Welcome to the fourth edition of On The Docket, which is the recently-ascribed name to the Beach Street Legal blog. This edition includes the following content:
- Extracting Actionable Takeaways From The SEC’s Staff Bulletin Regarding An RIA’s Standard Of Care
- Anatomy Of An RIA Sale, Merger Or Acquisition: 5 Important Legal & Compliance Steps
- When Does A Financial Coach Need To Register As An Investment Adviser? The “ABCS” Test To Determine Status
- Form ADV-W and Negative/Passive Client Consent
- Why I’m Not a Fan of Advance Notice Requirements to Terminate an Advisory Agreement
- The Case Against Commingling Records
- Converting From a Texas ‘Notice Filing’ to a Texas ‘Registration’
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Happy reading.
– Chris
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Extracting Actionable Takeaways From The SEC’s Staff Bulletin Regarding An RIA’s Standard Of Care
There is a general understanding that investment advisers have a fiduciary relationship with their clients – in other words, that they are required to act in the client’s best interests. But although this concept makes sense in the abstract, it isn’t always clear what an adviser needs to do to fulfill their fiduciary duty in real-life situations.
This article endeavors to extract the salient takeaways from a recent SEC Staff Bulletin and translate them into action items for advisers to evaluate and implement if needed.
Anatomy Of An RIA Sale, Merger Or Acquisition: 5 Important Legal & Compliance Steps
Purely from an economic perspective, founders of investment advisory and financial planning companies would do well to at least consider what a future sale or merger would entail. As an attorney who advises investment advisory and financial planning company founders on sales, acquisitions, and mergers, I can confidently say that it entails a lot – both from the perspective of the seller and the perspective of the buyer.
This article sets forth a discussion of the legal and compliance aspects of buying, selling, and merging an investment advisory and financial planning business. It will be by no means exhaustive or representative of all potential transaction structures, but instead primarily contemplates the sale of the entirety of a business to an external third party (and not, for example, a staged internal equity transfer designed to facilitate employee buy-in over time).
When Does A Financial Coach Need To Register As An Investment Adviser? The “ABCS” Test To Determine Status
As is typical in the world of investment adviser regulation, a “facts and circumstances” analysis must be applied to even the most threshold of questions under the Investment Advisers Act of 1940: Who exactly is required to register as an investment adviser?
This question is particularly acute for financial coaches who provide advice regarding certain financial and investment-adjacent topics, but are not registered as investment advisers with either the SEC or any state securities authority.
This article sets forth a discussion of the “facts and circumstances” that would indicate that a financial coach must register as an investment adviser.
Form ADV-W and Negative/Passive Client Consent
I happened across an interesting tidbit in the Form ADV-W (the form used to terminate a firm’s registration as an investment adviser), which has been excerpted below:
A few comments:
- The SEC generally permits advisers to assign their client agreements to another adviser via “passive” or “negative” consent (e.g., as part of a sale/acquisition). In other words, the client simply has to be provided notice of the assignment of his/her advisory agreement to another adviser, but need not sign anything or take any action for the assignment to be legally effective.
I wrote about this topic way back in 2014, but it still holds up. - The ADV-W excerpt is a bit misleading if read in isolation, as many states require clients of state-registered advisers to actually sign something or affirmatively indicate their consent to an assignment of their advisory agreement to another adviser (i.e., an “affirmative” or “positive” consent).
- In addition, regardless of whether the adviser is state or SEC registered, the advisory agreement itself has to permit passive/negative consent assignments to even be viable.
Why I’m Not a Fan of Advance Notice Requirements to Terminate an Advisory Agreement
I’m generally not a fan of retail advisory agreements that require some minimum # of days notice before they can be terminated.
Here’s why:
- Neither the client nor the adviser should be ‘held hostage’ in an advisory relationship any longer than desired. Wanting to disengage immediately but then being required to wait another 30 days to do so, e.g., is just awkward.
- Taken to its most cynical extreme, a long termination notice period may be viewed by a regulator as a ploy to collect extra advisory fees during that time (i.e., after the notice of termination is given by a client but before the termination is effective).
- The adviser may need to disengage from a client relationship immediately if the client is actively disregarding advice, placing self-directed trades that conflict with the adviser’s portfolio design, or is otherwise becoming hostile to deal with.
The Case Against Commingling Records
This Texas State Securities Board Inspections FAQ excerpt explains why commingling the records an adviser is required to keep alongside records an adviser is not required to keep can be problematic:
Are the potential simplification and cost-saving benefits of records commingling (with an affiliate, e.g.) worth it given the unneeded exposure of records an examiner is otherwise not entitled to?
Converting From a Texas ‘Notice Filing’ to a Texas ‘Registration’
Reminder for state-registered advisers that are located outside of Texas but ‘notice filed’ in Texas: You are required to convert your ‘notice filing’ to a ‘registration’ in Texas before you engage with your 6th Texas client during the preceding 12 months.
State-registered advisers without a place of business in Texas are generally required to notice file in Texas even if they work with just a single Texas client (Texas does not follow the ‘5-or-fewer’ client de minimis threshold that nearly all other states follow). This notice filing will typically be reflected on IAPD as a ‘Conditional Restricted’ registration status (screenshot below).
The ‘notice filing’ / ‘conditional restricted’ status is only valid for so long as the firm has no place of business in Texas and 5-or-fewer Texas clients within the preceding 12 months.
A full registration application must be submitted and approved before the 6th client can be engaged.