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."