Recent fine may hasten LPL Financial’s shift to fee compensation

Like other broker-dealers, LPL Financial has been moving a lot of its revenue from the commission side of the business to the fee-based advisory channel. After last week, it may be in even more of a hurry to do so.

The Financial Industry Regulatory Authority Inc. whacked LPL on Wednesday with a $10 million fine and ordered it to pay $1.7 million in restitution for widespread supervisory failures involving a number of complex products, including nontraditional exchange-traded funds, variable annuities and nontraded real estate investment trusts.

It is the latest in a series of regulatory actions LPL, the nation’s largest independent broker-dealer with 14,000 advisers, has faced in recent years, including a $7.5 million fine in 2013 and a $950,000 penalty in 2014.

The products for which Finra fined the company last week are all high-commission products sold by brokers and not typically recommended by advisers.

LPL advisers noted that the latest Finra fine could only hasten LPL’s growing emphasis on the fee side of the securities business over the commission side.

‘A BIG PUSH’

“We’ve noticed the firm is making a big push to RIA,” said Joseph Benedetti, an LPL adviser. “As far as recruiting goes, there is a sense that LPL is recruiting into the RIA.”

“LPL is not forcing you to go RIA, but the company is showing you the opportunity,” said Doug Flynn, another LPL adviser. “In the brokerage business, less and less is being done on that side.”

LPL tipped its hand last month that last week’s fine was coming when management disclosed in its first-quarter earnings that it had taken a charge of $11 million due to regulatory issues. Management stressed, however, that it expects compliance costs to decline in the coming quarters.

LPL’s failure to supervise sales of nontraditional ETFs occurred as recently as last month, according to Finra. Its failure to have adequate supervisory systems and guidelines for sales of nontraded REITs occurred from January 2007 to August of last year. In its order, Finra noted that, as LPL approximately doubled in size from 2007 to 2013, the firm “did not accompany this rapid growth with a concomitant dedication of sufficient resources to … meet its supervisory obligations.”

At least one LPL adviser is frustrated at the firm’s continued compliance problems.

‘LIKE AN ELECTRIC BILL’

“We’re doing our own audits and compliance on an ongoing basis,” said Frank Congemi, an LPL adviser who works in a group of 120 producing reps. “You have to treat it like it’s an electric bill. It’s every day.”

Independent broker-dealers are broadly becoming less reliant on commissions. According to InvestmentNews‘ 2014 survey of IBDs, commissions at the largest 25 firms grew only 5% last year, but were offset by an increasing reliance on fees. On average, their revenue from investment products and services that charge a fee, not a commission, increased 20%, reflecting the long-term trend in financial services.

LPL has recently acknowledged the growing importance of its fee and advisory businesses.

“In 2008, we launched our unique hybrid RIA platform, creating even greater flexibility for advisers to conduct advisory business through LPL,” Mark Casady, chairman and CEO of LPL Financial Holdings Inc., parent of the broker-dealer, said on an earnings conference call last month. “As a result, 90% of our advisers are currently licensed to provide both advisory and brokerage services to their clients and are already experienced fiduciaries for their clients.”

“The evidence of our advisory shift is perhaps most visible on our sales and asset mix,” Mr. Casady said. “In 2014, 62% of our gross asset sales were advisory, up from 45% five years ago and more than $180 billion of our total assets are now on advisory platforms.”

PROBLEMS WERE WIDESPREAD

LPL’s failures were widespread, Finra noted last week.

For example, it did not have a system in place to monitor the length of time customers held securities in their accounts or to enforce limits on concentrations of those complex products in customer accounts, Finra said.

The systems that LPL had in place to review trading activity in customer accounts were plagued by “multiple deficiencies,” Finra said. The firm failed to generate proper anti-money laundering alerts, for instance, and did not deliver trade confirmations in 67,000 customer accounts, according to a settlement letter the company signed.

The regulator also dinged the firm for failing to supervise advertising and other communications, including brokers’ use of consolidated reports.

“LPL’s supervisory breakdowns resulted from a sustained failure to devote sufficient resources to compliance programs integral to numerous aspects of its business,” Brad Bennett, Finra’s chief of enforcement, said in a statement. “With today’s action, Finra reaffirms that there is little room in the industry for lax supervision and that it will not hesitate to order firms to review and correct substandard supervisory systems and controls, and pay restitution to affected customers.”

LPL consented to the fine without admitting or denying the charges.

LPL spokesman Brett Weinberg wrote in an email to InvestmentNews that “LPL has taken significant steps to identify the gaps in supervisory systems and controls that grew out of our rapid growth in the past several years.”

Related Topics: Financial Industry Regulatory Authority, LPL Financial