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Top 6 Fee, Expense Failures That SEC Will Bust You For

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The Securities and Exchange Commission’s exam division released Thursday a Risk Alert detailing the top compliance failures relating to fees and expenses charged by advisors that were cited most frequently in deficiency letters sent to advisors.

Pete Driscoll, director of the agency’s Office of Compliance Inspections and Examinations, announced the release of the alert at the agency’s National Compliance Outreach Seminar for advisors and investment companies, being held Thursday at SEC headquarters in Washington.

SEC Chairman Jay Clayton said in comments during the event that “the importance of investment advisors and investment companies to our investors, in particular our retail investors, has increased dramatically,” noting one metric being the shift “from direct investment to investment through advisors.”

This fact, Clayton said, “only increases the importance of compliance functions” at advisory firms. “We are counting on you to do your jobs.”

The alert cites the following infractions involving client’s advisory fees and expenses, which are laid out in an advisory agreement and described in an advisor’s Form ADV, as:

1. Fee-Billing Based on Incorrect Account Valuations. OCIE has observed advisors that incorrectly valued certain assets in clients’ accounts resulting in overbilled advisory fees. “Because advisors 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,” OCIE states.

2. Billing Fees in Advance or with Improper Frequency. OCIE staff has observed issues with advisors’ billing practices relating to the timing and frequency for which advisory fees were billed. Staff observed, for example, advisors 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.

Staff also observed advisors that billed advisory fees in advance, despite the advisory agreement specifying that clients would be billed in arrears.

3. Applying Incorrect Fee Rate. OCIE staff has observed advisors that applied an incorrect fee rate when calculating the advisory fees charged to certain clients. Advisors have applied a rate higher than what was agreed upon in the advisory agreement or double-billed a client, or 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.

4. Omitting Rebates and Applying Discounts Incorrectly. Advisors failed to apply certain discounts or rebates to their clients’ advisory fees, as specified in the advisory agreements, causing the clients to be overcharged. For example, charging a client additional fees, such as brokerage fees, when such client was in the advisor’s wrap fee program and the transactions qualified for the program’s bundled fee.

5. Disclosure Issues Involving Advisory Fees. Trouble spots were seen in advisors’ disclosures of fees or billing practices, including making a disclosure in the Form ADV that was inconsistent with their actual practices; failing to disclose certain additional fees or markups in addition to advisory fees; collecting 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; and earning additional compensation on certain asset purchases for client accounts or that they had fee sharing arrangements with affiliates.

6. Advisor Expense Misallocations. Advisors to private and registered funds also misallocated expenses to the funds. Advisors allocated distribution and marketing expenses, regulatory filing fees, and travel expenses to clients instead of the advisor, in contravention of the applicable advisory agreements, operating agreements or other disclosures.

— Check out SEC Slams PNC, Securities America, Geneos With $15M Fine Over Share Class Violations on ThinkAdvisor.