Finra hampered by rising compensation costs, stagnant revenue

Critics complain about CEO's $2.6M pay package, wonder about the $1.6B investment fund

Jul 2, 2013 @ 2:57 pm

By Dan Jamieson

The Financial Industry Regulatory Authority Inc. faces many of the same challenges as its member firms — meeting rising costs in the face of stagnant revenue.

Finra's biggest revenue source, regulatory fees, remains depressed, according to the self-regulatory body's latest annual report, released last Friday. At the same time, however, costs — particularly its employee compensation expense — continue to rise.

That's sparked complaints from member firms about how Finra is being managed, and about its pay levels, especially executive compensation.

“The number of broker-dealers has been declining every month,” said Jim Biddle, founder of The Securities Center Inc. “Yet they maintain [chief executive Richard G.] Ketchum's million-dollar salary.”

Overall, Mr. Ketchum's pay fell 2% last year, to a total of $2.63 million, compared with $2.69 million in 2011. His salary held steady at $1 million while his bonus rose to $1.25 million from $1.2 million in 2011. His deferred compensation declined to $340,201 from $451,174 in 2011.

“You do have to pay a bit of money to get good people,” said Neal Nakagiri, chief executive of NPB Financial Group LLC. “But I don't know what the [Finra] board uses for comparison purposes.”

According to the Finra annual report, the organization competes against financial-services and law firms for talent, and has to offer long-term incentives to key executives to remain competitive.

But like many of its members, Finra also is struggling with flat revenues.

Its biggest revenue line, regulatory fees, encompasses a trading activity fee, gross-income assessments against firms, personnel assessments for registered persons and branch office assessments.

Regulatory fees remain stuck at about 10% below their 2008 peak, at $406.9 million last year.

Lower trading volumes are one contributing factor. But the number of broker-dealers, branch offices and registered representatives continues to shrink, as well. As of the end of May, Finra had 4,248 member firms, down 13.2% from 2008. The number of branch offices and registered representatives are off 6% and 5.3%, respectively.

“Now I understand the push that Finra is making in Congress to take on the oversight of RIAs,” Donald Rice, president of Money Management Services Inc., said after seeing Finra's latest financial results. “They're doing it for the revenue.”

Mr. Rice has lobbied against Finra overseeing investment advisers.

A spokeswoman for Finra refuted Mr. Rice's comments.

“Finra continues to believe that the current levels of investment adviser oversight and examinations are unacceptable … and that this significant gap in investor protection needs to be addressed,” spokeswoman Nancy Condon wrote in an e-mail..

She added that Finra would support an adviser fee to fund more supervision “if it becomes an achievable solution,” but with the lack of consensus in Congress, Finra is not currently pursuing adviser SRO legislation.

A year ago, as a result of the continuing losses, Finra announced a series of fee increases for member firms worth $60 million a year. The fee hikes, along with cost cutting and improved investment returns from its $1.6 billion portfolio, helped Finra eke out a profit of $10.5 million last year, reversing an $84 million loss from 2011. The organization, however, posted an operating loss of $89.2 million last year, slightly better than the $89.8 million operating loss it suffered in 2011.

By the end of last year, head count had reached 3,400, up 100 from the beginning of 2012. Employee compensation grew to 63% of total expenses last year. It was 56.1% in 2008.

“Head count is up because of contractor conversions to permanent staff,” Ms. Condon wrote. “Expenses are flat, reflecting that we have not added new or incremental head count.”

Compensation and benefits costs have been growing 3% to 4% annually as a result of “increases related to employee merit, promotion, equity and incentive compensation,” Finra said in its most recent report. Head count has risen in recent years due to a migration of Finra's market regulation functions from an outside vendor to a new in-house center, and from bringing on former NYSE employees.

Last year's $59.1 million gain on its investment portfolio put the organization into the black, but investment income may be muted in the future. Finra dramatically reduced risk in its portfolio following huge losses after the financial crisis in 2008. As of year-end 2012, 63% of its investment assets were allocated to high-quality bonds and cash, 20% in equities, and 13% in alternatives.

The $1.6 billion portfolio is invested in HighVista II Limited Partnership, a “broadly diversified multiasset fund” managed by HighVista Strategies LLC, according to Finra's latest report. The fixed income portfolio is run by Wellington Management Co. LLP.

Some members wonder what Finra is doing with all that money.

“Why [doesn't Finra] give it back to members?” said Yaron “Ron” Reuven, chief executive of Reuven Enterprises Securities Division LLC.

Some of the portfolio is derived from proceeds of the sale of the Nasdaq stock market more than a decade ago.

At the time the Nasdaq sale was being planned in 2000, smaller broker-dealers convinced the NASD, since renamed Finra, to commit part of the proceeds to reducing member costs.

“Finra uses its portfolio each and every year to subsidize its operating costs,” Ms. Condon wrote in her e-mail.

The fee increases “have been the first price increases in 10 years in some cases,” she added.

o, as a result of the continuing losses, Finra announced a series of fee increases for member firms worth $60 million a year. The fee hikes, along with cost cutting and improved investment returns from its $1.6 billion portfolio, helped Finra eke out a profit of $10.5 million last year, reversing an $84 million loss from 2011. The organization, however, posted an operating loss of $89.2 million last year, slightly better than the $89.8 million operating loss it suffered in 2011.

By the end of last year, head count had reached 3,400, up 100 from the beginning of 2012. Employee compensation grew to 63% of total expenses last year. It was 56.1% in 2008.

“Head count is up because of contractor conversions to permanent staff,” Ms. Condon wrote. “Expenses are flat, reflecting that we have not added new or incremental head count.”

Compensation and benefits costs have been growing 3% to 4% annually as a result of “increases related to employee merit, promotion, equity and incentive compensation,” Finra said in its most recent report. Head count has risen in recent years due to a migration of Finra's market regulation functions from an outside vendor to a new in-house center, and from bringing on former NYSE employees.

Last year's $59.1 million gain on its investment portfolio put the organization into the black, but investment income may be muted in the future. Finra dramatically reduced risk in its portfolio following huge losses after the financial crisis in 2008. As of year-end 2012, 63% of its investment assets were allocated to high-quality bonds and cash, 20% in equities, and 13% in alternatives.

The $1.6 billion portfolio is invested in HighVista II Limited Partnership, a “broadly diversified multiasset fund” managed by HighVista Strategies LLC, according to Finra's latest report. The fixed income portfolio is run by Wellington Management Co. LLP.

Some members wonder what Finra is doing with all that money.

“Why [doesn't Finra] give it back to members?” said Yaron “Ron” Reuven, chief executive of Reuven Enterprises Securities Division LLC.

Some of the portfolio is derived from proceeds of the sale of the Nasdaq stock market more than a decade ago.

At the time the Nasdaq sale was being planned in 2000, smaller broker-dealers convinced the NASD, since renamed Finra, to commit part of the proceeds to reducing member costs.

“Finra uses its portfolio each and every year to subsidize its operating costs,” Ms. Condon wrote in her e-mail.

The fee increases “have been the first price increases in 10 years in some cases,” she added.

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