Accounting for Compliance During the Initial Registration Process

5 min read
September 20, 2018

A common mistake made by new firm owners revolves around the lack of experience needed to see the “big picture” of compliance. Compliance as a subject matter covers each and every aspect of a firm’s business operations, including marketing, trading and portfolio management, advisory contracts, and employee supervision. One of the most overlooked elements of this all-encompassing view of compliance is the way in which a firm’s compliance program is impacted by accounting.

Many advisors are just as disinterested in learning about Generally Accepted Accounting Principles as they are in learning about compliance. As a general rule, advisors are most interested in serving clients, and back office operations tend to create undesirable obstacles to achieving that end goal.

However, failure to understand the way compliance and accounting issues coexist can create substantial headaches for both new and existing firms.

Let’s discuss what happens at the intersection of accounting and compliance.

The Books & Records Requirement

At the core of accounting related compliance issues is the books and records requirement, which specifies the minimum required records that each Investment Advisor must maintain and preserve, and the time period for which they must be maintained.

Books and records are consistently included in Audit Documentation Requests for both SEC and state-registered firms. Among those books and records is accounting records. Many new firm owners wish to use existing tax ID numbers that have been previously established as opposed to beginning a new business entity to register their firms.

In some cases, the firm owner had a previous relationship with an independent broker dealer, in which they were permitted to operate their RIA using their own unique DBA and tax ID number. In this instance, the temptation is to simply transition away from the broker-dealer to a new fee-only RIA, using the same business name, business entity, and tax ID number.

However, it is critical to remember that financials are often requested for review by regulators at the time that registration is requested. When a firm presents accounting records to a regulator for initial registration, those records need to have been accurately and adequately maintained.

Firm owners run into serious issues when they attempt to present financials that have not be meticulously maintained in attempts to register a new firm. This confuses the regulator and opens the door to a completely new line of questioning regarding the firm owner’s business practices in previous years. There are a couple of ways to circumvent this issue in the initial stages of firm registrations.

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Start Clean

One method by which this issue can be avoided is if the advisor “starts clean” with a new tax ID number and business entity. When this is the case, the issue as to whether or not balance sheets from previous years reflect accurate information becomes irrelevant to the registration process as the only assets, liabilities and owner's’ equity that will be listed will generally be for the current year.

It is still advisable that the firm owner take the appropriate steps to dissolve the previous entity and close those books accordingly. The downside to this solution is that the advisor will usually be required to acquire a new tax ID number and business entity through their Secretary of State or Business Oversight office. Additionally, a new business name will usually be required. Some advisors are genuinely tied to their name as a part of their brand.

Leave it to the Experts

Another option to circumvent this issue is to hire an experienced accounting firm to assist with reviewing the accounting records of the previous entity. This will provide the opportunity for a consultation and assessment of the accounting records so the advisor will be informed sufficiently to make decisions going forward.

The key here is to hire the accounting firm prior to beginning the initial registration process. If financials are submitted to regulators as a part of the firm registration request before they have been reviewed, then the door has already been opened for the regulator to dig deeper into the finances and create barriers to the registration approval. Once the regulator becomes involved, the options are limited as it pertains to the ability of the accounting expert to quickly and effectively correct any previously recorded accounting issues for the purposes of completing the registration.

Much of the reason that financials are requested by regulators during the initial registration process revolves around custody and minimum net capital requirements. The custody rule was put in place to protect clients against theft and/or fraud.

As a protective measure, the SEC imposed a number of requirements that registered advisors were expected to follow to avoid any conflicts. Regulators leverage net capital requirements to ensure the solvency and financial health of the firms they approve.

A part of minimizing potential accounting obstacles is spending a bit of time learning about custody and net capital requirements. Remember that firm owners begin wearing all of the “C” hats. By that I mean CEO, CCO, and CFO. If possible, new firm owners should invest in some educational materials and courses on accounting so the role of “Chief Financial Officer” does not get neglected altogether. Although accounting firms can step in and provide a majority of the legwork, the firm’s CFO will still be primarily responsible for ensuring the accuracy of the firm’s financials.

Make Accounting & Compliance a Priority

New firm owners can often feel overwhelmed by all of the moving parts that go into launching. The client-facing pieces of the puzzle, such as creating the firm’s name, logo, and social media pages, are often given the most attention.

The prospecting and client onboarding process is an attractive aspect because this leads to revenue. And ultimately, the primary desire of fee-only financial planners is to help their clients, so this is often the main focus at the onset of starting a firm.

But back office operations such as accounting and compliance cannot be placed too far on the back burner, or else the firm risks never getting off the ground to fulfill the overall objectives and goals of the advisor.

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About the Author

Scott is a licensed Securities Principal with experience in both RIA and broker-dealer compliance. He began his financial services career in 2006 as a Registered Representative with E*Trade Financial in Alpharetta, GA. He has also worked with J.P. Morgan Private Banking in Chicago, IL and with Wells Fargo Advisors in Chapel Hill, NC.

Scott’s most recent role before joining Team XYPN was as Compliance Officer of Carolinas Investment Consulting, in Charlotte NC. He’s a graduate of The University of North Carolina at Chapel Hill and holds FINRA Series 63, 65, 24, 4 and 53 Licenses.

Scott lives in Charlotte NC with his wife Meredith, and their two Sons Tyson and Jackson. In his free time, Scott enjoys watching sports, exercising, and operating the charitable organization he created upon his father’s passing.

You can connect with him on LinkedIn.

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