An Outline For Transitioning From Wire-House Broker To Independent Investment Adviser

10/11/2011

When one chooses to depart from a wire-house brokerage firm to solely provide independent investment advisory services, having a clear plan to establish the steps to establish your new business is an absolute necessity.  Also being aware of the pitfalls that may undermine your efforts is also prudent.  This article provides a practical outline of steps and considerations for the departing broker to assist in this process.

Analyze All Existing Agreements

The first step is to analyze all existing agreements with the current brokerage firm to evaluate any restrictive covenants and determine the extent of those restrictive covenants to assure that they are not violated.  In addition, all compensation and benefits agreements must also be reviewed to make sure that all rights are vested and that there is no impact upon the potential future distribution of compensation or benefits as a result of establishing a new investment advisory business or departing from a current employer.

Establish a New Entity

A new entity should be established, either a corporation or LLC.  That business should be established in an innocuous name and individuals leaving the brokerage firm should not be listed as officers or directors in the papers filed with the State of Florida or other jurisdiction where the entity is created.  Subsequent to the initial filing, non-public corporate records can be changed in order to appoint the management of the new entity.  If an LLC is used, care should be taken in creating the operating agreement to assure that it allows flexibility in ownership, operations, capital structure, distribution of revenue and profits.  An LLC entity will generally provide the most flexibility as opposed to other forms of business entities (i.e., corporations, Subchapter S corporations, partnerships or limited partnerships.)

Investment Adviser Application Process

Once the entity is formed, the initial principals of the entity should begin to file a Form ADV with the Securities and Exchange Commission or a state securities regulator to register the entity as a registered investment advisor.  Initial managers of the company can do this with a view to amending the investment adviser documentation once the business actually begins operations. Form ADV and RIA Registration must be in place to conduct any business. Keep in mind that once the RIA is established, changes of individual affiliations can be done almost instantaneously.

In order to establish the business operations and be prepared to conduct business, the following matters must be attended to and in place prior to the time that the business opens its doors and begins to deal with customers:

  • Develop operating and compliance materials including,
    • Client advisory agreements;
    • Referral agreements;
    • Code of Ethics;
    • Compliance procedures;
    • Custody procedures;
    • Privacy policy.
  • Develop client transfer process
  • Engagement of Public Company Accounting Oversight Board registered CPA

Practical Factors to Consider

Determinations must be made with respect to a number of practical factors in order to establish the business.  These factors include:

  • Satisfying all licensing requirements – this will include not only securities licenses, but local business licenses for cities or counties as required;
  • Select, contract, and establish the contractual arrangements with a brokerage firm/custodian to custody the accounts and assets that are to be managed by the newly formed Registered Investment Advisor;
  • Early selection of space for the offices of the entity is important to assure that enough time is available under the leasing arrangements to allow for the premises to be “turn key” immediately when one departs their current employer.  This means having furnished offices with all IT, telephone, and all vendor services in place and operational.
  • Arrangements need to be made with various vendors for the operation of the business, including:
    • IT consultants and providers;
    • Telephone providers and consultants;
    • Banking relationships;
    • Providers of stationery and other paper goods necessary for the businesses operations;
    • Office equipment, including copiers, fax machines, etc.;
    • Portfolio management, financial planning, and accounting software;
    • Insurance and benefits professionals in order to provide business insurance, as well as, health insurance for employees and other desired benefits for employees;
    • Employee leasing or payroll services to handle payroll, employee taxes and the like.

Matters Involving Broker’s Current Employer

One of the most important matters involved in establishing a new investment advisory or brokerage firm relationship is to assure that when this change is made, that one does not violate duties to a current employer.  The law is clear that one may prepare to start their own business prior to terminating their employment, but in so doing a person may not take any actions that undermine or are inconsistent with obligations to their current employer.  Obvious matters of this nature are:  (1) engaging in business on behalf of the new venture while on “company time”; (2) contacting or advising clients with respect to the fact that a new business will be opening with the intent of soliciting that business prior to the time that one has terminated the employment status with one’s current employer; (3) performing or not performing any business activities at the current place of employment, if it is inconsistent to one’s obligations to that employer.  (This includes such things as not executing large transactions in anticipation of business of the new firm, disparaging the current employer to customers or others; or otherwise warehousing or manipulating transactions with a view towards a change of employment.); and (4) wholesale recruiting of other staff or producers of a current employer can be viewed as inconsistent with a duty of loyalty owed by an employee.  Once you have gone such recruiting is game.  Prior to that point such activities should be limited.

It is important to keep in mind that the records that are utilized with the current employer relating to existing accounts and customers are the records of the current employer.  These records are often regarded as “trade secrets.”  One may not take or make copies of those records with a view to changing business or employment.  Such acts constitute the taking of business property of the current employer and may be a possible regulatory violation.  Generally personnel records of one’s own customers’ contact information will not be thought to be the property of an employer and improperly taken.  Thus, one not need delete all the information from their PDA or cell phone, but such conduct as using a thumb drive or disk to download all of the information relating to clients from computers at one’s current employer would be improper.  Emailing that data to your home computer is also improper[1]

Conclusion

There are two important takeaways from this article.  First get your new business properly created, licensed, and structured so you can start business immediately upon changing employment.  Not addressing any of the described items can cause you substantial delays when you cannot conduct business.

Second, the point to the foregoing cautions is clear.  When one starts a new business, it’s much more important to tend to that business than to have to deal with the expense and aggravation created by a former employer who believes that there is a basis to attempt to attack or impair one’s future business activities.  Being careful and prudent cannot stop unwarranted retaliatory conduct by a former employer, but having a clear record of conduct that took place to establish the new business makes it fairly easy to demonstrate that claims of the former employer are baseless and the impact upon a new business can be minimized.

 

 


[1]           Clearly be aware that if an argument starts, IT forensic experts can reveal exactly what has transpired on company and personal computer – down to individual key strokes.

 

For more information, please contact Burton Wiand at bwiand@wiandlaw.com or Dionne Fajardo at dfajardo@wiandlaw.com.