Also available as podcast (Episode #99)
What Do Advisors Fear About Compliance With The RIA Model?
There are several common misconceptions financial advisors have about managing the compliance responsibility of having your own RIA. These include variables such as what the costs will be, the time commitment involved, and who you can lean on for assistance. These misconceptions are often born by voices in the industry who are either naive to how the compliance process in the RIA model actually works, or who are agenda driven to scare advisors into thinking it is too risky or unmanageable. To the contrary, the industry has evolved to an entire ecosystem of support solutions that make the responsibility entirely feasible.
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What do advisors fear about compliance with the RIA model? That is today’s question on the Transition To RIA Question and Answer Series. It is episode #99.
Hi, I’m Brad Wales with Transition To RIA, where I help you understand everything there is to know about why and how to transition your practice to the RIA model.
If you’re not already there, head to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. Information on how to contact me. All kinds of resources to help you better understand the RIA model.
On today’s episode, we’re going to talk about something I often hear early in the conversations that I have with advisors.
By nature of what I do, helping advisors understand the RIA model, understand how it would look for their practice, what a transition to it would look like, I often hear feedback not only on the motivations advisors have for considering a possible transition, but also what their initial viewpoint of the RIA model is.
At times, that comes with misconceptions. Now, that’s not the advisor’s fault because, if you’ve never been in the RIA model, why would you necessarily know how certain things work? So there often can be misconceptions, just from having never been down the path before.
There is also a fair number of industry voices that are agenda-driven to try to speak ill of the RIA model because they don’t want advisors going down that path.
The classic example is the branch manager of a wirehouse firm. If you’re at a wirehouse, if you were to leave that branch and go in any other direction, the RIA model being an example, that branch manager has a personal economic incentive to have you not leave their branch.
A big part of how they are compensated is typically based on the production of the branch. They don’t want you to leave, so they have an agenda to try to scare you out of going down other pathways.
And that person has likely never been in the RIA model themselves. They likely don’t fully understand it either. They could be passing along misconceptions inadvertently, on top of maybe having an agenda.
You need to be careful which voices you are listening to. But regardless, it has created some misconceptions in the marketplace. I often hear them early in the conversation.
This topic came up recently when I was talking to my friend Rich Chen at Brightstar Law Group. We were talking about these misconceptions. I ended up writing a guest post for his website on some of the top compliance misconceptions that are out there.
And so, I wanted to turn it into an episode here as well and talk about some of the same points. These are things that I hear.
I’m going to go over five examples of where I hear advisors express fear over doing compliance as their own RIA.
For those of you that have watched or listened to a number of these episodes, you would know you have the option to join an existing RIA solution as opposed to starting your own. And if you join an existing RIA solution, part of what you are outsourcing to that firm is the compliance responsibility. They handle it for you.
So, to the degree you don’t want to have anything to do with compliance or the regulatory aspects of running an RIA, you can fully get that off your plate. I’ve done several episodes on why you might want to join an RIA versus starting your own. So, check those out.
But, on this episode, we’re going to talk about if the circumstances are as such, and we talk it through, and you think going down the path of your own RIA makes sense, what are some of the misconceptions that I hear about that?
I have five of them to discuss. This is not an exhaustive list, but it will give you context of the types of things I hear, and we’ll set the record straight on them.
First example, I hear advisors say, “I don’t want to pay for compliance.”
If you have your own RIA, there’s no regulatory requirement that you do this, but it is standard process to manage your compliance and regulatory responsibility by hiring a third-party compliance consulting firm. I’ve done several episodes on the kinds of providers in the marketplace, how they differ, etc.
As you’re hiring these folks, you likewise are paying them. But some advisors say, “I don’t want to have to pay to do compliance.” Well, guess what? You are paying for compliance currently. I don’t care what kind of affiliation model you’re in. For example, if you’re at a large broker-dealer and you’re getting the traditional payout, well, part of the firm retention part is going to pay for compliance.
If you get a payout of 45% and the firm retains 55%, guess what? Part of that 55% is to pay for compliance. They must cover the expense of their compliance team, the regulatory aspects of running the firm.
Even though you don’t get an itemized bill from them that shows exactly what part of their payout retention goes to compliance, make no mistake, you are paying for it. Regardless of what sort of affiliation model you’re in.
One of the benefits of being in the RIA model is because you pay it (the compliance bill) directly, you can determine if you are getting good value from your compliance provider for what you’re paying for it.
Try calling up your broker-dealer compliance department and asking them, “Could you tell me how much of my payout is going to pay you guys? Because I want to make sure that the support you are or aren’t giving me is worth what I’m having to pay for that.”
Obviously, they can’t or won’t do that. That is one of the benefits of paying for it directly is you can see exactly what you’re paying for. But the main takeaway is you’re paying for compliance regardless. You just have to mentally get over the fact that you’re going to see it on an itemized bill as opposed to just blurred into your bundled payout.
The next example, “I don’t want to be responsible for doing compliance myself.”
As I said at the top, if that’s a concern for you, there are some wonderful solutions in the RIA model that you can join, and they will do the compliance for you. So just as a initial takeaway, that should never be a misconception in the marketplace, “Oh, I don’t want to be responsible for compliance.” There are wonderful solutions where you can outsource that.
But to the degree you’re going to have your own RIA, consider the benefits of managing your own compliance.
Yes, it is an additional responsibility for most of you, that are not in the RIA model currently. For better or worse, you’re not managing compliance now perhaps. If you go in the RIA model and have your own RIA, that will be a new responsibility you will have.
There is a way to manage that responsibility though. You use third-party compliance consulting firms to help you.
Consider what changes when you are responsible for your own compliance. It comes with additional responsibility, but there is also a different dynamic now between you and how you are managing your compliance.
If you’re at a broker-dealer now, think of the perspective they have. If you were to call up those compliance folks, and there’s some wonderful folks out there, but if you were to call up the compliance team behind the scenes, would they think of you, the advisor, as the customer of their compliance department?
If they are not responsive to you, as the customer, you could take your business elsewhere. If they’re not willing to think through possible creative solutions of how to make something work for a particular client, do they fear that you’ll take your business elsewhere? That’s not how they think.
Early in my career, I worked for a brief time in a compliance department at a large broker-dealer firm. Trust me, that’s not how the compliance teams think about advisors. They should, but they generally don’t.
I did work for a compliance guy for a time, and he was very good. He would remind us (the compliance employees), “Don’t forget who signs our paycheck.” Implying it’s the advisor, meaning we wouldn’t have jobs if it wasn’t for the advisor, so we need to work cooperatively with them. To his credit, he would say that.
But I saw it firsthand, the rank and file compliance members often get caught up in, “We’re out to catch rule breakers, let’s go after this person.” They don’t think of you as the customer.
Consider how that is different in the RIA model. If you have your own RIA, you’re hiring a compliance consulting firm. You are hiring them. That makes you the customer. For most of you, that will be the first time in your career that you are the customer of compliance, not the other way around.
That gives you control. You are the one paying for the service. If that compliance consultant is not being responsive to you when you reach out and you need help with something, or you have a unique situation and you’re trying to think through a creative way to make it work within the regulations, and they’re not willing to think that through with you, guess what? You are the customer. You can fire the compliance consulting firm and go hire another firm that is more responsive to your needs, that will be more cooperative in trying to find creative solutions.
As the customer, you control the relationship. You don’t have that when you’re at some giant broker-dealer firm.
So when advisors say, “I don’t want to manage compliance myself,” again, number one, you could always join an RIA solution and fully take that off your plate. Or as your own RIA, you work to manage it yourself with the help of compliance experts.
There are 15,000+ SEC RIAs that are already managing this. There’s a way to do it. You need the right resources, but if you’re willing to take on the responsibility, there are benefits of overseeing compliance yourself. You get a better compliance partner in the process. There’s a big difference between the broker-dealer world and the RIA world.
The third misconception I often hear is, “The SEC will fine me for compliance deficiencies.”
This is a scare tactic, trying to infer that if you go start your own RIA, the SEC is going to examine you and give you some giant fine that’s going to put you out of business. That’s the most extreme example, but there are voices trying to put that scare tactic into advisors, so they get scared away of not making a transition.
For the most part, this is not something you need to worry about. If you have your own RIA, you are responsible for the compliance of it, and you will be examined by the regulators.
If you’re $100 million AUM or less, you’ll generally be state-registered. Above that, you’ll be SEC-registered. There are a few nuances that other variables could come into play, but for the most part, that’s how it plays out.
Let’s say you’re above $100 million. The SEC will examine you. It’s typically every couple years. It’s not an annual exercise. They will spend time going through your policies and procedures and trying to understand how you’re running the practice.
But again, to help you through this process, that’s why you’re hiring and paying for a compliance consulting partner. They know it will come along every couple of years. They help you get through it.
Regulators are for the most part there to protect the investing public. They are not out there to play got-you games and to screw over advisors or to fine advisors or anything like that. They are there to protect the investing public by finding the bad apples in our industry.
Any industry of size, and our industry certainly falls in that bucket, will unfortunately have some bad apples. It’s the regulator’s job to find those bad apples and remediate the situation, often which can include fines. That’s why you see fines happening.
But if as an RIA you are running a compliant shop, you are putting the necessary resources into managing your responsibility, you’re hiring and paying a reputable compliance consulting firm to help you, and if your guiding light is to do what’s best for clients, you generally do not have anything to fear from the regulators, let alone some big fine.
Now, yes, when they come in every couple of years, they will generally find “deficiencies” in your program. But that could be as simple as perhaps a box on the ADV that should have been checked and it wasn’t. And everyone can agree, that was inadvertently checked or not checked. There was no intent to harm the client. Let’s get that corrected.
It’s not like the regulators come in and just start handing out fines left and right. Now, if you are one of those bad apples and you are doing things to harm clients, you’re on your own at that point. There’s no compliance consulting firm that can bail you out of that if you are on the wrong side of the tracks.
But for those of you that are running a compliant shop, putting in the resources, you do not need to fear the regulators. You do not need to fear that they will come in and assess some big fine on you. Again, typically, all they’re going to find if you’re running a good shop is smaller things. They just want to see it get rectified.
The next misconception to note is something I most recently heard on a podcast just the other day. It was an industry recruiter that said it.
He was attempting to explain that if you start your own RIA, you’re going to have to hire a chief compliance officer and pay them $200,000 or more. It was basically a scare tactic to suggest you don’t want to be going down the path of your own RIA.
You should always consider someone’s motives as to why they answer things in a certain way. My guess as to why this recruiter made this statement was either, one, they’re not familiar with how it works, or, two, it is much easier for them as a recruiting firm to steer you into joining an RIA – that they have a recruiting relationship with – versus helping you start your own RIA.
There are pros and cons to starting your own RIA, versus joining an existing firm. One is not better than the other. It matters what is best for you based on your specific circumstances.
I help advisors down both paths equally. When I first start a conversation with an advisor or team, I can’t determine immediately from the start of the conversation which path would be best for them. It’s a process to figure that out.
But I could tell the answer the recruiter had given was an agenda-driven answer because it’s easier for them, perhaps more lucrative for them, to steer an advisor down the path of joining an RIA.
They in turn say things like, “You’re going to have to hire a chief compliance officer that’s going to cost you over $200,000, and you don’t want to do that. That’s very expensive.”
For most advisors and teams, that’s not going to be needed. If you get large enough, you might need or want specific in-house expertise – usually still coupled with an outside compliance consulting firm – but, typically, for most of you, you are not going to need to hire a standalone expert compliance person as the CCO that costs over $200,000 a year.
Every RIA is required to have a named chief compliance officer, CCO. You will have to have that. As an aside, there is a way – I’ve done episodes on this – to potentially outsource that CCO function, while still being our own RIA. Check out that episode if you want.
But unless you outsource it or unless you join an existing RIA, someone on the team must be named the CCO. Again though, to help that person manage that responsibility, that’s why you’re hiring the third-party compliance consulting firm. But the person on your team doesn’t necessarily have to be a $200,000+ experienced compliance officer.
Oftentimes, it is an operations person that’s also now wearing the hat of compliance. It could be a main principal or founder that is doing that and has members on the team supporting them with the day-to-day tasks.
But don’t think, “If I start my own RIA, I have to go hire this very expensive CCO.” That’s incorrect information. Again, there could be certain circumstances where you grow large enough and that’s the case, but for most advisors and teams considering the model, that’s not something you would need right from the jump.
I’m happy to help you understand if you’re in that camp of being large enough where it might make sense. But for someone to make a broad statement like I heard on the podcast that everyone that starts an RIA is going to need to do it, is absolutely incorrect.
The final compliance misconception I want to note – again, this is not an all-inclusive list – is I hear, “If I start my own RIA, I will be at a disadvantage to the larger firms if the SEC changes rules down the line. Once I make that leap, now I’m at the mercy of the SEC, and they could screw me over because they changed some rule, and I get crushed.” That’s simply that agenda-driven fear that the large firms are often putting out there.
We’ll pick on wirehouses for this example. Keep in mind, while we call wirehouses “broker-dealers”, they are duly registered. They are broker-dealers and RIAs.
Most advisors typically wear two hats if you’re at a wirehouse. You’re a registered rep, meaning you’re under the broker-dealer, that’s where you open your commission accounts. And you are an investment advisor representative under the firm’s RIA side of the house, that’s where you open your fee-based accounts. The wirehouse is essentially a giant RIA. We just happen to generally call them broker-dealers. But they’re a broker-dealer and RIA.
The implication that some of the people at these firms are trying to make is that, “We as a large RIA, we will be able to adopt or absorb these potential changes from the SEC. You and your standalone RIA, you will get crushed by any changes that come along.”
(Note: States have slightly different rules, so for explanations sake we’ll put state-registered RIAs to the side, but the same macro theme still applies.)
If the SEC changes a rule, and it’s a black-or-white rule, it says you can do X or you can’t do X, well, guess what? Every RIA must play by the same rule. The big firm and the small firm. If now you can’t do it, you can’t do it. Or now you can do it, you can do it. It’s very black or white. One firm is not an advantage or disadvantage to the other.
Where there can be a difference though is when rules come along, there’s often interpretation needed, “How does that new rule apply specifically to my RIA of whatever size I might be and how am I going to implement policies and procedures to follow that rule?”
It can be much more of a gray area. It could be something as simple as, “There’s a new rule that says advisors can or can’t do X, and we need to have some sort of way to document that we are monitoring that our advisors are doing or not doing X.”
That’s when you start to see variability because a giant firm with, say, 10,000+ advisors has to interpret and implement the new rule to potentially corral 5,000, 10,000+ advisors. That’s where you often hear the phrase, managing to the lowest common denominator when it comes to compliance.
If you have 10,000 advisors, anytime you get that big, there will be some bad apples. So they have to put guardrails in place, which are generally much tighter than the actual regulation itself. They are trying to identify and prevent those bad apples from doing things they shouldn’t be.
Compare that to if you have your own RIA where perhaps you have a dozen or maybe even fewer advisors on the team. Maybe it’s just you and one other advisor.
Now, when you say, “There’s this new rule. We have to implement something. We must be able to demonstrate that me and the one or two or three or five other advisors on the team are following that role.”
Who is going to have more flexibility in how that can be implemented? The RIA with 5 advisors to craft a new policy and procedure around, or the one with 10,000+ advisors?
We don’t know what rules will change in the future. Five years, 10 years, 15, 20 years from now, no one knows what new rules will come along. Knowing new rules will happen though, it is inevitable, consider your flexibility to adapt to them.
So, if someone says, “You’ll be at a disadvantage with rule changes,” no, I’d say you are at an advantage because you’ll be more flexible to adapt.
Again, this is not an exhaustive list. But these are misconceptions I often hear early in conversations with advisors. There are misconceptions about the economics of the model, misconceptions about the various responsibilities of the model.
I encourage advisors to make sure you are talking to a good source, someone that knows how this actually works. Not to give you some sales pitch, but this is all I do. I help advisors understand exactly how the RIA model works, how each of these types of things would apply to your specific practice and make sure you’re getting good information.
Before you discount the idea of the RIA model, consider if your understanding of it is fully accurate or not. Where have you obtained your information? What has the source of that information had for experience in being able to explain it? Have you checked to see how it actually works?
With that, like I said at the top, my name is Brad Wales with Transition To RIA. This is the kind of conversation I have all day long with advisors. Helping you understand how the RIA model works, how would it look for your specific practice, what the different pathways into the model are, how the transition process works, etc. That’s what I do for advisors. I’m happy to begin that conversation with you.
It typically starts with a lot of education on the front end, and then we figure out what pathways might make sense.
By the way, for some of you, the RIA model won’t make sense. We identify that on the front end. But for most advisors, it is a good fit.
As a starting point, head to TransitionToRIA.com. I have all kinds of resources to help you better understand the model. This entire series is available in video format, podcast format. I have articles, I have whitepapers.
At the top of every page is a contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me. Whether you want to talk about today’s topic or anything else RIA-related, I’m happy to have that conversation with you.
With that, I hope you found value in today’s episode, and I’ll see you on the next one.
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