Option Fanatic, RIA (Appendix B)

Today I will pick up with excerpt [1] from my last post.

The Investment Advisers Act of 1940 is a thing. Most people probably don’t know it, which would warrant a dedicated post.

The ’40 Act defines an investment adviser (IA) as any person or firm who is engaged in the business of providing advice to others or issuing reports or analyses regarding securities for compensation. The definition includes three parts with each as detailed as you might imagine any legal statute to be.

I disagree with the claim in [1] that “there is no need to be regulated.” If you are acting as an IA then you better be properly registered. Period. If you try to go “off the record” and get paid “under the table” then you’re engaged in tax evasion as well.

The same contributor wrote the following:

       > One of the most important things to consider when you start
       > managing other people’s money is how to deal with potential
       > losses. Most guys who’ve been profitable jump into this business
       > but when the first big loss arrives they have problems coping.
       > What are you going to tell investors? How would they react to
       > losses? Would they flee? How would this affect you financially?
       > Everyone has different psychology. In my career as money
       > manager, I’ve tried to select clients who are psychologically
       > stable and predictable. I had once a client who liked to call
       > he saw an article… about markets going down. He asked… am
       > I sure every time nothing will happen to his money? In three
       > months I decided to return his money and part ways for good.

Probably as much as anything else, this has been a good deterrent over the years against my entry to the IA business. For my own IA, I would be very cautious accepting money from strangers—especially people with little understanding about how the markets work. If working for someone else, though, I may not have much choice what clients I take.

I mentioned “red tape” in the fifth paragraph of Appendix A. Wikipedia describes red tape as follows:

> …an idiom that refers to excessive regulation… that is
> considered redundant or… hinders or prevents action or
> decision-making…
> …generally includes filling out paperwork, obtaining
> licenses, having multiple people or committees approve a
> decision… can also include “filing and certification
> requirements, reporting, investigation… and procedures.

I have studied most of the individual laws, but organizing everything into a manageable whole would be a herculean task. Compliance firms make it their business to handle these challenges for IAs. Compliance firms distill the various components of related laws (e.g. ’40 Act mentioned above, Uniform Securities Act, etc.) into generalized guidelines that will fit as many of their [prospective] clients as possible to maximize compliance firm efficiency.

I will continue tying up loose ends next time.