Case Study – How Small IBDs Can Leverage Compliance To Accelerate Growth Turnaround Strategies

Small and mid-sized independent broker-dealer / RIA firms that have recently recovered from regulatory-related challenges can mobilize compliance to support new growth

When large independent broker-dealer / RIA firms encounter a multi-year period of regulatory and legal difficulties, they will likely need to make some hard strategic decisions.

And for small firms with less than $10 million in annual revenues and fewer than 50 financial advisors?  Regulatory and legal issues can become an existential threat.

Rare it is to encounter a small firm that has successfully weathered years of regulatory and legal actions.

And even rarer is it for such a firm to actively ask how compliance supervision can help drive a successful growth turnaround strategy, versus viewing compliance as a necessary evil, at best.

But I recently had an informal discussion with a small firm that has reached just such an inflection point – And with the permission of the firm’s CEO, I’m sharing the backstory and my recommendations on an anonymous basis, as I believe there are potentially valuable lessons to be learned for small and mid-sized IBD / RIA firms across the wealth management space.

First, the Facts

Here are the basic facts about the firm:

• With roughly 40 financial advisors and annual revenues between $5 million and $8 million a year, the firm experienced a situation that many other firms have faced in the past decade:  Certain real estate alternative assets offered by the firm on its platform went sour several years ago, triggering a wave of legal and regulatory actions.

• While the firm’s net income has been dropping year over year since then, the last two years have brought about a recovery of sorts.  Legal and regulatory actions have been quietly settled for good.  

• The firm has also successfully recruited half a dozen advisors to its platform in the past 12 months.  Combined with headcount reduction savings driven by the adoption of new technologies, the future is looking brighter for the first time in years.

• Finally, the firm is assuming a reasonably high probability of at least one to three rate hikes by the Federal Reserve over the next 12-18 months.  This means revenues from cash sweep programs could become a significant added growth driver for the firm in the foreseeable future.

How Can Compliance Support a Sustainable Turnaround?

So with this scenario in mind, what is the role of compliance in making sure that the firm can stay on track in its turnaround…and make this a truly sustainable turnaround that drives healthy long-term growth?

Let’s start with this:  At a practical level, the role of compliance is to identify and mitigate risks associated with the operations of the firm.  For an IBD exiting a difficult period and preparing for growth, this is the perfect time to go back to basics.  

And for IBDs, there’s no question that people and products carry the highest level for potential future risk.  This is a perfect time for a firm starting on the path towards recovery and turnaround to evaluate each position and ensure each position has a responsible person with the right credentials, experience and character for the job.  

Character is the most important trait for a person in a small firm and the hardest to evaluate.  Without a doubt, hiring people with the right values, character and judgment is the best preventative of future compliance problems.  

Examine Your Product Offerings

While judging character isn’t always straightforward, examining product offerings can be a much more seamless journey for firms.

One of the very first things a firm should do is to examine its product offerings to determine a risk profile for potential future market events.  

The firm should test a “worst case scenario” for each product and extrapolate how that scenario would affect the firm from a capitalization, reputational and cost standpoint.  

Since adverse product events may lead to additional costs such as regulatory, due diligence, increased E&O insurance rates, arbitrations, etc., a firm should have a broad outlook and try and gauge an overall impact to the firm.  

Emphasize Time Tested Products

Inevitably, most product platform reviews can provoke outcries from certain home office executives and financial advisors about how certain doom is around the corner if various products are no longer approved by the firm.

Let the doomsayers state their case.  But remember:  Rarely does the sale of any specific product add enough revenue to the firm to offset the costs associated with a product failure.

The reality is that markets go down as well as up, and adverse market events tend to be highly unpredictable, and lead to highly volatile conditions that can last for quite some time.  

As such, I would always suggest that a firm begin its growth period with an emphasis on high-quality time tested products.  While these products may be offered at competitors, a small growth oriented firm should focus on customer service as their key differentiator.  

Lower Risk Financial Products Enables More Scalable Compliance Resources

Staying focused on lower risk products potentially enables the allocation of internal funds towards a robust compliance technology platform, and towards investing further in the training of high potential compliance and supervisory employees who understand the industry, the firm’s strategy and embrace their roles in supporting growth in a responsible manner.  

Firms that cannot view compliance as a growth asset will inevitably choose to hire and train new and unproven people, versus paying experienced employees a market, or above market, wage.  

But history shows that when firm growth outpaces the growth of its compliance technology and experienced supervisory employees, increased compliance costs result.  All of which, in turn, hinders future growth.  

Put more simply, for a small IBD in a competitive space, compliance can be an accelerant in a thoughtful turnaround strategy.

Sander Ressler is Managing Partner of Essential Edge Compliance Outsourcing Services, LLC, a national consultancy that delivers comprehensive compliance supervision solutions to independent broker-dealers, Super-OSJ groups and hybrid RIA firms