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Regulation and Compliance > State Regulation

Regulatory Considerations When Bringing On a New Advisor

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If you own an investment advisory business, growth is a good problem to have. It can become such a big problem, however, that you may consider hiring another you — another financial advisor to help serve your existing clients and prospect for new ones. There are many legal and compliance considerations to keep in mind when doing so, the most salient of which are described below.

IAPD Review

“Fit” and technical aptitude are clearly important considerations when entrusting another advisor to represent your business, but disclosure history is equally important. This public disclosure history can be reviewed through the Investment Adviser Public Disclosure website by selecting “Individual” and searching by name or CRD number. Once the correct individual is selected, scroll to the bottom of the page to click on “View Detailed Report.” The generated PDF document includes a wealth of helpful information pulled from the individual’s Form U4 such as current registrations, employment history, professional qualifications, disciplinary actions, criminal convictions, civil judgments and arbitration awards. It is also possible that the disclosure report contains pending actions or allegations that have yet to be proven.

Any disclosure red flags are worth reviewing before extending an employment or contracting offer because the advisor candidate’s disclosures may trigger disclosure obligations for your business as part of Form ADV Part 1, Item 11. If, for example, the advisor candidate has been charged or convicted of any felony within the last 10 years, charged or convicted of certain misdemeanors within the last 10 years, or found to have violated various federal or state rules and regulations, such incidents may very well affect an otherwise clean ADV. The entirety of ADV Part 1, Item 11 should be reviewed to determine what may need to be disclosed.

Licensing Registration

Though the advisor candidate may represent herself as a financial advisor, wealth planner, or some other title that implies prior registration as an investment adviser representative (IAR), that may not necessarily be the case. Because there is no meaningful regulation of titles for registered representatives of broker-dealers to distinguish them from IARs of investment advisers, your “financial advisor” candidate may not have ever passed the Series 65, obtained the CFP designation, or otherwise become eligible to perform advisory services. Confirm this eligibility by reviewing the IAPD report described above.

Assuming that she is indeed eligible for registration and will become registered as an IAR of your advisory business, the next step is to file a Form U4 through the Investment Adviser Registration Depository. This will “link” the new IAR to your advisory business, so to speak. If the advisor candidate was previously registered with another investment adviser, most of her information should pre-populate and carry over so that all the Form U4 fields won’t have to be completed from scratch. That said, it’s best to have the advisor candidate review her own U4 information to ensure it is accurate before submission to the Securities and Exchange Commission and state securities regulators. It is also important to register or notice file her in applicable states pursuant to state de minimis requirements (see, State De Minimis Registration Considerations for Advisors).

And finally, be mindful of inheriting a messy breakup from the advisor candidate’s prior firm — especially if clients are making the transition to your business as well. The last thing you want to be accused of is aiding and abetting the advisor candidate’s breach of a non-compete, non-solicit, or other restrictive covenant. Another signal may be found in the Form U5 filed by a prior firm, which will indicate if the advisor candidate’s departure was voluntary or not.

Independent Contractor or Employee?

Neither the SEC nor state securities regulators are in the business of second-guessing whether an advisor should be classified as a W-2 employee or a 1099 independent contractor, but the IRS is. The employee versus independent contractor distinction is important to get right from the start, because the consequences for getting it wrong can be significant (think back taxes and penalties). Whether your new advisor should be classified as an employee or independent contractor is highly fact-specific and beyond the scope of this article, but your determination should zero in on the control you exercise over his or her job performance.

If you require the new advisor to work certain hours, from a certain location, using a prescribed method and your equipment, that cuts in favor of employee status. The fact that you reimburse the new advisor’s business expenses, provide a benefits package and generally eliminate the advisor’s profit/loss potential adds more weight to the employee side of the scale. The inverse cuts in favor of independent contractor status.

Again — this is typically not a bright-line test that may involve a complex judgment call, so don’t use the paragraph above as your sole research.

Disclosure, Documentation and Insurance

Once the new advisor is registered as an IAR, there are a few documents that should be updated. The first is likely the Form ADV Part 2B Supplement, which must be prepared for any supervised person that formulates investment advice for a client and has direct client contact, and any supervised person who has discretionary authority over a client’s assets, even if the supervised person has no direct client contact.

If the new advisor will be an executive officer, director or functional equivalent — or if he will control 5% or more of your business through either voting rights, capital contributions or dissolution rights — the new advisor should also be added to Form ADV Part 1, Schedule A. This is accomplished by completing a Schedule C, which effectively amends Schedule A. (I know, right?) The Schedule A instructions to Form ADV Part 1 provide a more robust description of exactly which persons should be listed.

The next document (or set of documents) that should be updated is your internal compliance policies and procedures. Outdated references to certain individuals and roles/responsibilities may need to be tidied up, as will certain supervisory responsibilities and hierarchies. All advisors are required to maintain a current list of supervised persons, so be sure to update that list as well.

Speaking of supervision — and this should go without saying — supervise the new advisor pursuant to your freshly updated compliance policies and procedures, and document said supervision. If the new advisor is working out of an office other than your own, additional oversight will likely be required to ensure that the office complies with your recordkeeping, information security and custody policies (among others).

Lastly, it’s also probably a good idea to get in touch with your business’ E&O insurance broker or carrier to ensure that the new advisor will be covered under your existing errors and omissions policy. Additional paperwork may be required, but it’s well worth it to prevent your business from incurring an uninsured liability caused by your new advisor.


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