Just when you thought the Securities and Exchange Commission wasnt paying attention, the regulator is proving the brokers and asset managers wrong.
While the SEC has been busy talking about a Fiduciary Rule, a new Head of the Division of Trading and Markets and other headline grabbing items, it also is looking to more closely follow some of the more arcane aspects of trading – such as wrap fees and trading away disclosures.
Yes, the SEC is indeed paying attention and these esoteric, yet widespread practices. In recent months, one might have thought that the Commission has been relatively quiet on Wrap Fee Accounts, but that is simply not the case.
Why? Rumblings of abuses in this arcane part of the trading business have been surfacing and concerns are being voiced. Wrap account AUM, according to MMI, totaled $5.4 trillion as of the second quarter of this year.
Yes, $5.4 trillion.
And it affects the retail investor – the very person the SEC was created to protect from abuses. A Wrap Account is a retail account used by a broker to manage a customers portfolio for an all-inclusive annual fee based on assets under management. This fee generally covers all administrative, execution and management fees for the account. However, there can be cases where the execution occurs away from the broker and additional costs are incurred and paid by the customer.
Get the picture?
To that end, on September 25th of this year the SEC announced the formation of two new units, the Cyber Unit and Retail Strategy Task Force.
The Cyber Unit will focus on cyber-related misconduct such as market manipulation schemes, intrusions into retail accounts, cyber related threats to trading platforms as well as many other threats.
The Retail Strategy Task Force will focus on identifying large scale misconduct directly related to the retail investor. In a recent speech given by Stephanie Avakian, Co-Director, Division of Enforcement of the SEC, she outlined some of the issues that often involve widespread incidents of misconduct, such as charging inadequately disclosed fees and recommending and trading in wholly unsuitable strategies and products.
In relation to a comment directly related to Wrap Fee Disclosure, Avakian specifically sites the following as one of the issues the SEC continues to see:
Abuses in wrap-fee accounts, including failing to disclose the additional costs of trading away or trading through unaffiliated brokers,and purchasing alternative products that generate additional fees.
In the last 16 months at least one asset manager and three wrap fee sponsors have been fined by the SEC for their wrap fee disclosures, including their publicly disseminated language related to their trading away practices and additional costs incurred by their clients.
But what is trading away exactly?
Trading away is a term used when the wrap manager (sub advisor) trades away from the wrap sponsor (asset gatherer) when fulfilling their best execution requirements. Many times, the wrap manager pays their executing broker a commission or commission equivalent (markup/down) to affect the trade. It is this extra cost that must be disclosed to the end customer.
The guidance one must use in complying with the SECs disclosure requirements can be directly found in the findings of the Administrative Proceedings related to these three wrap sponsors and one asset manager.
And herein lies the problem – these extra costs arent always fully disclosed by wrap sponsors and/or wrap managers in the manner the SEC requires.
With the creation of the Retail Strategy Task Force, the SEC will be very focused on specific misconducts they have identified over the years as a threat to the retail investor. As a wrap manager or wrap sponsor, it is well worth reviewing your policies, procedures and public disclosures aligning them with the requirements as set forth by the SEC.
The entire October 26, 2017 speech by Stephanie Avakian can be accessed here:
Beyond acting as roadie for his two sons rock bands, Mark Viani is a thirty-two-year veteran of equity trading. He has spent the last 7 years running sell-side wrap post-trade execution businesses. For more information on the challenges of wrap trading, he can be reached at markviani1@gmail.com
