Q6 – Can I have discretionary accounts as an RIA?

Also available as podcast (Episode #6)

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Can I have discretionary accounts as an RIA?

Unlike while being affiliated with a broker/dealer in which you generally must seek permission from the B/D to use discretion with your client’s accounts, as your own Registered Investment Advisor (“RIA”) you are able to make that determination on your own.  However, there are a number of related disclosure requirements relating to both your client as well as ADV filings that are important to be aware of.

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Full Transcript:

Can I have discretionary accounts as my own RIA? That is today’s question on the Transition to RIA video series. It is question number 6.

Hi, I’m Brad Wales with Transition to RIA where I help advisors just like you learn everything there is to know about, why and how to transition to the RIA model.

Today’s question is as your own RIA, can you have discretionary accounts? Now the short answer of this is yes you can.

Now a big difference, you might be used to at your current firm is if you’re with one of the more traditionally either large or small firms, you probably had to get approval from your firm to be able to act with discretion with your clients. And dependent on the firm, the firm might have some sort of tenure requirement, experience requirement, training requirement, or what not. But basically, you are at the mercy of your firm to decide whether you were worthy or not of acting with discretion with your clients.

As your own RIA, you, the RIA get to decide if the advisors, yourself, have discretion with the firm’s clients. So obviously you get to decide what that approval process is or is not going through that.

Now one thing to keep in mind, this has nothing to do with the custodian you’re with. So you’ll need a custodian, and I’ll do a whole separate video on this, to house your assets for the RIA. So the RIA will be providing a service to the clients, the custodian will house the assets.

You do not need the custodian’s approval for discretion on these accounts. Quite frankly, the custodian is completely indifferent. They have no supervisory or compliance responsibility for the RIAs that use them for custody and clearing services. So likewise, they don’t have any obligation to decide whether you’re worthy or not of acting with discretion, they essentially stay completely out of it.

Because the reality is your relationship, kind of the three-way relationship between your client, your RIA, and the custodian, basically the client is giving the custodian authority to take trade instructions from you as the RIA. So that’s going to happen, the custodian has authority where the RIA says place this trade, I (the custodian) place the trade in the client’s account as custodian.

As to whether you have discretionary authority over that account with that client is between you and the client and has nothing to do with the custodian.

So the question is how would you kind of memorialize that? And that’s what’s called the advisory agreement which I’ll do a whole separate video on this. So as your own RIA, you will have your own advisory agreement which is the two-party agreement between the RIA and the client, the custodian is not part of that. And the RIA will say, “Okay, Mr. or Mrs. client, I’m going to act with discretion on your account and so it’s fully disclosed, and do you agree?” And by the client signing off on the advisory agreement they’re giving the approval for you to do that. So again, the custodian, the third party of the three parts of this is not involved in that at all as part of the decision.

Now last thing I would point out on this is sometimes I get the question, “Do I have to do all discretion or do I have to do all non-discretion, or can I do some clients one way and some clients the other way?”

The answer is the latter. You absolutely can do the latter. You can have some clients discretionary, some clients non-discretionary.  Or one way, or all the way the other.

Most RIAs generally are all discretionary or near all discretionary. I’ll give you an example where we do see some non-discretionary assets in there.

So let’s say you have a client that has $5 million and $2 million of that is in Coca-Cola stock, because they were a long time executive and they accumulated the stock and for the time being at least they want to hold on to that Coca-Cola stock. Usually, what we might see an RIA do is set up the remaining $3 million that the RIA will manage into one account, and they’ll have discretion on that account. And so basically I’m (the RIA) taking responsibility for managing the assets in this account. And then, we’ll open a second account with that Coca-Cola stock in it.  And client, just so we’re fully aware, as the RIA I’m not going to have discretion over that.

And the reason you want to do that as an RIA is because let’s say Coca-Cola stock plummets.  If you have discretion over that account, could that client fairly or not come back at some point in the future and try to say, “Oh, Mr. or Mrs. advisor, you had discretion…you saw the stock going down, surely you saw the stock going down, why didn’t you sell out of my position?”

And whether that’s fair or not, there is that risk. So one way you mitigate that is you do separate that asset aside and you make it clear to the client, “Hey, I’m acting in a non-discretionary capacity with respect to this portion of the assets.” So that’s usually where we see non-discretionary assets come in. Because again, most RIAs are running the money on a discretionary basis.

And the final point on that is all this has to be disclosed in the ADV. So you could actually…and anyone could…let’s fast forward, you’ve started your own RIA, you’ve moved your assets, you’ve updated your ADV with the latest assets, the ADV actually has to break it down. So let’s say you have $400 million in assets and $350 million of it, we’re using simple numbers here, are discretionary, then another $50 million for whatever reason is non-discretionary.  In the ADV you actually have to break that out and say, “Hey, I have $400 total, $350 discretionary, $50 non-discretionary.

So it does need to be out there for the clients to see, for prospective clients to see, the regulators to see.  But the main takeaway is you as the RIA have full autonomy to decide whether you’re going to offer discretionary services to your clients or not. Or, in some cases you might insist on some being non-discretionary.

But you don’t need to get anyone’s approval, you don’t need to get your current firm’s approval, like, you do now. You don’t have to get the custodian’s approval, because again, they are indifferent to it, it is solely up to you as the RIA as to whether you want to have discretion with your clients or not.

So with that, like I said, my name is Brad Wales, I’m with Transition to RIA. You can find me if you’re not already there, TransitionToRIA.com. Lots of videos, whitepapers, all kinds of resources. This is what I help advisors with every detail they want to learn and understand about how to potentially, first you have to learn about it before you actually start down the path, transition to the RIA model. So I’d love to help you with that as well. You can see all of my resources. Certainly, feel free to reach out and contact me. There is a contact link at the top of the page. You can instantly schedule a one-on-one Zoom conversation. We can begin to have a dialogue to help you with this exact sort of thing as you explore options, happy to help you with that.

So with that, I hope you found this video helpful, and I’ll see you on the next one.

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