Coordinated state exams conducted by members of the North American Securities Administration Association (NASAA) during 2015 uncovered the top registered investment adviser (RIA) compliance deficiencies across 20 categories. Last week, we discussed privacy-related investment adviser regulatory deficiencies, specifically related to the initial and annual delivery of the privacy policy. In this week’s installment, we cover another common RIA compliance deficiency category: client advisory fees.
The latest 2015 NASAA coordinated examination report shows that of the 1,170 investment advisory firms examined in 2015, 21.2% of firms with assets under management (AUM) had at least one fees-related regulatory deficiency. Compared to the 2013 NASAA report, at which time 18.1% of firms which were audited had at least one fees-related deficiency and the 2011 NASAA report that cited 19.4% of advisory firms as having at least one fees-related deficiency, the the frequency of fees-related issues has slightly increased in 2015 compared to prior years.
According to the 2015 study, roughly 20% of RIA firms with AUM less than $30 million had at least one fees-related deficiency compared to about 22% of investment advisory firms with greater than $30 million in AUM. Also of note, about 20% of firms with only one investment adviser representative (IAR) had at least one registration-related deficiency compared to around 22% of firms with more than one IAR. It’s interesting to note that larger firms, with higher levels of AUM and more IARs, appear slightly more likely overall to have regulatory compliance issues related to client advisory fees.
The Chief Compliance Officer (CCO) of every investment adviser firm needs to be aware of the top fees-related compliance deficiencies that are outlined in this most recent report. In 2015, the top issues were:
- Fee charged doesn’t match contract or Form ADV (54.8%)
- Unreasonable or excessive fee (17.5%)
- Charging miscalculated fees (overcharging) (12.7%)
- Charging undisclosed fees (5.4%)
- Preferential fees without reasonable justification or disclosure (4.2%)
In 2013, the top issues were:
- Fee charged doesn’t match contract or Form ADV (49.8%)
- Charging miscalculated fees (overcharging) (11.9%)
- Unreasonable or excessive fee (8.0%)
- Charging undisclosed fees (3.5%)
- Preferential fees without reasonable justification or disclosure (1.5%)
Comparing the most recent 2015 summary to the 2013 and 2011 results, it’s clear that inconsistency between the actual client advisory fee being charged with what is stated in the client contract or Form ADV remains a very common fees-related compliance deficiency. This is by far the most common fee-related issue we see as RIA compliance consultants. It’s essential that the CCO of every investment advisory firm regularly review and reconcile the client advisory fees being charged to ensure that the fees are consistent with that is stated on all other documents.
It’s also a bit concerning to see the increased frequency of RIA firms being cited for charging excessive fees. Investment advisers have a fiduciary responsibility to their clients to ensure that the fee being charged is reasonable, whether it be a traditional percentage of assets under management or a fixed or flat fee. Just because the client has agreed to the fee does not make it acceptable. In addition, we also regularly come across fees being miscalculated and thus a client being improperly charged. The vast majority of these types of mistakes are accidental, but nevertheless advisory firms need to consider investing in software and systems that will automatically calculate advisory fees to reduce such mistakes.
And lastly, while not directly noted in this most recent NASAA report, it’s vitally important for all state-registered RIA firms to remember that many states require RIA firms to send separate billing invoices (in addition to the custodian statement) to clients when a fee is charged. This is an operational challenge that many newly registered investment advisory firms often do not fully appreciate. Once again, firms should consider investing in technology that helps to automate the creation and distribution of client fee invoices.