Two Firms Charged with Compliance Failures in Wrap Fee Programs

September 26, 2016

The Securities and Exchange Commission (“SEC”) recently announced that it settled charges with two investment advisory firms related to compliance failures within their wrap fee programs. For violations of Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder, the firms agreed to pay penalties of $600,000 and $250,000, respectively.

The Wrap Fee Programs

A “wrap fee” is a single fee that covers investment advisory services, trade execution, custody and other standard brokerage services. Advisory clients at each firm paid a “wrap fee” to invest through separately managed accounts advised by select subadvisors. Under the wrap fee programs, subadvisors have sole discretion in selecting which broker-dealers will execute trades on behalf of advisory clients. If a subadvisor executes a trade with the broker through the wrap fee arrangement, the advisory client does not pay an additional fee. If the subadvisor opts to direct a trade to a broker-dealer outside of the wrap fee arrangement (a process known as “trading away”), advisory clients could incur additional trading costs, such as commissions or fees paid to that executing broker-dealer. These additional costs are embedded in the price of the securities, increasing the cost for clients.

The Violations

The SEC investigations found that the firms failed to establish policies and procedures to monitor the amount of commissions charged to their clients when subadvisors traded away. Both firms disclosed that subadvisors can trade away to other broker-dealers and incur additional costs for clients, but one did not collect information on the frequency with which subadvisors traded away or the associated costs; and the other only began collecting such information in 2014. Neither firm informed its clients or their financial advisors of the additional costs actually paid. Consequently, the financial advisors could not consider these costs when making suitability determinations regarding the use of particular subadvisors, and the wrap fee program in general, for individual clients. Further, certain clients were not able to consider these additional costs when negotiating their wrap fees.


In light of these orders, advisory firms with wrap fee programs should consider implementing procedures for monitoring the costs associated with, and the frequency of, subadvisors’ trading away practices. Such procedures should require periodic review of trading information received from subadvisors in wrap fee programs and the dissemination of such information to clients and their financial advisors. Additionally, firms should consider disclosing additional information regarding trading away cost on their websites, or in their wrap fee brochures, client agreements or other disclosure documents.





If you have any questions regarding the matters covered in this memo, please contact any of the partners and counsel listed below or your primary attorney in Seward & Kissel’s Investment Management Group.