SEC Targets Wrap Programs, Sponsors, and Advisers
The SEC’s Division of Examinations has issued a Risk Alert citing deficiencies with advisers sponsoring and participating in wrap programs.
The SEC has prioritized wrap programs because of examination deficiencies related to advisers’ fiduciary, disclosure and compliance obligations. The SEC faults wrap firms for failing to conduct best interest reviews both initially and ongoing to determine whether a wrap program is in the best interest of a client who may ultimately incur more costs than a non-wrap account (aka reverse churning) or pay undisclosed transaction charges (aka trading away). The SEC also criticizes disclosures that did not fully describe compensation arrangements and how supervised persons may be incentivized to recommend wrap programs and certain related transactions. Compliance programs often failed to address ongoing best interest reviews, trading away practices, custody implications, and portfolio manager due diligence. The staff offers several best practice recommendations including reviews that require direct information from the client, ongoing client communications, and specific disclosures about fees, expenses and conflicts.
We warned firms three years ago to reconsider wrap programs (see “10 Reasons Why the SEC Hates Wrap Programs”). We recommend that firms carefully weigh the revenue benefits of wrap programs against the regulatory, compliance and enforcement costs. We think that wrap programs will ultimately be swept into the same dustbin of financial products as real estate limited partnerships, long-short fund-of-funds, and market neutral funds.
Read Risk Alert here.