The staff (“Staff”) of the SEC’s Division of Examinations released a Risk Alert1 highlighting compliance issues observed by the Staff during its Advisory Fees Initiative2 in which the Staff assessed the various ways in which SEC-registered investment advisers (“advisers”) charge fees for their services and evaluated the adequacy of fee disclosures and the accuracy of fee calculations.
Advisory Fee Calculations
The Staff found that several examined 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 correctly calculated, householding of client accounts not being correctly calculated, and incorrect client account valuations being used. Additionally, several examined advisers either did not refund prepaid fees on terminated accounts or did not assess fees for new accounts on a pro-rata basis. The Staff also observed issues associated with refunding prepaid fees including advisers inconsistently refunding unearned fees and requiring clients to provide written requests to refund unearned advisory fees.
False, Misleading or Omitted Disclosures
Several of the examined advisers were identified as having a range of disclosure issues. Issues identified were related to incomplete or misleading Form ADV Part 2 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 were inconsistent across advisory documents. Examples of issues with fee-related disclosures that the Staff observed included insufficient descriptions of cash flows and their effect on fees, inaccurate disclosures regarding the timing of advisory fee billing, inaccurate valuations for fee calculations, and incomplete disclosure of other fee-related topics (e.g. minimum fees, extra fees, discounts).
Many of the examined advisers did not maintain written polices and procedures addressing advisory fee billing, monitoring of fee calculations and billing, or both. The Staff also noticed issues with financial statements at several examined advisers with respect to advisory fees. Specifically, some advisers did not record all advisory fee income and compensation expenses in general ledgers and on financial statements, and some advisers used a cash and modified cash basis of accounting, but prepared financial statements on an accrual basis of accounting.
Staff Observations of Industry Practices
The Staff provided observed examples of policies and practices to assist advisers with compliance in the area of advisory fee calculations. which include (i) adopting and implementing written policies and procedures addressing advisory fee billing processes and validating fee calculations; (ii) centralizing the fee billing process and validating that the fees charged to clients are consistent with compliance procedures, advisory contracts, and disclosures; (iii) ensuring resources and tools established for reviewing fee calculations are utilized; and (iv) properly recording all advisory expenses and fees assessed to and received from clients, including those paid directly to advisory personnel.
S&K Observations
The Risk Alert underscores the Division of Examinations’ continued focus on advisory fee calculations. Advisers should carefully review their policies, procedures, practices, and disclosures related to advisory fee calculations and billing. Seward & Kissel LLP, and our compliance consulting service SKRC (Seward & Kissel Regulatory Compliance), are available to assist advisers with the review, design, implementation of policies and procedures regarding advisory fee calculations.
