Advisers who purchase "off the shelf" compliance programs to meet more-rigorous regulatory requirements must be careful to tailor the programs to their own operations — or risk the consequences.
"We do see [insufficiently customized compliance programs] a fair amount, and primarily with newer investment advisers," said Lori Richards, director of the Securities and Exchange Commission's office of compliance inspections and examinations.
Since 2004, when the SEC adopted a rule requiring advisory firms to have written compliance policies and procedures, "a lot of firms hired -compliance consultants or purchased an off-the-shelf compliance manual," she said.
"It's fine to do that, but then there's got to be a second step," Ms. Richards said. "They really need to look at the procedures and make sure they make sense for their own firm."
The issue was highlighted in October when the SEC brought its first enforcement case under the compliance rule — against Memphis-based investment advisory firm Consulting Services Group LLC, and the company's founding partner and shareholder, Joe Meals
(InvestmentNews, Nov. 26).
Part of the case revolved around a pension consulting firm that had done little to tailor an off-the-shelf program to meet the firm's needs, the SEC said in its complaint. Mr. Meals was fined $10,000 and barred from acting as a compliance officer, a post he had held at the firm from 1990 through most of 2006.
PUSH TOWARD CONSOLIDATION
Some advisers fear that smaller firms will be particularly hard hit when it comes to adapting compliance programs effectively.
"If there are more cases like this going forward, I think there's going to be a push toward
consolidation in the industry," said Lou Stanasolovich, chief executive and president of Legend Financial Advisors Inc., a Pittsburgh advisory firm that manages about $350 million.
"I have never seen how a small firm could do all that's required and go through an SEC inspection with flying colors," he said.
Ms. Richards disagrees that stepped-up enforcement of the rule would lead to industry
consolidation, adding that the SEC does not expect small firms to have the same types of elaborate compliance policies and procedures that larger firms have.
"But they do have to relate to the particular compliance risks that exist at the firm," she said.
That's easier said than done, said Bill Cavell, executive consultant with National Regulatory Services, a Lakeville, Conn., company that has sold about 2,000 compliance programs to advisory firms.
In smaller firms, "the compliance person wears several hats, and compliance is not often the highest priority," Mr. Cavell said. "A time-consuming project like this usually gets 'back-burnered' because there are other things that are going on."
Such was the challenge for Bernard Kiely, president and chief compliance officer of Kiely Capital Management Inc., an advisory firm in Morristown, N.J., that manages $67 million for five families. Its only full-time employees are he and his wife, who is a partner in the firm.
To deal with compliance issues, Mr. Kiely tailored the compliance program he purchased from the Denver-based Financial Planning Association.
But following an SEC exam in late 2006, he received a deficiency letter saying that the firm's compliance manual's statement on its proxy-voting policy differed from its investment policy statements. In addition, the SEC said, the citations the firm advertised on its website were out of date, and information on the firm's ADV disclosure form about investment minimums was not correct.
Ultimately, Mr. Kiely found that the SEC's exam process was "a very healthy thing to go through," forcing him to do some overdue housekeeping such as closing inactive accounts.
"The SEC is looking for an atmosphere of compliance," he said. "They basically got that feeling in my office."
The FPA product is "designed to help adapt procedures to a financial planner's investment advisory model," said Duane Thompson, managing director of the organization's Washington office, adding that the program requires the advisory firm to go through each area of compliance.
Advisers who have long-standing practices are not likely to be forced out of business by compliance costs, he said. However, "if rules increase year after year, it's going to be harder for someone to break into the business. It adds to the hours they have to spend on compliance."
Joseph Capital Management LLC, which manages $80 million, purchased compliance programs and attempted to customize them after the SEC rule went into effect in 2004, said Ron Rhoades, chief compliance officer and director of research for the Hernando, Fla., advisory firm.
"But in reality, we didn't do a lot of customization," he conceded. The firm eventually restructured its entire compliance system, Mr. Rhodes said.
Identifying a firm's particular risks is crucial, he said. For smaller firms such as Mr. Rhoades', the risk of a fraud case looms much larger than it would at a larger firm, he said.
"I'm a lawyer. I've read the Investment Advisers Act. I've read all the rules. I've read a lot of the cases. And I'm sure a lot of advisers don't do all that," said Mr. Rhoades.
Customizing a firm's proxy-voting procedures is another area that often is overlooked when advisory firms go through compliance procedures, according to Nancy Johnson-Jones, chief compliance officer of BKD Wealth Advisors LLC. Many advisory firms' compliance manuals state proxy-voting procedures that are not followed, said Ms. Johnson-Jones, who works in the Denver office of the Springfield, Mo.-based firm.
"Many of the advisers don't realize how much personalization they have to do to that off-the-shelf program," she said.
Sara Hansard can be reached at [email protected].
