On August 14, 2018, the SEC settled an enforcement action involving a Registered Investment Adviser (“RIA”) that failed to inform clients about the costs arising from trading in wrap accounts. When clients enter into wrap fee arrangements, they pay one fee to the sponsor and portfolio managers that encompasses the cost of providing advisory, custody, and brokerage services. The SEC discovered, however, that certain expenses were not covered by the wrap fee, such as situations where portfolio managers directed the execution of trades through a broker-dealer that did not participate in the wrap program. This practice, known as “trading away” or “step-out trading,” caused clients to pay more than their annual wrap fee. Furthermore, wrap program clients were not informed that certain trades were stepped-out and were not advised regarding charges over and above the wrap fee.
According to the SEC’s order, step-out trading raised questions pertaining to a portfolio manager’s compliance with its legal obligation to seek best execution on behalf of wrap clients. In this case, best execution depended upon the particular costs and benefits of a specific step-out trade.
The RIA, which is based in King of Prussia, Pennsylvania, failed to implement policies and procedures governing the assessment, oversight, and disclosure of the trading away practices of the third-party portfolio management firms participating in its wrap program. Specifically, the RIA’s policies and procedures failed to require that material information regarding trading away would be obtained and considered by the firm before making the third-party portfolio management firm available to clients in its wrap fee program. In addition, policies and procedures did not ensure that this material information would be disclosed to clients.
The RIA’s policies and procedures failed to require the firm to determine whether a portfolio manager had a history of trading away or was likely to do so. In addition, the firm’s policies and procedures did not require the RIA to provide information about trading away to clients and their investment advisers after those portfolio managers were on-boarded into its wrap program. The RIA’s policies and procedures also did require the firm to identify and contact a portion of the portfolio managers that had traded away during the quarter. On a quarterly basis, the RIA was obliged to gather information about the selected portfolio manager’s trading policies and its rationale for trading away.
The SEC’s enforcement action alleged that more than 100 of the approximately 250 portfolio managers participating in the RIA’s wrap program traded away. Between 24 and 52 managers routinely traded away during a given month.
The wrap program sponsor got more than a rap on the knuckles. The SEC ordered the firm to pay a $200,000 civil money penalty. The press release and order can be found at https://www.sec.gov/enforce/ia-4984-s.
https://www.ncsregcomp.com/team/les-abromovitz/
NCS Regulatory Compliance
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