In Practice November 3, 2022

FINRA Prompts Succession Planning for Aging Adviser Industry

Financial Regulator FINRA issues guidance on succession planning for the graying adviser space, including small firms looking to sell.

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The Financial Regulatory Authority (FINRA) this week gave guidance to registered financial representatives on how to properly hand over the keys of their business with the goal of protecting clients from disruption.

The notice comes as the brokerage industry has an increasing number of representatives at or approaching retirement age, according to data collected by FINRA. Though the regulator does not require succession planning, it strongly advocates for it so brokerage clients are not disrupted by expected events, such as retirement, or unexpected events such as death or illness.

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“Registered representatives (representatives) often develop close and trusted relationships with their customers,” FINRA said in the Regulatory Notice. “The COVID-19 pandemic and industry demographic trends have spurred greater focus on, and adoption of, succession plans in recent years.”

In the 31-page notice, FINRA laid out the benefits of succession planning, common types of plans, and an overview of FINRA rules and administrative processes. The regulator advised the more than 600,000 brokerages on succession planning strategies including:

  • Creating teams of advisers to service customers as opposed to one-to-one relationships
  • Hiring developing or junior representatives to take over a book of business
  • Designating an official successor to the firm and customers
  • Signed contingency plans should a representative unexpectedly not be able to work
  • A firm plan for reassigning customers to another representative if needed
  • An agreement to transfer or sell a book of business to another firm or representatives at another firm
  • An agreement for a firm to merge into or be acquired by another firm

Small Firm Need

The percent of brokers at or near retirement age is higher at smaller firms—between one and 150 representatives—making them in need of succession planning that may involve selling the business outright, FINRA said.

“Particularly for small firms and sole proprietorships, a succession plan may involve the sale of a firm,” FINRA wrote. “While plan terms and complexity vary, succession plans typically address the sale of a book of business or firm assets or the reassignment of a representative’s customer accounts.”

The regulator also advised firms to be aware of ‘bad actors’ who may purchase a book of business to use the customer account information for fraudulent schemes. It cites a court case in which the SEC shut down a $10 million Ponzi Scheme in which the defendants bought up books of business and convinced the newly acquired clients to withdraw their savings and invest with the defendants.

The graying financial adviser industry has been part of the robust acquisition market for registered investment adviser practices, with a trend toward further, relatively smaller acquisitions going forward, according to a Q3 report from investment bank and management consultancy Echelon Partners.

As of the end of 2021, FINRA said that 16.32%of representatives were age 60 or older; 8.20%were age 65 and older; and 3.82%were age 70 and older.

While FINRA does not require succession plans, it does require brokerages have a business continuity plan (BCP). This requires firms to create and maintain procedures related to an emergency or business disruption at least annually.

Compliance November 2, 2022

SEC’s Proposed Outsourcing Rule Could Be Hardest on Small Advisers

The new rules, if approved, would likely require more catch-up by smaller firms to vet third-party providers, says a legal expert.

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The SEC rule proposed last week, which would increase adviser oversight of their subcontractors, could have a disproportionate impact on smaller adviser firms, an industry attorney said.

Marcia Wagner, the founder of the Wagner Law Group, said the proposal, which is intended to prevent financial advisers from taking a “set it and forget it” approach to outsourcing, could add work and costs for smaller firms that previously haven’t done the kind of due diligence the SEC now proposes.

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“Large investment advisers servicing retirement plan clients are presently devoting significant time and resources with respect to the vetting and monitoring of third-party providers, and the proposed SEC regulations, if adopted, would have a limited impact upon them,” Wagner said.

“However, for small firms who have not previously performed the due diligence requirements as set forth in the proposed SEC regulations, there will very likely be a significant cost increase, whether the adviser exercises increased oversight or brings the previously outsourced functions in house.”

The outsourced services that fall under this rule can include things such as sub-advising, cybersecurity, investment risk, portfolio management, regulatory compliance and valuation. The rule explicitly excludes clerical, utility and general office functions.

SEC Chairman Gary Gensler explained in a press release that the proposal is intended to “ensure that advisers’ outsourcing is consistent with their obligations to clients.”

The proposal would amend the Investment Advisers Act of 1940 to require advisers who make use of outsourcing to do the following:

  1. Do due diligence on the third party and continuously monitor their performance.
  2. Identify the scope and nature of the regulated function being outsourced.
  3. Identify the risks of outsourcing the service and develop a plan to mitigate those risks.
  4. Determine that the provider has the competence and resources to perform the regulated function.
  5. Require the service provider to keep books related to due diligence.
  6. Amend form DV to collect information on service providers, to include their identity, location and starting date of services.
  7. Identify any relevant sub-contracting agreements that the service provider has themselves.
  8. Obtain assurance that the provider will coordinate on issues of compliance.
  9. Obtain assurance of an orderly termination of services.

The proposal also has requirements for adviser oversight of recordkeepers. An adviser must obtain assurances that their recordkeeper will:

  1. Have internal processes for keeping records that meet recordkeeping requirements that are applicable to the adviser.
  2. Actually keep records in accordance with that policy.
  3. Provide the adviser access to electronic records.
  4. Ensure the continued availability of those records if their business relationship ends.

The public comment period for this proposal is open until December 27, 2022. There would be a 10-month transition period if it is adopted.

The full text of the rule and instructions on how to submit a public comment can be found here.

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