Independent broker/dealer LPL Financial reported second quarter net income of $43.1 million, or 42 cents per share, down 4.4 percent from $45.1 million, or 42 cents a share, in the second quarter 2013. Profits were dragged down primarily by general and administrative expenses, up 26 percent year-over-year, related to regulatory fines for sales of non-traded REITs and variable annuities.

“Just to be clear, we are not happy with these results,” said Chairman and CEO Mark Casady, on a conference call. “What is causing us not to get the leverage that we should be getting in the P&L, up and down the P&L, is essentially costs that we did not foresee or we would’ve talked about our expense profile differently, in a regulatory environment that is much more difficult than we anticipated. We own that, and that’s our problem.”

The firm had targeted an increase in expenses of 4.5 percent for the year, but that has been adjusted to 7 percent. Casady does not see these expenses as permanent to the business.

Adjusted earnings per share of 61 cents, flat year-over-year, missed analysts’ expectations by 1 cent.

The firm’s quarterly revenues were up 7 percent year-over-year to $1.1 billion, driven by a combination of newly recruited advisors, productivity of existing advisors and market appreciation, said Chief Financial Officer Dan Arnold. Those factors also lifted asset levels 17 percent over last year to a record $465 billion. Advisors have attracted $16.5 billion in net new advisory assets in the last 12 months, including $4.2 billion in the second quarter.

The firm added 114 net new advisors during the quarter, bringing its total headcount to 13,840. That compares to 13,409 a year ago.

LPL has recently faced fines by regulators and some states, including Massachusetts and Illinois, related to sales of alternative products. In March, FINRA fined the firm $950,000 for its failure to supervise sales of non-traded REITs, oil and gas partnerships, business development companies, hedge funds, managed futures and other illiquid investments. The Illinois Securities Department recently ordered the firm to pay $2.8 million in fines and restitution for failing to maintain adequate records for its variable annuity exchange business and failing to enforce its supervisory system related to variable annuity exchange activities.  

Casady said the firm has been behind the curve on investing in risk management and compliance resources. “As a result of being the curve in that, we're getting the regulators appropriately.”

He added that it’s not a problem with alternative products, which have performed well, and it’s not related to bad behavior of their advisors. Rather, it’s a problem with the way these investments are processed and LPL’s ability to oversee that process.

For example, some states have a limit to the amount one can sell. But if you round up to the nearest dollar, rather than round down, that’s a violation of that limit, Casady said. About 70 to 80 percent of the issues are rounding errors.

“It’s the lack of an automated system that lets us catch that in a way that then prevents the sale from going through,” Casady said.

The firm has created a centralized review team of 70 people to look at all activities that are more complex. The company is also investing in creating an automated system for processing non-traded REITs. LPL is ramping up training of its supervisors that oversee advisors.

“Once you’ve got the right people in place and you’ve got good technology in place—and we’re about halfway through at this stage—then that should start to create an environment in which those exceptions are more unusual than they are today.”