Untangling the wrap-fee rules.

• Author: McGuire, W. John
• Position: Investment Management

With wrap-fee programs proliferating at every turn, the SEC has decided it's high time for some regulatory sobriety. Here's a look at the commission's proposed regulations.

Recently, the Chicago Tribune reported that institutional and individual investors have poured an estimated $90 billion into wrap-fee programs. More conservative estimates place the number at $65 billion, but either way, this is still a major jump from the estimated $40 billion invested in 1992. One thing's for certain: Wrap-fee programs are the fastest-growing investment medium in the United States.

Large companies have always been the biggest wrap-fee customers, but now that smaller investors have begun to enter the picture, wrap-fee programs have attracted the attention of the Securities and Exchange Commission, which wants to make sure all wrap-fee clients receive proper disclosure and understand the services they're buying. If your company uses these programs, you should know that the SEC has proposed amendments to regulations in the Investment Advisers Act of 1940.

Under the proposal, investment advisers who are wrap-fee sponsors would have to give their current and prospective wrap-fee clients a concise brochure, which would spell out important information about the costs and services of the wrap-fee program. This brochure would take the place of the disclosure document that all investment advisers now have to give their clients.

By definition, a wrap-fee program bundles or wraps investment advice, custody and execution services under one contract for a single fee. Generally, these programs involve one or more investment advisers and a broker-dealer that provide the client with portfolio management and asset-allocation services, maintain custody of the client's funds and securities and execute client securities transactions. The fee is a flat annual sum based on the amount of assets under management (in contrast to separate fees for each transaction), and the price includes brokerage commissions based on the amount or type of securities transactions executed for a given account.

For companies with actively trading accounts, the main advantage of a wrap-fee program is not having to pay commissions on each transaction. The wrap fee also eliminates any incentive for brokers to "churn" accounts, since they aren't compensated based on the number of securities transactions. But for accounts that aren't actively traded, the program may impose excessive costs. Plus...