At the end of each calendar year, the Office of Compliance Inspections and Examinations (“OCIE”) staff of the United States Securities and Exchange Commission (“SEC”) publish a list of topics for the next year’s examination priorities. Not so surprisingly, the first item for the 2019 exam priorities listed is “fees and expenses”. This topic was also the highlight of an OCIE Risk Alert in April 2018 as one of the most frequent compliance issues identified in Examinations of Investment Advisers.
In the 2019 Examination priorities, the SEC indicated that the firms “selected for examinations will be firms with practices or business models that may create increased risks of inadequately disclosed fees, expenses or other charges.” Additionally, “OCIE will continue to evaluate financial incentives for financial professionals that may influence their selection of particular mutual fund share classes (12b-1 fees).”
Billing Deficiencies Identified for Fees and Expenses
Investment advisers are required to disclose fees and expenses to clients and prospective clients. Therefore, the client’s fee billing should be accurate and consistent with the signed agreement. However, in exams, the SEC identified examples of client accounts being billed incorrectly. Some of the examples highlighted were billing errors utilizing incorrect account values and including assets that had been highlighted in the advisory agreement as excluded from billing.
Additionally, billing in-advance or in-arrears and accuracy with the different billing cycles were identified as potential problem areas. Inconsistent billing rates were identified compared to the fees outlined in the client agreement. Failing to refund fees for clients who terminated their agreements where the firm utilized billing in advance were also identified as deficiencies.
Best Practices – Fee Billing
It is important to gain a full understanding of all the areas in which the firm is paid revenue. This may include 12b-1 fees, private fund fees, additional fees, mark-ups, client billing, etc. Firms should establish a system to regularly review and test the fee billing that factors in all types of revenue.
Additionally, it is wise to confirm the client’s fee billing rate is consistent with the client’s agreement. If the firm utilizes both in-arrears and in-advance fee billing, confirm whether the client’s billing period is in-arrears or in-advance as indicated on the client agreement. Identify clients that have multiple accounts in a household and ensure if they have a reduced bundled fee on the agreement and whether they are being billed a reduced bundled fee.
If overbilling is identified, process the appropriate refund(s) to the client as soon as possible. A thorough understanding of the billing processes and the appropriate fees provides a valuable understanding regarding any outliers with fees and revenue. The establishment of guidelines and documenting any outliers for this review process will aid in accessing the accuracy of the fee billing.