The SEC’s Division of Examinations issued a Risk Alert about wrap fee programs used by investment advisers. Wrap fee programs require advisory clients to pay a consolidated fee for investment advisory services and other expenses, such as commissions, trading fees, and administrative costs.
Wrap fees are calculated as a percentage of assets under management (AUM) in an investor’s account. The percentage is often high—typically between 1% and 3% of AUM. The SEC warns that wrap fee programs may “create conflicts of interest for advisers and risks to investors – such as incentives for advisers trading less frequently than may be in the client’s best interest, engaging in transactions that reduce costs to the adviser but increase expenses borne by the client, or mis-billing by failing to incorporate certain covered transactions costs into the wrap fee – to the extent that advisers or their supervised persons have incentives to lower their internal costs.”
Investment advisers owe their clients fiduciary duties. See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, SEC Release No. IA-5248 (effective July 12, 2019). These duties include care, full disclosure, and to act in the best interest of the client. As fiduciaries, advisers must evaluate on an ongoing basis whether or not participation in a wrap fee program is in the client’s best interest.
In a review of over 100 examinations of advisers associated with wrap fee programs, the SEC identified common deficiencies, including “advice to clients about participation in wrap fee programs and monitoring the clients’ wrap fee accounts, disclosures, and compliance policies and procedures.” According to the SEC, “many of the examined advisers had omitted or provided disclosures, particularly disclosures regarding conflicts of interest, fees, and expenses.” The SEC even identified inconsistent disclosures about wrap fees in account documents, such as advisory agreements and Form ADV Part 2A. Advisers also caused clients to pay excessive fees by recommending investments that incurred transaction costs that were not included in the consolidated wrap fee.
Account statements and account documents sometimes make it difficult to determine the total fees an investor or retiree is paying. As the SEC’s Risk Alert makes clear, advisory clients who think they are paying a single, set fee as part of a wrap fee program, may in fact be paying other fees on top of the wrap fee. Excessive and confusing fees are often accompanied by other mismanagement and financial misconduct by an investment adviser.
