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THE CNAI RMAN

UNITED STATES

SECURITIES AND EXCHANGE COMMISSIOf~{!

WASHINGTON, D.C. 20549

The Honorable John D. Dingell

Chairman

Committee on Energy and Commerce

U.S. House of Representatives

Washington, D.C. 20515

My 4, 1992 -~ .~

CH`AMRMAN'S OFFICE

MA(LED

MAY 0 4 1992

$i~nec~ bys.

Dear Chairman Dingell: }

I appreciate receiving your follow-up letter of April 14;

1992, regarding wrap fee arrangements and their comparison to

mini-accounts. The Commission is aware of the increasing

popularity of these arrangements, which has been demonstrated by

the large amounts of money flowing from more traditional

brokerage accounts into wrap fee accounts.

As I discussed in my letter of April 7, 1992, these

arrangements raise issues of best execution and adequate

disclosure to investors. For example, when an investment adviser

has discretion over a client's account it generally has a duty to

obtain the best price end execution for each transaction. Some

wrap fee programs require the adviser to use the program's

broker-dealer. Where a client directs the adviser to use a

particular broker-dealer, the adviser only has a duty to disclose

that the client will be foregoing any benefit from savings on

execution costs that the adviser could otherwise obtain through,

for example, negotiating volume discounts on batched orders.

Other wrap fee accounts permit an adviser to use broker-dealers

outside of the program. In these programs, an adviser still has

a duty to obtain best execution and should use a broker outside

the program if the total of the outside broker's price and

commission is less than the program broker's price. Moreover,

given the level of fees charged in wrap accounts, an investment

adviser or broker-dealer should consider whether a client is

better served by paying separately for advisory and brokerage

services.

In addition, as in a mini-account program, an investment

adviser in a wrap fee arrangement could make similar

recommendations for various clients. In the mini-account aria,

to assure an adequate level of individualization, the Commission

~ See Mark Bailey and Co., Investment Advisers Act Rel. No.

1105 (Feb. 24, 1988).
The Honorable John D. Dingell

Page 2

identified as relevant the adviser's provision of continuous

advice as to the investment of funds on the basis of the

individual needs of each client, the contact between the adviser

and client, a client's possession of the indicia of ownership of

the funds in its account, a client's authority and opportunity to

instruct its adviser to refrain from purchasing certain

securities, and the adviser's regular review of a client's

financial status and objectives. ~ Our review of wrap fee

programs has shown that these program providers furnish clients

with a level of individualization similar to that given to miniaccount clients. In fact, many wrap fee providers consider their

individualized services a strung selling point. Further, some

mini-account providers charge a wrap fee. The Division of

Investment Management has required these providers to disclose to

potential clients that the wrap fee may be higher than the fee

charged by other advisers for the same services.

Wrap fee arrangements differ from other arrangements

involving a referral fee, because the adviser and the broker both

provide significant services after the account has been

established. The adviser decides which securities to purchase

for the account and the timing of the purchases. The broker

advises the client on which advisers would be appropriate based

on the client's expectations, monitors the performance of the

chosen advisers, and executes the transactions on behalf of the

account. The Divisions of Investment Management and Market

Regulation have not encountered any problems with referral fees

peculiar to wrap fee accounts.

In addition, if a registered investment adviser pays a

referral fee in connection with a wrap fee program, the adviser

would be subject to Rule 206(4)-3 under the Advisers Act, the

cash solicitation rule. We believe that some investment advisers

in wrap fee programs pay referral fees, and to the best of our

knowledge these advisers comply with the Rule. In fact, in the

mini-account area, the staff has conditioned no-action relief, in

part, on a representation that the adviser will comply with the

Rule. Rule 206(4)-3 requires a written agreement between the

adviser and the solicitor, and requires the solicitor to give the

prospective client a copy of the adviser's brochure ~ and a

~/ Investment Company Act Rel. No. 11391 (Oct. 10, 1980)

(proposing Rule 3a-4).

Rule 204-3 under the Advisers Act requires registered

investment advisers to give prospective clients a written

disclosure statement describing, among other things, the

adviser's services and fees, educational and business

background, other business activities, and affiliations with
The Honorable John D. Dingell

Page 3

separate disclosure document describing the solicitation

agreement.

Finally, as I stated in my earlier letter, there have been a

number of inspections of providers of wrap fee programs. We have

not discovered any broker-dealers or investment advisers

participating in these programs who were not properly registered

with the Commission.

Please be assured that we intend to continue monitoring wrap

fee arrangements. I hope this letter addresses your concerns.

Please let me know if I can be of any further assistance.

Sin erel

,~,~ ...

Richard C. Breeden

Chairman

other securities professionals.
'NlO.lN ::. . ... .. ..... .. .... ..

JNf HUNDNEO SECONO CONGIIE55

~ JONN D. DINGEL4 MICHIGAN. CHAIRMAN

J~"'~ N. SCMEUE0. NEON YOl~K NORMAN F. LENT, NEW YOFK

WA%MAN. CALIFORNIA CARGOS J. MOORHEAD. CALIFORNIA

>HARP, INDIANA MATTHEW J. RIHALDO, NEW JENSEY

J. MARKEY, MASSACHUSfT75 N~~~LUA E DANNEMEYEit, CALIFOIWU

i WASNIHOTOH DON WTYER, ►ENNSYLVANIA

WtWSS GOWNS. IWNOIS THOMAS J. BULEY, JR., VIRGINIA

MIKE CYM/J~ OKLAHOAU JACK FIELDS. TIXAS

WJ. "!ILLY" TAUZIN, LOUISIANA MICHAEL G. O7(IEY, OHIO

IION WYDEN. OREGON MICHAEL BIURAK15, fiO~IDA

Ml1M M. MALL, TEAS OAM 6CHAEFEf~ COLOIUDO

DpINIS E ECKMT, OMq JOE 6ARTON, TF~(AS

SILL 1UCHAROSON, NEW MFJGCO SONNY CALLANAH, ALABAMA

JIM lUTTHtY, KANSAS ALFA( MCMIIUN, NORTH CAROLINA

aEMY `IKORSKI, MINNESOTA J. DENNIS HA6TENi, IWNOiS

JOMN ~MAIlT, TEAS CLYDE C HOLLOWAY, LAUISUNlI

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pC11AM K LEMMAN. G1l.IFORNIA

CLMlOE IIANYS. AIMAMA

JOHN E. ORtAN00. QrtEF OF fTAFF

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~.~. ~ou~e of ~ieprcgentatibeg

committee on ~nergp anb ~Cott~mercc

doom 2125. ~npbura ~uugc office ~uitDing

~a~~jittgton, ~~ 20515-61 t5

April 14, 1992

" ~ -~

V

APR 1 7 ~~

The Honorable Richard C. Breeden ~q~lative l~ffait"

Chairman p~cP ~f tr^ ~`~

Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 20549

Dear Chairman Breeden:

I appreciate receiving your letter of April 7, 1992 outlining the actions of the Divisions of Investment Management and

Market Regulation with respect to various wrap fee programs.

However, industry experts (See "Mutual Fund Distribution:

The 1980-82 Revolution And A Decade of Evolution" by Allan S.

Mostoff, 1992 Mutual Funds And Investment Management Conference

Materials, at I-38) advise that wrap fee arrangements raise at

least the following regulatory concerns:

whether the brokerage component of the wrap fee is

appropriate for the particular type of account and

customer;

whether the total fee is in line with the aggregate of

fees otherwise payable for individual component

services;

whether the wrap fee involves a disguised referral fee

or "kickback" arrangement;

whether recommendations made to participants in wrap

fee programs are individualized or, instead, raise

"mini-account" questions;

what standards should be applicable to selection of

executing brokers and determining best execution;

whether various service providers are properly qualified and registered to provide that service; and

whether the disclosure to clients is adequate.
The Honorable Richard C. Breeden

April 14, 1992

Page 2

I would appreciate assurances that the Commission is aware

of and focusing on these issues in the studies, examinations,

inspections, and possible form revisions discussed in your

letter. Any "kickback" arrangements are of particular concern

because they raise the specter of a revival of illegal "give-ups'"

that flourished under fixed commission rates. See Report of

Special Study of the Securities Markets of The Securities and

Exchange Commission Part 2, House Document No. 95, Pt. 2 (July

17, 1963).

Thank you for your coo nd attention to this matter.

rely,

JOHN D. DINGELL

CHAIRMAN

cc: The Honorable Edward J. Markey

The Honorable Norman F. Lent

The Honorable Matthew J. Rinaldo
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THE CHAIRMAN

UNITED STATES

SECURITIES AND EXCHANGE CAMMIS~~nN

WASHINGTON, D.C. 20549

The Honorable John D. Dingell

Chairman

Committee on Energy and Commerce

U.S. House of Representatives

Washington, D.C. 20515

d

April 7, 1992

C~]'A1R1VfAN'S OFFICE

MAIL;Ep

YQ~R - 7 1992

Dear Chairman Dingell:

This letter is in response to your letter of February 39,

1992 concerning "wrap fee" accounts at U.S. securities firms.

You expressed particular interest in the amount and structure of

fees under these programs and the issues raised under the federal

securities laws.

Wrap fee programs often combine money management, brokerage,

custody, and other administrative ser~rices for a single fee based

on a percentage of assets under management. Wrap fee accounts

typically involve the provision of financial services by

investment advisers and broker-dealers with differing roles and •

responsibilities. Fees for wrap accounts investing in equity

securities can be 2 to 3 percent of assets, depending on the size

of the account.

The management and brokerage services provided as part of a

wrap fee program may be beneficial for some investors, but not

for others. In view of the relatively high level of fees, these

programs may not be suitable for advisory clients who are not

active traders. For some clients, paying separately for

brokerage and advisory services may be more suitable than a wrap

fee.

In addition to suitability, wrap fee programs raise the

issue of best execution. An adviser's ability to choose a

broker-dealer varies among wrap fee programs, and, therefore, the

extent of its duty of best execution also varies. However, when

an investment adviser has discretion over a client's account it

generally has a duty to obtain the best price and execution for

each transaction.

See, e•a•, Rule 206(3)-2 (c) under the Investment Advisers

Act; Soft Dollar Arrangements, Securities Exchange Act Rel.

No. 23170 (Apr. 23, 1986).
The Honorable John D. Dingell

Page 2

The Divisions of Investment Management and Market Regulation

have been studying the structure of various wrap fee programs and

examining how investment advisers and broker-dealers comply with

their responsibilities under the federal securities laws when

they participate in these programs. In addition, inspections of

wrap fee providers have been conducted that focus on both

investment advisers and broker-dealers.

The Division of Investment Management is also considering

the desirability of revisions to the investment adviser

registration form, Form ADV, in part because of the growing

number of advisers participating in wrap fee programs. Any such

revisions would require brokers (who must also register as

advisers) and advisers to disclose more fully their wrap fee

arrangements to clients and prospective clients.

I hope this letter addresses your concerns. Please let me

know if I can be of any further assistance.

Sincerely,

• C, ~

Richard C. Breeden

Chairman

Form ADV already requires applicants to describe their fee

schedule in detail, and the Advisers Act requires advisers

to provide that information to clients and prospective

clients.
ONE HUNDRED SECOND CONGNE55

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JpMN D OIN GEIL MICNI(.AN. CHAIRMAN

~~~wES N. SCNEUE~, NEW V011K g011MAN F. LENT. NfW YORK

A WA1cMAN, CALIFORNIA CARl05 J. MOONNEM. CAUFORMU.

. 6NAll/, M/MANA MATTHEW J. RINAIDO, N(N/ JE115FY

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MIKE S~NMt ORUHOMA .LACK FIELDS, TEXAS

w~ -aur twune, iaxsiu~~ MICHAEL G O%lEt, OHIO

RON WYDEN. OIIEGON MICHAEL lIIIMKiS, FLORIDA

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GERpY SIKOR6K1. MINNftOTA J. DENNIS NASTEPT. IILtNOiS

JOAN EMANT, TE%AS CLYDE C. NOIIOWAV. LOUISIANA

I4CK EOUCNEI~ VIRGINIA fRED UPYON. MICHIGAN

J1M COOPER TENMESSEE

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J. 110Y ROM/LANO. GEORGIA

THOMAS J. WANTON. NEW CORK

EUOLPHUS TOWNS. MEW YORK

C. TNOMAS MCMI~LEN, MAl1YWID

GERRY E. STUDS, MASSACHUSETTS

►ETER H. KOSTMA►E0. rENNSYLVAHIA

RICHARD N. LEMMAM, CA11f011NM

CUUDE MAAPoS. ALAlAMA

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JOMM M. CLOUGH,JR, STAFF OIRECT011

~.~. gouge of ~cprcgentatibcg

Committee on ~nergp ana commerce

itoom 2125, itapburn ~ougc ~[ticc ~uitaing

~agfjington. ~Q~ 20515

The Honorable Richard C. Breeden

Chairman

Securities and Exchange Commission

450 Fifth Street, N.",~.

Washington, D.C. 20549

Dear Chairman Breeden:

February 19, 1992

RE~fi:~i~D

by~7~~

FED ? Q i9g2'

~cgisiati~re tZif7~-

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Pursuant to Rules X and XI of the Rules of the U.S. House of

Representatives and our continuing oversight of securities and

exchanges, the Committee is examining the growth of wrap-fee

accounts at U.S. securities firms as underscored by a recent

study prepared by Samuel Thayer of Harbridge House inc. and Jeff

Coburn of the Secura Group.

Concerns have been raised about, among other things, the

amount and structure of the fees associated with these products.

Please advise us what issues these arrangements raise under the

federal securities laws and what the Commission is doing in

response to these developments. We would appreciate receiving

your response by the close of business on Friday, March 27, 1992.

Thank you for your' cooperation and attention to this

request . ,,,,,......,

cc: The Honorable Edward J. Markey

The Honorable Norman F. Lent

The Honorable Matthew J. Rinaldo

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