Over the last three posts to the blog (overview, performance, promoters), we’ve interrupted our previous schedule to provide insight into the U.S. Securities and Exchange Commission’s (“SEC”) recently adopted changes to the rules governing investment adviser marketing and advertising. In today’s post, we resume our previous topic thread focusing on the necessary components of an investment adviser’s compliance program. Specifically, we’re going to examine valuation and fee assessments.

We’ve previously discussed that Advisers Act Rule 206(4)-7 (the “Compliance Rule”) requires that every investment adviser adopt and implement written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act of 1940, as amended and its rules. One of the requirements noted in the adopting release for the Compliance Rule was that all advisers must adopt policies and procedures to value client holdings and assess fees based on those valuations.

As a robo-adviser, you may read this requirement and assume that because you don’t hold securities on behalf of your clients, valuation isn’t an issue for your firm. While this may be the case, attention is still required to ensure compliance. As noted above, your compliance program must contain policies and procedures related to the valuation of client holdings. Your firm’s policy may simply recite that it does not hold client securities and that those securities are valued by the appropriate client account custodian. Attention to valuation may be especially important if your firm provides investment advice on hard to value asset classes, such as cryptocurrency or asset-backed securities. If you are in this situation, we highly recommend working with a legal or compliance professional to draft your policies and procedures.

The second aspect of this necessary compliance component is fee assessment. Fee assessment is tied to valuation because the fee a client is paying to most robo-advisory firms is derived from the value of the client’s assets under management at the firm. Any instance in which a client is paying for investment advisory services carries a high potential for SEC regulatory scrutiny. While there may be a variety of fee arrangements utilized by robo-advisory firms, the key is that your compliance program contains policies and procedures that require regular and reliable testing of your fee arrangement to ensure that clients are accurately charged in accordance to the terms of their agreement with your firm.

We hope you’ve enjoyed our series on critical compliance components. In our next blog, Marc will begin a new chapter in which we review the SEC Division of Examinations’ 2021 exam priorities and their applicability to robo-advisory firms. We thank you for your continued readership and hope that you’ll check back then.