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Regulation and Compliance > Federal Regulation

Advisors Say

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As an entrepreneur and business owner, one of the toughest things you may struggle with is relinquishing control of a business function and admitting that outsourcing may sometimes be the best solution for your business. That’s exactly what many advisors are doing in the wake of increased compliance requirements and expenses.

The new requirements for RIAs include naming a chief compliance officer and writing a compliance manual (to be accomplished during 2004), and this year, devising an individual code of ethics (the original deadline for which was Jan. 7; for various reasons, the SEC extended the deadline to Feb. 1, 2005). These regulations mandate that financial advisory firms adopt a formal code of ethics that reinforce the importance of an advisor’s fiduciary obligations. As a result, SEC-registered advisors who were not previously required to establish codes of ethics now must do so. Rule 204A-1 represents an expansion on what traditionally has been included in codes of ethics for mutual fund advisors.

For many of the investment advisors we spoke with as part of our ongoing survey of RIAs, some of their biggest concerns heading into 2005 were new securities regulations and their inherently high compliance costs. There’s good reason for such concern. According to Rydex AdvisorBenchmarking’s data, compliance expenses increased a dramatic 153% in 2003 compared to the previous year.

We asked advisors why compliance expenses had risen so sharply. More than half (50.47%) cited the expense involved with developing written supervisory procedures (a compliance manual) as the reason. The next most common reason for increased expenses was legal fees (29.72%), followed by insurance premiums (22.64%).

As a result of the new compliance requirements, most advisors needed to establish new procedures and processes. In fact, as shown in chart 2 below, 62.26% of advisors cited adoption of written supervisory procedures (compliance manual) as the number one step they took to meet new compliance regulations. Other changes made included the appointment of a Chief Compliance Officer (55.19%) and the development of a business continuity plan (37.74%).

Reducing Costs by Outsourcing

Because many firms lack the internal expertise needed to implement regulatory changes quickly and efficiently, it’s not surprising that outsourcing has become a popular cost-cutting solution. Managing compliance functions in-house usually requires more financial resources and time than outsourcing those functions. According to Jennifer Lane of Compass Planning Associates (Boston, Massachusetts), “For small firms, it’s a lot cheaper to outsource compliance than to hire someone and pay the salary and benefits in-house. It’s also more time-consuming [to do compliance in-house]. But even if outsourcing is helpful, you need to stay in close touch with the compliance company.” Gregory D. Gardner, a CFP from Gardner Group (Dallas, Texas), recommends outsourcing. “I think that compliance expenses are not just a money issue, but also a labor consideration. Outsourcing is a reliable way to meet all of the SEC requirements.”

While compliance costs saw the most dramatic increase last year, other expenses are on the rise as well. Because of these increased operational expenses, we also asked advisors whether these expenses might prompt them to consider selling their businesses. We received a resounding “No!” in response. Only about 5% of advisors were considering such a move.

Although rising compliance costs were a top issue for financial advisory firms last year, our research found that most advisors expect the costs would level off in 2005. While the increase is already realized, the compliance burden will not be going away any time soon, and it’s very likely that there will soon be additional changes to rules and regulations. These two facts alone may make outsourcing compliance functions more attractive.

Maya Ivanova is a

research analyst with Rydex, an affiliate of

Rydex Investments. She can be reached at [email protected].


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