Dropping Your FINRA Registrations: A View from Compliance

If you’re an advisor thinking about taking the fee-only path, welcome to the journey. As you weigh the opportunities ahead, you owe it to yourself to consider all the angles involved in dropping your FINRA registrations. Changing your affiliation model can be a momentous decision—especially from a compliance perspective.

As a fee-only advisor, you’ll no longer have the ability to sell FINRA commission products or receive FINRA trail revenue. Instead, your revenue will be based on an all-advisory business model, derived from charging AUM fees and flat or hourly fees for asset management and financial planning. This model can make sense for a lot of reasons (as discussed by my colleague Nikki Dillon in a recent post). But the heart of your decision to change your affiliation model may be your desire to market your services as a fiduciary. Overall, whatever your goals or value proposition, understanding the regulatory framework for a fee-only advisor is essential. To help you get there, I’ll review the current environment.

The Fee-Only Path: Not Just a Pricing Model

In today’s fiduciary-focused era, the news is full of information about two types of financial advisors: fiduciaries and nonfiduciaries. As a result, many of your prospects will be searching for advisors who market themselves as a fiduciary. Your existing clients may also be looking for—and asking you about—this type of service model.

How can you, as a financial professional, cut through the noise? As you think about whether converting to a fee-only model makes sense, it’s important to consider the following question: Do you value having the option to offer your clients commission-based products, particularly in spaces (such as alternative investments) where fee-based products may not yet be widely available? Depending on your client base, having the option to recommend commission-based products to meet the needs of certain clients may be more valuable than being able to market yourself as a fiduciary. There is no right or wrong answer—there are simply more factors to be weighed than what’s in this week’s headlines.

Nonetheless, in the current regulatory environment, if you do wish to market yourself as a fiduciary, you must operate under a fee-only service model. Here’s where the momentous decision I mentioned comes in—your choice of business model.

Which Business Model Will You Choose?

To market yourself as a fee-only fiduciary, you have two options:

  • Operate as an investment adviser representative (IAR) under an established registered investment adviser (RIA)

  • Operate as an IAR under your own RIA

Depending on which model you choose, your compliance obligations will be very different. That said, I’ll note that both IARs and RIAs who maintain an affiliation with an established RIA (such as Commonwealth) may benefit substantially from that firm’s compliance infrastructure.

The IAR Affiliation Model

It’s important to understand that as an IAR, the RIA with which you’re registered establishes the compliance policies and infrastructure under which you operate. While this structure may initially seem burdensome, you may find it beneficial, especially if you work with an RIA that has a strong compliance program. Partnering with a knowledgeable compliance team that has the experience to interpret the rules and apply them to real-life situations will make your work easier. You’ll have more time to do what you do best—building your business and taking care of your clients. In addition, the following regulatory differences will apply.

Continuing education (CE). Under the IAR model, two FINRA CE requirements are eliminated. Specifically, you’ll no longer be required to complete Firm Element training every year or the Regulatory Element training every three years.

Communications and marketing materials review. This is a typical compliance function—and one in which a partner firm’s Compliance department provides valuable oversight. When you change affiliations to go fee-only, your communication and marketing material reviews will be conducted based on the following two rules:

  • Marketing materials are subject to the provisions of the SEC’s Marketing Rule (Advisers Act Rule 206(4)-1).

  • Individual communications (such as email) are subject to the SEC’s anti-fraud provisions (Section 206 of the Advisers Act), which prohibit investment advisers from “employ[ing] any device, scheme or artifice to defraud any client” or “to engage in any act or practice . . . which is fraudulent, deceptive or manipulative.”

Overall, the review process will be substantially the same as for a registered representative. You might not notice that anything is different, given that the SEC rules address substantially similar risks as the FINRA rules covering the review of the same materials. But it’s important to note that this review will be conducted by your partner RIA if you choose to pursue the IAR route. RIAs are solely responsible for reviewing the communications sent by their associated IARs.

Running Your Own RIA

When dropping your FINRA registrations to form your own RIA, be aware of the following regulations:

  • SEC-registered RIAs are responsible for implementing a compliance program under SEC Rule 206(4)-7. Most state-registered RIAs are subject to similar state rules.

  • Under the SEC rule, RIAs must designate a chief compliance officer (CCO) who takes responsibility for the firm’s compliance program. As the SEC described in the adopting release for the Compliance Program Rule (206(4)-7 in 2003, an adviser’s CCO should be competent and knowledgeable regarding the Advisers Act and should be empowered with full responsibility and authority to develop, implement, and enforce appropriate policies and procedures for the firm. The CCO should have a position of sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.

Ready to appoint a CCO? A critical part of establishing and operating as an RIA is identifying a qualified individual to fulfill the CCO role. Among any number of other tasks, the CCO will be responsible for:

  • Ensuring that your compliance program is effectively developed, monitored, and tested on an ongoing basis

  • Filing and terminating registrations in a timely manner

  • Updating and filing your Form ADV Parts 1 and 2 each year

Ultimately, acting as a CCO is a demanding, full-time job. The CCO role should not be undertaken by individuals who don’t have time to fulfill the required duties, such as an advisor with client responsibilities. The CCO must also have the proper background to be an effective manager, which should typically include experience in an investment advisor compliance role. Creating and managing a compliance program takes significant time and effort. It’s unwise to take on this responsibility without an experienced CCO and seasoned compliance staff. There is significant risk involved for RIAs without the proper experience or that cannot devote sufficient resources to a strong compliance program. A cursory reading of the SEC’s enforcement actions can be sobering to anyone considering running their own RIA.

The Bottom Line

At Commonwealth, we believe that the best way to grow your business goes far beyond what regulatory affiliation you choose. The bottom line is that the decision about which business model to employ is a very personal one—often based as much on an emotional attachment to a particular value proposition as it is on the varying regulations for different business models. Dropping your FINRA registrations to pursue the fee-only path is one of the most important decisions of your career as a financial advisor. From a compliance viewpoint, the decision requires the utmost in due diligence.

Editor’s Note: This post was originally published in July 2016, but we’ve updated it to bring you more relevant and timely information.

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