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How to Avoid Compliance Policies That Cater To the Lowest Denominator

How to Avoid Compliance Policies That Cater To the Lowest Denominator

00:00 01 May in Articles Written by Jon Henschen

by Jonathan Henschen, CFS and featured in AdvisorBiz
May, 2010:

The past two years have been unlike anything I’ve seen since entering the financial services industry. Regulations have become increasingly labor-intensive, while broker-dealers are on the defensive; doing everything they can to shield themselves from the potential liability of their own advisors.

Regulations in our industry are seldom black and white. Plenty of room has been left, for example, for broker-dealers to decide how advisors are supervised, or how marketing materials are approved, or the complexity of business paperwork.

The ideal scenario is when advisors are with firms that do what financial services regulators require, but not much more. Problems arise, however, when broker-dealers experience certain triggers that end up making their advisors’ lives much more difficult. Here are a few examples of those triggers:

  • Large arbitrations paid – When markets tank, some clients go after advisors over market losses. When complaints start piling up, broker-dealers often make things even worse. After shelling out some large fines, for example, regulators may ask broker-dealers: “How will you keep that from happening in the future?” This is when some firms go from normal or under-compliance to over compliance, with management giving their Compliance departments free reign over company policies: making paperwork more extensive, loading it up with legalize, or becoming increasingly restrictive with anything and everything to do with liability.
  • Insurance broker-dealers – Although not really a compliance trigger, insurance broker-dealers with a history of compliance that caters to the lowest denominator tend to be obsessed with shielding themselves from their own advisors. Most insurance broker-dealers operate under OSJ (Office of Supervisory Jurisdiction) management style. This adds work and liability to advisors, but less to broker-dealers. Insurance broker dealers also have a tendency to be heavy on company policy that goes above and beyond what regulators require. It is not uncommon to find insurance broker-dealers policing of it Advisors to be 60% company-policy requirements and 40% regulator requirements, which substantially complicates how advisors run their businesses. Example: An insurance broker-dealer that paid large arbitrations in 2009 audits their advisors’ finances and checkbooks, as usual; but they are now doing the same with their advisors’ spouses. Talk about over the top.
  • Change of firm ownership – When a firm is sold out from under you, the usual advisor fear is: “Now, how will things change?” We’ve experienced non-insurance broker-dealers bought out by insurance broker-dealers with the worst-case outcomes. Advisors at non-insurance broker-dealers may have already fled insurance broker-dealers to gain a greater ease of doing business, but now find themselves back in the belly of the beast. You might be thinking to yourself at this point, “This guy must really hate insurance broker-dealers!” But my perception is driven not only by my experiences, but also by the many advisors we consult with every day for many years who have overwhelmingly given insurance-owned broker-dealers more negative feedback than others. Sure, exceptions prove the rule, and we continue placing advisors with several insurance broker-dealers that fight those generalities.
  • Firms with high ratios of small producers – When you’re part of a firm with a high percentage of small producers, it is almost unavoidable for their compliance policies to cater to the lowest denominator. For instance, a large insurance broker-dealer we’ve placed advisors with had recently paid a $1 million fine on an advisor who had grossed $25,000 in production. That single event prompted the broker-dealer to raise its minimum production requirement to $50,000. Except for advisors with outside businesses,–such as a P&C agency, a CPA/EA business or large fixed-insurance producers–small producers risk making unsuitable choices in client portfolios for the sake of earning livable incomes. One firm we actively place advisors with, for example, has a very high average production per advisor, only hiring those with at least $200,000 in production. When meeting with advisors considering joining their firm, one thing is made clear: “We don’t have compliance policies catering to the lowest denominator, because we don’t have lower denominator.!” On the flip side are firms giving excess leeway to producers who would have been fired if their production were at $100,000. In fact, some of the largest arbitrations we’ve seen come from those “large” producers who stayed off the firm’s radar screen because  a double standard.
  • Fast growing broker-dealers – When a firm grows more than 15%-20% a year, adequate staffing can become nearly impossible and supervision suffers, which can eventually lead to arbitrations. Moreover, a broker-dealer’s location can make a big difference in how much growth it can handle. For instance, a Chicago firm can place newspaper ads for operations people and get stacks of resumes, while a firm in central Wisconsin struggles getting any candidates from essentially the same ads. Another factor to consider is a broker-dealer’s staff-to-advisor ratio. We know of a firm in the Easten U.S. with access to legions of financial services personnel, but which sticks to a ratio of “10 advisors for every staff person.” Recently with the rapid growth they’ve experienced, that firm’s service level has fallen off a cliff, and their advisors are frustrated at the lack of communication at all levels. So is there any wonder that other problems are sure to follow?

Advisors who have been with the same firms for many years often have no way to compare if their compliance experiences are out of whack. If you’re wondering about that, consider these examples for perspective:

  • Highly restrictive on outside seminar platforms, such as the Bill Goode system.
  • New-client account forms with more than 3-4 pages. *Mutual Fund & Variable Annuity Switch Forms are over a couple of pages.
  • When the ability to 1035 Exchange Variable Annuities is extremely difficult. This is a Red Flag. You should be able to do 1035 Exchanges during proper protocol, but some firms have so much upfront paperwork, advisors are discouraged from even pursuing potential 1035 Exchanges.
  • Compliance approvals are too long. Brochures and letters should take no more than a week, seminars one to two weeks, and book approvals no longer than a month. If your timelines are beyond those, your firm is either understaffed in compliance or simply does not care about its own timeliness.
  • Marketing Materials & Seminars submitted to Compliance return with excessive omissions. This effectively squeezes out the original appeal the material may have had, and leaves you handing out a lot of useless generalities. If you ask Compliance to explain their omissions, but they come back with “That’s the way it is,” you have a problem.

Working with a broker-dealer’s balanced compliance policy can be liberating if you’ve experienced the alternative. It is not just for you, of course, but also for your clients. For with balanced compliance comes the freedom of marketing yourself with simplified paperwork, which does not intimidate your clients and, most of all, gives you a lot more time to spend with your clients–and your family.

As common sense as all this may sound, however, a lot of firms still take the low road to compliance, causing everyone to suffer for the sins of a few. Face it: If your firm is stuck on this low road, you might consider switching to another firm that enjoys traveling the high road.