This is the first installment of a new, regular column to answer questions from advisors who are considering transitioning to an RIA model. To submit your question, please email Brad Wales here.
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This question is not only one of the most frequent questions I get from advisors, but it is also one of my favorites. That begs the question, how could anything related to compliance be considered a favorite?!
I enjoy answering it because doing so corrects a common misconception held by advisors regarding the RIA model.
Bottom line, yes, RIAs need to pay for their own compliance. The cost of this is measured in thousands of dollars, not hundreds of dollars.
But, if you are in a broker/dealer environment (whether as an employee or independent contractor), you are already paying for compliance! Not only that, but you are also likely paying for more compliance than you need.
Let’s tackle each of those.
Suppose you are affiliated with one of the traditional employee broker/dealer models (or indie-BD for that matter). In that case, you receive a “payout” on the fees and commissions you generate. Let's assume you generate $1million in historical gross revenues (a.k.a., T12), and, as a result, you receive a “payout” of 40%. Now, whether you receive that entire stated 40% or not is a question for another day. For now, though, we’ll assume you are.
From your $1million in gross, you receive a net of $400,000. Or put differently, you are generating $1 million for yourself. From that, though, you are then essentially writing a check to your firm for $600,000 per year for the services it provides.
That $600,000 “bill” you are paying each year is presented to you as a bundled all-inclusive bill, not as an itemized bill. If it were the latter, what would appear on that bill is a portion of your $600,000 annual fee going towards the cost of compliance the firm provides for you.
You are already paying for compliance! It is hidden in a bundled, non-itemized bill. Having to pay for compliance as your own RIA would not be a “new” expense you previously never paid.
The next consideration is how much are you paying towards compliance, and how would that compare to the cost of compliance as your own RIA. This leads us to the second part of the answer.
As I noted, you are provided with a non-itemized, bundled bill every year from your firm. As an aside, how happy would you be with a non-itemized, bundled bill from a restaurant? Or how about a hotel? But I digress.
Even if you could receive an itemized bill from your broker/dealer (which you can’t), it still wouldn’t tell the whole story. Imagine, though, that you could hypothetically see a line item that said: Compliance……$X.
Yet, from that $X, how much actually applies to the necessary compliance needed for your specific practice?
Every broker/dealer is required to provide compliance (and supervision) over the brokers utilizing its platform. With potentially thousands of brokers on the platform, that compliance function must cover a wide range of experience levels, investment product types, services offered, client profiles, etc.
Therein lies why you are not only paying for compliance, but paying for more compliance than applies to you.
For example, due to the increased risks that foreign-based clients present for a firm, broker/dealers have large compliance teams responsible for limiting and managing that liability. Staffing and supporting those teams understandably comes with a hefty cost.
But what if in your practice you have no foreign clients, and perhaps have no interest in ever having foreign clients? Yet, part of your $600,000 annual bill is going to pay for those expenses.
Or consider the additional compliance oversight needed for firms to be able to offer certain esoteric, alternative-type products. Again, someone must pay for that compliance.
If you’re one of the users of such products, maybe you’re getting a good deal regarding that portion of your annual compliance tab. But, if you aren’t, you are paying for more compliance than applies to you.
How are things different in the RIA world?
There are three main advantages to paying for your own compliance directly as an RIA. (The standard approach to fulfilling your compliance responsibilities as an RIA is to utilize the services of specialty compliance consulting firms to assist you with it – I will address this topic in a future Ask Brad column.)
- You will know exactly how much you are paying in compliance costs to run your firm, and, to a degree, you have control over managing this expense.
- You can decide exactly which compliance consulting firm to work with. Compliance now works for you, not against you.
Next time you go out to a restaurant, if they bring you a non-itemized bill at the end of the meal and it includes items delivered to the booth next to you, would you take out your credit card and pay the tab? It’s time to rethink your compliance “bill” as well.
Brad Wales is the founder of Transition To RIA, a consulting firm uniquely focused on helping established financial advisors understand everything there is to know about WHY and HOW to transition their practice to the RIA model. Brad utilizes his nearly 20 years of industry experience, including direct RIA related roles in compliance, finance and business development to provide independent advice regarding how advisors can benefit from the advantages of the RIA model.
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