The Securities and Exchange Commission said Thursday that it has brought an enforcement action against a Richmond, Virginia-based investment advisor for failing to properly inform clients of additional transaction costs beyond those charged in a wrap fee program.
In wrap fee programs — which have been in SEC examiners’ crosshairs — subadvisors typically use a sponsoring brokerage firm to execute their trades on behalf of clients, and the costs of those trades are included in the annual wrap fee that each client pays.
RiverFront Investment Group disclosed to investors in Forms ADV that client trades were typically executed through the sponsoring broker so the wrap fee would cover the transaction costs.
However, the SEC found that RiverFront actually used brokers “besides the wrap program sponsor to execute the majority of its wrap program trading, resulting in additional costs to clients for those transactions.”
While RiverFront did disclose that some “trading away” from the sponsoring broker could occur, the SEC explains, the firm inaccurately described the frequency, rendering its disclosures materially misleading.
“Investors were misled about the overall cost of selecting RiverFront to manage their portfolios,” said Sharon Binger, director of the SEC’s Philadelphia Regional Office. “Investors in wrap fee programs pay one annual fee for bundled services without expecting to pay more, so if subadvisers like RiverFront trade in a way that incurs additional costs to clients, those costs must be fully and clearly disclosed upfront so investors can make informed investment decisions.”
As the SEC order states, RiverFront serves as a subadvisor to clients in various wrap fee programs created by a number of different sponsors.
In this role, RiverFront has “sole discretion” over whether to send trades to the designated broker-dealer for execution, in which case the transaction charges are covered by the wrap fee, or to send the trades to another broker-dealer in which case the client typically pays additional transaction costs charged by that broker-dealer, the SEC states.
The practice of sending trades to a nondesignated broker-dealer is referred to as “trading away” and these trades are frequently called “trade aways.”
“The extent to which a subadvisor trades away from the designated broker-dealer is relevant to a client selecting a wrap fee program because it entails additional costs to the client and could influence the client’s evaluation of the reasonableness of the wrap fee, which is often negotiable.”
RiverFront did not profit by trading away, the SEC states, and it claims to have obtained improved execution prices by doing so.
“However, when RiverFront traded away, any applicable transaction costs charged by the executing broker-dealer were passed through to clients on a per-share basis,” the SEC states. “Therefore, its clients paid millions of dollars’ worth of transaction costs charged by nondesignated broker-dealers that were not covered by the wrap fee.”
RiverFront neither admitted nor denied the SEC findings but agreed to settle the charges.
— Check out SEC Exam Chief Sends Warning on Wrap Accounts on ThinkAdvisor.