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Regulatory Considerations for RIAs When Hiring a Non-Advisor

By Chris Stanley

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A few months ago, I wrote an article about the regulatory considerations that an RIA should keep in mind when hiring a new individual advisor into its business. Because that article was specific to new investment adviser representatives (“IARs”), it focused on disclosure, licensing, registration, documentation and insurance matters. But what if an RIA wants to hire a new employee or retain an independent contractor that is not licensed or registered, and will not be providing advisory services?

Background Check

When hiring an IAR, that person will almost always have background and disclosure information that is searchable through the Investment Adviser Public Disclosure website (IAPD). The IAR’s detailed report will reveal current registrations, employment history, professional qualifications, disciplinary actions, criminal convictions, civil judgments and arbitration awards. The IAPD is effectively worthless, however, if a candidate has never had a U4 on file or has never been licensed or registered as an IAR.

Thus, employer-RIAs will need to rely on other means for performing background checks. To comply with federal law, check out the Equal Employment Opportunity Commission’s website on background check protocol. Aside from the obvious no-nos like discriminating against a candidate, an employer-RIA that utilizes a third-party to perform a background check must:

  • Obtain the candidate’s written consent to perform a background check
  • Provide a notice to the candidate that background report information may impact the hiring decision

If the background report information does impact the employer-RIA’s hiring decision (i.e., the candidate is not hired due to information revealed in the background report), it must also:

  • Provide a copy of the consumer report utilized to make the hiring decision and a copy of “A Summary of Your Rights Under the Fair Credit Reporting Act” as provided by the background check provider
  • Inform the applicant that the rejection was due to information in the background report and that the background report provider did not make the hiring decision
  • Provide the background report provider’s contact information
  • Inform the applicant that he/she has a right to dispute the accuracy and completeness of the background report

Importantly, state laws or local rules may be more restrictive (e.g., “Ban the Box”) or impose additional requirements that impact the background check and hiring decision process. Protocol will differ from jurisdiction to jurisdiction, but GoodHire has a helpful state-specific comparison of background check laws that can point prospective employers in the right direction.

Licence & Registration, Please

My prior article assumed that the candidate is an IAR, and would need to be licensed and registered as such to provide investment advice. This article assumes that the candidate is not an IAR and thus not licensed and registered as such — perhaps an office manager or marketing professional. The question thus becomes at what point an unlicensed and unregistered employee may need to become a licensed and registered IAR; or said another way, what job functions will push a non-IAR over the line to necessitate becoming an IAR?

As explained in the North American Securities Administrators Association FAQs:

Most states follow a definition of investment adviser representative similar to that in the Uniform Securities Act. An investment adviser representative generally is a person who, for compensation:

  1. makes any recommendations or otherwise renders advice regarding securities;
  2. manages accounts or portfolios of clients;
  3. determines which recommendation or advice regarding securities should be given;
  4. solicits, offers, or negotiates for the sale of or sells investment advisory services; or
  5. supervises employees who perform any of the foregoing.

If the candidate will not perform any of the above-enumerated functions, he/she will not be deemed an IAR or need to become licensed or registered.

The NASAA FAQ goes on to point out that only states register IARs, and not the SEC. What this means is that states may have different triggers that necessitate the licensing, registration or notice filing of an IAR. Case in point is the solicitation of clients; some states require solicitors to be IARs, and other states do not.

For advisers registered with the SEC (and notice-filed in one or more states), there may also be different triggers that necessitate licensing, registration or notice filing of an IAR depending on the employee’s place of business, and pursuant to the individual state’s de minimis rules and the federal definition of investment adviser representative under Rule 203A-3 of the Investment Advisers Act of 1940. This federal definition of investment adviser representative carves out persons that:

  • Do not on a regular basis solicit, meet with, or otherwise communicate with clients of the investment adviser, or
  • Provide only impersonal investment advice that does not purport to meet the objectives or needs of specific individuals or accounts.

Thus, what triggers IAR licensing and registration for a state-registered adviser may not necessarily be the same for a federally registered adviser.

As a side note, be wary of Texas, Louisiana and New Hampshire, as each state has funky de minimis rules as I explained in a prior article.

Employee or Independent Contractor

I addressed the importance of the employee v. independent contractor analysis briefly in the prior article referenced at the beginning, so I won’t repeat myself here. The bottom line is that such determinations will ultimately require a judgment call.

Access Person?

Much like an employer-RIA will need to determine whether the candidate will need to be an IAR, it will also need to determine whether the candidate will be considered an “access person” for purposes of reporting personal securities transactions and holdings.

By way of background, advisers are generally required to establish, maintain and enforce a written code of ethics that contains certain specific provisions applicable to “supervised persons” and “access persons” (two distinct but not necessarily mutually-exclusive personnel categories). Access persons are required to report their personal securities transactions and holdings to the employer-RIA, and the employer-RIA is required to review such securities transactions and holdings.

An access person includes any supervised person of the adviser:

  • Who has access to nonpublic information regarding any clients’ purchase or sale of securities, or nonpublic information regarding the portfolio holdings of any reportable fund, or
  • Who is involved in making securities recommendations to clients, or who has access to such recommendations that are nonpublic.

If providing investment advice is the employer-RIA’s primary business, all of its directors, officers and partners are presumed to be access persons.

The real kickers are the access to clients’ transaction activity or securities recommendations. Even if the candidate will be performing clerical or administrative functions, if he/she has the ability to view clients’ account activity or the adviser’s recommendations through portfolio reporting software, a CRM system or custodial website, he/she will be deemed an access person and subject to reporting of personal securities transactions and holdings.

This assumes that the candidate will be a “supervised person” of the employer-RIA, but the definition of supervised person is fairly broad, and includes any partner, officer, director (or other person occupying a similar status or performing similar functions), or employee of an adviser, or other person who provides investment advice on behalf of the adviser and is subject to the supervision and control of the investment adviser.

Confidentiality & Information Security

Even if the candidate will not be an IAR or access person, it is still a good idea for employer-RIAs to have all new employees or independent contractors sign a confidentiality or nondisclosure agreement at the time of hire.

A confidentiality agreement not only sets the tone for the sensitivity of the employer-RIA’s business and the seriousness with which client information must be protected, but it also can protect the employer-RIA’s business processes, investment strategies and other trade secrets.

Importantly, the confidentiality agreement cannot prohibit the candidate from reporting violations of the securities laws to the SEC, or requiring the candidate to first disclose securities laws violations to the employer-RIA. As the SEC’s director of the Division of Enforcement stated in connection with a 2015 enforcement action, “SEC rules prohibit employers from taking measures through confidentiality, employment, severance, or other type of agreements that may silence potential whistleblowers before they can reach out to the SEC.  We will vigorously enforce this provision.”

For more on whistleblower protection requirements, take a look at the SEC’s Risk Alert on the subject.

Related to confidentiality is the employer-RIA’s policies and procedures with respect to information security. As a general matter, employees and independent contractors should only be granted access to information and systems on a need-to-know basis; overly broad access to sensitive client information in particular is not just poor business practice, it also jeopardizes an adviser’s ability to comply with regulatory expectations. Employer-RIAs should at all times maintain an inventory of who has access to what, and have a process by which access can be revoked upon the termination of employment or contracting.

Other Stuff

There are a host of other legal requirements to bear in mind when hiring an employee that are not specific to advisers (e.g., verifying eligibility to work via IRS Form I-9, state/federal tax reporting and withholding, workers compensation insurance, etc.), but such matters are beyond the scope of this article. Suffice to say there is plenty for potential employer-RIAs to bear in mind in this article alone.

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