Financial advisors who form their own registered investment advisory firms have greater control, independence and flexibility, but they need to beware of the added time, cost, liability and regulatory burden.

There is added time staying on top of ever-changing regulations, added cost because it is wise to have insurance to protect the firm, and added liability because with any misstep or violation of a regulation the firm is at risk, compliance industry professionals say.

"One of the first things advisors and reps need to take into consideration with becoming an RIA is that they are going to be on the line for any regulatory issues or client complaints," says Tammy Emsick, senior compliance consultant and director of business development at RIA Compliance Consultants in Omaha, Neb. "One regulatory violation could, if serious enough, cause the company to shut down."

Many advisors who set up an RIA mistakenly think that they have a simple business model and therefore aren’t likely to get in trouble, Emsick says.

"If you get a disgruntled client, however, it's going to be up to somebody else's interpretation of whether you wronged the client or not," she says. "You're foolish not to think that it could happen to you no matter what type of business you have."

It doesn’t even have to be the client, Emsick says.

It could be an heir to the estate who thinks that an advisor wronged the client.

The biggest challenge that advisors face in setting up their own business is understanding the role that compliance has to play in running the firm, according to industry professionals.
This takes a different skill set over and above advising clients on their finances.

"You have to be a compliance administrator because you're interacting with the custodian brokerage firm, and you need to be able to perform all the functions a wirehouse would have done for you," says Brian Neville, an attorney at Lax & Neville in New York that advises reps on RIA issues. "You could be very good at advising clients regarding their investments but not very good at compliance and administration."

As a precaution, both Emsick and Neville advise reps early on to set up a written supervisory program of policies and procedures.

They say to make sure the program focuses on maintaining appropriate records and documents to support advice given to clients, and that it covers correct procedures for receiving email, correspondence, advertising and marketing.

It also must be kept up to date because regulations continually change.

Finally, RIAs are fiduciaries under the law. A big part of the fiduciary duty is disclosing or eliminating all conflicts of interest if they are material to a client's investment decision.

Examples could include outside business activities that may influence a client's decision to invest with the advisor or a product that carries a commission that benefits the advisor.

Otherwise if the client's needs aren't properly handled and conflicts aren't disclosed, they could be a source of liability, Neville says.

Bruce W. Fraser, a New York financial writer, contributes to Financial Planning and On Wall Street.

This story is part of a 30-day series on going independent.