As part of the SEC’s new Form ADV filing requirements taking effect on October 1, 2017, registered investment adviser (“RIA”) firms that act as a sponsor or portfolio manager for a wrap fee program will be required to disclose attributable regulatory assets under management (“AUM”) and other additional information. Wrap fee programs continue to be a focus area for state and SEC regulators. The SEC staff notes that this new requirement “will help us better understand a particular adviser’s business and assist in our risk assessment and examination process.”
What is a Wrap Fee Program?
As a quick refresher, Rule 204-3(g)(4) defines a wrap free program as:
a program under which any client is charged a specified fee or fees not based directly upon transactions in a client’s account for investment advisory services (which may include portfolio management or advice concerning the selection of other investment advisers) and execution of client transactions.
In other words, a wrap fee program is generally when an RIA firm “wraps” the advisory fees and commissions that would be charged to a client into a single, all-inclusive fee. For example, instead of an RIA firm charging a client a 1.00% advisory fee and brokerage commissions being charged separately to the client, a wrap fee program generally includes all brokerage commissions. Generally, when sponsoring a wrap fee program, an RIA firm would pay all brokerage commissions on behalf of the client and charge the client a “wrap fee” of perhaps 1.25%.
Wrap fee programs remain an investment adviser regulatory compliance focus area due to frequent issues with insufficient or misleading disclosures related to transaction fees (e.g. other fees such as trade-away fees that may or may not be included as part of the wrap fee). In addition, wrap fee programs also create potential “reverse churning” issues related to whether a client may be better served not being placed into a wrap fee program (e.g. accounts with low levels of trading activity).
Form ADV Changes Taking Effect on October 1, 2017
Beginning on October 1, 2017, when an RIA firm files a Form ADV amendment, the firm will need to provide additional information related to applicable wrap fee programs. Item 5.I. of the Part 1A will now read:
(1) Do you participate in a wrap fee program? Yes No
(2) If you participate in a wrap fee program, : what is the amount of your regulatory assets under management attributable to acting as:
(a) sponsor to a wrap fee program? $_________
(b) portfolio manager for a wrap fee program? $_________
(c) sponsor to and portfolio manager for the same wrap fee program? $__________
If you report an amount in Item 5.I.(2)(c), do not report that amount in Item 5.I.(2)(a) or Item 5.I.(2)(b).
If you are a portfolio manager for a wrap fee program, list the names of the programs, their sponsors and related information in Section 5.I.(2) of Schedule D.
If your involvement in a wrap fee program is limited to recommending wrap fee programs to your clients, or you advise a mutual fund that is offered through a wrap fee program, do not check Item 5.I.(1) or enter any amounts in response to Item 5.I.(2).
Each wrap fee program for which the RIA serves as a portfolio manager will need to be listed in the revised Section 5.I.(2) of the Schedule D which will now read:
If you are a portfolio manager for one or more wrap fee programs, list the name of each program and its sponsor. You must complete a separate Schedule D Section 5.I.(2) for each wrap fee program for which you are a portfolio manager.
Check only one box: Add Delete Amend
Name of Wrap Fee Program ______________________________________________________
Name of Sponsor _______________________________________________________________
Sponsor’s SEC File Number (if any) (e.g., 801-, 8-, 866-, 802-) ________________
Sponsor’s CRD Number (if any): _________________
New Form ADV FAQ SEC Staff Guidance
On June 12, 2017, in preparation for the upcoming Form ADV changes, the SEC staff released new Form ADV FAQs related to the forthcoming wrap fee program disclosure requirements:
Q: My advisory firm serves as a portfolio manager under a wrap fee program. For purposes of counting the number of our clients to which we provided investment advisory services in the last fiscal year, should I count the wrap fee program itself as one client or should I count each of the participants in the wrap fee program as clients?
A: Each wrap fee program participant to whom you provided investment advisory services should be counted as a client.
Q: My advisory firm serves as a portfolio manager under a wrap fee program. For purposes of determining the types of our clients in response to Item 5.D, should I view the wrap fee program itself as one client or should I disclose the types of participants in the wrap fee program?
A: To determine your types of clients, treat each wrap fee program participant to whom you provided advisory services as a client.
In preparation for the upcoming Form ADV changes, RIA firms should review the use of all wrap fee programs to identify what information will need to be disclosed on the Form ADV. An RIA firm that files a Form ADV amendment on or after October 1, 2017 should be prepared to disclose all relevant wrap fee program information including the attributable regulatory AUM. Thus, firms need to take steps now to ensure that portfolio management and reporting systems are modified to properly categorize regulatory AUM by client type as needed. Wrap free programs have traditionally been a common area for regulatory enforcement actions. With these new Form ADV changes, advisory firms that participate in wrap fee programs should expect more frequent regulatory audits given the increased risk profile of the firm. All RIA firm principals and Chief Compliance Officers should also review the latest SEC Office of Compliance Inspections regulatory exam priority list released earlier this year which lists wrap fee programs as a continued focus area.