Advisory Fees and Billing – Addressing key issues identified by the SEC

Balakrishnan Narasimhan

Vice President – Pre-Sales

Balakrishnan (Bala) Narasimhan is a Vice-President at SunTec Business Solutions, whose technology powers Revenue Management for financial services and powers over 300 million clients worldwide. Bala has more than 24 years of experience across multiple functions spanning banking operations, product management, technology transformations and management consulting. He has specialized expertise in core banking, CRM, digital channels, alerts and messaging, AI, retail and commercial payments, cards (credit and debit), liquidity management and system integration, and has deep experience working with clients in the US and globally.

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The recent past has seen large asset management houses in the United States paying penalties running into millions of US dollars for a variety of billing and compliance errors. Earlier this year, on April 12, 2018, the Office of Compliance Inspections and Examinations (OCIE), under the Securities and Exchange Commission (SEC) sent out a risk alert to Investment Advisory firms, across the $82T market, outlining frequent issues identified in the area of Advisory Fee and Expense compliance. The overarching theme – come clean and self-report any known billing issues in their organizations before June 12, 2018, so as to avoid possible penalties.

Given this ultimatum that is just literally around the corner, Investment firms have been working towards finding interim stop-gap solutions to address these issues before June 12th. However, the broader fact is that many of these issues are likely to arise due to operational and systemic processes or data issues on the technology side, so in the medium to long term, there are key things that Investment firms should ideally look to implement to ensure solid compliance.

In this article, I have outlined some of these key things that these firms should seriously consider and solve for, especially with respect to meeting these medium to long term needs. More importantly, this will help avoid such issues in the future, with a focus on systemic mechanisms replacing manual or archaic procedures. There are 6 key issues in Advisory Fees and Billing that were identified by the OCIE, so let us look at each of them closely

1. Fee-Billing based on incorrect account valuations

Key issues identified by the SEC

• Valuing assets using a different metric than what was specified in the client’s advisory agreement (For example, not using fair market value to assess valuation).
• Valuing assets using a different process than what was specified in the client’s advisory agreement (For example, using market value at the end of billing cycle rather than an average and including assets that were supposed to be excluded from the advisory billing).

How to address the issues

• Systemize (eliminate manual records) the process to capture the details under the client advisory agreement, and use this in your fee calculations and subsequent billing.
• Automated matches between contracted fees agreed with customers and the actual fees calculated, to flag off inconsistencies – Do this before sending invoices or statements to customers.

2. Billing Fees in advance or with improper frequency

Key issues identified by the SEC

• Billing monthly, while having agreed to a quarterly frequency.
• Billing in advance, despite having agreed to bill in arrears.
• Billing new clients in advance for a full billing cycle, instead of prorating from the relationship start date.
• Billing clients who terminated their relationship, for a full billing cycle, instead of prorating it based on the relationship end date.

How to address the issues

• Define Billing frequency as a client attribute, and ensure that is used to automate the bill generation cycle – Eliminate any manual processes.
• Always determine Billing frequency and application based on preset rules and negotiations as per the client advisory agreement that is applied automatically (and not by an individual).
• Implement an automated mechanism of billing computation that always pro-rates for mid-cycle new relationships and terminations, based on an identifiable “billing start date” and “billing stop date”.

3. Applying incorrect fee rate

Key issues identified by the SEC

• Rate applied was higher than what was agreed upon.
• Charged a non-qualified client, performance fees based on a percentage of their capital gains.

How to address the issues

• Ensure that fee rates are systemically configured based on pre-agreed or negotiated rates– and then calculate and apply them through an automated process.
• Deploy an appropriate rules engine to automatically identify and flag off qualified customers that need to be charged performance fees, while ensuring that non-qualified clients are not incorrectly billed.

4. Omitting rebates and applying discounts Incorrectly

Key issues identified by the SEC

• Not aggregating client account values for members of the same household for fee billing purposes.
• Not reducing a client’s fee rate when the value of that client’s account reached a prearranged breakpoint level.
• Charged a client additional fees, such as brokerage fees, when such client was in the adviser’s wrap fee program and the transactions qualified for the program’s bundled fee.

How to address the issues

• Systemically distinguish and link accounts belonging to a single household.
• Automatically compute fees based on cumulative household balance.
• Compute fees through an automated process based on either a Breakpoint level (tiered) basis or Fixed basis, with the ability to automatically change the rates based on the variations in balances and make sure that relevant rebates are applied.
• Define wrap accounts with a rule to waive charges automatically on all additional fees not applicable to the wrap relationship.

5. Disclosure Issues Involving Advisory Fees

Key issues identified by the SEC

• Inconsistency between client agreed fee rates and disclosure under Form ADV.
• Non-disclosure of additional fees or markups in addition to advisory fees. For example, collecting expenses from a client for third-party services that exceeded the actual fee incurred, or earning additional compensation on certain asset purchases for client accounts that were not disclosed

How to address the issues

• Automate the end to end revenue process – from the client advisory agreement, to fees computation, to billing to output generation. In this case, the form ADV would be generated automatically using client specific data – avoid manual intervention to reduce data errors.
• Transparency to the client with the details of each fee computed, source of fees and the methodology used. Make sure that your frontline staff are also able to access this information.

6. Adviser Expense Misallocations

Key issues identified by the SEC

• Misallocation of expenses to the funds. For example, allocating distribution and marketing expenses, regulatory filing fees, and travel expenses to clients instead of the adviser.

How to address the issues

• Review existing expense management and allocation mechanisms to make sure that expenses are always itemized, and a rules engine is used to ensure that non-qualifying expenses are not allocated for recovery from clients.
• Again, transparency to the client is key. Make sure that every component of fees that are shown in the client statement provide the details around the source of expenses that are being billed to the clients, if any.

In summary, and to reiterate, while addressing the immediate need to self-report any known issues is critical for June 12th, the part that is even more vital is for Investment firms to address this from the perspective of the medium to long term. The primary focus should be on ensuring end to end systemic processes and maximizing automation as opposed to manual and archaic processes.