How to Become a Registered Investment Advisor

The rewards of becoming a registered investment advisor (RIA) have been well documented. For the right person transitioning from the securities brokerage, insurance or financial-planning fields, the financial, personal and intellectual benefits are substantial. However, becoming an RIA is a complex challenge. This article will provide an overview of the steps involved.

Although sending astronauts to the moon may have been slightly more complicated, launching an RIA firm is not for the faint-hearted. Aaron Hattenbach, a San Francisco-based RIA, described the 26-step process he followed when establishing his firm several years ago. Not every single step was compliance-driven, but many were. So why pursue this path? Because the financial opportunities are excellent.

The Schwab RIA Compensation Report (based on its 2020 RIA Benchmarking Study) found that senior client account/relationship managers received a median total cash compensation of $240,000 in 2019. This included owner profit distribution. Obviously with median compensation of nearly a quarter million dollars, half of senior staff made more than that, some a lot more.

Of course, money isn’t everything. The personal rewards of helping clients as well as the intellectual satisfaction of mastering arcane investment strategies, provide additional motivation to start an investment advisory firm. As an RIA, you get to keep the entire payout and can avoid the conflicts of interest inherent in the wirehouse and independent/regional broker-dealer (BD) business models.  You also don’t need to seek client approval for each trade you make. Plus, you no longer will be limited to BD-approved products, since RIAs can access any product available on the securities markets. Becoming more of a “master of your destiny” is one of the biggest attractions of going independent.

The above advantages put the RIA transition into context. As long as you know the steps involved, are diligent in ticking off each box and adopt a serious commitment to doing business in full compliance with the law, becoming an RIA is highly achievable.

When to Register as an RIA

The first question you’ll face is whether to register as an RIA. The Investment Advisers Act of 1940 requires it if you will be engaged in the business of providing investment advice to others for a fee. If you give friends free advice, you don’t have to register. Another requirement is you must be in the investment advisory business. This means if you give a financial-planning client a small piece of investment-planning guidance and receive no compensation other than, say, a small gift, you wouldn’t need to register. The act of helping your friend would be viewed as an incidental activity, not part of a formal investment-advisory business.

Finally, your advice must deal with investments, not just general financial matters. Paid advice on general money management, debt reduction, retirement planning and related matters does not fall under the purview of the Investment Advisers Act. But there’s a caveat. If you’re holding yourself out as a financial advisor, especially if you earned and include your Certified Financial Planner® (CFP) or Chartered Financial Analyst® (CFA) designation on your business card, federal and state authorities will often expect you to register as an RIA.

Where to Register as an RIA

The next question to consider is where to establish your RIA. The two options are the Securities and Exchange Commission (SEC) and the state and territorial financial regulator that oversees investment advisors in your domicile area. You’ll register with the SEC if you have at least $100 million in assets under management (AUM). Those with less than $100 million in AUM will register with a state/territorial regulator.

Generally, your business entity becomes your RIA. For example, if you created an LLC for your business, that entity would serve as your RIA. If you’re planning to operate as a sole proprietorship, you, as sole proprietor, would be the RIA. Once you register your firm, you’ll have the authority to hang out your shingle and to begin soliciting prospects (as long as you’re licensed). As you add clients from other states, you’ll have to register in those states, as well.

How to Become Licensed as an IAR

Getting registered is not the same as becoming licensed. Your business entity gets filed as an RIA. However, to actually deliver investment advice, you must be licensed as an investment advisor representative (IAR). If you’re operating as a sole proprietorship, you will become an IAR of yourself. If you’re operating as an LLC or as a form of corporation, you will be an IAR for that entity. To become an IAR, you must complete the FINRA Series 65 exam. Or if you’re coming from a broker-dealer, your Series 66 and Series 7 exams will cross qualify you as an IAR.

Can you opt out of taking the Series 65 test? Yes. If you already have your Series 66 and Series 7 license—or have already earned the CFP, CFA, ChFC or American Institute of CPAs (AICPA) PFS designations—you don’t have to take the Series 65 exam. You will already have the Series 65 subject matter well in hand. But if you don’t have one of those designations, you’ll want to take a Series 65 exam prep course or review an exam prep book before taking the test. Many reasonably priced learning programs are available on the internet.

Getting registered and licensed is just the beginning of your journey. Many steps remain before your RIA firm will be up and running. Here are some of the major ones:

• Review your current employment agreements: To avoid legal disputes with your current employer, ask your attorney to review all existing employment agreements. The goal is to make sure there are no issues in your non-compete, client solicitation or confidentiality agreements that will jeopardize your new venture. If there are, your attorney will help you to resolve them.
• Decide on a business entity: Most advisors establish limited liability corporations (LLC). But some also form corporations, S corporations, or partnerships. It’s best to seek legal counsel before deciding on which business entity to establish.
• Establish an operating budget: At the outset, you’ll need to project your initial start-up costs as well as your recurring expenses, including how much you’ll need for income. Marketing, technology and compliance costs will be major budget items. Some of those costs will continue beyond the start-up phase.
• 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 facilitates RIA registrations and public disclosures. Even though you’ll likely register at the state level, you’ll use FINRA’s IARD to set up your registration and to submit key disclosure documents such as the Form ADV Part 1.
• Complete Form ADV: Once you’ve established an IARD account, use it to file your Form ADV. This is a long document consisting of three parts. Part 1 includes information about your business, the people who own or control your firm and whether you or any of your personnel have ever been sanctioned for violating securities law. Part 2 consists of two elements: 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 practices, conflicts of interests and types of clients served. For Part 2B, you’ll include information about additional advisory personnel in your firm, including their education and business background, legal or disciplinary events, compensation, and how the firm will monitor the advice you provide to clients. Part 3 (“Form ADV Part 3/Client Relationship Summary”) offers additional information relating to conflicts of interest and standards of care. RIAs who continue to operate as registered representatives must comply with the SEC’s new Regulation Best Interest and to include in their Form ADV a so-called Client Relationship Summary (CRS). “Pure” RIAs must provide clients with the CRS form, but don’t have to comply with Regulation Best Interest.
• Take and pass the Series 65 or Series 66 Exam: As mentioned earlier, to actually work as an IAR you must pass either of these competency exams. The Series 65 refers to the Uniform Investment Advisor Law Examination and Series 66 to the Uniform Combined State Law Examination. You can’t provide investment advice without passing either of these tests or having one of the qualifying financial certifications.
• Handle other RIA compliance requirements: Because the compliance requirements are so complex, consider hiring a knowledgeable RIA compliance consultant to guide you through the process. Ideally, you should retain your consultant before you submit your Form ADV, as the firm will likely have useful templates to speed the process. It will also help you with other required compliance tasks, including developing a client advisory contract, a policy and procedures manual, a privacy policy statement and a Code of Ethics.
• 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. Therefore, perform your due diligence and choose your custodian wisely. Make sure the custodian’s reputation, processes, tech platform, and overall culture match what you are looking for.
• Invest in technology: Back in the day, RIAs could do business on a legal pad and paper financial ledgers. No longer. All RIAs today rely on sophisticated computer hardware and software to run their businesses. Some of the technology elements you’ll need to purchase include:
• Hardware (computers, printers and scanners, etc.).
• Website domain and content.
• Email marketing.
• Customer relationship management (CRM) software.
• Investment performance tracking software.
• Financial planning software.
• Client financial management software (billing).
• Client portfolio analytics and presentation.
• Social media compliance.

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 step: investing in errors and omissions (E&O) insurance and Cyber Liability with Data Breach insurance. Without these two insurance products, 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 them money through unforced errors or omissions.
• 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 targeted 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.
• Even before pandemic times, cyber and data breaches were on the rise. Now they’re exploding! New RIA owners are extremely susceptible to these growing risk exposures since most don’t have access to cyber security measures their broker dealers may have invested in. Starting out as an independent is challenging enough, even without a cyber-attack or data leak. A single negative cyber event can take a new RIA down quickly. A Cyber Liability and Data Breach insurance policy helps plug a huge gap that a fledgling RIA would not have otherwise been able to manage on its own.
• New RIAs have a lot on their plates. This sometimes 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 or one data breach to turn a long-term satisfied client into a vengeful plaintiff.

So here’s the bottom line. If you’re planning to establish an RIA, mitigating your E&O risks should be a high priority. With the many challenges ahead, the last thing you’ll want is an uninsured E&O settlement or judgment. 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.

Paying too much for your RIA E&O or Cyber Liability 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. To learn more, visit our website.