Advisors cite new, more demanding compliance environment.

    Gordon E. Jones, principal of Jones Advisory Group in Sarasota, Fla., has $25 million in assets under management, so he knows firsthand the strain of complying with new and differing rules from the Securities and Exchange Commission and other regulatory bodies. He is a sole proprietor with no extra staff or office help other than his wife, a CPA who keeps his financial records. He formed his own Registered Investment Advisor firm through the SEC in January. As a result, he doesn't have the resources a broker-dealer has to help satisfy the requirements.
    To comply with new SEC rules, Jones has had to hire an outside compliance advisor to create a compliance procedures manual (80 pages); a code of ethics (25 pages); a business continuity plan (60 pages); and set up record keeping and forms to satisfy these manuals. "This cost me $4,500 for the initial work, and required 20 to 30 hours of phone interviews with the advisor over several months," laments Jones, who does double duty as his own compliance officer.
    Yet he plans to hire the same outside advisor on a yearly basis to do mock audits to ensure he is well prepared if the SEC comes calling. That will run at least $1,000, plus expenses, for each trip. In addition, he has invested approximately $4,000 in new computer hardware, and will spend between $1,500 to $2,000 a year in new software license fees to ensure his books and records are complete and readily accessible for the SEC.
    "The SEC requirements and steps are so detailed," says Jones, "that it's highly likely I won't follow all my own rules perfectly, setting me up for the SEC to find violations [bureaucrats call them deficiencies] in an audit."
    Jones is hardly alone. Compliance issues these days are a major challenge for financial advisors, involving increased commitments of time and expense. Largely because of the business scandals, and ensuing attempts to rein in corporate malfeasance, compliance has moved front and center on advisors' agendas, whereas it used to be just one of many issues. "When I'd be in front of a large group of financial advisors in the past, you might get comments about compliance being the sales prevention department or the cops," says Laurie Lennox, chief compliance officer of Commonwealth Financial Network, an independent broker-dealer. "I don't get that anymore. Instead, advisors seem genuinely concerned about the current regulatory environment, and are more often seeking our advice and counsel."
    For the most part, regulations today are similar for both federally and state registered advisors. In fact, most state regulators take their cues from the SEC. For instance, both state and federal regulations now require firms to update suitability information on clients every three years, which means smaller clients-the ones with only $500 or $1,000 to invest in a mutual fund, for example-may no longer be profitable.
    Compliance at both state and federal levels today involves greater reporting requirements, greater disclosures and more record keeping, necessitating more continuing education on the part of advisors to keep up. In addition, barriers to entry into the profession are higher. "It's tougher these days to become and stay a registered rep or investment advisor. I turn away people constantly," says Andy Martin, an Office of Supervisory Jurisdiction (OSJ) official for AIG Advisor Group in Nashville, Tenn. Only those financial advisors who are associated with broker-dealers come under the jurisdiction of an OSJ, who is employed by a broker-dealer and acts as a frontline supervisor to advisors. Every piece of correspondence or trade done by a registered rep has to be approved by the OSJ. RIAs across the country who aren't affiliated with broker-dealers answer to state regulators.
    Owen H. Malcolm is chief operating officer as well as compliance officer for Sanders Financial Management in Norcross, Ga., a six-person RIA with $100 million under management. To meet the stepped up rules, the firm is spending nearly $2,000 annually for compliance consulting to keep abreast of the changes, and it has an outside firm file its ADV updates and do other compliance chores, says Malcolm. "We used to be able to keep up with everything, but we felt it was quickly getting to the point that we needed to hire outside experts," he explains. "In addition, we're spending another $2,000 per year on continuing education and seminars specifically for compliance, to stay on top of changes and best practices." Other procedures involve constant updates to its compliance manual, code of ethics, anti-money-laundering procedures and Regulation S-P (privacy policy).
    Bob Rockwell, a CFP licensee and an investment advisor representative for broker-dealer Cambridge Investment Research, works out of Clackamas County Bank in Sandy, Ore., near Portland. His location at a bank provides Rockwell with more resources than most solo practitioners. One step he is taking to become more compliant is being more open to audits and suggestions from banking regulators. "We also have our own internal auditor who is mostly concerned with banking audits but does a cursory review of some of my activities," relates Rockwell. "I think we're going to spend more time on internal audits to ensure we're prepared for external audits."
    In addition, Rockwell has a full-time assistant who helps him keep up with documentation, filing and retention requirements. He says he has cut down on e-mail correspondence with clients because regulators now consider e-mail to be written correspondence, and it has strenuous documentation and retention requirements.
    Another helping factor is that Rockwell gets paid a straight salary by the bank, with no bonuses or incentives. "Many of the abuses are caused by advisors trying to make more commissions," he notes. "It takes the commission part of the equation out."
    Keith Newcomb, a CFP license-holder and a wealth manager at Full Life Financial LLC in Nashville, Tenn., says becoming affiliated early on when he formed his firm with large independent broker-dealer AIG Advisor Group has helped him immensely with compliance issues. "When you're an individual advisor, selecting your vendors is one of the most important things you can do. It's going to help you or hinder you in serving your clients and pursuing your vision for your business," says Newcomb, adding that the smaller the advisory shop, the more important it is to affiliate with a large broker-dealer or custodian with deep resources.
    Whenever Newcomb has a compliance problem, he often consults the OSJ's Martin, who serves as his frontline supervisor on compliance matters. Says Newcomb: "I'd rather get compliance right from the beginning, with the guidance of my OSJ and broker-dealer compliance team, than learn a better practice was available by way of a deficiency letter from a regulator."
    For independents registered with the SEC, broker-dealers can often ease the compliance pain. As a rule, they derive revenue from both fees and commissions. Cambridge Investment Research, for example, derives 55% of its revenues from fee-based accounts and serves more than 800 advisors, according to Eric Schwartz, CEO and president. 
    Cambridge has a separate division that helps advisors form their own RIA firms and then continues to assist them on an ongoing basis, Schwartz explains. Cambridge provides compliance consulting on as-needed basis, and also offers a customized compliance program wherein the firm takes responsibility for running the compliance part of the advisor's investment advisory program. Schwartz says Cambridge found many of its advisors were spending upwards of $10,000 annually, as well as considerable time, on compliance issues. "The idea behind the new initiative," Schwartz says, "was to drive that cost down to $5,000 or less a year, and free the advisor up to focus on successfully growing his business."
    Commonwealth Financial Network, whose average production per advisor (the revenue paid to a broker-dealer) is approximately $211,000, is equally committed to the 960 independent advisors it serves. "We're empathetic to the advisor's concerns about the increased documentation and paperwork burden," relates Lennox. "For our part, we're trying to find ways to make it as easy for them as possible through consolidating and eliminating forms. We're also exploring ways to better utilize technology to deliver important disclosures and information to the advisor's clients."
    Commonwealth's recruiting efforts have focused more recently on larger-sized advisory practices, according to Lennox. It's a strategy embraced by other firms as well, including the Royal Alliance unit of AIG Advisory Group.
    "From my perspective," Lennox says, "the increased regulatory demands aren't going to go away anytime soon. Given that and the related administrative burden some of the compliance requirements carry, I think it will be increasingly difficult for the $100,000-producer to be successful. That's in part due to the fact that most successful producers have a support staff of some sort, and to afford an assistant at the $100,000 level is financially challenging, even in areas where the cost of living is low."
    Schwartz says the trend at Cambridge is also toward larger-producing advisors serving larger clients. At the same time, however, he is "hopeful that through programs that help support advisors in compliance and technology, efficiencies can be created in more moderate-sized offices serving large and small clients alike." For example, while Cambridge's average advisor's production has grown from $40,000 to $165,000 in the last seven years, Schwartz also sees "a trend towards the larger, $500,000-plus producer adding one or two junior producers to successfully service smaller clients."
    Despite the extra financial and time burden, many advisors feel much better about their businesses, having gone through the compliance process. "Although no business owner is happy to pay money for an expense that we may feel isn't needed. I applaud the new rules and regulations," says Malcolm. "Honest firms have nothing to fear, and compared to other industries ours is low on the regulation side. The biggest downside is that the one-person firms are getting squeezed."