by Cynthia Harrington

Investors begin to understand the true meaning of risk when the stock market declines and their accounts shrink.

Some look to recoup those losses by complaining about their treatment by their broker/dealers, thereby increasing the workload of their compliance officers. The current upward trend of complaints is typical for a bear market. In fact, the number of arbitrations filed with the National Association of Securities Dealers jumped from 5,558 to 7,704 over the past two years.

This, however, is not the norm for firms catering to CPA advisors. “The numbers of our complaints are always extremely low,” said Ed Wiles. Wiles is senior vice president and chief compliance officer at GE Financial Assurance, which includes the GE Financial Network. “I’m aware that our competitors in this channel report the same experience.”

Camico, one of the largest insurers of accounting practices, confirms the rise in arbitration actions. “We’re seeing no appreciable increase in claims,” said Ron Klein, vice president of claims for the Redwood City, Calif.-based company. “Most of the complaints against financial advisors are against brokers for beefs about specific stocks or for churning.”

National Association of Securities Dealers statistics reveal that the largest number of arbitration cases that have been filed have involved common stock. Over 3,000 cases involved direct ownership of stocks, while only 1,249 involved mutual funds. Wiles credits the fact that their business is largely with mutual funds as one reason for their low numbers of complaints.

“About 80 percent of our business is what we call the check-and-app business,” said Wiles. “By and large, our reps are not engaged in the activities that are in the headlines. They’re not producing research, they’re not underwriting and they’re not involved with initial public offerings.”

Mike Pagano, chief compliance officer at 1st Global Inc., in Dallas, sees the CPA channel as less likely to generate complaints than the traditional brokerages. Pagano said that complaints are low and that the numbers held steady throughout the recent boom-and-bust market cycle. “With the CPA advisor, the client and the rep are more likely to talk through problems themselves,” said Pagano.

CPAs have unique characteristics that separate them from traditional brokers. They know the customer’s estate and tax planning needs from the accounting relationship. They’re highly educated in financial concepts. And they don’t want to jeopardize the relationship with the client and the accounting practice. “CPAs are vested in their career,” said Pagano. “That means that they’re pre-disposed not to do anything wrong.”

The record of low customer complaints should not cause CPA advisors to become complacent. While most arbitration cases involved common stock, the biggest increase in cases filed involved mutual funds, which were up by 130 percent in 2002, from 543 cases to 1,249.

The public was alerted to one type of mutual fund infraction, misusing breakpoints, in a NASD/New York Stock Exchange/Securities and Exchange Commission study released in March 2003.

Broker/dealer compliance departments focus on recruiting the right kinds of reps, on upfront and ongoing training, and on regular communications to keep the number of complaints low.

Wiles reported that screening new reps at GE Financial Network is different today than a few years ago. “About half are now coming from other firms, not just starting out in the business,” he said.

1st Global trains recruiters to screen potential reps with questions about past complaints, as well as questions about their business and their financial standing. They immediately disqualify any rep with any affirmative answers to the complaint question on the U4 Form filed with the NASD. “That doesn’t mean we terminate if a 1st Global rep has a complaint,” said Pagano. “But we have the background documentation for our reps and we can’t see that through the NASD on other reps.”

While all reps have learned the rules of the investment business in the Series 6 and Series 7 licensing process, broker/dealer compliance departments keep training.

1st Global recently created an in-house training program motivated by the study on misusing breakpoints. All 1,200 reps were required to access the Web-based seminar, which included an example of their exact order screen and instructions on how to enter orders that complied with the rules. “Our reps are not apt to do something they shouldn’t, but we want to make sure they’re educated so they don’t inadvertently misstep,” said Pagano.

All reps undergo annual compliance training. Firms send regular communications with reminders and alerts on any new rules or requirements.

Their efforts keep the numbers of complaints low, but some still surface. Both 1st Global and the GE Financial Network have about 1,200 reps and report about 10 complaints for 2002. The complaint process is fairly standard. The firm collects all the documentation from the client, the rep and the back office, and assesses the situation. “Our bias is always to satisfy the customer,” said Wiles. “If there’s any question about the situation at all, we take action to make the customer happy.”

Not every customer complaint hits the rep’s permanent record. Some are misunderstandings that are cleared up easily. In rare cases the rep is asked to leave. “I’ve had to terminate three reps in the last two-and-a-half years,” said Pagano. “If there’s a serious problem we don’t talk about it -we terminate the rep right away.”

While CPA advisors’ complaint record didn’t change in the bear market, their interest in compliance issues has increased. Compliance officers feel the difference in reps’ attentiveness from the way it was during the 1996 to 1999 period. “When the market was going up by 20 percent and 30 percent each year, reps didn’t care much about discussions on the risks of investing,” said Pagano. “Now they’re much more receptive to learning about the risks to protect their practices.”

Pagano reported that he learned something from the boom-and-bust cycle, as well. He administers the process of communication with reps. All are required to attend annual compliance meetings. The reps receive bulletins from Pagano’s department, as well as notices with NASD alerts and mailings. The quarterly bulletin also explains the reasons behind a procedure or rule.

“But now we make sure to hit points over and over in the different methods,” he says. “We have really ratcheted up the contacts, and not just relied on our annual meetings to deliver everything.”

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