Key Takeaways:
- Identifying and overcoming the most disruptive obstacles while transitioning to an Independent RIA.
- Understanding the importance of selecting technology through the transition to create maximum alignment between operations and compliance processes.
- Designing a compliance program that addresses the risk areas most likely to impact the Adviser's firm based on commonly leveraged firm criteria.
Brian Heimer (00:07):
All right. Good afternoon, and thank you for joining us today for a conversation about two things that many advisors spend a lot of time thinking about going independent and the importance of staying compliant. I am Brian Heimer, Editor-in-Chief of Financial Planning. With me today are Scott Gill, Founder, Senior Compliance Consultant at Synergy, RIA Compliance Solutions. Scott has spent time at E-Trade Financial, JP Morgan private banking, and Wells Fargo advisors, and he serves as compliant, has served as Compliance Officer Carolina's Investment Consulting and director of Compliance and senior compliance consultant for XY Planning Network. We are also joined by John Carr, an attorney at Carr Butterfield, where he represents financial services professionals and regulatory investigations, enforcement actions, arbitrations and court cases in Oregon and Washington. Did I get that all right, guys?
Scott Gill (00:54):
That's good enough. Yeah, absolutely. Thank you.
Brian Heimer (00:57):
All right, so we are going to jump right in. When we talked about this last week or so, guys, we talked about what your custodian can do for you in terms of data transfer, those sorts of things. John, can you start us off talking a little bit about compliance in that area?
John Carr (01:11):
Sure. We do a lot of work with lifting advisors out around the country. We have a couple hundred advisors around the country that we have either helped lift out or we are counseled for them afterwards, but on the lift out, there is kind of two tracks, and you are getting the entity set up and looking at your employment agreements, your rep agreements with your current broker dealer or firm. And then you are also trying to figure out how's the best way to migrate my data? And oftentimes after you select a custodian, the custodian has resources to help you figure out how best to migrate that data from your current firm to the landing firm. So that is the main piece there on the custodian piece. You want to add anything?
Scott Gill (01:55):
Yeah, yeah, absolutely. So I think that there is another element of that, which is really making sure that your custodian is going to work well with the overall tech stack that you plan to have, and making sure the custodian's prepared to be integrated with that tech stack. A lot of times we will find that advisors will be selecting a custodian without thinking about the reports that they are going to need to run and checking and doing due diligence to make sure that the custodian either offers those reports or can establish an account feed with a data aggregator that will allow them to run those reports as well. And so from our perspective, we are always thinking about compliance, operational processes and how we are going to pull data in the event of a regulatory exam. And I think that that is kind of important to consider as well.
John Carr (02:46):
And that a little piggyback embedded in your agent or rep agreement or advisor rep agreement depends on where you are. There is all kinds of provisions that the confidence, there is confidentiality provisions, so you want to make sure that you are adhering to those and you have counsel or a consultant that help you adhere to that. So you do not violate Reg SP or other pieces or contractual provisions in the client agreement, your agreement with the broker dealer or the investment advisor. So that is a key thing here. And then also, obviously there is your rep agreement. You have to determine whether are you fully an independent so that your data, so to speak, and your clients are yours, you are not going to have any list or non-compete talk to the hand type of situation where you have to look at maybe going broker protocol or not, whether that is available. And if it is not available, then you have to analyze the laws in the state, what laws apply per that contract, etcetera on that.
(03:45)
So those are things like early on compliance and legal wise, before you really get going, it is kind of like there is two tracks. There is kind of the legal analysis side of things. You know, have your entity you have set up to go independent to use. If you do not already have a holdout entity, you have ownership all figured out for that. Got, if you have employees, how are you going to pay them there? Are they going to be employees, are they going to be contractors or are your reps going to be contractors? You have all that kind of lined out. And then the other track that is Scott and our firm, we also do is all the regulatory filings, the client agreements for your end clients, the compliance manuals, the ADV filings, all that. And Scott can, he's talk to more about the stack and the tech stack and all that on the compliance side as we are getting that set up.
Scott Gill (04:35):
One of the interesting things too, I do not think that we see sometimes advisors to think through is understanding the structure of the different rep codes at the firm and how your firm's going to operate. Some advisors will actually see where maybe you are the primary advisor of the firm in your intention is to have one rep code at the custodian or one master, but you might have two or three other advisors that are operating under that same rep code. Is that necessarily the best thing when it comes time to run reports to determine, for instance, how many clients one advisor has in a particular jurisdiction? Is your rep code structure going to allow you to run the reports that you need? And what kind of internal operations are going to trigger perhaps getting another rep code? Do you have one for your discretionary accounts, one for your non-discretionary accounts, right?
(05:29)
Do you have a wrap fee, rep code, wrap code, and one that is transaction based? Just getting into that part of it I think is very important as well, right? Sure. And then from a regulatory filing perspective, I mean, as it pertains to custodians, most of the time we are going to get language directly from the custodian to put into your form ADV filing. There are certain pieces that most regulators like to see in terms of disclosure, potential, soft dollar benefits, any directed brokerage relationships and things of that nature. And so that part of it is fairly straightforward for most of the well-established custodians. There may be some cases in which if you are selecting a newer custodian where that language either won't be readily available or regulators just might not be used to seeing it, that may cause some hiccups in the process. But from an initial registration standpoint, I think that the custodian selection and implementation piece from a filing perspective is one of the least challenging, in my opinion.
Brian Heimer (06:30):
Yeah. Scott, you have got specific thoughts on designing compliance plans, designing specific compliance plans. These aren't a one size fits all situation, so can you talk about the importance of that and how to get those right?
Scott Gill (06:42):
Absolutely. Yeah. So one of the things I talked the most about is compliance program design. And when I talk about compliance program design, I am really referring to taking a look at the demographic layout of a firm to determine what elements of the firm's compliance program you are going to focus on. Because the reality is, if you look in the Investment advisors act in 1940, right? No one has time to take a look at everything all the time. And so you have to pick out what pieces you are going to focus on. And the way that you do that, right, in my opinion, is through your transition process and when you are first getting your firm started going through a process by which you look at, okay, what jurisdiction is the firm going to be registered in? That matters a lot, okay? There is some things that fly in California that do not fly in Washington, that core piece there is one of the beginning pieces of compliance program design.
(07:37)
What types of clients are you going to service, right? We talked a little bit earlier in the session about the difference between servicing older and younger clients that matters. What types of services are you going to provide? I always see this where financial planning focused firms, in my opinion, sometimes spend too much time on their compliance program on assets under management compliance. When 80, 90% of your revenues coming from financial planning services, it might make sense to spend more time in your compliance program creating policies and procedures for financial planning services. And I think that it does take some knowledge and expertise and awareness of the regulations to be able to make those types of assessments, but I think that that is also a critical part of the process of launching a firm that new firm owners do not undergo. And there is a couple of reasons for that.
(08:27)
One reason is because a lot of new firm owners are wearing multiple hats, right? Your CEO, your CFO, your CO everything. And so you do not have time to sit down and learn enough about compliance in order to design a compliance program that works for what it is you are trying to accomplish. And so what we see, even the types of investments that you are going to offer, if you are playing vanilla stock bonds, mutual funds, that is kind of one compliance program or one piece of your program, consider if you are going to be offering alternatives or real estate investment trust, that is another part of your firm's compliance program. If you are an insurance agent and you'll be selling insurance products to your existing RIA clients, that is another element that you want to consider. And I think that that is kind of the core piece of that.
John Carr (09:12):
That's really good. And also, if the CRM system, the trading platform you are utilizing, you want to have that figured out and well in advance of going live. Again, it goes back to getting things really dial in and organized on the legal side and the operation side before you go live. A lot of times we are doing lift outs for groups, A Morgan group or somebody, they have a billion bucks, and we have to do everything under the cover of darkness and have everything ready to go, have everything dialed. Here's the resignation on Friday afternoon, here's what it says, your broker protocol, you are not or whatever. And then Monday morning at the new office, new shop. So you have to have all that totally dialed in. But as far as one of the things also, we talked about this on our conference call, kind of prepping for our clients that we are doing lift out.
(10:04)
It's like, what does the SEC, this example, what is the SEC looking for? What's your end game? So the SEC has a mandate those last put in seven, eight years ago, where they do new registrant examinations. So if you are registered with the SEC, normally within 18 months, two years or less, they'll come out and do kind of a light touch examination. So we provide those to our clients and walk through, here's what they are going to want to see. Okay. So you want to be able to, Scott will tell you this also, you want them in and out as quickly as possible. A lot of them are correspondence online exams, you know, do a, not teams, what do they use? WebEx? I think it is WebEx call, but they call you the request letter, and then you go through the process within two weeks, often you have to harvest all this data and upload it onto their system for them to start reviewing.
(10:58)
So if you are going independent, if you have the ability within months or so of going live, of being able to harvest those requested materials and produce them in short order, you are going to be miles ahead of a lot of firms, frankly. And one, and the outcome of that new registrant exam will be very positive. And we also provide standard course, the latest, we have seven exams going right now with clients. We try to take out the most recent version and redact all the names and all that, and here's this request. And so for example, the latest requests, we have got a couple from the New York office, they deepened the new advertising rule that just went into effect in November of last year. It's a page and a half of advertising rules. So anyway, if you have that, this is your eyes on the prize, this is the end game.
(11:58)
When the SEC comes out, that is going to be very, very helpful for you to help build out and figure out exactly what you need to do. Plus, I'll plug this also, A good compliance program will help you in the, if God forbid, you get sued or have a claim brought by a client, if you have things dialed in on the compliance side, you have documented things well and the CRM system and all that, we have made many claims go away by just getting that data from a client and kind of refuting step by step the allegations of the claims that made by the plaintiff's securities attorney, all that. So I want to put that plug in. It's also a win-win to get it all right, early on.
Scott Gill (12:40):
And then I really want to just reiterate and piggyback on that, the access to data and having it in a readily accessible location, to be honest, is probably, in my opinion, the single most important factor to getting through a regulatory exam without, with minimal disruption to your standard firm operations. And so one of the things that we focus on is making sure that firms understand the importance of having a data aggregator. If in fact, you are going to have more than one custodian. And going back to the original conversation, if you have two custodians and the SEC comes in knocking at the door and you do not have a data aggregator, well, that is two different systems that you have to go and get data from, alright? And TD Ameritrade system doesn't look just like Fidelity system. So now you have got two systems that you have to get data from.
(13:29)
You got a 10 day turnaround, the SEC wants the documentation in 10 days. All right? And so we also know that there are various levels of service that you are going to get when you go to the custodian. So if you do not automatically know, go to fidelity.com, click here, click there, click there, you are going to have to get on the phone or call somebody or email them. And now you are at the mercy of the quality of service that you are going to receive from your custodian in the middle of your regulatory exam. And that is a very painful place to be.
John Carr (13:57):
Yeah, I can tell that is spot on, because literally this last four months, I have had a client just banging their head against the wall because we had to get extensions to just produce a really nice trade blotter. We had Schwab, we had a, I forget the other firm. Oh, we had SSE I had to get some stuff from them, but also Morningstar, and hopefully we Morningstar here. But morning, it was a nightmare to get data from Morningstar. Hopefully it is not rocket.
Scott Gill (14:24):
But Well, yeah. So yes, perfect point, perfect point. And not to get too far off topic here in terms of going independent, but this is also critical for firms that are undergoing mergers and acquisitions. We are starting to see that more and more firms to two firms that are merging together. And one of the most important planning pieces that we will lay out there on the front end as a part of the due diligence process and say, okay, tell me where your data is and let's make a decision about where your data's going to live after we undergo this corporate action transaction. Because if not, and it just goes back to the core piece. The most difficult examination request lists that we deal with are those that have four custodians and the data's in four different locations, and we are trying to take it and piece it together into one Microsoft Excel spreadsheet. It's just a painful process. So if there is an investment that is to be made data aggregation and data management is where to make it.
John Carr (15:21):
By all accounts or upon something.
Scott Gill (15:24):
I love Orion, so I love Orion Black Diamond. Those are advise on a really great platform at a little bit lower call price point than the other two. I have seen AssetMark work a little bit for some firms.
Scott Gill (15:43):
Right? No, you have to build a report custom. And so the data, correct? Yeah. So ultimately, and so there is multiple versions of the SEC examination request list, and it depends on the type of business that you are undergoing. So for the ESG examination request list that have been coming out, that data doesn't exist anywhere. There is just no, you have to piece that one together. Before a new registrant desk exam, you should be able to pull a decent trade blotter, nice tidy client list with account numbers and maybe an investment management strategy attached to it. But you are correct, you have to configure it, right?
Audience Member (16:20):
Doesn't even support this.
Scott Gill (16:22):
Nope. That's horrible. Yeah. Yep. Exactly. So we used to log in, I used to log in and give a request out to td, we would tell them what columns we want. Yeah, probably not going to get it.
John Carr (16:31):
You are downloading this data, they are requesting it in an Excel spreadsheet. You probably have seen that. And it is got, so they can go through and they have algorithms and computer programs to go through, rip through all that data. They want to check your fees. Are they matching up with what you say you have on the client agreement and the ADV. They want to make sure your assets under management match what your ADV says with what they actually actually is over the custodian and all those types of things. But as back to some tech piece, one of the things that you want to have can seriously consider lined up or identified as you go live is some sort of, if you can do an electronic checklist, we put together the old school, here's an Excel checklist that mirrors that compliance manual that hits all the marks.
(17:19)
The advisors act in 1940. But there are programs out there, and I think Scott's team does some of his customization piece where it helps track, okay, this is the quarterly personal securities transaction piece I have got to do, oh, this week or this quarter or this month, I have got to do a spot check of the emails. All these types of things that you have to document those. And here's a mantra you will, you have probably heard before also, but you might have this shiny manual and you might be doing some of these things in adherence to compliance with that manual. But if it is not documented, the SEC doesn't think it is happening. And you'll be written up with a deficiency note and a post examination letter. And by the way, a deficiency letter is a win as post examination. Absolutely. Even though it could be one page could be 30 pages, but the loss in my mind is when the exam staff sends it over to enforcement, enforcement and enforcement, that is where the lawyers get involved. They start an investigation and you do not want to go there. And then you hope it, that is where it ends, where the fines and the suspensions and all that regulatory stuff that is disclosable and expensive comes out on your four and your ADV, etcetera.
Scott Gill (18:39):
Absolutely.
Brian Heimer (18:41):
We have only got a few minutes left, so I want to see if there is anybody in the audience that has a question or any comments can raise your hand. We can do that in the interim if Intel anybody does that. Anything else on your minds? Anything else that we should be touching on this topic before we adjourn here?
Scott Gill (18:59):
Well, and I would love to go back just a little bit here on the conversation regarding exam preparation and most specifically as it pertains to compliance task management software. I would like to touch on that. So garbage and garbage out, everybody knows that. So one of the things that we always tell our firms, we focus on process. So it is one thing to have a system that is going to remind you when it is time to do something. It's an entirely different thing to know how to do it. And so what we see a lot of times with some firms is you will get a compliance task management system, and all it is a reminder of stuff you do not know how to do. And so you look up six months later and you have got 25 past due task and you still do not know how to do them, right? And so I always tell firms, focus on your process first, and then you can use a compliance task management software if it is time for you to do your email review and document your email review.
(19:53)
If you do not know how to do a email review, haven't designed a process. And going back to compliance program design, how many emails do you need to review? Well, how many each you get advisors you have, okay, right? What's your email volume? What system are you using those questions first? And then using that to create your email sampling methodology is more important than just having a system that is going to tell you it is time to do email review. And so I always encourage firms, and the beautiful part about it is, and I do say it is beautiful because I believe genuinely it is like riding a bike. If your firm is pretty much the same structure, the same size, maybe growing a little bit, but not merging and acquiring other firms, you go through a year of compliance tasks the next year, you just do the same thing you did last year.
(20:38)
Very true. Right? Yeah. And that is why I think that it is so important to design the firm's compliance program and get through that first year of compliance task management, because very little should change. Now, every once in a while, the SEC is going to come out with a new marketing rule, DOL's going to hit or something like that. But these are minor tweaks and adjustments. If you get the core piece, kind of the items at the bottom of the pyramid, you get those pieces in place and put those kind of automate those, get those running, then the rest is just looking for outliers and finding areas that there might be an issue, right?
John Carr (21:12):
Sure. Yeah. I mean, the SEC loves the fact, even if you are not hitting all the marks, that at least you are making a best effort and you are documenting those best efforts to make things happen. You are doing the personal securities transactions, you are doing the annual compliance review, you are you, and those are two low hanging fruit pieces that a lot of firms are dropping the ball on. And then they are doing the updates like the marketing rule into effect November, the DOl before that 2022, the PTE more things are coming down the pike. I mean, they have been super, this last six to nine months, the SEC's been super active. Super active in rolling out proposed, proposed rules. They are all, they are proposed right now, but they are like a new custody rule, which would be put some more burden on advisors, especially some smaller shops, would be almost be too burdensome.
(22:09)
So hopefully we will get turned around with some comment letters, the third party verification that is largely, that probably will come through, but that we will basically they are codifying what they want you to do anyways is making sure the third parties are. But they talked about that just on this last panel about verifying this third party that you are group that you are hiring to due to this monitoring to do that, are they actually doing that? So anyway, and then to your point on the compliance checklists and calendar and all that, I mean, yeah, early on, early adopters, getting it in place that you are your money ahead. And also if you do not know what something the task is, make sure you are talking to your equivalent to Scott or me. Hopefully you are using a council or a good regulatory consultant to get things going and not winging it alone. But those are huge, huge pieces there.
Brian Heimer (23:10):
Great. Well, Scott, John, I want to thank you both for being here today and great conversation. Appreciate it. Absolutely. Yeah. Thank you.