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Advisor Misconduct: How Widespread?

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A new study of advisor misconduct is drawing attention to bad behavior in the financial industry — and to itself for what industry players and analysts point to as exaggerations, skewed data and other issues.

The research, published by University of Minnesota’s Mark Egan and University of Chicago Booth School of Business’ Gregor Matvos and Amit Seru, is extensive. It relies on 10 years of records from FINRA’s BrokerCheck database.

The authors claim that advisor misconduct “is broader than a few heavily publicized scandals.”

“The incidence of misconduct varies systematically across firms, with the highest incidence at some of the largest financial advisory firms in the United States,” they write. “We find evidence suggesting that some firms specialize in misconduct. Such firms are more tolerant of misconduct, hiring advisors with unscrupulous records. These firms also hire advisors who engage in misconduct to a lesser degree.”

But not everyone is convinced, note SIFMA and several industry analysts. (Several broker-dealers cited in the research declined to comment on it.)

“I do not think that the data really support the sensational conclusions of the study that rogue brokers are rampant on Wall Street,” said executive search consultant Mark Elzweig, in an interview.

“The study says that 12% of advisors have been accused of bad behavior and 7.7% have settled a claim or have been fined [between 2005 and 2015]. What is needed here is some context. Are a small group of firms skewing industry results? How do these numbers compare to other professions? Have these numbers [for specific firms and across professions] increased or decreased in recent years?” Elzweig asked.

When it comes to comparing the prevalence of misconduct between different jobs (such as between advisors and lawyers), “We don’t go there,” Matvos said. “And as for the 7.7% [10-year misconduct] figure, investors and others reading the study can say that is high or low — it’s their prerogative … The public can decide.”

The research shows the per-year level of misconduct across some 1.2 million registered reps was less than 1% in the 2005 to 2015 period. It started the decade near 0.5%, rose to nearly 1% in 2008 and 2009 and then fell to roughly 0.5%.

“While we appreciate what the authors of the study are seeking to determine, in our cursory review we believe their model overstates the level of relevant misconduct, including allegations related to declines in value due to volatility or infractions completely unrelated to the advisors’ professional responsibilities,” said SIFMA in a statement.

A Disclosure Is a Disclosure Is a …?

Egan, Matvos and Seru report that more than 12% of active financial advisors’ records from 2005 to 2015 include a disclosure, meaning “any sort of dispute, disciplinary action, or other financial matters concerning the advisor.”

“Not all disclosures are indicative of fraud or wrongdoing… [and] we classify [certain] categories of disclosure, which are indicative of fraud or wrongdoing, as misconduct,” the authors explained. This includes behavior (and complaints) tied to unsuitable investments, misrepresentations, unauthorized activity, omission of key facts, fraud, negligence and excessive trading, for instance.

According to the research, of the 7.7% of advisors with misconduct-related disclosures, about one-third are repeat offenders, the professors say. They also say certain firms seem to be more tolerant of misconduct. “In my experience, most firms — especially major firms — run a very tight ship as far as only hiring advisors with good compliance records,” Elzweig said. “Having said that, there are firms that want the gross production and are willing to tolerate or even become havens for bad actors.”

As Matvos sees it, the study clearly states what “subset of disclosures” constitutes misconduct. “We also disclose the number of disputed disclosures,” he explained in an interview.

“In 2015, for instance, FINRA’s disclosure rate [for advisors was] 12.6%, which is very close to our figure of 12.7%. That tells me that we did not bungle that …Our [misconduct] focus was on [only] six of 22 categories, which we think are clear,” the professor said.

Lies, Damn Lies & Statistics

At the top of the list of 10 firms with a high percentage of misconduct are Oppenheimer & Co., First Allied and Wells Fargo Financial Network. UBS is on this list and also is on the list of 10 firms with a low percentage of misconduct, since the authors looked separately at wealth management and institutional/investment banking operations.

The first list says UBS Financial Services had more than 12,100 reps in the 2005 to 2015 period, while today it has about 7,100. Industry observers say the numbers for advisors with at least several other firms are incorrect.

In other words, the figures for advisors and the records of misconduct include individuals working with financial firms who have taken professional examinations but do not necessarily work with clients.

But, asks Matvos, if such figures are overstated, doesn’t that then mean the percentage figures for disclosures and misconduct “are too low?”

“I get it that there are mistakes in the methodology,” said Chip Roame, head of Tiburon Strategic Advisors, who nonetheless believes the study needs to be taken seriously and shouldn’t be dismissed by the industry over data concerns.

“The retail versus institutional distinction is important, and penalizes independent broker-dealers and big retail firms, while making institutional firms look better,” he explained in an interview.

Furthermore, complaints and even settlements “are not necessarily proof of bad actors,” Roame states. “And the study also excluded RIAs, an industry that positions itself as holier than thou but also may have generated the [Bernie] Madoffs, [Allen] Stanfords, etc.”

Several firms, which declined to comment specifically about data that referred to them, believe that settlements between advisors, firms and clients do not prove misconduct and should not have been included in the study’s statistics. In other words, the settlements were reached to put an end to a conflict but do not necessarily represent “guilt” tied to misconduct.

“It would be helpful to have a study — one without any questions about its methodology — that would shine a spotlight on firms that routinely hire advisors with proven records of misconduct,” said Elzweig. The size of settlements or awards could be used to distinguish between serious offenses and cases in which a firm paid off a plaintiff just to avoid more costly litigation.”

Nonetheless, the study finds that the median settlement tied to misconduct from 2005 to 2015 was $40,000.

“That’s not chunk change,” said Matvos. “And looking at the top 25% of settlements, we are talking about a median of over $120,000 — not just nuisance lawsuits.” The study also argues that some firms seem to foster, or at least tacitly accept, a culture that puts up with misconduct — an argument that many firms vehemently dispute. “Our findings suggest that some firms specialize in misconduct and cater to unsophisticated consumers, while others use their reputation to attract sophisticated consumers,” the authors explained.

For its part, Oppeheimer says it “has made significant investments to proactively tackle risk and compliance issues in our private client division.” For instance, it appointed a new global compliance officer and added over 20 staff members to its compliance and audit teams.

“Oppenheimer recognized the need to address these legacy issues head on, and we are confident that we have put in place safeguards to ensure that our advisors and other employees meet the highest ethical standards,” it explained in a statement.

Worthwhile Research?

Roame believes the industry needs to reflect — and act — on what the researchers present. “The study should be taken seriously, and the industry should set out to fix itself,” the consultant said. “Sure, the data has flaws, and one should be careful analyzing the individual firm data. But the broad industry conclusions are accurate.”

Parsing this data is difficult, Roame explains, since it involves making plenty of assumptions. “But the bottom line is that the industry has a lot of bad actors and a high misconduct rate,” he said.

Rather than deflecting attention from the study’s broader points — which is “counter to public good,” Roame argues — “admit it and weed [the bad actors] out.” (He also hope the authors will “clean up” their data so the industry can move ahead on the issue.)

The report, says Matvos, has “a lot in it,” including research about repeat offenders, which account for some 33% of advisors with misconduct records.

And this finding cuts across all types and sizes of firms: “Differences between them do not come into play at all,” he said.

Also noteworthy is what happens to advisors after misconduct is dealt with: 48% of advisors leave the firm but only 27% leave the industry. “In some ways that tells you firms are pretty active about addressing misconduct overall. But what about firms that hire those advisors after misconduct. What is going on there?”

SIFMA is concerned the study does not adequately highlight steps being taken in the industry today to curb misconduct. “We believe the report fails to properly explain the process used by one regulator, FINRA, which reviews all disclosure filings and initiates enforcement proceedings or statutory disqualification proceedings as appropriate to properly penalize the small minority of registered representatives who engage in true sales practice misconduct,” the group said.

Matvos admits that the study’s research “just scratches the surface.” And its value is in revealing “incredibly rich data, which [are] publicly available. It’s an area we should have more facts on, and that is why we did the research,” he said. “It is useful to know.”


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