As breakaway advisors consider their move from a wirehouse to their own RIA, the question of whether to provide a wrap fee program will undoubtedly arise.
Before we get into the weeds, what is a wrap-fee program and what are its implications?
According to the SEC, a wrap fee generally involves an investment account in which the end client is charged a single, bundled fee for investment advice, brokerage (or custodial) services, administrative expenses and/or other fees. This fee can use asset-based pricing or transaction-based pricing. Either way, the RIA has to determine if the custodian should debit this fee directly from the client account, as a separate line item next to the RIA’s advisory fee, or charge one advisory fee that includes the custodial costs (hence the name “wrap fee”).
While most long-standing RIAs are used to passing on custodial expenses directly to clients, in the wirehouse world, clients typically only see one bundled fee. For most breakaway advisors, it is much easier to remain consistent with what their clients are accustomed to and keep all fees shown as one line item on their statement. This alone becomes the biggest benefit of having a wrap fee as an advisor aims to replicate the client experience they offered through the wirehouse.
The downside to having a wrap fee program is the added compliance oversight and administrative burden of monitoring all fees that are debited from client accounts. With a wrap fee, when the SEC audits the firm, they instinctively dissect the fee schedules much more sharply and question whether the fees are too high because they are part of a wrap program. As the SEC continues to scrutinize excessive or undisclosed fees, per Buffalo, N.Y.-based Peak Reps LLC co-owner Glenn Wiggle, RIAs must be extra cautious when calculating all fees in addition to the RIA’s wrap fee. He states, “One SEC concern, and rightfully so, is the wrap-fee programs that use third-party managers [where] brokerages incur additional trading costs that are not properly disclosed.” My firm, PFI Advisors has found, however, that as long as advisors are consistent in how they assign fees and can easily convey their rationale to an SEC examiner, they need not worry.
In my experience, after a few years (and perhaps a few SEC audits) have passed, advisors often conclude that clients don’t value the single bundled fee as much as they had originally anticipated, and the administrative burdens brought on by the wrap-fee program are more than they had initially anticipated. Advisors need to have a discussion with their clients to educate them that a custodial fee will be taken out of their account instead of bundled together in their advisory fee, and then they can continue business as usual.
While it may feel more convenient to start with a wrap-fee program for consistency of the client experience through a breakaway transition, advisors oftentimes dispose of the program when they feel comfortable having deeper fee discussions with their clients, alleviating any additional compliance and administrative burdens. Like any inquiry pertaining to setting up an RIA, advisors should consult with their legal counsel about the implications that are specific to their business.
As long as an advisor is building their new RIA to service their clients in the best way possible, questions like “to wrap or not to wrap” are minute details in the grander scheme of things. And with that, that’s a wrap!
This article originally appeared on Advisor Persepectives
Anna Maria Garcia oversees the formation of both office buildout and RIA infrastructure setup for breakaway advisors at PFI Advisors, an operations & technology consulting firm based in Hermosa Beach, CA. Her responsibilities run the gamut, from managing vendor relationships to coordinating office furniture and technology solutions for newly-formed RIAs.