Here Are the SEC’s Top 6 Fee and Expense Compliance Issues

The SEC’s Office of Compliance Inspections and Examinations (OCIE) has listed the fee and expense compliance issues that were cited most frequently in deficiency letters sent to RIAs.

The April 12 OCIE Risk Alert, which reflects issues identified in deficiency letters from more than 1,500 adviser examinations completed during the past two years, recommends that advisers review their practices and procedures “to ensure compliance with their advisory agreements and representations to clients in light of the fee and expense issues.”

Below are the six most identified fee and expense compliance issues identified in the alert. The alert does caution that the list does not address all deficiencies or weaknesses related to advisory fees and expenses.

1. Fee-Billing Based on Incorrect Account Valuations

The OCIE cites advisers who incorrectly valued certain assets in clients’ accounts resulting in overbilled advisory fees, such as using a different metric or a process that differed from that which was specified in the client’s advisory agreement. The alert notes that because advisers generally assess fees as a percentage of the value of assets they manage in each client’s account, an incorrect account valuation will lead to an incorrect advisory fee being assessed to that client.

2. Billing Fees in Advance or with Improper Frequency

This includes issues pertaining to advisers’ billing practices relating to the timing and frequency for which advisory fees were billed. For example, billing advisory fees on a monthly instead of quarterly basis as stated in the advisory agreement or disclosed in Form ADV; or billing a new client in advance for an entire billing cycle, instead of pro-rating charges to reflect that the advisory services began mid-billing cycle.

3. Applying Incorrect Fee Rate

Observations were made regarding advisers who applied an incorrect fee rate when calculating the advisory fees charged to certain clients. For example, applying a rate higher than what was in the advisory agreement, double-billing a client or charging a non-qualified client performance fees based on a percentage of their capital gains inconsistent with Section 205(a)(1) of the Advisers Act.

4. Omitting Rebates and Applying Discounts Incorrectly

 This category includes advisers who did not apply certain discounts or rebates to their clients’ advisory fees, as specified in the advisory agreements, causing the clients to be overcharged.

5. Disclosure Issues Involving Advisory Fees

 OCIE observed issues with respect to advisers’ disclosures of fees or billing practices, such as not disclosing certain additional fees or markups in addition to advisory fees. This also includes, for example, making a disclosure in the Form ADV that was inconsistent with actual practices, such as advisers who disclosed in the Form ADV a maximum advisory fee rate, but had an agreement with a certain client to charge a fee rate exceeding that disclosed maximum rate.

6. Adviser Expense Misallocations

The staff observed advisers to private and registered funds that misallocated expenses to the funds. An example includes advisers who “allocated distribution and marketing expenses, regulatory filing fees and travel expenses to clients instead of the adviser, in contravention of the applicable advisory agreements, operating agreements, or other disclosures.”

According to the alert, some advisers, in response to OCIE staff’s observations, “elected to change their practices, enhance policies and procedures, and reimburse clients by the overbilled amount of advisory fees and expenses.”

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