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Industry Spotlight > Broker Dealers

Massachusetts Hunts for ‘Rogue Brokers’ at 241 BDs

By Janet Levaux

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The Massachusetts Securities Division said Monday that it is conducting a sweep of state-registered broker-dealers with “an above average number of representatives with current misconduct reports on their record to learn details of the firms’ hiring policies and procedures.”

The regulatory body has reached out to 241 firms where more than 15% of advisors have at least one current disclosure incident on their record. The firms have two weeks to respond to the request information on hiring since Jan. 1, 2014, and must tell regulators the number of representatives terminated or placed on heightened supervision in that period.

“My office diligently works to keep the bad actors out of the Commonwealth,” said Commonwealth Secretary William F. Galvin, the state’s top securities regulator, in a statement.

“This sweep is intended to establish how the industry is meeting this critical investor protection responsibility of keeping the rogue broker out of the industry,” Galvin said.

At least one industry observer says the steps taken by Massachusetts regulators are a good thing for the industry.

“Regulators are cracking down on broker-dealers that are providing havens for rogue brokers,” said Mark Elzweig, head of the executive search consultancy Mark Elzweig Co. in New York, in an interview. “They are focusing on firms that are regular destinations for advisors with serious compliance issues — those who’ve been terminated and those who require special supervision.

“Some firms have built their businesses by serving as ‘go-to destinations’ for advisors with serious compliance issues,” the recruiter said. “Penalizing these firms and shutting down these unsavory business practices is a good thing for the industry as a whole.”

The issue of bad advisor behavior has been attracting the attention of both legislators and regulators of late.

In mid-May Sen. Elizabeth Warren, D-Mass., asked Financial Industry Regulatory Authority CEO Richard Ketchum to tell her — by June 15 — how the self-regulator plans to rein in broker misconduct. Warren along with Sen. Tom Cotton, R-Ark., queried Ketchum on the steps FINRA is taking to address advisor misconduct in order to protect investors.

The senators asked Ketchum what “specific steps” FINRA is taking to address “unacceptable levels” of advisor misconduct across the financial services industry; cracking down on the “high rates” of recidivism among brokers with a disciplinary history; and beyond more disclosures in BrokerCheck, how FINRA is tackling the problem of firms that employ “a large share” of brokers with a disciplinary history.

Ketchum told The Wall Street Journal on May 9 that BrokerCheck database would now include new disclosures about where brokers accused of misconduct concentrate.

Warren cited a February National Bureau of Economic Research working paper analyzing data from BrokerCheck, finding that one in 13 advisors have a misconduct related disclosure on their record. The study also found that only about half of advisors who committed misconduct lost their jobs, with 44% of those obtaining a job at another advisory firm within a year.

The study made waves in the advisory industry when it was released, but some analysts and industry groups questioned its methodology.

Industry Research

Galvin’s actions appear to come in response to the study and recent actions taken by FINRA. The report was written by the University of Minnesota’s Mark Egan and the University of Chicago Booth School of Business’ Gregor Matvos and Amit Seru; it examined 10 years of records from the Financial Industry Regulatory Authority’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 thinks the study’s methodology and examination of the FINRA records hold up when the research is put under the microscope, according to the Securities Industry and Financial Markets Association and several industry analysts. (Several broker-dealers cited in the research declined to comment on it.)

“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],” Elzweig said at the time.

“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?” he asked.

The research finds the per-year level of misconduct across some 1.2 million registered representatives 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,” SIFMA said in a statement.

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,” he said. “Our [misconduct] focus was on [only] six of 22 categories, which we think are clear.”

— Check out FINRA’s Ketchum Warns on Dangers of Poor Firm Culture on ThinkAdvisor.

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