What's the buzz at almost every industry conference these days? People and compliance. Neither is discussed with much fondness, since both subjects are raising the anxiety levels of anybody who is running a financial advisory business these days. This intersection of a firm's human capital with its risk management initiatives is not always a conscious connection until the you-know-what hits the fan, but we can see a pending collision from blocks away in how a firm practices. While Mr. McGoo stumbles through traffic loaded down with client files, one car is carrying the growing cost of insurance, another the rising number of claims, and a third the expanding amount of time that is dedicated to protecting the business from disaster. Tires are screeching and he can't hear the shouts to "look out." But even if he did, in which direction should he turn?
In the year 2000, 83% of broker-dealers offered errors & omissions insurance to their reps; in 2005, 73% of broker/dealers offered coverage. For those reps still able to purchase coverage, premiums have reportedly tripled. In one of the studies done by Moss Adams of large advisory practices (more than $900 million of AUM), the annual cost of compliance has risen to an average of $250,000. This is consumed in staffing as well as insurance. We don't know the full impact on productivity yet but, anecdotally, advisors in all platforms complain of how the extra steps in how they render advice and deliver service is keeping them away from working with clients and prospects.
Unfortunately, the issue of safety has a broader reach than just compliance. Safety impacts how you accept clients, how you fire clients, how you hire and manage staff, and how you monitor receipts and disbursements. With advisory firms becoming larger, the span of control becomes more difficult to manage and your ability to control events becomes even more tenuous. Often, advisors only confront slippage when audited or sued. How often do you discover after the fact that something bad has occurred, and some feckless individual would say "Oh, I knew that was going on." It makes you want to pull your hair out (and hers).
It Starts at the Top
On one of my many cross-country plane trips, I sat next to a hotel specialist who said the best companies are those that indoctrinate all of their people into believing that "if you heard the problem, it's now yours." His point was that regardless of your position in the hotel hierarchy–from housekeeper to receptionist to general manager–if you see an issue, it's your obligation to make sure it gets addressed by somebody who can fix it. This is not just about pride in the client service experience but about having a sense of ownership in your company. How often do we wish that when someone on our staff sees or hears about a problem that they would own it?
Like everything, the tone is set at the top. Are we encouraging a culture of competence and safety? Do we leave issues to fester because we don't have the time or sense of urgency necessary to resolve them? Do you make exceptions to your own policies? Do you ensure that everyone has a responsibility for safety?
Well-managed firms consider the concept of "safety" as one of their pillars. The other two would be "people" and "clients," each of which supports their business model. As with any structure, if you have a weak framework, your foundation will collapse. By making safety a featured part of how you operate, you may find that decisions about clients, staff, processes, and procedures get examined in light of their potential impact on your business.
Let's look at four areas of safety that are not specifically compliance issues but if neglected could ultimately become compliance problems for your firm: Client Acceptance & Retention; Work Environment; Quality Control; and Operating Control.
Safety Area #1: Client Acceptance & Retention
What is your filter for evaluating whether a client is appropriate for your business? Is it net worth or assets alone? Are there other characteristics that you should examine? The principals at the firm Brightworth (formerly Polstra & Dardaman) in Atlanta have implemented what they call a "Client Fitness Test" that allows them to evaluate new clients on a variety of subjective factors such as behavior toward each other, attitude about investing, and proclivity to delegate. Whoever has developed the prospect has to demonstrate to the partners that this would be a good client for the firm. Their discipline around client acceptance has not only reduced their client complaints and their compliance risk, but has made their work all the more pleasant because they don't have to serve clients they don't enjoy.
Other firms go through an annual review of their current clients to see if it is still appropriate for them to retain a relationship. The urgency of this idea came clear in a recent story I heard about an advisor who, for four years in a row, had advised one of his clients to begin reducing a concentrated position in his company stock. The recommendations were documented and renewed every year, yet the client never took action. As might be expected, the stock plunged in value, the client's net worth rode down with it, and he sued. He got the benefit of a jury trial that ruled in favor of the plaintiff to the tune of many millions of dollars. Would circumstances have been different had the advisor terminated the client or not charged a fee for all of the client's assets, including the concentrated stock? That would be a good discussion during a client review to determine how much risk you're willing to take to keep the relationship.
Safety Area #2: Work Environment
Many people in the securities business miss those halcyon days when everything would go, ribald jokes would fly, and their business life would flow over into their social life. Missed by everybody, that is, except those who were offended by the behavior of their bosses and co-workers, or who were denied opportunities because they didn't play along.
Safety plays a role in how we treat each other. Respectful behavior leads to a more positive and productive work environment. The failure to honor this code can result in turnover or, worse, lawsuits alleging harassment. Every practice, regardless of size, has its own culture about what is tolerable and what isn't. But as an action step, it's a good idea to review with everybody what would put your practice or yourself at risk if someone (including yourself) crossed the line. This is not just a problem for big business–in fact, it's rampant in small businesses that don't have human resource departments to implement formal training, or a complaint process to manage the issues.
The challenge for owners of practices today is to take action with staff members who are putting the firm at risk. Because of what many see as a talent shortage, there is a reluctance to be firm with those who produce a lot of revenue, or who bring unique skills to the job. You have to ask yourself whether those benefits are reason enough to overlook how problem employees might be impacting staff, clients, and the firm itself.
Safety Area #3: Quality Control
