7 Tips For Properly Disclosing Advisory Fees and Staying Compliant

7 Tips For Properly Disclosing Advisory Fees and Staying Compliant

6.5 MIN READ 

With year-end compliance reviews coming due in addition to annual updating amendments, now is a great time to review your disclosure documents and advisory agreements in regards to advisory fees to assess if any changes are needed (i.e., fee increases or decreases). However, beyond making minor changes to change the value in which you’ll be charging, you should also consider if your disclosures around fees are accurate and clear—especially in instances where your fees might have changed from year to year or even changed dramatically from the date when you first launched your firm. With many minor amendments being made, perhaps as a whole, the disclosures may not be as consistent or as accurate as they once were.

In November 2021, the SEC issued a Risk Alert identifying concerns around registered investment advisors and the common deficiencies seen during examinations around the subject of fee billing. The SEC conducted 130 examinations of investment advisors, all of whom provided advice to retail investors for a fee. The fees charged were generally tiered assets under management fees. Based on the SEC’s findings, we’ve compiled seven tips and considerations advisors should incorporate when disclosing their advisory fees.

7 Tips For Properly Disclosing Advisory Fees

1. Disclose if fees are negotiable.

It is required that advisors disclose whether their fees are negotiable. The SEC stated that advisors failed to disclose “the negotiability of fees or falsely disclosed that fees were not negotiable when they, in fact, could be negotiated.” Remember to also disclose this in your advisory agreement(s).

2. Make sure the advisory agreement matches what is charged.

As stated above, at times advisors will negotiate fees to a lesser amount or have a special arrangement, such as waiving fees for the first quarter. For any of these instances, the purpose of the advisory agreement is to illustrate what fees are actually being charged. At the end of the day, the advisory agreement is the agreement between you and the client of what both parties agreed to provide. For the advisor, it outlines all of the services the advisor stated it would provide, and for the client, it outlines the fees the client agrees to pay. If you tend to customize your fees for each client, then each advisory agreement should also be customized.  

3. Disclose if account values used to calculate fees differ from the custodian.

Oftentimes, advisors use third-party software in order to calculate their fees, such as Capitect, Orion, or Bluefin, among others. The SEC noted advisors included in their account valuations “inaccurate account values due to timing differences in cash and dividend transactions in electronic custodial feeds compared to the available balance at the custodian (e.g., certain pending deposits may be excluded from available balance).” Advisors should be spot-checking advisory fee calculations at the same cadence they are pulled.

For example, if the advisor states in their agreement that fees are based on the account value as of the last business day of the quarter, the advisor should review whether the account value used matches the account value as published in the client’s statement provided by the custodian. If the values do not match, advisors should investigate the reason why. Most likely, the reason is due to the timing of dividends that settled into the account. In such a case, advisors should add disclosures explaining that the account value used to calculate advisory fees may differ from that of the custodial account statement. Moreover, if the advisor provides the client with an invoice, this disclosure should also be added to the invoice.

The SEC also noted advisors included in their account valuations “assets that disclosures stated would be excluded from the fee calculations, such as legacy positions.” Some Advisors choose to exclude certain assets from their fee calculation, such as cash, legacy positions, or positions in which they do not provide any advice but are held in the client’s account. If the advisor chooses to exclude these assets, this should be disclosed in your Form ADV and Advisory Agreement. In addition, you should ensure your fee-billing software is able to detect these assets, and you should perform spot-checks to make sure these assets are actually excluded.

4. Disclose the formula used.

In many states, it is required to provide clients with an itemized invoice if you directly deduct fees from a client’s account. The invoice should include the formula used to calculate the fee, the amount of assets under management that the fee is based on, and the time period covered by the fee. When disclosing the formula, advisors should be including the following:

  • Whether fees are based on the last business day of the prior quarter or the average daily balance
  • If charged quarterly, whether fees are divided by four or the number of days in the quarter divided by days in the year (i.e., 90/365), or another method
  • If using a tier, if the fees are calculated using a straight tier or blended tier
  • If the firm allows for “householding” accounts, meaning fees for accounts in the same household are aggregated for the purposes of achieving the advisory fee breakpoint discount
  • If using net worth or annual income rather than account value, how the advisor determines net worth and annual income

Essentially, regulators prefer that if they were to view a client’s invoice, they would be able to look at the invoice and the client’s statement and be able to recalculate the fee themselves without making assumptions. Advisors should review their disclosures in Item 5 of their ADV to ensure if it is robust enough to clearly disclose all factors when determining their fees.

5. Disclose your policy regarding charging on deposits or withdrawals.

Clients may make a large deposit mid-billing period or vice versa, make a large withdrawal. Advisors should consider, when formulating their fee disclosures, the advisor’s policy regarding these circumstances. Advisors should consider whether they will prorate these transactions for billing purposes or if there will be a certain threshold amount that prompts a proration. In addition, if the advisor does prorate for deposits, does it also prorate for withdrawals, and does the advisor’s fee-billing software, custodian, or third-party investment advisor have functions to allow for this.

6. Disclose and determine how prepaid fees are refunded.

Where advisors charge their fees in advance, firms should have a clear and concise termination policy to ensure clients receive a prorated refund upon termination. We recommend that each time a client terminates their engagement with an advisor, the advisor keeps a spreadsheet that outlines the following: the name of the client, the date notice was received, the date of termination, account number, the assets under management on the date of termination, and the refund amount (if applicable) and method in which the refund was given. In addition, the advisor should keep a copy of the termination notice, the final invoice or statement, and a copy of the refund (if applicable).

Note: Many advisors who bill in arrears may bill other fees in advance, such as financial planning fees. In this case, advisors should consider how they will prorate their fees in the event of early termination prior to the financial plan being delivered. For example, will proration depend on the percentage of work done and subtracting that from the fixed fee, or will it be determined by the advisor’s hourly rate (if one is disclosed)? Thinking through these circumstances and properly disclosing the actual method will help not only you when these situations arise but also helps avoid any deficiencies during a compliance audit.

7. Add procedures to your Compliance Manual.

Lastly, the SEC noted that “Many of the examined advisors did not maintain written policies and procedures addressing advisory fee billing, monitoring of fee calculations and billing, or both.” Especially in the case with firms with more than one advisor representative, it’s important to outline your policy regarding how you calculate your fees in order for staff to be on the same page about how fees are determined and how that is communicated to clients. In addition, fee calculations should be tested on a regular basis. In drafting your policy language, consider the following:

  • valuation of illiquid or difficult-to-value assets included in the assets for the calculation of advisory fees
  • fee offsets
  • Fee reimbursements for terminated accounts, where the client prepaid fees
  • prorating fees for additions or subtractions of assets in accounts
  • family account aggregation (householding) or the application of breakpoints for fee calculations

The end of the year, reviews, and the timely SEC Risk Alert identifying common deficiencies seen during examinations around the subject of fee billing make this an ideal time to make sure you are properly disclosing your fees and staying compliant. These seven tips are meant to help you get there.

If all you want this holiday season—or whenever—is to have a team of experts guide you through the ins and outs of all things compliance, you’re in luck. XY Compliance Solutions is perfectly positioned to partner with you and make that a reality. Check out our services and get in touch with us here.


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About the Author

Terria Heng has spent her career in financial regulatory compliance. She started out as a compliance consultant at a boutique compliance firm located in Beverly Hills, CA, where she assisted breakaway brokers in transitioning from wirehouses to the independent RIA space. Prior to joining XYPN, Terria was a financial examiner at the Texas State Securities Board for 6 years. Terria has extensive knowledge in state compliance examinations, including effectively communicating with regulators, responding to regulatory inquiries, and best practices in practice management. Currently living in Portland, Oregon, Terria enjoys hiking the Columbia Gorge with her dog Kuba or going on long road trips with her partner in their Sprinter van.

 

 

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