Q8 – How often will my RIA receive a regulatory exam?

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How often will my RIA receive a regulatory exam?

There are a number of risk variables involved that drive the frequency in which your Registered Investment Advisor (“RIA”) is examined by your applicable regulatory body (SEC or state).  You can generally expect to receive an initial introductory exam within your first year of registration as the examiners want to ensure your firm is starting on a solid footing.  Thereafter, the aforementioned risk profiles, as well as other potential extenuating variables (e.g. what state you are located in) will generally drive the frequency on a going-forward basis.

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Full Transcript:

How often will my RIA receive a regulatory exam? That is today’s question on the Transition To RIA video series, it is question #8.

Today’s question is how often will my RIA receive a regulatory exam? Now, I’ve made a lot of videos, certainly more videos to come. And a lot of that I talk about the benefits and the positives of the RIA model. And I think it is fair to make sure yes, there are a lot of positives, there are a lot of benefits, but there are responsibilities as well that come with it. And so, one of those responsibilities to be fair, we should cover both sides is, as your own RIA regulated by either the SEC or state, your RIA will be examined by the respective regulator. And so, today’s video, and we’ll talk in different videos about what to expect during that process, how you can get ready for that process. But today’s video, I just wanted to quickly touch on, how often can you expect that process to happen?

That’s what we’re going to talk about here. And I’d preface it by saying keep in mind, literally thousands of RIAs, not just advisors, RIAs, which then within each of those RIAs usually has multiple advisors so you can do the math, have come before you, have already started their own RIA, and have gone through this process kind of on a routine basis, gone through an exam. So, do not be scared off by this. It is worth being aware of what the process is and what to expect. So, again, that’s what we’re going to touch on here.

If you have your own RIA, yes, you will be examined either by the SEC, or by the state, and it all depends on who your regulator is. Now, I did a video on this already. So, go back and take a look.  It depends primarily on your asset size and some other nuances. So, it’s worth watching that video of whether you’re SEC or state. For argument’s sake, we’ll say you’re SEC. So, the question is, well, how often is the SEC going to come and examine my firm? And I’ll touch on the state part as well.

Two main parts to that. It is very likely in your first year of existence, that you will get an exam in that first year. Now, this is not the regulators trying to make your life difficult or anything like that. But the thought is, this is a partnership between the RIA and the regulators to say, “Hey, let’s make sure you’re off to a good start here, we hope you’ve done all your homework on the front end, you’ve got steps in place, you’ve got policies and procedures in place. But hey, before we go too far down a path, and it may be the wrong path, let’s take a look, let’s work together just to make sure you’re off to a good start.”

And so, that first one is really in a partnership of let’s just make sure you’re set up and ready to go. And yeah, they probably will find things because some of this is going to be new to you. But certainly, they understand, hey, this is within that first year, you have the bulk of it done, you’re going through the motions, you’re going through the steps, but hey, maybe these three things (for example) you’re not realizing. So, let’s get those three things on track now while you’re still in that first year then kind of on an ongoing basis. So, again, typically you could expect to receive, there’s no guarantee of it, but typically, you could expect to receive an exam in that first year.

Then on an ongoing basis this really varies between the SEC and the states. And there’s some variables which we’ll talk about, which might kind of dictate it but generally speaking right now, and I saw a stat the other day that the SEC was reporting…I think it was 17% of RIAs…SEC registered RIAs, were examined in the past year, the last time they released that information that I saw. And so, that equates to roughly every 5 years as an RIA if you’re SEC. If they’re only doing roughly 17% you kind of round up to 20%, that means roughly you’re getting that exam every 5 years. So, it’s not an annual exercise generally by any means.

And then as far as if you’re state-registered, that’s all over the board as well. I mean, each state can be different. Some states literally have much more capacity on their regulatory team to get out more frequently and others perhaps have less capacity. I’ve heard of RIAs going certainly much longer than five years between exams and sometimes it’s less than that. But you can kind of think somewhere in that range. I typically say, four to seven years. If you’re SEC or state is probably the frequency of how often you’d be examined.

Now, a big variable to put into that is also the complexity and the risk level of your firm. If you were in charge of the examination process, it would behoove you with limited resources to try to effectively score the RIAs that you have to oversee. And certainly, if some potentially are higher risk than others, maybe you do those more frequently than the lower-risk ones.

There could be a host of different variables that drive that. A billion-dollar RIA clearly has a lot more on the line than a $50 million RIA. And so, the regulators might say, “Okay, all else being equal, we will probably do the billion-dollar RIA more frequently than the $50 million one.” Other variables could be the kind of products you offer with clients or the services you provide, or do you have maybe a hedge fund on the side, and that kind of adds some risk.

There’s no perfect formula for it, that give or take range of four to seven years. But again, depends on that risk level and how you’re kind of profiled as an RIA, it could be more frequently or it could be less frequently as well.

A couple of tips on how to manage this process and to not not be intimidated, not be worried about it.

Number one, and I’m going to do a whole bunch of videos, you’ll hear me say over and over again talk about compliance consultants, that’s just part of having an RIA is working with these compliance consultants. This is one of the main things compliance consultants do. You don’t just hire a compliance consultant to help you set up your RIA, which is part of the process. You then pay them on an ongoing basis to make sure you’re following rules, to be aware of changes to rules that are out there, and being ready for that exam when it happens. They will help you make sure you’re ready to go whenever that regulatory exam does come up.

And to further test it, the second tip is, a lot of these compliance consultant firms will do a mock audit of your RIA. The idea is they come in, they have the wherewithal of…because they are helping hundreds of other RIAs go through exams…..so, they know what the regulators are currently asking about and digging into and wanting to really file through to learn more about. And so, they’ll come in and basically try to replicate that process with your RIA and say, “Okay, let’s go through a dry run with just us”, the RIA and the compliance consultant. And “let’s do a dry run and see how we do here. And if we can get that polished up, then we should feel comfortable the day the regulator comes in as well.” So again, a mock audit is a pretty typical thing used.

The third tip is, even though you’re using a compliance consultant firm, which I encourage all advisors to use, you are still going to want at least one person in the RIA to be the lead on compliance matters. Technically, you have to name a Chief Compliance Officer, even if they’re essentially outsourcing most of that work to the compliance consultant. But you really want someone (internal), fairly well versed. So when that exam comes up, you’re organized, you know who’s going to take the lead on working with the consultant to walk through the examination with the regulator. So get ahead of that, decide amongst yourself who’s going to kind of have that…who on the team is going to be the lead on that and be prepared for it.

And then last, and you’re…I’m sure you’re doing this anyways. But the reason you shouldn’t get intimidated by this is just as long as you’re doing what’s best for the client, you shouldn’t fear an exam. The regulators are not there just to make your life difficult, or miserable, or anything like that. Their ultimate goal is to make sure clients are not being harmed. So, as long as that’s your guiding light, and let’s do what’s best for the clients, that’s going to go a long way.

Now, yes, in an exam, they might find some clerical oversight you haven’t done that, oh, you should have…because you offer this service, it should have been noted in paragraph three of the ADV Part 2…but you noted it in a different section so let’s fix that. That sort of stuff will happen and you’ll go through it. But again, the regulators are going to have more sympathy for something like that, as opposed to if they feel you’ve genuinely harmed the client. So, as long as your guiding light is always do what’s best for clients, everything else will fall in place and you generally don’t have a lot to fear from this process. Especially when you’re using a compliance consultant to keep you on track with all this.

Bottom line, exams will happen. They won’t happen annually generally unless the world changes, but historically, it has not been an annual exercise. Again, you might have it the first year, you might have it every, call it four to seven years after that. Some of you might have it less, some of you might have it more. But it is a process, it’s just part of running the business and there’s a way to manage it.

In a future video, I’ll do a whole video on what to expect when that day comes and the examiners notify you, “We’re going to examine you.” I’ll do a video on what that process looks like and what to expect. And it’s not just a one-day thing, it’s usually a multi-week process, not necessarily a week(s) on-site in your office. But I’ll walk you through that to the degree you want to know what you’re going to expect there.

Again, to recap, you’ll have an exam upfront, and then you’ll have it at some kind of periodic basis over the years as well.

So with that, like I said, my name is Brad Wales, and I’m 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. That’s everything from what are the benefits? How do the economics work? How might this look for your individual circumstances specifically? I have that conversation all day long with advisors and I’d love to help you with that as well. How would my practice look if I were to transition? And then if that looked like a good thing to do, what are the steps with actually transitioning to that model?

If you’re not already there, head on over to TransitionToRIA.com. And you can see plenty more videos I’ve made, I have whitepapers. And I encourage you to jump right up at the top is a Contact link. You can easily and instantly schedule a specific date and time to have a one on one conversation with me and we can begin this kind of dialogue to say, “Hey, what does your practice look like? And what would it look like as an RIA and what might that mean to you?” I’d be happy to have that conversation with you.

I hope you found today’s video helpful and I look forward to seeing you on the next one.

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