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Nuisance Fines are Hurting Small B-Ds and Driving Consolidation, Warn Experts

By Mrinalini Krishna March 11, 2019

Regulatory and compliance asks are hurting smaller broker-dealers — typically those with fewer than 100-150 representatives — and forcing some of them to roll up into larger firms, warns Frank LaRosa, founder and CEO of Moorestown, N.J.-based Elite Consulting Partners.

“Smaller broker-dealers are being strangled with the increased burden of Finra oversight. And both Finra and the SEC are coming down with more and more penalties for nuisance issues, which is really squeezing broker-dealers essentially out of the business. And what they're doing is they're rolling up,” LaRosa says.

LaRosa says his team worked on several transactions last year and is currently working on a few such deals.

While LaRosa is not saying regulators are going after small broker-dealers in particular, he does say the scale of their operations makes it more difficult for smaller firms to recover from regulatory actions such as audits or fines.

“The amount of time it's taking away from the principals of the firm to work with the regulators — it's lost productivity, and it's creating a situation where it's making principals of smaller broker-dealers (where the margins are thin anyway) really look at whether or not owning a broker-dealer is even worth the hassle anymore,” LaRosa says.

Other recruiters agree fines impact small broker-dealer firms more.

“They don't have the profit spreads to be able to afford large Finra fines. And for some of these firms, they're literally one Finra fine away from going out of business," recruiter Jon Henschen of St. Croix, Minn. based- Henschen & Associates, who works with independent broker-dealers, says.

Jodie Papike, president of recruiting firm Cross-Search, feels that smaller firms have a tough time deciding between allocating resources to meet compliance needs as opposed to putting them towards needs like technology or recruitment that could help grow their revenue.

“If a firm is having to put a lot of their resources into compliance costs, they may be lacking in other areas that advisors want to be in,” says Papike. “If you're not able to recruit new advisors, you’re not able to increase your revenue. That's a really big problem.”

Compliance costs at small firms seems an obvious scale problem. But LaRosa says that over the past few years — especially with the brouhaha about the Department of Labor’s fiduciary rule — more firms are considering the acquisition route to reduce their compliance risk.

For some like Ellis Smith, dealing with regulatory and compliance issues may not have been the prime reason to roll up his firm with a bigger player, but it played a role in his decision-making. Smith, co-founder of Messner & Smith, which was acquired by Carmel Capital Partners in September 2018, started looking for a succession plan after his partner’s death two years ago. He says if it were a larger shop, he could have considered selling internally. But because it was a smaller outfit, he began to look for acquisition opportunities — or in his words, “kiss frogs.”

Some of these firms are literally one Finra fine away from going out of business
Jon Henschen
Henschen & Associates

“You realize the succession plan is driven by a lot of extraneous influences,” says Smith. “I don’t want to say that to get out from underneath the regulatory side was the reason I did it, but it was definitely a benefit.”

Finra, on its part, has been working on making life easier for small firms. It conducts a free conference call series called the Small Firm Report with senior Finra officials talking about “trending topics, new rules and regulatory guidance and best practices.”

In January 2018, the self-regulator also announced a Small Firm Helpline to provide more support to firms with fewer than 150 representatives, among other initiatives.

But recruiters believe that the regulators often come after firms for matters of little importance, adding to the “nuisance” value of disciplinary actions.

“I have to say, there's a lot of nuisance fines. The things that really matter — where consumers are being wronged and they're directly impacted — I don't think a lot of the fine volume is in that area. A lot more of it is geared towards tracking and record keeping,” says Henschen.

For different people, “nuisance” means different things — and because of its amorphous definition there is no data, save anecdotal evidence, to prove this problem is rampant.

Henschen talks of an example of a firm he worked with that self-reported the loss of a month’s worth of email data while changing its email vendor.

Frank LaRosa

“They were quick to go to Finra and let them know, ‘Hey, we lost about a month worth of data in our process of switching over to this new email vendor.’ And Finra was like, ‘Oh, thank you for letting us know, right away. We appreciate it … Oh, by the way, we're going to fine you, like $350,000 for that,’” says Henschen. He adds that his client then “haggled” and was able to bring down the fine, but Henschen says areas tied to tracking and record keeping are “hotbeds” for Finra to generate fines.

Compliance expert Francois Cooke, managing director at ACA Compliance Group, agrees that the area of records management lacks formal structure.

“There's always been a focus on records management. Over time, it's gotten more electronic and the regulators are now enforcing it more. But I've seen a weakness of the industry is a records management process — a formal process — and as long as there is not a formal records management process, you will see more and more cases on records management issues,” says Cooke.

Finra makes public its Sanctions Guidelines that detail the considerations and the range of fines levied on firms for various infractions.

Finra says “these guidelines are not intended to be absolute. Based on the facts and circumstances presented in each case, Adjudicators may impose sanctions that fall outside the ranges recommended.”