Jan 30 Brokers who want to set up their own
advisory businesses have a lot of compliance issues to consider,
especially when they plan to hold licenses through both of the
top U.S. securities regulators instead of just one.
The allure of more income and independence drives many
brokers to set up their own practices. They often set up an
advisory firm that registers with the U.S. Securities and
Exchange Commission, and also affiliates with an independent
broker-dealer licensed through Wall Street's industry-funded
watchdog, the Financial Industry Regulatory Authority (FINRA).
These so-called "dually-registered" firms are one of the
fastest-growing sectors in the securities industry.
Dually-registered firms managed nearly $1.1 trillion at the end
of 2012, a 21.5 percent spike from 2011, according to Cerulli
Associates, a financial services industry research firm in
Boston. Its 2013 data is not ready.
But that freedom typically triggers a brand-new set of
compliance responsibilities. Holding licenses through two
regulators means more scrutiny than an adviser may anticipate.
The SEC, for example, is honing in on dually-registered
advisers as part of its 2014 program for examining firms,
according to a list of "priorities" it published on Jan. 9.
Among its concerns: "reverse churning," a practice in which
brokerage firms trade very infrequently in accounts they manage
for fixed fees.
At issue are two different ethical standards: Advisers who
register with the SEC or states are "fiduciaries" and,
therefore, must give advice in clients' best interests. But
those who also hold licenses through FINRA are bound by other
regulations that require recommendations to be "suitable" for
investors, based on factors such as risk tolerance or age. There
may also be differences in regulations for record-keeping,
disclosures and other issues, say compliance professionals.
Advisers with dual-licenses provide advice for a flat fee
through the firm's investment advisory arm - typically a
percentage of the total assets under management - but may also
offer services through the firm's brokerage arm, such as
accounts in which clients can stash money for college.
A big challenge for dually-registered advisers is making
sure clients know the standards in play and when they apply.
"The fact that the SEC has a separate category called 'dual
registrants' speaks volumes,' said Kevin Taylor, chief
compliance officer of Pershing Advisor Solutions LLC, a unit of
Pershing LLC, a subsidiary of The Bank of New York Mellon Corp
While the business model itself is not a problem, some
advisers jump in without thinking through their new compliance
responsibilities, Taylor said.
Here are four compliance issues advisers should consider
before taking the leap:
1) Use caution with client details: Brokers risk regulatory
violations when they take client information from their old
brokerage to their new dually-registered firm. In many
situations, the new advisory firm is not a signatory to an
industry-wide agreement in which firms agree not to sue one
another as long as brokers take only basic information, such as
a client's name and email address, said Tom Lewis, a lawyer at
Stevens & Lee in Princeton, New Jersey.
In that case, advisers who take just a list of clients'
names can trigger SEC and FINRA investigations for violating
privacy regulations. It's a "hot-button issue" leading to fines
and suspensions for some advisers, Lewis said. Advisers can
avoid the problem by having their new firms enter the
industry-wide agreement just as the advisers leave their former
firms. The agreement is available through the Securities
Industry and Financial Markets Association, a Wall Street trade
2) Square away disclosures: Clients need to know which type
of adviser they are dealing with and when, said Nicholas Olesen,
a partner at The Philadelphia Group, a financial advisory firm
in King of Prussia, Pennsylvania.
Olesen tells new clients at the onset that he can provide
services either through the registered investment advisory arm
of his practice, or the brokerage arm. His firm, affiliated with
LPL Financial, a unit of LPL Financial Holdings Inc, has
separate agreements for the two divisions outlining the
different responsibilities, fees, and potential conflicts of
interest, Olesen said.
Clients review the fees and disclosures every year and sign
new agreements, Olesen said. Some advisers also verbally remind
clients of their two hats, depending on the situation.
3) Give clients a fair deal: Flat fees for advice that some
clients may pay at an advisor's new business are higher than the
total commissions they paid for trades in a brokerage account at
the advisor's former firm. That is especially true for clients
who do not trade regularly. SEC and FINRA officials have both
voiced concerns about the practice, known as "reverse churning."
Advisers whose clients move with them to the new business
have to calculate which model costs less and disclose that to
the client, said Joel Beck, a lawyer in Lawrenceville, Georgia
who advises brokers. "Clients may still be OK with the extra fee
when the understand the difference between the two types of
accounts. But they can make an informed decision," Beck said.
4) Get help: Brokers who launch an independent firm without
help from a compliance professional may run into trouble when
regulators uncover problems down the road. They may not realize,
for example, that policies they must follow for the brokerage
with which they affiliated, such as LPL Financial or Raymond
James Financial Inc, do not extend to the advisory arm
that the SEC oversees.
Consultants charge anywhere from $3,000 to more than $10,000
to set up a registered investment adviser, depending on factors
such as the number of advisers and business model. Services
typically include filing a mandatory SEC disclosure form to
developing a compliance manual and documents. The bill may be
tough to stomach, but cleaning up a regulatory violation could
cost even more, say lawyers.