Operational Risk

It’s important to understand the operational risks caused by manual processes used within your incentive compensation procedures. Managing and leading an investment services firm is an enormous responsibility. Top challenges include:

    • Growing the firm’s revenue while keeping overhead in check.
    • Ensuring that payroll is timely and accurate.
    • Hiring, coaching, and retaining financial advisors.
    • Enforcing regulatory compliance.

Many of these challenges are intertwined with operational risk. While it’s not feasible nor possible to eliminate risk, there are ways to manage and reduce it.

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Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people, and systems. It pertains to the day-to-day execution of business activities that ultimately ensure the profitability of the firm.

Many investment firms use manual processes in their incentive compensation program. In-house technologies are difficult to scale and frequently entail a significant amount of manual steps. Using manual incentive compensation processes exposes your firm to numerous kinds of operational risks. According to Gartner, manual compensation processes are subject to error rates between 3-8% of total incentive payouts. If your firm pays out a total of $5,000,000 in incentive compensation a year, on the low end a 3% error rate costs $150,000 and on the high end, an error rate of 8% costs $400,000.

Potential Risks

Using manual incentive compensation processes exposes your firm to the following types of operational risk:

1. Human Error Risk

An extraordinary number of firms use spreadsheets as their primary compensation tool–up to 62%, according to CSO Insights. Research shows that nearly 88% of spreadsheets contain errors. This certainly illustrates the limitations of using spreadsheets, and by themselves, the risk they pose as a potential single point of failure. However, it’s the user that makes the error–whether it’s inserting a decimal in the wrong place or an error in a formula.

2. Regulatory and Compliance Risk

Your firm is at risk when business is not conducted in compliance with regulations. The increasing cost of compliance–in time and money–is something broker-dealers face every day. FINRA reported a total of $61 million in fines in 2018 with the average fine per action filed of $66,232—a 40% increase from 2017. Manual processes lack the ability to effectively and efficiently conduct surveillance and monitoring as well as customer identification and AML programs. According to an analysis performed by Eversheds Sutherland, in 2018, FINRA levied $27.3 million in AML fines.

3. Human Resources / Attrition Risk

There is a talent shortage in the financial advisory industry. Older advisors are retiring at a rapid rate, by one estimate 35% of the current financial advisors will retire over the next ten years.

According to a recent study from Kehrer Bielan Research & Consulting, losing a tenured advisor typically costs a firm at least $2 million in revenue. Revisiting the Gartner research cited in the introduction, commission error rates between 3-8% will foster an environment of frustration and distrust. Accurate and timely commission payouts must be a top priority, especially if your firm is experiencing a high attrition rate.

Reduce Operational Risk With Technology

How incentive compensation management technology can help reduce operation risks:

  • Reduces the potential of human error by automatically calculating and processing commissions per your compensation rules and plans.
  • Supervisory policies and procedures (FINRA Rule 3110) are simpler to enforce in your firm via automated trade surveillance and audit trails.
  • Provides a single source for data aggregation, making errors, and miscalculations easy to track and solve.
  • The amount of administrative work decreases for you and your sales leaders, allowing them to lead and support their advisor team.

Automating your incentive compensation will reduce operational risks. Less time will be spent on resolving commission disputes and putting out fires freeing you to focus on strategy, forecasting, and leading your advisor team.


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