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The Long Goodbye

The Long Goodbye

I'm leaving you. I'm leaving you for someone else. It's over. It's been great, really. You've given me so much space, so much freedom. Most people don't understand our relationshipI don't want this to end. But I don't have a choice. It's bigger than the both of us. It's the law. So I'm leaving you, SEC. I'm moving in with my state regulator. (Actually, it feels more like she's moving in with me.)

“I'm leaving you. I'm leaving you for someone else. It's over. It's been great, really. You've given me so much space, so much freedom. Most people don't understand our relationship…I don't want this to end. But I don't have a choice. It's bigger than the both of us. It's the law.”

“So I'm leaving you, SEC. I'm moving in with my state regulator. (Actually, it feels more like she's moving in with me.) But someday, someday…when my AUM tops $90 million, we'll be together again. I swear it.

“Wait for me.”

This year, about 3,200 mid-sized RIAs will say goodbye to the Securities and Exchange Commission, transferring their registration to the states where they do business. For some, it will be a difficult break. Many of these firms were quite comfortable dealing with the SEC. After all, the regulator only came calling — to check books, policies, procedures — on average, once every 11 years. Just 9 percent of roughly 11,000 RIAs that were registered with the agency were audited in 2010, the agency reports. State oversight is likely to be more onerous, by comparison. Many states mandate audits within the first year of registration. Some states also mandate capital requirements and additional reporting. And some RIAs will have to register with more than one state — which will mean adhering to different and possibly overlapping rules. Advisors worry that the additional chores and compliance burdens will take time away from their clients and hurt the profitability of their small businesses. Some are even considering joining a larger firm so they can stay with the SEC.

The deadline for the switch is fast approaching. Firms with assets under management of $25 million to $100 million have until March 30 to file amended ADV forms stating their AUM, and until June 28 to complete their registration with their home state and any others where they have significant business. Those who haven't gotten their state registrations in place by then face the prospect of running a practice outside the law. “You can't decide to do this in May,” says advisor Sandra Wales, who moved her practice under the corporate umbrella of a larger RIA in California last fall.

Like Wales, hundreds may already have made the move; the Investment Advisers Association notes that the number of mid-sized advisors registered with the SEC last year fell nearly 14 percent from 2010. That could reflect the early migration of RIAs to the states ahead of this summer's deadline, the IAA says.

Driving the move is the Dodd-Frank regulatory reform that was passed in 2010. Part of the idea in switching the mid-sized RIAs to the states was to give the SEC a break, and allow it to focus its resources on the larger practices, increasing audit frequency. Until now, the SEC governed all practices with over $25 million in assets, with the rest left to the states. In selecting the mid-sized advisors for transition, legislators inserted some wiggle room into the process, given that assets often fluctuate from year to year. A “buffer” rule actually mandates state oversight if AUM falls below $90 million; the SEC steps in to regulate the RIA if AUM reaches $110 million or more.


Juggling the demands of multiple states will be a “nightmare” for advisors, says Mark Tibergien, chief executive officer of Pershing Advisor Solutions. “Let's say you're doing business in 12 states, all of whom do things differently, have their own forms, their own processes, their own audit reports. Yikes!” he says. “It will be horrible. It's hard enough already for advisors to keep up with compliance.”

In California, for example, advisors with discretion over client accounts must have $12,000 in net capital at all times, or $42,000 if they have custody of client assets, says Patrick Burns, a Beverly Hills, Calif. attorney who specializes in compliance issues. Forms that document the capital positions must be submitted to the state. It's not something the SEC requires of mid-sized firms. In addition, all states require advisors to mail notices to their clients every billing period outlining their fees. The SEC is satisfied when the custodians include that information in their statements to advisors' clients.

“If you have hundreds of clients, you now have to send out hundreds of statements. Most advisors don't see the point of doing that if (their clients) get a statement from the custodian anyway,” Burns says. “It's not very complicated, but you have to check the accuracy of the invoices and have somebody physically mail them out. It's more an annoyance than anything. Clients that were with an SEC advisor may not be used to getting that. They just provoke phone calls or concerns from clients — ‘Is this a bill that's due?’”

Michigan takes the rule a bit further, says Chris Winn, founder and managing principal of AdvisorAssist in Pembroke, Mass., which consults on compliance and other matters. Advisors must mail letters to investors seven days in advance of withdrawing fees from accounts, outlining the fees and explaining the methodology for calculating them, he says. “If you're a state advisor in Michigan, you deal with it,” Winn says, adding that Michigan is “kind of an anomaly.”

Some state rules are likely to have RIAs writing checks. In Pennsylvania, advisors with custody of client assets are required to have net worth of $35,000 and provide financial statements audited by a CPA. (Florida also requires annual financial statements.) And advisors shouldn't expect a quick scan of their applications for registration in Pennsylvania, either, says Paul Schwartz, director of licensing for the Pennsylvania Securities Commission. “We're going to look for every ‘i’ that's dotted and every ‘t’ that's crossed,” he says. Nearly every application is returned to the advisor for deficiencies that must be addressed in resubmission, Schwartz says, although the state provides 60 days for advisors to do so. The audit regimen is more rigorous than the SEC's, he adds, with a goal of reviewing RIAs at least once every six years. The commission has budgeted for two new accountants and three new examiners to assist with the added scrutiny.

Maryland Securities Commissioner Melanie Lubin believes concerns over big changes in regulation and overlapping state rules are overdrawn. The state requirements “are very consistent, if not the same” as federal requirements, she says. The vast majority of advisors who are switching to state regulation have business exclusively in their home state and won't need to register with multiple jurisdictions; according to the North American Securities Administrators Association, just 558 RIAs had a material number of clients in four to 14 states. (Clients in 15 or more states entitle the advisor to remain under the SEC.) Industry experts note that the more states an advisor has business in, the more likely it will be that his AUM will be large enough to push him across that $100 million AUM SEC threshold. NASAA is managing a coordinated review program for advisors who must register in four or more states. (The deadline for signing up is the end of March, but by mid-February only a dozen firms had done so.)

“There are a lot of people out there flinging arrows without a lot of facts to back them up,” Lubin says. “People think it's going to be incredibly difficult. I think a lot of the noise is concern that, ‘Wow, a regulator is actually going to be looking at my documents.’ But what we look at when we look at documents is, are you disclosing what you're required to disclose to your clients? Are your documents internally consistent? Does your contract say what your disclosure says? Are you setting up requirements that are consistent or inconsistent with the regulations?”

Sticking Around

For mid-sized advisors who still prefer federal to state oversight, one solution is to bulk up on assets to get above the $100 million asset threshold by joining a larger RIA firm.

David Samuels, 59, set up an RIA in 2007 in San Jose, Calif. His firm, Corinthian Wealth Management, has about $45 million in assets under management and a staff of two, including his wife Joan. He had undergone a routine audit by the SEC just once. He recalled a time-consuming process, one that he wouldn't want to replicate with multiple states.

“They would sit in a room and you wouldn't hear from them for two days, and on day number three they might ask for 10 different things. It was a little nerve-racking. Here you are, answering phones, prospecting, trying to run a business, and they're sitting two desks away plowing through your files and paperwork. I passed, there were no problems, but it is nerve-racking,” Samuels says.

With Dodd-Frank “definitely foremost in my mind,” Samuels made a big switch in his business 18 months ago. He dropped his own RIA and joined the corporate RIA of Concert Wealth Management, a larger firm with over $1 billion in assets that is also located in San Jose, Calif. Concert offers compliance, technology, marketing and other back-office support that Samuels felt he needed to compete in a world of narrowing margins. The deal keeps him under the SEC umbrella, and he doesn't have to register in a handful of other states where he has clients.

“I'm looking down the road. For my size, [increased compliance] is going to really cut into the profitability and into the joy and the fun of the business, because the joy and fun of the business is working directly with clients,” he says. “With the SEC, we feel we know what we're getting.”

Micah Porter, who runs Minerva Planning Group with AUM of about $70 million in Atlanta, says he went looking for possible partners when he dropped in on the TD Ameritrade conference in Orlando last month. Some of his vendors were helpful with leads, he says, since more assets under his management mean more assets to their platforms. But he's resigned to state jurisdiction for at least a year before he's able to find someone who's the right fit.

“The ideal advisor for us would probably be an independent broker/dealer rep who wants to transition into an RIA, who's got somewhere between $25 and $60 million in assets under management,” Porter says. “I want to make sure they're not someone with an esoteric investment strategy and a high amount of risk. … Advisors are an independent lot. Most of us didn't get into this business because we wanted to work in some huge corporate environment. We got into this business because we wanted our own business and we wanted to do what we enjoy doing.”

Some large RIAs say they've gotten calls from smaller firms expressing interest in so-called “tuck-in” deals, in which a mid-sized practice merges with a larger partner in the RIA. Rajini Kodialam, co-founder and managing director at RIA aggregator Focus Financial Partners in New York, said she received about a dozen calls last year from advisors who were eager to act quickly, although no deals emerged from the interest.

“These don't happen overnight. I suspect that as time moves along, these calls will come back, and we will do some of them,” Kodialam says. Other issues besides compliance play a role in the acquisition game. “You can't just merge with a company based on, ‘I need regulatory support.’ You've got to look at multiple things: the investment philosophies, client profile, geography, and more important than anything else, the personalities of the people involved. These are all entrepreneurs.”

Felipe Luna, chief executive at Concert Wealth Management, said the company has talked with about 180 RIAs in the past seven months about their options. About 20 percent plan to register with the states, while another 20 percent want to grow their practice or merge with another to stay above the SEC threshold, Luna says. The rest haven't made a decision.

“It's going to be like tax season, I think. There's going to be a rush to register,” Luna says. “I think the states have really focused some effort on staffing. But from what we're hearing, registration time frames are 90 days to, in some places, four months, depending on the state.”

Some advisors are willing to wait a year or so and see how the system plays out. Matthew K. Brinker, senior vice president of partner development and acquisitions at United Capital Financial Advisers, a national RIA aggregator in Newport Beach, Calif., says he's spoken to just three potential tuck-ins in the past six months. “Why make a move preemptively without complete information when only time will tell?” Brinker says. “Once this is better understood and the iodine has run through the system, the implications will probably be known, and you'll probably see mergers of equals, you'll see acquisitions. … I think the writing might be on the wall for those folks who just can't get the economies of scale to work, the operational efficiencies to work, and manage the compliance burden.”

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