Navigating the regulatory landscape for emerging investment advisors
A good number of talented, young independent financial advisors emerge each year to attract attention in the investment world because of their outsized investment returns. Emerging asset managers might invest between $5 million and $10 million of client wealth. Operating as private funds of that size, they aren’t subject to much regulation. Their focus is on the investment strategy and making money for their clients.
Life can get a lot more complicated in a hurry when you experience significant asset growth and a substantial increase in regulation — which is why you should be proactive and engage a compliance professional sooner rather than later.
Growth in the wealth management industry is almost never linear. When big-money investors come calling, they will often push a fund over $150 million — an important threshold that activates many of the more complicated regulations promulgated by the Securities and Exchange Commission (SEC), including an annual private fund audit. Investment advisors who have successful transitions to a higher level of regulation do so because they learned about the regulatory requirements that were about to hit and enlisted help for compliance reporting proactively.
The regulatory landscape for investment advisors
The SEC is the government entity that is primarily responsible for market integrity and investor protection. It requires public corporations to file annual reports and engage in annual audits. It also regulates investment advisors, establishing rules for custody of client assets and advisor authority to withdraw funds or securities on behalf of clients.
Its regulations are considered demanding, strict and thorough. It has broad authority to pursue professional investment advisors at the civil, criminal, federal, state, regulatory and non-regulatory levels. Registered investment advisors (RIAs) generally must register with the SEC when assets under management (AUM) exceed $110 million. This registration process involves filing Form ADV, which requires extensive disclosure about the investment advisory firm and its practices.
State securities regulators operate in most, but not all, states. Investment advisors with less than $100 million in AUM or who maintain discretion over a certain amount of investor assets must register with the state regulator where the advisor has its principal place of business.
The regulatory authority advisors register with depends mostly on the value of the assets they manage. In general, investment advisors who have at least $25 million in assets under management or provide advice to investment companies are required to register with the SEC. Advisors managing smaller amounts typically register with state securities authorities.
Becoming a registered investment advisor (RIA)
The Investment Advisors Act of 1940 defines a registered investment advisor (RIA) as a “person or firm that, for compensation, is engaged in the act of providing advice, making recommendations, issuing reports, or furnishing analyses on securities, either directly or through publications.”
As a professional providing advice to investment advisors, I always suggest that they progress toward RIA status as soon as possible. We see quite often that the institutional money comes in and all of a sudden, the advisor is over the SEC’s compliance threshold. Their assets just jump. Becoming an RIA means the advisor must provide investors with audited fund financial statements within 120 days of year-end.
By being proactive and getting an early start, the investment advisor knows what the RIA requirements are before having a chance to run afoul of them. The advisor is prepared to line up either audits or inspections. Asset custody is established with a qualified custodian. Contact an auditor and an attorney for a conversation about the business and a look at the accounts. Then, let them take care of compliance matters.
Harsh penalties for noncompliance
The SEC has the authority to revoke an investment advisor’s license. The advisor could no longer trade on behalf of clients, which is effectively a loss of livelihood. The SEC can also levy fines for serious offenses.
For a lesser transgression, the SEC sends a deficiency letter outlining a violation. The advisor has a chance to respond and correct any errors made in a submission. We also suggest the advisor get an attorney involved to draft a response letter and make sure there is a clear understanding of the regulation going forward. If the action is taken in accordance with guidelines, the matter is closed and the advisor continues operations. However, less leeway will be granted for subsequent offenses.
The bottom line: Most investment advisors don’t care to spend time worrying about regulations and responding to notices of likely infractions. When they spend less time on compliance issues, they have more time to earn money for their investors.
Investment advisor compliance: key considerations
For RIAs, compliance is a critical aspect of operations. Some key areas of focus for investment advisor compliance include:
- Privacy and cybersecurity: Protecting client information and maintaining robust cybersecurity measures.
- Custody: Ensuring proper handling and reporting of client assets.
- Chief compliance officer: Designating a qualified individual to oversee the firm’s compliance program.
- Conflicts of interest: Identifying, disclosing, and managing potential conflicts.
- Code of ethics: Establishing and enforcing ethical standards for the firm and its representatives.
- Disclosure: Providing accurate and complete information in Form ADV and other client communications.
- Recordkeeping: Maintaining accurate and complete records of transactions, communications and compliance activities.
- Annual review: Conducting a thorough review of the firm’s compliance policies and procedures.
- Trading compliance: Ensuring the best execution and fair allocation of investment opportunities.
- Advertising rules: Adhering to SEC guidelines on marketing and promotional materials.
How Wipfli can help with RIA compliance
At Wipfli, we are committed to helping wealth management and asset management firms succeed and grow with compelling and powerful insights, resources and solutions. Our team provides practical solutions that support and monitor regulatory compliance issues and helps develop policies and train employees.
We offer a range of services to assist RIAs with their compliance challenges, including:
- Developing and implementing comprehensive compliance programs.
- Conducting mock regulatory audits to identify potential issues.
- Providing compliance education for investment advisor representatives.
- Assisting with Form ADV preparation and filing.
- Offering guidance on regulatory obligations and compliance requirements.
- Supporting portfolio compliance and best execution practices.
- Helping firms navigate anti-fraud provisions and other SEC rules.
Visit our webpage to learn more about our investment advisory services and how we can help your firm meet its regulatory obligations while focusing on growth and client service.
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