A white-hot regulatory agenda is bedeviling independent broker-dealers.

There's good news and bad news at independent broker-dealers these days. Sales have bounced back as much as 30% from last year's dismal showing, and that's welcome news all around. But truth be told, business has rebounded despite a crush of costly regulatory demands that has firms' compliance departments crying overload.

"Every meeting I go to, the conversation among chief executive officers isn't about how to build a better broker-dealer, the direction of the markets or how to create better products," says Art Grant, CEO of Cadaret Grant, in Syracuse, N.Y. "It's about compliance and what the next regulatory shoe to drop will be."

Grant echoes the sentiments of a number of brokerage executives and compliance experts, who say that firms are being required to dig out from under an unprecedented amount of new regulation, much of which is fallout from sins committed by shops often outside the independent channel.

Firms and their compliance departments are being asked to turn on a dime, do massive data collection and analysis and create new systems, often with little notice. It may be to grapple with mutual fund trading scandals, new point-of-sale disclosure requirements or, in one of the National Association of Securities Dealers (NASD) latest promulgations, a regulation that asks firms to justify the superiority of their fee-based accounts in terms of services and customers' costs over commission-based offerings.

"We're under siege, and I believe there will be unintended consequences for the industry and American society because there is simply not enough time to think through the ramifications of these regulatory demands," says Tony Batman, chairman of the Atlanta-based Financial Services Institute (FSI). The institute was founded in January to represent the interests of independent broker-dealers. One such unintended result "may be that the industry grinds to a halt because we're creating an environment where every advisor is out of compliance and violating rules at all times."

Mary Schapiro, the NASD's president of regulatory policy and oversight, told compliance officials at the Securities Industry Association' (SIA) March Compliance and Legal Conference in Phoenix that the self-regulator has issued some 95 different regulatory initiatives in the last two years alone.

Twenty of these 95 regulations impact independent broker-dealers on a large scale, the FSI estimates. The overall cost to firms is immeasurable, says Batman, whose association represents 88 firms and 100,000 reps (out of the industry's approximately 660,000 registered reps).

But one figure is sending shockwaves through the industry. The SIA has estimated that it will cost firms some $17 billion in the first year to meet the new point-of-sale disclosure requirements mandated by the Securities and Exchange Commission (SEC) earlier this year. "That's more than the industry will earn in a year," maintains Batman.

Schapiro says that the pace and aggression of new regulation is unlikely to abate. She told compliance officers point blank at the Phoenix meeting: "I must admit to a concern that, deep down, many on the business side cling to a belief that 'this too shall pass,' that at some point we will return to the normalcy of lessened regulatory scrutiny and demand. Such thinking, if it does exist, misperceives the lasting effect of recent events. A tipping point has occurred and this industry will, for the foreseeable future, face increased obligations and heightened scrutiny of regulators. There is no reason to pretend that this change is not permanent, and dangerous consequences lie ahead if we fail to recognize this and act accordingly. Yes, we have burdened your regulatory load significantly over the years, and inevitably more is to come."

Both the FSI and SIA have asked regulators at the SEC and NASD for a formal moratorium on new rules. "At this point, we're requesting it so we can be more thorough in analyzing the application, implementation and consequences of any new regulation," says Batman.

As Schapiro bluntly said, that's not going to happen. Other NASD regulators concur. "It just wouldn't fly," says one NASD district regulator, who admits that while independent brokerage firms and advisors have tended to cause far fewer problems than do their captive peers, it would be virtually impossible to carve them out from regulation.

"Regulators have acknowledged that these are very different times and that as a result there is more regulation to come. So while we don't currently see a moratorium, we might be able to hope for more thoughtful regulation," says Batman, who is also chairman of First Global Inc., a Dallas-based independent broker dealer.

Thoughtful regulations would be welcome, says Michael O. Brown, a former NASD compliance examiner who launched BD Solutions, an Atlanta-based consulting firm, in 1993. In one six-month period last year, his staff found 50 different NASD notices to members that required brokerage managers to ask if their firm needed operating changes. Compounding the sheer volume is the fact that regulations can be dense and often difficult to understand. "Sometimes clients get different answers to questions, district to district and within the same NASD district," Brown says.

Sometimes compliance departments are simply tarred with the wrong feather, Brown says. One case in point: The latest NASD breakpoint rules, which required firms to find cases where brokers and firms themselves may have missed giving customers appropriate breakpoint discounts on the mutual funds they sold them. Firms were required to sift through years of sales, take out advertising underscoring the fact that the public may have been overcharged and send a letter advising each pertinent customer that they may be owed a refund.

Brown maintains that the customer overcharges were caused not by compliance neglect, but by technology that failed to match and calculate total relevant client purchases. "I think as a regulator, the NASD does not understand technology," says Brown. "If they did, I think they would require that chief technology officers be licensed. Right now, they (CTOs) have no skin in the game and until they do, I don't think technology will be the answer regulators want it to be."

Broad-based requests for information that require whole compliance departments to turn on a dime can also be trying, says Leslie Durant, vice president of compliance at Capital Analysts in Radnor, Pa.

"We're following our strategy and the breakpoint issue comes along, with the new technology and additional staff it required. Then regulators add documentation requirements for revenue sharing and shelf space and sponsored programs, and they give you like eight days to respond," says Durant, who recently hired a new compliance person to look daily at mutual fund breakpoint exception reports.

Of the 12,000 letters Capital Analysts sent out to customers who may be able to claim a breakpoint discount refund, "about 275 came back and probably 75 % didn't understand what they were sending back." Durant says. According to the compliance officer, some customers wrote things like: " I have no idea what this is, but if I can get some money back, I'm all for it."

Also of concern are pending regulations that would change the way the NASD defines a branch. In the case of Capital Analysts, the rule would increase their 50 current registered locations to 250, which would quadruple the firm's expense for audits, the travel they require and even for branch registration. There's also some chance that 100 locations could be redefined as OSJs-offices of supervisory jurisdiction-which require more comprehensive supervision and annual audits.

"I'd like to think that some of this will subside soon," says Durant. "It's always in the best interest of customers to be on guard, but I hope regulators come to their senses and realize we're on the same side."

Richard Averitt, president of Raymond James Financial Services in St. Petersburg, Fla., agrees. "We really are on the same side. We want the agencies to reassert their authority and create the clear impression in Congress and with the public that they're doing a good job."

Part of the problem is that a couple of states made it look like federal regulators were asleep at the wheel when it came to abusive mutual fund trading and other problems. "That would impact anyone, and I can understand that they're scrambling to be seen as doing their jobs," Averitt says. "But in the process I think there are rules that are difficult and not well designed."

One of the initiatives that sits uneasily with the Raymond James executive, and a number of other senior managers, is the NASD's recent notice that seeks to put the industry's $225 billion in fee-based accounts under a microscope. The notice asks broker dealers to look back over two years at their asset-based accounts with a low number of trades, and be prepared to justify why these customers are better off in fee-based and not commission-based accounts (since the latter may have cost the client less).

The NASD fears broker-dealers are pressuring customers to opt for fee-based accounts because of the recurring revenues they generate, without adding advice or other services in exchange for the fees. Yet regulators like former SEC Chairman Arthur Levitt encouraged brokerages to steer clients towards these accounts to impose a disincentive to churn. "Now they want us to tell them what the clients paid in fees, what they would have paid in commission accounts and if they would have paid less, why they aren't in one," Averitt says.

The brokerage veteran said that it's a mistake to reduce all brokerage business to pure cost and omit the wide range of other considerations, services and client choices involved. "We've been moving to fee-based business for years, so our folks sit on the same side as investors and only get paid more when investors' assets grow. It strikes me that all interests are aligned when that happens," says Averitt. "Now we're being told maybe that's incorrect. I think that criticism is wrong thinking, and I hope regulators have begun to see that."