Q7 – Do I have to get Outside Business Activities approved as an RIA?

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Do I have to get Outside Business Activities approved as an RIA?

While being affiliated with a broker/dealer you are generally required to get the B/D’s permission before engaging in any sort of Outside Business Activity (“OBA”).  As your own Registered Investment Advisor (“RIA”), you are able to make sure determinations on your own as to what sort of activities you desire to participate in.  However, there are disclosure requirements and potential conflict of interest considerations relating to certain types of activities that are still important to be aware of.

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Full Transcript:

Do I have to get Outside Business Activities (OBAs) approved as my own RIA? That is today’s question on the Transition To RIA video series. It is question #7.

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

On today’s question, we’re talking about Outside Business Activities, also commonly referred to as OBAs. If you are currently at a broker-dealer, it is almost all but certain you have had to, and you’ve probably gone down this process perhaps many times, had to ask permission from your broker-dealer firm to do some kind of external activity alongside your normal job as being a financial advisor for that firm. Not only do you have to ask permission, then you have to wait and see if they actually approve it or not. And they might very well reject you if for some reason they don’t want to approve it.

It comes back to why might that firm have issue with that, or why do they require that you seek out this permission? And it all comes down to the responsibility of the broker-dealer and the firm. They have a supervisory responsibility over you as a registered rep of their firm. So, they want to make sure that the activities you are providing out there in the marketplace are something that they’re comfortable with because again of that supervisory responsibility. But make no doubt about it, it is also to limit their liability.

They want to make sure it’s very clear that any activities you’re doing that perhaps are not, narrowly defined in the scope of a “financial advisor,” that there’s no confusion by the client that, oh…..“Mr. and Mrs. Advisor was providing that service. I thought he or she was doing that under the umbrella of this broker-dealer”. Where it turns out they’re not, and then there could be perceived liability for the broker-dealer. So, a broker-dealer will be very cautious about this sort of thing. And they just as well at times tell you no, you can’t do certain things because we don’t want it to risk our liability or be a potential supervisory responsibility for us.

Now they will, of course, approve quite a few, but it is quite conceivable they say, “No, we don’t want you doing that.” Nonetheless, you still have to ask their permission to do this.

Part of where that comes into a challenge is, if you are with a very large firm, thousands of advisors, some of the larger firms over 10,000 advisors, a challenge is it’s not just a matter of whether you are capable of properly doing some sort of activity in addition to being a financial advisor…..but they generally have to treat everyone, all 10,000 plus advisors kind of similar. Because otherwise there’s just no conceivable way to really manage that.

Even if you yourself have the experience and the tenure and the knowledge and the responsibility to be able to perform some outside business activity, well, there’s probably a lot of advisors mixed into the 10,000 that don’t have those same characteristics. And so, all too often, it will be easier for the firm just to say….“hey, across the board, we don’t let our advisors do activity X”.

And so, that really, limits your abilities. Again, not because you yourself are not capable of it, it’s just the reality of being part of this very large firm and the concept, I’ll do a video on this, but, you know, managing to the lowest common denominator. So, you’re going to be put in the same apple basket there as every other advisor, regardless if you have 30 years experience and they have 3 days of experience. You’re all kind of lumped in together. So, some of the realities of having to ask for permission on that.

As your own RIA, though, you, the RIA decide what activities you will or won’t do. You don’t have to seek anyone’s permission. At that point, if you’re not with your current firm (any longer), you’re certainly not asking their permission. You don’t ask the custodian that you use. It’s not their responsibility to oversee whatever services or activities you’re performing. You just say, “Hey, as an RIA, am I comfortable with this activity being performed?”

A couple examples of activities that are pretty common out there. You see whether it’s advisors, RIAs that also want to sell insurance, provide tax services, maybe be a mortgage broker, provide mortgage services, maybe even real estate services. These can all be kind of bundled into the services that they offer their clients.

Now, a couple things I want to clarify on this. Just because you can do these things doesn’t mean there’s not a couple of nuances to be aware of. Number one is just that the aspect that some of these services have technically nothing to do with the RIA. So, an RIA is to provide advisory services to clients. So, if you under one roof, also want to provide real estate brokerage services to your clients, which would, you know, functionally be an Outside Business Activity. Technically, it’s not the RIA providing that. It’s hey, the RIA provides advisory services. And hey, we also do this over here, maybe again under a parent umbrella, we provide real estate brokerage services.

So, again, just a clarification that it’s technically not the RIA providing some of these things, especially once they go beyond the scope of directly what we would think of as a financial advisor.

Next step, even though you don’t have to get permission from anyone besides yourself as the RIA, certain Outside Business Activities still have to be disclosed on your ADV Part 2.

I say over and over in these videos you’ll be working with….and this is exactly what I help advisors understand and know what the options are….as your own RIA, you’ll be working with a compliance consulting firm that helps you with all of this. Helps you with the RIA setup, helps with the ongoing compliance. Part of what they do is making sure your ADV is properly filled out. So part of the ADV on Part 2, you have to disclose certain activities if they’re of more of a financial nature.

So, if you have a rental property which right now, because that’s generating you income, your current firm might make you seek permission and get approval because technically, you’re making money, it’s an Outside Business Activity. And they probably always approve that, to be fair. Under your own RIA, again, you certainly could do that, but that sort of thing would not have to be required on the ADV because clearly, it has nothing to do with the financial services being provided.

But certain things like if you want to offer, tax services, arguably, that would need to be disclosed. And again, that’s a conversation you have with your compliance consultant and say, “Okay, here’s the activities I will be doing because I have the right to approve it. Which ones do we need to disclose in our ADV?” So, just something to be aware of. Again, the compliance consultant will help you understand this and make sure you’re properly disclosing it all.

And then the final point I would just point out is to, as your mind might start kind of thinking through, “Wow, if I transition to the RIA model and I have more flexibility, what additional services would I like to provide?” And just keep in mind, just because you can doesn’t necessarily mean it’s always a good fit.

I’ll give you an example. What this comes down to is, conflicts of interest. Which by the way, as an RIA, you always have to either try to mitigate or eliminate conflicts. Or where they exist you have to disclose and it’s usually in your ADV Part 2 where you disclose….“here’s a potential conflict of interest. I want to disclose it. I want to make sure client, you are fully informed of this and can make a decision whether working together is the best fit for you.”

An example, let’s say you want to offer mortgage brokering services, and there’s ways to do that. And there’s the ways you can disclose that. But just as an example, keep in mind as a financial advisor, you might be advising a client on….“okay, should you refinance your mortgage because you’re paying this interest right now, and this is how much is left on the mortgage” or whatever. All the variables. That’s a common conversation a financial advisor can have with a client.

The challenge is if then you also say, “Hey, and if you do want to refinance that mortgage, I over here, I offer that service and I do mortgages.” Again, you can certainly do this above board. It’s certainly doable, but you could see where there could be a conflict there because you have the chance to get the mortgage business.

Maybe over here (under the RIA) you do encourage them to go ahead and refinance the mortgage. Would you have made that same recommendation if you were merely going to send them off to some external mortgage broker that you would have no financial gain from?

I’m not trying to suggest that financial advisors would, succumb to this conflict and not provide that accurate, good advice in the front end. But it is nonetheless a perceived conflict or arguably, a conflict. And that’s the type of thing just to decide, “Hey, do I even want to be in that situation where a client might view something one way or the other?” Or, “I think this is a service that the clients need and want, and it’s going to be easier if I can help them with it, so let me just make sure I properly disclose it to the clients and disclose the conflicts and explain how I mitigate that. And why, hey Mr. and Mrs. Client, you can come to me for the mortgage, or you can go to any other source if you want. I’m more than happy to help you, whatever path you go on.”

There are ways to work through it. But it is something to be aware of nonetheless. So, end of the day, as your own RIA, you decide what Outside Business Activities, OBAs that you either do or do not take part in. But again, just keep in mind, there are some disclosure requirements, conflicts of interest, things you want to be aware of as part of that.

With that, I’m Brad Wales with Transition To RIA. I help advisors with this exact sort of thing. I help advisors learn everything there is to know about the RIA model. Why you might want to move into the RIA model, and how that process actually works to transition into it. I’m more than happy to help you with that.

If you head on over, if you’re not already there, TransitionToRIA.com. I have all kinds of videos, resources, easy contact link at the top of the page. You can click on that, instantly set up a Zoom call with me. We can begin this sort of dialogue to walk you through anything and everything you want to know about the RIA model. I’d be happy to help.

With that, I hope you enjoyed this video and I’ll see you on the next one.

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