Financial compliance requires all actions, procedures, guidelines, and business culture to abide by the rules and regulations set by the regulatory authorities of the financial market. For example, the Securities and Exchange Commission (SEC) in the United States or The Financial Consumer Agency of Canada (FCAC) in Canada. Although the purpose is simple: to protect investors, customers, the economy, and society from financial crimes but on the other hand it increased compliance challenges for financial advisors.
However, what would happen if stringent regulatory measures didn’t exist? The 2008 global financial crisis is one of the biggest examples of how significant it is to have proper compliance regulations in place in order to create a safe and healthy financial ground for the people. There is a reason that financial compliance covers such a broad spectrum of areas that need to be regulated: without it, the markets will be in chaos.
The primary cause of the 2008 global financial crisis was the deregulation of the financial industry. Unethical investment banking and insurance practices that handed all the risk to the investors resulted in one of the biggest financial crises after the Great Depression. Had there been appropriate compliance measures in place, a huge population’s retirement funds, pensions and houses have been saved.
All advisors are required to know and adhere to the regulatory requirements and despite regulatory authorities trying their very best to enforce regulations, all advisors do not or are not able to abide by them for various reasons. Following are examples of some of the common unethical practices in the financial marketplace.
Bear in mind the standards that a Registered Investment Advisor is held accountable to and a broker-dealer is, are different. Since broker-dealers have less stringent suitability standards than RIAs, their compliance concerns differ. RIA’s are required to register with the state security regulation authorities as well as strictly act as fiduciaries for their clients and thus have stricter and more complex compliance concerns.
Related: Compliance and Automation – An Ideal Unison!
The encumbrance nature of the compliance regulations has only increased ever since the 2008 financial crisis and even more so in recent years. Despite the regulators increasing measures to maintain transparency and integrity in the financial dealings of the market, mistakes happen even by the most well-intentioned advisors.
FINRA received 5,472 investor complaints in 2020 (an almost 50% increase from the previous year), filed 808 new disciplinary actions, imposed $57 million in fines, barred almost 246 individuals, and suspended 375.
Maintaining regulations and mitigating risks is becoming so increasingly complex for advisors that even regulation authorities lack enough skilled people to check and enforce the rules. Compliance teams are coming to realize that finding capable staff members to undertake these tasks has become extremely difficult, especially where manual methods are still being relied upon.
Not many industries have gone through change and increased regulations as much as financial trading. Furthermore, the advancement in technology has made matters even more complicated. Gone are the days when trading occurred only during face-to-face meetings. Now, “over-the-counter” trades have become increasingly popular with the emergence of digitization and remote communication.
To quote former U.S. Deputy Attorney General Paul McNulty, “If you think compliance is expensive, try non-compliance.”
The cost of maintaining compliance for advisors is increasing at an alarming rate in several areas. The time it takes to collect and manage clients’ data uses up a considerable amount of hours in a week and in any business, time is money. Not only that, the added cost of hiring financial service employees to manage data adds to the cost of securing that data.
Even still, advisors need to comprehend that adhering to rules and regulations no matter how costly, can save a huge amount of time and money in the long run. In addition to enforcing a new set of stringent rules, regulation authorities are increasing the value of fines imposed in case of failing to meet compliance regulations. Fenergo’s research indicates that Europe, the Middle East, and the African region saw an increase in the value of financial penalties from just over $1bn in 2020 to $3.4bn in 2021.
The varying degree of technological adoption at which firms stand makes market abuse even more difficult to monitor, for data of trading operations could be stored in a hardcopy spreadsheet in the house somewhere for one firm while another has sophisticated data management software. Bringing together the trading operations from differing communication mediums such as emails, phone calls, chat messages, and social media is still a challenge, one which regulatory authorities are still struggling to streamline.
Protecting client data is one of the keys to saving yourself from compliance hurdles. Unfortunately capturing, collecting, analyzing, and safeguarding all this data can be quite costly. It is a constant expense that digs steadily into the budget and can be further exacerbated by cyber attacks. Simple SSL certificates often tend to be not enough and stronger security walls demand expense.
Independent advisors may require additional staff to assist with data recording and maintenance as well as an IT expert to ensure digital data safety. As a financial advisor, you need to be diligent about your client’s data security as well as maintain proper records to save yourself from compliance issues that may arise during audits.
Furthermore, as technology constantly progresses, more recent compliance regulations are being introduced which is making it difficult for firms that are still reliant upon manual measures to keep pace. Any firm that still hasn’t adopted digitization or automation is at a greater risk of landing in hot water with the regulatory authorities. At the same time, regulation authorities are now adopting the use of advanced data analytics and management software to enforce compliance measures making things even more complicated.
A financial advisor is obligated to act as a fiduciary and provide them with financial advice based on complete and accurate information provided by the client. However, what if the client fails to provide the full picture? Dealing with clients that fail to fully disclose their personal information that may have implications on financial decisions could lead you down a rabbit hole of compliance issues.
For a CFP (certified financial planner) or RIA, the obligation to acquire complete data and provide recommendations in accordance with it is even more crucial. In order to protect yourself from legal complications resulting from clients not fully disclosing information, it is best to collect as much required information as possible through various means. Conduct interviews and request questionnaires, surveys, records, and documents. Have everything signed, documented, copied, and safely stored.
If needed, be confident enough to ask clients directly. They may have refrained from providing information either because it’s embarrassing or they consider it a deterrent to their financial goals. Explain that failure in providing to do so may seriously impact failing to give them advice that is in their best interest for their financial goals and could eventually lead to compliance complications for both parties.
Every industry in the world is facing unprecedented times and the financial industry has had to face more challenges due to new compliance regulations and increased enforcement measures. The soaring compliance costs are taking a toll on the budget of many firms, often diverting them from investments needed to be made.
In addition, firms that have failed to integrate and automate their processes are coming to realize that their manual methods are no longer feasible and a change is required in order to keep up with the enhanced data analytics now used to put further compliance pressures on firms.