RIA Compliance and Practice Management Blog

New RIAs should be Cautious using 120 Day SEC Registration Exemption

Posted by RIA in a Box

Feb 21, 2017 1:02:15 PM

SEC new RIA 120 day registration exemption information

Recently, we've seen an increasing number of newly formed registered investment adviser ("RIA") firms rely on the Rule 203A-2(c) exemption which allows an RIA firm to register initially with the Securities and Exchange ("SEC") if it has "a reasonable expectation that it would be eligible to register with the Commission within 120 days after the date the investment adviser's registration with the Commission becomes effective." According to the latest SEC registration statistics as of February 1, 2017, of the 12,258 firms currently registered at the federal level, 184 firms are presently relying on this exemption as the basis for registration. Download our Free 10 Step Checklist to Start an RIA Firm

One of the key reasons Rule 203A-2(c) exists is to account for the common scenario in which "breakaway brokers" and other experienced advisors in the financial advisor industry technically have minimal or no regulatory assets under management ("AUM") on the new firm's initial registration date, but the firm is likely to quickly exceed $100 million in AUM as the advisors migrate previous client relationships to the newly formed RIA firm. This is particularly relevant because, in general, an investment advisory firm can not register with the SEC until it reaches $100 million in regulatory AUM or satisfies another registration exemption. Thus, Rule 203A-2(c) allows a new firm to directly register with the SEC on day one instead of initially registering with the relevant state(s) before shortly thereafter having to transition to SEC registration once it reaches $100 million in regulatory assets.

Rule 203A-2(c) reads as follows:

(c)Investment advisers expecting to be eligible for Commission registration within 120 Days. An investment adviser that:

(1) Immediately before it registers with the Commission, is not registered or required to be registered with the Commission or a state securities authority of any State and has a reasonable expectation that it would be eligible to register with the Commission within 120 days after the date the investment adviser's registration with the Commission becomes effective;

(2) Indicates on Schedule D of its Form ADV ( 17 CFR 279.1) that it will withdraw from registration with the Commission if, on the 120th day after the date the investment adviser's registration with the Commission becomes effective, the investment adviser would be prohibited by section 203A(a) of the Act ( 15 U.S.C. 80b-3a(a)) from registering with the Commission; and

(3) Notwithstanding § 275.203A-1(b)(2) of this chapter, files a completed Form ADV-W ( 17 CFR 279.2) withdrawing from registration with the Commission within 120 days after the date the investment adviser's registration with the Commission becomes effective.

While the term "reasonable expectation" may be subjective, we are seeing an increasing number of new firms utilize this exemption to initially register with the SEC even though it seems unlikely the firm will reach $100 million in regulatory assets within 120 days. It appears some firms are taking this approach to expedite the registration process as the SEC registration process generally moves more quickly than many initial state registration processes. While at first glance this registration approach may seem logical, we've observed that many of these firms do not understand that the firm's registration with the SEC must be withdrawn on or before the 120 day registration anniversary date if the firm is no longer eligible to be registered with the SEC.

This realization presents a challenge because the registration process for many states can take 2 to 3 months to complete. Thus, if a firm waits too long to recognize it is unlikely to still be eligible for SEC registration, it risks having its registration with the SEC canceled before its registration application with the relevant state(s) is approved. This scenario can result in a "gap in registration" during which the advisory firm is not able to conduct any advisory business. In addition, this scenario can lead to a new advisory firm having to pay a third party to now also assist with the state registration process which can result in significant additional expense by needing to register "twice."

As RIA compliance consultants, we recommend that advisors looking to start a new RIA firm and deciding between filing the initial registration application with the relevant state(s) or the SEC consider the following:

  1. While most advisors are ultimately successful at transitioning the vast majority of client assets to a new RIA firm, this process can often take longer than anticipated. As a rule of thumb for initial registration purposes, advisors should plan for only half of the anticipated assets to flow to the new RIA in the first 120 days. Thus, if the team of advisors is planning on $100 million of client assets to transition to the new firm, we'd recommend that the advisor initially register at the state level to be adequately prepared if assets transition slower than planned.
  2. Before filing the initial registration, the firm should further familiarize itself with the definition of regulatory AUM to ensure that all of the firm's managed assets will qualify as regulatory assets when attempting to reach the $100 million threshold.
  3. If a firm does choose to utilize the 120 day exemption to initially register with the SEC, at the 60 day mark into the first 120 days, the firm needs to re-evaluate whether it has a realistic chance to reach the $100 million regulatory asset level by day 120. If there is any concern that this target is out of reach, the firm should immediately begin the registration process with the relevant state(s).
  4. Per instructions provided by the SEC, before the conclusion of the 120 day exemption period, the new advisory must 1) file an amendment to update the firm's response to Item 2.A. of the Form ADV Part 1A to either indicate the firm's new qualification to remain SEC-registered or to acknowledge that the firm is no longer eligible for federal registration. If the firm is no longer eligible for registration with the SEC, it must also file an accompanying Form-ADV to withdraw the firm's registration with the SEC.

In general, new advisory firms that utilize this special exemption to qualify for SEC registration need to exercise great caution and be highly attuned to the exemption's details. Early regulatory missteps, even if unintentional, can unfortunately lead to increased regulatory scrutiny for years to come.

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Topics: RIA Operations, RIA Compliance

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

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