The formation of a registered investment adviser (“RIA”) can be both an exciting and daunting process. On the one hand, the opportunity for financial professionals to achieve independence and the prospect of increased revenues as an independent RIA is an attractive possibility.
On the other hand, the financial commitments and regulatory requirements may feel daunting to financial professionals and some might be asking themselves “where do I even begin?”
While there are many requirements to consider, the process of forming an RIA does not have to feel like an insurmountable task, and with the right amount of planning and assistance from a seasoned securities attorney, the process of forming an RIA can be seamless.
Here are three things that we feel are important to consider when starting the process of forming an RIA.
How Should the RIA be Structured?
An important first step in forming an RIA is determining which type of corporate structure you want to use.
Have you considered forming a corporation, limited liability company, or limited partnership? Are you working alone and wish to be a sole proprietor, and do you understand your liabilities? Do you know where and with whom you need to file paperwork and submit fees for registering your corporate entity? What are the tax and insurance implications for your new organization?
Each of these situations has their own unique characteristics and need to be explored with careful consideration of liabilities, tax implications, annual fees and reports, and the structural advantages and disadvantages for the firm, owners and its clients.
Additionally, the RIA will need to consider the documents required for their formation including articles of incorporation, articles of organization, by-laws, operating agreements, statements of information, annual reports, among others.
Bearing in mind these considerations, it is important to contemplate the counsel of a seasoned securities attorney, accountant, and insurance professional to assess all of these moving parts so that you can make an informed decision about which corporate structure will be the most appropriate for you and your firm.
Where Do You Plan to Register?
The question of where and with whom you plan to register is one of utmost importance because it will be determined by a number of factors including what type of services the firm offers, the amount of assets under management (“AUM”), the firm has at its inception, and where the firm is physically located.
Some RIAs might only seek to provide only financial planning services. Some firms might have sizeable books of business because of pre-existing relationships, and other firms might only act as an adviser to private funds and therefore might be able to register as an exempt reporting adviser.
For purposes of this blog, let us look at RIAs that plan to manage client assets. Obviously, every RIA would like to have sizeable AUM but not all RIAs will have over $100 million in AUM at the inception of their business. RIAs with $100 million in AUM will need to register with the Securities and Exchange Commission (“SEC”), while RIAs with less than $100 million will need to register with various states.
RIAs will also need to consider where they are located and whether they have more than the de minimis number of clients for a specific state, which is typically 5, but sometimes fewer.
If the RIA is a state registrant, it might need to register in each state where it conducts business whereas an SEC registrant will need to notice file in each state.
What Registration Documents Should I Draft First?
After the organization has been formed and the RIA has determined where and with whom they need to register, they need to consider which documents they need to create in order to complete their registration.
The requirements for state and SEC registrants will vary. For example, RIAs seeking to register with the state of California will need to draft and file the following documents:
- Form ADV Part 1A – the application for registration, which contains important data regarding the firm including identifying information, the form of the organization (e.g. corporation, LLC, LP, and sole proprietorship), succession information, information about your advisory business and services, other business activities, industry affiliations, participation or interest in client transactions, custody, information about the firm’s control persons, civil, criminal and regulatory disclosures, and execution.
- Form ADV Part 1B – information regarding state registration; additional information not already included in Form ADV Part 1A; bond information; and additional disclosures.
- Form ADV Part 2A – the firm’s “Brochure,” which describes, in a narrative format the firm’s services, fees and compensation, receipt of performance fees, types of clients, investment strategies and risks, disciplinary information, other financial industry affiliations and activities, code of ethics, brokerage practices, client referrals and compensation, custody, investment discretion, proxy voting practices, financial information, and specific requirements for state RIAs.
- Form ADV Part 2B – the “Brochure Supplement” that describes the employment and professional background of the firm’s financial professionals, outside business activity and receipt of additional compensation and relevant disciplinary information.
- Wrap Fee Brochure – the “Brochure Appendix” for RIAs that employ wrap fee programs describing services, fees, and compensation, account requirements, portfolio manager selection and evaluation, client information provided to portfolio managers, client contact with portfolio managers, additional information, and specific information for state registered RIAs.
- Minimum Financial Reporting Requirements Worksheet, Balance Sheet, and Profit/Loss Statement – RIAs that have custody of client funds or securities, discretionary authority over client funds or securities, or accept as prepayment, more than $500 per client, and six or more months in advance, have minimum capital requirements that must be met and substantiated on at least an annual basis, and sometimes more frequently, through the submission of a worksheet along with the RIA’s balance and profit and loss statements to the state.
- Privacy Notice – Describing the firm’s protection of client personal identifying information and how the firm shares client data with affiliates and third-parties for everyday use and marketing purposes, and how and when the client can prevent the sharing of that data.
For SEC registrants, there are similar requirements with some important distinctions:
- SEC registrants are not required to submit Form ADV Part 1B, minimum financial requirements worksheets, or Form ADV Part 2B to the SEC; however, just like state RIAs, they need to provide the Form ADV Part 2B at the onset of the client relationship and any time there is a material change.
- Form CRS, also known as Form ADV Part 3, is the client relationship summary that provides important disclosures in a two page, and sometimes four page format for dually registered RIAs and broker-dealers, describing the firm’s services, fees, conflicts of interest, outside compensation, and important links to information for investor regarding the risks of investing and needs to be filed with the SEC and delivered to clients at specific intervals including within 30 days of a material change and 30 days from the date of a request
RIAs will also need to create the following documents to support their compliance programs including:
- Compliance Policies and Procedures Manuals
- Business Continuity and Disaster Recovery Plans
- Cybersecurity Policies and Procedures
- Code of Ethics
Summary of Considerations
As you can see there a multitude of steps that need to be taken into consideration when first forming your RIA. These tasks are not insurmountable but also require experienced professionals that can assist you with ensuring the execution of the formation of the RIA and filing of the documents listed above is done correctly so that your firm can get started as soon as possible.
Jacko Law Group, PC can help your firm with corporate formations, analyzing where and with whom you need to register, drafting and filing required regulatory forms, and generating important policy and procedure documents to ensure that you are in compliance with state and SEC regulations.
Our team of attorneys will use our extensive experience to assist you with your formation requirements in order to ensure the successful registration of your firm.
- Managing Partner and CEO
Michelle L. Jacko, Esq. is the Managing Partner and CEO of Jacko Law Group, PC, which offers securities, corporate, real estate and employment law counsel to broker-dealers, investment advisers, investment companies ...
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