Thought Leadership in Action

The Securities and Exchange Commission outlined its approach to compliance this year in a recent Risk Alert. 

The commission plans to take a closer look at the effectiveness of compliance policies and procedures, program oversight and the disclosures financial advisers make to their clients and shareholders. 

Here’s what financial advisers can do to prepare themselves for examinations in 2022 based on the SEC’s priorities:

Expect Advisory Fee Disclosures to Be Scrutinized

The SEC has identified disclosures regarding the costs of investing as an examination priority since 2018. This year is no different.

What has changed is that regulators concluded a national initiative last year that probed advisory fees — predominantly those charged to retail clients — at roughly 130 SEC-registered investment advisers. The SEC found deficiencies related to the advisory fees charged during most of these examinations. 

The most common deficiencies fell into three categories:

1. Advisory fee calculation errors: This included over-billing of advisory fees, inaccurate calculations of tiered or breakpoint fees, and inaccurate calculations due to incorrect householding of accounts.
2. Not crediting certain fees due to clients: For example, some advisers did not credit prepaid fees for terminated accounts or prorated fees for onboarding clients.
3. Fee-related compliance and disclosure issues: Rules require that fees “should be sufficiently specific so that a client is able to understand the material fact or conflict of interest and make an informed decision whether to provide consent” under the Investment Advisers Act of 1940.

SEC warned that advisers who fail to adhere to the terms of their agreement and disclosures, or who otherwise engage in inappropriate fee billing and expense practices, might violate their fiduciary duties in the Advisers Act, including its anti-fraud provisions.

3 Things SEC Examiners Will Review Closely

Based on the initiative that examined 130 advisers last year, regulators will focus on these three areas in 2021:

• Accuracy of the fees charged: Examiners want to know if advisers overcharged clients.
• Accuracy and adequacy of advisers’ disclosures: SEC will be looking at disclosures provided to clients related to the advisory fees billed, including whether certain types of assets should be excluded for fee billing purposes.
• Effectiveness of the examined advisers’ compliance programs and accuracy of their records: When reviewing advisers’ compliance programs, the staff will gauge the policies and procedures related to advisory fee billing practices and the calculation of assets under management used for fee billing purposes. The SEC will closely monitor the valuation of unique or hard-to-value assets.

Of course, if the SEC finds advisors have engaged in inappropriate fee billing and other fee-related deficient practices, the regulators will extend their examinations to other operations of the advisory firm in question.

How to Prepare for SEC Examinations

Advisory fee calculation and billing will be a hot spot for regulatory review in 2022, but advisers can take steps to reduce the risk of high legal costs, fines and enforcement actions. In fact, the SEC outlined four actions advisors can take now:

1. Adopt and implement written policies and procedures addressing advisory fee billing processes and validating fee calculations.
2. Centralize the fee billing process and validate that the fees charged to clients are consistent with compliance procedures, advisory contracts and disclosures.
3. Ensure resources and tools established for reviewing fee calculations are utilized.
4. Properly record all advisory expenses and fees assessed to and received from clients, including those paid directly to advisory personnel.

Automating these processes with Ebix’s SmartOffice will not only enhance an adviser’s business operations, but it may also help SEC examinations run smoothly.

Additional Resource

Check out the recording of Brian Edelman, FCI CEO, and Cybersecurity expert on What the SEC Cybersecurity Crackdown Means for Financial Advisers for additional thoughts on how to prepare for SEC Examinations.