Those who wish to work as financial advisors, to either manage assets or provide advice to clients, can take one of two basic approaches: They can either be sponsored by a broker-dealer and become licensed under FINRA regulations to become a stockbroker, or, they can register directly with the Securities and Exchange Commission (SEC) as an investment advisor. Many financial planners and asset managers have chosen the latter path as a means of escaping the rigid compliance rules and restrictions that often come from working with broker-dealers.
Licensing and Qualifications
The first step to becoming an RIA is to pass the Series 65 (Uniform Investment advisor Law) exam. Although this exam is administered by FINRA, takers are not required to be sponsored by a broker-dealer as they are for most other securities-related exams. The test itself covers federal securities laws and other topics related to investment advice. It has 140 multiple choice questions, of which 10 are pretest questions that will not count towards your final grade. Students are allowed three hours to take the exam and must get a grade of at least 72% to pass.
It is important to note that while no other licensure or designations are required in order to become an RIA, most advisors will find it rather difficult to bring in business without additional qualifications, such as the CFP® or CFA designation. In fact, many states will actually allow advisors who carry the following designations in good standing to waive the exam:
- Certified Financial Planner® (CFP®)
- Chartered Financial Analyst (CFA)
- Chartered Investment Counselor (CIC)
- Chartered Financial Consultant (ChFC)
- Personal Financial Specialist (PFS)
If you intend to provide investment advice or asset management services as a primary source of business, the next step to becoming an RIA is to register with either the SEC or the state(s) in which you intend to do business. However, you will not have to do this if providing investment services or advice is purely incidental to your business. A list of professionals who may qualify under this exception includes:
- Advisors who work exclusively with U.S. government securities
- Advisors who are registered with the Commodity Futures Trading Commission and for whom providing investment advice is not a primary line of business
- Charitable organizations
Firms that register with the SEC are never required to file with states as well, but they must file a notice of SEC registration with each state in which they do business. The majority of states do not require registration or filing of notice if the advisor has less than five clients in the state and does not have a place of business there. Most firms register with these entities as a corporation, with each employee acting as a representative of the investment advisor (IARs). It should be noted that while corporate registration may limit an advisor's financial liability, it will not allow him or her to escape legal or regulatory action if the RIA violates rules.
The Registration Process
The first step in the registration process is to create an account with Investment Adviser Registration Depository (IARD), which is managed by FINRA on behalf of the SEC and states. There are a few states that do not require this, so advisors who only do business in those states do not have to use this system. Once the account is open, FINRA will supply the advisor or firm with a CRD number and account ID information. Then the RIA can file Form ADV and the U4 forms with either the SEC or states.
The Form ADV is the official application document used by the government to apply to become an RIA. It has multiple sections that all must be completed, although only the first section is electronically submitted to the SEC or state government for approval. Part II of the form serves as a disclosure document that is distributed to all clients. It must clearly list all services that are provided to clients, as well as a breakdown of compensation and fees, possible conflicts of interest, the firm's code of ethics, the advisor's financial condition, educational background and credentials and any affiliated parties.
This form must also be uploaded electronically into the IARD and given to all new and prospective clients. Preparing and submitting these forms typically takes most firms a few weeks, and then the SEC must respond to the application within 45 days. Some states may respond as soon as 30 days but the process, in either case, is often delayed by requests for additional information and questions that need clarification. All firms that register with the SEC must also create a comprehensive written compliance program that covers all aspects of their practice, from trading and account administration to sales and marketing and internal disciplinary procedures.
Once the SEC approves an application, the firm may engage in business as an RIA and is required to file an annual amendment to Schedule 1 of the ADV, which updates all of the firm's relevant information (such as the amount of assets currently under management). Also, while the SEC has no specific financial or bonding requirements for advisors, such as a minimum net worth or cash flow, it does examine the advisor's financial condition closely during the application process. Most states require RIAs to have a net worth of at least $35,000 if they have actual custody of client funds and $10,000 if they do not; RIAs who fail to meet this requirement must post a surety bond. (The rules for this requirement, as well as several other aspects of registration, vary from state to state.)
Nature and Scope of Business
The majority of RIAs choose this form of registration because it allows them greater freedom to structure their practices than they can usually have if they are securities licensed. Registered representatives that work for broker-dealers must always pay a percentage of their earnings as compensation for their back office support and compliance oversight, which most brokers will readily concede can be very overbearing at times.
Brokers also usually work on commission, while the majority of RIAs charge their customers either a percentage of assets under management or a flat or hourly fee for their services. Many RIAs also use another firm, such as a discount broker, to house their clients' assets instead of holding the accounts in house, in order to simplify their recordkeeping and administration. However, many brokers with securities licenses also carry the Series 65 license in order to offer professional money management services such as wrap programs.
Battle for Regulatory Oversight
Although the SEC and the states have the responsibility of overseeing RIAs, FINRA has spent the past few years lobbying Congress to change this. FINRA claims that research shows that the SEC cannot adequately oversee the RIA industry by itself, and either needs more resources to do so or else needs to cede oversight of RIAs to a Self-Regulatory Organization (SRO) such as FINRA.
In a study done by the SEC itself in 2011, it showed that it only had the capacity to review less than 10% of all RIAs under its jurisdiction in 2010. FINRA has maintained that it has the resources to effectively oversee and review all RIAs on a regular basis; however, the RIA community has fought to stop FINRA from intruding upon its territory. The cost of administrating this additional regulation would place a heavy financial burden on advisors, and many smaller firms would likely be put out of business.
Many RIAs also view FINRA as an ineffective organization that is heavily biased toward the broker-dealer community, and some statistics indicate that FINRA has ruled substantially in favor of the major wire houses in arbitration cases where clients sought large amounts of money in transactional disputes. Advisors also see FINRA substantially lowering the protection given to RIA clients now, as RIAs are legally required to act in a fiduciary capacity for their clients at all times.
Brokers and securities licensed reps only have to meet the suitability standard, a much lower standard of conduct, which only requires that a given transaction performed by a broker must be "suitable" for the client at that time. The fiduciary standard requires that advisors unconditionally put their clients' best interests ahead of their own at all times and in all situations and circumstances. FINRA oversight would likely put an end to this standard for advisors.
FINRA attempted to move a bill, titled The Investment Advisors Oversight Act, through Congress in 2012, which would allow it to become the SRO for RIAs. However, the bill was met with bipartisan opposition, and FINRA announced in 2013 that it has no plans to reintroduce the bill at this point. Although most RIAs rejoiced at this development, many are still wary of FINRA and its allies such as the Financial Services Institute. They feel that these organizations are only making a tactical retreat for the time being and will likely make further attempts in the future to impose themselves as the SROs for investment advisors.
The Bottom Line
Registered Investment advisors enjoy greater freedom than their counterparts in the industry who work on commission. They are also required to adhere to a much higher standard of conduct, and most advisors feel strongly that this should not change. Of course, those who register to become RIAs must also contend with the normal startup issues that most new business owners face, such as marketing, branding and location, in addition to the registration process. For more information on becoming an RIA, visit the SEC website.
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