It's a paradox confronting brokers all over the country: In a business climate that calls for ever-increasing advisor-client intimacy, financial professionals are measuring their words more carefully than ever.
Consider the case of an advisor we'll call Sally, a rep with four years tenure at a midsize brokerage firm. Many of her domestic clients prefer to communicate via email, and Sally has happily and freely conversed with them this way — until recently. With her firm's compliance department taking a hard line on the content of customer-broker correspondence, she now censors herself aggressively, in part to avoid using forbidden phrases that might get her in trouble with the compliance folks. It's even worse with emails to overseas clients, which her branch manager must approve before she can even send them out.
“One client just asked why I'm always so curt on email these days,” she says. “I told her, it's because I'm not allowed to say anything.” (Sally agreed to be identified for this article, but was overruled by her compliance department.)
Join the Band
Sally is not alone. Because of the scandals raking the securities industry, the days of compliance departments quietly toiling in the background have necessarily given way to a much more active brand of risk mitigation. This means reps are coming under more scrutiny than ever before, and many say it's making it harder to land the high-net-worth clients that everyone pines for.
One measure of how much more active compliance departments are getting is technology spending. According to TowerGroup, the Needham, Mass.-based research firm, compliance technology outlays at North American brokerages were up $1.5 billion, or 7 percent, in 2003.
The compliance efforts frequently focus on how reps communicate with clients — everything from letters and emails to newsletters and seminar announcements. One result: a record-breaking year in filings related to client communications to the NASD, an anticipated 85,000 in 2004, up from 79,000 the year before.
“Firms are adjusting to an environment of regulatory scrutiny,” says Tom Pappas, associate vice president, advertising regulations for the NASD.
For advisors, these stepped-up compliance efforts are a major headache. Routine matters, like sending out a letter to a client, now often require managerial approval. Supervisors monitor emails and badger reps about the particulars of their correspondence. Sally says she works about 10 to 20 hours a week more than she used to, thanks to all the compliance-related paperwork she has to complete; much of it pertains to client communication.
Says another rep: “It's awful. I've spent two years bumping my head against (new compliance rules).”
What, exactly, are the official rules related to client communication, according to the NASD? Basically, the agency makes a distinction between what it calls sales literature and correspondence. Sales literature is defined as written, mass communication to the public. Correspondence, on the other hand, is anything that goes to existing clients or to fewer than 25 prospects in a 30-day period. The big difference is that, while both types of documents have to go through a firm's compliance department, sales literature has to be sent to the NASD within 10 days of first use. Newsletters might be considered sales literature and often have to be sent to the NASD, especially if they deal with mutual funds, public limited partnerships, variable annuities or variable life insurance. These, of course, are subjects most reps would touch on in any newsletter they send out.
The Reluctant Cops
It's generally up to each firm's compliance department to interpret the rules and how best to follow them. Herein lies part of the problem: Many compliance officers, unnerved by the hyper-regulatory environment, are erring on the side of overcautiousness when faced with the matter of written communications with clients. This result is an overstrictness with reps. At Sally's firm, for instance, any letter sent to more than 10 clients has to be preapproved.
Another result is that compliance officers are more likely to send documents to the NASD that don't require the agency's attention.
“Compliance departments submit things more often than not these days, rather than risk getting caught in something later,” says Nancy Johnson of Strategic Compliance in Indianapolis, a compliance-consulting firm.
Emails probably top the list of communications that make compliance officers nervous. This is true for a few reasons: First, emails occur in large volume, which makes them hard to monitor and edit effectively. Second, the fact that people tend to use email conversationally means that some exchanges can veer quickly into dangerous territory.
Lastly, and perhaps most important, the regulators have singled out electronic messages for scrutiny.
“The NASD and the SEC have made it clear that emails and instant messaging count,” says Lisa Roth, president of Compliance Max Financial, a San Diego compliance consulting firm, and a board member of the National Association of Independent Broker/Dealers. Roth reports receiving three to four times as many client inquiries about electronic communications this year from previous years. “Firms are still really struggling with how to handle it,” she says.
But firms and brokers are not the only ones who are confused. The regulators themselves are struggling with how new rules translate into enforcement actions. According to some industry experts, various branches of the SEC and NASD have their own interpretations of, say, what records should be retained.
“One says all email should be kept except for spam, while another insists they keep spam,” says Johnson. “There's not much logic to it.”
RIA Rules
If you're also an RIA, a clarification of SEC rules slated to take effect in October may make matters even tougher. The new interpretation of what's known as the “books and records rule” will, for the first time, explicitly require that advisors be able to produce all email correspondence related to investments from the previous six years to auditors and have written procedures for what advisors can and can't delete. This means archiving everything from an important memo to a lunch confirmation with a reference to a stock selection.
“Everyone is scrambling to figure out how to retain these records and, if they don't, how best to delete them,” says James McCaim, the compliance officer for GW Henssler & Associates in Marietta, Ga.
William Lako, a managing director of Henssler Financial Group, estimates his firm handles 50,000 emails every month. Until recently, the firm purged its system of emails every 90 days. Now, he's installing a new system that will store six years' worth of “everything but spam,” while avoiding the retention of messages that could unnecessarily catch an auditor's attention.
“Some email you just don't want to have read by the SEC, which may make a mountain out of a molehill,” he says.
Lako is also launching a campaign to educate his 13 reps about email dos and don'ts, devoting a significant portion of their every-other-Friday-morning meetings to the subject.
At bigger firms, emails are aggressively screened with software that looks for red-flag words or phrases. These firms also issue rulebooks for reps about both email and written correspondence. Smaller shops typically handle email manually, with compliance officers doing spot checks of 10 percent to 25 percent of messages. In either case, if someone in charge finds something objectionable, reps will hear about it fast and may have to send in writing an explanation within 24 hours.
For most reps this adds up to a continuous, time-consuming hassle.
“There's no flexibility anymore,” says Sally.
Consider one rep at a major wirehouse. (She also feared the wrath of her compliance department and asked not to be named.) Recently, she wanted to mail clients a notice about an upcoming seminar and submitted it to compliance for approval, since, she says, “Every single thing we send on letterhead has to go to compliance.”
But the letter used her own wording, not the off-the-shelf material the firm provides. When two months went by without hearing from compliance, she decided to take the easy way out and use the company's standardized form. But, it also meant that her pitch was probably less effective since, “What I had to use was pretty bland,” she says.
In another instance, she points to a longtime client with an interest in new issues. Before, she would simply buy an allotment of shares, fill out an order and sign a form saying that the client wasn't a director of the company. But, recently, when the customer wanted to purchase a new issue, she had to send him a copy of the prospectus — easier said than done, because he didn't have email.
“I had to print out a 260-page prospectus and mail it to him,” she says. If that were one isolated example, of course, it would have been a mere annoyance. But on top of countless other similar demands, “It makes communication more cumbersome,” she says.
What About the Client?
Then there's the problem of customer confusion. The same rep, for example, now has to present each client with research reports including the firm's research opinions, plus those of two other organizations. That's different from the old days, of course, when advisors only had to include the firm's take on whether to buy, sell or hold. Trouble is, the evaluations often conflict and customers want to know why.
“It's difficult to explain why different analysts have different opinions,” she says.
What's more, she says, her employer expects reps to stick by the firm's recommendation.
What can you do? If you're an independent affiliated with a broker/dealer, one possibility is to switch to one with less onerous rules. Contact the compliance departments of b/ds you're considering, as well as affiliated reps, about how quick their turnaround and response time is. Three years ago, Jim Butler of Videre Asset Management in Exton, Pa., switched his b/d to Commonwealth, partly because he found his former b/d's compliance rules regarding client communication to be too cumbersome.
“With a smaller b/d, there's not as much red tape as at some other places,” says Robert Isbitts, president of Emerald Asset Advisors in Weston, Fla., who is affiliated with Lockwood. Isbitts sends a regular newsletter to clients and says he rarely encounters hassles.
Another tack is to use only your firm's standard forms for anything from seminar invitations to new business pitches. Advisors who prefer their own words must learn to avoid certain phrases likely to raise compliance hackles.
One biggie: making unsubstantiated comparisons. “Don't say you're the best unless you can point to a current story in, say, The Wall Street Journal proving it,” says Nancy Lininger, founder of The Consortium, a compliance and marketing firm in Camarillo, Calif.
Also, eschew implied guarantees — “We'll work with you to build a good retirement plan,” is better than “We'll help you build a successful financial plan.”
Remember: If you're an RIA, you can't use testimonials in your literature. That's true for people who are both RIAs and reps, also.
Perhaps most important, be as careful when writing electronic communications as you are with any letter. What's more, if your firm still allows instant messaging, don't use it. (Most firms have stopped allowing it anyway, since IMs can't be retrieved or archived). As a matter of fact, whenever possible, just say no: Use the telephone instead.
“Many reps get around the rules by just not putting anything in writing,” says Roth.
It can even have its advantages. One wirehouse rep, for example, who uses the telephone most of the time, says he recently nabbed a seven-figure account from a client who liked the fact that he called on the phone frequently.
In fact, all those rules can have other benefits, as well. The same rep points to his firm's standardized form letters, as an example. “I've seen most of those letters, and they were good,” he says. “There were things I could never have thought of on my own. I'm not in marketing.”
At some point down the line, compliance officers might just calm down a little and turn off the heat.
Realistically, that's unlikely to happen anytime soon. “I would expect the current situation to stay in place until (brokerage houses) regain their comfort level,” says the NASD's Pappas.
The message is clear: Until then, deal with it.
