SEC Initiates Enforcement Action Against Investment Adviser for Over Charging Clients

Investment Adviser Settles SEC Enforcement Action for Failure to Conduct Fee Audits

August 30, 2023


Reading time : 6 minutes

Summary

The United States Securities and Exchange Commission (“SEC”) recently initiated an enforcement action against with an investment adviser firm for allegedly failing to conduct sufficient fee audits which resulted in overcharging more than 10,900 investment advisory accounts, amounting to over $26.8 million in advisory fees. Without admitting or denying the SEC charges, the investment adviser firm has agreed to pay a $35 million civil penalty to settle this proceeding.

Background Facts

According to the SEC’s allegations, the investment adviser firm had initially negotiated reduced advisory fees from the firm and its predecessor’s standard pre-set advisory fee rate with thousands of clients. These negotiations were formalized through handwritten or typed changes on the clients’ investment advisory agreements, indicating the reduced fees at the time their accounts were opened. However, the SEC claims that the investment adviser firm failed to honor these negotiated advisory agreements in several instances.

Specifically, the account processing employees at the investment adviser firm and its predecessor firms allegedly did not enter the agreed-upon reduced advisory fee rates into the firm’s billing systems. This oversight led to the overcharging of certain clients who had opened accounts prior to 2014, extending through the end of December 2022.

For advisory accounts established through predecessor firms, the investment adviser firm allegedly failed to audit whether the fee rates entered into the fee billing system were consistent with the client agreements.

For certain accounts below the amount of $250,000 from 2009 to 2014, the investment adviser firm allegedly failed to conduct quality control process which involved checking whether the account set-up information was consistent with the client agreement and then correcting discrepancies.  In 2014, the investment adviser firm implemented the quality control check for all new account regardless of value but allegedly failed to review whether the accounts established from 2009 to 2014 were set up correctly.

The SEC also alleges that the firm did not adopt and implement written compliance policies and procedures that were reasonably designed to ensure the accuracy of the billing systems.

Applicable Statute and/or Rule

This SEC enforcement action involves Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 as amended and Rule 206(4)-7. These statutory sections pertain to anti-fraud provisions and the rule concerns need for an investment adviser registered with the SEC to adopt and implement written compliance policies and procedures.

Violation

The cease-and-desist order states that the investment adviser willfully violated Section 206(2) of the Investment Advisers Act, which prohibits an investment adviser from engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client. Additionally, the order alleges that the investment adviser willfully violated Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which requires an investment adviser adopt and implement written policies and procedures designed to prevent violations of the Investment Advisers Act.

Fine & Remedial Efforts

The investment adviser firm has agreed to pay a $35 million civil penalty to settle the SEC’s charges. Additionally, the firm reimbursed affected account holders approximately $40 million, including interest.

Key Takeaways & Best Practices

Risk of Growth through Acquisition – This SEC enforcement proceeding is particularly noteworthy because it highlights the complexities and pitfalls associated with fee billing of investment adviser firms that have grown through acquisitions. The SEC emphasizes the need for such investment adviser firms to ensure that their growth does not compromise client protection, particularly when it comes to honoring predecessor fee agreements.

 Duty to Small Accounts – This case reinforces an investment adviser firm’s obligation to make sure its fee calculations are accurate and consistent with the agreed upon terms for all clients and not merely high net worth clients.

Internal Controls – This SEC enforcement proceeding underscores the importance of an investment adviser firm establishing internal controls when entering fee details into a fee engine and/or calculating the advisory fees.  For instance, two individuals should review and verify the accuracy of the data entered into the fee engine or database with respect to the fee rate.

Regular Fee Audits – The SEC and other securities regulators expect an investment adviser firm to audit a sampling of client account each billing period for accuracy.  Such an audit should start with reviewing the fee section of the client agreement to verify that the contractual terms are consistent with the investment adviser firm’s actual practices.

 Compliance Policies & Procedures – An investment adviser firm should document in writing its processes and internal controls for ensuring that the fees are correctly calculated and deducted.

Resources

Fee – Audit Spreadsheet – Internally Calculated Asset-Based Investment Adviser Fees

Fee – Audit Review Form

Recorded Webinar: Compliance Talk with RCC Consultants – RIA Fee Billing Practices (4/18/2019)

Recorded Webinar : Investment Advisory Fees & Other Expenses (6/21/2018)

SEC Fines Investment Adviser for Failing to Refund Unearned Fees When Client Terminates Advisory Services (7/26/2018)

Texas Revokes IAR’s Registration Over Performance Fees (5/19/2021)

Disclosures

The information contained in this blog post is general in nature intended for educational purposes only and is not intended to be a comprehensive analysis of this topic. This is merely a summary and does not necessarily include all material facts from the proceeding or order.  RIA Compliance Consultants, Inc. has not verified the accuracy of the securities regulator’s order and is not offering any opinion whether the allegations made by the securities regulator in the administrative proceeding referenced above are accurate.  This post is not intended to constitute compliance consulting advice or apply to any particular investment adviser firm’s specific situation. Please consult the applicable securities regulator’s order, rules and published guidance for more details about the topics referenced above.  For more information about the limitations of this blog post and information on our website, please see our Disclosures webpage.

Posted by Bryan Hill
Labels: Endorsements, Fee Audit, SEC
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