Wrap Fee Programs

Thank you, Vicky. Up next we have wrap fee programs. Wrap fee programs are on the 2017 exam priorities, and we're seeing them once again for 2018. One of the main concerns here is whether or not a wrap fee program is suitable for a client. Often wrap fee programs have a higher fee than a non-wrap fee program. And if an account is not actively trading clients, may pay a higher fee in wrap fee program than they would if they paid separately for advisory and brokerage services.

One of the test you can perform to check wrap fee suitability is calculating portfolio turnover. One thing you obviously see when looking at portfolio turnover is turning or if an account is frequently traded. However, the concern with a wrap fee program is the opposite. What you want to look for is low portfolio turnover or what is referred to as reverse turning. This can be an indication that a wrap fee program may not be suitable for the client.

I also recommend periodically reviewing portfolio turnover and making sure you document this review. You also want to look for accounts with a high cash balance because that may be another indication that a wrap fee program is not suitable. You also want to ensure that clients receive accurate disclosure with respect to a wrap fee program. All clients must receive the form ADV part 2A Appendix 1. This is also known as a wrap brochure. This is a written disclosure statement prepared by the wrap fee sponsor. In here you want to be sure to disclose that the program may cost the client more or less than purchasing services separately. And also, disclose any incentive that you have to recommend a wrap fee program over other types of accounts.

Also, you want to include any fees that the client may pay in addition to the wrap fee and describe the circumstances under which a client may incur those fees. Clients also need to be provided with the investment adviser's form ADV part 2A if the sponsor is not also the investment adviser to the wrap fee program.

Also, this year what's new is in the new part 1 of form ADV, the SEC is requiring additional information regarding wrap fee programs under item 512. They're asking for the amount of regulatory assets under management attributable to wrap fee programs, and they're asking you to break it down for the amount to which you are a sponsor, the amount to which you are an investment adviser or the amount to which you are both sponsor and investment adviser to a wrap fee program. I think it's probably likely the SEC is going to use this information to chose firms for examination.

Also, you want to be sure that you don't forget to conduct periodic reviews of best price and executions. Just 'cause you're recommending brokerage services of only one broker doesn't mean you don't need to review best pricing execution. Here I recommend that you review the services provided by your recommended broker, and also periodically research alternatives so you can ensure that clients are receiving best price and execution.

SEC examiners generally will ask for documentation of your review of price and execution. Also, I saw a recent request that's from the Philadelphia office, and it's focused on wrap fee program, and one of the questions was to see whether the wrap fee program recommended by the adviser permits managers to trade away from the sponsor's trading desk. If so, please describe the conditions under which this is. You want to be sure to disclose to the client whether or not trading away is permitted, and if it is permitted, the associated cost of trading away. And so also, advisable to have a policy regarding the conditions under which trading away is permissible, for example, for fixed-income securities or a liquid security, which may have limited availability through the wrap fee sponsor. Here you want to make sure that you're monitoring these tradeaways, that the policy is being followed and also, that all of the costs are fully disclosed.

May just to give you a few an example of some of the other questions that I saw on this request list, 'cause I thought it was particularly interesting for wrap fee, those of you with wrap fee programs. They were asking for policies and procedures specific to initial and ongoing suitability reviews, specific to wrap fee accounts, monitoring of wrap fee client accounts, monitoring of wrap fee client accounts with high cash balances, monitoring of wrap fee accounts with low levels of trading, oversight of any branch offices or managers not located at the home office, initial and ongoing due diligence of wrap fee sponsors, programs and managers, and also, fee billing policies and procedures, so this kind of wrap goes back ... The fee billing part goes back to what Vicky was talking about earlier with respect to retail clients. And you'll see throughout the presentation a lot of overlap in some of these areas in the exam priorities.

 This webinar was co-hosted with Victoria Hogan and Colleen Montemarano of NorthPointCompliance.com