New SEC regulations covering whether RIA firms are covered under SEC rules or under state rules have sparked controversy over whether the "switch," once enacted, will force firms with less than $100 million in assets under management to merge with other firms in order to survive financially.
The gist of the rule for RIAs was the raising of the threshold for SEC (federal) regulatory jurisdiction from $25 million to $100 million in AUM. The concern centers on how different state rules could impose additional costs and labor for those firms compared with the federal standards.
According to SEC Commissioner Kathleen L. Casey, "The Dodd-Frank Act is a massive law, and implementation of the act will require massive regulatory effort." One way to mitigate that effort was to shift responsibility to the states for a large portion of the regulatory work, principally with those smaller financial practices. And while initial thoughts on this focused on the states' ability to undertake such additional responsibilities, the result was assumed to be a revenue boon for the states, as costs to provide such regulatory activity would easily be covered by the fees imposed on those smaller firms subject to state regulatory rules.
Gary Davis, vice-president of practice operations with Market Counsel (marketcounsel.com), made the following points:
"I think the 'switch,' as it is called, will add to a sub- $100 million RIA firm's financial stress. Today, about 40 states' notice filing fees and state registrations fees are roughly the same cost. We are not sure what the new notice filing fees or state registrations fees will be once the switch occurs, but we can assume both will increase as each state's responsibility for oversight is now increasing.
"I also think some firms will not look to merge, but will look to 'roll up' or 'tuck in' with those firms who are looking to add new advisors to their practices."
This process of rolling up is already occurring as smaller firms recognize the need to consolidate operations in an effort to save operational costs. The concept is to simply migrate a financial advisor's clients to another practice and then become a member of the new firm. No merger is actually occurring in this case; it is simply a roll-up of the practice clients into the other practice for employment consideration. And while this may be the right move for some practices, it is not the only solution and in some cases could actually be the wrong move.
In some cases, choosing a firm that does not properly align with the way the financial advisor works could result in a defection of clients. Working with a firm, for instance, that uses a different custodian, could cause unease with clients. And working with a firm that takes a "silo approach" to operations could actually be less financially advantageous than other choices. (In this case, a silo approach might refer to those firms that struggle to coordinate practice operations efficiently with advisors who work in different market segments.)
Scott Brown, an associate director of securities and regulatory compliance with Market Counsel, suggests:
"I do not think the switch will be the sole reason why sub-$100 million [firms] will look to merge over the next 12 to 24 months, but be one of the reasons why. Firms that make the switch will endure some growing pains. Firms that have to register directly with the states could take several weeks to receive approval to conduct business in that state. Those who are able to notice file with states due to SEC registration will likely receive approval in a couple of days.
"At the end of the day," Brown continues, "who really knows if the switch is really going to happen? As of two days ago [mid-April], the SEC sent NASAA a letter proposing that the due date for the switch be extended to the first quarter of 2012. The reason I bring this up is, again, any future regulatory requirements or changes [are] merely one of several factors smaller advisory firms must consider when deciding to continue to grow their business along"-by deciding whether to bring on a partner, merge or "tuck in" to another firm.
Gary Davis has identified some other areas that advisors may be wise to focus on: