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RIA Compliance Departments Are Hurting—And It's Going To Get Worse

The financial services industry is the devil.

The financial services industry is the devil. And the regulators charged with policing brokers and advisors are either inept or crooked. If you think we're exaggerating, just check out today's testimony of Madoff whistleblower Harry Markopolos before the House Financial Services committee. In short: You can expect a major overhaul of the regulatory apparatus governing broker/dealers and registered investment advisory firms. Oversight in 2009 and beyond is going to get more active and much more restrictive. But many firms may not be prepared to handle it thanks to one of the worst financial crises since the 1930s.

"What we're hearing anecdotally indicates that a lot of firms are cutting resources," says David Tittsworth, executive director of the Investment Adviser Association. "It isn't just compliance resources. Some firms are laying off investment professionals, research, marketing people, operations people, too. I think that if I had to generalize, compliance professionals are having to do more with less right now because of the economic crisis and its impact on a huge majority of firms."

Most RIA firms were already understaffed when it comes to compliance. According to data collected by the Investment Adviser Association in the summer of last year, 64 percent of firms have no more than one full-time employee who works in legal or compliance. And 79 percent of chief compliance officers wear two or more hats—they are responsible for many non-compliance tasks. Meanwhile, only 44 percent of firms indicated that they had "fully sufficient resources devoted to compliance."

Some firms are turning to compliance consultants as a lower-cost alternative to having a compliance officer in house. "We know our clients are making less money, but they are spending more money with us," says Bryan Hill, president and founder of RIA Compliance Consultants, which helps investment advisors with registration and compliance. Hill says he has noticed a shift in the firm's billable hours: Whereas it's usually an even split between startups and existing firms, that has shifted. Now about 75 percent of his firm's hours come from existing firms.

Hill says his RIA clients are spending more time on what he calls crisis management: potential customer complaints, disclosure issues, trade errors, auction-rate securities problems, pricing issues, liquidity. A lot of firms are also taking more preventative measures, increasing mock exams, annual reviews, doing more thorough reviews of marketing materials. "They're just doing more in the wake of Maddoff. They're anticipating a tougher regulatory regime," he says.

Brian Hamburger, consultant and attorney at MarketCounsel, a regulatory and compliance consulting firm, says it's mostly the larger firms ($100 million to $1 billion in assets under management) that are opting to use consultants, whereas he's seen some business dry up from the smaller firms that can't even afford his services, much less have someone in house. "They're finding they just can't justify having an in-house compliance person," he says.

Firms are clearly facing tough decisions in this market. The industry has already been warned by regulators about skimping on compliance. Back in early December, even before Bernie Madoff's blowup hit the newsstands, Lori Richards, director of the Office of Compliance, Inspections and Examinations, sent a letter addressed to the CEOs of all SEC registered firms, admonishing them not to cut back. "While many firms are considering reductions and cost-cutting measures, we remind you of your firm's legal obligation to maintain an adequate compliance program reasonably designed to achieve compliance with the law," she wrote.

On the broker/dealer side of the business, many firms are anticipating a need to increase their compliance staffing in the future. According to data collected by Cerulli Associates in the summer of 2008, more independent b/ds expect to make increases in compliance staff than in any other staffing area (some 83 percent plan "moderate" increases). Meanwhile, about half of regional b/ds say they expect to make significant increases in compliance staff, on par with the number of b/ds who expect to increase their technology staffing.

"Clearly, we're in a more robust compliance environment than ever before. As a result, many broker/dealers are finding they need to staff up to meet increasing regulatory requirements," says Cerulli analyst Bing Waldert.

Robust indeed. One executive of an insurance company that owns broker/dealers says, "If Sarbanes-Oxley was a one, this [new regulatory framework] will be 1,000."

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