A Basic Overview: RIA Compliance Responsibilities

The information contained in this post is meant to be a basic overview of a RIA’s compliance responsibilities and areas IA firms and their Chief Compliance Officers (CCO) should be aware of. The topics discussed vary and include but are not limited to the following areas:

  • RIA Registration

  • Federal & State Filings

  • Licensing Period

  • Recordkeeping

  • Custody

  • Disclosure

  • Fiduciary Duty

  • Regulatory Audits

What does RIA, IA & IAR stand for?

“RIA” and “IA” refers to investment advisers while the term “IAR” refers to investment adviser representatives. IAR’s work for/under the investment adviser umbrella. So the IAR is the individual that provides advice to others regarding investments for a fee. The client pays the IA a fee for the IARs services and the IA then pays the IAR.  Both the IA and the IAR are required to register or become licensed in the appropriate jurisdiction.

IA Registration/Licensing

There are two main items that help determine if one is considered an investment adviser, and they are:

  1. Provides advice and/or analysis regarding securities either by making recommendations and/or providing opinions and/or research on securities and/or securities markets.

  2. Receives compensation for the advice, analysis, recommendations, opinions they provide regarding investments/securities.

State Registered Investment Advisers – The IA that has $0.00 assets under management(AUM) up until they have $100,000,000.00 in AUM should fall under State jurisdiction.  IAs that hold themselves out as financial advisers and only focus on financial planning or soliciting prospects/clients on behalf of other IAs also fall under the the State jurisdiction.

SEC Registered Investment Advisers – The IA that has AUM of $100,000,000.00 or more would need to register with the SEC.  Also included in this federal registration jurisdiction are:

  • Advisers to investment companies under the Investment Company Act of 1940;
  • Advisers that providing services in 15 or more states;
  • Retirement plan advisors and pension consultants providing investment advice to employee benefit plans, governmental plans and/or church/charity plans with respect to assets of plans having an aggregate value of $200,000,000.00.
  • IA firms that operate mainly through an interactive website.

IA State Notice Filing

SEC registered IA firms must notice file with the state if they have a place of business within the state and/or have five (5) or more clients located in that state within a twelve-month period. Notice filing is not as simple as it sounds. It’s similar to registration and licencing, with the main difference being the IA’s main compliance responsibilities lie with the state regulations within the appropriate jurisdiction.

What licensing is required to register an investment adviser representative (IAR)?

Employees of RIA firms may be required to register as investment adviser representatives (IAR). In order for an individual to get licensed/registered they must pass the Industry exam Series 65. Exemptions do exist for individuals to qualify as an IAR without having to take the Series 65. Check with the specific states licensing requirements to see if an exemptions exists. The IA firm holds the registration/license, however, the investment adviser representatives is the individual who performs services on behalf of the registered/licensed investment adviser firm.

IA Firm Filings

State & SEC securities offices not only have an interest in how the investment adviser does its job, they have a responsibility to protect their constituents. Most states, as well as the District of Columbia and Puerto Rico each have a registration/licensing requirement for IA firms. These state and SEC securities regulators will usually require the following:

  • IA firms to register or become licensed in their jurisdiction.
  • Federally covered advisers to make a notice filing of their Form ADV.
  • Passing of the Series 65 exam.
  • Payment of an application fee.
  • Require various disclosures to the regulator and/or the public.
  • Certain financial requirements such as a bond or a minimum net capital.

Application for registration/licensing is either through the state or the SEC and requires the IA to complete the various form ADVs with the state where one wants to offer advisory services, along with any state-specific forms, filing a Form U-4 for each IAR who intends to provide services on behalf of the IA. Individuals that don’t qualify for an exemption (qualified professional designation or combination of the Series 7 and 66) must successfully pass the Series 65 exam with a passing grade of 70%.

Annual IA & IAR Licensing Period

IAs are generally required to maintain and keep current the following records. Recordkeeping requirements are determined by the home state of the adviser. These requirements include:

Recordkeeping Requirements

IAs are generally required to maintain and keep current the following records. Recordkeeping requirements are determined by the home state of the adviser. These requirements include:

  • Receipt and Disbursement Journals

  • General Ledger

  • Order Memoranda

  • Bank Records

  • Bills and Statements

  • Financial Statements

  • Written Communications and Agreements

  • Electronic Communications (Email & Social Media)

  • List of Discretionary Accounts

  • Disclosure Statements & Solicitors’ Agreements

  • Marketing/Advertising

  • Personal Transactions

  • Order Execution Quality

  • Client Records

  • Power of Attorneys On File

  • Performance Reporting

  • Client Information

  • Customized Policies & Procedures

Records required of advisers who have custody of client assets will require:

  • Securities Transactions and Movements

  • Client Ledgers/Account History

  • Copies of all Client Confirmations

  • Record Client Interests and Location of the Security(s)

  • Securities Transactions and Movements

  • Client Ledgers/Account History

  • Copies of all Client Confirmations

  • Record Client Interests and Location of the Security(s)

IA Record Maintenance:

All records are required to be maintained and easily accessible for a period of 5 years, the first 2 years require all records to be maintained in the advisers principle office. These records should include client purchases and transaction history as well as the client’s current investment positions.

Custody Rules for RIA Firms

If an adviser has direct or indirect access of client funds and/or securities, they are considered to have custody. This practice brings additional scrutiny. State-registered investment advisers and applicants for state investment adviser registration should become familiar with the custody requirements in the state(s) in which they are registered or seeking registration.

As part of registration and audit/examination review, state securities regulators require IAs to show how clients assets are handled by asking themselves the following questions:

  • Has the adviser complied with the rules regarding the safeguarding of client assets in which the IA has custody?

  • Does the Form ADV Part 1 coincide to reflect what is in ADV Part 2 in regards to the advisor having custody?

  • Are these assets maintained in separate accounts?

  • Does the IA maintain the required records of client assets held in its custody?

  • Does the client receive an itemized statement every three months showing all the assets in the adviser’s custody and the activity in the account?

  • Has a surprise audit of client assets has been conducted at least annually by an independent accountant?

  • If the adviser has discretionary authority over the client’s account, is there any evidence of excessive trading, self-dealing, preferential treatment, unsuitable recommendations, unauthorized transactions or incomplete disclosure?

Disclosure, Disclose, Disclose…

The most important duty of an IA is the disclosure of all information relating to the relationship between an adviser and a client. Advisers can tailor their client experience and services as long as clients are aware about such things as:

  • What services are available?

  • Who is providing the services?

  • What fees and other expenses will the client be subject to and are they negotiable?

  • Is the adviser being compensated from other sources?

  • Is the adviser affiliated with another adviser, a broker-dealer or an issuer of securities?

  • Can you implement a financial plan anywhere or do you only get to keep the plan if you implement it through the adviser?

  • What other potential conflicts of interest exist that would affect the adviser’s advice and recommendations?

The key document for disclosure in regards to client experience  is Part 2A of Form ADV (Firm Brochure that is required to be delivered to clients). This document should clearly spell out the details of the advisory relationship with the client and other business interests and relationships of the adviser.

Regulators will look for disclosure-related items not only in the disclosure document but in any material describing any facet of the adviser’s business that a client or potential client might see. This can and does include the following:

  • Portfolio Reviews, Results and Recommendations
  • Print, Radio, Video and TV ads
  • Marketing and Advertising
  • Seminar Materials
  • Fee Schedules
  • Website(s)
  • Mailings
  • Contracts

Fiduciary Duty

The anti-fraud provisions of the “Investment Advisers Act of 1940” and most state laws impose a duty on IAs to act as fiduciaries when dealing with their clients. Many states impose these requirements as part of their unethical business practices rules, or through other rules or caselaw. Fiduciary duty requires the IA and IAR to hold client interest above its own in all matters, at all times. Conflicts of interest should be avoided at all costs and if present in any way, be disclosed immediately both verbally and in writing.

The SEC has said that an adviser has a duty to:

  • Make reasonable investment recommendations independent of outside influences
  • Select broker-dealers based on their ability to provide the best execution of trades for accounts where the adviser has authority to select the broker-dealer.
  • Make recommendations based on a reasonable inquiry into a client’s investment objectives, financial situation and other factors
  • Always place client interests ahead of its own.

Examples of practices that IAs should avoid are:

  • Acting as an issuer or affiliate of an issuer of securities
  • Recommending unregistered, non-exempt securities
  • Using unlicensed broker-dealers
  • Contracts seeking to limit and/or avoid an IA’s liability under the law (hedge clauses)
  • Other situations which require disclosure of the conflict include, but are not limited to:
  • Limiting a client’s options with regard to the pursuit of a civil case or arbitration
  • Failing to disclose to all customers the availability of fee discounts
  • Any activity that acts as a fraud or deceit on clients
  • Borrowing money from or lending money to clients
  • Charging unreasonable fees
  • Acting as a broker-dealer and/or securities agent
  • Receiving transaction-based compensation, including 12b-1 or other marketing fees, related to securities recommended to its clients
  • Receives any type of compensation from any source for soliciting or referring clients to another adviser or a broker- dealer.
  • Hidden fees in the form of undisclosed service charges, wrap fees or expenses reimbursed by other parties.

The regulator/auditor will always view perceived conflicts from the client point of view. Questions they will ask are as follows:

  • Was the disclosure or lack of disclosure a factor in the client’s decision to use an adviser’s services or ratify an adviser’s recommendations?
  • Was the customer misled in any way shape or form?
  • Was the customer placed at a disadvantage or taken unfair advantage of as a result of the conflict and the adviser’s compliance with disclosure requirements?

The burden of proof will always lie with the IA.

IA Historic Audit Results & Findings 

IA firms are subject to periodic, unannounced, audits by regulators. The purpose of an audit is to determine the IA’s compliance with the appropriate regulator’s licensing, books and records, and anti-fraud requirements.

The most common audit findings usually involve:

  1. Books and Records
  2. Registration
  3. Contracts
  4. Breach of Privacy
  5. Proper Brochure delivery

As you can see, the IA industry requires attention to detail and knowledge of your regulator’s securities laws and rules. If you would like to speak to an expert, an ACS representative can help you to determine the requirements that affect you and your firm.