When it comes to the potential liabilities associated with compliance failures, the numbers don’t lie.
Consider a recent arbitration award case involving a small, independent broker-dealer on the East Coast. Regulators slapped the firm with a $3 million fine, holding it, its CEO and its chief compliance officer jointly and severally liable — which means if the broker-dealer is unable to pay, those two executives are on the hook.
There are countless other stories like this, and they all highlight a fundamental reality that confronts many smaller IBDs and offices of supervisory jurisdiction (OSJs) in today’s environment. That is, the difference between having a thriving enterprise and going out of business due to a single compliance misstep.
Performing required compliance and supervisory functions is both time-consuming and costly, making proper oversight a tall order. The onset of Reg BI only will raise the stakes and make this undertaking more expensive.
It’s hardly surprising, then, that small-to-medium-size firms and OSJs, faced with increasingly slim margins, are having a hard time recruiting advisors. True, expanding compliance and supervision costs are just one part of a complicated picture, but it’s impossible to ignore how the regulatory climate is constraining the way these types of firms can operate.
It is feasible, however, for small to midsize IBDs, as well as their OSJ affiliates, to have top-notch compliance and supervisory oversight without breaking the bank. The answer is outsourcing tasks such as branch inspections and email review.
To be sure, these are not responsibilities you can farm out to anyone other than an experienced, discerning, unbiased professional who has a long history of contending with compliance issues that are unique to our industry. For example, if a firm outsources branch inspections, an experienced professional will more than likely do their homework before exams and work through their checklist diligently but quickly, aiming to wrap up an exam in one day.
Small and midsize firms typically pursue one of two avenues when it comes to compliance. One is to hire a chief compliance officer to serve in-house. That sounds great in practice, but experienced CCOs often demand generous salaries, which puts a strain on finances and can crimp profits. At the same time, opting for someone a bit greener to save money could expose firms to greater risks if they are not up to all the demands of the job.
Another option is to delegate compliance and supervisory functions to OSJ managers. However, this approach is rife with training costs and potential conflicts of interest because OSJ manager compensation may be tied to the financial performance of the very office they are auditing. Certainly, many professionals have performed admirably in this role, but there’s still no mistaking that it is possible to overlook problems if exposing them would be painful financially.
Based on our firm’s experience, a small branch thousands of miles away that either intentionally or unwittingly has run afoul of regulators is precisely the sort of thing that keeps an IBD CEO awake at night.
The key is spotting these risks before they manifest into serious problems, including lawsuits that may pose an existential threat.
Given the potential fallout, the unavoidable question that all small and midsize firms should be asking themselves is: In whose hands do you want to trust the future of the firm — an inexperienced employee-examiner, an OSJ manager tasked with auditing their own cash cow or an unbiased, experienced and meticulous third-party professional?
While the idea of outsourcing some compliance and supervisory tasks probably seems like it comes with its own set of risks, the reality is it often is the most thorough, cost-effective and sensible approach. What’s more, it can bolster a firm’s value proposition with recruits.
Sander J. Ressler is founder and managing director of Essential Edge Compliance Outsourcing Services LLC, a Delray Beach, Florida-based regulatory and compliance supervision consultancy.