What You Need to Know
- Before they're bought out, RIAs in these deals have below-average levels of misconduct.
- Misconduct is stronger in firms with higher post-buyout growth in AUM per advisor, the study found.
- The findings should give pause to advisors mulling a sale to a PE firm, Michael Finke says.
RIAs acquired by private equity firms had a 147% increase in the percentage of their advisors committing misconduct and a 200% increase in the average number of misconduct incidents after the ownership change, according to a just-released study.
The research released by the University of Oregon examined whether ownership by private equity firms encourages or deters financial misconduct.
The authors analyzed the records of individual advisors around buyouts of investment advisory firms by private equity.
“Our estimates suggest that private equity ownership leads to an increase of 147% in the percentage of the acquired firm’s financial advisers committing misconduct,” the study states.
“While the misconduct rate of the acquired firms is only about 40% of the industry average before the buyout, it becomes on par with the industry average after the buyout,” the study explains.
The increase in misconduct “is stronger in firms with higher post-buyout growth in assets under management per adviser and is concentrated in firms whose clients include retail customers,” the report states. “Our results suggest a tension between advisory firms’ profit motive and ethical business practices, especially when customers are financially unsophisticated.”
Responding to the study, Michael Finke, professor and Frank M. Engle Chair of Economic Security at The American College of Financial Services, told ThinkAdvisor in an email message that “private equity firms aren’t either ethical or unethical. They are simply smart and creative at identifying profit opportunities.
“Clients of advising firms that charge asset-based fees tend to be sticky, and there are opportunities to gather additional assets or obtain additional revenue from these clients through less ethical practices. This presents a business opportunity. A more ethical advisor builds a clientele of trusting investors that are ripe for less ethical revenue harvesting.”
The University of Oregon study, Finke continued, “finds that acquired firms are significantly less likely to commit misconduct before being acquired. In other words, their clients have a good reason to trust their advisor. This makes them more vulnerable to exploitation. Firms who have a lot of individual investor clients, who tend to be less sophisticated, are also seen as more profitable takeover targets.”
The study states that overall, its findings indicate “that PE chooses cleaner firms in terms of misconduct as buyout targets. After PE takeover, however, firms commit more misconduct.”