More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
I have had the privilege of assisting many independent broker/dealers (IBDs) and their representatives throughout the country for many years. Like the wirehouses, IBDs and their reps are regulated by FINRA. The relationship between the wirehouse and its reps is generally that of employer/employee, pursuant to which the employee rep provides services directly from wirehouse-branded and supervised offices. Compare that to the current typical independent contractor relationship between the IBD and its reps, whereby the rep provides services from rep-controlled and branded offices throughout the country. The IBD model generally enables its representatives to choose how they desire to provide service to the client: on a commission basis as a registered representative of the IBD; on a fee basis as an investment advisor representative (IAR) of the IBD's investment advisory division or affiliate; or, as is most generally the case, a combination of commissions and fees. While the IBD model offers reps more independence than that of the wirehouse, its also poses different regulatory and operational challenges regarding supervision and responsibility.
Challenge No. 1: Balance. The independent broker/dealer has the challenge of balancing its responsibility to supervise its reps' activities at remote locations consistent with both broker/dealer and investment advisor regulatory requirements with the desire of the rep to maintain his independence and hold himself out to the public as the owner/operator of his branded business enterprise (for example: Smith and Jones Financial Services).
Challenge No. 2: Independence. As a result, the IBD needs to determine how much "independence" it will permit its reps to exercise. Will it require the rep to provide all fee-based advisory services exclusively as IARs via the IBD's advisory platform, or will it permit the rep to establish and offer services directly via the rep's independently registered advisory firm? If the latter is the case, with the enhanced independence come some additional challenges and responsibilities for both the IBD and the rep.
Challenge No. 3: Supervision. For the IBD, as a FINRA member, it continues to have supervisory responsibility for the rep's independent advisory activities. How will the IBD balance that supervisory responsibility with the rep's desire to exercise independent operational and decision-making authority? How will the IBD be compensated for the costs associated with such supervisory obligations, and the corresponding risks that such independence may present? Will the IBD, given the scope of the broker/dealer's internal supervisory capabilities, risk aversion, and insurance liability coverage, impose certain parameters regarding the independent advisory firm's activities, including the types of services or investments that it may--or may not--utilize for clients or the custodians that it may recommend to clients? Should the IBD, depending upon the scope and amount of its E&O coverage, require the rep to obtain a separate policy for his/her independent advisory entity?
Challenge No. 4: Responsibility. The rep will assume responsibility for the newly formed advisory firm's compliance with state or SEC regulatory requirements. While certain IBDs may provide assistance to their reps' RIA firms, the rep herself retains direct entity responsibility. Despite the level of assistance that the IBD may provide, the rep should seek separate initial and ongoing professional assistance. Compliance is not difficult--nor need it be--if the rep understands from the commencement of her independent firm exactly what is required to fulfill the firm's regulatory responsibilities, and, just as important, what it is not required to do.
Too many firms spend way too much time and resources because they have not tailored their compliance efforts to the scope of the firm's operations. There is no such thing as "compliance in a box" and one size never fits all. The scope of the firm's compliance efforts will directly depend upon the scope of the firm's advisory operations. Correspondingly, depending upon the scope of the firm's operations, ask yourself these questions:
Will the E&O liability coverage generally provided as a rep of the independent broker/dealer extend to the rep's independent advisory firm?
If so, how much coverage is afforded?
Should the rep seek a separate policy for his own firm?
Our general, and often overlooked, recommendation is yes.
How much independence is right for you? Understand the facts, ask questions, seek assistance, and make an informed decision.
The Compliance Coach, Thomas L. Giachetti, is partner in charge of the securities niche for Stark & Stark, in Princeton, NJ. He can be reached at email@example.com.