How Should an RIA Count the Number of Its Clients?

Each year from January to March, nearly all Registered Investment Advisors (RIAs) are busy gathering information to update and file the Form ADV annual updating amendment.   The three most frequently asked questions they have are: How should they count the number of clients, how do they calculate their regulatory assets under management, and what other reporting requirements must be met?  This is the first in a three-part series of articles to address these most frequently asked questions.

The U.S. Securities and Exchange Commission (SEC) and the various states have not issued a statute or rule explaining the method by which federal- and state-registered RIAs should count clients.  However, SEC guidance in the form of Frequently Asked Questions helps answer the question of how to calculate the number of clients for purposes of answering Item 5.D. in Form ADV Part 1A.

Households vs. Multiple Clients

The SEC states that RIAs should report clients in Item 5.D. the way the firm normally counts them in its books and records.  Some RIAs treat multiple members of the same family (and family trusts) as a single client, while other RIAs treat multiple members of the same family (and family trusts) as separate clients. As long as the RIA is consistent year-over-year with its method of counting clients, and the methodology is sound, the SEC and state securities regulators will tend not to interfere.

Rule 202(a)(30)-1 Definition of “Client”

The SEC provides Rule 202(a)(30)-1 as a safe harbor for investment advisors relying on the Foreign Private Advisor registration exemption, and has stated that RIAs who are not Foreign Private Advisors may rely on the Rule when counting clients for purposes of Item 5.D.  However, RIAs must still abide by the Form ADV Glossary of Terms, which defines “client” to include those persons from which the firm receives no compensation. 

Per the Rule, an RIA may deem as a single client:

1. A natural person (i.e., a living human being) and: 
   
   1. any minor child of the natural person,
   2. any relative, spouse, spousal equivalent, or relative of the spouse or spousal equivalent of the natural person who has the same principal residence;
   3. all accounts of which the natural person and/or the persons referred to in this sub-paragraph (1) are the only primary beneficiaries; and
   4. all trusts of which the natural person and/or the persons referred to in this sub-paragraph (1) are the only primary beneficiaries.
2. A legal organization (including a trust other than a trust listed above) to which the RIA provides investment advice based on the legal organization’s investment objectives rather than the individual investment objectives of its shareholders, partners, limited partners, members, or beneficiaries; and
3. Two or more legal organizations described above that have identical owners.

Examples of the Different Methods to Count Clients

Because there is no “right way” to count clients, some RIAs apply a strict methodology and count each individual or high-net worth individual, trust, institution, pool, charity, pension plan, or other entity as a “single client.”  Other RIAs will lump together households and trusts or related business entities as “distinct relationships” of a single client.  

Example: Individual A and Spouse B reside together in one household but have separate accounts managed by the RIA.  Per Rule 202(a)(30)-1(a)(1)(ii), Individual A and Spouse B may be counted as one client, regardless of the fact that they each have separate accounts under management.

Example: Individual A and Trust A.  Trust A is an irrevocable trust created by Individual A (the trust grantor), and Individual A is the sole trustee and beneficiary of the trust.  Per Rule 202(a)(30)-1(a)(1)(iv) Individual A and Trust A may be counted as one client. 

Example: Individual A and Trust A.  Spouse A is still the sole trustee, but is not the only beneficiary of the trust.  Spouse B and Children A, B, and C (each having separate accounts managed by the RIA) are also beneficiaries.  If Spouse B and Children A, B, and C all reside in the same household, they may be counted as a “single client” with Individual A per Rule 202(a)(30)-1(a)(1)(iv). 

Example: Same facts as above, however Spouse B no longer resides in the household, or Children A, B, or C are not minors and no longer reside in the household with Spouse A.  Rule 202(a)(30)-1(a)(1)(ii) would not apply and Spouse B or Children A, B, or C should be counted as separate clients.

Example: Individual A and Company A.  Individual A is the CEO and sole owner of Company A, which is also an RIA client.  Per Rule 202(a)(30)-1(a)(2)(i), the RIA should count Individual A and Company A as two clients because the RIA provides investment advisory services to Individual A separate and apart from the investment advisory services provided to Company A.

Example: Individual A is the sole owner of Company A and Company B.  Per Rule 202(a)(30)-1(a)(2)(ii), the RIA could potentially count the two companies as a single client.

Best Practices

As long as an RIA’s method of counting clients is reasonable in light of the varying investment objectives of related family members, trusts, and legal organizations, and the method is consistent year-over-year, the SEC and state securities regulators generally will go along with the RIA’s method.  

If you need help with determining who should be considered a “client” and counted for purposes of Form ADV, or you have any questions about your firm’s other regulatory filing requirements, please contact us at Info@AdvisorGuidance.com.