There's no such thing as an easy route to independence. But there are some things reps can do to ease the transition. Consultants say the most critical time for an RIA startup is likely about three to six months prior to its launch. The actions taken during that pre-launch period will determine the level of ease with which advisors can transition to their new digs. From the very basic (making sure you've got the right licenses) to the most complex (taking your clients with you), the hurdles to becoming an investment advisor rep can be reduced with some preparation.
In short, you have to plan, and plan carefully. But — and here's the tough part — if you work at a firm that has signed the so-called Broker Protocol, a pact signed by most of the big brokerages and even some RIAs (created to cut down on abusive temporary restraining orders against departing reps), you may not tell your clients you are leaving. All your planning be damned, you may only contact them after you have left.
Says one RIA with over $300 million in assets, “No firm is going to be happy about losing you. But this is the old ‘Wall Street Shuffle.’” You don't want to get sued.
For firms who didn't sign the Protocol, it depends upon their client privacy policy. Can't remember what that is? It's a document sent to your clients each year. Some independent broker/dealers allow clients to opt out of the terms of this policy. You'll have to do your own research before deciding when to tell clients about your move.
“A lot of people don't take the time to do the lead work, and sometimes get caught up in ugly litigation that can be devastating and expensive,” says Bryan Hill, president and founder of RIA Compliance Consultants, which helps investment advisors with registration and compliance.
“A lot of proprietary firms treat their client information and the underlying data as trade secrets, and have confidentiality agreements that say, you, the broker, cannot share it with third parties,” says Hill. That applies after a rep's relationship with the firm has ended — in which case the rep himself becomes a third party. “You have to dig into the detail of what you can and cannot do,” he adds.
It gets more complicated. Even if you don't have a contract that prevents you from contacting clients upon departure, you may not be able to solicit current clients about your move while still employed at the old firm. Why? Because you — and indeed employees of any business — are held to the Duty of Loyalty standard, which simply means there are limitations to the extent that a rep (or any employee) can setup a new, competing business while still employed at his b/d (or any employer). “It's one thing to have hired a lawyer for consultation, but you can't go to existing clients and ask them to come with you,” Hill says. Not only that, but if a firm believes a rep has broken any agreements, it may file a temporary restraining order (TRO) — a legal motion that prevents reps from contacting clients.
Mitigating all this is the fact that some state courts may reject the broad language of employment contracts anyway, which helps reps in contract disputes. “National firms might overreach on their post-employment restrictions — which may not be valid in certain states. The court can say, ‘The contract might say one thing, but we're not enforcing it if it doesn't agree with our Supreme Court decisions,’” Hill says.
Halfway There
Independent contractor reps are faced with significantly fewer obstacles when starting their own RIAs. Independent b/ds typically believe the client relationship belongs to the rep, thereby alleviating any TRO-like problems upon an advisor's departure. Most independent reps are already accustomed to running their own businesses, from paying rent, setting up computers, phones and internet access and the like; the transition into RIA-land, therefore, is far less complicated.
Of course, nothing is too easy. There is a new regulatory challenge that departing independent reps are facing these days. The effects of a routine SEC audit of an independent b/d last year are being felt by all firms these days. NEXT Financial, a Houston-based b/d, was found to be accepting investor information from new reps coming from other firms, and using it to fill out new account and account transfer forms before the reps had officially joined. The practice was not all that uncommon among independent b/ds, which allow their reps to leave with client information, but the SEC told NEXT that the process violated customer privacy rules. As a result, independent b/ds across the country are changing their privacy policies, and some are even being investigated by the SEC.
Patrick Burns is the managing attorney of the Law Offices of Patrick J. Burns, Jr., and co-founder and president of Advanced Regulatory Compliance, a regulatory compliance services firm. He says NEXT Financial's run in with the SEC is a “warning signal” to other independent b/ds, custodians and reps that the privacy policy rules will be more strictly enforced from here on out. “In 2008, you'll see more of the same,” he says.
In order to avoid any privacy policy blunders, reps should be aware of their b/ds' privacy rules. “Independent b/ds are now establishing privacy policies that tell clients, ‘We let our reps take your information with them, but you can opt out of this arrangement,’” Hill says. Otherwise, reps must get affirmative consent from each client in order to take their information. He even suggests getting help from the current b/d. “If your b/d doesn't have a clear, laid-out plan about leaving, and isn't willing to help, you may need a legal expert,” he adds.
LICENSE TO ADVISE
One of the first steps to starting your own RIA is making sure you've passed the necessary exams. Here's a quick summary of what you need to know about all those licenses.
-
Generally, advisors without the Series 7 need only the Series 65 to become investment advisors.
-
In many states, the Series 7 and Series 66 combination act as a substitute for the Series 65. This combination is usually used by b/d reps who want to be dually registered as investment advisors.
-
An individual can be exempt from passing the Series 65 if he holds one of the following professional designations: Certified Financial Planner (CFP), Certified Financial Analyst (CFA), Chartered Financial Analyst (ChFC), Personal Financial Specialist (PFS), or Chartered Investment Counselor (CIC).
Source: RIA Compliance Consultants
THE CHECKLIST
An RIA consultant provides a list of “to-dos” to complete before making the big RIA leap.
-
Consider retaining legal counsel or a compliance consultant to assist you.
-
Draw up a business plan to help establish business goals and objectives.
-
Apply for, and receive, the approval of your employing broker/dealer if you are with a firm that allows registered reps to set up and maintain an RIA (for independent broker/dealer reps).
-
Ensure you have adequate errors and omissions insurance for your proposed RIA activities (either through your employing broker/dealer or independently obtained coverage).
-
If you are with a wirehouse, do not inform/pre-notify clients of your pending departure plans (this violates your Duty of Loyalty obligations to your employer).
-
Ensure that you are mindful of any non-compete and/or non-solicitation provisions in your employment agreement if you are with a wirehouse (though their enforceability varies state by state).
-
Ensure that your transition plans are in line with state and federal privacy laws when moving client accounts.
-
Ensure that any promissory note obligations you may have to a former broker/dealer firm can be met when you leave. While promissory note paybacks can often be negotiated post resignation, you should ensure you have documentation showing what you have paid to date, and how much you think is left on the note.
-
When setting up an RIA, it is important to choose the right legal entity for tax and legal liability purposes.
-
Establish written supervisory procedures to help establish a strong compliance program.
-
Allow four to six months of planning. In some cases, with smaller firms, the time frame can be condensed.
-
For team transitions, a strong detailed agreement needs to be in place to prevent any misunderstandings. Failure to do so can be fatal to a new business venture.
Source: Advanced Regulatory Compliance, Law Offices of Patrick J. Burns
