Does Your Financial Advisor Have a Fraud Record?


(Luke Sharrett/Bloomberg via Getty Images)

March 3, 2016

Financial advice is big business in the United States. More than half of all households use a financial planner. But just how much can investors trust the industry?

A new working paper by professors from the University of Chicago and the University of Minnesota suggests cause for concern. According to the study, 7 percent of advisors have been disciplined for a fraud dispute or some form of misconduct. That can include anything from putting a client in unsuitable investments, to misrepresenting or omitting key facts, “excessive trading,” negligence, or trading on a client’s account without his or her permission. Of the registered advisors who engaged in misconduct at least once, 38 percent are repeat offenders.

The findings, write the authors, show that “financial advisor misconduct is broader than a few heavily publicized scandals.”

Misconduct is not necessarily a career killer, though. While roughly half of advisors lose their jobs after an offense, 44 percent are back in the industry within a year. That’s especially troubling, as “prior offenders are five times as likely to engage in new misconduct as the average financial advisor,” according to the study.

“This simple summary statistic strongly suggests that misconduct does not arise due to bad luck or random complaints by dissatisfied customers,” say the authors. Moreover, “Advisers working for firms whose executives and officers have records of misconduct are more than twice as likely to engage in misconduct,” they note.

It’s likely that the true rate of fraud and misconduct is much higher. To conduct their analysis, the first of its kind, the authors pored through disclosure information in BrokerCheck, a database run by the industry’s self-regulatory organization, the Financial Industry Regulatory Authority (FINRA). The database — which draws on information from regulatory filings, and from information that firms and investment professionals must file to register with FINRA — has 23 disclosure categories, but the authors analyzed just six of them.

Records for about 1.2 million financial advisors registered in the United States from 2005-2015 were used for the study — roughly 10 percent of total employment in the finance and insurance industry.

A spokesman for FINRA said the organization has not yet reviewed the paper, but that “protecting the investing public from unscrupulous brokers has long been one of FINRA’s top priorities, and we are vigilant in our efforts to identify and remove them from the securities industry.” In 2015, he noted, FINRA barred 500 individuals and 25 firms from the industry.

The clients most vulnerable to misconduct, the paper suggests, may be the ones in need of the most assistance. Misconduct was concentrated in firms that cater to retail investors who buy and sell for their personal accounts, as opposed to institutional clients, and the most common victims were those with high incomes, low education and the elderly. This suggests that regardless of wealth, “misconduct is targeted at customers who are potentially less financially sophisticated.” Simply put, the authors say, some firms “specialize” in misconduct, “and cater to unsophisticated consumers.”

The worst performer in the study was Oppenheimer & Co., where 19.6 percent of the firm’s 2,275 advisors had been disciplined for misconduct. Morgan Stanley, with 3,807 advisors, had the lowest rate: 0.79 percent.

In a statement, a spokeswoman for Oppenheimer said the firm “has made significant investments to proactively tackle risk and compliance issues in our private client division … We are confident that we have put in place safeguards to ensure that our advisors and other employees meet the highest ethical standards.”

In terms of location, the states with some of the highest rates of misconduct were Arizona, California and Florida.

For its part, the Obama administration has sought to implement industry-wide safeguards to protect for misconduct. The Department of Labor has proposed a new rule that would require financial advisors to put their customers’ interests before their own whenever dealing with retirement accounts.

Currently, much of the industry goes by what’s known as the suitability standard, meaning their advice technically meets a client’s needs or tolerance for risk, but legally doesn’t have to be in their best interest. The Obama administration first proposed raising the standard in 2010, but in the face of opposition from the financial services industry, Republicans in Congress and even some Democrats, it has yet to take effect.

Jason M. Breslow

Jason M. Breslow, Former Digital Editor



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