SEC Steps In on RIA Succession Planning

A new rule could require registered advisers to meet strict, and potentially expensive, guidelines for business continuity and transition plans.


Investment adviser Tom Hamlin was between conference calls at his office in Portland, Oregon, one day last week when he got an urgent message alerting him that a client had passed away. Hamlin, the founder and CEO of Somerset Wealth Strategies, was shocked and saddened, having worked closely with the client for decades. The situation was a sharp reminder of the importance of succession planning, something Hamlin says advisers often wait to consider until it’s far too late.

“If that happens to somebody who is a key figure in an organization, what does that look like?” he says.

In the case of Somerset, Hamlin knows the answer. In the wake of the 9/11 terrorist attacks in New York, which dealt a heavy blow to several financial organizations, including Morgan Stanley and Cantor Fitzgerald, Hamlin and his colleagues created a detailed business continuity and transition plan for Somerset. He knows exactly what will happen to his stake in the firm and who will take over leadership if something happens to him. If Somerset’s systems are damaged or destroyed, there are redundant servers in several safe locations to keep the business going.

The Securities and Exchange Commission is hoping to persuade more registered investment advisers to take similar steps. On June 28, the regulator issued a proposed rule that would require RIAs to adopt and implement both business continuity plans, which were already required under the SEC’s compliance programs rule, as well as transition plans. The new proposed rule requires maintenance of critical operations and systems; data backup; the selection of prearranged alternate locations at which to conduct business in the event of an emergency; a plan for communication with clients, employees, service providers and regulators should the contingency plan become necessary; and identification of third-party services that are critical to a firm’s operation. It also requires a transition plan that addresses any issues that would arise in the event that the business had to be wound down or shifted to a new lead adviser or firm.

SEC chair Mary Jo White said at the time that the proposal was “the latest action in the commission’s efforts to modernize and enhance regulatory safeguards for the asset management industry.” But some in the industry interpreted the new rule, specifically the part that deals with transition or succession, as an overstep of Dodd-Frank–era regulation, putting pressure on an industry that poses little or no systemic threat.

“How does this apply to me?” asks Hamlin about the rule proposal. “My whole company literally could go down on a plane, and my clients’ money is still fine.”

Hamlin actually ensures that everyone in his company is never on the same plane at the same time, but Karen Barr, president and CEO of the Investment Adviser Association, agrees with his point. Since RIAs’ clients technically hold their money at custodians or banks, when investment advisers go out of business, it’s relatively easy to simply find another adviser without having to move any money, experts say. According to the IAA and SEC, of some 12,000 RIAs in the business, the largest 120 firms manage 50 percent of the assets in the industry, and 71 percent of advisers manage less than $1 billion.

“Quite frankly, the vast majority of RIAs are small businesses,” says Barr. “Each new rule is a new layer of complexity and cost.”

In its proposal, the SEC said it expects that creating and implementing new business continuity and transition plans will cost RIAs between $30,000 and $1.5 million apiece, depending on the adequacy of each individual adviser’s existing plan. Ongoing costs are expected to range from $7,500 to $375,000 annually. Barr, who is concerned about the agency taking a one-size-fits-all approach to the issue, says the IAA plans to participate in the comment period, which ends September 6, in hopes of clarifying how flexible the rules will be.

In the wake of catastrophic events such as 9/11 and Hurricane Sandy, and with the ever-growing threat of cybercrime, many RIAs have taken extra precautions when it comes to business continuity. Still, transition planning has generally not been a high priority. It’s also not something on which many smaller firms believe they can afford to spend precious resources.

David Tittsworth, counsel at law firm Ropes & Gray in Washington and former president and CEO of the IAA, says that while conducting workshops on succession planning, he experienced this attitude especially from smaller firms. He tried to impress upon them what they should expect if they tried to sell their business or implement an internal transition plan.

“It was clear they were not doing much to address that or put in place any plans,” Tittsworth says. “I think a lot of it is just an unwillingness to look at the reality.”

It’s not fun to talk about the possibility that a business will have to be passed on one day, even if no catastrophe strikes, but Tittsworth says it’s important to remember another reality as well: Investment advising is a very personal business built on relationships, and the value and direction of an individual firm often depend heavily on the individual at the helm. If advisers need convincing to plan, regardless of what the final SEC rule looks like, Tittsworth suggests they remember this: “If you’ve been working your whole life to develop this firm, your idea of what it’s worth may be very different from what the market believes.”

Follow Kaitlin Ugolik on Twitter: @kaitlinugolik.