In September, Dale Brown, the chief executive of the Financial Services Institute (FSI), a lobbying group representing 106 member firms with more than 124,000 independent-contractor broker/dealers, hosted an industry conference attended by the NASD. Brown asked Barry Goldsmith, director of enforcement for the NASD, what he thought about “independent” financial advisors. The regulator told attendees bluntly: “There are aspects of your business that raise questions for us,” Brown recalls.
This comes as no surprise to some independent advisors, who have noticed for years that regulators seem to regard the independent-contractor business as less-than legit. In 1998, for example, years before the current batch of investment-related scandals, the NASD notified members to monitor independent contractors who operate out of the sight of branch managers and compliance officers. For some independents, this clearly demonstrates regulatory bias against them: An advisor working on his own in a satellite office, without any direct supervision, is somehow prone to committing crimes against the investing public. Is going independent a bit of a devil's bargain — a chance for bigger payouts and a greater degree of freedom, but with the drawback of being caught in regulators' crosshairs?
Regulators say that contractors are not subject to extra scrutiny. In fact, says the NASD, it does not differentiate between the independent contractor model and the traditional employee b/d model. The NASD says that it approaches its investigations on a case-by-case basis, letting the facts speak for themselves. “Our approach to regulating our member firms is not based on any model,” says Daniel Sibears, executive vice president of member regulations at the NASD. “There could be an independent firm that we may perceive as having a greater risk [than a full-service firm], but that is not based on the model itself.”
Thomas Giachetti, chair of the securities compliance and arbitration group at legal firm Stark & Stark and a former registered representative, says he has seen no regulatory crusade against independents. “There is simply no bias one way or the other,” he says.
Yet, at times, he notes, there “has been the assumption that the level of supervision at an independent office does not match that of a captive wirehouse office.” And that concern did, in fact, prompt the NASDR notice in 1998. In short, despite what they may say, regulators do seem to be undecided on whether someone working in a home office is under the same degree of regulatory oversight as someone working in a branch office of a full-service b/d.
For independent advisor advocates, like the FSI, preconceived notions about the independent-contractor model need to be dispelled.
“We do know regulators have questions about certain aspects of our business model, and our ability to supervise and ensure compliance,” Brown says. “Our members are independent contractors, not employees — they are generally in smaller offices, and many are small business owners involved in other financial services business beyond what they do as a b/d,” Brown says. This blurring of boundaries could be a challenge for regulators, he admits. “We acknowledge those unique aspects of our business model. But we don't think that causes our business model to be suspect when it comes to compliance. There is no concrete evidence that independent brokers have any greater likelihood of violating regulations, he notes. (Nationwide stats measuring this are not available.) These days computers run daily exception reports to monitor far flung FAs, says Lon Dolber, CEO of American Portfolios, an independent b/d based on Long Island, N.Y. So the chances of getting caught are the same as in wirehouse branches.
Regardless of whether going independent means a more regulatory scrutiny or not, advisors thinking of going out on their own need to understand just how much work such a move will entail in terms of keeping up with the ever-changing world of regulations.
“Compliance is going to take more time than you anticipated,” says Mark Snyder, an independent advisor affiliated with Royal Alliance, based in Medford, N.Y. Snyder keeps an SEC attorney on retainer just to handle the various regulatory hurdles he encounters.
There is no doubt that the regulatory environment has grown more complex over the past few years. Reforms like the Sarbanes-Oxley Act have introduced a host of new accounting and transaction regulations, and the NASD has issued a flurry of new guidance proposals — in the first half of 2005 alone, the NASD reportedly put out more than 35 separate notices to members.
“Over the past two to three years, there have been a lot of regulations coming at us,” says one independent b/d executive. “Compliance has become an ever-increasing force.”
Worse, the atmosphere seems to be changing at will, independent advocates say. “We are in a rulemaking-by-enforcement environment — there is no assurance that our members' compliance efforts today will be deemed to be sufficient tomorrow, or next week,” Brown says. “That's not a healthy environment.”
What has independent advisors most concerned is the rising costs associated with compliance. And the onslaught of new regulations does not look like it is going to end any time soon. There are a couple of proposed new regulations that have independent contractors concerned. One is a redefinition by the NASD and the New York Stock Exchange of what constitutes a branch office, a proposal just approved by the SEC in early October.
Historically, various regulatory bodies have defined the term “branch office” differently, which resulted in conflicting requirements that made securities firms have to file different application forms with multiple regulators to register or renew the registration of branch office locations. The new regulation, which goes into effect in May 2006, streamlines the process, but could cause headaches for some independent contractors.
Until the recent redefinition, the NASD had a fairly narrow definition of what a branch office was, which did not cover a number of satellite offices. Now, a branch office is, with some exceptions, defined as any place where one or more reps regularly conduct business. This could lead to some independents having to claim a number of satellites as branch offices, and thus having to shell out thousands in registration fees for each.
“With respect to a nonbranch location where a registered representative engages in securities activities, a member must be especially diligent in establishing procedures and conducting reasonable reviews,” the NASD said. “Based on the factors outlined, members may need to impose reasonably designed supervisory procedures for certain locations and/or may need to provide for more frequent reviews of certain locations.”
The SEC has also been busy. One new SEC proposal would require a point-of-sale disclosure for a variety of products, including variable annuities and 529 plans. The SEC is proposing two new rules and rule amendments under the Securities Exchange Act of 1934 that “would require b/ds to provide their customers with targeted information, at the point of sale and in transaction confirmations, regarding the costs and conflicts of interest that arise from the distribution of mutual fund shares, unit investment trust interests (including insurance securities) and municipal fund securities used for education savings.”
The SEC is also proposing amendments that would require b/ds to provide investors with additional information about call features of debt securities and preferred stock, and is proposing amendments to Form N-1A, the registration form for mutual funds, to improve disclosure of sales loads and revenue sharing.
For the independent advisor, these proposals could translate into a ream of new paperwork for thinly-staffed offices. For example, each time a financial advisor recommends a mutual fund to a client, the advisor would have to provide a written document detailing the possible costs of the fund, as well as disclose any conflicts of interest the advisor may have with the fund issuer.
On the surface, that seems like a fair requirement. but independent industry advocates like Brown say that forcing such paper-based disclosures will add up compliance costs to FAs over time and, as a result, will force more independents to offer far fewer choices in terms of products like mutual funds
Already, FSI's Brown has mapped out some worst-case scenarios that could affect his members. One independent b/d has told Brown that if the regulation goes into effect, he likely will have to reduce his mutual fund offerings from a current list of 3,000 to about 300. Variable annuities, a popular offering for many independent FAs, have also been a key focal point for regulators, and there are some concerns that heightened or restrictive regulations pertaining to VAs will cut some independent advisors out of that lucrative business.
Rob Wright, at Schannep Investment Advisors in Tucson, Ariz., says that approval time for his company's transactions is actually far quicker now that he's affiliated with an independent b/d. “In our case, we get much faster responses,” he says. “It used to be two to three days before you got approval for a trade, now sometimes it's one hour for us.” Wright also disagrees with the notion that independents are under the microscope any more than wirehouse reps. “I don't think we're being looked at any closer.”
Beatty agrees that he has not seen any singling out of RIAs over wirehouses. “We're all working harder now — wirehouses and RIAs-to make sure we're compliant.” He has noticed, however, that a cottage industry is emerging of former SEC officials that have set up advisory practices to cater to the needs of independent advisors — call it another loop in the circle.
Industry advocates believe that whether the perception of independents as being regulatory targets is correct or no, the main goal should be for the industry to keep its cool, as no one will benefit from a harsh response to any regulatory edict. “We know that in order to accomplish our goal to shape a more healthy regulatory climate, we've got to have a good dialogue. Throwing stones is not going to get us anywhere,” Brown says.
|Year Decided||All Customer Claimant Cases Decided (Hearings & Papers)||All Customer Cases Where Customer Awarded Damages||*Percentage of Customer Award Cases|
|*Percentage of customer claimant award cases has been recalculated to reflect only instances in which investors as claimants recovered monetary damages or non-monetary relief.|
|Firm:||Producing Reps||Avg. Payout||Recruiting Executive||Clearing Firm||Parent Company|
| Linsco/Private Ledger |
San Diego, CA, 858-450-9606
|5,854||$136,617||Mark Casady |
Private Ledger Corp.
|LPL Holdings Inc.|
| HD Vest Financial Services |
Irving, TX, 972-870-6000
|5,500||20,631||Roger Ochs||WFI||Wells Fargo & Company|
| Raymond James Financial Services |
St. Petersburg, FL., 800-998-7537
|3,506||150,559||Richard Averitt||Raymond James||Raymond James Financial|
| Lincoln Financial Advisors Corp. |
Fort Wayne, IN, 800-237-3813
|2,390||146,030||Robert Dineen||National Financial Services, LLC||Lincoln Financial Group|
| Financial Network Investment Corp. |
El Segundo, CA, 800-879-8100
| Sun America Securities/ Sentra Securities/ Spelman & Co. |
Phoenix, AZ, 800-GOAIGFA
|2,228||97,060||James Cannon||Pershing||American International Group|
| ING Financial Partners |
Des Moines, IA, 800-356-2906
| Royal Alliance Associates |
New York, NY, 800-821-5100
|1,894||150,559||Mark Goldberg||Pershing||American International Group|
| InterSecurities |
St. Petersburg, FL, 727-299-1800
|1,658||71,170||Tom Moriarty||Pershing||AEGON USA|
| Securities America |
Omaha, NE, 800-989-8441
|1,603||154,472||Steve McWhorter||National Financial Services, Pershing||Ameriprise|
| Mutual Service Corp. |
West Palm Beach, FL, 561-835-4100
|1,410||110,513||John Poff||Pershing||Pacific Select Distributors|
| Walnut Street Securities |
St. Louis, MO, 877-WALNUT 1
| Securian Financial Services |
St. Paul, MN, 888-237-1838
|1,349||35,325||George I. Connolly||Pershing||Securian Financial Group|
| FSC Securities Corp. |
Atlanta, GA, 800-547-2382
|1,315||134,657||Joseph Gruber||Pershing||American International Group|
| National Planning Corp. |
Santa Monica, CA, 888-711-6720
|1,117||125,226||Shawn Dreffein||Pershing||National Planning Holdings|
| Equity Services |
Montpelier, VT, 800-344-7437
|1,179||28,500||Kenneth Ehinger||NFS LLC||National Life of Vermont|
| NFP Securities |
Austin, TX, 512-697-6000
|981||217,859||Jeff Montgomery||National Financial Services, Pershing||National Financial Partners Corp.|
| Multi-Financial Securities Corp. |
Denver, CO, 800-929-3485
| Transamerica Financial Advisors |
Los Angeles, CA, 800-245-8250
|941||31,544||Sandra Brown||Pershing||AEGON USA|
| ProEquities |
Birmingham, AL, 800-288-3035
|750||69,077||Mike Mungenast||Pershing||Protective Life|
|Source: BD Connect|