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September 26, 2014 at 05:00 AM
The Securities and Exchange Commission’s exam chief recently warned sponsors of wrap fee programs to do a better job of monitoring and disclosing the number of “step-out” trades performed by the wrap account’s investment managers, as these types of trades require clients to pay a fee on top of the wrap fee.
“The issue we have is one of disclosure,” regarding wrap accounts, Andrew Bowden, head of the SEC’s Office of Compliance Inspections and Examinations, told attendees at the CFA Institute’s Global Investment Performance Standards (GIPS) Annual Conference in Boston Sept. 19. “If you’re a wrap fee sponsor, it’s your responsibility to actually monitor the frequency with which the managers participating in your program are actually ‘stepping out’ trades so that you can make proper disclosures.”
Bowden said that the agency’s 30 exams of wrap accounts to date had found that sponsors were “unaware of how often this [step-out trading] activity is taking place.”
Step-out trading is the practice of one brokerage executing an order on behalf of a client but giving credit (and part of the commission) to another brokerage.
Bowden explained that wrap fee sponsors tell clients that investment managers will direct trades to the sponsor to be executed as part of the wrap fee, and that the investment managers may step out certain trades and receive an “extra commission,” however the commission paid to the broker gets passed through to the client as a fee. “We are finding that … the investment managers are stepping out a lot of trades that should be directed to the wrap fee sponsor,” Bowden said.
Standard disclosure to clients “shouldn’t be that from time to time the investment manager may step out trades and that you [the client] may pay a commission,” Bowden said. “The disclosure should be that your investment manager will ‘step out’ trades, 30%, 50%, 80% of the time and you’re going to pay a commission in addition to your wrap fee for those.”
OCIE sent recently an Information Request List to registered investment advisors regarding their wrap fee programs, signaling such programs will face scrutiny during upcoming exams.
The SEC also recently won a court victory against an advisor who lied to his clients to get them to switch their accounts so that he could pocket a higher wrap fee.
