I recently had lunch with an independent adviser affiliated with a firm that had acquired a smaller broker-dealer and most of its reps some time ago. Since then, highly anticipated platform enhancements the acquirer had planned to make that would have benefited the firm's existing reps never materialized, much to this adviser's disappointment.
The reason, in the adviser's words, was as follows: "The home office didn't weed out recruits with major compliance issues that were in the acquired block of reps who joined our firm. The regulatory fines kept coming after they transitioned to our firm, and at a certain point, this ate up the capital set aside to reinvest in the business."
Unfortunately, this is an issue that independent advisers may increasingly face as
consolidation – and fears of potential
consolidation – begin driving waves of advisers into the marketplace.
When firms fail to protect themselves against high compliance-risk reps that come in as part of a large volume of new recruits, existing advisers at these firms lose out. Payouts can suffer, while new investments in tech and service platforms could be significantly delayed.
Although Finra and the SEC have been taking steps to provide further regulatory guidance on the recruiting and supervision of "high risk and recidivist" reps, firms across the industry owe it to their existing advisers to take these steps to block recruits with checkered compliance histories.
FOUR STEPS
Step 1: Drive closer alignment between the business development and compliance supervision teams in identifying and vetting recruits. It's essential to provide the compliance and supervision functions of a firm with a seat at the new-adviser selection committee table. This maximizes the chances of flagging, from the outset, potential track-record issues.
Step 2: Establish a uniform cap on the number of compliance disclosures allowable for new recruits. It's not unheard of for firms to adopt a "case by case" approach in determining the upper limit of compliance disclosures.
While this may work when prospective new recruits can be very carefully vetted on an individual basis, when it comes to high-volume adviser transitions that are part of a consolidation-driven event, a more uniform upper limit must be established as a basic vetting tool. Whatever the number of maximum allowable disclosures for new recruits, the upper limit must be transparently communicated and enforced without exceptions.
Step 3: Clarify your compliance risk "no fly zones." Beyond establishing an upper limit of allowable compliance disclosures for new recruits, also remember that not all disclosures are created equally. Each firm should have a clearly articulated list of "no fly zone" disclosures that are an absolute block against allowing a prospective recruit to join the firm, regardless of whether the total number of disclosures has reached the allowable upper limit or not.
Examples of this could be prior terminations for undisclosed Outside Business Activities (OBAs) or selling away. What constitutes an absolute block may vary by firm, but there must be a clearly communicated list of non-negotiable compliance issues.
Step 4: Never assume the first disclosed lien is the only one. When bringing onboard advisers with a disclosed lien, it's crucial that firms not assume the Form U4 is current and up to date. Firms should conduct credit and background checks before allowing a new recruit that fits this description to join their platforms, and keep doing this at least once a year for the next two to three years thereafter.
Unfortunately, the first disclosed lien is frequently followed by a second and third. Firms should be particularly wary of new recruits with disclosed liens who fail to disclose subsequently received liens, as this suggests a willful attempt to evade disclosure.
Whenever the consolidation drums start to beat across the industry, firms can lose sight of certain critical risk management protocols as the competitive quest to grow through large-volume recruiting of displaced or acquired advisers takes center stage.
While consolidation-driven recruiting growth can represent an opportunity that should be captured aggressively, this should be carefully balanced with an embrace of the obligations owed to existing advisers by ensuring waves of new recruits don't jeopardize other aspects of the business over the long term.
Steve Youhn is Chief Compliance Officer of ProEquities, Inc.
