LPL Financial Holdings Inc. (LPLA) said late Tuesday that it expects third-quarter regulatory charges of $23 million, about $18 million more than initially anticipated. The charges, which will lower earnings by $0.11 per share, are related to issues involving its “systems, policies and procedures.”
The independent broker-dealer’s Q3’14 revenue should be about $1.1 billion, while net income should be about $33 million, or $0.33 per share, it said in an earnings update filed with the Securities and Exchange Commission. Adjusted earnings should be about $0.48 per share based on net income of $109 million; analysts polled by Yahoo! Finance were expecting the company to earn $0.58 per share.
In a statement, Chairman and CEO Mark Casady said LPL had “made progress towards the resolution of certain regulatory matters.” Casady also explained that “the nature of these matters makes it challenging to identify and evaluate the exact timing and magnitude of their resolution, but we are now able to estimate the potential costs associated with addressing these regulatory matters.”
One financial analyst following LPL Financial says the company’s regulatory costs have been on the rise and may not “return to historic norms.”
“We are increasingly cautious as regulatory expenses have been steadily rising and have proven difficult to predict,” said the analyst, Steven Chubak of Nomura Securities in a report issued early Wednesday. “We have no basis on which to suggest that these costs should begin to decline.”
In Q2, LPL Financial executives said its full-year regulatory costs should be $19 million for the current fiscal year. Tuesday’s announcement pushed this figure up to $32 million.
The company is scheduled to announce its third-quarter results on Oct. 30.
In the first half of 2014, LPL expensed $9 million in charges. Before Tuesday, the company expected, “based on consideration for the overall regulatory environment,” that these costs would average $5 million in charges in both the third and fourth quarters.
LPL says it will “continue to re-engineer our risk management and compliance capabilities,” and that “the strength of our fundamental growth drivers remain intact,” according to Casady.
After Tuesday’s announcement, Nomura Securities downgraded LPL Investment from Buy to Neutral (with a price target of $45 vs. an early price of $55). LPL’s stock traded down about 7% at $40.16 per share midday Wednesday.
“Management’s inability to guide effectively on expenses (and regulatory costs in particular) has been a recurring problem in 2014,” Chubak said. “While we empathize with management given the seemingly difficult task of predicting regulatory fines, we expect shareholders to be less forgiving, and to likely remain on the sidelines barring visible progress in this area.”
Annuity, Regulatory Issues
As of year-end 2013, according to Investment Advisor’s annual directory of independent broker-dealers, LPL had 13,673 producing reps and $4.05 billion in gross revenue, of which about 21% of sales came from variable annuities.
(In the same period, variable annuities accounted for 13% of sales for Commonwealth Financial, 12% for Raymond James Financial and 14% for Cambridge Investment Research.)
Earlier this month, LPL Financial agreed to pay $541,058 to senior citizens in Massachusetts after it failed to properly disclose surrender charges these clients paid when switching variable annuities.
In a memorandum of understanding with the Massachusetts Securities Division, LPL acknowledged that certain annuity switch transactions were conducted in “the absence of accurately disclosed surrender charges or in which other determinations were not properly documented.”
The IBD agreed to pay Illinois regulators $2 million earlier this year for failing to maintain adequate books and records and failing to enforce its supervisory systems and procedures involving variable-annuity exchanges, or 1035 exchanges, between 2009 and 2013. It also had to pay some $820,000 in restitution.
In 2013, FINRA fined LPL $9 million for 35 separate “significant e-mail system failures.”
In its second quarter, LPL reported a 4.4% drop in net income from the prior year, blaming the decline on unforeseen regulatory costs that increased general and administrative expenses, which were up 24.6% in the quarter year over year.
“In reviewing our third-quarter core G&A costs, excluding the incremental $18 million of regulatory expense, we expect our run rate core G&A to be $167 million to $169 million,” said CFO Dan Arnold, in a statement Tuesday. This would represent a 4% increase in expenses from 2013’s third quarter.
During the firm’s earnings call in July, Casady said that roughly 80% of the regulatory fines in the second quarter were rounding errors in transactions that primarily use paper-based products. At the time, the company had grown its legal and compliance department by 41% to mitigate future regulatory costs, according to its chairman and CEO.
In the short term, Normura analyst Chubak says, the company has to show investors that it can turn both the regulatory outlook and its spending situation around.
“Our updated target price of $45 (vs. $55 previously) reflects a lower target multiple of 14 times earnings, as the valuation will likely remain depressed until progress is made in meeting forward expense guidance. In short, LPLA has become a ‘show-me’ story,” said Chubak.
— Check out LPL to Pay More Than $500,000 Over Annuity Surrender Charges on ThinkAdvisor.