Broker-dealers have been taking it on the chin from regulators lately, with three retail firms in the past couple of weeks disclosing disappointing earnings related to compliance and regulatory issues.
Where does this rash of regulatory actions come from? Is it specific to one type of firm, or does it indicate that the retail financial advice industry has not learned the lessons of the credit crisis and stock market collapse of 2008? And can financial advisers better help and protect clients when the regulators are finished and the broker-dealer has paid its fines?
First, the litigation expenses and fines:
Earnings fell at
UBS Wealth Management Americas as it reported that it had set aside $44 million for litigation, mostly related to its investments in Puerto Rico municipal bonds. Through 2012, the company sold more than $10 billion of closed-end funds that focused on damaged Puerto Rico debt. This issue will dog
UBS for years as it fights clients and plaintiff's lawyers in arbitration.
LPL Financial Holdings Inc. had flat second-quarter earnings because of increased general and administrative costs, mostly related to the regulators. For example, the Illinois Securities Department in June fined
LPL Financial, the broker-dealer subsidiary, $2 million and ordered the company to pay $820,000 in restitution for failing to maintain adequate books and records documenting variable annuity transfers, known as 1035 exchanges.
EATING AWAY
Finally, Oppenheimer Holdings Inc. said Wednesday that regulatory expenses had eaten away at its bottom line — reserving more than $12 million in light of investigations from the Securities and Exchange Commission,
Financial Industry Regulatory Authority Inc. and the Treasury Department.
Tallied, the three brokerage firms have set aside or paid fines of about $59 million for completely unrelated issues. Shareholders of those companies, all publicly traded or parts of a public company, share the pain as that money has gone to pay legal bills instead of being used to bolster the equity of the company.
Conversation with executives and insiders across the financial advice arena reveal that the industry has one mind when it comes to securities regulators. In the post-Madoff world, everyone is looking to increase market share, even the regulators, they say.
“It is an overzealous regulatory environment at the moment,” said Arthur Grant, chief executive and owner of independent broker-dealer Cadaret Grant & Co. Inc., which had total revenue of $154.4 million in 2013. “The prevailing point of view by industry people is that regulators believe they can create structures that insure that investors will never lose. This is the most aggressive regulatory environment since I've owned the firm.”
Echoing comments many in the securities industry make, Mr. Grant points to the ebb and flow of power in Washington as part of the reason for the current regulatory zeal. Regulators in general, “have been empowered by the Obama administration and are following its spoken or unspoken lead. And the thing is, the securities industry is not the only industry going through it.”
Large firms at one time or another will have compliance issues, Mr. Grant admits.
“I think it's awfully hard in a big company not to find areas where people crossed the line the company didn't want them to cross,” he added. “It's good business to avoid problems but stuff can creep in inadvertently. We've avoided problems with alternative investments that have drawn scrutiny because we think those products are more complex than they need to be.”
In the end, a significant part of the financial advice industry, retail brokerage, is in a perpetual clinch with state and national regulators. The securities cops ferret out industry wrongdoings in variable annuity exchanges, in the case of LPL Financial, and the rest of the retail brokerage industry is put on notice of potential violations and fines.
This constant grappling between the two sides, broker-dealer and regulator, fails financial advisers whose ambition is to help their clients plan for their futures, according to one outspoken adviser, Frank Congemi.
“The regulators are draconian at the moment,” said Mr. Congemi, who is affiliated with LPL Financial.
“Before, I could get discretion for a client if there was a problem with a product. Today, everybody is worried about a lawsuit or what the regulators will think. In my 30 years as an adviser, I've never seen more regulation and less effective regulation.”
The financial advice industry is incredibly multifaceted, and securities regulators have been slow to adapt to and understand these changes, Mr. Congemi said. “The regulators don't have multiple platforms for compliance review. It's one size fits all, and it's not how advisers work. It would be helpful if regulators actually had licenses so they knew what we did.”
“The regulators are constantly looking for the mother lode of bad advisers, bad practices or bad products, but they fall short in consumer protection and education,” Mr. Congemi said. “Everybody in this industry is worried about making money but nobody is worried about making it better for the consumer.”
