RIA Compliance Group has observed that SEC and state examiners are scrutinizing advisory firms’ fee arrangements and disclosures. Registered Investment Advisers (RIAs) must ensure that they have fully disclosed all of their fees in Form ADV including, but not limited to:
- Management fees;
- Planning fees;
- Consulting fees;
- Maintenance fees;
- Account set-up fees;
- Onboarding fees;
- Redemption fees; and
- Technology fees.
These fees should also be disclosed in RIAs’ advisory contracts, so it is clear that clients knowingly agreed to pay those charges.
An RIA’s failure to adhere to its agreement with the client and to provide full disclosure may violate the Investment Advisers Act of 1940 and its rules, including the antifraud provisions of the statute.
When a contract is ambiguous, it is interpreted in favor of the party that did not draft the agreement. As a fiduciary and the party that drafted the contract, ambiguities in an RIA’s advisory agreement must be resolved in favor of the client. Therefore, ambiguous fee schedules and fee calculation language will not be interpreted in the RIA’s favor and might result in clients being overcharged. Overbilling is a clear breach of an RIA’s fiduciary obligation to clients.
RIAs’ billing practices must be consistent with advisory agreements and Form ADV
It is not uncommon for RIAs’ actual billing practices to be at odds with their advisory agreements and Form ADV disclosures. As an example, investment advisers should be careful not to bill advisory fees at a time that is different from the timing set forth in the advisory contract or as disclosed in Form ADV Part 2. Examiners have sanctioned RIAs that billed advisory fees in advance when their contracts required that clients be charged in arrears.
Certain RIAs have charged clients a higher fee percentage than what was agreed to in the advisory contract and disclosed in Form ADV. In some instances, the mistake results from an RIA’s failure to apply rebates and discounts correctly. Examiners sometimes discover that an RIA failed to aggregate client or account values for members of the same household when preparing their bills. When breakpoint billing rates are not applied correctly, clients pay too high a percentage on their assets under management and overpay the fees owed to the adviser. RIAs have also gotten in trouble for not refunding prepaid fees when clients leave the firm, or they neglect to prorate the fees of new clients. In addition, RIAs involved with wrap fee programs sometimes charge clients for inappropriate expenses.
RIAs must value assets as they agree to do so in the client’s advisory agreement. Certain firms make the mistake of using the market value of clients’ assets at the end of the billing cycle, even though the contract stipulates they will utilize the average daily balance of the account during the entire billing period. In some cases, RIAs include certain assets in calculating their fees, such as cash or cash equivalents, even though the client’s advisory agreement excludes them from the calculation. Another valuation mistake might occur when an RIA uses the original cost of an illiquid asset instead of the fair market value.
Disclosure issues involving advisory fees
Certain RIAs provide inaccurate descriptions of their fees in Form ADV, and these disclosures are inconsistent with their actual practices. These RIAs sometimes charge more than the disclosed maximum fee.
Advisers to private and registered funds should ensure that they allocate their expenses properly. RIAs potentially violate their advisory and operating agreements, as well as their disclosures, if they allocate travel expenses, regulatory filing fees, and other expenses to clients instead of the firm.
Disclosures related to advisory fees and expenses are extremely important to investors as they decide whether to hire an RIA or to choose a different firm. Without full disclosure, investors do not have the opportunity to compare fees and services among RIAs.
When RIAs overbill their clients, even if it’s an innocent mistake, refunding the overpayment will not necessarily end the firm’s problems with securities regulators. Regulators may impose fines and other sanctions on the RIA. Furthermore, once examiners find compliance deficiencies at an RIA, they may schedule a follow-up examination sooner than expected.
Robust policies and procedures can help to ensure that an RIA’s fees and fee calculations are accurate and fully disclosed in all client-facing materials. During its annual review of its policies and procedures, an RIA should make certain that the firm is using every tool at its disposal to protect clients from being overcharged.
RIAs are likely to make fewer fee-related mistakes when they implement specific written policies and procedures for supervising, calculating, reviewing, and billing advisory fees. RIAs and clients will benefit from policies and procedures that establish periodic internal testing of their billing practices. This internal testing can identify situations where clients were overcharged. Firms should quickly make the client whole when those mistakes are discovered. And when clients have been double-billed or overcharged, RIAs must revise and enhance their policies and procedures to prevent future mistakes.
About RIA Compliance Group: RIA Compliance Group is an investment adviser compliance consulting firm based in Delray Beach, Florida. The firm’s mission is to provide affordable, timely, practical, and cost-effective compliance advice. We help investment advisers to comply with the myriad of state and SEC regulations and compliance obligations facing their firms. RIA Compliance Group takes pride in giving personal service and real world compliance advice, not theoretical concepts and legalese. The firm interacts on a daily basis with SEC and state securities regulators.