Shutdown hits breakaway advisors starting RIAs

With the federal government shutdown moving into its fourth week, compliance experts and industry lawyers say it’s derailing breakaway advisors’ plans to launch their own RIAs.

Chris Payne, the chief operating officer of Key Bridge Compliance in Covington, Kentucky, said some of his firm’s clients have been left in regulatory limbo by their inability to have a new advisory business registered with the Securities and Exchange Commission during the shutdown. A small group had been planning to leave their current firm this month and quickly hop over to running their own SEC-approved registered investment advisory. 

Now all that’s been put on hold, Payne said.

“It’s a complicated decision,” he said. “They have tried to coordinate with lots of key stakeholders and to make sure that they don’t violate their employment agreements. And it’s a timing exercise, because they will typically put in their resignation the same day that their SEC registration gets approved.”

No end in sight to shutdown

Like many federal agencies, the SEC has been operating with a skeleton staff since the shutdown took hold on Oct. 1. An operations plan the SEC circulated in August called for only 393 of the agency’s 4,289 employees, or about 9% of the total, to continue working should lawmakers reach an impasse on spending legislation and be unable to continue funding government activities.

Industry lawyers and other experts have said the priority of the remaining skeleton crew would be to fight fraud and prevent imminent harm to investors. Many other SEC responsibilities, like registering RIAs, would go by the wayside.

And that’s exactly what has happened. The industry tracking firm AdvizorPro has found that although new firms continue to be registered at the state level, not a single one has been approved by the SEC since Oct. 1. Payne said that’s a concern not merely because of the delays in the short term. 

With no end to the shutdown in sight, there’s a strong possibility of delays owing to the huge backlog that’s likely to exist once the government opens up again.

“Typically, the SEC is pretty timely,” Payne said. “Forty-five days is the expectation on new registrations, yeah? But now it’s kind of like we don’t know how long that long game is going to be.”

Government shutdown also causing problems with tax ID numbers

And the SEC is not the only government agency that affects advisors’ ability to start new firms. Brian Hamburger, the founder of the wealth management and regulatory compliance firm MarketCounsel Consulting and The Hamburger Law Firm, said his clients have also struggled with tasks like obtaining a tax ID number from the IRS.

Fortunately, Hamburger said, the actual registration of new businesses is done at the state level.

“But if I can’t get a tax ID number, I can’t open a bank account, I can’t initiate payroll,” Hamburger said. “You need a tax ID number for almost everything, so we have had to get very creative to help launch new businesses.”

The longer the shutdown lasts, the more painful it becomes to clients who have been laying careful plans to break away from a current employer and start a firm.

“The macro impact is negligible, but for anyone who is trying to time their launch, this is everything,” Hamburger said. “Now we are talking about contingency plans and alternatives. How do we launch this business amidst a government shutdown when there’s no end in sight?”

Is state registration an option for some?

Others in the industry have heard fewer causes for concern from compliance, although they understand why the shutdown is stirring anxieties in the industry. Max Schatzow, a founder and partner of RIA Lawyers in Parsippany, New Jersey, said his firm was lucky in not having any registrations it was preparing to submit or awaiting approval when the government was put on standby.

One of Schatzow’s clients had an odd situation in which he could have sought either state or federal registration for his firm. Generally, the SEC requires RIAs with $110 million or more in client assets to be registered at the federal level but allows firms with between $100 million and $110 million to choose between federal or state registration. (Advisors with less than $100 million must get registered at the state level.)

Schatzow, who did not provide an AUM figure for his client, said the government shutdown made the decision to list with the state almost inevitable. But he understands how some advisors without that option could struggle in coming months.

“I’m sure there are advisors who would love to leave a large firm in December or January, and now they’re in this limbo period where they are going to have to wait or possibly join other firms as a stepping stone,” Schatzow said.

Richard Chen, the founder of New York-based Brightstar Law Group, said he’s likewise fortunate in having few clients whose business-formation plans are being disrupted by the shutdown. There will be delays, he said, but very little long-term disruption once the SEC reopens and returns to business as usual.

“It’s a nightmare for some people,” Chen said. “But for a lot of people, it doesn’t matter much because they can stick it out longer even if they are going to have a backlog of registrations.”

Meanwhile, registration remains open for firms and employees who maintain brokerage licenses through the Financial Industry Regulatory Authority. FINRA, the broker-dealer industry’s self-regulator, is technically a private entity subject to SEC oversight.

Missing the best time to start a firm

Payne at Key Bridge Compliance said another cause of pain for recently started RIAs is the likelihood that they won’t receive an initial regulatory examination from the SEC. Most new firms are visited within eight to 14 months of being started by SEC examiners who check for compliance with basic industry rules.

Those early examinations are typically less thoroughgoing than the ones RIAs are subject to after they’ve been going concerns for a while. But with regulatory exams paused during the shutdown, some new firms are likely to lose that initial compliance check, Payne said.

“It makes the first exam much worse for many advisors,” he said.

Payne said some advisors may even end up putting off their departures for quite a while. Many teams like to leave their firms and start new business in the middle of the year, when they are least likely to be busy.

Those who miss that window this time around may decide they’re better off waiting another year for it to open again.

“Typically, in the fourth quarter, they spend a lot of time with [individual retirement accounts],” Payne said. “And the first quarter is all about taxes. So we usually see an uptick in advisor moves in the summer months.”