Kitces know the ways of the checklist-resistant but says the challenge of becoming a registered investment advisor is highly doable and can save an advisor money and time stuck in a morass

February 22, 2017 — 6:41 PM UTC by Guest Columnist Michael Kitces

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Brooke's Note: What exactly is an RIA? The answer, to some extent, is: It depends. But while for many of us the definition of a registered investment advisor is intellectual or regulatory, for others it's a far more practical issue. I get a surprising number of phone calls from people asking me: How the hell do I become an RIA, where do I sign up and who is going to throw a mind-wrenching test in my path to slow my advance? I have written articles over the years to get at the answer (here is one of them: What exactly is an RIA?) But I delivered broad strokes more than hard wires. More recently, I have referred aspiring RIAs to the article below, taken from the transcript of a January session of Michael Kitces's weekly webcast. The publisher of Nerd's Eye View covers the exact rules that determine when you have to get a license to become a financial advisor – or technically, to register as an investment advisor by creating an RIA and becoming an IAR (investment advisor representative) of that business. We are pleased to run it here.

With more and more people looking to become a [fee-only] financial advisor – given both the rewarding nature of helping people and the income potential it brings – questions about when you actually have to register as a financial advisor are becoming more common. Does any financial advice trigger a requirement to register? What kind of license do you need to become a financial advisor? And can you wait until you get clients, before you go through the process? 11 steps to becoming an RIA without upsetting Merrill Lynch, the SEC or your clients

The core requirement under the Investment Advisers Act of 1940 is that it’s “being in the business of giving investment advice for compensation” that triggers the need to register. While there are forms of financial advice that may not require registration, such as “financial coaching,” the reality is, almost anyone who’s holding themselves out as a financial advisor – particularly as a CFP certificant – is likely giving some form of investment advice, and consequently will need to register.

Registration as an investment advisor can happen one of two ways: either registering with the primary state in which you do business, or registering with the Securities and Exchange Commission (SEC). However, registering with the SEC requires a minimum of $100 million of regulatory AUM, or doing business in 15-plus states; as a result, most advisors just starting out will initially register the RIA at the state level, and then become an IAR (investment advisor representative) of that RIA. See: RIAs switching to state registration may be examined by a second regulator, too

Series 65 required ... unless

Notably, though, to become an IAR, you must also pass the Series 65 exam (or have the Series 7 and 66 if you are coming from a broker-dealer).

Most states will waive this requirement for those with an advanced certification such as the CFP, CFA, CHFC, or the AICPA’s PFS. But ultimately that means to get started, you must both pass the Series 65 exam (or possess one of the requisite designations), and go through the registration process. See: How to ace the grueling Series 65 exam and keep your wits and your nerves intact in the process.

And the registration process in the advisor’s home state itself should be done before actually going into business. As the financial advisor adds clients in other states, and crosses more than five clients (for most states), it’s also necessary to extend the registration in those states. But soliciting the first client requires the advisor to at least create the initial RIA in their home state, first.

Fortunately, it’s still fairly inexpensive to get up and running as a financial advisor (at least relative to the income potential it brings, and the cost of starting a business in other industries). However, that doesn’t mean it’s easy to make the transition – because the real challenge is not just the startup cost to become a financial advisor, but filling the “income gap” of launching a business with no clients or revenue, and needing to build up to the point where you can actually pay yourself a fair wage! On the other hand, in the long run, successful financial advisors still have the potential to make many times the average household income in the United States.

Today I want to talk about what it takes to become a financial advisor. Or actually, an investment advisor, since it’s the investment advisor laws that cover most of those who get paid for giving financial advice. Which means if you want to get licensed as a financial advisor, most likely you’ll be getting licensed as an investment advisor.

And with more and more people looking to become financial advisors these days, given both the potential for working with people and helping them (which is psychologically rewarding) and the sheer financial compensation potential for being an advisor (which is very financially rewarding!), I’m getting more and more questions about when you actually have to register as an investment advisor, or just how you get a license to become a financial advisor.

A good example of this was a recent question I got from Jeff, who’s graduating from a financial planning program soon and about to become a financial advisor. Jeff had inquired to the blog and asked:

“I’m starting an advisory business. I don’t have any clients yet. Is it true that I can wait to reach the five-client minimum in my state before I need to set up my RIA?” See: How and why I'm starting an RIA from scratch and what I'm spending to make it happen.

This is a great question and one that I’m hearing a lot. So let’s delve a little into some of the technical terms and rules that apply to becoming a financial advisor (or an investment advisor) that’s going to get paid for financial advice.

What is an investment advisor? (Hint: Somebody who profits)

Under the Investment Advisers Act of 1940, an investment advisor is defined as an individual or entity who, for compensation, engages in the business of advising others on investments.

There are a couple of key points here.

Number one is that you have to do it for compensation. Free advice does not trigger registration and licensing requirements. That’s why media personalities don’t have to register… because they’re not directly getting paid for the financial advice.

Part two is that you have to actually be in the business of advising. So if one day I gave someone a little bit of advice and they bought me dinner as compensation, doesn’t necessarily trigger investment advisor registration, either. You have to be in the business of giving advice, ostensibly aiming to do it on an ongoing basis. Though once you’re launching a business to do it and you’re holding out as being in the business of advice, you have to register. See: How exactly I started a specialized RIA for under $10,000.

The third component is that you have to be advising on investments. Technically, that means generalist financial advice, or even comprehensive financial planning, doesn’t necessarily trigger a requirement to register as an investment advisor and get the license, if you give no specific advice about investments.

This is important because we’re now seeing the rise of areas like financial coaching, where people advise on cash flow, spending, debt management and general financial behaviors, but they don’t give investment-specific advice, and so they don’t necessarily have to register as an investment advisor. See: Why love has everything to do with the next frontier in financial planning and our relationship to money

Notably, many states just presume that if you’re holding out as a financial advisor (and especially if you’re putting “CFP” on your business card), you must be giving some kind of investment advice at some point along the way. As a result, they’ll require you to register, simply because you’re holding out in a way that implies investment advice will be part of the services offered. But technically, it’s the giving of investment advice that’s the portion of financial advice that really triggers a registration requirement. 

It’s also important to note here that when we talk about the compensation for getting paid for advice that requires you to become an investment advisor, it means actually getting paid a fee for financial advice. If you’re looking to get paid commissions to sell investment products and work under a broker-dealer, then you’ll need to get sponsored by a broker-dealer and pass the Series 6 or Series 7 exam to be able to legally get paid commissions to sell investment products. Similarly, you have to get a state insurance license to sell insurance products. In other words, the rules for getting paid to sell products are completely different than the rules for getting paid for financial advice.

Sometimes they are overlapping, as there is such a thing as being a hybrid advisor who does both, but, functionally, what we’re talking about here is getting paid for financial advice. And this can get confusing sometimes because people across all of those different types still use broad labels like “financial advisor” to characterize all the different structures. 

Requirements to become a registered investment advisor

If you actually want to be in the business of engaging investment advice for fee compensation, then you’ll be acting as an investment advisor. Under the Investment Advisers Act of 1940, if you’re acting as an investment advisor, you must register as one.

So registration of an investment advisor happens one of two different ways: either (1), you can register in the primary state in which you do business as a state-registered advisor, or (2), you can register with the Securities and Exchange Commission.

In general, SEC registration is reserved for advisors who have at least $100 million in assets under management. It’s for larger RIAs, from $100 million all the way up to billions of dollars and beyond. The SEC needs to clean up its semantics before accusing RIAs of inflating AUM

For those who have less than $100 million (all the way down to zero because you don’t have any clients or assets under management yet, or maybe you don’t even intend to have assets under management because you’re just getting paid hourly or monthly retainer fees), all of those advisors register with their state.

In this context, registering simply means registering either yourself personally as an investment advisor, or a business entity as an investment advisor, and becoming a registered investment advisor. That means it’s literally the person or the entity who’s been registered as such.

Technically, the RIA is the business (e.g., either a business entity or you acting as a sole proprietor). The person who gives the advice in that business is an investment advisor representative (or an IAR) under the RIA. Either you’re an IAR of yourself because you’re a sole proprietor, or you’re an IAR of the entity that’s registered as an investment advisor.

That’s important because in order to become the IAR – i.e., the person that actually gives the advice under the registered entity – there’s another requirement: you have to complete the Series 65 exam, or have completed the Series 66 and the Series 7 from the broker-dealer side, which cross-qualifies you for the Series 65.

The real challenge is not just the startup cost to become a financial advisor, but filling the 'income gap' of launching a business with no clients or revenue.

The Series 65 exam is a 130-question exam that you have three hours to complete. You have to get a 72% to pass, and it’s a straight pass-fail exam. If you fail, you can retake it after a short waiting period (and paying another exam fee). It’s not a terribly difficult exam, but it does require you to learn all the core laws that apply to investment advice. Most people will at least sign up for a Series 65 exam prep course, or buy some study materials like “Pass the 65,” which is a popular book for studying for the Series 65 exam.

For those who have CFP certification, or a related designation like the CFA, the ChFC, or the AICPA’s PFS designations, most states will actually waive completing the Series 65 requirement because, the reality is, if you’ve done something like the CFP exam, you’ve already covered way more than what the Series 65 covers anyways.

Ultimately, what all this means is to get paid for financial investment advice, you need to both sign up for and pass the Series 65 exam (or have the requisite designations), and then you actually have to go through the process of registering a business as a registered investment advisor, or RIA.

You can think of it like becoming eligible to legally drive a car. Ultimately, you need to both pass the driver’s test, and have a driver’s license. In the context of being a financial advisor, the Series 65 is like the driver’s test. Becoming an RIA and registering is the equivalent of the license. It’s a little confusing in our world, because we actually call the Series 65 the license and the RIA the registration, but the point is the same. You need to both pass a test and get registered in order to move forward. The good news is, there are compliance consulting firms that can help with the registration process for a cost of typically a couple thousand dollars to do that.

When do you have to register as an investment advisor?

For most advisors who are just getting started, you’re going to have to become an RIA in your home state, because you won’t have the $100 million of regulatory AUM that it takes to get registered with the SEC.

In practice, registering with the state typically happens in two stages.

First, you establish your initial RIA that you register in your home state in order to start doing business and actually hold yourself out as a financial advisor.

Then, as you add clients in other states, you have to extend your registration to those other states as well. The good news is, you do the Series 65 once, and that covers the licensing exam requirement to do any and all of the registrations in all of the states.

The initial registration process in your home state is a little more intense because that’s the actual creation of the business, and the completion of all of the filing requirements of Form ADV to register it. 

Adding additional states is easier. It does require a filing fee, which typically varies from as low as about $50 and up to a few hundred dollars, varying state by state. And states will generally want to review your Form ADV, which is the formal registration document that you create in your original home state that basically details what you do for clients, what you charge, and what services you’re offering, so that the state can affirm that what you will be doing is appropriate.

In practice, I find that most states pretty quickly affirm a new state registration if what you are already doing is acceptable in your home state. But there are some differences among states, particularly for those who don’t do assets under management and, instead, provide other types of financial advice for hourly fees, fixed fees, retainer fees, monthly subscription fees, and such.

Irony and transparency

Since the AUM model is pretty standardized, it’s very straightforward for regulators to review it and approve it. Ironically, what we’re finding is, while fixed fees and hourly fees and monthly fees are a more transparent compensation model, since they are newer and regulators are less familiar with them, they can trigger a more intense review. They’re going to go through the ADV in more detail, and they’re going to want to make sure you’re really clear about what you’re doing in return for the compensation you’re receiving (i.e., that you’re serving clients appropriately). See: RIAs switching to state registration may be examined by a second regulator, too.

In terms of the timing, the rules state that you add a new state registration any time that you have clients in the state. A few states, like Texas and Louisiana, say you have to register before you accept even your first client. Most states, however, have what’s called a “de minimis” rule, which says if you have a minimal number of clients (less than five), and you haven’t set up any physical location in the state, you don’t have to register yet. Or, stated another way, you don’t actually have to register in the new state until you have more than five clients, a physical location in the state, or you’re otherwise actively marketing and soliciting for clients in that state. 

Once you register with the SEC (if you go that route or you’re eligible), the SEC is essentially a single federal registration that transcends all the states. While you still have to notify states that you’re doing business in their state, it’s a much simpler notification process and typically doesn’t entail as intense of an ADV review.

For those who are state-registered, which will be most people who are getting started, you’re still going to go state by state, and you’re going to have to add the states over time, because even if you get to $100 million in SEC registration down the road, you’re still going to start in your home state and add the states incrementally until you get to that $100 million of assets under management. See: Which type of AUM is worth more to a buyer?

Notably, there is a special rule that says that if you need to register in at least 15 different states, you can also qualify for SEC registration, even if you don’t have the $100 million in AUM. The reasoning is, at that point, you’ve got so many states that the federal registration provides some relief, so they will allow you to register Federally with the SEC. Still realize, however, that means you’re going to have to acquire five clients in each state (getting yourself over the 5-client line), and do that for over 15 states – which is not actually very common for many solo practitioners, as that would mean you’re already at 75-plus clients (which usually takes years!) 

For advisors who already work for a broker-dealer and are switching to an RIA, it’s important to recognize that there are separate legal requirements, under the so-called Broker Protocol, that must be complied with when taking client information in the transfer, to avoid breaching client privacy laws. 

Getting a financial advisor license

In the context of Jeff’s original question about whether he can wait until he gets five clients to set up his RIA, the answer is actually no. Once you’re going to hold out as giving investment advice for compensation, you should register as an investment advisor in your home state before you start soliciting clients. Once you create the initial RIA in your home state, then you won’t have to add other states until you reach their de minimis requirements which, as I mentioned earlier, is at least five clients in most states (except for Texas and Louisiana). But that home state registration – the initial registration – should be happening before you take on your first client.

Fortunately, the reality is the cumulative costs to set up an established RIA are still pretty modest, at least relative to the income potential of being a financial advisor. I’ve seen a lot of advisors get their advisory business launched for less than $10,000, including the compliance consulting support and the core technology you need in order to run the business. In point of fact, organizations like XY Planning Network cover almost all of that for about $5,000 a year.  

In reality, though, the biggest constraint in the costs of starting an RIA isn’t actually the cost to create the business and register to make it legal. It’s the income you won’t earn while you’re acquiring your first clients!

And unfortunately, that’s not the kind of thing you can usually get a startup loan for. Banks may loan you money for hardware, equipment, and the stuff you need to run and operate the business, but they’re not going to cover your personal expenses while you’re waiting to get enough clients to cover those bills yourself. As a result, you should always have a plan for that income gap between when you walk away from income in an old job, and when you’ll get enough clients and enough revenue to take out a healthy income from the new advisory business.

But the key point here is simply to recognize what it takes to legally become a financial advisor (really an investment advisor who gets paid for financial advice that includes advice on investments), and that you do have to register as an investment advisor and complete the Series 65 licensing exam in order to do so. And you should do all of this in your home state before you start soliciting clients. The whole point of licensing and registration so that the regulators know that you’re in the business, before you’re actually in the position where you could cause client harm as a result of not being set up appropriately!

CFP optional

However, you don’t have to actually get designations like CFP certification to be licensed as a financial advisor. They are purely voluntary. I’m a strong advocate that every financial advisor should get some professional designation like CFP certification so that you actually know what the heck you’re talking about when you give people advice about their life savings. You don’t want to hurt your clients due to your own lack of knowledge or accidental ignorance! But, these extra certifications are voluntary. There’s no actual technical competency requirement for being a financial advisor beyond the minimum Series 65 licensing exam, which is more about knowing investment advisory laws than it is about giving actual financial advice. Arguably, it’s actually still too easy to become a financial advisor from that perspective!

Michael Kitces is a Partner and the Director of Wealth Management for Pinnacle Advisory Group, co-founder of the XY Planning Network, and publisher of the continuing education blogfor financial planners, Nerd’s Eye View. You can follow him on Twitter at @MichaelKitces.


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