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June 30, 2001

A Hard Time for The Little Guy: Firms Grapple With Huge Compliance Costs

By Sanford Wexler

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  • A Hard Time for The Little Guy: Firms Grapple With Huge Compliance Costs
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A regulator may soon be citing your firm for reporting violations. In fact, given the wide range of reporting systems, it is easy for firms today to run into problems, says a former regulator.

"When there are many different systems out there it's easy for firms to run afoul of the NASD," according to Joe Mays, a former NASD examiner and now president of the Securities Consulting Group in New York. And he warns that, "They [the NASD] are putting all of the burden on the broker dealer."

Mays's comments add up to this: The escalating cost of compliance could put some broker dealers out of business, especially smaller ones, an assessment seconded by many industry experts.

Regulatory Quicksand

An example of the regulatory quicksand waiting for broker dealers is the introduction of the SEC's disclosure of order execution and routing practices rule for listed and Nasdaq trades. The rule is aimed at ensuring market centers provide regular statistics showing they are fulfilling their "best execution" obligations for order-entry customers.

However, the unintended consequence for small firms in this case is the relatively steep cost of gathering the stats. For behemoths like Merrill Lynch it's no big deal. For the smaller market centers the tab adds to a growing list of other fixed compliance costs that must be absorbed to keep the regulators off their backs.

A large number will undoubtedly outsource the complicated job. The SEC estimates that an individual market center would pay $2,500 monthly to a service provider.

Across the industry, increasing regulation by the National Association of Securities Dealers and the Securities and Exchange Commission is causing a growing number of broker dealers to allocate a larger percentage of their operating budgets toward dealing with compliance-related issues. These include the order handling rules, the Order Audit Trail System (OATS) requirements, Regulation FD and the Manning Rules.

Instead of beefing up their compliance staff, some small-size firms are outsourcing their compliance workload. "They would rather pay a little more and vary their costs and pay as they go than get into fixed costs with personnel," said Howard Haykin, president of the New York-based consulting firm, Compliance Solutions.

While new rules and regulations often mean additional work and higher costs for broker dealers, they are also benefiting vendors, such as Mantas in Fairfax, Va., Chicago-based Market Systems Inc. (MSI), and Transaction Auditing Group (TAG) in Northport, N.Y., which slice and dice trading data. "It's becoming a cottage industry," Haykin said.

Report Card

Ted Karn, president of MSI in Chicago, said the biggest impact from the order disclosure Rules 11Ac1-5 and 11Ac1-6 will not be the regulatory burden but rather the requirement to issue an electronic "report card" that discloses detailed data about best execution.

(Rule 11Ac1-5 requires market centers to make publicly available monthly electronic reports that document order execution quality; Rule 11Ac1-6 requires broker dealers that route customer orders to other venues to publicly identify the venues.)