Compliance Considerations: Hiring for Your RIA

While new RIA owners often have different values that shape the trajectory of their business, they are often driven by a singular goal: to grow their firm. The more clients you serve, the more people you’re giving the opportunity to live their best lives and to feel financially secure and prepared for the future. And, at the end of the day, your clients are the people who keep the lights on.

With increased growth of an RIA comes increased compliance supervisory responsibilities that many firm owners are not naturally prepared to handle. Supervisory practices that were once unnecessary for a one-person firm are now needed to provide structure for supervising additional employees. The process of adopting these new practices can seem overwhelming. By following a few critical steps, you can simplify the process while gaining a sufficient understanding of ongoing compliance responsibilities. 

One of the most common questions surrounding this topic, is “How do I determine whether or not I need to register my new employee as an Investment Advisor Representative?” In this blog, I’ll bring clarity to the process by outlining 5 steps to make this determination.

Step 1: Identify the Need for the New Hire

The first step in this process is to identify the need for the new hire by examining the areas of growth for the business. If you are onboarding clients quickly and find data entry to be a pain point, hiring a paraplanner may seem appropriate.

If you wish to grow your business laterally by bringing on an existing advisor with their own client base, then an additional Investment Advisor Representative (IAR) may be the solution.

If you find prospecting has been fruitful, but the percentage of prospects that are being converted to clients is low due to your limited capacity to handle calls and emails, an administrative assistant may be more appropriate.

And while all firms could benefit from full-time operations and compliance support, this hire may be a bit expensive for new RIAs that are still trying to gain adequate data to forecast future years’ revenues. Bringing someone on to handle back office functions may be a more cost-effective and viable option early on.

By first identifying the need for the new hire, you can begin the process of organizing the compliance tasks that will support the supervisory functions of the newly onboarded employee. 

Step 2: Outline the Functions of the New Hire

It sounds simple, but this concept is often overlooked. It is impossible to know how an employee should be supervised if you don't know what the employee does.

Many advisors identify and maintain the needs for their new hire by thinking through the pain points they experience as their business grows. But few advisors take the time to physically document the needs for the new hire by outlining critical pieces of the puzzle that will shape their job functions and supervisory requirements. These aspects of employment include, but are not limited to: 

• What client personal, non-public information they will be given access to through the firm’s technology and through client communications.

• Whether or not they will be communicating with clients directly outside of the advisor’s presence.

• What access to trading and money-movement functionality they will be given access to, and how this access will be used.

• Whether or not they will be communicating with Third-Party Vendors on the firm’s behalf, outside of the advisor’s presence (including third-party managers, TAMPS and sub-advisors).

• What access to internal firm documents they will leverage for their job duties, and whether or not they will need to alter or change documentation (e.g. Form ADV, Advisory Contracts, Compliance Manual, etc…).

Compiling and documenting this information is critical as it pertains to the subsequent steps in this process.

Step 3: Find the Definition of Investment Advisor Representative for Your Regulatory Jurisdiction

In a vast majority of cases, advisors can do a quick search on the website of their regulatory jurisdiction to locate the definition of Investment Advisor Representative. By examining the paragraph and subsequent bullet points often presented to clarify this definition, you can begin the process of understanding how to adequately articulate the role of your new employee as it pertains to this definition. Should there be any future disputes between the firm and regulators regarding the registration of the new employee (or lack thereof), you will be prepared for this discussion. This can be supplemented by another search to locate the regulatory commentary regarding what constitutes clerical and administrative duties, if you choose to classify your employee in that manner.

Step 4: Finalize the Duties of the New Employee with Parameters that Consider the Definition of Investment Advisor Representative

This step is defined by a comparison between the list of duties and access privileges of your new employee, and the definition of IAR as outlined by the regulatory guidelines. By this time, you should be able to determine whether or not your new employee or independent contractor will need to be registered and supervised as an IAR in order to work in the capacity you need. This step is critical when determining the classification of paraplanners because all regulators do not agree on whether or not paraplanning activities constitute investment advisory activities for the purpose of defining the role. Firms can therefore craft their own interpretation to prepare for a conversation with regulators, as long as that interpretation sufficiently references the regulatory definition of Investment Advisor Representative.

Step 5: Execute Accordingly

Some Compliance Officers may want to play it safe here and reach out to regulators before proceeding. To do so, you can send a detailed summary of the anticipated new hire with the list compiled in Step 2 above and your interpretation of the state’s definition of IAR to the regulator with request for comment. Those who would rather ask for forgiveness than permission will simply document these items internally in preparation for that line of questioning in an exam. With either method, you can rest easy knowing you have done your due diligence in preparing your compliance program for your new hire.

Initial Onboarding and Ongoing Supervision

Once your employee has been hired, it’s time for initial onboarding and ongoing supervisory procedures. Generally speaking, all employees will need to demonstrate adequate knowledge and acceptance of your firm’s policies and procedures, regardless of whether they are classified as an IAR or as a clerical or administrative employee. It is therefore best practice to have all employees sign an acknowledgement that they have read and reviewed your firm’s compliance manual (aka written supervisory procedures), code of ethics, and privacy policy. This is critical for the you to be able to hold all employees accountable for their adherence to your firm’s compliance program. From there, you will be responsible for ongoing supervision based on the role of the employee. An optional Non-Disclosure Agreement may be appropriate to administer upon hire to protect the firm and clients’ personal information. Some firms will also conduct an optional credit check and/or background check.  

You can minimize the potential for audit deficiencies by maximizing the documentation that is collected from your employees on an ongoing basis. A best practice here is to collect details on personal securities transactions and outside brokerage account activity for access persons, both at hire and on an ongoing basis.

To execute this method, a regular collection of brokerage statements and trade confirmations for any accounts held outside of the firm is appropriate. Compare these records to your firm’s trade blotter and client account statements to be certain no trading violations are occurring. An effective Compliance Program will execute an Initial Holdings report and create a process for collecting information on political contributions both at hire and on an ongoing basis (check out this link to SEC Regulatory background on personal securities trading supervision requirements). Sure, there is a chance that a regulator will never ask for trade confirmations from an employee you have determined to be purely clerical and administrative. But it is also possible that the regulator will disagree with the employee’s classification of clerical and administrative, and will therefore request to see that their personal securities transactions are being adequately monitored. Each compliance officer will need to decide to what extent they wish to be prepared for either case.

For IARs (as defined through the 5-step process above), a Form U4 must be filed via the FINRA Firm Gateway website. If the IAR has a previous history as an advisor, then you will need to review their Form U5 and potentially research dual registration as needed. Additionally, a Form ADV Part 2B will need to be created and filed via the FINRA Firm Gateway (the additional ADV Part 2B filing is generally a requirement for state-registered firms only).

W2 vs. 1099

It is a common misconception that the compliance officer has fewer supervisory responsibilities for workers classified as 1099 independent contractors. To the contrary, regulators consider the supervisory responsibilities of a compliance officer to be the same for anyone operating within the definition of IAR, whether they are classified as a W2 employee or a 1099 independent contractor. At the core of this principle is the definition of IAR and the outline of functions to be completed for the 1099 contractor, as discussed earlier. This outline and comparison to the definition of IAR is perhaps more critical to execute for 1099 Independent contractors because of ambiguity created by the decision not to hire the worker as a W2 employee. For advisors who wish to operate for other firms in the capacity of a 1099 independent contractor, the primary difference is that the compliance officer of the firm hiring the 1099 contractor will need to go through steps 1-5 as outlined above. The advisor who will be working as the independent contractor may want to maintain a copy of the records that have been created by the hiring firm, and will list their activities as an Outside Business Activity on Form ADV and Form U4.

When growing your firm, you will inevitably reach a point at which you need to hire more employees. New employees help increase your capacity and alleviate the growing pains of an expanding business. They also increase your compliance supervisory responsibilities. By following the 5-step process above, you can be sure your firm maintains compliance with each new hire.

About the Author
Scott is a licensed Securities Principal with experience in both RIA and broker-dealer compliance. He began his financial services career in 2006 as a Registered Representative with E*Trade Financial in Alpharetta, GA. He has also worked with J.P. Morgan Private Banking in Chicago, IL and with Wells Fargo Advisors in Chapel Hill, NC.

Scott’s most recent role before joining Team XYPN was as Compliance Officer of Carolinas Investment Consulting, in Charlotte NC. He’s a graduate of The University of North Carolina at Chapel Hill and holds FINRA Series 63, 65, 24, 4 and 53 Licenses.

Scott lives in Charlotte NC with his wife Meredith, and their two Sons Tyson and Jackson. In his free time, Scott enjoys watching sports, exercising, and operating the charitable organization he created upon his father’s passing.