New SEC risk alert puts advisory industry ‘on notice’

The Securities and Exchange Commission has targeted advisor billing practices in a new risk alert which one law firm says is consistent with a “pattern” of soft deterrence by the regulator intended to “put the industry on notice.”

The latest investigation, undertaken by the SEC’s Office of Compliance Inspections and Examinations, says that its staff observed overbilling due to incorrect valuations when advisors used “a different metric than that which was specified in the client’s advisory agreement, such as using the asset’s original cost to value an illiquid asset rather than valuing the asset based on its fair market value.”

The alert specified other accounting practices that resulted in overbilling, including using the market value of the account’s assets at the end of the billing cycle, instead of using the average daily balance of that account over the entire billing cycle. Another was including assets in the fee calculation that were excluded by the advisory agreement from the management fee, such as cash or cash equivalents, alternative investments, or variable annuities.

In a note commenting on the observations, governance and compliance advisor Duff & Phelps said there is “increasing evidence that the Commission is leveraging more of the deterrence tools in its arsenal to discourage misconduct,” and that “a pattern of utilizing ‘softer’ deterrence tools such as speeches, investor alerts, risk alerts…and other forms of outreach to put the industry on notice” can be gleaned from recent developments.

The risk alert also said OCIE staff observed cases of advisors billing with greater frequency than stated in the contract between the two parties, saying some firms billed advisory fees on a monthly basis, instead of on a quarterly basis as agreed, and that it also saw advisors billing fees in advance “despite the advisory agreement specifying that clients would be billed in arrears.”

Other practices highlighted by the OCIE included omitting rebates and applying discounts incorrectly and inconsistencies between actual and reported billing practices. The regulator said that as a result of its observations it had noted some change in practices including proactive reimbursement for incorrect fees and expenses.

Duff & Phelps said the OCIE’s “fixation” on advisory fees and expenses can be traced back to 2014 and a speech by the regulatory body’s then director Andrew Bowden. It recommends 12 steps advisors should take to ensure they don’t fall afoul of the regulator, including considering a five-year look back review of disclosures, charges, calculations and methodologies used.