Ep. #2: Premature Registration

Sometimes, doing less helps you earn more, and avoiding premature registration is one of those times. Struggling CTAs register too early, and they live to regret it. Listen to this episode to find out why Commodity Trading Advisors that delay registration earn more money.

Transcript:

Welcome to The Profitable CTA, the only podcast that helps commodity trading advisors grow their businesses and boost their bottom lines. I’m Kelly Hollingsworth and I’m happy you’re here because today we’re going to talk about profitability problems that are caused by premature registration. We’re going to discuss exactly what registration is, why early registration is a problem, and why avoiding registration for as long as possible leads to more business and more profits.

So with that is the backdrop of where we’re going, now let’s dive in.

What is a Commodity Trading Advisor, and how do you become a CTA?

The first thing I want to cover is what exactly does it take to become a CTA? In other words, what makes a commodity trading advisor a commodity trading advisor?

Most of us are under the impression that a CTA isn’t really a CTA unless it’s registered with the CFTC and a member of NFA. As with many CTA problems, I blame the internet for this impression. If you google “How to become a commodity trading advisor” or “how to launch a commodity trading advisor” the first thing you’ll see is that you must register. You must file some forms with the CFTC and NFA and pay some fees and take the Series 3 exam.

Would-be CTAs who read this advice very reasonably conclude that if you’re not registered, you’re not really a CTA, and nothing could be further from the truth.

Registration doesn’t make you a CTA. If you give advice about trading in futures or Forex contracts, you are a CTA, whether you’re registered or not. It’s the advice, not the registration, that creates a CTA.

This advice comes in two forms, by the way. There’s direct advice, meaning you manage someone’s account under a power of attorney. This is called having discretion over the customer’s account. And there’s also indirect advice, meaning that you just sell trading signals or trading suggestions. And this latter activity—signal selling–is not something that we’re going to talk a lot about in this show, because it’s not very profitable relative to managing the accounts. That’s where the  real money is, for reasons that we will discuss in an upcoming episode. For now, I’d just like you to know two things. When I’m talking about a CTA in this show, unless I specifically state that I’m talking about the kind of CTA that sells signals but doesn’t manage money, I’m always talking about the kind of CTA that manages accounts. That’s the kind of CTA that this show will focus on.

The other thing I want you to know is that if you manage accounts for someone other than yourself, you’re a CTA, whether you’re registered or not. And many very profitable CTAs never register at all. They make a lot of money, and they just don’t need the headache.

So here’s the big takeaway for this episode. The really important thing to know. Not every CTA is required to register. Registration is an add-on to this business of giving trading advice. It’s something that some CTAs do.  A few CTAs register at the time when registration is actually required. These CTAs tend to be the profitable CTAs. Most CTAs register way before it’s required. And they do this because they want to feel like a real business, and they’re under the impression that they’re not really a CTA—it’s not a real business– if they’re not registered.

As I said earlier, this isn’t true, but it is unfortunate. What happens with these CTAs that register prematurely? They struggle. They register before they need to, so they can feel like a real business or because they have a misunderstanding that they’re not really a CTA unless they’re registered, and this premature registration sets into motion a very predictable and unprofitable series of events that ultimately ends in business failure.

Why does premature registration lead to CTA failure? Let’s walk through an all-too-common example so you can see how it happens.

Anatomy of a CTA Failure

The typical CTA failure, which takes years to play out, almost always begins with premature registration—the decision to register before registration is necessary. To see why this is a problem, the first thing you have to know what it means to register.

What does it mean to register as a commodity trading advisor?

When you register as a CTA, you essentially put your name on a list. NFA maintains this list on behalf of the CFTC, and by putting your name on the list with these two regulators, that means you are submitting to regulatory scrutiny. NFA can walk into your office at any moment and conduct an inspection of your activities and your business. It also means you are submitting to comply with a host of rules and requirements that aren’t applicable to unregistered CTAs, and you must submit certain information and reports to the regulators, and there is of course a cost associated with all of this.

What do you get in exchange? What you get is the ability to solicit the general public. Registration marks the moment when a CTA can begin advertising to the general public and trading for strangers. In this respect, registration is to a CTA what an initial public offering is to a stock. It’s the moment when anyone can invest—strangers, members of the general public–rather than just the people you know.

So here’s something I’d like you to think about. No one would take a company public before it has a proven business model, some revenues under its belt, and it’s worked out the kinks in its operations. No one would take a company public before it has a track record of success in dealing with its customers and helping them achieve results. They wouldn’t do it, because no one would buy that IPO.

But “going public” on day one is what CTAs are routinely instructed to do. CTAs are told to register before they have a single customer, and this doesn’t make any sense and it kills their profitability.

Does every CTA have to register?

The good news is that no CTA has to go public right away. Some very profitable CTAs never register at all. How do they accomplish this? It’s easy.

In the United States, the CFTC and NFA are the regulators, but they aren’t completely in charge. Congress is above them, and Congress says that you don’t have to register with the regulators as long as you aren’t holding yourself out to the public as a CTA and you haven’t traded for more than 15 accounts in the previous 12 months.

15 may not sound like a lot, but it takes a while to gather 15 accounts, and you actually get more than 15 as an exempt or unregistered CTA because of the way the counting rules work. If you’re managing an account for your parent or your spouse, for example, they don’t count as one of your 15 at all. Certain family members are excluded from the count. If you manage an account for a friend, and his wife decides she wants to open an account, that’s two accounts for your business, but they only count as one because of the way the counting rules work. And if each of them decides to open an IRA account with you, also a common scenario, that’s four accounts that only count as one.

So you can build up a pretty substantial business trading for these folks. Some of my CTAs manage 10 or 15 accounts and make tens of thousands of dollars per month in additional revenue, on top of the trading profits in their own accounts. And if they’re unregistered, they save money avoiding expenses that registered CTAs can’t avoid.

So there’s an immediate cash incentive to delay registration for as long as you can. And there’s also a long-term profit incentive, and this long-term incentive is huge. If you spend some time, in the early stages of your business, managing money for your friends, family, and existing business associates, when you do register you’re going to look much better to the public than the CTA who hits the street, hat in hand, with no customers, no revenues, no assets under management, and no customer track record.

And looking better is what  makes you stand out. If you do this, you will stand out because few CTAs have the patience to wait. Most CTAs want to go public and begin soliciting strangers right away, before they have any other customers, and it doesn’t work, and now I’ll explain a bit about why it doesn’t work.

Strangers Won’t Allocate to a CTA with no Customers

Consider a trip I took to Alaska. I was walking on a paved sidewalk along the shore, and I was drawn to the water but no one else was down there so I was reluctant to go as well. And eventually, I asked some passersby, “Why is no one down on the beach? What’s happening that no one is getting near this water? It is polluted or something?”

And the answer was that the beach isn’t really a beach. It’s not sand. It’s actually mud flats that act like quicksand, and tourists who walk on these mud flats often get stuck in them and then drown when the tide comes in, because they cannot be pulled out of the mud.

So the question here is, why was I suspicious about going down to the water? Because no one else was down there. And the same thing happens with CTAs. If you register and solicit the public before anyone in your acquaintance has decided to invest with you, strangers are going to think the same thing about you that I thought about that empty beach in Alaska. They may not think it consciously, but on some level they’re going to wonder what’s going on. They’re going to be suspicious. Why, if this is such a great thing, aren’t the people who are really familiar with this situation diving in head first?

As humans, we’re highly evolved to pay attention to what other people are doing, especially people who are positioned to know far more about a situation than we do. This is why strangers generally aren’t the first people to allocate to a CTA. With notably rare exceptions, It’s almost always friends, family, and existing business associates. Strangers need these folks to go down to the beach first, so they know it’s safe.

What does this mean for CTAs? It means there’s absolutely no reason to register in the first year or two of your operations. And there’s every reason not to. We’ve already talked about the unnecessary expenses of premature registration, but even worse is the distraction.

Distracted CTAs are Dead CTAs

Prematurely registered CTAs typically get so consumed with running a registered CTA and chasing after strangers in search of money that their track records suffer. This is fatal. A CTA that’s been operating for 8 or 10 years can afford a losing year. It’s not great, but they can get past it. But if you lose money in your first year, you don’t have a CTA because there aren’t multiple years of positive performance to offset that bad year and give people some assurance that you actually know what you’re doing.

And some CTAs get so distracted that they don’t even trade at all. Every week I speak with struggling CTAs who aren’t even trading their accounts or following their trading strategies because they are on a protracted roadshow looking for money.

So that’s the first big problem of premature registration aside from expenses —the distraction of registration kills your track record, thereby killing your CTA before it even gets going.

Premature Registration leads to Premature Solicitation

Another business-killing problem of premature registration is premature solicitation. Because they are able to solicit the public, early-registering CTAs typically begin doing so immediately, before they have customer assets under management or a sufficient track record of success to give those strangers a reason to buy. Going back to our IPO analogy, if you were offered stock in a company run by a stranger, and the company has no operating history, no customer has ever purchased this company’s product, would you buy that stock? No. Of course you wouldn’t. It’s not proven yet.

And the same thing happens to CTAs that go straight to the public with no track record of managing assets for customers, and no assets under management. The public doesn’t buy. And not only do they not buy now, they will never buy.

If you go on a road show and start soliciting strangers before you have a track record of trading for those in your inner circle, before you have proof of concept to give strangers a comfort level about you, what happens? They don’t just say no and send you on your merry way. What they will say is, “Not now, but stay in touch.” They say this because everyone wants to be polite. And then what happens? You dutifully follow up with them over the course of months or years, and you very predictably become the CTA that they said no to, not once, but multiple times. They develop a habit of ruling out your CTA because you approached them prematurely. And, people being people, they don’t like to admit that they were wrong, and in their eyes you’re the CTA who just doesn’t cut it. It’s very difficult for them with all of this rejection history going on to ever change their minds and decide to allocate to you.

This is a huge CTA killer. CTAs that solicit prematurely infect their networks with what I call rejection bias, and it’s almost impossible to overcome. I was at a conference for emerging CTAs (where an emerging CTA, by the way, was defined as one with assets of less than $500 million), and one CTA, clearly very frustrated with how long it was taking him to get institutional money, stood up and asked a panel of institutional allocators, “How long is this going to take? How long do I need to follow up with you? What is your investment timeframe?” And the answer from one of the panelists was very revealing. He said, “our investment timeframe is one quarter to never.”

What does this tell us? It tells us that if you approach a customer, institutional or otherwise, at the right time, in the right stage of your business, when you have a track record that is long enough for that customer, and when your customer AUM is high enough for that customer, they will allocate to you. If you approach them too early, you could follow up with them in perpetuity and they are never going to say yes.

No small business can afford this. And you want to avoid this because it will kill your business. But here’s the sad fact for struggling CTAs. You won’t see this coming, if you get sucked into it, until you’re 3 or 5 or 7 years in to your business. After all these years, you’ve been chasing institutional money, and it’s been eluding you, and years into this fruitless effort is when you’re going to start hearing a different message from all these customers. they’ve been telling you, “Stay in touch,” and eventually you’re going to hear a much more honest and disturbing message. They’re going to say, “Wait a minute. What’s going on here? You’ve been registered for all this time, but you don’t have any assets under management. We can’t consider you because we require steady growth in AUM as part of our allocation process.”

This is when my clients who didn’t listen to me about delaying their registration, who dive into registration head first because they want to get off one the right foot and set the world on fire, call me and say, “Why the bleep didn’t I listen to you?”

So here’s the thing you must know if you ever hope to attract institutions, as almost every CTA does. Institutional investors demand to see steady growth in assets under management from the day you register. Why do they want to see this? Because institutions are managing money for other people. They are fiduciaries. As fiduciaries they’re very careful about their decisions. No institution wants to allocate to a CTA that no one else is allocating to. It’s very easy for institutions to say, “We made a decision to give money to that CTA because everyone else was giving them money.” It’s very difficult to say, “Yeah, we realize no one else was giving money to the CTA but we just went ahead and gave him money anyway.” People lose their jobs over that kind of thing. Institutions get sued, successfully, over that kind of thing. And institutions are run by people who want to keep their jobs and who want to stay out of lawsuits. So if your AUM is slow to grow following your registration date, you’re going to have a hard time capturing the attention of institutions. They will run in the other direction, and you can chase them forever, as many CTAs do, without a snowball’s chance in hell of ever catching them.

This is why I tell my clients to delay registration for as long as they’re legally able to do so, and grow their businesses as exempt CTAs first. This is step one in running a profitable CTA. I can’t overemphasize how important it is to your profitability to grow your business as an exempt CTA before you register. Trade for your friends, family, exiting business associates until you have enough people congregated on your beach that strangers feel comfortable diving in. Then register and watch everyone else come running.

A big reason that CTAs are reluctant to operate in an unregistered capacity for a period of time, even though this strategy sounds really compelling, they often say to me, “That sounds great, but I don’t know how to do that.” There’s almost no information available on how to operate as an unregistered exempt CTA. So if you’re interested in learning how to do this, text the word “exempt” to 44222 and I’ll that will enable you to sign up for an email list. The first thing you’ll receive is a free checklist with everything an unregistered CTA needs to know to launch and run a profitable CTA now, that is easy to transition into a registered CTA later, that is very attractive to institutions and other public customers. I would love to teach you how to do this, it is the most important thing that you can know in launching your CTA and setting it up to be profitable now, and extremely profitable later. So that’s all you have to do. Text the word “exempt” to 44222 and I’ll set you up with that information.

So that’s what I have for you today. This is one of those instances where doing less helps you  earn more, and you should take advantage of those situations every time you come across one.

Before I close for today, I want to thank you for joining me and also to let you know that I’m not just a business advisor to CTAs. I’m also an attorney, so this podcast may constitute attorney advertising. Also, you shouldn’t take anything we discuss in this podcast as legal advice. We discuss general business principles against a legal backdrop, but you shouldn’t take anything I say as legal advice that’s applicable to your situation unless you actually hire me as your attorney. To talk to me about doing that, email me at kelly@profitablecta.com or go to profitablecta.com and you can access my calendar and schedule a call with me. Thanks and I look forward to speaking with you if you’d like some help with your CTA, and I look forward to connecting with you in the next episode.

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