Smaller managers feel pinch of compliance, regulation costs

The added costs of compliance and regulation are putting more pressure on money management firms of all sizes, but smaller shops are feeling the most heat.

Money managers expect a 10% to 20% increase costs in the coming year to meet tougher regulatory requirements, according to a survey of 40 asset managers by Boston-based Cerulli Associates.

Karen Keene, senior analyst, said she expects firms will spend 8% to 10% of their operating budget on compliance in 2005, up from 6% to 8% this year.

The biggest push to comply with the Securities and Exchange Commission came this fall, when managers had to install a chief compliance officer and develop compliance policies and procedures by Oct. 5.

Outsourcing the work "would be nice, but it doesn't work within our budget," said Patricia Hall, co-founder of Beacon Investment Management, Raleigh, N.C., which has $42 million in total assets under management.

In addition to her role as compliance officer, Ms. Hall, serves as office manager and corporate secretary. She said she relies on Thomson Media's National Regulatory Service for compliance-related forms, updates and reminders. Samuel Bass serves as president of the firm.

Roughly $3,500 of Beacon Investment's $407,000 2005 operating budget will be spent on compliance and regulation, up 40% from $2,500 in 2004, Ms. Hall said.

Some companies may face a bigger crunch. As a two-person operation, Beacon is keeping most responsibilities in-house. "It's just the two of us," Ms. Hall said. "I just do a lot of things."

At Knightsbridge Asset Management, Newport Beach, Calif., which has $190 million in total assets under management, John Prichard also has a triad of duties. Mr. Prichard, managing director, portfolio manager and chief compliance officer, said his focus this year has been on learning new regulations, as well as tightening up procedures related to ethics, employee trading, and the settlement and allocation of trades. He also shares ideas with other money management firms through The Southern California Compliance Group, which has more than 50 members meeting quarterly in various Southern California locations.

"We resisted leaning on our own securities attorney," he said. "It's really expensive to turn to an attorney to understand and formalize compliance. We thought about hiring a consultant, but resisted that as well (because of the cost)."

While the decision to keep head count at a minimum helps control expenses, it takes a toll on how the firm spends its time and resources, Mr. Prichard said.

"It's an opportunity cost of time usage, primarily," he said. "I spend time talking to my partner about compliance issues as opposed to doing (stock) research. I think if we continue to grow, we will hire someone or use an outside consultant."

Other firms had the compliance capability already built in.

Kathleen Crane, chief financial officer of Karpus Investment Management in Pittsford, N.Y., which has $930 million in total assets under management, shifted her focus to compliance one year ago.

The company allocated 10% of its operating budget to compliance and regulation this year, up from 7% in 2003, according to Marijoyce Ryan, Karpus vice president of fiduciary services. Most of the increase went to installing a new database that enables the firm to comply fully with the SEC rules, even with issues such as electronic delivery of client communications, Ms. Ryan said.

"We'll have to see how (cost) shakes out in future years, but some technology and projects will be one-time (events) to get them up and running," she said.

Some small firms are still searching for permanent compliance officers.

Six-year-old Diamond Portfolio Advisors LLC of Los Angeles has temporarily given operations and compliance responsibilities to Tom Weary, its portfolio manager, while the firm has interviewing candidates for director of operations, said Managing Director Jay Rogers. About 5% of Diamond's operating budget is dedicated to compliance — a figure that has ticked up as the company has grown and regulations increased, Mr. Rogers said. Diamond has $30 million in assets, of which $5 million is tax exempt.

The cost is "not that overwhelming," he said. "As we grow, it will be more of an issue."

Diamond is getting interest from a few potential buyers, Mr. Rogers said, but the firm is not for sale. "Both myself and my two partners have come from large organizations and we want to work for a small firm," he said.

But as operating costs escalate, selling is an option that firms might have to consider, said Dan Sondhelm, a partner at SunStar, a marketing communications firm in Alexandria, Va.

That's what Carl Peterson, chief executive officer of Parkway Advisors, Abilene, Texas, is expecting. Mr. Peterson, whose firm manages $518 million, is seeking to buy a money manager with mutual funds that will expand Parkway's offerings and grow its own Memorial Funds.

"I have to believe that there are some smaller funds who have said, ‘No, we're not interested,' but as time goes by, interest will go up," Mr. Peterson said.