Over the years, I’ve had quite a few off-the-record conversations with people at the Securities & Exchange Commission, asking them about the escalating compliance obligations that they impose on financial planners. They’ve told me, confidentially, a very consistent story, which goes something like this.
1. Brokerage firms initiate a terrible, awful scandal. (Think: Fabulous Fab boasting about selling junk tranches of CMOs, or brokerage house analysts extolling the virtues of this or that company to their investors while writing internal memos describing the same companies as garbage, or being caught offering generous incentives to sell in-house investments when there are far better alternative products.)
2. The SEC catches onto the scandal only after it blows up in the press. The SEC top brass is embarrassed and angry, and tells the auditors and enforcement staff to come down hard.
3. The SEC enforcement staff tells the brokerage firms about the harsh measures they’re going to take to force them to start dealing fairly with the public.
4. The brokerage firm executives (and their teams of high-priced lawyers) agree to some (heavily modified) measures, but then say that the SEC shouldn’t give those independent financial planners (”rogue brokers,” in their parlance) a free pass. ”Be fair. Make them live under the same rules we do.”
5. The SEC institutes draconian, intrusive regulations on the brokerage firms (who were caught fleecing the public) and on the independent RIA firms (who were not).
6. The brokerage firms win, because they’ve made it harder for the RIA firms that compete with them to do business, while all they (the brokerage firms) have to do is hire a few additional lawyers to fill out the paperwork. Scale works greatly to their advantage in the compliance world.
The cycle has gone on for so long that most of us have grown used to it. When Bernie Madoff was finally exposed as the ultimate Ponzi schemer, advisory firms paid the price with more stringent compliance rules and more intrusive audits. When broker-dealer reps sold the share classes that put the most money in their pockets, the SEC auditors started demanding that independent RIAs prove that they’re recommending the institutional share class in all client portfolios.
Independent RIAs didn’t initiate any of these scandals, and more importantly, if they’re totally or mostly fee-only (possibly with some term insurance sales mixed in) they have no incentive to do any of the things that the SEC is crawling up their anal passages to investigate. One might imagine that regulators should punish the actual culprits with additional regulation, but that isn’t how the SEC works – and it all goes back to the brokerage firms and broker-dealer lobbyists who cry for ”fairness” whenever they’re caught with both hands and a foot in the cookie jar.
You might argue that additional scrutiny is not so terrible, but in fact I’m starting to hear from advisors who are just too tired to cope with the ever-increasing levels of compliance paperwork, oversight, preparation for audits, and all the rest of it. They capitulate and sell their firms to one of the larger aggregators or PE-backed firms just to get out from under the hassle – and we lose one more independent RIA, and another one, and this is not the way the free market is supposed to work. This dysfunctional process doesn’t benefit or protect clients.
We are about to go through another cycle.
Most of us have read, at least at the edges of our attention, about how Deutsche Bank has been heavily involved in laundering money, much of it from Russia and Iran. Part of the investigation has centered around the Trump organization, which has brought the story forward toward the headlines.
So now the embarrassed Treasury Department wants to tighten up on the U.S. financial system to prevent organizations from blithely ignoring the rules on the books. Who do they go after? The banking institutions that have flaunted the rules? A bit, yes, although we have yet to see consequences at Deutsche Bank. Instead, the Treasury Department consulted with the SEC about who to include in a sweeping regulatory crackdown on laundering money, and the result is a new proposed rulemaking that would extend anti-money-laundering compliance burdens to all investment advisory firms.
You can see a summary here: Basically, the government is proposing that all RIA firms develop written anti-money laundering compliance policies and procedures and designate an anti-money laundering compliance officer. The firms would have to train their staff on the money laundering rules, establish customer identification programs, verify the legal entity of their clients and do independent testing of their AML programs. They would be required to monitor and report all suspicious activities to the Financial Crimes Enforcement Network, including transactions above (hold onto your hat) $5,000.
Most onerously, the FinCEN auditors would be able to require RIAs to provide information about their customers upon request, which would seem to violate several privacy provisions.
Since custodians (where client money goes) are already subject to these rules, it’s unclear why advisory firms are falling under these requirements, but considering the above story, it’s not hard to see how it came about. You tell the banks that you’re going to impose tighter regulations, and some of those banks happen to also be wirehouses. The wirehouses urge the regulators to be ”fair” and not single out the actual perpetrators of these crimes, but keep the playing field level by imposing the compliance burden on firms that had nothing to do with the crime, and who already understand their customer bases well enough to know they’re not Russian criminal cartels. One suspects that Russian (or Iranian) cartels or Mexican drug rings aren’t coming to advisory firms with $5,000 to invest.
My ongoing complaint about all this is that the CFP Board, the FPA and NAPFA have been largely silent and toothless in their efforts to get the SEC (and now Treasury) to understand that the RIA business model is fundamentally different – and more consumer focused, and has very different incentive structures – than the brokerage firms and international banking institutions. In a rational world, the regulators would encourage firms whose fiduciary obligations and incentive structures have kept them out of scandal, and ease their efforts to gain additional market share from the firms that are constantly making headlines for all the wrong reasons.
Instead, we have created an environment where the founders and leaders of those independent firms are increasingly exhausted by compliance obligations that make no sense to their business model, being slowly driven from the marketplace because the SEC (and now Treasury) buy this bogus argument for ”fairness.”
It’s time to completely rethink how to regulate the RIA profession, and put the compliance burden where it belongs: on the firms that constantly require the regulators to double down on their oversight. That would not only protect consumers; it would give them more and better access to advice that benefits them, rather than the institutions that are constantly looking for sly ways to get their hands in the cookie jar.
(Please feel free to share this with anybody who might be interested. we should start building a collective outrage, as a start toward better messaging and lobbying efforts.)
Bob Veres' Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog at: www.bobveres.com.
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Over the years, I’ve had quite a few off-the-record conversations with people at the Securities & Exchange Commission, asking them about the escalating compliance obligations that they impose on financial planners. They’ve told me, confidentially, a very consistent story, which goes something like this.
