RIA Industry Insight – Growing Pains Ahead!

RIAs and hybrid RIA firms are rapidly gaining ground in the U.S. wealth management sector.  According to industry research cited within Kingswood Acquisition Corp.’s October 2020 SPAC filing, RIAs/hybrid RIAs have been gobbling up AUM over the past 15 years and are expected to surpass the big four wire-houses (Merrill, Morgan, Wells & UBS) in asset market share by 2023 (29.6% vs. 29.2%). But it’s not all roses; this type of growth attracts significant attention and growing pains will follow. Two groups have taken note, the Securities and Exchange Commission (SEC) and the leading plaintiff’s bar for investors: Public Investors Advocate Bar Association (PIABA).

The SEC has made regulatory examinations of RIA firms a regulatory priority, including dual registrant firms, firms that have not been examined in some time, and new RIA firms that have not been examined.   The SEC publishes its exam priorities known each year (2021 SEC Exam Priorities) and has recently focused on compliance programs, conflicts of interest, alternative/private investment, and business continuity planning, including a significant cyber focus.  The SEC has taken numerous enforcement actions against RIAs as of recent.  A quick scan of SEC Press Releases reveals the nature and scale of these actions. Keep in mind that many regulatory initiated actions are resolved short of formal proceedings.

Traditionally the Plaintiff’s Bar’s focus has been on suing broker-dealers through FINRA arbitration.  However, possibly because of the growth of advisory firms, there is now attention being paid to litigating against advisory firms.  In fact, during their 2021 annual meeting held last Fall, PIABA held two separate sessions titled “How to Bring RIA Cases” and “Discovery in RIA Arbitration Cases”.   Litigation in the RIA space is bound to increase.

So, what is an RIA to do?

With regards to the SEC exam/enforcement exposure, below are some critical actions to take:

• Engage regularly with competent compliance counsel.
• Enhance ADV disclosures/Compliance Program.
• Carefully review your insurance program, namely E&O/D&O to understand how and when it would respond to SEC matters.
• Stay on top of regulatory priorities. The SEC publishes its Exam priorities typically in the first quarter of every year, and these should be reviewed, and pre-exam self-evaluations should occur to ensure compliance with such priorities.  For example, the Commission has initiated a number of cyber security-related enforcement proceedings which have resulted in significant fines and these types of matters were flagged as exam priorities in 2021.

Concerning the litigation threat:

• Consult with counsel to determine whether the advisory firm should include arbitration provisions in agreements. On balance, arbitration is far less costly than litigating in court (assuming the proper forum is selected) and can result in less burdensome discovery.
• Ensure Investment Policy Statements are concise and accurate and are updated periodically.
• Know that alternative strategies (Private Placements, Derivatives, Hedge Funds, etc.) have traditionally been fertile ground for litigation.  Tread carefully and put in the extra layers of due diligence and documentation when using/recommending to clients. Consider implementing caps or hard limits on overall percentages that can be allocated to such investments and make sure all relevant risk disclosures have been reviewed by the client.
• Carefully review your insurance program, namely E&O/D&O to understand how and when it would respond to investor-driven litigation.
• Recent cases include failed alternative investments (failure to perform due diligence), failure to adhere to investment policy guidelines, and failure to disclose all sources of compensation.

The RIA industry is growing up, and there is bound to be increased scrutiny and litigation.

TTE Law Group LLP is a west coast litigation firm that specializes in the defense of financial services, professional liability, legal malpractice, and D&O liability.  The firm’s attorneys have defended broker-dealers, advisor firms, issuers, and individual representatives and advisors in lawsuits, arbitrations, SEC and FINRA enforcement matters, as well as employment matters. 

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

At Golsan Scruggs, we believe it is incumbent upon us to earn the right to be appointed as your insurance and risk-management agent. Our RIASURE process exists to serve that purpose.

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