The 2018 SEC Exam Priorities once again listed wrap fee programs as one of their areas of focus this year. This is not unexpected, as the continued push by the SEC to protect retail investors (and the subset of senior/retiring investors) often revolves around the issue of fees. Often times, the SEC looks at how the obfuscation of how fees affect the performance of investments - and the confusion for investors trying to understand these fees is not acceptable.
Wrap fee programs, which are essentially providing a single fee for a bundle of services, can be extremely beneficial to the right type of investor. However, as we all are well aware, every investor is different and must be carefully analyzed to find the appropriate solution to their needs. Advisers know and should disclose that wrap fee programs are not for everyone.
Recommendations of wrap fee programs have come under scrutiny in the past because of their tendency to hide precisely how fees are being charged. They simultaneously make it difficult to compare the potential performance of a service compared to the separate purchasing of the individual components that have been bundled together. Thus, the pushing of a wrap fee program may also be a conflict of interest, depending on how the compensation for such a program compares to other types of investments available to a firm's clientele.
There have also been several enforcement actions in the recent past against firms who had some significant compliance failures with respect to wrap fee programs. This is not to say that wrap fee programs are inherently predatory - rather, it is simply the case that wrap fee programs have perhaps been abused in the past and can be difficult for the average retail investor to understand. For this reason, they garner special scrutiny.
To that end, if the firm offers wrap fee programs, now is the time to ensure those programs are solidly in line with existing regulations.
Firms with Wrap Fee Programs Must Take Special Care and Ensure Compliance
This year, the SEC has said they are looking at three basic parameters with respect to wrap fee programs:
"Whether the recommendations to invest in a wrap fee program and to continue in the program are reasonable"
"Whether conflicts of interests are disclosed in compliance with applicable regulatory requirements"
"Whether investment advisers are obtaining best execution and disclosing costs associated with executing trades through another broker-dealer" (Source)
Essentially, this boils down to a simple question - is a firm fulfilling its fiduciary duty when recommending or selling a wrap fee program or not? Unfortunately, it is the case with wrap fee programs that fiduciary duty can be breached simply by not carefully examining the effects of the fees. This can happen when either the investor or the firm fails to look closely at the fees and their implications, which is why they can be so tricky.
It only makes sense that wrap fee programs be examined as part of the broader effort by the SEC to protect retail investors, especially the aging Baby Boomer population. Aging investors are particularly vulnerable to agreeing to or signing up for a wrap fee program that they don't fully understand, due both to a possible lack of education on the side of the investor and/or a lack of proper disclosures on the side of the firm.
Even given the fact that all investors interested in wrap fee programs are generally given the information necessary to parse out how the fee is applied and how that will affect their investments, a wrap fee can still prove confusing to even the most discerning and aware investor. It's easy to see how it could be significantly more so to an aging investor who may be in the beginning stages of Alzheimer's or dementia.
Given that the SEC also plans to focus (as it generally does) on never-before-examined investment advisors this year, if you offer a wrap fee program and have yet to be examined, now is the time to examine your program closely for compliance.
Have you provided all necessary disclosures? Is your wrap fee program fully compliant with all applicable rules and regulations? If you haven't examined them closely in at least the last 12 months, it should be on your radar to do so soon.
Contact us now - we'd love to help you with every aspect of your compliance needs.
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