The SEC fined a wrap sponsor and ordered it to enhance its policies and procedures in connection with failures to evaluate and disclose trading away practices by third party portfolio managers. The SEC, which reviewed the firm’s practices back to 2008, asserts that 40% of the portfolio managers stepped-out trades to non-participating brokers, resulting in additional costs to the wrap client. The SEC faults the sponsor for neglecting to (i) provide historical trading away information about the portfolio managers to participating advisers so that they could conduct adequate suitability reviews and (ii) disclose the costs of trading away practices. The SEC charges violations of the compliance rule (206(4)-7) for failing to adopt reasonable policies and procedures.
OUR TAKE: We have warned that the SEC does not like wrap programs. If your firm insists on operating a wrap program, we would recommend a strict policy against trading away with a non-participating broker-dealer, unless the portfolio manager can document the execution benefits on a trade-by-trade basis. Of course, the wrap sponsor must disclose the trading away information as soon as possible to participating RIAs and wrap clients.