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

[Cyrix]

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.)

Jay

Thanks so much for your detailed reply.

One thing unclear to me is why you didn't choose route 1, the RIA route.
From your explanation it appears that the RIA route requires much less paperwork and maintenance, but is still able to generate client income on IB. You have even passed series 65, but didn't end up being a IAR/RIA.

Is there any particular disadvantage of managing client money on IB by creating an LLC as a RIA and the trader becoming an IAR. Could you please give some more insights? This is actually the route I am seriously considering, thinking that it requires less administrative work/costs than a hedge fund (or is it not the case?). I am also in California.

Thanks again.

 

[Jay77]

Cyrix,
> 1) One thing unclear to me is why you didn't choose route 1, the RIA route.
> 2) [Does being an RIA] require less administrative work/costs than a hedge fund?

At first, I was where you are now, exploring which routes to take, so I chose to explore both to some degree. After I started the hedge fund, then there was no remaining need to register as an RIA because the fund would be exempt from registration unless and until it amassed a very large AUM. Now that I've closed the fund, I might personally reconsider the RIA route. I don't -need- to be an RIA because income is already fine, but being an RIA could still have advantages for others. There are entities and people I know who'd like to invest with me, and such interest would likely continue to grow as the good track record continues. I have some time while I could still register as an RIA if I like... The series 65 test passing result is good for 2 years after completion.

I don't know if an RIA setup would be easier to maintain than a hedge fund. I know running the hedge fund was an awful lot of maintenance, but I have never been an RIA. Maybe someone else in this forum could answer this question? let me know if you find some opinions on the topic. I'd be curious to know.

> Is there any particular disadvantage of managing client money on IB by creating an LLC as a RIA and the trader becoming an IAR.

I tried to think of "cons" of being an RIA, over the hedge fund. I can't imagine there would be many downsides, but this is what I thought of.
1) You'd have to pass the 65 to be an RIA. Some people may not want to, or think that they can.
2) Client accounts would be segregated with an RIA. At the time I made the hedge fund, I thought this might possibly add extra daily trading work. Because, I use algorithms. I ideally need all client accounts to have the -same state- (same positions) at all times, with the exception of the number of shares purchased. With one hedge fund account, there can be only one state, so problem solved. However, with multiple client accounts, what if one client gets an order filled and other clients don't? I'm not sure how RIAs typically handle this situation. Especially if they have -many- clients. Do they manually adjust each account? Are there broker tools to help? (I would hope and guess there are.) At the time I had just imagined one account might be simpler to administer than many accounts. However, I have since realized that segregated accounts have a huge advantage as well. Namely, segregation creates -much- simpler client accounting because you no longer have to track what money belongs to whom. (All the money in each account belongs to the single client.) And simpler accounting means simpler (or less) third party services may need to be purchased and dealt with. Side note... it turned out that in practice the hedge fund did have at least a few different broker accounts and subaccounts, that got used for different purposes. So it was not quite as much simpler as was imagined.
3) Billing of fees might theoretically be a bit simpler with a hedge fund, because any and all fees are just withdrawn from the fund account. I'm not sure how performance fee transactions work with RIA accounts. I don't have that experience with the advisor accounts.
4) Margin and trading permissions may differ by account. With a hedge fund, there is only one account that needs to "qualify" to get maximum margin permissions, and the rights to trade all security types. With a smaller client account (under 100k), they may not qualify for portfolio margin, though I don't know for sure. I suppose in that case, you could just set position scaling to a lower value, but it would have an impact on the returns for those particular clients.

I'd be interested in finding out if being an RIA could be simpler to maintain than a hedge fund, on a monthly and yearly basis.

-Jay

 

[Jay77]

Another possible strategic difference:
5) A hedge fund could theoretically avoid disclosing exact trade history, and therefore could have an easier time keeping strategies confidential if needed. With an RIA, trades occur in the client account so I am unaware of a way that an RIA could keep trade history private. Note that I'm speaking only of trade history logs (exact entries and exits), and not things like performance history reports. Summarized performance and financial reports would be disclosed by both types of businesses.
-Jay

 

[Cyrix]

Another possible strategic difference:
5) A hedge fund could theoretically avoid disclosing exact trade history, and therefore could have an easier time keeping strategies confidential if needed. With an RIA, trades occur in the client account so I am unaware of a way that an RIA could keep trade history private. Note that I'm speaking only of trade history logs (exact entries and exits), and not things like performance history reports. Summarized performance and financial reports would be disclosed by both types of businesses.
-Jay

All great points. Thanks so much for your time and information.
As you have brought it up, this 5) is actually pretty important. It may make the RIA much less attractive because it does increase the risks of my algos being reverse engineered.

 

[Jay77]

For the benefit of anyone interested: I was able to confirm with IB support that when using an Advisor account(aka RIA/IAR account) with managed accounts/client accounts at Interactive brokers, there is NO option to avoid disclosing full trade history to clients. All trades are transparent to the clients.
-Jay

 

[Robert Morse]

For the benefit of anyone interested: I was able to confirm with IB support that when using an Advisor account(aka RIA/IAR account) with managed accounts/client accounts at Interactive brokers, there is NO option to avoid disclosing full trade history to clients. All trades are transparent to the clients.
-Jay

This is never the case at any broker with an SMA. You need a pooled asset, not in the customer's name.