As new rules pile up, so do the costs and the frustration.

    For independent broker-dealers, these are the best of times and the worst of times. Rarely has the potential of the business, with a huge demographic wave of baby boomers approaching retirement, looked brighter. But never has the regulatory climate been more challenging.
    "The pendulum has swung far to one side," says Joe Deitch, CEO of Commonwealth Financial Network in Waltham, Mass. "A lot of the changes, like increased awareness and disclosure, are good. On the other hand, this is a paperwork industry and if people have too much paperwork, it's a problem."
    The combination of a hostile regulatory climate and a lackluster environment for the financial markets is driving advisors' fee business. At Commonwealth, fees now represent about one-third of its total revenues and the fastest growing part of the business.
    At LPL Financial Services, the nation's largest independent broker-dealer, fees contribute to more than 50% of the firm's revenues and many of the firm's bigger offices are doing more fee business than that. "The biggest change we've seen is the drive towards advisory relationships," says Mark Casady, LPL's CEO. "It focuses on what the client needs."
    Casady concedes that new demands from regulators are taxing the firm's reps. "There now is a tremendous amount of paperwork involved in opening a new account," he explains. "People are frustrated but they are learning to cope."
    As chairwoman of the National Association of Independent Broker Dealers, LaRae Bakerink has been a proponent of practices that provide full disclosure to consumers. Yet she has also been a proponent of balance in the way rules are promulgated to support transparency in the marketplace. Sometimes, she and others in the broker-dealer marketplace feel, the balanced has tipped too much to the side of paperwork, bureaucracy and tedium.
Bakerink, for example, supports the goals behind NASD Rules 3013 and 3012, which were approved last year to ensure that firms have systems in place to supervise and monitor their regulatory compliance operations.
    What she does find discouraging, however, is that the rules in some ways adopt a one-size-fits-all set of regulations for ensuring compliance. The new rules create, among other things, a significant amount of paperwork for CEOs, who are now required to meet regularly with their compliance officers and annually attest that the firm has a process for establishing, maintaining and reviewing compliance and supervisory procedures.
    What the rules don't explain, however, is how the paperwork is going to enhance disclosure at a broker-dealer like WBB Securities in San Diego, where Bakerink serves as both CEO and chief compliance officer. "We're still struggling with how to do it appropriately," she says.
    Like Bakerink, a lot of broker-dealer executives say they are walking a fine line when it comes to the wave of new rules and regulation that have hit the securities industry the past three years. In one sense, they acknowledge, it's hard to argue against more disclosure and safeguards for consumers, particularly in light of the scandals that have helped touch off the renewed regulatory vigilance on both the state and national levels.
    Yet, with the rules coming so frequently and so fast, it's also true that broker-dealers are straining to keep up-in terms of compliance operations, the training of personnel and dealing with the resulting increase in operating costs. Particularly among broker-dealers who feel they've been following the rules all along, a certain degree of annoyance and resentment is evident the fact that their operations have been made more difficult by those who have not followed the rules.
    It is at the point where compliance has become perhaps the top issue facing broker-dealers, particularly smaller firms where the cost of compliance represents a substantially larger share of operating budgets compared to larger competitors. "I would say that at every industry meeting that I have been involved in, no matter what the original purpose, it has turned into a compliance and regulatory discussion," says Brian Murphy, chief executive at Woodbury Financial Services in St. Paul, Minn.
    Other broker-dealers also report that compliance issues have become more pervasive in firm operations, impacting everything from technology spending to corporate strategy to the time individual reps must spend dealing with added paperwork. Timothy Lyle, senior vice president and chief compliance officer at Mutual Service Corp., says the sheer volume of regulatory oversight continues to accelerate, and has since about 2003.
    "Prior to the last couple of years it was pretty rare, other than if you messed up something on a filing, to hear directly from the SEC.," Lyle says. "Now it's much more common for them to contact you a few times a year and ask for updates and procedures."
    Another change is that people are being made more accountable, such as is happening with the new CEO certification requirements. Lyle says it has created a "newfound anxiety" within the workplace. "There seems to be a little more personal risk-not just at the compliance officer level, but other levels also," he says.
    While acknowledging this could have the positive effect of making people more accountable, Lyle also sees at least one unintended impact. "Right now there are good compliance people leaving compliance organizations not willing to take that risk," he says.
    Mark Goldberg, president and CEO of Royal Alliance, says the new regulatory environment means that broker-dealers have to be proactive during the early stages of the rulemaking process. "The days of waiting for the SEC or NASD to issue some proposal and ask us to comment, and then getting involved, are over," he says. "It's obviously not going to work. It hasn't worked and it's not going to work going forward."
    Among the things Goldberg is pressing for is a study by the NASD that would compare the compliance record of wirehouses versus that of independent broker-dealers. "We believe it would show that the independent financial services have a great deal less problems than other distribution channels," Goldberg says.
    Another indication of how important compliance has become in broker-dealer operations is the burgeoning compliance services industry. The rise of new regulations continues to spawn companies whose services can range from compliance consulting to actually carrying out certain facets of regulatory compliance as a third-party vendor. It's estimated that compliance software applications have grown into a $1 billion business; some studies suggest the sector will grow to $2 billion in sales by 2009.
    "I think the biggest challenge is that broker-dealers don't have any guarantee that what they're doing today is going to be deemed in the rules by the regulators tomorrow," says Dale Brown, CEO and executive director of the Financial Services Institute, an association of independent broker-dealers founded in January 2004. "It's been such an overwhelming environment over the last two years that I don't know that anyone has had the ability to make the kind of adjustments they need to stay ahead of this."
    In the current environment, broker-dealers say, preparing for rules under proposal is just as important as reacting to rules that have received final approval. The FSI, Brown says, has taken on the job of acting as a "filter" for members by "helping them identify rule proposals on which they out to focus attention."
    Broker-dealer compliance officers have also been active subscribers to NASD and SEC publications to keep up with potential rule changes.  "We don't like to get blindsided," says B.J. Johnson, senior vice president for compliance at Cadaret, Grant & Co. in Syracuse, N.Y. The firm keeps staff apprised of current and upcoming rule changes through a monthly newsletter and its Web site, she says. "It's very difficult to anticipate what's going to happen, but you try. You always look for ways to improve your procedures and being proactive helps."
    Another way in which broker-dealers are choosing to be proactive is involvement in the rulemaking process. Murphy at Woodbury Financial Services says his firm has decided to actively comment on rules up for proposal-partly so it isn't finding out about the consequences of rules after they are approved.
    "We are doing it just about every time they ask," he says.
    Among the proposals that are getting the most attention from broker-dealers are the CEO certification requirements, mutual fund point-of-sale requirements and new suitability and disclosure rules in the sale of variable products.
    The rule proposals, for example, would require broker dealers to do an analysis of fees and other costs for each client and each individual mutual fund or variable product in which they may choose to invest. The analysis is largely based on each product's prospectus.
    Broker-dealers say the rule changes could have a significant impact, considering that advisors could be faced with the task of doing hundreds or even thousands of fund analyses for one particular client.
    "The unintended consequence is a lot of broker-dealers will be forced to dramatically cut back on the number of mutual funds they offer," says FSI's Brown.
    Another drawback could be that it will place too much emphasis on fees, and not enough on the investment management, says Bakerink of the NAIBD. "Clients could be hurt in the long run because the fees don't have a lot to do with return," she says.
    While lauding the goal of full disclosure, broker-dealers are calling for balance between the ideal and the practical. Brown fears that if the paperwork piles up much more, clients visiting their advisor will be similar to what purchasing a mortgage is like since the Sarbanes-Oxley Act. "You end up signing a big stack of documents that very few people take the time to read thoroughly and completely," Brown says. He feels that prospectus documents already provide most of the information consumers need to make informed choices, and that regulatory efforts should be aimed at making them more accessible.
     "The prospectus is already a challenging document to understand. Adding disclosures on top of the prospectus-I don't see that as helping," he says. "They ought to focus on making the prospectus more plain English and understandable."
    Bakerink worries about the impact on small broker-dealers, noting that the number of NASD-regulated firms has decreased the past two years, while the number of branch offices has increased. "That tells me firms are either merging or being acquired," she says.
    Those with a history in the broker-dealer industry note that previously there have been in which compliance and regulation have been hot issues. "The pendulum has definitely swung in one direction," says Brown. "The question is whether it's going to come into a more balanced place, where self-regulation can strive and fulfill its function in the securities industry."

With all these challenges, many brokerages are placing more emphasis on helping reps upgrade their management skills through a variety of consulting services. "I learned the hard way that running a business is not intuitive and that I was not alone," Deitch says. "It's a function of how you leverage your talents."