A wrap fee program is an arrangement between financial institutions (typically broker-dealers and investment advisers) that enables customers to pay an all-inclusive fee (usually as a percentage of assets) for investment advisory services bundled with various other services, such as execution, clearing, and custodial services. Wrap fee programs create a number of suitability issues for the financial institutions that sponsor the wrap fee program or participate in the program.
An investment adviser’s participation in a wrap fee program will not only increase its compliance and disclosure responsibilities but it will also raise its regulatory profile with heightened focus on the programs. A firm that is, or may be thinking about, participating in a wrap fee program must be conscious of the regulatory environment and some of the increased compliance responsibilities that go along with such a program.
Firms with wrap fee programs, among other requirements, must provide a detailed disclosure of the program to clients, as well as ongoing monitoring of the accounts. Rule 204-3(d) of the Advisers Act requires firms to prepare and provide to clients a brochure that explains the wrap fee program.
Participating in wrap fees increases a firm’s disclosure requirements and presents a need for heightened awareness of suitability for the program. Most of the suitability review will be concentrated around fees and the comparison of clients in wrap fee programs to firm clients not in the program. A firm’s compliance program must document and review the fees, determine whether a client is being overcharged, and whether the program is suitable for that particular client on an ongoing basis.
Firms should test the effectiveness of compliance controls around wrap fee programs, including decisions to accept new accounts and monitor existing accounts. An independent review — whether conducted by internal audit/compliance or an independent third party — is essential to demonstrating an effective compliance program.
In addition, firms should test and analyze quantitative assertions made in disclosures, including the wrap fee program brochure. Proactive assessment will help firms prepare for SEC scrutiny. It is important to calculate the relative cost of wrap fees versus traditional fee arrangements for existing and new accounts. Those accounts that generate substantially higher fees under wrap fee programs are likely to be subject to a higher degree of regulatory scrutiny.
Employing forensic auditing and data analytics tools early on can help to detect potential abuse of wrap fee programs, remediate issues before they become larger problems and demonstrate a firm’s commitment to compliance.