Q11 – Won’t I have to pay for doing my own compliance as an RIA?

Also available as podcast (Episode #11)

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Won’t I have to pay for doing my own compliance as an RIA?

As your own Registered Investment Advisor (“RIA”), you will be responsible for the compliance of your firm.  While you in theory could attempt to manage this responsibility entirely on your own, the standard approach is to utilize the services of a specialty compliance consulting firm.  Of which, you will have to pay for.  However, when you consider how exactly this option compares to what you are currently receiving (and technically paying for) with your current firm, you will see it is generally more advantageous to pay for your own compliance.

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Full Transcript:

Won’t I have to pay for my own compliance as an RIA? That is today’s question on the Transition To RIA video series, it is question #11.

Welcome, everyone. I am Brad Wales with Transition To RIA and today’s question is won’t I as a financial advisor have to pay for my own compliance if I transition to start my own RIA?

Now, I would tell you, this is actually one of my favorite questions to get, because besides a relatively easy answer, I think it really starts driving home how you need to mentally approach the RIA model. And I’ll give examples of certain ways. When we start thinking things through, I think you’ll see them in a whole new light than you maybe previously thought of it.

So, when an advisor says, “Well, geez, aren’t I going to have to pay for my own compliance?” I do ask them to kind of reset their thinking, which is what I’m going to do here on this video, and I think it’ll have the same effect of you as well.

The short answer is, do you have to pay for your own compliance? And the answer is, yes. So, unlike now, you are probably most likely at a large broker-dealer/RIA firm, say a wirehouse-type firm, and for that the firm itself is providing compliance for you and it’s providing supervision for you. And that’s because they’re required to do that. They are required to oversee from a compliance perspective and a supervision perspective.

If you were to start your own RIA, the RIA itself has those responsibilities and functions. A custodian does not do that for an RIA. An RIA is completely independent of any other vendor, so certainly the custodian would not play that role. And so, yes, as your own RIA, you do have responsibility for your own compliance and the costs that come with that. So, again, the short answer is yes, you do have to pay for your own compliance.

Now, the quick answer for how do I go about doing that? And I’ve done some videos talking about compliance consultants, I’ll do some more as well. And the reality is no RIA tries to do it on their own. You work with specialty expert compliance consultants that help RIAs manage their entire compliance program. You would not…while you technically could from a regulatory standpoint try to do it on your own, this is the approach used with every RIA I’ve dealt with. You work with a compliance consultant to help you with managing that responsibility. And yes, you do have to pay them for that service.

In the next video, I’ll go into exactly what you can expect from a cost structure, working with these compliance consultants. But I do wanna break that out because that is a separate topic with some nuances from just this core question at the moment of…won’t I as the advisor, I start my RIA now have to pay for these compliance costs? And what I would challenge you to think through is at your firm now, they are providing you with compliance already.

The reality is when someone says to me, “Won’t I have to pay for it (compliance) as my own RIA?” Well, you are already paying for it! Make no mistake, you are already paying for your compliance, it just happens to be to your existing firm.

The example I always give is, and by the way, it’s in your payout. So, the example I always give is, and we’ll just use some easy simple numbers here. But let’s say you are an advisor who generated a million dollars in trailing 12 revenue or historical gross revenues, whatever phrase you’d like. And let’s say your payout is 40% on that. That of course means the firm is keeping 60% of the payout. And from that 60%, plus a multitude of other ways a firm makes money off of the advisor relationship, but we’ll just keep it simple with from that 60%, that’s $600,000 you’re effectively paying to your firm to be on that platform. Make no mistake, in that $600,000 this is for again, a simple example of a million-dollar producer, is the cost of providing you with that compliance.

So, right out of the gate, you mentally need to reset if your thought is….“I don’t pay for compliance now, but I would have to pay for it as my own RIA.” You’re absolutely going to pay for it under either scenario. The question is, which one is more advantageous for you to have to pay for it?

The example I always give is getting an itemized bill. Right now, and this is the mental exercise, right now to use that 40% payout example, if that was you as the advisor just kind of given this bundled all in 60% bill, that you…okay, you owe $600,000, for all the services we provide you. And it’s not an itemized bill. Maybe sometimes “see no evil”, maybe it’s better like that you feel at times, oh, gosh, and everything’s just bundled in there.

But I would challenge you, if you could instead be presented with a bill that’s maybe half that amount, but it’s all itemized. And so, you need to see each of these individual expenses. And yes, there is that compliance in there and there’s a number next to it and I’ve never had to see that before because it was all kind of blurred into my bundled thing over here. But if the bundle cost 60 cents on the dollar, and the itemized is 30 cents on the dollar, do you really care that you can see an individual line item that you’ve never seen before, if the aggregate total is still substantially less than what that bundled cost is?

I challenge you to reset your thinking and don’t think….“oh, it’s a new cost.” It’s not a new cost at all. It’s now just a cost that’s more transparent. And more importantly, you now have some control over it.

What I mean by that is with your current firm, and if you are at one of these large firms with we’ll say 10,000 plus advisors, keep in mind that compliance apparatus that you are paying for has to cover the entire spectrum of 10,000 plus advisors.

To give you some examples, keep in mind, that’s advisors of all different experience levels. Perhaps you have 10, 15, 20 years experience or more but there’s also advisors there that have two years’ experience. And guess what? The compliance has to cover all of you equally together. And so, the terminology you’ll hear is the lowest common denominator approach. Which means….“okay, as a big firm, we have to set our compliance to the lowest common denominator because we don’t know what these advisors on that lower experience level, or higher risk level, are going to do so we just lump everyone in together in our compliance program.” So, it’s not just a financial thing, it’s literally the lowest common denominator approach of what you’re paying for right now.

A couple more examples……because you’re going with this bundled approach, which has this bundled compliance, blanket approach of all advisors at your firm, you’re being bunched in with advisors that have, for instance, a lot of dings on their CRD. They are arguably making less ideal choices with clients and it’s causing problems for them, it’s causing problems for the firm. And guess what? You’re being lumped in with that as well with this compliance that you’re paying for.

You also have advisors that may be using some very esoteric products with their clients that maybe you don’t. Maybe you’re pretty plain vanilla, and you use some pretty simple models that you maybe have generated from ETFs or mutual funds. But guess what, the same compliance program that oversees you has to oversee these more exotic approaches as well. You’re having to basically subsidize that even though you’re not using some of those products or services, it doesn’t matter. You’re paying for this full compliance solution.

Another example would be some advisors have a lot of foreign clients. There’s a lot of additional AML, anti-money laundering oversight responsibility for those sorts of clients. That compliance program has to be able to manage all of those as well. Now, if that happens to be you, maybe you’re getting a good deal from that cost of compliance you’re paying for. But if you’re an advisor that has only a few or maybe no foreign clients, keep in mind, again, what you’re paying for is covering a client base in part that you don’t have anything to do with, and again, it’s because of that bundled solution.

Then the last example, I’ll throw out there is if advisors at your firm run into trouble with clients and it results in settlements, something has to pay for that. There is a cost with that, again, that all gets bundled in, you just happen to be along for the ride, perhaps because you were paying for this all in bundled solution.

Main point, something has to pay for all of these things. And so, when you’re a large firm, and I always point out these large firms, I think they are…I’m certain they are, run by well-intended people that are good people. Instead, I point out it’s more of a structural problem. When you’re one of 10,000 advisors, even well-intended management of that struggles with some of these things. How do we put a compliance program in place that covers all of these different client bases, or advisor bases, and experience levels and all these things and you get lumped in all together?

Whereas if you have your own RIA, you get to build a compliance program specifically based on just you and any other advisors you choose to have there with your firm. That’s a completely different way to put a program together than it is having to bundle everyone. And so, likewise, when we talk cost, keep in mind, the cost for you to work with a compliance consultant to build a compliance program for a much simpler model than what the large firms have to do to cover all of their 10,000 plus advisors. You are arguably paying currently more in compliance right now, for a lot of stuff that doesn’t even have anything to do with you, than you would if you can itemize it out and pay for it yourself and pay for only what you need based on your particular circumstances.

I really challenge you to reset your thinking both in the optics of….“oh gosh, do I have to pay for a line item of compliance, or is it just kind of blurred in the 60% I give back to the firm?” And then really think through your flexibility from a compliance program. Are you being lumped in with 10,000 advisors and maybe for a whole host of reasons that’s limiting your abilities with what you can do with your practice and your clients? Versus being able to make a very customized compliance solution based solely on the advisors there in your RIA. I really think it’s something for you to think about.

Bottom line, yes, you do have to pay for compliance. There’s no escaping that. I would challenge you though to reset your thinking of both from a financial and flexibility standpoint of what that difference would be between your current arrangement and if you were to transition to the RIA model, how that would look.

With that, like I said, my name is Brad Wales with Transition To RIA. What I do is I work with advisors to help them understand everything there is to know about why and how to transition to the RIA model. Today’s topic is a perfect example of that, why might I want to transition to the RIA model? And when it comes to compliance, it’s for these very topics.

This is the sort of conversations I have with advisors, and I’d be more than happy to help you think it all through as well. This is just one pillar of all the variables that go into this.

If you’re not already there, if you head on over to TransitionToRIA.com, you can see plenty more videos I’ve made, I have whitepapers you can get. And then the most effective and easiest way to begin a dialogue to learn all these sorts of things is to go ahead and reach out to me. At the very top is a Contact link. You can easily and instantly schedule a specific date and time for us to connect and I’d be more than happy to begin the sort of dialogue with you. To help you think through and understand, okay, what is your current situation as an advisor and what might a transition to the RIA model look for you and your specific circumstances? And then ultimately, if that does have an appeal to it for you, and it does seem to be a path you should go on, what are those steps to actually transition to the model? That’s what I help advisors with. Would be happy to have that dialogue with you as well.

With that, I hope you learned something on today’s video and I’ll see you on the next one.

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