RIA Books and Records Requirement: Financial Statements

Registered investment adviser (“RIA”) firms of every size are required to keep true, accurate, and current books and records related to financials. This is a requirement of both firms who are registered with the Securities and Exchange Commission (“SEC”) and state-registered firms. The Chief Compliance Officers (“CCO”) needs to understand the financial requirements its firm held to and avoid compliance deficiencies related to financials by following regulatory guidelines, best practices, and keeping required financial records where necessary. 

For SEC-Registered Firms

As mandated by the SEC’s Rule 204-2(a), or “Books and Records Rule:”

Every investment adviser registered or required to be registered under section 203 of the Act (15 U.S.C. 80b-3) shall make and keep true, accurate and current the following books and records relating to its investment advisory business

This includes:

• A journal or journals, including cash receipts and disbursements, records, and any other records of original entry forming the basis of entries in any ledger.
• General and auxiliary ledgers (or other comparable records) reflecting asset, liability, reserve, capital, income and expense accounts.
• All check books, bank statements, cancelled checks and cash reconciliations of the investment adviser.
• All check books, bank statements, cancelled checks and cash reconciliations of the investment adviser.
• All bills or statements (or copies thereof), paid or unpaid, relating to the business of the investment adviser as such.
• All trial balances, financial statements, and internal audit working papers relating to the business of such investment adviser.

The format for these records is not specified by the SEC and audited financial statements are generally only required in certain circumstances. In addition, unlike many states, the SEC does not have a net capital requirement. However, it is recommended that the firm stay solvent or it may be subject to other regulatory disclosure requirements such as Item 18 of the Form ADV Part 2A.

For State-Registered Firms

States generally have books and records requirements which directly match or closely mirror the SEC’s requirements. However, some states have additional or altered requirements as it relates to financial records. For many state-registered firms, financial statements-related requirements may include:

• A balance sheet, statement of cash flows, income statement, and a statement of all shareholders or members equity (some states may require certain financial statements to be filed as part of the firm’s annual registration renewal process)
• Financial statements prepared on an accrual basis in accordance with Generally Accepted Accounting Principles (“GAAP”).
• While not common, some states, in certain circumstances, may require an RIA firm to submit financial statements that have been audited by an independent certified public accountant (“CPA”).

Unlike the SEC, some states do have a minimum net capital requirement and almost all require solvency. This requirement may depend on their business model and depending on the state, firms may be able to obtain a surety bond in lieu of meeting the minimum net worth requirement. If a firm falls below the required minimum net worth, states typically require the firm to notify the state by the next business day. Additionally, state-registered firms also have a similar requirement as it relates to Item 18 of the Form ADV Part 2A. When referencing the most recent financial records, most states will assume the most recent quarter, but there are some states that require financials to be kept on a monthly basis.

Key Financial Terms for RIA Firms to Know

• Generally Accepted Accounting Principals (“GAAP”): a standard set of accounting principles and principles that include a requirement to prepare financial statements on an accrual basis. 
• Net Worth: An excess of assets over liabilities, as determined by GAAP. In general, the following types of assets excluded when calculating net worth: prepaid expenses (with exceptions), deferred charges, franchise rights, organizational expenses, patents, copyrights, marketing rights, unamortized debt discount and expense, other intangible assets, home, home furnishings, automobiles, personal items not readily marketable, and advances or loans to partners or to stockholders and officers
• Journals: Formatting of journals should be notations of cash receipts and disbursements, records, and any other records of original entry forming the basis of entries in any ledger.
• Ledgers: General and auxiliary ledgers (or other comparable records) reflecting asset, liability, reserve, capital, income, and expense accounts.
• Balance Sheet: Summary of a firm’s net worth at a specific period of time. Many new firms will have a simple balance sheet to start but complexity may grow over time. Many advisory firms will use accounting software such as Intuit’s QuickBooks Online to help automate the preparation of financial records.
• Income Statement: Also known and a Profit and Loss Statement or “P&L,” the income statement shows overall profitability of the firm, summarizing revenues and expenses over a period of time. 
• Cash Flow Statement: A summary of cash inflows and outflows over a period of time generally organized across categories: cash flow from operations, cash flows from investing, and cash flows from financing. 

The vast majority of registered investment adviser firms will not employ a full-time chief financial officer (“CFO”). For many firms, one of the firm’s principals will be primarily responsible for preparing financial statements often with assistance from an outside CPA firm. In addition, some advisory firms will utilize the services of an outsourced or part-time CFO who is familiar with the RIA business model. Private fund managers or firms deemed to have custody of client assets may be subject to additional federal or state requirements such as an independent third-party audit. Too often, financial statement regulatory requirements are overlook by RIA firms and are one of the leading categories of regulatory compliance deficiencies discovered during regulatory examinations.