How to Break Away and Become an Independent Advisor

“Breaking away” is a common term used to describe securities registered representatives who leave their wirehouse broker-dealers to leverage the financial advantages of the RIA channel. But it’s also used when current IARs need to find a more hospitable home for their talents, creating their own companies if no other opportunity fits the bill.

Why would you be unhappy with your current RIA employment? You may be dissatisfied with:

• Your compensation plan
• Lack of ability to truly serve client’s needs
• Compliance or broker-dealer regulations, restrictions and limitations
• Your desire for career and financial independence
• Your firm’s tech support
• Its research capacity
• Its service offerings
• Its customer service capability
• Your benefit package
• Lack of mentorship
• Advancement opportunities

Now, let’s be real. No work setting will ever be perfect. You’ll always be unhappy with one or several aspects of your job. But when dissatisfaction spreads to nearly every facet of it, you may want to consider breaking away. But don’t rush into it. Think objectively about your situation. Is it really as bad as it feels? Can you take steps to improve it? What do trusted colleagues, mentors and others think? After thinking carefully about your current prospects, make a change only if what you stand to gain is greater than what you stand to lose.

How to Become Independent

Transitioning to independence as an RIA is an intricate compliance puzzle. But it’s not as complex as one might think. Here are the significant steps/issues involved:

When to register as an RIA: Since you already worked as an IAR for another RIA, you don’t need to worry about getting an IAR license. However, you do need to register your new business as an RIA. The first issue you face is whether to register at the federal level (SEC) or the state level (state securities regulator). You must federally register when you have $100 million or more in assets under management (AUM). If you have less than $100 million, you can register with your state or territorial regulator.

Generally speaking, the legal entity you plan to use for your new business becomes your RIA. For example, if you plan to establish your business as an LLC, that entity would serve as your RIA. Similarly, if you wish to operate as a sole proprietor, then you’d register your sole proprietorship as your RIA.

Once you’ve become an official RIA, you can hang out your shingle and begin attracting new clients. If you add clients from outside your domicile state, you’ll need to establish your RIA in those states, as well.

Which legal entity to select: Most independent investment advisors opt to form limited liability corporations (LLCs). Others decide to establish corporations, S corporations or partnerships. Because there are many legal and tax nuances between the various legal entities, consider getting input from both an attorney and a tax accountant before making your final decision.

How large of a start-up budget to make: At the outset, you’ll need to project your initial start-up costs, including how much you’ll need for income. Marketing, technology and compliance costs will be major budget items. Will you lease office space? Some of those costs will continue beyond the start-up phase.

What to watch for in your employee agreements: To avoid legal disputes with your current employer, have an attorney review all existing employment agreements. Be sure there are no time bombs in your non-compete, client solicitation or confidentiality agreements that might jeopardize your new venture. If there are, your attorney can help you to defuse them.

How to register with the IARD: Developed and operated by the Financial Industry Regulatory Authority (FINRA), the Investment Advisor Registration Depository (IARD) is an electronic filing system that manages RIA registrations and public disclosures. Even if you register at the state level, you’ll use FINRA’s IARD to establish your registration and submit key disclosures such as the Form ADV Part 1.

How to handle Form ADV: Once you’ve set up your IARD account, use it to file your Form ADV. This long-form consists of three parts: Part 1 shares information about your business, the people who own or control your company and whether you or any other employees have been sanctioned for violating securities law. Part 2 consists of Part 2A (the “Brochure”) and Part 2B (the “Brochure Supplement”). For Part 2A, you’ll provide information about various elements of your advisory business, including your business procedures, conflicts of interests and target markets. For Part 2B, you’ll disclose information about additional advisory personnel in your firm, including their education and business backgrounds, legal or disciplinary events, compensation, and how the firm will monitor the advice you give clients. Part 3 (“Form ADV Part 3/Client Relationship Summary”) offers additional information about conflicts of interest and standards of care. “Pure” RIAs must provide clients with the Client Relationship Summary (CRS) form but don’t have to comply with Regulation Best Interest. Those planning to offer securities still must comply with the SEC’s new Regulation Best Interest as well as provide clients with a CRS form.

How to handle other RIA compliance requirements: Because these tasks are so complex, consider hiring a knowledgeable RIA compliance consultant to guide you. Ideally, retain your consultant before submitting your Form ADV since the firm will likely have useful templates to speed the process. It can also help with your other compliance tasks such as developing a client advisory contract, a policy and procedures manual, a privacy policy statement and a Code of Ethics.

How to select a custodian: This entity will receive and safeguard your clients’ assets. Its ability to efficiently process and document changes in client assets, as well as assure the highest level of cybersecurity, means your custodian will be one of your most important partners. Select one with great care.

Invest in technology: Years ago, RIAs could do business on a legal pad and with manual financial ledgers. RIAs today rely on sophisticated computer hardware and software to run their firms. Some of the technical elements you’ll need include:

1. Hardware (computers, printers and scanners, etc.)
2. Office applications (word processing, spreadsheets, presentations)
3. Website domain and content
4. Email marketing
5. Customer relationship management (CRM) software
6. Investment performance tracking software
7. Financial planning software
8. Client financial management software (billing)
9. Social media compliance application

Determine your service menu: As part of your business plan, define your target market and the types of services you plan on providing to this market. Define it as narrowly as possible, and then frame your offerings in a compelling, creative manner. If you describe what you do the same way every other RIA firm in your market does, you’ll have no basis upon which to differentiate yourself.

Establish your marketing and sales strategies: Start by defining your method of identifying prospects and getting them to agree to speak with you about their investment needs. Consider the specific tools—online and offline—you’ll use to promote your firm and what message(s) you want to convey using those tools. Once you know your marketing approach, think about how you’ll convert prospects into clients through personal selling activities. What should your sales funnel look like? Do you prefer in-person meetings or online video conferences? What will you say during your first meeting? How will you assess identified needs and present a recommended solution? How do you plan to close prospects, and how many meetings do you expect to need? How you answer these and other questions will determine your RIA’s sales strategy.

Why E&O insurance is essential for Registered Investment Advisors

After you complete the above steps, you’ll be on your way to becoming a successful RIA. But there’s one more crucial task: investing in solid errors and omissions (E&O) insurance. Without it, you’ll leave yourself unprotected against client lawsuits. This is unwise, especially during the early years of your RIA. Here’s why:

• Clients who seek investment-advisory services are generally sophisticated and demanding investors. They will not be tolerant of investment professionals who lose their money, especially if unforced errors or omissions are a factor.
• As client assets under management (AUM) have grown, a legal cottage industry has emerged to attract prospective litigants. Lawyers have become so aggressive that RIAs selected for SEC or state enforcement become targets of online marketing campaigns designed to attract angry plaintiffs. This has made the RIA marketplace even more legally treacherous in recent years.
• New RIAs have a lot on their plates. This can cause them to make excuses for not mitigating their business risks. As people learn through hard experience, reality has a way of trumping excuses. All it takes is one investment planning or execution error to turn a long-term, satisfied client into a vengeful plaintiff.

Here’s the bottom line. If you’re planning to establish an RIA, mitigating your E&O risks should be job one. With the many challenges ahead, the last thing you’ll want is an uninsured E&O settlement or judgment as a firm payable. With time and cash flow constraints, litigation at this point of your business can be fatal. Solution? Buy E&O insurance today or if you’ve already purchased it, review your coverage to make sure it’s still current.

Are you paying too much for your RIA E&O insurance? Then compare your current policy with those available from NAPA Premier. Our insurance for RIAs, investment advisor representatives, registered representatives and financial planners starts at $72.08 per month. Establishing sound coverage only takes minutes. To learn more, visit our website.