Andrew Wels, Esq. Two-Part Primer on Registered Investment Advisers (RIA)

April 29, 2016



By Andrew Wels, Esq.

The RIA Times They Are A Changin'

If you've been a successful broker long enough to remember Bob Dylan then you must have thought about leaving your brokerage firm to start your own firm as a registered investment adviser ("RIA").  But if you haven't done so yet, then get ready to do it now. Historic changes in regulation and technology are converging in a perfect storm that will transform the financial services industry.  Over the next few years, every broker will have to consider becoming an RIA.

In this two-part series, I hope to explain the trends that are now forcing this fundamental change, and what you can and should do to protect yourself and your clients. These insights come from more than 30 years of personal experience as regulatory counsel for some of the most innovative firms on Wall Street.

To Know Where We Are Going, We Must First Know From Whence We Came

In the beginning, everyone was a broker.  A group of traders met under a Buttonwood Tree on Wall Street and agreed to trade only with each other.  Everyone else who wanted to buy or sell had to go through them and pay a fixed commission that they determined. There were no laws, rules or regulations.  Just a gentleman's agreement that created the brokerage industry.

There was little in the way of change for almost a century.  Then Thomas Edison perfected the ticker tape machine and stock brokers moved from Wall Street to Main Street.  It took the government 60 years to catch up, but they did, and in 1934 Congress passed the Securities Exchange Act to regulate brokers.

However, conspicuously missing from the Securities Exchange Act was any regulation of investment advisers, because at that time all advice was passed through brokers. Advisers were not regulated until Congress passed the Investment Advisers Act 1940 which was designed as a means to regulate the managers of investment companies. In fact brokers were specifically excluded from the regulation as long as they did not receive special compensation for providing advice. The brokerage business remained unchanged.

Changes in Regulation and Technology Began A Shift to RIAs

The world changed on May 1, 1975 - "The Big Bang" - when fixed commissions, the last remnant of the Buttonwood Agreement, fell at the push of regulators.  Almost overnight a new industry of "discount" brokers appeared led by visionaries such as Charles Schwab and Larry Waterhouse - NYSE members who founded firms that would go on to jump start the investment adviser industry.

After The Big Bang the brokerage business - i.e., the business the business of executing trades - became separated from the business of providing investment advice. Brokers could no longer charge monopoly prices for trade execution and competition quickly drove down the price of commissions.  Although full service brokers still charged high prices as long as they did not receive "special compensation for providing advice" many brokers realized that their true value was in the advice and their relationship with clients.

The advent of internet trading in the 1990s accelerated the transition. Brokers were no longer tied to the major brokerage firms for trading systems and research.  Instead of pushing products and placing trades to meet sales minimums, enterprising brokers could open their own shops as investment advisers with very little capital, custody client assets at one of the discount firms, use a fee based business model that was more aligned with their customers' interests and take advantage of the relatively light regulatory model offered under the Investment Advisers Act.

Will Everyone Become An RIA?

The twin drivers of regulation and technology are relentlessly pushing the industry to a world where most brokers will be forced to consider setting up their own RIA or becoming an investment adviser representative for another RIA.  In fact, as a result of the Department of Labor's "Fiduciary Duty Rule" any broker servicing a retirement account may soon have to shift the account to a fee based model or deal with onerous new disclosure and business conduct regulations.   And once a broker has made the shift for some accounts, why not for all?  The cost of compliance, just measured in terms of the time necessary to address the befuddling universe of FINRA regulations, can be traded for the satisfaction and economic rewards of focusing on client needs and running your own firm.

Technology is also making the transition easier.   The tools necessary to start and run an RIA are readily available, and many custodians offer packages designed to facilitate the transition quickly. These include everything  . . . website design, bookkeeping systems, trading, research, client reporting, and, of course, compliance.

Setting Up Your Own RIA -- How Does It Feel To Be On Your Own?

There are several business models to consider when starting your own firm.  Will you be fee only, or fee based (or hybrid)?  Do you want to go it alone or work with an aggregator to jump start your transition?   In part II of this series I will review these alternatives and outline the process of creating an RIA, including entity formation and SEC registration.



By Andrew Wels, Esq.


In Part I of this series, I reviewed the regulatory and technological changes driving the financial industry to the day when I believe most brokers will have to consider becoming investment advisers.  In this Part II, I will review what it means, as Bob Dylan said, to be on your own - the decisions you have to make, and the partners you have to choose to succeed. 

Without a Home . . .

Going independent does not mean you are going to be alone.  To the contrary, you will need good, reliable partners to get started and remain successful.  In fact one of the biggest decisions you will make is picking your new home - the firm that will act as custodian for your customers' assets. 

The big players in this space are the brokerage firms and banks who offer RIA clearing and custody as an adjunct to their core businesses.  Among the brokers are the discount firms that pioneered low cost trading - TD Ameritrade, Fidelity, Schwab and Scottrade.  At the other extreme are the major banks such as State Street, BNY Mellon and Royal Bank of Canada, with offerings that appeal to larger and more sophisticated, institutional size firms.  At the sweet spot in between are brokerage firms such as Raymond James that have expertise in dealing with high net worth customers and have developed creative ways to support brokers looking to move away from commission based business.  

The market also includes RIA Aggregators such as Dynasty Financial, Focus Financial and Hightower - firms that specialize in consolidating existing RIAs and helping brokers start new RIAs.  But their help comes at a price, and although the models for each of these firms is different, in each case you are getting a partner that will take a recurring fee or some degree of ownership in your business.  

So how do you decide?  The key differentiators are price, service and technology.  Beware of hidden fees and conflicts of interest.  

You're Invisible Now, You Got No Secrets to Conceal 

Once you are ready to go independent, you will need to create your new business and register to become an investment adviser.  The registration process includes completing Form ADV - a detailed disclosure document that is publicly available - out there for the world to see.   And once you are registered, you own compliance responsibility including responsibility for making sure all conflicts of interest are disclosed. 

So how do you make a smooth transition without letting you intentions become known?  How do you avoid creating unnecessary angst and anxiety from your clients and possible retaliation from you current employer? And how do you set up a good compliance program?

Lawyers, Guns, and Money  

Going independent may be the biggest move of your career.  Do not do it alone, and do not rely only on guidance from a firm that may have a financial interest in how you go on your own.  Spend a little bit of time, and maybe a little bit of money, to understand the legal nuances of how to leave your current firm as amicably as possible.  Guns are not recommended, and with deference to Warren Zevon, if you do it right, they aren't necessary. 


The law firm you select should have more than just basic experience with setting up RIAs.  Do your due diligence.  The firm should have deep regulatory, corporate and litigation expertise. 

What else do you need to know?  Here are the answers to some of the most common questions: 

Where do I register?

In general, SEC registration is available to firms that expect to have over $100 million of regulatory assets under management within the first 120 days of operation.  Firms that do not expect to meet this threshold must register in each of the states where they are doing business. 

How long does it take?

It may take two to four weeks to create a new business entity and prepare the SEC investment adviser registration materials.  Once filed, the SEC is required to approve or reject the filing within 45 days of its receipt.  But that time frame is somewhat illusory as the SEC staff will frequently delay the approval by asking questions and making requests to clarify the filing. Other factors such as disciplinary events and multiple state filings can cause additional delays. 

What will it cost to register a new firm? 

The primary cost involved to register a new entity is the legal time and effort necessary to prepare Form ADV.  Firms with a simple business model and no disciplinary matters can generally be registered with the SEC for approximately $10,000 (including the de minimis filing fees), but the actual fee may vary considerably (higher or lower) depending upon a number of factors such as the scope of regulatory review.  

Do I need a Series 65?

It depends on where your office is, where your clients live, and what industry experience you have.  The Series 65 / investment advisor representative examination is a state requirement.  Most, but not all states, require it if you have an office in the state or 5 or more clients in the state.  However many states offer waivers for individuals with certain professional designations (for example, the CFP (Certified Financial Planner), or CFA (Chartered Financial Analyst) or with a Series 7 and Series 66. 

What other regulatory and legal costs should I expect?

To commence operations the firm would need client agreements and related disclosures, as well as an effective compliance program.  The cost to implement a compliance program could be $20,000 -$40,000 in the first year, depending largely on the experience and skill of the firm's compliance officer.  Beware of in-expensive turnkey manuals.  When the regulators come in (and they will - often in the first year) the compliance manual is one of the first documents to be reviewed.  Regulators quickly recognize a turnkey manual, and if yours has not been customized, they will target your firm for a long, and potentially painful examination. 

Bringing It All Back Home

Your custodian and law firm are two of the most important decisions to be made as you get set to go on your own.  But what about the other decisions? Here's a list of some of the most important things you will need to have in place before you start. 

Final Thoughts

Regulation and technology are driving financial advisors to become RIAs.  For commission based brokers, the time to change has come, and the transition need not be painful.  In fact, a well-planned transition developed with the right partners can help you keep in line with industry trends and your clients' needs.

SEE the RIA Start-Up Checklist



Andrew Wels, Esq.

Gusrae Kaplan Nusbaum PLLC

120 Wall Street  New York, NY 10005

Telephone: (212) 269-1400

Andrew Wels, Esq. leads Gusrae Kaplan's investment advisor unit. A veteran of the securities industry with more than 30 years of experience as a regulatory attorney and compliance officer, Andrew specialized in providing practical regulatory advice. He regularly helps clients develop effective compliance programs, prepare for routine regulatory examinations, and respond to complex investigations. Andrew's experience across asset classes for investment advisers and broker-dealers provides a unique perspective to help clients navigate the confusing and frequently overlapping regulatory requirements for investment advisers and broker-dealers.

Andrew has provided legal and regulatory guidance for the development of several successful financial services, including the high net worth investment advisory programs for clients of JPMorgan Chase and the Dreyfus Division of BNY Mellon, and the investment adviser services platform for TD Ameritrade.  

Prior to joining Gusrae Kaplan, Andrew served as Assistant General Counsel and Director of Compliance at Cantor Fitzgerald / BGC where he oversaw all legal, regulatory and compliance matters - and helped guide business development for the firm's trading, brokerage and asset management businesses.  

His experience includes almost every asset class including swaps, foreign exchange, life settlements and futures (including movie futures), as well as matters involving trading, clearing and settlement. Andrew launched his career in the public sector working for the National Association of Securities Dealers and the U.S. Securities and Exchange Commission. A graduate of the Wharton School, Andrew has a B.S. in Economics and Finance as well as a J.D. from Boston University School of Law.