We are long-standing advocates of financial advisors going into the independent channel. In fact, this year Cutter & Company is celebrating our 30th year as an independent broker-dealer.
The more recent trend in the industry is where advisors explore their future as their own Registered Investment Advisor (RIA). As a long-time senior compliance executive for both our broker-dealer and RIA practices, this move strikes me as one that is often not given enough thought by the renegade Financial Advisor who is striving to be completely independent. Sure, you get the freedom to run your business as you see fit and offer products or services that you desire to make available to clients which may not have been previously accessible to you. But a whole lot more goes along with being able to put your own name on the door.
Unless you have actually delved deeply into the regulatory requirements mandated by the Investment Advisors Act of 1940 – you may not realize what you are getting yourself into. The formal steps required to become a RIA — which involve passing the Series 65 exam, completing a Form ADV and submitting it along with a filing fee to either the SEC or state in which you wish to register — are the easy ones. Outsourcing this aspect of starting your own RIA can be a solid plan, since there are many good compliance companies that will do this for you at a very low cost. They can’t, however, be responsible for mistakes or oversights in the disclosure document they prepare for you.
For example, if you bill clients in arrears and in advance of the quarter – your disclosure document must say so. Do you bill on the average balance of assets or value of the account at the end of the quarter? Do you provide refunds for prorata withdrawals? Whatever your billing method – be sure your disclosure document states how you will charge and that the person responsible for billing in your firm knows the ins and outs of what your ADV disclosure says.
This was cited as one of the most common mistakes made by advisors. (HTTPS://WWW.FORBES.COM/SITES/TEDKNUTSON/2018/04/12/FINANCIAL-ADVISERS-WARNED-ABOUT-COMMON-OVER-BILLING-PRACTICES-BY-SEC/#1614B9CB4480)
Do You Have Custody?
Another common pitfall is determining whether you have custody over client assets. If you do (and you may be surprised how easy it is to be considered to have custody – even when using a qualified custodian to hold client assets) – you are required to have a surprise custody audit each year, conducted by an accounting firm registered with the PCAOB. This audit alone can cost thousands of dollars, plus the time involved in working with the auditor.
Who Should Be Considered Access Persons?
Any financial advisor who has discretion over client accounts, along with their assistant(s) as well as direct family members, may have “access” to information that a client doesn’t have. Therefore, anyone in these categories will be considered an “Access Person”. Firms are required to supervise Access Person holdings and trading by reviewing activity and holding reports regularly. They must also verify that all Access Persons follow the firm’s Code of Ethics as it relates to trading.
I thought I had this rule all figured out. But – Surprise! I was informed by the SEC during our most recent RIA audit that even those financial advisors in the firm who DO NOT have discretion over a client’s account is considered an Access Person. So it turns out that virtually anyone affiliated with your RIA is an Access Person, except ministerial and clerical persons. This finding alone nearly doubled the time and effort we had to spend in supervising Access Persons.
Most important decisions involve trade-offs. That is the case when an advisor is considering which path to independence is best for them. Those who set up their own RIA practice gain a lot of flexibility and keep more of the revenue. But they also incur additional up-front legal fees and take on a stringent, ongoing compliance responsibility.
If you prefer spending your time on these sorts of activities versus face time with clients, then starting your own firm could be a solid strategy. However, for those of you who are already receiving 85-95 percent payouts, the portion you split with your firm is likely not going to be much different than if you went out on your own. Plus, in the latter case, you would need to hire continuous competent compliance support of your own. In my mind, the main differentiator is the fact that you can concentrate all of your time on your clients and let the corporate RIA worry about the rest of the regulatory details for you.
If you would like to discuss this topic directly, we invite you to reach out. We value independent financial advisors and can help you make the best decision for your situation.