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Wrap Sponsor Pays $97 Million for Inadequate Due Diligence

A large bank agreed to pay $97 Million, including a $30 Million fine, for compliance failures in its wrap programs.  The bank represented in marketing materials and Form ADV that it performed significant initial and ongoing manager due diligence.  However, according to the SEC, during a 5-year period from 2010 to 2015 (when it sold its wrap business), the respondent failed to perform such due diligence on several programs and managers because of a lack of internal resources and miscommunications between functions, even though the bank continued to charge significant account level fees to provide such services.  The respondent was also charged with overbilling clients as well as using more expensive mutual fund share classes when lower-fee classes were available.  As part of the settlement, the bank agreed to pay $3.5 Million in customer remediation and $49.7 Million in fee disgorgement in addition to interest and the fine.

OUR TAKE:  Over the last 2 years, the SEC has warned about wrap programs (See e.g. SEC 2017 Exam Priorities Letter) and has brought several cases against wrap sponsors alleging a number of violations: trading away, reverse churning, revenue sharing, mutual fund share classes.  In this case, the SEC adds a requirement that the fees charged must be commensurate with the due diligence services provided.  This analysis appears borrowed from mutual funds where Boards must ensure the reasonability of fees charged.  We recommend that compli-pros perform an internal sweep of wrap practices before the SEC shows up at the front door.

https://www.sec.gov/litigation/admin/2017/33-10355.pdf

Wrap Sponsor Fined for Failing to Monitor Trading Away Practices

The SEC fined and censured a wrap fee sponsor for failing to provide sufficient trading away information to financial advisers and their clients.  The wrap program’s third-party sub-advisers had full discretion to direct trades to any broker, but a program client would only be charged additional fees and commissions if a sub-adviser chose a broker other than the respondent’s affiliate.  According to the SEC, the sponsor discovered that many of the sub-advisers placed a majority of trades with third-party brokers.  The SEC faults the program sponsor for failing “to inform its clients when they have incurred these additional trading away costs or provide its clients with the amount of the additional trading away costs.”  As a result neither the clients nor their financial advisers could assess suitability or best execution.  The SEC found that the wrap sponsor violated the compliance rule (206(4)-7) for failing to implement reasonable policies and procedures to monitor brokerage practices and costs.

OUR TAKE: The SEC will scrutinize wrap programs and other sub-advisory relationships to ensure proper supervision and full transparency to clients.  It is noteworthy that the SEC is concerned that the clients didn’t have sufficient information to make an assessment about execution quality and suitability, but the SEC did the not allege the clients failed to receive best execution.

https://www.sec.gov/litigation/admin/2017/ia-4665.pdf