Also available as podcast (Episode #28)
What can I expect to happen during an RIA regulatory exam?
Undergoing regulatory examinations is a routine part of having your own Registered Investment Advisor (“RIA”). With proper preparation, and awareness as to the process, examinations should not be viewed as something of concern. The key is to be familiar with what the steps are in the process, what the expectations the regulators will have of you are, and how you will work with your compliance consultant to manage it all.
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What can I expect to happen during a regulatory exam of my RIA? That is today’s question on the Transition To RIA video series. It is question #28.
Hi, I’m Brad Wales with Transition To RIA where I help advisors like you understand everything there is to know about why and how to transition to the RIA model.
On today’s video, I want to help you understand what you can expect if you become an RIA from a regulatory exam perspective. I did do a prior video on the frequency you can expect for how often you will get a regulatory exam. To the degree you haven’t watched that video yet, I encourage you to watch that as well because I dive much more into it.
At a very high level you can generally expect, as your own RIA, oftentimes to have a regulatory exam in your first year. That’s more of a kick-off exam to make sure you’re on the right track, there’s a reason they generally do that. Again, watch the other video. It gives more details on that. But that’s pretty typical.
Then on an ongoing basis, and it depends whether you’re SEC-registered or state-registered – and what state you’re in if you’re the latter. There are a number of variables that could change the frequency but typically, it could be in the once every four to seven years that you get examined. That comes down also to your risk profile.
Understandably, larger RIAs will probably get examined more frequently than smaller RIAs because arguably there’s more at risk there to the investing public. Or maybe the services and products one RIA offers versus another might be scored a little higher on that risk scale. Watch the other video to really dial into some of those components to it. But again, usually pretty early in the RIA’s existence, in that first year, and then four to seven years after as well.
What is that actual process like when that day comes? It will come, and if you’re in existence long enough it will come a number of times. The good news is they generally don’t just show up. Unless they have some specific concern about your RIA, they generally don’t knock on the door one day, and here we are. They will generally reach out to you ahead of time of the whole process. That’s what we’re going to work through on today’s video is what to expect from that first call all the way through the end of the cycle.
First step is being notified. Generally, they might call you. They could write you but generally, they might call you, explain who they are, explain….”We are going to come out. We’re going to examine your RIA.” They will generally tell you the exact day they will be there. It might be three, four weeks out or something like that. They’ll give you….”On this day, we will be coming out to your office to give you the portion of the exam that’s on-site.” The whole exam process is not done there on-site.
By the way, I should have prefaced this before I started this timeline, and I’ll reiterate it at the end, but one of the things – I talk about this in lots of videos, is you work with compliance consultants to help you with your RIA compliance, both in the initial setup and on an ongoing basis. This is what compliance consultants help you with on that ongoing basis. So as I explain this whole process, don’t think you’re going to be out on an island having to remember this or figure all this out on your own. That’s part of what you’re paying the compliance consultants for is to help you be prepared, and then when it actually happens to help you get through it. I should’ve prefaced that before I even dove in, but be aware of that.
The regulators will call you, they’ll say….”we’re going to come out on this date.” They will generally explain what you can expect from the process. “We intend on being there one day.” Maybe they’ll say….”We’re planning on being there a couple of days,” if you’re a really large RIA, “Here’s what we need from an accommodation standpoint,” and they’ll explain that process to you.
They will typically also confirm good contact information for who at the office they can exchange information with, and so that might be you or whoever in your office you decide it’s going to be. With that email address, again, usually done by email, one of the things they’ll do shortly thereafter, and they’ll explain they’re going to do this is they’ll say….”we’re going to send you a list of items that we need you to answer and address and send back to us before we come out to your on-site visit.”
Again, the exam process is not done entirely on-site. There’s a whole number of steps they need to do, and the bulk of it quite frankly, they can do without being on-site. Part of that is the discovery process of….”we’re going to send you a bunch of questions, we need you to answer those and get that back to us.” Again, that’s where you’d use your compliance consultant to help you address all of that.
They will send that list to you. They will also at this point in time, be pulling your ADV, which is online. The regulators and the public can see it too. I’ll do a separate video on how anyone can see your ADV. But they’ll pull your Part 1, your Part 2, your Form CRS, all those sorts of things. They’ll start looking through that and start deciding maybe certain things they want to ask you about when they are on-site based on what you’re saying in that ADV.
A lot of homework (by the regulators) goes in before they actually show up there on-site. A couple other thoughts on this list of items they’re going to send you. It is going to most likely be dozens of questions long. It’s not going to be….”here’s five questions we have.” It’s going to be dozens of questions. It’s pretty boilerplate. It’s generally not necessarily specific to your RIA, especially if they don’t necessarily have any particular concern about your RIA. It’s a standard template, they might send all RIAs in that year that they’re going to examine. They certainly revise it over time as focus areas change and what they’re looking for when they’re making those examinations. They’ll send it to you. Again, it’s usually dozens of items long, asking for a number of things.
An example of something they could be asking for, and they want you to send them ahead of time is a copy of your RIA’s advisory agreement. That’s the agreement between the RIA and the client. I did a whole separate video on that as well of what is an advisory agreement, and how do I create one? If you’re not already familiar with it, certainly check out that video, I explain all of that.
That’s a pretty typical request, they’ll say….”send over the advisory agreement you use with your clients because before we get out there, we want to look that over and see if we have any concerns about any of the verbiage in there because if we do, we’ll probably address that with you when we’re there on-site.”
They might also ask for a list of all your clients. It might be names and asset levels. They’re probably going to look at that. Usually, when they come out on-site or any of this pre-work, they don’t have the capacity to check and look into every single account you have, and every single client you have. Instead, they’ll do a sampling of that sort of thing. And so “send over that client list ahead of time.” It can help them pick which they’re going to include in their sample for maybe some follow-up questions.
Another typical thing is they’ll ask you for information on the fees that you’re charging your clients and want to see proof of….“send us the last four quarters worth of fees that you submitted to your custodian, and that the custodian paid back to you from the client.” They’re maybe going to try to match that up with some of the actual client files when they’re there on-site to make sure it all matches.
A couple other things, it’s not shown on that list, but on this pre-visit period before they actually show up at your office, they might very well also go to your custodians, if you have more than one, plural, or single custodian and ask for information from them as well.
A reason they might be doing that is they might want to ask you….”do you make your own (for example) quarterly performance reports that you create, you send out to clients about the values in their account and how the account is done?” If you do that – which is a pretty typical thing for an RIA to do – an example of where they might sample, they might want to pull….”these 10 clients, we would like to see those reports that you sent them for the fourth quarter of whatever year. You’ve told them that they had $X dollars in their account on that end date.”
They might then pull it from the custodian, and say….”On this same end date, what was the client’s value in their account?” They want to make sure that matches up. That’s a pretty typical thing. They might go to the custodian and ask for information as well.
This is usually why when they first reach out to you, it’s usually a number of weeks before they come out to see you on-site because one, they need to give you time to respond to all of these information requests….two, they might request from the custodian who needs time to respond….and then three, they want to do their homework on that information before they come out and actually visit you.
Another example, and this is not an exhaustive list, it is almost guaranteed they will look at any past exams they have already done on your RIA. If you’re a brand new RIA, this is the first time you’re being examined, obviously that doesn’t exist. Once you have any length of existence in your history though, you’re going to have exams, and they will absolutely go back to, most likely the most recent one, and say….”what deficiencies were found during that exam?”
You can be certain they will be double-checking to make sure all of those were rectified. You would have responded to that prior exam and explained how you rectified all of those, but it’s almost guaranteed they will use this next exam as a chance to confirm that you implemented those steps as well. So just know, they absolutely will probably pull your prior exam.
Let’s fast forward. Now, it’s the day of the exam. Again, in most instances, you will know what day it is – or days, potentially plural, it is. You want to plan for that day(s) and be prepared for it.
A couple of things to be aware of on that day. Number one, do not take offense to what they are doing. This is their job. It is their job to come in and potentially find deficiencies with your RIA. Imagine being one of these examiners, and if every week or every other week, you went out to a different RIA, and every time you came back and say….”we didn’t find anything.” That’s obviously not a good look for them. It screams….“Are you lazy? Are you not doing your job?”
So they will dig. This is their job. The reason they’re even there in the first place is to protect the investing public. So even beyond their own personal job security, the reason they exist is to protect the investing public. They want to dive deep into these things. The key is, do not take any offense to this. They are simply doing their job.
During the on-site visit, they very likely will also want to talk to the main principals of the RIA, the main owners. They also can ask basically to talk to whoever they want. They might say….”who’s the person sitting out front there? We’d like to talk to him or her. Could you bring them in so we can have a conversation with them as well?” It’s quite conceivable they’ll want to talk to people, mostly the main principals, but they could ask to talk to whoever.
They also might ask to see certain documents. They might say….”can you show us X?” That might be for two reasons. One, to see if you literally can produce it. And then two, it might be to double check something they’ve already confirmed with your custodian and now they want to match it up.
An example of being able to produce it – you have to give your ADV Part 2 to every new client. If they say….”Can you give us your ADV Part 2?” – even though they’ve probably already got it, but if they ask you and you can’t produce it, that’s not a good look because you should be able to produce it all the time as you’re bringing on new clients.
You go through that whole process and now it’s post-exam. I will absolutely say, when they walk out of there, you’re not going to have any answer. They’re not going to say….”You did a great job. Here’s the two things you need to do and on we go,” absolutely not. Don’t expect that at all. That (in-person) exercise, that day or days is information gathering. They’re going to take all that information, take everything they already got ahead of time, and then go back and put it all together and find out if they have any concerns or not. That process generally takes weeks, if not months. Unfortunately, you might have to wait a bit of time to hear back from them.
From an expectations standpoint, when they’re walking out of there, they might give you some general commentary of how they thought the day went or something like that. And you certainly can have a dialogue with them to try to feel them out and see what they think. But they’re not going to give you any concrete answer on that day, that you’re good or you’re bad or anything like that. Unfortunately, it will usually be weeks or months before you get that.
Then eventually what you will get is you’ll be notified of their findings. “Here are the deficiencies we noted of your RIA when we came out and visited, and all the things we asked about or we talked to a custodian about,” whatever the case is, “here’s what we found.” They usually then give you a period of time – but certainly not a lot of time – when you have to address them.
If they say you’re doing X wrong, you obviously need to fix X. You go through each item on their list. They also want you to respond back and indicate how you have rectified all of these deficiencies. Then they want to make sure they’re comfortable with what your response is. That might even result in some follow-ups.
If they point out something that’s simply (for example) a clerical issue in your ADV, they’ll probably take your word for it that you fixed it. Maybe they’ll make a note that the next time they come out to exam they’ll look at it. But if there’s any meaningful deficiency, they very well might do some additional back and forth….”You say you fixed this, we would like you to send that to us, so we can see firsthand.”
From start to finish, when they first reach out to you to when it’s all said and done, it’s usually a couple months. As long as you have the correct expectations though, it’s certainly manageable.
I want to finish with a couple of tips related to all this. First, they’re doing their job. Don’t take any offense. They generally will find something. I have occasionally heard of some RIAs that literally had a “perfect exam” and the response back from the regulators was no deficiencies. That is the white elephant. That is the absolute rare exception. In almost every instance, they will find something even if it’s sometimes just a clerical thing. No harm, no foul, no client was harmed, but we do need you to fix this. So again, don’t take any offense. This is their job to be out there looking for these sorts of things.
The next tip is be accommodating, especially if they give you a notice ahead of time on the day or days they’re going to be there. Absolutely have a conference room or some sort of place they can sit and spread out and be comfortable. Be prepared for them. Don’t put them in some uncomfortable corner, thinking that will run them out of there earlier. Be accommodating. They’re simply doing their job. They want to make this as easy for you as possible. Return that favor. Get them set up in some sort of setting. It’s not like you have to wine and dine them or have a breakfast selection or anything like that for them but do make sure you have accommodations that they can use.
The next one, again, they will find deficiencies. Don’t take offense to that. It could be 10 deficiencies. You might think…..“Wow, that’s a lot.” But a lot of those might be little clerical situations and so not that bad, or they could be meaningful. Absolutely take the process serious, which I’m sure you would. But they generally will find deficiencies.
I talked earlier about don’t get overwhelmed by all this. This is what you pay a compliance consultant for. Both beforehand because they’ve prepared you and they’ve set up your RIA correctly and helped you with everything you need to be doing so that when this day comes, you are prepared for it. And then when the day does come, they will help you through that process. They will help you on the back-end with responding to any deficiencies and those sorts of things. That is what you are paying them for.
Some compliance consultants will even do – I talked about this on a different video as well – some compliance consultants will even do what they refer to as a mock audit. The idea there is, before the regulators show up every (for example) four to seven years, the compliance consultant themselves goes through this exact process with you. “Let’s try to recreate what we could expect of the actual exam. Let’s do a dry run just between us. Let’s try to hash out any concerns now.” They call that a mock audit. That’s a way to try to get ahead of the day that the actual regulators come out to do the exam themselves.
The last thing I’d leave you with from a tip perspective is….you’re an honest advisor. You’re in this business to help clients, to help them make good decisions in their financial lives. As long as that remains your guiding light through all of the decisions you make about your practice of how to set up the RIA, and the processes you put in place, and the services you’re going to offer. As long as that’s your guiding light, you’re going to be okay with this exam process. Yes, you will probably have something you overlooked from a logistical standpoint that should have been done. But as long as your guiding light is what’s best for clients, and the regulators can see that is your guiding light, you’re going to be okay with this process.
Now, if you go off and you want to cut corners, and you don’t want to pay compliance consultants, and you’re maybe not too good to your clients….all bets are off at that point. But as long as you’re doing things correctly, you’re making the right investment into what it takes to run an RIA, and your guiding light is to do what’s best for clients, you don’t need to be overwhelmed or worried about this process.
With that, like I said, I’m Brad Wales with Transition To RIA where I help advisors like you understand everything there is to know about why and how to transition to the RIA model.
In this case, we’ve been talking about something that happens after you become an RIA, but going into it, before you make that transition, it’s helpful to be aware of….”what can I expect after I become an RIA?” In this case from a regulatory exam perspective. That’s the exact sort of thing I help advisors with. I want to make sure you are fully informed about everything there is to know about this model and how it works and how you can transition into it, and what you can expect on a going forward basis. That’s absolutely what I help advisors with all day long. I would be more than happy to have that conversation with you as well.
If you’re not already there, head on over to TransitionToRIA.com. You can see plenty more videos I’ve posted, I have whitepapers. The easiest thing, there’s a contact link right there at the top, you can click on it and instantly and easily schedule a time for us to have a conversation. I’d be more than happy to go into any questions you have on today’s video, or anything to do with the RIA model. And certainly, if you’re asking yourself….”What might my current practice and its current situation look like if I were to make that move?” That’s what I help advisors with. I would be more than happy to help you as well.
I hope you found value in today’s video and I’ll see you on the next one.
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