Many registered investment advisers, through either affiliated or unaffiliated broker/dealer firms, develop and implement individualized money management programs. These programs can be referred to by several different names such as asset allocation programs, asset management programs, investment management programs, mini-accounts, and separately managed accounts. Regardless of the name used to describe a program, registered investment adviser firms must analyze their programs to determine if the program falls under the U.S. Securities and Exchange Commission’s (SEC) definition of “wrap-fee program”. Investment advisory programs meeting the definition of wrap-fee program are subject to additional disclosure requirements under Rule 204-3(f) of the Investment Advisers Act of 1940.
The following information is intended to provide guidance and a general overview regarding some of the more common issues relating to wrap-fee program disclosure issues and Rule 204-3(f). However, this webpage is not intended to be an all-encompassing analysis of wrap-fee program issues, and you should not solely rely on the contents of this page to determine if your registered investment adviser is the sponsor of a wrap-fee program. For an individualized consultation regarding the programs offered by your firm, please contact us to find out more about our Form ADV Part 2 Appendix 1 Wrap-Fee Disclosure Brochure consultation services.
Rule 204-3(g)(4) defines wrap fee program to be a “program under which any client is charged a specified fee or fees not based directly on transactions in a client’s account for investment advisory services (which may include portfolio management or advice concerning the selection of other advisers) and execution of client transactions.” (Italics have been added for emphasis.)
Under a typical wrap-fee program, a client will pay the sponsor a single fee (typically no more than 2.5% of the client’s total assets held within the account or under management) for management, brokerage, custody and other services provided under the program.
The key to understanding whether any one of your advisory services is a wrap-fee program is to analyze the brokerage fees charged to the client. If clients are charged for execution services based on a percentage of the overall client assets being managed, the program should likely be considered a wrap-fee program. If clients are provided advisory services, but are charged advisory fees along with transaction-based commissions, the program is likely not a wrap-fee program. In fact, the SEC has specifically stated that when transaction fees are charged to clients separately from the overall management fee charged to the client, such an arrangement is not a wrap-fee program. These types of programs have been referred to by the SEC as managed account programs and mutual fund asset allocation programs.
Other parties may also receive a portion of the client’s overall management fee. For example, a program can allow the portfolio manager to select one or more other money managers. Each money manager selected for the client receives a portion of the client’s fee for managing a portion of the client’s assets. Another example involves the ability for outside or unaffiliated registered investment advisers to act as portfolio managers or solicitors of the program. Under these arrangements, the outside registered investment adviser also receives a portion of the client’s overall management fee.
Appendix 1 is the disclosure brochure for wrap-fee programs. Under Rule 204-3(f)(1), a registered investment adviser that is compensated under a wrap-fee program for sponsoring, organizing, or administering a wrap-fee program, or for providing advice to clients under the wrap-fee program, must provide clients Appendix 1 of Form ADV Part 2A. Appendix 1 must be provided to clients in lieu of providing the registered investment adviser’s Form ADV Part 2A. Therefore, Appendix 1 is a completely separate document from Part 2A of Form ADV.
While considered separate documents, Part 2A of Form ADV and Appendix 1 will contain similar language and details. Appendix 1 must contain specific information about the wrap-fee program. It does not need to contain information regarding other programs offered by the registered investment adviser, such as information which must be contained in Part 2A of Form ADV. A registered investment adviser must provide enough information to meet the minimum requirements listed in the instructions to Appendix 1.
According to the instructions, the Appendix 1 must contain a cover page and table of contents. Other requirements include providing a description of the fees charged under the program, a description of the portion of fees provided to persons providing services under the program, and the services provided. Conflicts of interest and other material arrangements must also be disclosed in Appendix 1. Click here to access the instructions of Appendix 1.
Sponsors of wrap-fee programs may use the same Appendix 1 brochure to disclose multiple programs offered by the firm. When a firm uses only one brochure per program, disclosure must be included that the firm sponsors other wrap-fee programs described in separate brochures.
The registered investment adviser responsible for sponsoring and administering the program must prepare Appendix 1. Usually the sponsor of a wrap-fee program will also be registered as a broker/dealer or affiliated with a registered broker/dealer. However, independent registered investment advisors also sponsor wrap-fee programs through unaffiliated broker/dealers such as discount broker/dealers.
Because there may be several entities or intermediaries involved in a wrap-fee program, the responsibility to provide the brochure can be confusing. Ultimately, the sponsor must ensure all clients with an account in its program have received a copy of the brochure. However, the sponsor does not have to deliver the brochure. The sponsor registered investment adviser is not required to furnish the brochure if another registered investment adviser is required to furnish and does furnish the disclosure brochure to clients. Clients will typically acknowledge their receipt of the brochure in the program contract or in a separate Appendix 1 receipt.
Many wrap-fee programs are structured so that other registered investment advisers can serve as portfolio managers or solicitors of the wrap-fee program. It is these registered investment advisors that will have direct contact with clients of the program and are in the best position to fulfill the initial Appendix 1 delivery requirements. For wrap-fee programs with written client agreements, typically the Appendix 1 brochure is provided at the same time the written client agreement is signed by the client. In most situations the portfolio manager or solicitor is responsible for the execution of the agreement and therefore also responsible for delivering the brochure.
It is important to note the Appendix 1 is considered the disclosure brochure for the sponsor of the program only. It does not suffice as the disclosure brochure for the portfolio managers, solicitors, or other entities that may be involved in the program. Therefore, registered investment advisers that participate in a wrap-fee program sponsored by a separate registered investment adviser must still provide their own Form ADV Part 2.
Depending on the investments recommended within a wrap-fee program, clients may be required to receive other disclosure brochures. For example, if the wrap-fee program allows the portfolio manager to select from a pool of other money managers registered as investment advisers, clients must receive the selected money manager’s Form ADV Part 2.
At least annually, the Appendix 1 must be offered to all participants in the wrap-fee program. This rule is identical to the requirement that all registered investment advisers offer their Form ADV Part 2 annually. The sponsor of the wrap-fee program is generally in charge of delivering the annual offer.
Timing requirements for delivering Appendix 1 are identical to the delivery requirements for Part 2A of Form ADV. The Appendix 1 must be provided to clients prior to or at the time of entering into a written or oral agreement to participate in the program.
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