What’s the buzz at almost every industry conference these days? People and compliance. Neither is discussed with much fondness, since both subjects are raising the anxiety levels of anybody who is running a financial advisory business these days. This intersection of a firm’s human capital with its risk management initiatives is not always a conscious connection until the you-know-what hits the fan, but we can see a pending collision from blocks away in how a firm practices. While Mr. McGoo stumbles through traffic loaded down with client files, one car is carrying the growing cost of insurance, another the rising number of claims, and a third the expanding amount of time that is dedicated to protecting the business from disaster. Tires are screeching and he can’t hear the shouts to “look out.” But even if he did, in which direction should he turn?

In the year 2000, 83% of broker-dealers offered errors & omissions insurance to their reps; in 2005, 73% of broker/dealers offered coverage. For those reps still able to purchase coverage, premiums have reportedly tripled. In one of the studies done by Moss Adams of large advisory practices (more than $900 million of AUM), the annual cost of compliance has risen to an average of $250,000. This is consumed in staffing as well as insurance. We don’t know the full impact on productivity yet but, anecdotally, advisors in all platforms complain of how the extra steps in how they render advice and deliver service is keeping them away from working with clients and prospects.

Unfortunately, the issue of safety has a broader reach than just compliance. Safety impacts how you accept clients, how you fire clients, how you hire and manage staff, and how you monitor receipts and disbursements. With advisory firms becoming larger, the span of control becomes more difficult to manage and your ability to control events becomes even more tenuous. Often, advisors only confront slippage when audited or sued. How often do you discover after the fact that something bad has occurred, and some feckless individual would say “Oh, I knew that was going on.” It makes you want to pull your hair out (and hers).

It Starts at the Top

On one of my many cross-country plane trips, I sat next to a hotel specialist who said the best companies are those that indoctrinate all of their people into believing that “if you heard the problem, it’s now yours.” His point was that regardless of your position in the hotel hierarchy–from housekeeper to receptionist to general manager–if you see an issue, it’s your obligation to make sure it gets addressed by somebody who can fix it. This is not just about pride in the client service experience but about having a sense of ownership in your company. How often do we wish that when someone on our staff sees or hears about a problem that they would own it?

Like everything, the tone is set at the top. Are we encouraging a culture of competence and safety? Do we leave issues to fester because we don’t have the time or sense of urgency necessary to resolve them? Do you make exceptions to your own policies? Do you ensure that everyone has a responsibility for safety?

Well-managed firms consider the concept of “safety” as one of their pillars. The other two would be “people” and “clients,” each of which supports their business model. As with any structure, if you have a weak framework, your foundation will collapse. By making safety a featured part of how you operate, you may find that decisions about clients, staff, processes, and procedures get examined in light of their potential impact on your business.

Let’s look at four areas of safety that are not specifically compliance issues but if neglected could ultimately become compliance problems for your firm: Client Acceptance & Retention; Work Environment; Quality Control; and Operating Control.

Safety Area #1: Client Acceptance & Retention

What is your filter for evaluating whether a client is appropriate for your business? Is it net worth or assets alone? Are there other characteristics that you should examine? The principals at the firm Brightworth (formerly Polstra & Dardaman) in Atlanta have implemented what they call a “Client Fitness Test” that allows them to evaluate new clients on a variety of subjective factors such as behavior toward each other, attitude about investing, and proclivity to delegate. Whoever has developed the prospect has to demonstrate to the partners that this would be a good client for the firm. Their discipline around client acceptance has not only reduced their client complaints and their compliance risk, but has made their work all the more pleasant because they don’t have to serve clients they don’t enjoy.

Other firms go through an annual review of their current clients to see if it is still appropriate for them to retain a relationship. The urgency of this idea came clear in a recent story I heard about an advisor who, for four years in a row, had advised one of his clients to begin reducing a concentrated position in his company stock. The recommendations were documented and renewed every year, yet the client never took action. As might be expected, the stock plunged in value, the client’s net worth rode down with it, and he sued. He got the benefit of a jury trial that ruled in favor of the plaintiff to the tune of many millions of dollars. Would circumstances have been different had the advisor terminated the client or not charged a fee for all of the client’s assets, including the concentrated stock? That would be a good discussion during a client review to determine how much risk you’re willing to take to keep the relationship.

Safety Area #2: Work Environment

Many people in the securities business miss those halcyon days when everything would go, ribald jokes would fly, and their business life would flow over into their social life. Missed by everybody, that is, except those who were offended by the behavior of their bosses and co-workers, or who were denied opportunities because they didn’t play along.

Safety plays a role in how we treat each other. Respectful behavior leads to a more positive and productive work environment. The failure to honor this code can result in turnover or, worse, lawsuits alleging harassment. Every practice, regardless of size, has its own culture about what is tolerable and what isn’t. But as an action step, it’s a good idea to review with everybody what would put your practice or yourself at risk if someone (including yourself) crossed the line. This is not just a problem for big business–in fact, it’s rampant in small businesses that don’t have human resource departments to implement formal training, or a complaint process to manage the issues.

The challenge for owners of practices today is to take action with staff members who are putting the firm at risk. Because of what many see as a talent shortage, there is a reluctance to be firm with those who produce a lot of revenue, or who bring unique skills to the job. You have to ask yourself whether those benefits are reason enough to overlook how problem employees might be impacting staff, clients, and the firm itself.

Safety Area #3: Quality Control

One of the downsides of growth is that our span of control changes. The founder of the practice no longer touches everything involved with the client. There may be somebody responsible for the forms, another for the development of the financial plan, another for the investment or insurance recommendations, and yet another for the production and delivery of reports. As advisory firms grow, it’s important to implement a set of checks and balances to catch the inevitable human error, especially as you add new people to the mix (or people who don’t have a real aptitude or interest in the job you are asking them to do).

As practices go through periods of deconstruction and reconstruction to prepare for the next wave of growth, many advisors are mapping their workflow to ensure they have the right people doing the right things the right way. In one case where we helped a growing practice to evaluate how a single client was handled from the moment she was a prospect to when the first quarterly statement was delivered, we found they had 18 discrete steps in the process. This means there were 18 potential areas of breakdown that could have impacted either the quality of what was delivered or the client experience itself.

In a recent advisors’ study group discussion on this subject, we found that more and more firms are implementing a system of risk assessment for their staff and partners. This isn’t intended to find blame but to identify behavior that has to be changed. Some have created a template that forces people in a practice to assess themselves as well as others with the results addressed by the owner or leaders in the practice. If the owner himself is the biggest culprit, this presents a unique set of challenges but may be one reason why people leave a firm. Such conflict is a good reason to have someone independent evaluate your practice procedures beyond what is required for an SEC or NASD audit.

For example, in one practice that has multiple advisors, they annually review each other. Each partner randomly picks five to 10 clients of their colleagues and evaluates everything that has been done with those clients from start to finish. At Budros, Ruhlin &

Roe in Columbus, Ohio, they have another solution: A natural set of checks and balances as they rotate client

meetings among their three partners. In the process of familiarizing themselves with what has been done by the

other partners, they can detect if something is amiss.

Safety Area #4: Operating Control

Over the past year there have been rumblings that the SEC may require all registered investment advisors to get audited financial statements regardless of whether or not they are taking delivery of securities. The initial reaction to this idea was that it was another overreaching effort on the part of regulators that will make it harder for small firms to stay in business. Yet as independent firms grow, there is clearly a need for tighter financial controls.

In both the independent RIA and the broker/dealer rep model, life becomes complex when practices grow to over $1 million of annual revenue. In either model, where the firm is independent of a larger company, there is someone in the practice accountable for managing the assessment of fees and the payment of bills. We are also hearing more anecdotes about how the fee assessments aren’t always accurate and that clients may have grounds to challenge advisors for overcharging.

More frightening is what might be happening in client accounts or with the advisor’s own bank account if the owner is not prone to monitor his financials carefully. There will come a point in the larger practices when they will require assurance that what is received and what is paid is appropriate and not fraudulently or mistakenly conveyed. This will happen regardless of SEC regulations.

One of my colleagues, Tom Davis (who is a fraud specialist and former FBI agent), is frequently sought as an expert witness in litigation matters. He has told me many horror stories about clever internal accountants and bookkeepers that manage to dupe firm owners for a long time out of a lot of money. He says that many of these cases could have been detected early had the businesses implemented a systematic fraud prevention program. When one considers the volume of money–not just fees assessed but assets gathered–for which an advisory firm is responsible, the idea of accounting controls to provide for tighter checks and balances seems to be a good idea.

Now that we are living in a litigious world, it is just good business to have a way to monitor all the areas that put a financial advisory business at risk. While most practices we have encountered are managed by good, ethical people, it is often the perception of bad behavior that costs them, not the actual act itself. Imagine that Mike Wallace and his 60 Minutes camera crew comes into your office to ask you why you did this or that. With beads of sweat on your upper lip, and eyes averted, how will you come off if the question is about how your people, processes, clients, or internal controls are being managed? Do you have in place what needs to be done? Or will you have to say “I’ve been meaning to get to it, but I’ve been too busy bringing in new business.”

Clearly, the advisors most at risk are those who have not made safety a part of their culture and who have framed all of their decisions purely in terms of NASD or SEC compliance. The best managed firms have made risk management a responsibility of everybody who works there and have implemented a systematic process for assessing both staff and clients. For those who don’t look the other way as a matter of practice, but value safety as much as growth in clients and service, they will find that the investment of time and attention in such an initiative will save them from major and costly distractions.

Mark Tibergien, a principal in Moss Adams LLP, is chairman of the firm’s Securities & Insurance niche. A nationally-known consultant to financial advisors, he is the co-author of Practice Made Perfect, available through the IA Bookstore. E-mail him at mark.tibergien@mossadams.com.