The Plight Of The Small Broker-Dealer

Joe Romano’s firm is a good example of what small broker-dealers are up against.

Last year in March, the Department of Labor began an exam at his firm, Romano Brothers & Co. in Evanston, Ill., that went in fits and starts over a period of 18 months.

The DOL was looking at 30 profit-sharing plans the firm manages, says Romano, president of his family-owned firm, which has been around for 55 years. “It concluded with a three-page letter that basically said, ‘You’re good,’” he says.

Shortly after the DOL began its exam, Finra started its routine cycle exam, followed two weeks later by the SEC’s investment advisor examiners. In August, the SEC’s broker-dealer exam unit came in. And don’t forget the two separate Finra sweep inquiries last year Romano had to respond to.

None of the regulators found any problems, “but between providing documents and the back and forth, it’s very time intensive,” Romano says. “It’s stressful [with] gotcha-types of questions [and] issues that get examined into oblivion. … I really wonder where we are going with this” type of oversight.

The regulatory pile-on has made it “more and more expensive for small firms to comply,” adds Shawn McLaughlin, chief executive at McLaughlin Ryder Investments in Alexandria, Va., and a member of Finra’s small firms advisory board. “It’s an expensive business to be in.”

And if anything like the DOL fiduciary rule comes to pass, B-Ds will face even more challenges.

The DOL and other regulators are “pushing firms in a direction they’re not best suited for,” says Wendy Lanton, chief operations and compliance officer at Lantern Investments in Melville, N.Y.

Small firms have lots of traditional commission-based brokers and accounts, she says, and “you can’t take a salesperson who’s transaction-oriented and has a deep relationship with their clients and push them into managed accounts.”

Smaller B-Ds with their transaction-heavy business mix for the most part plan to retain their commission business should the DOL rule go into effect, and would try to work with the DOL’s best-interests contract exemption under the rule. “Every single one of your customers [would need] to sign” the BICE, Lanton says. “That’s very challenging” with a clientele that’s not used to signing contracts.

Lanton adds that small firms can’t afford to train and revamp their sales forces to comply with the host of rules and product changes that are forcing more assets into level-fee accounts. She worries about transactional reps playing a role they’re not suited for—becoming portfolio managers and holistic wealth managers.

Oftentimes, DOL rules could clash with the SEC’s. “If the DOL had its way, every account would be level fee,” Lanton says. “Then the SEC would have a field day … saying [those fee accounts] need to be appropriately managed.”

With the DOL rule delayed, another issue has resurfaced: the cost of getting certified audits. “The No. 1 thing I hear about from other small dealers is the PCAOB audits,” McLaughlin says.

Under the Dodd-Frank Act, financial statements filed with the SEC must be performed by an accounting firm certified by the Public Company Accounting Oversight Board. Brokerage firms say auditors certified by the PCAOB cost several times what a normal CPA would charge, and since small firms generally don’t custody assets, there’s little risk of the Madoff-type fraud certified auditors are designed to stop.

“In our case, the audit went from $4,000 to $15,000 a year,” says Carrie Wisniewski, president of BD Compliance Associates Inc. in Lilburn, Ga., and head of Bridge Capital Associates, an investment banking firm. “And [PCAOB auditors] don’t even prepare the audit. … I send [financials] to the auditor with supporting documentation, and they sign off on it,” she adds.

Romano, a Finra board member, has on his own initiative met with PCAOB executives and SEC staff about working out an exemption for small firms, an initiative that has been in the works for years but gone nowhere.“That has been very frustrating,” Romano says. The regulators “just don’t see it the way firms see it.”

Of late, cybersecurity and elder-abuse issues have also gotten the attention of regulators, and pose additional risks for B-Ds. Independent B-Ds, with their remote offices, have always been challenged with compliance, concludes Joel Beck, a former Finra lawyer now with the Beck Law Firm in Snellville, Ga.

“Supervision is becoming more of a challenge,” he says, “especially for smaller firms [that] don’t have a big staff.” The regulatory pressures continue to push some smaller operators over the brink.