What the Financial Industry Regulatory Authority Is

When should RIAs keep or drop their FINRA registration? It’s a tricky question with serious consequences. Get answers here.

As a registered investment advisor (RIA), you’re well aware of your Securities and Exchange Commission (SEC) or state registration requirements. But should you also register with the Financial Industry Regulatory Authority (FINRA)? The answer depends on the specific products and services you provide today and your future marketing goals.

FINRA in a Nutshell

FINRA is a non-government self-regulatory organization. It develops and enforces rules to assure that broker-dealers and their registered representatives don’t perpetrate fraud on the investing public. It arose from the 2007 merger of the National Association of Securities Dealers (NASD) with the regulation, enforcement and arbitration arms of the New York Stock Exchange (NYSE).

Unlike the SEC and state investment-advisor regulators, which oversee professionals who provide investment advice for a fee, FINRA keeps tabs on broker-dealers and their representatives who sell securities for a commission. FINRA also maintains a testing and licensing system, as well as a public database of FINRA registrants. Consumers can search FINRA’s online BrokerCheck database to see whether a securities broker has ever violated FINRA regulations.

FINRA is distinct from the SEC and from state securities agencies. The SEC supervises investment advisors who manage at least $110 million in client assets under management (AUM). Advisors who control less than $100 million must register with the state investment-advisor regulator in their domicile state. From $100 million to $110 million, advisors can opt for federal legislation or remain with their state regulator. Once they hit $110 million in AUM, they must register with the SEC.

Do You Need to Register with FINRA?

The answer depends on your current business model, especially your product/service portfolio and compensation system. If you’re currently a FINRA-licensed securities broker planning to become an RIA, you must retain your FINRA license if you wish to continue earning commissions from selling securities. However, if you expect to only provide investment advice for a fee, you don’t need to maintain your FINRA registration. Instead, you can register with either the SEC or a state investment advisor regulator depending on your AUM level.

Not sure whether keeping your FINRA license (or licenses) makes sense? Here are some questions to consider:

• How much of your current business revenue comes from securities commissions? Do you plan to continue this level of securities work or to transition entirely to providing investment advice for a fee? If it’s the latter, you may find it isn’t necessary to maintain your FINRA license.
• Can you convert some of your current securities business to fee-based compensation? If you can convert all or most of it (and let the remainder go off the books), then an SEC or state registration may be advisable.
• Do you have clients who’d object to paying fees for investment advice vs. continuing to pay commissions on securities sales? If so, you might want to continue servicing their portfolios under your existing FINRA license.
• Would most of your clients prefer to decide for themselves whether to work with you on a commission or a fee basis? Then you’ll want to maintain both licenses.
• What are your motivations for moving to the investment-advisor business? If your goal is to adopt a fiduciary model that eliminates conflicts of interest, then you may choose to discontinue selling securities on commission. This will make your FINRA registration no longer a necessity.
• How important is operating as a fiduciary investment advisor from a marketing perspective? If you view it as essential—and a major reason for making the transition—then you’ll want to stop selling securities on commission and drop your FINRA license.

Transitioning from a FINRA-licensed securities broker to either a dual-licensed investment advisor or a pure fiduciary advisor is a complex matter. Dropping your FINRA license can be a marketing benefit for those who believe providing fiduciary investment advice is the wave of the future. But for advisors with a heterogeneous client base (who want both securities transactions and investment portfolio management) and who want to continue receiving securities commissions, it might make more sense to become a dual-licensed advisor/representative.

Either way, given the transition challenges, it’s best to partner with an investment-advisory compliance team who can guide you through the many steps involved. Wherever you land, be sure your licensing reflects your intended business model and the preferences of your existing and future client base.

Don’t Forget E&O Insurance

Finally, remember to protect yourself from client litigation in your new venture. Buying an RIA E&O insurance policy is crucial for new owners (or investment advisor representatives) who wish to reduce their risks, avoid catastrophic financial claims and protect their customers from costly mistakes. With legal exposures being so great and affordable RIA E&O insurance easily available online, it makes sense to get—and stay—insured.

If you plan to hold both FINRA and SEC (or state) investment advisor licenses, then your business risks will compound. You’ll be required to comply with the SEC’s Regulation Best Interest and to give all clients the Form Client Relationship Summary (CRS).

All dual-registered RIAs must comply with both Regulation Best Interest and the Form CRS, while “pure” investment advisors must only provide clients with the CRS form. Either way, failing to comply might open RIAs to regulatory scrutiny, fines and E&O litigation. The risks are even greater for new RIAs who might not be used to the heavy compliance burdens of being an RIA in the current environment.

Bottom line? Regardless of your investment-advisor license, follow the letter of the law and buy insurance to shield your business and personal assets from litigation. With RIA coverage in place, you’ll be well equipped to build a successful RIA business that produces career satisfaction and financial security.

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