Rhoades Steps Down As Chair-Elect Of NAPFA Over Registration Errors; Advisors Say Compliance Violations Are Easy To Make; Need To Outsource Compliance Is Increasing Hot

Rhoades, who is chair of the Alfred State College Financial Planning Program, was elected to the position of National Chair on May 7, 2012 and was scheduled to begin his term on Sept. 1, 2012. (Read NAPFA Elects Leading Voice of the Fiduciary Standard as National Chair for 2012-13.)

Rhoades and his firm, for which he serves as president and chief compliance officer, failed to file timely registration papers with Florida’s state division of securities.

Rhoades formed ScholarFi, a RIA serving select clients on the east coast, last September as a state registered firm in New York. At the time, ScholarFi had 11 clients from Florida, which exceeds the de minimis five-client threshold for registration in that state.

Rhoades considered in late summer of 2011 whether to register in Florida but he wrongly believed that he could wait until the first quarter of this year to register with the state. Rhoades submitted the registration documents to Florida in February, but in late May, Rhoades became aware of his error.

“While my mistake was unintentional, the violation of compliance regulations is nevertheless material in nature,” Rhoades said in his letter (see below). “The mistake made was mine, and mine alone. I accept full responsibility for my personal mistake and all consequences that may flow therefrom, including the decision by NAPFA to move on without me serving as chair in the coming year.”

In an email to me, Rhoades says the following: “My error highlights the need to outsource various aspects of compliance in a small firm.  Notwithstanding my excellent knowledge of securities laws and regulations, I made an error which a compliance consultant – who deals with issues like this daily – would not have made.  This one error has cost my firm tens of thousands of dollars in lost revenue, and has had a negative impact on me, personally, and the professional associations with which I am associated, for which I am deeply apologetic.”

Rhoades, for the record is now using Cindi Hill as his firm’s compliance consultant now.

Empathizing With Rhoades

Advisors, meanwhile, were sympathetic to Rhoades’ plight, saying that it’s far too easy for small RIAs to make compliance violations, especially when they don’t outsource their compliance and registration functions.

“I'm just as susceptible to misinterpreting rules if not more so,” says Rob Schmansky, CFP of Clear Financial Advisors.

“I empathize with the circumstances that led to the oversight,” says David Bergmann, CFP of David R. Bergmann Group.  “My first thought is of the old adage of our advisory profession – ‘30% of your professional time is working on compliance.’”

And Rick Miller, CFP, the president of Sensible Financial Planning, says this: “I think this is a very unfortunate situation. Ron is a very respected professional.”

Insource Or Outsource

Advisors, not surprisingly, have differing opinions about the insource vs. outsource debate.

“This issue hits close to home for me, as I am looking to set up a Boston address within the next few months,” Pamela Sandy, CFP, CEO and president of Confiance, LLC. And that decision to establish a firm in Massachusetts has a lot to do with the regulations – particularly de minimis rules. 

For her part, Sandy has a good deal of small firm experience. She was the former CCO of her former firm and the sole owner/practitioner of CONFIANCE, LLC. “I can easily relate to costs vs. the need to get outside collaboration on something as important as regulatory compliance,” she says.

Sandy, however, says outsourcing isn’t a panacea. “Even when outsourcing, the information needs to come from within – only the firm can push out the information (client data) that triggers an additional filing,” she says. What’s more, Sandy says “the cost of outsourcing may be a detriment for small/startup firms and yet the expertise gained from such an association could be invaluable.” And lastly, compliance obligations can be cumbersome and many firms may find themselves in unfamiliar territory. “Lack of ‘compliance’ in small firms is many times not about willful disregard of regulations, but merely a misunderstanding of those regulations,” says Sandy.

Schmansky, meanwhile, says he outsources registration but handles compliance in house. “A major benefit of outsourcing is not only working with people who know the rules, but they also often know the people at the states personally,” Schmansky says. “My firm received a notice with an initial filing with Florida as well that I was initially very concerned about. But, a phone call to the right person from my registration team handled quickly what seemed to have been a larger problem.”

And Bergmann offered this commentary about insourcing vs. outsourcing: “Having read some of Mr. Rhoades past blogs, commentaries in the public press and commentary in professional publications, I am fairly confident he had checklists, procedure manuals and other ‘regimen management’ processes in place so it would be hard to suggest to advisors that with the right processes in place ‘insource’ is fine and you need no ‘outsourcing’, or, alternatively stated, ‘oversight’.  On the other hand, outsourcing (‘oversight’) has its costs and time involvement, albeit reduced, in ‘assisting’ the overseer with access to what they need to oversee.  Perhaps it would be good advice for advisors to ensure that they have regimens and processes in place that have been reviewed by an ‘overseer’ for compliance efficacy and reporting quality and then when you do anything that deviates from your workspace in any way like acquiring ‘one’ new client ‘account type’, ERISA/non-ERISA, for example, or a new client ‘state of residency’, that you then bring in the overseer to update those regimens and processes.” 

A practice’s ‘stage of development’ might preclude a practitioner from hiring a CCO (Chief Compliance Officer), says Bergmann but at a minimum a practitioner needs to outsource “the regimen and processes development set-up (have your ‘I’s’ dotted and ‘t’s’ crossed before you begin rather than catching up later) and then do what is appropriate as suggested above.  Keeping in mind best practices and sticking to protocols at all times goes a long way to avoiding or minimizing mistakes and their repercussions.”

Others also say that outsourcing compliance makes a lot of sense.

“If someone who has the right background to understand the requirements can make this kind of mistake it points out the importance of getting professional help in compliance,” says John Comer, CFP of Comer Consulting. “That missing a filing—although important, not any error that has a direct impact on clients—can cause him to lose a voluntary position and get negative, national press points to the impact compliance can have on an advisors’ practice.”

Comer says many of the advisors he meets these days, especially those first coming from a broker/dealer environment where they had compliance support, have a limited or skewed view of compliance requirements or what he calls the “sales prevention” mentality.  “They need continued professional support to stay out of trouble on technical issues,” says Comer.

And Joe Pitzl Director of Financial Planning at Intelligent Financial Strategies says his firm outsource that function. “In short, it is a simple cost-benefit comparison,” he says. “In our opinion, the benefits of saving some money by doing this internally do not outweigh the cost of missing a deadline or filing incorrectly. It’s just not worth it to leave the slimmest possibility something is missed.”

Others see the benefit of outsourcing, but also say outsourcing doesn’t absolve advisors from their responsibilities. Plus, outsourcing raises questions about the legal duties of the vendors. “Rhoades’ case reminds me of the proverb ‘Trust in God, but lock your windows.’” says Jude Boudreaux, CFP, the founder of Upperline Financial Planning. “I think we all count on service providers to help us with critical functions like this, but we've got to know what the critical dates and items are and be sure we're doing whatever we need to do on our end.  Also, what is the legal responsibility for these service firms?”

Compliance Is Complicated; Easy To Make Mistakes

Lee Baker, CFP, of Apex Financial has a similar point of view. “Because of the potential of having something like this slip through the cracks, any advisor should at least consider outsourcing some or all of compliance work,” he says. “Keep in mind the advisor still has take the additional step of making sure that the firm used for compliance is on top of their game as well.  Ron's a terrific guy of great character and made a mistake.  This just goes to show how complicated the world of compliance can be.”

Indeed, advisors also say Rhoades’ compliance violation is further evidence of the need for less complicated laws and regulations. “I am certain if Mr. Rhodes is capable of misinterpreting the rules, it says something about the need for greater simplicity and clarity,” says Schmansky. “Unfortunately, small firms either need to become experts at and stay current on the laws of the states they operate under, or hire experts.”

Others agree. “I think this represents a commentary on the fragmented and complex nature of investment advisor regulation in this country,” says Miller. “Whether outsourcing regulatory compliance would have been helpful in (Rhoades) case is very difficult to know.”

Florida Is Backlogged

Meanwhile, some advisors say Rhoades’ plight is also a reflection of the state of the SEC and state securities divisions. “I just think the SEC is outmatched – in every way,” says Bonnie Sewell, CFP, CDFA, AIF, a principal with American Capital Planning. “The states are strapped too but they have a closer interest in my view.  When I register with state, there’s a real person that emails me over changes in my ADV Part II and I’m good with that.  I appreciate the attention to detail because they can explain why they’re asking for something and then I can comply pretty easily.  I find the state level (Georgia and Virginia at least – Florida was a nightmare and very backlogged – just like the SEC, right?) to be pretty responsive.”

In the case of the SEC, Sewell says her firm can upload the ADV Part II but they “always have to re-establish access through a phone call for a new password, then go in and run through their system.”  Says Sewell: “That system works reasonably smoothly but I feel like the people at the state level are actually trying to help me in my business as long as I follow their form instructions.  It is easy to overlook deadlines when things are hopping though.”

Rhoades’ Letter To The Media

August 20, 2012

 To Interested Members of the Press:

Over the past several weeks I discerned that I and my firm (of which I serve as Chief Compliance Officer and President) had committed a compliance violation by failing to timely file registration papers with the State of Florida Division of Securities.

My firm was formed in September 2011 as a state-registered firm in New York.  At the time of formation, the firm accepted a total of 11 clients from Florida, which exceeds the de minimis threshold for registration in the State of Florida (which is five clients).  I had considered in the late summer of 2011 whether to register in Florida, but mistakenly believed that I could wait until the first quarter of 2012 to register with the state.

Registration documents were submitted to the state in February 2012, but in late May 2012 I was made aware of my mistake.  Since then I have undertaken candid disclosures of all requested facts to the state, and I await their final determination of this matter.  

While my mistake was unintentional, the violation of compliance regulations is nevertheless material in nature.  The mistake made was mine, and mine alone.  I accept full responsibility for my personal mistake, and all consequences that may flow therefrom, including the decision by NAPFA to move on without me serving as chair in the coming year.

Sincerely,

Ron A. Rhoades, JD, CFP^®

President, ScholarFi, Inc.

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