The Advisor's Professional Library

Disaster Recovery Plans and Succession Planning

January 1, 2012

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In the Dilbert comic strip, the socially-awkward engineer prepared for the complete meltdown of the country’s financial system by stocking his house with food, water, batteries, flashlights, and gold coins. His co-worker had no plan other than jotting down Dilbert’s home address. She assumed that his preparations would be more than adequate for the two of them.

RIAs must do more than just prepare for financial disasters. During every season of the year, natural disasters threaten RIAs and their clients. In the spring and summer of 2011, tornadoes ravaged the Midwest and even hit states as far north as Massachusetts. Floods destroyed homes and businesses in several states. During May through November, many areas of the country also face the threat of hurricanes. In late August 2011, Hurricane Irene caused horrific damage up and down the Eastern Seaboard.

A compliance examination can be a disaster if the RIA has not engaged in contingency planning. As mentioned previously, examiners report their findings in a deficiency letter. According to one deficiency letter, an RIA’s disaster plan should address business continuity issues, especially if it’s a small firm. Whereas a disaster may lead to a business continuity problem, succession planning addresses situations where a key person leaves the firm.

In a speech on March 21, 2011 at the IA Watch Annual IA Compliance Best Practices Seminar, Carlo V. di Florio, the director of the Office of Compliance Examinations and Inspections (OCIE) discussed best practices for RIAs. Among other areas, the SEC will pay close attention to an RIA’s business continuity and disaster recovery plan. According to di Florio, “business continuity and disaster recovery planning has always been an important part of our overall examination program, including for investment advisers. The recent natural disasters in Japan and New Zealand highlight the continued importance of this for firms and markets.”

On any given day, a disaster might be looming, and the threat of death or disability is present as well. For these reasons, investment advisors must plan for the worst and hope for the best.

Keys to Successful Succession Planning

According to John Sullivan, Editor, Investment Advisor, the 2011 FA Insight Study of Advisory Firms: People and Pay, found that a “staggering two-thirds of firms do not have an adequate plan in place for transitioning equity, management responsibility, and client relationships to a new generation; more than half of these firms indicate having no succession plan at all.” In view of this, RIAs should focus their attention on the issue of succession planning.

In conjunction with disaster planning, RIAs should engage in succession planning, ensuring a smooth transition if an owner of the firm dies, retires, scales back, or leaves the business. Effective succession planning can benefit clients and results in financial rewards for the adviser who is retiring or leaving the business. Staff members also take comfort in knowing that the advisory business will remain viable, even after a key person dies or leaves the firms.

As part of their fiduciary duties, it is important for RIAs to protect clients by putting a contingency plan in place for the time when owners or principals move on to other phases of their lives. A sound succession plan ensures an orderly and seamless transition to a different management team or a merger with a different firm.

Elements of a Sound Succession Plan

Succession planning takes a great deal of information into consideration. Much depends on whether an owner wants to retire, sell the company, or continue in a limited capacity. Family, tax, and estate planning issues must also be considered.

A sound succession plan requires consideration of many issues including the following:

  • The goals of shareholders and owners
  • The value of the business
  • Potential buyers
  • Contingency planning in case key people leave the firm or are otherwise unavailable
  • Terms of a buy-sell agreement
  • Funding options such as life or disability policies
  • A process for reviewing and updating the plan

Founders of most investment advisory firms would like to see their business go on without them. One possibility is to groom a successor who shares the founder’s values and investment philosophy. This approach allows clients to become comfortable with the person who may one day run the firm.

Internal successions are quite common. This takes place when the advisory business is sold to principals or employees. According to a TD Ameritrade Institutional survey published on November 14, 2011, finding an internal successor is the preferred exit strategy for half of the advisors who participated. Eleven percent hope to sell the firm, while eight percent plan to merge with another RIA.

Although solo practitioners have fewer options, succession planning is every bit as important. One option for solo practitioners located near one another is to negotiate an agreement to take over each other’s practice if one of them dies or becomes incapacitated.

Establishing a Value for the Business

Investment advisors usually spend decades building a business of value. Putting a price tag on that advisory business for succession planning purposes isn’t always easy. Although there are rules of thumb, which set a value for the business based on gross revenue or net profits, many factors should be considered. For example, an advisory firm in a large and growing area might be worth more than one situated where the population is declining. Nevertheless, no matter where the firm is located, growth may not continue at the same pace. There are also no guarantees that clients will stay with the firm after a key person dies or retires.

The state of the market also influences the value of an advisory firm. The firm’s value might not be as high during an extended bear market. There are additional factors affecting the value of an advisory firm such as:

  • the quality of client relationships and whether they will survive the succession;
  • any other assets that are transferable to the successor firm; and
  • cash-flow available to help fund the sale of the advisory practice.

Having a clean compliance record, as well as a good reputation, adds to the value of the advisory business.

An effective plan addresses situations where the eventual succession is sudden or conversely when it is a planned departure. The plan establishes a valuation methodology agreed to by the parties. This approach is likely to prevent disputes with the IRS or a fight between the heirs to the RIA’s estate.

Issues to Resolve during Succession Planning

There are numerous issues to resolve as part of the succession planning process. They include the following:

  • Deciding whether an owner wants to retire, sell the company, or continue to run the firm on a part-time or full-time basis
  • Determining if there are family considerations or estate planning issues affecting the succession plan
  • Planning for death, disability, or incapacity
  • Calculating the value of the business
  • Identifying potential buyers, including internal candidates, and how the sale will be financed
  • Evaluating the tax ramifications of any and all alternatives

Successor Registration

An advisory firm may not continue operating unless it is properly registered to conduct business. Successor registration enables advisors to operate for a limited period of time without interrupting their day-to-day business. No RIA wants to lose clients while it takes steps to ensure the firm is properly registered.

When a new firm assumes the business of an RIA or an RIA changes its legal framework, a new organization is created. This new firm can rely upon the prior entity’s registration if an application is filed within thirty days. If the new firm does not qualify for successor registration, they may not provide advisory services until the application for registration is approved. This process might take months.

In most cases, the new advisory firm files for succession by application. Yet, in limited situations, succession by amendment is the appropriate course of action. There cannot be a succession by application or by amendment if the original investment advisory firm continues to exist after the transaction. If the prior advisory firm continues to exist after the succession, the new RIA must file its own independent registration and may not operate until the application is approved.

Succession by application may be the appropriate choice where a new advisor is acquiring all or substantially all of the assets and liabilities of an advisory business. The following requirements must be satisfied:

  • The successor advisor must file a new application within thirty days after the succession. Under Section 203(g) of the Investment Advisers Act, the successor is deemed registered until and unless the SEC denies, revokes or suspends its registration.
  • The successor may rely upon the registration of the advisor acquired until its new registration is effective, but only if the original adviser is no longer conducting advisory activities. Upon approval, new registration numbers are issued.
  • Once new registration is effective, a Form ADV-W must be filed to withdraw the registration of the acquired advisor.
  • The successor must acquire all significant assets and liabilities of its predecessor.

In contrast, succession by amendment is available only if the new RIA is formed solely as a result of a formal change in its structure or legal status and there has been no practical change in control or management of the advisory firm. The RIA’s registration is amended to reflect these changes rather than filing a new application.

In either case, the successor provisions are not available in class where RIAs are attempting to:

  • sell their registrations;
  • thwart lawsuits or reduce their liability exposure;
  • spin off personnel; or
  • facilitate the transfer of the registration to a shell organization.

State-registered advisors may face different registration requirements. It is important that state regulators be contacted to determine the advisor’s registration obligations.

Investment advisory contracts are automatically terminated if they are assigned without the client’s consent. With successor registration, however, clients need not agree to the assignment and the RIA is permitted to notify them in writing about the succession. Generally, RIAs may presume that the client has consented if there is no objection made within a reasonable time.

Even though this change in control or ownership is not necessarily viewed as an assignment, RIAs are encouraged to notify clients in writing regarding the change. If there has been a material change in the person who directly or indirectly controls the RIA’s management and policies, an other-than-annual amendment to the firm’s Form ADV must be filed.

The Big Picture

On August 24, 2011, Bill Winterberg posted the following suggestion on regarding how advisors might test their disaster recovery plans. Winterberg suggested that on Monday morning, RIAs should shut off the circuit breakers to their offices and lock the doors. Winterberg asked:

“Can essential business functions be restored by the end of the day? Think of how one would manage trading or withdrawal requests from clients. What about contacting clients and employees? Where is their latest contact information stored? Hopefully not on a server or workstation that doesn’t have any power.”

Winterberg’s suggestion was bold and would certainly test an RIA’s disaster recovery plan.

RIAs must also focus on succession planning. Having worked many years to build their practice and relationships with clients, most advisors want to see the firm stay in business long after they are gone. Succession planning facilitates a smooth transition of ownership and avoids a disruption of service. Clients are usually relieved if the firm they trust will be available to counsel their children and grandchildren. A common strategy is for senior members of the firm to gradually sell off equity to younger RIA representatives.

Though the owner of an advisory firm may know a great deal about taxes and estate planning, it is always wise to engage professionals who specialize in these areas, such as a CPA or an estate planning attorney. There are many different types of buy-sell agreements that should be considered.

The TD Ameritrade Institutional survey cited earlier in this chapter found that satisfying clients’ expectations is the main reason RIAs have a succession plan. The RIAs’ surveyed were also motivated by a desire for the firm to be viable for the future and for easing the advisor’s transition into retirement. RIAs should also be motivated by a desire to satisfy their fiduciary obligations to clients.

Fiduciary Duty to Plan for Disasters

RIAs owe a fiduciary duty to their clients to prepare for disasters and other contingencies, which may devastate the advisory firm. If an RIA does not have a disaster recovery plan in place, clients’ financial well-being may be jeopardized through no fault of their own.

A disaster recovery plan should contain the steps that an RIA will take in situations where service to clients might be interrupted. This plan should be a formal document that is sent to employees, and should be updated at regular intervals. Each revision of the plan should be shared with employees.

Employees need to understand their responsibilities in the event that business operations are interrupted. A comprehensive disaster plan should address contingencies such as specifying an alternative location for employees to meet and conduct business in the event of a disaster. An RIA should have access to current contact information for clients, employees, regulators, suppliers, and service providers as part of their disaster recovery program.

Protecting sensitive information is at the heart of every disaster plan, and the plan should stipulate that computer systems must be backed up on a regular basis. An RIA should test its ability to store, maintain and recover backed up electronic data. The results of this testing should be documented and retained in the RIA’s books and records. Finally, the firm should also make certain that third-party vendors, like broker-dealers, have implemented their own disaster recovery plan.

Les Abromovitz

Les Abromovitz

Les Abromovitz is the author of The Investment Advisor’s Compliance Guide, published by The National Underwriter Company/ALM Media.

An attorney and member of the Pennsylvania bar, Les has handled hundreds of consulting and publishing projects for National Compliance Services,, a leading compliance and regulatory services firm. He has conducted a number of seminars and training sessions dealing with compliance subjects. Les is also the author of several white papers that analyze compliance issues impacting Registered Investment Advisors (RIAs)‎.

To contact Mr. Abromovitz, email or call 561-330-7645 Ext. 213‎.