The Startling Percentage of Financial Advisors with Misconduct Records

One in twelve financial advisors have been disciplined for serious misconduct, according to a recent study by finance professor Mark Egan and colleagues. The bad apples are rarely punished.
by Michael Blanding

Even as President Donald Trump and Republican leaders seem set on a course to weaken Obama-administration consumer protection regulations, a soon-to-be-published study reports that 7.3 percent of financial advisors in the United States have been cited for abuses.

All financial advisors are required to disclose any whiff of misbehavior to the Financial Industry Regulatory Authority (FINRA), an independent monitoring organization regulated by the Securities and Exchange Commission. A research team examined those records to determine the extent of wrongdoing, especially among financial advisors.

By examining this data in detail, they found that financial misconduct is widespread within the financial industry, with one in 12 financial advisors in the US censured for abuses.

“A lot of this is driven by consumers who lack financial sophistication”

”These things are not frivolous,” says Mark Egan, an assistant professor of finance at Harvard Business School and a co-author of the study. “The average settlement is in excess of $100,000 and the median is $40,000. These are costly offenses.”

Included in the study was any record of customer disputes and civil cases settled in the favor of the client, criminal cases in which advisors were found guilty, and any firing for cause.

The findings are contained in the forthcoming paper The Market for Financial Adviser Misconduct, scheduled to be published in the Journal of Political Economy. It was written with co-authors Gregor Matvos of Booth Business School at the University of Chicago, and Amit Seru of Stanford Graduate School of Business. Their initial working paper on the results made business headlines in 2016.

The best, the worst

The researchers found that when it comes to misconduct, not all firms are created equal. Oppenheimer & Co. had 20 percent of its advisors with a past record of misconduct, First Allied Securities had 18 percent, and Wells Fargo had 15 percent. Egan notes that these numbers include all advisors, not just those who deal with clients, so the actual percentage of client-facing advisors with misconduct disclosures may be higher.

Near the top for best ethical practices was USAA Financial Advisors, which serves military families and had only a 3 percent rate of misconduct.

More distressing than the rates of financial malfeasance was just how little advisors were punished for them. Roughly 30 percent of the bad apples in the study were repeat offenders, with an advisor with a past record of misconduct five times more likely to engage in misconduct again in any given year.

Advisors were particularly apt to prey on customers who were older and less educated, and therefore might not understand where or how their money was being invested.

“A lot of this is driven by consumers who lack financial sophistication,” Egan says. “Without good knowledge by consumers, that’s not something that competition will necessarily solve.”

Additionally, misconduct was more prevalent with clients with higher income, where there might be more of an incentive due to higher returns.

Only about half of those censured for abuses, however, were fired. And half of those found a job at another firm within the next year. “The career prospects of these advisors were not that dismal,” Egan says.

There was, however, a catch: they tended to move from firms with lower rates of misconduct to firms with higher rates. “It seems like there is some sorting going on, with some firms more tolerant of misconduct than others.”

In other words, while individual firms may be willing to discipline or even fire bad apples, the industry as a whole doesn’t seem to keep them accountable.

Resources for investors

If consumers are concerned about the integrity of their advisor, Egan recommends that they look them up on BrokerCheck, a free, publicly accessible portal to the FINRA database. After all, just because a firm has a high percentage of misconduct doesn’t mean all of its advisors are bad.

“Customers shouldn’t necessarily be afraid of firms with high levels of misconduct, but they should make use of the resources publicly available to them,” he says. Since past behavior can be predictive of future missteps, an advisor with a record should raise a red flag. “It certainly warrants having a conversation.”

(The researchers have also created a website around their findings: The Market for Financial Advisor Misconduct. See chart below.)

More data on companies and their financial advisors.

The industry has also taken some steps to level the playing field by making consumers more aware of the resources they have. In 2015, FINRA launched a national ad campaign to highlight its BrokerCheck service, with spots on cable that show, for example, a bride surprised by her organist’s choice of music for her wedding march with the tagline: “You wouldn’t hire an organist without hearing them first, so why would you invest without checking BrokerCheck?”

Since the working paper appeared in 2016, some firms proactively took it upon themselves to educate consumers. Vanguard, for example, now includes a link to BrokerCheck on its home-page, with an invitation for clients to “research our firm.”

Such moves are a step in the right direction, says Egan, helping to ensure that the market punishes bad actors through public shaming and fewer clients, and providing an incentive for other advisors to toe the straight and narrow.

Washington looks at deregulation

The research takes on added weight as Obama-administration regulation protecting financial consumers faces an uncertain future.

The US Labor Department’s fiduciary rule, in the planning stages since 2010, was partially installed this summer but full implementation is now under a review initiated by the White House.

The regulation requires financial advisors who handle retirement investments to operate in the best interests of their clients. Proponents say the rule is needed so that advisors are unbiased in their recommendations and that consumers are saved unnecessarily high fees. Opponents argue the rule would create an uneven playing field between products and raise fees.

Related Reading:

Are Stockbrokers Illegally Leaking Confidential Information to Favored Clients?
Why White-Collar Criminals Commit Their Crimes
Connecting School Ties and Stock Recommendations

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About the Author

Michael Blanding is a writer based in Brookline, Massachusetts

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