In the RIA universe, a few bad apples may have spoiled things for the rest of us. Actually, for the rest of you. When I founded a registered investment advisory firm more than 20 years ago, I benefited from an atmosphere much more conducive to entrepreneurial advising. But in the intervening decades, regulatory and legal strictures have rendered the environment for RIA startups overwhelmingly hostile — not to mention expensive.
It wasn't supposed to be this way. The passage of the Glass-Steagall Act in the early 1930s limited the activities and affiliations of commercial banks in such a way as to allow community banks to thrive; their size and local ownership lend themselves to relationship building. Likewise, the value of an RIA — as recognized by Glass-Steagall era legislation codifying the advising profession — is a knowledge and history of each client's portfolio.
How did a landscape primed for small business change so dramatically? For one, the very legislation that created the climate of lending accessibility has been dismantled. The final blow to Glass-Steagall was dealt in 2010, with the passage of the Dodd-Frank financial reform bill.
DODD-FRANK
This alleged solution to “too big to fail,” in the wake of the subprime mortgage crisis two years prior, must have seemed like a good idea. But Dodd-Frank has clearly backfired. The market-based contraction of community banking, quietly ongoing for ages, went into overdrive in the wake of Glass-Steagall's repeal. As the recent Harvard working paper “The State and Fate of Community Banking” showed, by increasing the average compliance costs for the smallest banks by the greatest proportion of their operating costs, this ill-advised legislation has driven industry consolidation at a faster rate than before — and even during — the Great Recession.
The credit crunch facing would-be RIAs, along with many of their small business clients, is daunting enough. But for advisers wishing to strike out on their own, legal roadblocks also have mounted.
Three distinct categories of Financial Industry Regulatory Authority Inc. rules come into play here. First, a series of regulations governing how investment professionals are allowed to proceed could curtail startup. The adviser may need Finra permission even to conduct an outside business activity, along with authorization to acquire the interests of a private company; the rules clearly prohibit private securities transactions. There are additional state privacy laws that address sharing of client information. Further, presoliciting of clients from the adviser's firm may be deemed “selling away” — an outright violation even if the firm has no applicable internal policies.
Second, a firm's employment terms are critical, and any breach could trigger a lawsuit. If an adviser is terminated, this could void the protections of Finra's Protocol for Broker Recruiting, whose principal goal is clients' freedom of choice regarding their registered representatives. And, depending on the state, the adviser may be liable to the firm for failure to uphold a duty of loyalty.
SURVEILLANCE
Finally, the adviser's wish to “go independent” immediately after leaving, while understandable, may be unrealistic. As a rule, firms conduct surveillance on all manner of employees' public filings; this certainly includes new businesses.
On the adviser side, the Securities and Exchange Commission requires all RIAs to fill out an ADV form listing firm owners and officers. This filing is logged into the commission's database, the Investment Adviser Registration Depository, inevitably leaving a trail. Wirehouses, in particular, have advanced observation tools to detect changes to their employees' IARD records. (They can also monitor email correspondence, track printer output increases and survey file downloading.)
The importance of timing cannot be overstated: If caught, the adviser can be fired on the spot and clients dispersed to other representatives. That is opportunity squandered and projected income lost.
The new RIA will need every penny.
Startup costs have skyrocketed above what the last generation paid. Typically, a launch entails hiring an attorney, accountant and/or a filing service to determine the most appropriate type of entity and prepare the corresponding documents. Then there's the incorporation fee.
That's just the preliminary outlay. Next are the securities registration and registered representative licensing fees, which vary widely by state. (Some regulators may require registration of additional branch offices if business will be conducted from multiple locations.) Finally, RIAs must pay processing fees to be listed in the IARD.
This is only the baseline expenditure. Figure in the number of states involved (all of them, if the adviser desires national exposure), a seasoned compliance professional to sort all this out, and sundry unanticipated bills. The final tally can put independence out of reach for many advisers.
In sum, today's RIA startup hurdles would be too high, at least for me. It's clear the powers that be, through a web of regulatory and legal constraints, have upset the apple cart that so well served investors, their independent advisers and the pursuit of small business success in this country.
Chris Markowski is a radio show host and founder of the national financial planning firm Markowski Investments.
