While no one likes having to conduct an internal audit, it is imperative that RIAs confirm (on a regular basis) that the fee rates written on their client contracts match those loaded in their billing software, be that their reporting software or some other invoicing system. For those up to the challenge, at the end of the fee auditing process lies opportunity: this process provides an intimate knowledge of one’s client base and a power over their profitability to those daring enough to complete this venture. The successful fee audit should be conducted with a logical methodology, be performed on a set timeline, and lead to specific follow up conversations with firm leadership and perhaps even with the end clients themselves.
Methodology
When conducting this analysis, it is essential to document key aspects of both the Investment Advisory Agreement and the fee rate assigned in either the reporting provider or invoicing system. Key information to note would be: ensuring that all signatures are in their proper places (including all clients related to that specific contract, as well as the counter signature of the advisor), the agreement on file is the most recent version of the firm’s client agreement, and the exact wording of the fee rate in the agreement, including fee methodology. This is crucial as, while some firms maintain the same agreement, most firms update agreements with new language, change standard fee schedules, impose, or change the firm’s minimum fee, or even change billing methodology over time. Similarly, it is important to document all aspects of the fee schedule that the client is assigned in the billing system, including what the specific fee rate is within that schedule, the billing methodology applied to it, and the minimum fee (if applicable).
Timeline
There are two different ways to conduct this audit – there is a smaller, random sampling style audit (such as how the SEC would conduct an audit of fee rates), and there is a more comprehensive, full book of business audit. The former, according to Andrew Melnick of Murphy & McGonigle, should be conducted, “at least annually” and be a review of a select set of accounts, “across the spectrum of types of accounts.” This annual audit is typically manageable in terms of time investment and can be conducted alongside other annualized firm review tasks. This timetable is helpful as it can assist in guiding conversations in client annual reviews, specifically around any updates that may need to be made to their agreement, or the more difficult conversations that could arise from situations like accidental under or overcharges.
The latter analysis is typically a larger under-taking that may tie up a considerable amount of time from various team members, depending on how accessible the data is and what format it comes in. This full analysis is typically only done once every few years and is usually instigated by some key event such as the preparation for a sale (to show the acquirer that their contracts match the fees they charge their clients), or discovery of a major issue uncovered by the annual random sampling audit.
Follow Up Conversations
Once this analysis is conducted by an RIA’s operations or other back-office team, it is important that this consolidation of information be in a format that is digestible by management. This is to ensure the right conversations are had with the specific individuals that could have follow-ups from the insights that come from this analysis – be that the CCO, COO, or the advisory team. To best guide higher level strategic conversations, it is best to present this data visually via a dashboard or series of charts and graphs so that the overall health of the firm’s application of proper fee rates can be assessed. From there, the specific issues such as list of clients that have actionable issues (such as the need for additional signatures or discussions about past accidental under- or over- charges) can be distributed to the proper relationship owners to be discussed in a manner sensitive to the nature of each specific relationship. Finally, once each discrepancy has been addressed, it is incumbent upon the back-office team to ensure that all records are updated accordingly.
While this may seem like a very long-term project with follow-through that could potentially continue out across several weeks, these action items truly present a powerful opportunity for the firm to not only amend whatever errors have occurred, but also confirm the RIA’s commitment to clients that the firm is diligent and transparent in the way they handle their clients’ financial lives.