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New SEC Proposal Will Force Advisors to Plan for Succession

Few clients are aware of one profound risk of working with their investment advisor. Some 70 percent of advisors don’t have a plan for their businesses, or their clients, should they unexpectedly die, become incapacitated or for any other reason be unable to continue operations, according to a recent survey by SEI. A new proposal would force advisors to address the issue.

The SEC proposed a rule Tuesday that would require investment advisors to put in place business continuity and transition plans, detailing how they would "minimize material disruptions" to service in the event of natural disasters, cyber attacks, technology failures, the departure of key personnel or other events. Advisors could tailor their plans to fit their operations and risks specific to their particular business models.

Most industry observers think most responsible investment advisory firms should have this kind of plan in place regardless of the regulations. “I would agree that a lot of firms are still trying to strike the appropriate balance in their succession plans. A rule like this that requires you to have your plan in writing may well accelerate those kinds of efforts,” said Karen Barr, president and CEO of the Investment Adviser Association (IAA).

Barr said advisors are already required to have business continuity plans in place under the Compliance Program Rule, adopted in 2003. But this proposal has specific components that advisors should consider and also requires a transition plan.

Under the proposal, they would need plans to maintain systems and protect data, arrange alternative work sites, keep up communications and review third-party service providers. They would also need to show how they would handle the transition of winding down or stopping services.

Advisors would have to review their plans at least annually.

Click to read the full rule.

Michael Kitces, publisher of the Nerd’s Eye View blog and partner and director of wealth management at Pinnacle Advisory Group, said the proposal was a long-expected move from the SEC to match what the states did a year ago. In April 2015, the North American Securities Administrators Association implemented a rule requiring advisors to adopt continuity plans.

“Hopefully it will accelerate the marketplace for ‘exit planning’ continuity options beyond just traditional succession planning paths, which I’ve long noted are a gap in the advisor marketplace,” Kitces said in an email.

“The focus should be on how to redesign a firm into a lifestyle practice, with ways to ensure that clients are well served even if an advisor stays in their practice until the very end, and that an advisor’s spouse or heirs might even receive some ‘terminal’ value to the practice once they are gone (in addition to enjoying the cash flow from the business along the way) … rather than continuing to collectively attempt to ‘guilt’ advisors into leaving a practice that they don’t want to personally or financially let go of anyway,” Kitces wrote in a blog post.

“I think it’s going to increase the velocity of conversations around this topic, and in so doing it is going to require advisors to think of potential solutions and then maybe a ‘hey, this is a good-for-now solution,’” said Brian Hamburger, founder of MarketCounsel and The Hamburger Law Firm.

But succession has always been a difficult topic for advisors to discuss, Hamburger said.

“Let’s be real, they’re dealing with their own mortality when dealing with these issues,” he said. “But these are real issues and we have seen more and more cases every single year where there is the sudden absence of a principal of a firm and these firms are perhaps the most perishable asset you've ever seen because if there is not a plan in place or if the principal is the only one who knows of a plan, then what ends of happening is the firm quickly begins to unravel.”

GJ King, president of RIA in a Box, said the rule should make it easier for advisors to ensure that their plan is up to SEC standards. But if the rule, and other SEC rules, such as new anti-money laundering requirements, become overly burdensome for smaller advisors, it could cause the regulator to raise the federal registration threshold for RIA firms above the current $100 million in assets.

“There are more and more firms the SEC is faced with regulating each and every year as the industry continues to grow,” King said. “So there is perhaps the argument that one of the alternatives out there is to allow the SEC to focus more and more on the largest firms out there because the profile of a $200 million RIA firm is quite different than your $25 billion financial institution, but those are all under the same purview today of the SEC.”

Barr says the IAA will look closely at the costs to RIAs of implementing the proposed rule. The proposal says one-time costs could range from $30,000 to $1.5 million per SEC-registered advisor, depending on the facts and circumstances of an advisor’s business.

“We certainly are going to look at this very closely to make sure that the component parts of this rule don’t impose unnecessary costs,” she said.

Reuters contributed to this article.

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