The SEC is following through on its promise to investigate use of these products, and advisers should take heed.
Wrap accounts, through which a portfolio of investments is managed for a bundled fee rather than individual trading commissions and other costs, aren't exactly new. They've been around for a few decades. But make no mistake, the Securities and Exchange Commission is examining these products — and advisers' use of them — with fresh eyes.
In fact, the industry regulator included wrap fee programs in its 2014 exam priorities under the category “New and Emerging Issues and Initiatives.”
That document, released in January, laid out the SEC's intention this year to take a closer look at advisers' recommendations of these products and whether they meet “fiduciary and contractual obligations to clients.” Notably, the document also mentions “related conflicts of interest.”
While an impetus for creating these products was to diminish the churning of accounts to boost trading commissions, in fact the opposite can be true. If holdings for a client are simple and activity is minimal, the additional cost for managed accounts — up to a few hundred basis points per year — cannot be justified.
The SEC is following through on its promise to investigate use of these products, and advisers should take heed. In Mark Schoeff Jr.'s Aug. 14 story, “SEC cracks down on wrap accounts,” Patrick J. Burns, an attorney who specializes in investment advisory compliance, warned in relation to these accounts, “It's definitely going to hit firms by surprise that that level of focus is being placed on just one issue.”
But should it be so surprising? The amount of assets in these accounts has grown phenomenally — reason enough to catch a regulator's eye. According to Cerulli Associates Inc., total managed-account assets hit $3.46 trillion in 2013, a 25% increase over their 2012 level of $2.76 trillion.
And the SEC has shown it means business. The latest instance was on Aug. 13, when it won a case against Benjamin Lee Grant, an investment adviser who faced charges that included improperly placing his clients' assets in wrap programs. Damages in the case are yet to be announced.
CLIENTS FIRST
“This case sends an important message to investment advisers that they must put the needs of their clients before their own,” Andrew Ceresney, director of the SEC's Division of Enforcement, said in a statement.
When advisers face the SEC at exam time, those who universally place clients in wrap accounts — regardless of suitability to individual circumstances — will find themselves on the hot seat. They will be given an “information request list” with 21 questions about use of the products, including account activity, transaction fees, best execution and client disclosures.
If you include wrap accounts among the products offered to clients, you'd better be sure you have the right answers at the ready.
