On May 12, 2020, the Securities and Exchange Commission (“SEC”) announced that Morgan Stanley Smith Barney (“MSSB”) agreed to settle charges that it provided misleading information regarding transaction costs and services to retail clients in its wrap program for the period from 2012 to 2017.
Without admitting or denying wrongdoing, MSSB will be contributing a total of $5 million to a fund specifically created for clients who were harmed by the firm’s practices.[1]
Read the full SEC Press Release Here.
Background on the SEC’s Order
MSSB offers wrap fee programs to retail clients that combine their advisory fee and brokerage fees into one fee or “wrap fee.” MSSB’s wrap fee program allowed its clients to select a wrap manager that acts as a sub-adviser for the client’s account on a discretionary basis.
MSSB’s marketing materials, Form ADV Appendix (“Wrap Fee Brochure”), and on-boarding documents highlighted MSSB’s transparent fee structure and MSSB Financial Advisors touted the transparency of the wrap fee program to their clients.
However, the SEC’s order found that MSSB had been negligent in failing to disclose additional costs to retail customers when the wrap managers “traded away” i.e. used brokers other than MSSB to execute trades for client accounts. MSSB was aware of the additional transaction costs and understood that some wrap managers would only direct smaller, maintenance-based trades to MSSB.
While the Form ADV and the management agreements did indicate that some trading costs would not be covered if the wrap manager directed the trade away from MSSB, MSSB did not disclose how much those transaction costs were and how those costs were passed onto the client.
In turn, some, but not all, wrap managers executed large trades with additional transaction costs that were not covered by MSSB’s wrap fee, according to the order. Those costs were embedded in security prices and were not made apparent to MSSB’s wrap fee clients.
Lastly, according to the order, MSSB failed to adopt policies and procedures reasonably designed to prevent violation of the Investment Advisers Act of 1940 (the “Advisers Act”).
Specifically, MSSB failed to create policies and procedures (“P&Ps”) designed to address trading away in wrap fee accounts, monitoring trade execution costs and services, disclosure of additional trading costs for wrap fee clients, and P&Ps that prevented wrap managers from trading away with MSSB affiliates where MSSB would in turn be receiving fees for trades in addition to the wrap fee it was already charging its clients.
What Should I Consider When Evaluating My Disclosures and P&Ps for My Wrap Fee Program?
Investment advisers need to ensure that their Wrap Fee Brochures, Form CRS, marketing materials, and investment management agreements accurately describe additional costs that will be incurred by the client. As indicated above, transparency is paramount for a client to fully understand all of the costs that are both covered and not covered by the wrap fee program.
Investment advisers should review their disclosures to make sure that they disclose all costs that fall outside of their wrap fees, especially if the wrap managers are trading away portions of the clients’ accounts.
Additionally, if any investment advisers use broker-dealer affiliates to execute trades, this conflict of interest needs to be disclosed to the client so that the client can understand that the adviser has an interest in directing trades to the affiliate.
Lastly, investment advisers should review their P&Ps to ensure that they address disclosure of conflicts of interest, advisory fees, as well as monitoring best execution and trade management.
As noted above, a failure to maintain adequate disclosures and P&Ps can result in significant fines and reputational damage that could have a lasting impact on a firm’s ability to conduct business.
How Can You Help Me with Evaluating My Disclosures and P&Ps for My Wrap Fee Program?
Jacko Law Group can help with reviewing your firm’s Form ADV, CRS, marketing materials, and investment management agreements to ensure that your disclosures are accurate, up-to-date, and are transparent when disclosing wrap fees. Additionally, we can assist you with evaluating and revising your P&Ps to better address conflicts of interest, advisory fees, and best execution and trade management. Our team of attorneys will use our extensive experience to ask detailed questions designed to determine if your whistleblower program is thorough, accurate, and up to date.
[1] “SEC Charges Morgan Stanley Smith Barney With Providing Misleading Information to Retail Clients.” SEC.gov, U.S. Securities and Exchange Commission, 12 May 2020, www.sec.gov/news/press-release/2020-109.
