updated following a change in billing practices.
- Breakpoint or tiered billing rates were not calculated correctly.
- Householding was not applied correctly because the advisers did not aggregate client or family accounts for purposes of applying fee breakpoints.
- Incorrect account valuations were used, for example, including assets that should have been excluded (such as legacy positions) in fee calculations; relying on stale account balances; or incorrect valuation dates.
- Failure to refund prepaid fees on terminated accounts; failure to apply fees on a pro-rata basis; or requiring clients to request refunds of unearned advisory fees in writing.
In addition to erroneous fee calculation practices, the Risk Alert also identifies incomplete or misleading disclosure practices, missing or inadequate policies and procedures, and inaccurate financial statements. On the disclosure side, the Exams staff noted that advisers did not always disclose their fees with “sufficient clarity for their clients to understand the costs associated with their services.” This should include Form ADV disclosure of fee billing practices: current fee schedules, whether fees are negotiable, timing and mechanics of fee billing, as well as the process for implementing householding and the related eligibility criteria, and fees for wrap and non-wrap fee programs. Although not the focus of this Risk Alert, advisers also should continue to prioritize identifying, managing, and disclosing conflicts of interest associated with the receipt of direct or indirect services, fees and other compensation from third-parties. Compensation-related conflicts of interest continue to be a significant priority both on the examination and enforcement side, and the SEC staff noted that the same principles and disclosure obligations discussed in the Risk Alert apply to such conflicts.