Firms pumping millions into their compliance departments to keep regulators at bay

After a series of embarrassing and expensive compliance and regulatory failures, LPL Financial hired David P. Bergers, a rising star from the Securities and Exchange Commission, as its chief legal officer.

Mr. Bergers came with a hefty price tag. Although he started only in August, he was paid $4 million in salary, stock bonuses and other compensation last year, thrusting him into the top echelon of LPL executives.

While no one doubts Mr. Bergers’ abilities, his substantial compensation may say more about the state of compliance in the banking and securities industries these days than anything else. With regulators breathing down the necks of firms both big and small — and leveling expensive fines when violations are uncovered — they are pumping millions of dollars into their compliance departments to keep these agencies at bay.

13,000 HIRED

Jamie Dimon, the chief executive of JPMorgan Chase & Co., said in an April letter to shareholders that since 2012, JPMorgan had hired an additional 13,000 employees to handle regulatory issues and compliance.

John Shrewsberry, chief financial officer of Wells Fargo & Co., which owns a wirehouse employing some 15,000 advisers, underscored rising compliance costs in a call with analysts this month to discuss third-quarter earnings.

“Our quarterly expenses related to risk and compliance have increased by approximately $100 million over the past year and we’ve added over 1,500 team members in this area,” he said.

41% INCREASE IN STAFF

LPL, which has paid at least $20 million in regulatory fines, restitution and settlements in the past few years, now has 636 employees in areas that focus on compliance and oversight, a 41% increase since the start of 2013, according to chief financial officer Dan Arnold. Just last week, LPL, which has 13,800 independent brokers in its ranks, said it will take $23 million in charges in the third quarter for regulatory matters, $18 million more than it originally forecast.

“When I came here, there were a number of challenges, and part of that stems from [LPL’s] rapid growth in the past,” Mr. Bergers said. “What’s very clear to me, now that I’ve been here for almost 15 months, is the size of the commitment LPL has made to risk, compliance and control functions.”

It is not only larger companies that are struggling with regulators and investing in compliance. WFG Investments Inc., a midsize broker-dealer with 270 registered representatives, has seen a 50% increase in compliance costs from 2012 through today, said David Williams, the firm’s president.

WFG disclosed in an SEC filing that it is facing a $650,000 global fine by the Financial Industry Regulatory Authority Inc. Mr. Williams declined to comment about the Finra fine, which comes on the heels of a $200,000 fine last year. In an interview in September, Mr. Williams said that WFG has made “wholesale changes” over the past 18 months, including hiring a new chief compliance officer and doubling its compliance staff to nine people.

Regulatory enforcement actions cover a wide range of infractions. In the last two years, LPL has faced disciplinary actions over e-mail system failures and violations regarding the sale of nontraded real estate investment trusts and variable annuity transfers, among others. WFG’s fine last year was for alleged lapses that led it to miss a stock fraud scheme.

“O8 CRISIS AND DODD-FRANK

While some industry observers trace increased securities regulation back to the early 2000s, the most recent surge in regulation is the result of the financial crisis of 2008 and the Dodd-Frank financial reform law, which has put pressure on regulators to increase enforcement. In 2013, Finra filed 1,535 new disciplinary actions, up 33% from what it filed in 2009. This month, the SEC preliminarily reported a record 755 enforcement actions taken in fiscal 2014.

The focus on compliance and regulation not only has driven up costs for banks and advisory firms, it has created a growing demand for compliance personnel.

“Ten years ago, no one wanted to work in compliance — it wasn’t sexy,” said Kurt Kraeger, managing director in New York for Robert Walters, a global recruiting firm that focuses on compliance professionals. “Now firms are under pressure. If they don’t have people in those positions, they will get fined and can’t do business. The chief compliance officer is starting to take on the same stature as the [chief financial officer].”

2ND ONLY TO THE BOSS

Mr. Bergers’ $4 million pay package put him only behind LPL’s chief executive, Mark Casady, whose total compensation in 2013 was $6.1 million, and ahead of LPL president Robert Moore, who last year earned $3.1 million in total compensation.

“Four million dollars really typifies how important compliance is to these companies,” Mr. Kraeger said.

Mr. Bergers declined to discuss his compensation.

If they have the right skill sets, Mr. Kraeger said compliance professionals can increase their compensation 20% when they change firms. “There are only a limited pool of people who have these skills, and there is definitely a grab for legal and compliance talent,” he said.

In the face of the compliance surge, many industry executives and attorneys wonder whether the emphasis on compliance is worth it, or if it is a case of regulators’ overreacting because of a failure to catch the root causes of market meltdowns in 2000 and again in 2008, along with embarrassing frauds such as the Bernard Madoff Ponzi scheme. Clients ultimately pay more as firms increase fees to cover increased compliance costs, many in the industry believe.

“It began in the early 2000s, with an onslaught of new rules,” said Alan Wolper, a partner with Ulmer & Berne and a former NASD director. “Today, regulators are sort of manic.

“Now little firms need a guy just to respond to general requests from Finra,” Mr. Wolper said. “And it’s just a steady stream of those requests. People spend all their time pulling documents to satisfy regulators. At the end of the day, there is an avalanche of paper, and broker-dealers think they are over-regulated.”

The tug of war between increasing compliance and legal costs and the industry’s doubts about the worth of such efforts is at the heart of the burgeoning debate over CARDS — Finra’s controversial proposed Comprehensive Automated Risk Data System.

The rule introduced at the end of last month would establish the system in phases, the first of which would require about 200 clearing firms to submit customer-account information to Finra regarding securities accounts they clear for brokers. The information would include transactions, holdings and account profile data.

The second phase would require about 1,850 brokerages to submit account information either directly to Finra or through a third party that would include investors’ time horizons, objectives, risk tolerance and net worth, but would exclude personally identifiable information. Both groups would have to submit the information on a monthly basis.

Critics worry that the costs of CARDS for technology infrastructure, maintenance and security will outweigh the benefits for smaller broker-dealers.

“And can any reasonable person who has witnessed the massive expansion of Finra’s reach and the growth of the fees and fines to feed the beast not believe that this CARDS program will continue to grow in its real-time demands for information?” Dan Pisenti, the former president of Whitehall-Parker Securities Inc., wrote in a comment letter to Finra.

CARDS “will add great expense to the operations of the firms in this industry, and it will embroil firms in litigation with Finra and other entities full-time,” Mr. Pisenti wrote.

Finra spokeswoman Nancy Condon declined to comment about criticism of the CARDS proposal.

LPL’s former chief legal officer resigned to join a law firm. An earlier version of this story erroneously mischaracterized the reason for her departure.

Related Topics: Financial Industry Regulatory Authority, Securities and Exchange Commission