08 February 2022
Main Contributor: Gretchen Sturdivan, CSCP Creative Director & Client Service Manager
The Division of Examinations (the “Division”) continues to focus on retail clients in their most recent Risk Alert, which highlights deficiencies around advisory fee billing practices. The deficiencies the Division notes often result in financial harm to the client and do not uphold the adviser’s fiduciary duty of care and loyalty. Every dollar a client pays their advisor, is one less dollar they have to invest. Therefore, advisers have a responsibility to ensure that their fees are reasonable for their service level, accurately calculated, and clearly disclosed.
A Risk Alert, which also addressed fee billing procedures, was released in 2018 and is worth a read through, if only to understand the continued focus on this same risk area.
Fee Calculation Practices & Valuation
The Division included 130 examinations in this focused initiative and identified advisory fee calculation errors in most firms. Fee calculation errors can include over-billing of fees, inaccurate calculations of tiered billing, and inaccurate calculations due to incorrect householding of accounts. The Division also found several instances where clients were charged a fee that was different from their contractually agreed-upon rate or the time period for the billing was applied inconsistently.
Valuation was another focus area, as some firms used incorrect client account valuations with stale account balance information or included assets that disclosures had stated would be excluded from the fee calculations.
Terminated client billing, including client refunds, was also an area with substantial deficiencies. Terminated client billing should be equally prioritized to ensure you consistently refund unearned fees and do not unnecessarily delay providing refunds.
Outline your process for billing in arears or in advance within your policies and procedures, along with any refund policies, and include the process in the advisory agreement, as well as the disclosure documents provided to clients. The same applies for your valuation and fee calculation process for current clients. Design your policies and procedures to address and mitigate the calculation and valuation issues specific to your firm, record all of the fees you bill properly, and maintain your financial statements.
Consider centralizing your billing practices to reduce risk and simplify oversight. Whether you use technology or Excel to calculate fees, make sure you have a process in place to review and reassess the accuracy and consistency with fee rates agreed upon with clients.
Fee Disclosure Concerns
You know your internal billing practices are tight and you’re sure it’s documented in a few places, but the Division asks, “is it consistently and accurately disclosed to retail clients?” A fair question, and one that highlights a major risk area for deficiencies, as they can be considered incomplete or misleading. If you avoid fully describing how you calculate fees, you should consider adding transparency to ensure the description is accurate and reflects the client experience. The Division found that advisers were often not billing as they disclosed in the ADV Part 2A and that the disclosure documents provided to retail clients were contradictory or inconsistent with each other.
It is critical to ensure that clients know the fees they will pay, that those fees are calculated correctly, and that the required disclosures are clear and consistent. For example, you do not want to have the client sign a contract with a higher fee rate than is disclosed in your Part 2A. You should maintain transparent disclosures around whether you bill in advance or arrears, how the refund process will work should a client terminate, and a description of how fees are calculated, using current and accurate fee rates.
Additionally, we have seen issues around billing on cash and firms inconsistently billing on margin with their agreements and disclosures with clients.
Keep your ADV Part 2A updated and promptly file an other-than-annual amendment if you make any changes to your fee billing process or rates. If any changes are made to a client’s contracted fee rate, disclose the updates, and as a best practice, document the client’s written consent. If you calculate and charge fees in any way that is inconsistent with your disclosures, you will violate your fiduciary duty.
Policies and Procedures
This may sound like scratched vinyl and something we all fall back on as a default, no-brainer exercise, but policies and procedures are critical for maintaining compliant fee billing procedures and should be your first line of defense. Policies and procedures should explicitly address your firm’s fee calculation and monitoring procedures and be designed to support the “fair and accurate” charging of fees.
Your policies lay the foundation for applying a standardized methodology to your fee billing procedures and will ensure your invoices are consistent from client to client. For all fee billing risk areas, assess your policies and add clarity or consistent language where needed to ensure your road map isn’t missing a major landmark.
Of course, your policies are only as good as your training efforts. You must ensure that all employees understand the firm’s policies and procedures around fee billing and then follow them to a “T”. The documents are only as good as the humans putting them into practice!
As with any risk area, documented testing is a critical element of your compliance program and annual review. Whether you conduct the review manually or use technology, ensure you have a system in place to review and test your current fee billing process. Doing so highlights any clients for whom you may have inconsistencies between disclosures and agreements. It can also highlight places where your process is not in line with your policies or brochures provided to clients, which will also be helpful in the event of an SEC exam, to demonstrate that your policies are in line with your day-to-day practices.
As a fiduciary, you are responsible for ensuring that your fees are reasonable for the service level you provide and can be substantiated. Along with reasonableness, your firm needs to place emphasis on the correct calculation of your fees and valuation. It may seem like a basic function for your firm, but if you don’t have a strong foundation in place to support your billing process, this basic function can quickly crack. Clearly and accurately address your disclosures and update them when material changes come about, ensuring they are consistent with each other. Revisit your policies and procedures and train on them annually so they don’t become stale or forgotten. As always, risk alerts are a great reminder to tighten up your practices and avoid deficiencies to uphold your fiduciary duty.