Registered Investment Advisor Consultants OCIE Risk Alert. In a recent Risk Alert, the Office of Compliance Inspections and Examinations (“OCIE”) issued a list of most frequently identified compliance issues relating to fees and expenses in deficiency letters provided to RIA firms. Although this Risk Alert is issued by OCIE and based upon their examinations of federally registered advisors, the compliance issues mentioned easily apply to state RIA firms too. Here are the Most Frequent RIA Compliance Issues:
Fee-Billing Based on Incorrect Account Valuations. OCIE staff has observed registered investment advisers that incorrectly valued certain assets in clients’ accounts resulting in overbilled advisory fees. 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. For example, staff observed advisers that:
- Valued assets in a client’s account using a different metric than that which was specified in the client’s advisory agreement, such as using the asset’s original cost to value an illiquid asset rather than valuing the asset based on its fair market value.
- Valued a client’s account using a process that differed from the process specified in the client’s advisory agreement, such as:
- Using the market value of the account’s assets at the end of the billing cycle, instead of using the average daily balance of that account over the entire billing cycle as specified in the advisory agreement.
- Including assets in the fee calculation that were excluded by the advisory agreement from the management fee, such as cash or cash equivalents, alternative investments, or variable annuities.
Billing Fees in Advance or with Improper Frequency. OCIE staff has observed issues with registered investment advisers’ billing practices relating to the timing and frequency for which advisory fees were billed. Staff observed, for example, registered advisers that:
- Billed advisory fees on a monthly basis, instead of on a quarterly basis as stated in the advisory agreement or disclosed in Form ADV Part 2. Similarly, staff observed advisers that billed advisory fees in advance, despite the advisory agreement specifying that clients would be billed in arrears.
- Billed a new client for advisory fees in advance for an entire billing cycle, instead of pro-rating such charges to reflect that the advisory services began mid-billing cycle. Relatedly, staff observed registered investment advisers that did not reimburse a client a pro- rated portion of the advisory fees when the client terminated the advisory services mid-billing cycle, despite disclosing that they would do so in Form ADV Part 2.
Applying Incorrect Fee Rate. OCIE staff has observed advisers that applied an incorrect fee rate when calculating the advisory fees charged to certain clients. Staff observed, for example, advisers that:
- Applied a rate higher than what was agreed upon in the advisory agreement or double-billed a client.
- Charged a non-qualified client performance fees based on a percentage of their capital gains inconsistent with Section 205(a)(1) of the Advisers Act.
Omitting Rebates and Applying Discounts Incorrectly. OCIE staff has observed advisers that did not apply certain discounts or rebates to their clients’ advisory fees, as specified in the advisory agreements, causing the clients to be overcharged. For example, staff observed advisers that:
- Did not aggregate client account values for members of the same household for fee-billing purposes, which would have qualified such clients for discounted fees according to the adviser’s Form ADV or advisory agreement.
- Did not reduce a client’s fee rate when the value of that client’s account reached a prearranged breakpoint level, which entitled that client to a lower fee rate according to the adviser’s Form ADV or advisory agreement.
- Charged a client additional fees, such as brokerage fees, when such client was in the adviser’s wrap fee program and the transactions qualified for the program’s bundled fee.
Disclosure Issues Involving Advisory Fees. OCIE staff has observed several issues with respect to advisers’ disclosures of fees or billing practices. For example, staff observed advisers that:
- Made a disclosure in the Form ADV that was inconsistent with their actual practices, such as advisers that disclosed in the Form ADV a maximum advisory fee rate, but nevertheless had an agreement with a certain client to charge a fee rate exceeding that disclosed maximum rate.
- Did not disclose certain additional fees or markups in addition to advisory fees, such as advisers that did not disclose that they:
- Collected expenses from a client for third-party execution and clearing services that exceeded the actual fee charged for those services by the outside clearing broker.
- Earned additional compensation on certain asset purchases for client accounts or that they had fee sharing arrangements with affiliates.
Adviser Expense Misallocations. OCIE staff has observed advisers to private and registered funds that misallocated expenses to the funds. For example, staff observed advisers that 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.
For a complete copy of OCIE’s Risk Alert, Click Here!
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