We want to take the opportunity to wish all of our clients, friends, and colleagues the absolute best year ahead. As we move into 2022, here are some of the things front and center on the SEC’s radar that we have been thinking about.

Fee Billing:

The Division of Examinations’ observations on fee calculations should have firms re-examining their billing practices, testing calculations, and disclosures in key documents.  Some of the issues highlighted by the SEC include:

• • Inaccurate advisory fee calculations due to errors such as incorrect rates, double-billing, missed breakpoints, and incorrect valuations such as including assets that were disclosed or agreed to be excluded.
• • Failure to refund prepaid fees on terminated accounts or prorate fees for new accounts where advisers were obligated do so by disclosure or agreement.
• • Failure to correctly apply fee breakpoints or combined account values (“householding”), resulting in higher fees to clients.
• • Inaccurate or incomplete disclosures in (or among) Form ADV, client agreements, and/or other governing documents. This includes inaccurate disclosure regarding timing and basis of fee billing, as well as failures to disclose other fee-related topics, including minimum fees, eligibility for householding or other discounts, and admin or other applicable fees.

Firms should ensure that their policies and procedures address the processes for computing, billing, and testing of advisory fees as well as address material advisory fee components, as applicable:

• • valuation of illiquid assets included in the calculation of advisory fees;
• • fee offsets, such as those offered for 12b-1 fees;
• • reimbursements prepaid fees for terminated accounts;
• • prorating fees for additions or withdrawals in accounts;
• • family account aggregation (householding);
• • the application of breakpoints for fee calculations; and
• • handling of client queries or disagreements.

If you have any specific way of calculating fees that may be unclear to clients, be sure that you clarify this to clients, include the detail in your policies and procedures, adopt controls around the process, and test it. Examples could range from disclosing and testing the basis of fee calculations – such as end of period versus average daily balance – to reliance on valuation estimates for illiquid holdings.

WhatsApp Use Resulted in $200 Million Penalty

On December, 17 2021 the SEC issued an order resulting from an administrative proceeding against J.P. Morgan Securities LLC (JPM) for failures to maintain and preserve electronic communications. This is illustrative of the issues firm face. As described in the SEC’s order, between 2018 through 2020, JPM employees communicated about business matters on their personal devices using personal email, text messages, and the WhatsApp application. These communications were not captured and preserved by the firm as required, and violations included citing supervisors and directors. Ultimately JPMS admitted to the findings and agreed to pay a $125 million penalty ($75 million to CFTC) in addition to making improvements to its compliance policies and procedures to settle the matter.

While JPM’s case may be on the extreme side, there remains among many firms the potential for employees to adopt a mode of communication that is outside a firm’s infrastructure for capturing and preserving business communications and other records.  This has been of particular concern in the COVID era, as firms and employees have had to adapt to remote work environments – adopting new technologies along the way.  With this in mind, we’ve been asking some specific questions in periodic testing:

• • Do policies and procedures explicitly identify approved and prohibited media for business communications?
• • Do policies and procedures provide examples of appropriate responses to business queries initiated on devices or applications beyond those approved by the firm?
• • Does the firm have a process for adapting its practices to clients’ demand and new technologies?
• • Are there procedures in place designed to identify communications in use outside those approved by the firm?
• • Are supervised persons providing specific attestations in higher-risk areas that require individual adherence and are harder for the CCO to review?

New Advertising Rule

The new advertising rule became effective on May 4, 2021 with a compliance date of November 4, 2022. The new rule made substantial changes, in particular to the treatment of prohibited practices, particularly the use of testimonials, and use of performance.  In addition to establishing presentation standards akin to those applicable to mutual funds (1-year, 5-year, and 10-years or since inception), the rule has implications for extracted, successor, and hypothetical performance.

As a follow-up to the new rule, over 100 Staff statements and No Action Letters were modified or withdrawn in the categories of Advertising and Solicitation. Of the 66 letters affecting Advertising, 60 were withdrawn -including the performance stalwart Clover Capital Management NAL (October 28, 1986).  Other guidance letters that may be cited in policies include the Franklin Management (Dec. 10, 1998), Investment Council Association (Mar. 1, 2004), and TCW Group (Nov. 8, 2008) letters relating to acceptable use of past specific recommendations; the Sept. 23, 1988 Staff letter to the Investment Company Institute regarding the use of gross performance in institutional or high-net-worth (one-on-one) presentations; and the J.P. Morgan Investment Management (May 7, 1996) letter related to the deduction of model fees (at maximum applicable rate) in calculating performance used in client presentations.

Many of these have been references in firms’ compliance manuals for years, whether or not they are named. Firms should be sure to update policies and procedures to reflect the requirements of the amended Rule and, in particular, check their reliance on specific guidance versus the SEC’s Modified or Withdrawn Staff Statements to ensure that any practices reliant on withdrawn guidance is supported by the Rule, or the practices themselves are updated.

Other areas we are being sure to include in our reviews include cryptocurrency, ESG, SPACs, “gamification”.

Reach out to us if we can assist you with your compliance questions.