Most Common Reasons For Seeking Independence – Start Your Own RIA

I work almost exclusively with independent investment advisers. My most typical client is someone who has, for one reason or another, become disillusioned with their current employer or business partner. The three most common refrains I hear from clients and prospective clients considering independence are:

  1. Restrictions. They feel like they are unnecessarily restricted or burdened by legal or compliance restrictions.
  2. Equity. They want to be more entrepreneurial and create a business with real equity, and
  3. Revenue. They don’t want to continue giving up 20-60% of their revenues to their employer or business partner.


The legal and compliance restrictions I hear about most frequently from financial professionals include:

  1. Inability to Manage Outside Assets for Compensation. Every financial professional knows that a large portion of U.S. individual’s personal wealth is tied up in their employer-sponsored retirement accounts. However, most employers won’t allow them to manage these accounts or provide advice on these accounts in exchange for compensation. If 80% of a person’s wealth is in their retirement account, why would a financial professional spend so much time and energy with that client when their revenue is tied to only a small portion of their wealth? Independence provides solutions to this problem. You can consider retainer-based fees or you can charge asset-based fees for managing these held-away accounts.
  2. Restrictions on Internet and Social Media Prospecting. Many financial professionals are prohibited from using social media, “Google My Business”, or Yelp for developing business. Obviously, employers have valid concerns relating to record retention and supervision, because they don’t want to open up the floodgates and create a headache for their compliance departments. However, smaller, nimbler investment advisers are able to engage in these activities in compliant ways.
  3. Prohibition Against Outside Business Activities. Many financial professionals want to engage in outside business activities that could be investment-related. Almost unanimously, most larger firms will prevent financial professionals from engaging in these activities for fear of liability.
  4. Inability to Serve as Trustee or Executrix. A number of financial professionals want to accept roles as trustee or executrix for longtime clients. I am not aware of any larger firms that permit these activities. These activities can be both personally rewarding and lucrative. Independence allows you to consider performing these services.


Equity is another important reason financial professionals consider independence. Based on industry-wide studies and my own experience, independent investment advisers are valued at between 1 to 4 times their annual revenue. Larger firms stand to receive upwards of double digit valuations. If you are an employee that renders investment advice at Morgan Stanley, Merrill Lynch, Goldman Sachs, UBS, Wells Fargo, or most other investment advice firms, there is an extremely high likelihood that you are not earning meaningful equity in the company. Chances are you aren’t earning any equity or you might receive some pittance of stock in an employer stock plan. Most likely, if you are deemed successful by internal standards, you will have the luxury of earning bonuses that are intended to serve as “golden handcuffs”. So many financial professionals treat their business like it is already a distinct, legal business, but in reality, they are employees of larger organizations. I find that many financial professionals want to build true equity in their business so that they can leave a legacy, build meaningful value in their business, and have endless flexibility when it comes to succession planning.


When I speak to prospective clients, another common reason for considering independence is the potential for increasing revenue. The thought of increasing revenues immediately to 100% is alluring. They all understand they will have increased expenses, but they also understand that they can control their expenses. Many people contemplating independence these days are comfortable with home offices and shared office space. Others are very comfortable with leasing their own space with equity markets at all time highs and commercial real estate at all time lows. Once you have a grasp on expenses, the math becomes quite easy. In terms of typical expenses, the following are the most meaningful recurring expenses: staff compensation, office lease or mortgage, insurance, software and technology, legal and compliance, and advertising. It is very possible for really lean businesses to keep these recurring expenses below $10,000 or $15,000. For more corporate and professional operations, it becomes more difficult to pin down the precise amount of expenses, but common percentages I often hear are between 10-20% of revenue. Every percentage can make a difference between resounding success, break-even, or a decrease in earnings, so it is essential to spend time plotting expenses.

Equity and Revenue Tools

If you are interested in charting out whether it makes sense from an equity or income perspective, Schwab Advisor Services has an interesting digital tool that allows you to compare revenues and equity in a world where you are independent versus your current model. While not perfect, this tool does provide a real sense of how income and equity can change in the independent space.


I am always happy to entertain free conversations with financial professionals considering independence. Please feel free to call or email me and we can plot out your course to independence.

Branch Office Supervision in Light of OCIE Guidance

On Monday, OCIE released a Risk Alert focused on their recent observations from focused examinations of investment advisers that operate out of multiple locations or branch offices. I provided a summary of that guidance here.

So what does this mean for investment advisers who operate multiple offices or branch offices? Advisers should review their policies and procedures and determine whether they sufficiently address business being conducted at these offices. Firms should consider the following:

Code of Ethics

  • Are “access persons” at these offices subject to the firm’s Code of Ethics?
  • Do employees prepare and submit initial holdings reports, quarterly transaction reports, and annual holdings reports?
  • Do employees at these offices report their gifts and entertainment appropriately?
  • Does the office have sufficient policies and procedures to prevent insider trading?
  • Is the business aware of and does it understand all outside business activities engaged in by employees?
  • Is the business tracking political contributions of branch office employees?

Advertising and Communications with the Public

  • Does the business treat advertisements and marketing activity consistently across branch offices?
  • Is social media use and review comparable across branch offices?
  • Are advertisements reviewed and approved in a similar manner?
  • Are performance presentations reviewed by the headquarters? Are backtested performance presentations being used without knowledge?
  • Are third-party rankings or awards being used in advertisements without approval?
  • How are client complaints handled at branch offices?
  • Are electronic communications (both internal and external) handled similarly?

Custody Related Issues

  • Does the business have policies and procedures to identify instances where a branch office activity could deem the business to have custody under Rule 206(4)-2?
    • Most commonly, I see issues in:
      • identifying “related persons” that may be deemed to have custody under the rule;
      • not identifying employees that have agreed to serve as trustee or executor for non-familial clients;
      • serving as a general partner or manager of a private investment vehicle;
      • receiving checks that are inadvertently made payable to the business or receiving stock certificates from clients;
      • obtaining check writing authority from clients;
      • obtaining login credentials to a client’s bank or brokerage account that provides the employee with ability to transfer assets; and
      • maintaining authority over a client’s managed account that provides broad disbursement authority without compliance with no-action guidance issued by the Staff.
  • If the branch office is deemed to have custody, does the business have policies and procedures to comply with Rule 206(4)-2?
    • Are client funds or securities maintained with a qualified custodian?
    • If you open an account with a qualified custodian on your client’s behalf, either under the client’s name or under your name as agent, do you notify the client in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, promptly when the account is opened and following any changes to this information?
    • Do you have a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each of your clients for which it maintains funds or securities, identifying the amount of funds and of each security in the account at the end of the period and setting forth all transactions in the account during that period?
    • Are the client funds and securities subject to an actual examination annually by an independent public accountant (or do you rely on the limited partnership audit exception)?

Investment Advice, Disciplinary Histories, and Litigation Risks

  • Do you have policies to identify and document instances of disciplinary or litigation events?
  • Do you have procedures to closely monitor individuals with disciplinary or litigation histories with a view towards how they render advice?
  • Have clients been notified of employee disciplinary events requiring disclosure under Form ADV Part 2B?
  • Especially when representatives serve as portfolio manager, but in all instances, have clients received appropriate disclosure of the strategy being managed by their portfolio manager?
  • Does the firm disclose all material conflicts of interest associated with rendering of investment advice at branch offices?
    • Are representatives at branch offices recommending investments where they have a material ownership interest or business relationship?
    • Are representatives receiving any type of kick-back or revenue sharing for recommending an investment?
    • Are representatives selecting or recommending non-optimal securities for a client (such as more expensive share classes)?
    • Are disclosures regarding wrap fee programs accurate? Has the business disclosed additional fees and expenses, including potential trade away fees?
  • Does the business automatically rebalance client accounts, and if so, does the business take steps to avoid paying short-term redemption fees?

Administrative and Billing Issues

  • Does the business supervise billing performed by branch offices?
  • Does the business review advisory agreements entered into by branch offices to ensure that clients are being charged the appropriate fee?
  • Are credits and reimbursements being applied consistently?

Recommendations from the Staff

  • The Staff suggested that businesses with “centralized processes mitigated instances in which supervised persons or branch offices had independent billing options or fee arrangements that deviated from client agreements or disclosures.”
  • The Staff hinted that advisers that automate and/or centralize their review and approval of personal transaction activity and educate employees on their code of ethics and personal trading policies were better positioned for compliance.
  • The Staff intimated that uniform portfolio management and centralized trading was favorable.
  • The Staff favorably highlighted compliance testing and periodic reviews of essential activities at branch offices and focused on portfolio management, monitoring trading and management activities, and supervision that did not focus exclusively on self-reporting.

This is not intended to be a verbatim recitation of the Staff’s guidance and serves to highlight some of the key points raised by the Staff. Compliance officers and legal counsel should review the Staff’s guidance and review their policies and procedures in light of this guidance.

Risk Alert Following OCIE Examinations on Branch Offices

Today, OCIE released a Risk Alert focused on their recent observations from focused examinations of investment advisers that operate out of multiple locations or branch offices.

These examinations focused on whether the examined investment advisers had adopted and implemented reasonably designed written policies and procedures and implemented investment advice in an appropriate manner. As a summary, the staff reviewed firms’ main and branch office practices for:

(1) compliance with various rules under the Investment Advisers Act of 1940, including Rule 204A-1 and Rule 206(4)-2;

(2) the adherence by branch offices to comply with disclosures and agreements with clients relating to fees and expenses;

(3) the oversight of investment recommendations, and ensuring that those recommendations are suitable and consistent with disclosures to clients;

(4) management and disclosure of conflicts of interest; and

(5) allocation of investment opportunities.

Determining Whether a Client Can Invest in a Private Investment

I often receive questions from investment advisers on whether their clients can invest in a hedge fund, private equity fund, private company or some other type of private investment. For purposes of this article, I refer to them all as “private investments”. For example, clients will ask “can John Doe’s Trust invest in 123 Capital, LP?” My inevitable answer is always let me review the law and the offering documents and get back to you, because the federal securities laws are a nightmare in this area.

Federal securities laws require investors to meet certain qualifications in order for the securities transaction in question to be exempt from registration. These exemptions are found in two bodies of law–the Securities Act of 1933 (the “Securities Act”) and the Investment Company Act of 1940 (the “1940 Act”). Issuers of these investments have to be careful not to disregard these laws or else they could be found to have engaged in public offerings of non-exempt securities or investment companies, which would have a pretty draconian impact on their business.

The Federal Securities Laws

In practice, the Securities Act exempts from registration securities offered exclusively to “accredited investors”. The 1940 Act permits investment by (i) up to 100 “accredited investors”, or (ii) an unlimited number of “qualified purchasers”, in a pooled investment vehicle without registering as an “investment company”. The Securities Exchange Act of 1934 could also require registration if an issuer has a class of equity securities “held of record” by 2,000 persons.

Where to Begin?

The starting point in conducting analysis on whether a client can invest in a private investment should always be the investment’s governing documents. You should review the partnership agreement or operating agreement, the investment’s offering memorandum, and any subscription agreement that the client will need to execute in order to make an investment. These documents will typically describe what qualifications the investor must maintain in order to be eligible to invest. As alluded to above, these qualifications are determined based on business and regulatory considerations. You will want to primarily search for the terms “accredited investor” and “qualified purchaser”.

Identifying the Standard

The easiest and best place to begin in determining the standard for investment is the investor questionnaire that is usually part of the subscription agreement. As examples, click here and here. You should always be able to determine what the standard is by reviewing the subscription agreement.

Determining Client Eligibility

Once you have identified the standard required of an investor, then you must determine whether your client meets that standard. In a high percentage of instances, you will review a subscription agreement and know pretty quickly whether your client is eligible to invest.

Is your client an “accredited investor”?

Rule 501 of Regulation D under the Securities Act sets forth which investors qualify as “accredited investors”. The determination is made “at the time of the sale of the securities to that person”. While not an exhaustive list, the definition includes:

(1) banks, savings and loan associations, broker-dealers, insurance companies, registered investment companies,

(2) government benefit plans having assets in excess of $5,000,000;

(3) employee benefit plans if the investment decision is made by a fiduciary that is a bank, savings and loan association, insurance company, or registered investment adviser,

(4) employee benefit plans with total assets in excess of $5,000,000 ,

(5) employee benefit plans where investments are self-directed so long as investment decisions are made solely by persons that are accredited investors;

(6) nonprofit organizations (so long as they are not formed for the specific purpose of acquiring the securities offered) with total assets in excess of $5,000,000;

(7) Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000 (the “accredited investor net worth test”).

(8) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year (the “accredited investor income test”);

(9) Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a person with knowledge and experience in financial and business matters that is capable of evaluating the merits and risks of the prospective investment; and

(10) Any entity in which all of the equity owners are accredited investors.

Is Your Client a “Qualified Purchaser”?

Rule 2(a)(51) under the 1940 Act defines who is a “qualified purchaser”. This determination is also made at the time of acquisition. While not an exhaustive list, the definition includes:

(1) any natural person who owns $5,000,000 in investments (the “qualified purchaser investment holdings test”),

(2) any company that owns $5,000,000 in investments and that is owned directly or indirectly by or for 2 or more immediate family members (the “family member test”);

(3) any trust that is not covered by the family member test and that was not formed for the specific purpose of acquiring the securities being offered, so long as the trustee or other person authorized to make decisions with respect to the trust, and each settlor or other donor of property to the trust is a qualified purchaser; and

(4) any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, not less than $25,000,000 in investments.

Fuzziness Surrounding Standards

Most lawyers, compliance officers, and people who routinely invest in private investments don’t have issues determining the status of a person as an “accredited investor” or a “qualified purchaser” where they are advising investors who are natural persons (i.e., Joe or Nancy Smith) and they clearly meet the accredited investor net worth test, the accredited investor income test, or the qualified purchaser investment holdings test. However, the other standards all require a bit more analysis which will inevitably be covered in future posts.

SEC Should Provide Clear Guidance Following Two Ocean Crypto Banking Relief

On October 26, 2020, the Wyoming Division of Banking issued “no-action” relief to Two Ocean Trust stating that i) Two Ocean is permitted to provide custodial services for both digital and traditional assets under Wyoming law, and (ii) that Two Ocean
can refer to itself as a “qualified custodian” as that term is defined under the Investment Advisers Act of 1940, as amended (the “Advisers Act”).

Under Rule 206(4)-2 or the “custody rule”, an investment adviser is generally required to maintain cash or securities for which it is deemed to have custody with a “qualified custodian”. The custody rule defines “qualified custodian” to include, among others, “[a] bank as defined in section 202(a)(2) of the Advisers Act (15 U.S.C. 80b-2(a)(2)).”

Section 202(a)(2) of the Advisers Act defines “bank” as:

(A) a banking institution organized under the laws of the United States or a Federal savings association, as defined in section 1462(5) of title 12, (B) a member bank of the Federal Reserve System, (C) any other banking institution, savings association, as defined in section 1462(4) of title 12, or trust company, whether incorporated or not, doing business under the laws of any State or of the United States, a substantial portion of the business of which consists of receiving deposits or exercising fiduciary powers similar to those permitted to national banks under the authority of the Comptroller of the Currency, and which is supervised and examined by State or Federal authority having supervision over banks or savings associations, and which is not operated for the purpose of evading the provisions of this subchapter, and (D) a receiver, conservator, or other liquidating agent of any institution or firm included in clauses (A), (B), or (C) of this paragraph.

(emphasis added).

The Wyoming Division of Banking effectively concluded that Two Ocean is a trust company meeting all the requirements of prong (C).

Given this outcome, I believe that the SEC’s Division of Investment Management should offer guidance to the industry that reliance on these state-issued no-action letters is reasonable in concluding that an entity is a “qualified custodian” for purposes of the custody rule under the Advisers Act. This level of guidance will only further legitimize the crypto and digital asset movements and provide much needed clarity to the investment management industry.

A Growing Trend for RIAs – Become a One-Stop Shop

As of October 1, 2020, out of 13,810 investment advisers registered with the U.S. Securities and Exchange Commission (SEC), more than 200 reported being actively engaged in the business of being an accountant or accounting firm. Almost a 1,000 reported an affiliation with an accountant or accounting firm. Another 28 reported being actively engaged in the business of being a lawyer or law firm. And 447 reported an affiliation with a lawyer or law firm. The growth in the number of registered investment advisers has seen an increase in the number of firms that offer legal or accounting services.

Investment advisory clients and prospective clients–especially high net worth clients– are continuing to seek out trusted advisers that can render investment, tax, and estate planning services under one roof (a “One Stop Shop”). Conceptually, it makes a lot of sense. Instead of seeing three medical specialists, wouldn’t it be more efficient to receive all those services in a single visit from one business? Wouldn’t you reduce your opportunity costs? Wouldn’t you expect to receive some type of pricing discount?

There are a number of competing forces that prevent everyone from engaging a One Stop Shop. Similarly, there are forces that prevent investment advisers from creating their own One Stop Shop.

Some clients are quite happy with their current tax professionals and estate planning lawyers. Some clients may have very simple tax and estate planning needs and believe that it would be less expensive to seek out individual practitioners instead of bundling their services. Some clients may prefer name recognition for their accountants and estate planning lawyers. Some clients may trust and like their other current professionals.

In addition, some investment advisers rely heavily on centers of influence for referrals. They might determine that bringing these services in-house or merging with an accounting firm or law firm could jeopardize these relationships and referral streams. This is a fair concern.

In any event, before expanding your services as an investment adviser to be a One Stop Shop, you may want to consider the available options and their pros and cons. Below is a short list of available options. I have counseled clients through each of these approaches.

  1. Enter into an engagement letter with accountant or accounting firm. This can be as formal or informal as your business requires. You may determine to start small and engage them to only prepare tax returns for your clients. You may also engage them to assist you with addressing issues that are important to your clients. For example, if one of your clients needs tax planning assistance, you could directly engage the accountant to render those services to your client.
    • Pros: This is typically an inexpensive method. Easy to control costs by negotiating hourly rates or fixed fee in contract.
    • Cons: May not be able to control work flow and timing of deliverables. Introducing other service providers may result in client poaching. Inability to closely supervise work product and client satisfaction.
  2. Hire an accountant or estate planning lawyer on staff. Another option to creating a One Stop Shop might involve hiring one or more accountants or estate planning lawyers. If you will be charging additional or separate fees for these services, this could present an ethical issue for the accountant or estate planning lawyer as it relates to sharing accounting or legal fees with non-lawyers, which most state rules of conduct generally prohibit. It is best to review those rules with any potential hire and make sure that your plan doesn’t run afoul of those rules.
    • Pros: Better able to control work flow and timing of deliverables.
    • Cons: Higher, fixed cost due to salary and benefits typically than entering an engagement letter. Expectation of increased cost in future years. Added liability for errors and omissions (can be offset with insurance).
  3. Enter into a formal merger, acquisition, or re-organize your business with an accounting firm or estate planning law firm. We are seeing more and more name-brand accounting firms push deeper into the wealth management space. A lot of regional accounting firms have also begun offering wealth management services. This trend appears to be continuing.
    • Pros: Can provide in depth knowledge for clients. Likely have an accountant or lawyer with experience to address almost any client issue. Extreme efficiency of communicating between staff members, which are typically in the same office or on electronic communications platforms.
    • Cons: Can create conflicts of interest for the accounting firm or law firm that jeopardizes independence or would require recusal. Additional regulatory, compliance, and disclosure complexity (primary issues include conflicts of interest, insider trading, confidentiality, and data security).

This list and the pros and cons are intended to be a high level discussion for investment advisers evaluating their options. It may not comprehensively address all of the possible options and risk and rewards of each option. You should consult with knowledgeable legal and compliance professionals prior to contemplating your One Stop Shop.

Recent “Guidance” on Form CRS Disciplinary History Is Bad “Law”

Recently, I wrote a post that investment advisers and broker-dealers should review their Form CRS in light of new guidance on the disciplinary history section (Review your Form CRS Disciplinary History Disclosure in Light of New Guidance). As that post addressed, earlier in the month, Commissioner Clayton and Directors Blass and Redfearn put forth a Joint Statement Regarding New FAQs for Form CRS. On the same day as the Joint Statement was issued, the staff of the Division of Investment Management and the Division of Trading and Markets amended its Frequently Asked Questions on Form CRS by adding four new questions and answers.

As a follow up to my earlier post, I wanted to examine this guidance, ponder its intent, poke holes in its legality, and question whether it is even good public policy.

The Relevant Guidance

The guidance from the Joint Statement boils down to two major concepts:

  1. “Firms do not have discretion to leave the answer blank or to omit reportable disciplinary history from the relationship summary. ”
  2. “When responding to the disciplinary history heading in their relationship summaries, firms may not add descriptive or other qualitative or quantitative language.  Adding such language might, intentionally or unintentionally, obfuscate or otherwise minimize the disciplinary history.  However, as we describe below, firms or their financial professionals may provide the relevant disciplinary history directly to retail investors.”

Intent of the Guidance

I think Commissioner Clayton and Directors Blass and Redfearn were feeling pressure from the recent reporting by the Wall Street Journal – Financial Firms Fail to Own Up to Advisers’ Past Misdeeds – on the lack of accurate disclosure on Form CRS. Based on that pressure, they reacted by putting forth the Joint Statement and tried to clear up confusion in the industry regarding disciplinary history reporting on Form CRS. I think their Joint Statement went too far in trying to clear up that confusion, and caused them to provide guidance that is contrary to the Instructions to Form CRS.

Legality of the Guidance

The first bit of guidance referenced above is legally enforceable, was well-intentioned, and was a matter of good public policy. It is based on the Instructions to Form CRS and complies with the intent outlined in the proposing and adopting rule releases.

However, I believe the second bit of guidance is less likely to be legally enforceable, was an overreach in reaction to the Wall Street Journal’s reporting, and is also bad public policy.

The Instructions to Form CRS make it clear that investment advisers and broker-dealers must respond to each question and only include disclosure that is required or permitted by the instructions. Instruction 1.B. states, “You must respond to each item and must provide responses in the same order as the items appear in these instructions. You may not include disclosure in the relationship summary other than disclosure that is required or permitted by these Instructions and the applicable item.” However, instruction 2.B. states, “All information in your relationship summary must be true and may not omit any material facts necessary in order to make the disclosures required by these Instructions and the applicable Item, in light of the circumstances under which they were made, not misleading. If a required disclosure or conversation starter is inapplicable to your business or specific wording required by these Instructions is
inaccurate, you may omit or modify that disclosure or conversation starter.” (emphasis added). Footnote 92 of the adopting release identifies the tension between these two instructions by using the legal signal “Cf.” when comparing the two instructions.

Footnote 91 of the adopting release provides somewhat relevant guidance on instruction 2.B. It states, “We are adopting this provision to ensure that firms are not compelled to include wording in their relationship summaries that is misleading or inaccurate in the context of their business models. This provision may apply in limited circumstances. For example, the headings and conversation starters prescribed by the final instructions are worded at a highly generalized level and cover selected key topics that are broadly applicable to broker-dealers and investment advisers and their relationships with retail investors, irrespective of business model (i.e., relationships and services the firm offers to retail investors, fees and costs that retail investors will pay, specified conflicts of interest and standards of conduct, and disciplinary history).” (emphasis added). This signifies that a firm could add additional content to their discussion on their disciplinary history if they did so to make their disclosure more accurate or less misleading.

In addition, the adopting release goes on to state:

Firms or financial professionals would have the opportunity to provide more information about and encourage retail investors to ask follow-up questions regarding the nature, scope, or severity of any disciplinary history, so that retail investors have the information they need to decide on a relationship. In particular, financial professionals who themselves have no disciplinary history can make clear that a “Yes” disclosure in response to the heading question relates to the firm and other personnel (if applicable) and not to them.

Adopting release at p. 176

The adopting release isn’t clear on whether firms or financial professionals could provide more information in the Form CRS itself, but the ambiguity should be interpreted against the SEC in this case.

Guidance from a single Commissioner or the SEC staff do not have the impact of law. In fact, the Joint Statement acknowledges this in footnote 1. “This statement represents the views of Chairman Clayton and Directors Blass and Redfearn. It is not a rule, regulation, or statement of the Securities and Exchange Commission (“Commission”). The Commission has neither approved nor disapproved its content. This statement has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.” The introduction to the FAQs have a very similar disclaimer.

This is important because the law in effect is the Form CRS and its instructions. Whereas, guidance is issued to help interpret or clarify an existing law. Whether the Joint Statement and FAQs are even to be considered guidance is up for debate because of the disclaimers they contain. Even if they were to be treated as guidance, I think that a federal court would agree that they are inconsistent with the regulation, which is historically the standard used in determining whether the guidance should be afforded deference. 

Bad Public Policy

I personally don’t understand why an investment adviser or broker-dealer could not provide additional clarification in response to a disciplinary question on Form CRS so long as they do so in a non-misleading way. I believe that the investing public would benefit from having additional, relevant information about the disciplinary history of a firm or a financial professional at a firm. While Chairman Clayton and Directors Blass and Redfearn believe that it could obfuscate or minimize a firm’s reportable disciplinary history, I believe that additional information is fair, and even warranted, in certain instances.

For example, I am aware of a small firm where one of its financial professionals had a single incident that caused the firm to make an affirmative response to the disciplinary history question. The event at issue involved a nearly 30-year old administrative error that resulted in a financial professional temporary having his license to render advice suspended by a state securities regulator in a state that he didn’t even have any clients or prospective clients. I hold this firm and the individual in question in high regard and I think it is unfair that they cannot provide a little bit of context around their affirmative response to make it not misleading.

Chairman Clayton and Directors Blass and Redfearn opted to try and make “black and white” that which is always a balancing act–the federal securities laws.

Should Your Firm Add or Remove Context?

I can’t tell you whether your firm should or should not provide context if it responds affirmatively to the disciplinary history question. That is a business decision. However, you should understand the law, the impact of guidance (and non-guidance), understand that this issue will likely arise during an examination, may be referred to enforcement, and determine whether you are prepared to litigate over this issue. For most investment advisers and broker-dealers with disciplinary histories, the answer will be easy–remove the additional context.

Review your Form CRS Disciplinary History Disclosure in Light of New Guidance

On October 8, 2020, Securities and Exchange Commission’s Chairman Clayton along with Dalia Blass, Director, Division of Investment Management and Brett Redfearn, Director of Division of Trading and Markets released a Joint Statement Regarding New FAQs for Form CRS. The Joint Statement focused on the disciplinary history section of Form CRS, which became effective earlier this year. On the same day as the Joint Statement was issued, the staff of the Division of Investment Management and the Division of Trading and Markets amended its Frequently Asked Questions on Form CRS by adding four new questions and answers.

The most newsworthy guidance under the amended FAQs effectively states that investment advisers and broker-dealers should not include additional information to explain their disciplinary history in Item 4. The precise language of the FAQ states:

Q: If we answer “Yes” in Item 4, may we include additional information in our relationship summary to explain the disciplinary history?

A: No. Item 4 requires a “Yes” or “No” response, along with the required reference to (Item 4.D.(i)) and the required conversation starter (Item 4.D.(ii)). Item 4 – and the conversation starter in particular – is designed to encourage a discussion regarding the nature, scope, or severity of any disciplinary history, including any differences between the firm’s disciplinary history and the financial professional’s disciplinary history, if applicable. Form CRS does not preclude firms or their financial professionals from providing separately copies of additional regulatory disclosures (e.g., Form ADV Part 2B brochure supplements or a print-out of the IAPD or BrokerCheck “Disclosures” section for the particular firm or financial professional). (Posted October 8, 2020)

This runs counter to what many lawyers and compliance professionals assumed (including myself).

Now is a good time to take a look at your firm’s Form CRS and amend, as applicable. The question remains whether this would be a material change requiring notification to investors, but I would posit that it is not.

On the other hand, it is important to note that the Joint Statement and the FAQs have no legal force or effect, do not alter or amend applicable law, create no new or additional obligations for any person, and have not been approved (or disapproved) by the Commission.  A firm may determine to make a business decision to provide additional content in response to Item 4, but they should do so knowing all of the relevant guidance.

SEC Proposes Exemptive Relief for “Finders” – A Win-Win Scenario?

I was recently quoted by on the recent “finders” exemption proposal by the U.S. Securities and Exchange Commission. That proposal would provide clarity to “finders” on how they can avoid allegations that they are acting as broker-dealers in need of registration under Section 15 of the Securities Exchange Act of 1934. The proposal is available here.

The Office of the Advocate for Small Business Capital Formation created a very helpful chart that shows how the proposed finder relief will work, if adopted. That chart is set forth below:

As you can see, the exemption provides two tiers of exemptive relief for finders. Tier 1 provides a finder with the ability to receive transaction-based compensation for (i) simply providing contact information for accredited investors, (ii) to non-reporting (private) companies, (iii) for primary exempt offerings, subject to certain conditions. It would only available for individuals and these referrals are proposed to be limited to once in a 12-month period. My only concern with this tier is that issuers may be able to deceive a finder or ultimately refuse to compensate a finder from their earned compensation, because of how “hands off” the approach must be under the proposal.

Tier 2 allows for the finder to be slightly more involved in the process–namely they can help contact potential investors, distribute offering materials, discuss the issuer, and arrange for meetings.

Lately, I have been finding myself in less agreement with Chariman Clayton on proposals, but I think this proposed relief benefits the industry without necessarily creating any increased risk for the investing public. As a practicing lawyer who works on securities offerings, I see these proposals as a win-win.

These activities are already taking place and investors are already being pitched ideas by unlicensed people who stand to benefit from those pitches. This relief at least provides clarity for the unlicensed people, and at the same time would seem to increase protection for those investors.