From the September 2004 issue of Investment Advisor • Subscribe!

Compliance Zero Hour

More On Legal & Compliance

from The Advisor's Professional Library
  • The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations.  When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.    
  • Nothing but the Best Execution Along with the many other fiduciary obligations owed by RIAs, firms owe a duty to seek best execution of clients’ transactions.  If they fail to do, RIAs violate Section 206 of the Investment Advisers Act.

The October 5 deadline for advisors to appoint a chief compliance officer and adopt formal compliance procedures is right around the corner. Are you ready?

My guess is that the majority of advisors are prepared. But if you have procrastinated, there's no time to waste. You don't want to get caught with an old set of compliance rules that don't apply to your current business, or, worse yet, none at all, when the Securities & Exchange Commission or state regulators come calling.

Joel Shaps, president of Bedrock Capital Management in Los Altos, California, can attest to how important it is to be prepared. He whizzed through an SEC exam about a year ago because his firm was already getting compliance help from National Regulatory Services (NRS) in Lakeville, Connecticut, and from consultants Monahan & Roth (www.monahan-roth.com) in San Diego. "We were ahead of the game," he says. "If you try and prepare for [an SEC or state exam] the day they call, you'll never make it. Someone has to take ownership of the compliance issue in every company." Shaps appointed himself chief compliance officer, or CCO, and is using the NRS (www.nrs-inc.com) compliance manual template and Monahan & Roth's Form ADV aids. During his firm's last exam, the SEC asked for 69 items. Because Shaps was prepared, it took him only a few days to pull everything together.

Peggy Cabaniss, a planner with HC Financial Advisors in Orinda, California, was the sole compliance guru in her small firm until she had to start going online to update her firm's ADV through the Investment Adviser Registration Depository (IARD) and NASD systems. That's when she started using a consultant for compliance help because, like other small advisory firms, Cabaniss was having a hard time keeping up with the deluge of compliance rules. But more help means shelling out more money. "My costs are going to be about $1,500 to $2,000 per year to have our consultant update our ADV regularly, keep our compliance manual up to date, and conduct a mock audit once a year of our firm," Cabaniss told me in a recent e-mail. But she is "happy to pay" the extra costs because new regulations have become so onerous.

Finding a Helping Hand

When looking for help with compliance matters, advisors turn to such resources as outside consultants, their custodians, broker/dealers--and trade magazines like Investment Advisor. For example, advisors can get compliance information from The Consortium's CompliancE-News monthly newsletter, which costs $25 a year for 12 issues and is written by Nancy Lininger. In addition, the Camarillo, California-based Consortium (www.liftburden.com) provides consulting services to investment advisors and broker/dealers on compliance and marketing issues.

In addition to mandating a chief compliance officer, the SEC also requires advisors to come up with a business continuity or disaster recovery plan. Most "advisors don't have a clue where to start," Lininger says, because "how you get your office back up and running is more of a technology issue." With the help of a business continuity expert, Lininger has put together a disaster recovery template that's available to advisors. Fidelity Investments Institutional Brokerage Group, through its PracticeAdvantage services for advisors, also offers a disaster recovery and contingency planning CD-ROM with step-by-step guidelines on setting up a plan.

Among other custodians, Ameritrade recently started offering a compliance e-mail bulletin to advisors who use its AmeritradeAdvisor Platform. The bulletins are provided by National Compliance Services (www.formadv.com) in Delray Beach, Florida. "Trying to comply with all of the SEC and state rules is the number one priority for advisors right now," says Tracy DeWald, Ameritrade's chief compliance officer. Ameritrade asked 20 advisors from its leadership committee for the types of information that they needed nowadays, and the overwhelming response was compliance assistance, he says. The e-mail newsletter is "one of the first initiatives [Ameritrade] has launched to meet those needs."

Jim Blankenship, of Blankenship Financial Planning in New Berlin, Illinois, receives the Ameritrade e-mail bulletins, and also gets compliance help through the Garrett Financial Planning Network (www.garrettplanningnetwork.com). The Garrett Network, which is run by Sheryl Garrett and includes member firms that serve middle-income consumers, sends out e-mail compliance updates as well and holds a quarterly conference call with members to discuss compliance issues.

Blankenship says his compliance burden has typically been pretty light because he doesn't custody clients' assets. But his firm is still required to have a compliance manual. Thanks to help from the Garrett Network, he's had a compliance manual in place for six months. He says he didn't have to spend lots of cash to get compliant: "It's a time issue more than a money issue."

Considering the Costs

To help advisors decide how much money they'll need to devote to compliance, Lininger points advisors to her template that details the cost of setting up a practice. For instance, advisors get compliance tips from many publications. If they don't qualify to receive a free subscription to trade magazines--which are typically the most helpful--they'll have to shell out some extra money each year. Next come costs for compliance newsletters and reference books like the NASD manual. "Professional services" and "legal and accounting" are two other categories. Then there's "compliance consulting." Advisors will also have to devote cash to obtaining different registrations--like registered rep fees, filing an IARD, or state registration fees.

Don't forget about the costs of obtaining various professional designations, like the CFP. Software is another expense, as are memberships to trade associations like FPA or NAPFA, both of which offer compliance help through newsletters and conferences. To buy Lininger's template on setting up your practice, advisors would have to pay an initial setup charge plus annual fees, Lininger says.

Michelle Heyne-Wyrick of the consulting firm BDIA Complete in Seattle says that since the SEC issued its October 5 deadline, her firm has seen a rush of new advisor clients. "Most planners have had [compliance] procedures in place, but they have nothing to do with their actual business," she says.

So how much money should advisors be spending on compliance? "Whatever it takes to maintain a superior program," says Mark Tibergien, IA columnist and partner-in-charge at the Securities & Insurance Niche of Moss Adams in Seattle. "Advisors can't afford to be cheap," he says, "because the risk to the business it too great." Labor, compliance, and errors and omissions insurance are the "fastest rising costs for advisory firms today," Tibergien says. Independent advisors that aren't affiliated with a broker/dealer "will need to ramp up their productivity and capacity to support higher levels of revenue in order to keep pace with these rising expenses," he says. The new "critical mass" for advisory firms, he says, is $1 million in revenue, "though, in reality, it's probably closer to $3 million." It should be higher, he says, because "firms must invest in infrastructure, processes, and technology to maintain a safer business." All of this has to occur "while keeping the principal's compensation as well as the staff's at reasonable levels and producing a reasonable return on equity."

Guy Talarico, co-CEO of EOS Compliance Services in New York, agrees that now is not the time for advisors to cut corners when it comes to compliance. He says that presidents and CEOs of advisory firms that choose to assume the CCO role "have to be very careful" to ensure they can handle the added workload. "Advisors have to make sure that they are fulfilling [the CCO role] and are taking it seriously." Some presidents and CEOs may not be familiar with the Investment Advisers Act of 1940 and other compliance matters, he says, to effectively administer a compliance program. Talarico suggests advisors consider outsourcing the CCO position to a firm like EOS. His firm already serves as CCO for a handful of larger advisory firms and mutual fund complexes with assets ranging from $400 million to $2 billion. Mutual fund firms are having to pay anywhere from $150,000 to $300,000 in annual salaries to bring on a CCO, he says. But EOS's services aren't cheap. Annual fees range anywhere from $75,000 to $125,000. But the problem with outsourcing the CCO role is that the SEC requires that the officer be "intimately familiar with the firm's operations." This could be difficult if the firm you outsource the function to is located across the country.

Money-Laundering Rules

If the new SEC rules were not enough, right around the corner are U.S. Treasury money-laundering regulations for RIAs. The proposal that RIAs have their own set of money-laundering rules came out last May, and industry officials expect the final rule to be issued any day. A fair number of advisors are already affiliated with mutual funds, banks, or broker/dealers and are thus subject to anti-money-laundering rules. But "the U.S. Patriot Act didn't include investment advisors," says David Tittsworth, executive director of the Investment Counsel Association of America (ICAA) in Washington. "Who knows if Congress [omitted advisors] with great understanding, but I think it was appropriate because advisors don't have custody of client money in most cases. The whole idea of anti-money laundering is basically 'follow the money.'" But Treasury is arguing that advisors should be subject to anti-money-laundering rules because advisors are in a know-your-customer position. That argument "is not without merit," Tittsworth admits.

Whether they like it or not, advisors are being barraged with new regulations from all corners. No longer is the motto "be prepared" just for the Boy Scouts. Fortunately, advisors have plenty of resources for building their defenses.

Washington Bureau Chief Melanie Waddell can be reached at mwaddell@ia-mag.com.

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