Wrap Fee Programs
Now that you understand both broker-dealer and investment adviser compensation models, wrap fee programs sit at the intersection, bundling advisory and brokerage services into a single fee.
Definition
- A wrap fee program is an advisory program under which a client pays a single, bundled ("wrap") fee that covers:
- Investment advisory services
- Brokerage execution
- Administrative expenses
- Instead of paying separate fees for advice and per-transaction commissions, the client pays one all-inclusive fee (typically a percentage of assets under management (AUM))
Regulatory Treatment
- Wrap fee programs are regulated as investment advisory programs
- The wrap fee sponsor must deliver a Form ADV Part 2A Appendix 1 (the wrap fee program brochure) to clients
- The brochure must disclose whether the program is more or less expensive than paying for advisory and brokerage services separately
The Conflict: Reverse Churning
Wrap fees create an incentive structure that is the opposite of commission-based accounts:
| Account Type | Broker-Dealer/Adviser Incentive | Risk to Client |
|---|---|---|
| Commission-based | More trading = more revenue | Churning (excessive trading) |
| Wrap fee | Less trading = higher profit margin | Reverse churning (too little trading, also called "parking") |
In a wrap fee account, the adviser collects the same fee regardless of how many trades are executed. This means the adviser profits more by trading less; the cost of executing trades comes out of the bundled fee.
Exam Tip: Gotchas
Both conflicts must be disclosed. Commission accounts risk churning; wrap accounts risk reverse churning. The exam loves testing this inverse relationship.
Suitability Considerations
Not every client is suited for a wrap fee arrangement:
| Client Profile | Wrap Fee Suitability |
|---|---|
| Infrequent traders | Generally unsuitable; they pay the same fee regardless of activity and would be better off with per-transaction pricing |
| Active traders | Generally suitable; they would otherwise pay high per-transaction commissions |
The adviser must evaluate whether the wrap fee arrangement is appropriate given the client's:
- Trading frequency
- Investment needs
- Total cost compared to unbundled services
Exam Tip: Gotchas
The wrap fee brochure is Form ADV Part 2A Appendix 1, not the regular Part 2A brochure. Wrap accounts are unsuitable for buy-and-hold investors who trade rarely; they pay the same fee regardless of activity.