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SEC Risk Alerts Provide a Great “Heads Up”

SEC Risk Alerts Provide a Great “Heads Up”

About our Contributors
ICS Group is a regulatory compliance consulting firm specializing in providing compliance support to the financial services and insurance industries. We help our clients comply with regulatory requirements and industry standards. Our clients include: registered investment advisers, private equity funds, hedge funds, mutual funds, broker-dealers, insurance companies and state pension plans. Our team of highly experienced compliance professionals know from first-hand experience what regulators are looking for, the industry standards that apply, and how to develop and implement cost-effective business-oriented solutions.


In addition to the annual publication of its exam priorities, the SEC’s OCIE issues periodic Risk Alerts which are aimed at promoting compliance by sharing the most frequently-cited deficiencies arising from its exam program.

To bring attention to issues that the SEC has concerns about and to foster increased compliance, the SEC issues Risk Alerts. Two Risk Alerts have been issued so far in 2018:

1. RISK ALERT – MOST FREQUENT ADVISORY FEE AND EXPENSE COMPLIANCE ISSUES IDENTIFIED IN EXAMINATIONS OF INVESTMENT ADVISERS (April 12, 2018)

This Risk Alert lists the most frequently observed compliance issues related to advisory fees:

  • Fee-billing based on incorrect account valuations. OCIE staff has observed advisers that incorrectly valued certain assets in clients’ accounts resulting in overbilled advisory fees. Because advisers 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.Examples include billing fees in advance or with improper frequency such as billing advisory fees monthly instead of quarterly as stated in the advisory agreement or disclosed in Form ADV Part 2. Similarly, staff observed advisers that billed advisory fees in advance, despite the advisory agreement specifying that clients would be billed in arrears; or billing a new client for advisory fees in advance for an entire billing cycle, instead of pro-rating such charges to reflect that the advisory services began mid-billing cycle.
  • Applying Incorrect Fee Rate. OCIE staff observed advisers that applied an incorrect fee rate when calculating the advisory fees charged to certain clients.Examples include billing fees in excess of the fee schedule in the investment advisory agreement or double-billing clients.
  • Omitting Rebates and Applying Discounts Incorrectly. OCIE examiners found instances of advisors inadvertently neglecting to apply fee rebates or accurately calculate fee waivers.Examples could include miscalculating fee waivers, such as, in the case of private equity funds, applying waived fees across all other investors as opposed to the advisor bearing the waived fee or applying performance-based fees before certain breakpoints in the advisory agreement have been reached.
  • Disclosure Issues Involving Advisory Fees. OCIE staff observed several issues related to an advisor’s billing practices that were inconsistent with its Form ADV disclosure or its investment advisory agreement.Examples include advisors that disclosed on the Form ADV a maximum fee rate but nevertheless had an agreement with a client to charge a fee in excess of the disclosed maximum rate.
  • Inaccurate valuations. With respect to fees billed based on incorrect valuations, the SEC focused on fair valuation of investments. Specific issues related to valuations were:
    • Valuing assets using a different metric than that specified in the advisory agreement.
    • Valuing assets at the end of the billing cycle, instead of using the average daily balance of the account over the entire billing cycle as required by the advisory agreement.
    • Including assets in the fee calculation that should be excluded from the management fee per the advisory agreement.

The Risk Alert points out that the disclosure clients receive, especially regarding advisory fees and expenses, is critical to their ability to make informed decisions, including whether to engage or retain an adviser. Therefore, the failure by some investment advisors to adhere to the fee structures disclosed in their Form ADV and other governing documents may constitute a violation of the antifraud provisions of Investment Advisers Act of 1940 (the “Advisers Act”).

Key takeaways: Advisers should review their practices, policies, and procedures to ensure compliance with their advisory agreements and disclosures and their fiduciary duty to clients in light of the fee and expense issues noted in this Risk Alert.

2. RISK ALERT – MOST FREQUENT BEST EXECUTION ISSUES CITED IN ADVISER EXAMS (July 11, 2018)

As a fiduciary, an adviser who is responsible for selecting broker-dealers and executing client trades has the obligation to seek to obtain “best execution” of client transactions, taking into consideration the circumstances of the particular transaction. An adviser must execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances. Best execution requires consideration of the full range and quality of a broker-dealer’s services such as the value of research provided, access to management, execution capability, commission rate, financial responsibility, and responsiveness to the adviser. Failure to use best execution may constitute a violation of the Advisers Act.

This Risk Alert identifies the most frequently observed compliance issues related to best execution:

  • Not performing best execution reviews. OCIE found advisers who failed to assess broker-dealer selections based on the best execution factors and the inability to support with documentation their decisions to use certain brokers over others.
  • Not considering materially relevant factors during best execution reviews. The OCIE found advisors who did not consider materially relevant factors during best execution reviews.

    Examples include advisers who did not consider the full range and quality of a broker-dealer’s services such as financial responsibility and responsiveness to the advisor, or failure to solicit input from the firm’s traders or portfolio managers.

  • Not seeking comparisons from other broker-dealers. OCIE staff observed advisers that selected a broker-dealer without comparing competing brokers-dealers initially or on an ongoing basis or utilized a broker-dealer based solely on a hasty review of the broker-dealer’s policies or the broker-dealer’s own summary of their services.
  • Not fully disclosing best execution practices. The OCIE staff observed advisers that did not disclose that certain types of client accounts may trade the same securities after other client accounts and the potential impact of this practice on execution prices. They also found advisors whose disclosure documents said they assessed brokers for best execution but in practice they did not.
  • Not disclosing soft dollar arrangements. The staff observed that advisers did not make full and fair disclosure of their soft dollar arrangements.

    Examples include advisers that did not appear to adequately disclose the use of soft dollar arrangements or advisers that did not disclose that certain clients may bear more of the cost of soft dollar arrangements than other clients.

  • Inadequate policies and procedures relating to best execution and/or not following best execution policies and procedures.

    Examples include advisers that did not have any policies relating to best execution and advisers who did not assess the execution performance or their brokers.

Key takeaways: Investment advisors who employ directed brokerage – and even those who only use brokers to sell stock distributions – should reassess their policies, procedures and practices to ensure that they are complying with their best execution obligations.

The SEC is making a concerted effort to increase the transparency of its examination programs. Risk Alerts should be viewed as additional insight into the OCIE’s priorities and areas of focus. Investment advisors should study the Risk Alerts and act upon them to further refine their firm’s compliance program. Once a Risk Alert has been issued there really is no reason for any investment adviser to incur the same or similar deficiencies.

For help with this and all other compliance-related matters, contact ICSGroup. We’re here to help.

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