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November 11, 2008

Reeling over Regulations

Compliance Burden Squeezes Smaller Firms

By James Ramage

Regulators asleep at the switch? Firms in need of more oversight? That may be the case in the wider financial world, where the subprime debacle capsizes bank after bank. But down in the trenches of equities trading, executives paint a different picture.

Head traders and compliance pros at small trading operations tell Traders Magazine they are overregulated. They say the number of new rules they must deal with continues to multiply. They say their compliance manuals grow fatter by the day and their supervisory responsibilities more numerous and complex. They say the time and money they must spend on compliance goes up every year, as well.

The problem is especially acute at the smaller houses. Unlike their larger competitors, they just don't have the money and manpower to throw at compliance. Thus, executives are spending more time filling out reports and checking and rechecking their trade data than they used to. Some are at their desks on weekends.

Costs Rising

Their complaints are borne out by data and information made public by the regulators, as well as industry studies. Two Securities Industry and Financial Markets Association studies-The Cost of Compliance in the U.S. Securities Industry (2006), and U.S. Securities Industry Financial Results (2007)-compare securities industry compliance-related expenditures with its total expenses.

Industry compliance costs rose 94.7 percent from 2002 to 2005: to $25.5 billion in 2005, from $13.1 billion in 2002.

Total expenses-minus interest-in the same period rose just 14.4 percent: to $168.1 billion in 2005, from $146.9 billion in 2002.

Overall, securities industry firms spent 13.1 percent of their net revenue on compliance-related activities in 2005, compared to 8.3 percent in 2002.

The compliance study did not break out how much of these costs were directly related to trading. It covered a wide array of compliance-related activities, issues and expenses within the securities industry-from internal audit and risk management to information technology and human resources overhead costs.

For certain, rules and regulation numbers only move in one direction: They ratchet upward.

The Financial Industry Regulatory Authority announced roughly 190 regulatory notices from 2006 through the first week in October, according to its Web site. About 100 of those notices represented some kind of amendment or new rule, most of which affected the equities marketplace.

Many of these could just be small tweaks that require no adjustments on firms' parts, or could even be changes that make life easier for firms. But their numbers do reveal how often FINRA ponders its rules.

A perusal of fines made public by FINRA this year makes clear that the regulators are homing in on the minutest of problems. Failure to report correctly to FINRA's ACT trade-reporting and the Order Audit Trail System-or OATS-order-reporting services tops the list.

With ACT, broker-dealers are being penalized for using incorrect symbols, modifiers, prices, execution times and shares. They are getting dinged for failing to report cancellations and getting their legs wrong on riskless principal trades.

With OATS, FINRA is flagging upstairs desks for inaccurate, incomplete or improperly formatted data. They are being punished for incorrect clock synchronization; failing to include special handling instructions; and failing to report Reportable Order Events in a timely manner.