Big glitches go beyond the numbers

In today’s world, $23 million isn’t a lot of money. Particularly if your firm is raking in billions of dollars in sales or revenue. As such, it can be easy for a CEO or other top executive to pass off as inconsequential a speed bump of that size.

But $23 million is the amount of an accounting error uncovered last week at real estate investment trust giant American Capital Realty Properties Inc., known as ARCP. It also happens to be the amount that independent-broker-dealer LPL Financial set aside to cover compliance failures.

Both ARCP and LPL are publicly traded, and when they independently reported their $23 million news last month, shareholders had the chance to tell the companies’ leaders, ARCP’s Nicholas Schorsch and LPL’s Mark Casady, just how they felt. And they did, driving ARCP shares down 24% and LPL’s down more than 7% on the days the news hit.

LONGER-TERM DRAG

The stock drops might serve as some kind of punishment for the folks running these firms, as executive compensation is often tied to stock performance. And the inevitable shareholder lawsuits already are beginning to filter in, at least for ARCP, which could be a longer-term drag on the company. In LPL’s case, Mr. Casady asserted that it had gone about 60% of the way toward getting out of its regulatory wilderness. If history is any guide, the remaining 40% will be costly.

For both firms, what today is $23 million could tomorrow be $46 million or more, when all is said and done. And who, ultimately, would pay for that? Shareholders, employees and clients, that’s who. Particularly for employees and clients, who include financial advisers, brokers and their clients, $23 million is not chump change.

For advisers, it goes beyond the numbers. Clients today are better informed than ever and, rightfully so, more demanding than ever. The advice business is no longer just about portfolio returns but about relationships, goal planning and goal reaching. It’s about frank discussions around life goals and how to get there. And as always, clients want value for their financial planning dollar and they want to understand how that value is generated.

So advisers and brokers working for LPL or one of the Schorsch-affiliated companies can expect to be faced with tough questions that don’t come with neat and tidy answers.

And that’s what’s so disturbing about these two situations. By all rights, the independent-broker-dealer business is thriving, as, indeed, LPL, the nation’s largest IBD, can attest. The firm last week reported that over the prior 12 months, it brought in $17 billion in net new advisory assets, including a record $5 billion in the third quarter.

For Mr. Schorsch, his empire has been growing by leaps and bounds, as he has amalgamated a clutch of independent broker-dealers, including those in the well-known Cetera Financial Group; built American Realty Capital into the largest sponsor of nontraded REITS and other illiquid alternative investments; and made American Realty Capital Properties Inc., a listed, net-lease real estate investment trust, a $21.3 billion-in-assets behemoth.

Perhaps, however, that’s part of the problem here: too much growth, too fast.

Eventually, the breakneck pace of growth leads to cracks in the once-Teflon-coated corporate façade. Early on, company officials tend to wave off such cracks as mere distractions, one-time hiccups. Often, the hiccups don’t go away and the costs mount, as in the case of LPL and its compliance failures. Or, as with ARCP, a major problem is uncovered. In both cases, management is forced to confront the problem, putting out any related fires in the process, all of which means it is not focused on running a sound business. And the costs mount.

On LPL’s third-quarter conference call, Mr. Casady at least had the grace to apologize to shareholders for the length of time it has taken the company to get ahead of the problem. He should be apologizing to employees and clients too.

Mr. Schorsch took a different tack in a conference call with 300 broker-dealer executives, explaining that the accounting problems would not affect the number of nontraded REITs his businesses create and sell. Despite a tepid apology at the end of the call, the message was clear: We’re moving forward.

At LPL and ARCP, no less than full accountability and transparency is demanded. Advisers, clients and shareholders should expect nothing less if the industry is ever going to have gold-standard respect.