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:
"I think many 'smaller' RIA firms have already been feeling financial pressure, not just in compliance, but in the following areas":
Marketing and business development budget.
Cost of back-office operations.
- Staffing
- Technology
Office expenses.
It won't be just the financial stress that will cause smaller firms to look to merge or form a strategic alliance. The following contribute to the decision-making process:
Time management. The principals of many small firms are already wearing multiple management hats. Yes, the switch will add to each firm's workload in dealing with multiple regulators, the possibility of multiple audits in a given year and either the time it will take to keep up the annual registration in these states or outsource this work to a compliance consulting firm.
Process management. Firms are going to need to implement proactive operational processes in order to deal with the multiple state regulators. The need to integrate the compliance management process into a smaller size RIA firm's day-to-day operational processes will become a must in order to be efficient with a firm's workload.
The reality is that many firms have enjoyed unprecedented growth with little pressure to lower infrastructure costs or provide greater operational efficiencies until now. With the last couple of years of stock market activity coupled with these new regulatory issues, the focus has definitely shifted to net profitability, which can be enhanced not only with increased marketing and new client acquisition methods, but also by providing greater cost efficiencies in providing services.
This can fall into several areas of practice operations, including management and technology. Standardized processes can have the effect of increasing the productivity of employees, even in smaller firms. With technology, many procedures may be automated. Some firms fear such moves as they see their firms as providing customized solutions. Yet technology can provide ways to deal with this in a more efficient work environment. Some firms have already purchased such technology, yet due to the work involved in adapting the technology to work the way the firm needs to operate, that same technology may not have been fully utilized.
It makes sense to fully investigate your choices and talk to industry experts about the likely consequences of those choices. Specifically, running a cost/benefit analysis that compares those choices side by side might be an effective way to evaluate and determine your best choice.