When it comes to Securities and Exchange Commission advisor examinations, the fees that advisors are charging clients on certain investments continue to top the list of red flags, commission officials said today.

Advisors should expect examiners to drill down into the fees they’re charging clients, the adequacy of their fee disclosures and how investment choices impact investors’ bottom lines.

Those insights came from current and former SEC officials during the 21st Annual IA Compliance conference in Washington, D.C., today.

“Every dollar an investor doesn’t get to leave in the market for compounding will hit their wallet,” said Dan Kahl, deputy director of the SEC Office of Compliance, Inspections and Examinations.

The SEC’s goal is to ensure that advisors are choosing the lowest-cost, most appropriate investments for investors, said Kahl. Advisors must clearly disclose any higher-cost investments they have chosen—or if their clients have legacy investments that are higher-priced than other options.

“This is an area where it is easy for us to test, run spreadsheets and come up with deltas that show us where clients are being overcharged,” said Kahl. When overcharges are found, SEC examiners will “expect you to make clients whole,” he added.

It is critical for advisors to ensure that they’re following client agreement contracts regarding their billing and controls “because if we’re there, we’ll do audit work ourselves,” Kahl said.

Voluntary Settlement Program

Despite more than a year of publicity, the SEC is continuing to see problems with firms still using higher-cost mutual fund share classes when less expensive shares are available, often without disclosing the less pricey options to clients, the SEC official said. This is despite the agency’s voluntary share class settlement program, which allowed firms to self-report transgressions to the SEC and make clients whole in exchange for an elimination in penalties.

“We allowed firms to come in and ’fess up, but we’ll continue to be looking at whether you’re disclosing this or not,” said Kahl.

The SEC has yet to release results of the voluntary share class settlement, but said the SEC’s office of compliance is still very much involved in making enforcement referrals in the area.

Kahl also told audience members that the agency is unlikely to go lightly on firms that opted not to make voluntary disclosures, and it’s more likely it would make enforcement referrals in its efforts to cleanse firms of higher priced share classes.

Douglas Scheidt, the former associate director and chief counsel in the SEC Division of Investment Management, said he has no doubt that firms have spent sleepless nights deciding whether to self-report their share class violations to the agency.

“If I were working with a firm, I’d say first of all, ‘Clean up your shop, make clients whole and weigh the differences between laying down and getting a sure enforcement action, or if the SEC finds you’ve taken care of clients the [agency] may just move on,’” Scheidt said.

Compliance consultants at the conference said the SEC is sending out letters even to those firms whose clients came in the door already holding legacy positions in higher-priced share classes. Sometimes, clients may not want to sell their higher-priced shares because of the taxes the sales would trigger.

“These firms are getting the same hammer, when they’re not getting any of the benefits and didn’t sell the investment in the first place,” one consultant said.

Still, if those advisors dealing with legacy investments are nonetheless putting more client dollars into those same shares during normal quarterly reallocations, they will have a problem, said Jennifer Suellentrop, vice president and associate general counsel at Fidelity Investments.

In these cases, at the very least “make sure you provide disclosure that explains the various options and costs and get client consent,” Scheidt said.

Kahl said mutual fund break points—discounts that advisory firms negotiate with fund companies—also continue to be a red flag for examiners.

In the end, advisors should not only be educating clients about the fees and choices they have; they should be able to explain clearly why they’re putting investors into wrap fee programs, which charge advisory fees instead of commissions.

“We’ve seen lots of problem with regard to firms still charging additional brokerage commission to clients who have wrap fee accounts,” Kahl said.