When one entity acquires substantially all of the assets and liabilities of an existing registered investment adviser (RIA) firm, the Investment Advisers Act of 1940 (the “Advisers Act”) allows for a continuation of the advisory business by the successor entity – a succession. The Advisers Act successor rules are intended to be used only where there is a direct and substantial business nexus between the predecessor and the successor, meaning that while the acquirer need not assume every asset and liability of the existing adviser, it may not exclude any “significant” asset or liability.
The purpose of the successor rules is not to allow RIA firms to spin off personnel, transfer of the registration of a “shell” organization that does not conduct any business, eliminate substantial liabilities, or sell their registrations. Therefore, an entity that is not assuming substantially all of the assets and liabilities of its predecessor is not entitled to rely on the successor rules, and must wait until its own registration becomes effective before engaging in business as an investment adviser.
The successor rules may allow the entity assuming the prior advisory firm’s business to take place in two different manners, depending on the facts and circumstances of the successions: (1) Succession by Amendment or (2) Succession by Application. The first option, Succession by Amendment, is considerably simpler and more beneficial to successors and is therefore discussed in greater detail below. Succession by Application, on the other hand, requires the succeeding adviser to file and complete its own entirely new application and ultimately attain approval from the relevant jurisdiction(s).
- Succession by Amendment
In limited circumstances, the successor rules permit the successor to file an amendment to the predecessor firm’s Form ADV, instead of having to files its own original application for registration. In order to avail itself of the Succession by Amendment, the succession must be the result of a merely formal change in the structure or legal status of the existing adviser. This means that the occurrence giving rise to the succession must involve the creation of a new legal entity, but no practical change in the control or operations of the existing investment advisory firm. Determining a “change of control” ‘ depends upon the facts and circumstances of the particular transaction. A concomitant condition of eligibility for Succession by Amendment is that the predecessor RIA currently in business must cease operating as an investment adviser. The three specific types of successions that can be consummated by filing an amendment are:
A. Change in Legal Status
This is the most commonplace occurrence necessitating a succession filing for a RIA firm. A “change in legal status” in this context means a succession resulting from shifting the form of business, such as from a partnership to a limited liability company (LLC) or from a sole proprietorship to a corporation, or changing the state of incorporation.
B. Change in Form of Organization
A “change in form of organization” sounds like it could describe the situations above, but it refers instead to an internal corporate reshuffling wherein advisory activities are transferred from one entity to another within the same organization. Such a reorganization would be more likely for larger firms with multiple entities under the same corporate umbrella.
C. Change in Composition of a Partnership
A change in the composition of a legal partnership (by removal or inclusion of a partner) can trigger the partnership’s dissolution under local law. If this does not entail a change in control of the partnership, Succession by Amendment would be available to keep the registration intact. This is the narrowest circumstance of the three Succession by Amendment options discussed herein and would typically apply only when death, withdrawal, or addition of a partnership results in legal dissolution without a change in control.
2. Succession by Application
If Succession by Amendment is not applicable, then the successor entity can avail itself of the Succession by Application option. This allows the new advisory business to operate under the registration of the existing RIA for a limited period of time but only if the new adviser files its own complete Form ADV application for registration within thirty days of the succession. Under Succession by Application, the registration of a predecessor investment adviser or broker-dealer typically ceases to be effective as the registration of the successor application forty-five days after the successor’s application is filed.
Thus, Succession by Application differs from the prototypical new registration process in that it allows the successor to parallel process: it can continue management of the advisory clients’ accounts while separately commencing the RIA registration process for the successor entity. This scenario would apply to acquisitions (where an unregistered entity acquires substantially all of the assets and liabilities of the RIA and then operates the advisory business) and consolidations (where two investment advisory firms merge into an unregistered third entity acting as successor) that involve a change in control. This would also be the case for an existing investment adviser firm splitting up its advisory operations into separate successor entities (possibly by client size or type) or a firm dually registered as a broker-dealer and investment adviser spinning off its advisory business as its own company. In these circumstances, the predecessor entity would file a Form ADV-W if ceasing advisory services.
As RIA compliance consultants, we strongly adviser investment advisers to exercise extreme caution when it comes to the registration of successors. As noted above, this is a detailed and sometimes confusing process with often narrow and specific definitions as to what circumstances it applies to.