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State Warns BDs: Watch ‘Bad Actors’ or We’ll Do It For You

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Massachusetts securities regulators have issued the results of their June sweep of over 240 broker-dealers with a “higher than average” number of advisors that have disciplinary incidents on their records.

According to Commonwealth Secretary William Galvin, the state’s top securities regulator, few registered representatives with such records have been placed on heightened supervision by the BDs, as the research shows.

“As I stated at the time of the sweep, my office works diligently to keep the bad actors out of the Commonwealth and expects the broker-dealer community to assist us by aggressively policing and monitoring their own workforce,” Galvin said in a statement on Thursday. “The results of the sweep indicate that this is not happening.”

Scope of Study

The sweep covered broker-dealers’ records from January 2014 to June 2016. It looked at the number of reps either terminated or placed on heightened supervision because of their disclosure history.

The regulators also obtained copies of the firms’ policies and procedures relating hiring, evaluation and firing of advisors.

Of the nearly 8,600 reps hired with disclosures, relatively few of them were put on heightened supervision by the broker-dealers.

(The 241 BDs were picked due to the fact that they had employed 10 or more advisors registered in Massachusetts and employed a higher-than-average percentage of reps with at least one one misconduct disclosure.

Read on for more details related to the major results and conclusions of Galvin’s “bad agent” (aka “bad broker”) report.

broker dealer checks 

 1. All broker-dealers do background checks.

Although some firms’ vetting processes are “more robust than others, the Massachusetts regulators conclude, all of the 241 broker-dealers in the June sweep perform due diligence on advisors’ backgrounds before hiring them.

Furthermore, nearly all of the BDs have written rules and regulations on vetting the reps they hire.

All 241 broker-dealers responding to Galvin’s request for information confirmed that they vet the reps they hire, usually “by searching publicly available data, verifying information submitted on the [advisor’s] Form U4, conducting credit checks, checking criminal databases, or requesting that candidates fill out a firm questionnaire regarding the agent’s past.”

bd policies

2. Most BDs hiring advisors with misconduct records have written policies in place.

According to Galvin’s office, 236 of the 241 broker-dealers queried, or 95%, say they have hired advisors with disclosure records, and nearly all of which have written policies and procedures for such hiring.

However, 12 broker-dealers, or 5%, indicate that they do not have such written policies and procedures.

bad brokers

3. Nearly one in five reps hired by the firms in the study has a record of misconduct.

In Galvin’s study, a large majority of responding BDs shared specific information on when they hired brokers with disclosure records — 183 of 241 responses, or 76%.

More than 18% of the 47,300-plus advisors hired by these 183 BDs between January 2014 and June 2016 had disclosure incidents.

The average percentage of advisors employed with one or more disclosures at all broker-dealer firms doing business in Massachusetts was about 15% as of June, Galvin’s office says.

bad brokers 

4. The percentage of reps being hired with misconduct records is increasing slightly.

The Massachusetts regulators say they found a trend among about 40%, or 74 of the 183 BDs surveyed. These 74 BDs shared information on the specific time periods for their hiring of advisors with disciplinary histories.

“More concerning [than the findings of Slide 3] is that the rate at which a subset of the broker-dealers hire agents with disclosure incidents has slightly increased,” according to the report.

In 2014, about 12,040 brokers were hired, and 1,925 — nearly 16% — had records of disciplinary events.

In 2015, close to 13,060 advisors were hired, with almost 2,170 — close to 17% — having disclosure incidents in their records.

In the first half of 2016, broker-dealer added nearly 5,100 FAs; some 890 — close to 17.5% — had disclosure records.

broker misconduct

5. More than one in five reps at some firms have misconduct records.

The majority of broker-dealers that shared information with Galvin’s office, 60%, did not break down the year they hired advisors.

Among these nearly 110 BDs, about 17,150 reps hired from January 2014 to June 2016 had disclosure incidents on their records. This represents about 21% of hired FAs vs. 18% among the other 40% of BDs that responded to Galvin’s sweep.

Earlier this year, a study titled The Market for Financial Adviser Misconduct by Mark Egan, Gregor Matvos and Amit Seru found that advisors with misconduct-related disclosures “are five times more likely to be involved in another incident alleging misconduct than agents who have never been the subject of a misconduct disclosure.”

broker misconduct

6. Most BDs do not place reps with misconduct records on heightened supervision.

The analysis for most broker-dealers in the sweep — nearly 110 out of 183 — shows that of the 3,602 agents hired with disclosure incidents, only 7.5% of those agents were placed on heightened supervision.

That left a large majority of such reps, 92.5%, not subject to such increased scrutiny.

“Heightened supervision is a mechanism for firms to create investors protection by creating a regulatory program to prevent future abuse by agents with a history of regulatory problems,” Galvin said, “As a recent academic study showed, these individuals are more than likely to be repeat offenders.”

broker misconduct

7. The limited percentage of reps with records of misconduct placed on heightened supervision appears to be rising slightly.

According to 74 other broker-dealers, 4% of 1,925 advisors hired in 2014 with disclosure incidents were placed on heightened supervision.

This figure rose to 5.2% in 2015, when these BDs hired almost 2,170 with disclosure histories.

In the first half of 2016, these BDs brought on close to 890 reps with disclosure records, and nearly 6.5% were placed on heightened supervision.

“While disclosure incidents can run the gamut of allegations and not all would necessarily mandate being place on heightened supervision,” Galvin explained, “the numbers my office found raise a strong presumption that certain firms continue to hire bad brokers but are unwilling to take on the obligation of zealously monitoring their interaction with customers.”

broker misconduct

8. Overall, a very small percentage of reps with misconduct records are subject to increased supervision.

According to the Massachusetts securities regulators, their report’s most troubling finding is “the vast majority” of reps hired with disclosure incidents are not placed on heightened supervision.”

Of the close to 8,600 such FAs at 183 BDs that responded to the sweep with detailed information, just 6% overall received heightened supervision by their BDs vs. about 94% that did not.

The report notes that heightened supervision “requires a firm to monitor and mitigate the known risks that [brokers] with disclosure incidents may pose to investors. Implicit in heightened supervision is the broker-dealer’s willingness to accept the responsibility to monitor and protect investors from harm from potential repeat offenders.”

In Galvin’s mind, the situation means regulators have to step in and fill the void.

“This report should act as a warning to the broker-dealer community,” he said,” that if the industry is not willing to self-police in this area, then regulators will step in and demand changes by regulatory action.”

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