Is the NASD's regulatory clampdown over? Major
changes are in place at the sales force level.

    You probably would never expect to see Commonwealth President and COO Peter Wheeler decked out in a police officer's uniform or outfitted as a judge, but he says there have been in times in the past five years when he felt a little like both-thanks in large part to the National Association of Securities Dealers massive and repeated sweeps and mandates.
    "I do feel like we are treating our representatives like they're criminals, and that's the base we're forced to start from," says Wheeler, whose firm works with 1,000 independent reps and advisors who keep more than $10 billion with the Boston and San Diego-based broker dealer. It's not as if Wheeler doesn't believe some of the NASD scrutiny wasn't understandable given highly publicized scandals, or that Commonwealth hasn't developed the least intrusive sales practice monitoring systems the industry can produce. He just wants to be able to redirect his resources and take the focus off the negative when it comes to the independent brokers who are Commonwealth's bread and butter.
    And Wheeler isn't alone in that sentiment, or when he says he wants to get back to the business of helping reps and advisors build their practices. "My mandate in 2006 is that we overreacted," Wheeler admits. "We have to back up and be more conciliatory in helping reps accomplish their goals.     Because senior management overreacted and got spooked, compliance has been given unlimited budgets and they reacted."
    While it remains to be seen whether the NASD will at least curtail the pace of its regulatory inquiries and mandates (recently there have been some fairly vague promises to that effect from top NASD cop Mary Schapiro), leading broker-dealer executives say they are hard-pressed to imagine what area the NASD would look at next.
    "It's interesting, when I watch the NASD come in our offices now," says Wheeler. "We used to be able to say, 'Hey, at least they didn't ask for this file or that.' Now, they have everything covered. I think there is nothing a broker-dealer is doing in any arena that is not being covered. I'm kind of impressed with that."
    He has company when it comes to the begrudging impression that the NASD has hit just about every nook and cranny the independent broker-dealer area has. "They've gone through so many areas. Are they going to go back and look at them again?" asks Bill Dwyer, managing director of national sales at LPL Financial Services. "To the extent this [the NASD's pace] slows down, it will be positive for everyone," says Dwyer, whose firm grew revenues some 27% last year.
    Which doesn't mean there aren't still any number of major compliance issues left for broker-dealers to grapple with. In fact, the heightened supervisory procedures that the NASD has mandated drill down to every sale in every single customer's account every day, and even to which rep is making the sale. Many broker-dealers have been very aggressive designing systems that will stop certain sales that seem to be questionable or not in keeping with what customers said they wanted when they opened their accounts.
    "We're at the forefront when it comes to matching customer suitability with what is sold," says LPL Chief Compliance Officer Joe Tuorto. "When a new client establishes an account with LPL, we collect all the typical 'know-your-client' info like financials, net income, age and investment objectives. If a new sale or trade doesn't appear to match that profile, the account is restricted and the rep can't do business with that account," Tuorto says.
    What happens at LPL if, for instance, a rep tries to invest an 85-year old widower with modest financial resources in an aggressive growth fund? "The account will automatically be restricted until compliance contacts the registered rep to see why the client wants aggressive growth. We won't take off the restriction off until we're satisfied," Tuorto says.
    Does the firm see many "restricted accounts?" "We open thousands of accounts, and we don't get many, but we do get some on occasion and we follow up with the branch right away," he says.
    AIG Financial Advisors' "rules engine" also requires that all sales be run through the system and compared to "know-your-investor" information. Transactions get a green light (go, of course) or a yellow or red light. Transactions that get a yellow light are reviewed carefully by each branch supervisor and by the broker-dealer's compliance department. Transactions that get a red light are stopped until a branch supervisor and compliance agree, usually with input from the rep, on what action should be taken, says Bridget Gaughan, AIG's executive vice president and general counsel.
    "The rules engine allows us to set thresholds," says Gaughan. "For instance, we don't allow B-share mutual fund transactions above the $100,000 mark, so if a rep makes such a sale, they will get a red flag and be stopped. We can also set the threshold, say, $10,000 lower, so the supervisor, compliance and rep get a yellow flag at that point that lets them know that if the client were to add another $10,000 investment, the transaction will be deemed inappropriate."
    Do reps like this kind of high-touch daily oversight? "For the most part, people have made the adjustment," says AIG Financial Advisors President and CEO Jim Gannon. "We've all had to make adjustments to it. Although we've had a lot coming at us as an industry in the past few years, some of the changes were necessary. And I believe deep down that we need to do what is right for the customer, and the [sales] force accepts that."
    In a new twist on what was long considered an insurance product, firms such as LPL have started requiring that the sale of all equity-indexed annuities, which the NASD has expressed concerns about, be run through the broker-dealer. "We did a survey and found that not many of our reps were involved. Still, to be on the safe side, about a month ago we decided that all sales must go through the firm," LPL's Tuorto says.
    A similar LPL tool evaluates if each and every variable annuity replacement or exchange is appropriate and blocks those deemed not to be in the clients' best interests. "It's not mandated for new sales, just exchanges or replacements," says Tuorto. "This gives us documentation if a regulator comes in and asks."
    Last, but certainly not least, is the new NASD rule requiring that broker-dealers create "heightened supervisory procedures" in branches where 20% or more of overall sales come from one rep. A little more than 200 of the 6,700 reps at LPL are now undergoing this enhanced supervision from the broker-dealer. One new upshot: LPL will be visiting these branches each year. "I'd argue that our larger producers have less problems, but the NASD's concern is that the manager who is benefiting from the higher revenues might have a conflict of interest when it comes to supervision," Tuorto says.
    If reps are feeling a good bit less independent these days, they also may be feeling a bit less wealthy, since many firms have felt pressured enough by the heaping helping of new regulation to hire or at least designate a full-time person to manage compliance in their branches. That's a line-item cost that all but the largest practices have never incurred before.
    At the rep level, costs are a critical area, but every smart rep knows they have to have a person almost dedicated to complying with requests from their broker dealer," Commonwealth's Peter Wheeler says. "The other day I asked one rep who had been vocal in her constructive criticism of regulatory demands why she was being so quiet. She told me she had decided to turn over compliance to a person in her office and was now happy to be back out in front of clients," he says. "Reps should be doing what they do best. To do that, they probably have to add a staff person. In a sense, they're getting harder hit than we are."
    AIG's Gannon says that a business development division the firm created about 18 months ago is doing outreach to reps to teach the effectiveness of appointing "a champion of compliance issues so that the advisors can spend their time serving customers. I can think of several offices that did not manage compliance in a centralized fashion and it just wasn't effective," says Gannon. "Now that they have someone, they're much more efficient."
    Gannon says his company characterizes a compliance person in each branch to reps as "an insurance policy that preserves their business and its worth not just with regulators but with possible successors, as well."