Unregistered California investment advisors can't charge fees at IB?

Discussion in 'Professional Trading' started by Jay77, Mar 8, 2017.

  1. Jay77


    I am an algorithmic investor, and I was applying for a friends and family account at Interactive Brokers as my first step towards professional trading. I am currently exempt from registration requirements at the California state and federal level. However, at the end of the application process, Interactive Brokers informed me that I would not be able to charge any fees to clients.

    After reading the California corporate code investment advisor statutes, I was not able to locate the California law prohibiting this. (And IB has stated that they will not specify the statute number that they are referencing, because that could be considered legal advice or shared legal research). I am wondering if any other traders here have heard of this prohibition against California unregistered advisers charging fees? (Or a similar restriction in any other state?)

    This is a quote from a message from the Interactive Brokers new accounts department:
    "Thank you for your patience. Per compliance review, you will not be permitted to charge Securities client fees as the state of California laws prohibit this for non-registered advisors. Please note this decision is final."

    My remaining alternatives seem to be either 1) to take the series 65 and become registered, or 2) possibly to open a hedge fund instead of a friends and family account.

    Thanks in advance for any insights or advice,
    antelo likes this.
  2. Robert Morse

    Robert Morse Sponsor

    I can't give legal advice either, but I can cut and paste.


    Exemptions from the licensing requirement for broker-dealers and investment advisers are found in Code Sections 25200 thru 25209 and California Code of Regulations (“CCR”) Sections 260.200 thru 260.204.12.

    Code Section 25202 is specifically related to investment advisers and provides a de minimis exemption from the licensure requirement to any investment adviser that (1) has no place of business in this state and (2) during the preceding 12-month period has had fewer than six clients who are residents of this state.

    Give me a call if you need more help.

  3. Jay77


    Hello Bob,
    Thank you for the useful reference. Yes, section 25202 is the state-level exemption I claimed for myself. Although my home is in California, the SEC has published a specific definition for a "place of business" within the context of investment advisers.

    § 275.203A-3 Definitions.
    (b) Place of business. “Place of business” of an investment adviser representative means:
    (1) An office at which the investment adviser representative regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and
    (2) Any other location that is held out to the general public as a location at which the investment adviser representative provides investment advisory services, solicits, meets with, or otherwise communicates with clients.

    Since I would only be trading client accounts from my home, (not giving verbal advice, or meeting clients here, or other listed activities), my home does not seem to meet this definition. IB appears to have accepted this exemption for me. (They will still allow me to open the friends and family account if I desire it.)

    IB only stated that unregistered investment advisors in California are prohibited from charging fees, and stated that any friends and family account I opened while unregistered would have this restriction. I thought it was a mystery... because I have not been able to locate a state law prohibiting unregistered advisers from charging fees. I am curious if anyone else knows about this prohibition against fees.

  4. Robert Morse

    Robert Morse Sponsor

    When I called another state, the home office was considered their place of business . You should call CA to confirm. I have some other ideas if you want to call me directly that might help.
    drm7 and Jay77 like this.
  5. tommcginnis


    IB cares about
    1) tax authority(s)
    2) exchanges
    3) profitable operations

    So, nothing happens without making sure that those three things (and especially the first two) are happily situated.

    For you, then, and regardless of the 50 different state regulatory schemes (and it sounds like CA's is similar to perhaps half of the states), for IB, the Friends&Family Adviser set-up specifically excludes assessing adviser fees to "client" accounts. If you require fee-charging abilities, that keys not only those sections of the adviser Account Management tabs, but as well, it keys Professional status with regard to data and trading fees, and a different set of 1099s at the end of the year. These keys keep IB on good footing with the IRS, *and* whatever exchanges to which you aim orders, and *hopefully* garner them sufficient dollars to be around next year.

    None of this is the end of the world, but if you want to say, "WTH??? How come that can't be explained like that??" you'll have more than a couple of sympathetic ears.

    No biggie. Shoulder to the wheel. Get on it. (And BEST WISHES.)
    Jay77 likes this.
  6. Jay77


    Follow up (FYI):
    I spent some time on the phone with the California Department of Business Oversight. They explained that every advisor is considered to have -some- place of business. (Even if they are not meeting clients in their home, or giving verbal advice.) So the fact that I am a resident in California, and intending to manage clients investments, and have no pre-existing place of business in another state, would mean that California and/or my home is my "place of business", and I would not qualify for California exemption 25202. The person further explained that this exemption was targeted at advisors who already have a place of business in some other state (and are registered in that other state).

    As far as I can tell, if you're living in California and want to be an advisor, of even a small number of clients or relatively small amount of assets under management, then California requires you to register with the state.

    It looks like my "standard" way forward is likely to take the series 65.
    tommcginnis likes this.
  7. tommcginnis


    Hit 65 materials off of eBay -- the material will be trivial (and is more directed at your learning *vocabulary*) -- and "updates" are triviality^2......
  8. Cyrix


    Could you give an update on your situation?

    After you have completed the series 65, are you able to charge fees on IB?
    Have you incorporated to protect your liabilities as many advisors do?

  9. kj5159


    I can tell you if you take the series 65 route the test is easy AF, nothing like the series 7 in terms of difficulty.

    I'm not 100% sure as it's been a while but I think you would also need the series 63 and register in the state(s) your clients live in, also a very easy exam.
    tommcginnis likes this.
  10. Jay77


    Hi Cyrix,

    Our own situation is likely unusual and probably would not apply well to most other investors. I'll update on our status anyway, and offer some info and references on how one may be able to legally charge investing fees. (Since that was the original thread question from a few years ago.)
    Disclaimer: These are legal topics. I am not a lawyer. I might be WRONG about any or all of the following, so one should consult with a lawyer to be sure of any of these topics. Info is about the USA only.

    ### These might be options for charging investing fees:
    (Any one of the below may be an option. Consult with a lawyer first.)

    1) One could pass the Series 65 exam, AND registered as an RIA (registered investment advisor), and/or an IAR (investment advisor representative), and open an advisor account at a brokerage. Corporate entities, including ones own entity if applicable, can become RIAs. Individuals can become IARs. IARs work for a particular RIA.

    2) One could start a hedge fund, and open a hedge fund brokerage account. A person may not need to become an RIA/IAR to -exclusively- advise one or more hedge funds, so long as the fund(s) are under a certain combined AUM size.
    (See this page for details on when one is required to register with the SEC: https://www.riveleslawgroup.com/launching-a-hedge-fund-is-investment-adviser-registration-required/). Look for, "When am I exempted from SEC Registration?" and "(1) Private Fund Adviser and RAUM below $150 million".

    Note 1: -State- level registration requirements can vary. But many states will offer registration exemptions that are similar to the SEC exemptions.
    Note 2: Starting and running a hedge fund can be challenging. There is much, much red tape, both to create the required documents and to open a hedge fund account. A lawyer experienced with the process is useful, and is usually costly.

    3) One could start a corporate entity or LLC/LP, with the investment manager and the investor(s) as entity owners. When people own an entity together, they may not need to register with the SEC to manage money that the entity invests. There are limits to how many owners, and how much AUM, such a company could manage before one would have to register with a state or the SEC under this option. Once again, both state and federal registration laws, and available -exemptions- to registration, should be examined for compliance and requirements.

    ### Summary of our own business situation.
    We ran a hedge fund (did #2 above), and also passed the Series 65 exam, but did not register as an RIA/IAR (did a part of #1 above), because we were exempt. The extra education from the Series 65 study and test was enjoyable and useful. We added personal assets to the fund. We ran the fund for about a year, and learned much. Although the fund was successful, we realized we could earn similar profits, with much less workload, by closing down the fund and investing personal assets only. So we closed the hedge fund and moved our shares to brokerage accounts owned by personal entities. We've still been investing ever since, with about 80% of the income, and 20% of the workload as before.

    We've done well. As of this writing, our algorithmic strategies have been earning over 60% CAGR for a little over 2.5 years. (Though a person should generally be skeptical of grandiose sounding performance numbers without requesting third party verification.) Statistically, most asset managers generate returns that are similar to or lower than the S&P 500. (From memory, I think many managers average around 4% to 6% per year or so). With industry average returns I imagine that profits derived from client assets may have a much larger impact on overall compounded earnings.

    ### Personal hedge fund experience details.
    Running a hedge fund (properly) typically requires A) hiring a fund administrator company, B) a CPA, C) a hedge fund lawyer, D) publishing monthly reports to several performance databases like Morningstar and BarclayHedge, E) easily triple the tax work each year as personal investing, F) specialized fund unit accounting work, etc etc... This list could keep going. It can be challenging for an individual or small group to start a hedge fund, but surprisingly it can -stay- quite demanding after it is up and running. You would think you could pay other companies to do all the aforementioned maintenance and regulatory tasks, and you CAN, but every person one hires requires support work and plenty of communication, to help them do -their- jobs. It's hard to delegate these items completely. A hedge fund may be a useful construct in some situations, but it can be good to look at all options.

    ### A Series 65 Class:
    -Kaplan offers a Series 65 course. The textbook is massive, even by "textbook" standards. It took me about 6 months to complete. It's a good course if one is self motivated. LOTS of study. Among other things, this course includes full details about who must register with what regulatory bodies, and when, and what laws apply to all kinds of investment advisory activity. It is mostly a -legal- topics study course and in majority, a legally focused test. It's probably worth noting that it actually teaches very little about how specifically to invest well. (In case that is what someone is expecting.)

    #10     Jun 23, 2019