Financial Advisers: Quite the Unsavory Lot? (Part 2)

Today I will continue my discussion of the abstract by Egan et al. and then conclude with some additional comments about the article.

     > Firms that persistently engage in misconduct coexist with
     > firms that have clean records… differences in consumer
     > sophistication may be partially responsible for this
     > phenomenon: misconduct is concentrated in firms with
     > retail customers and in counties with low education,
     > elderly populations, and high incomes.

This is shocking. In so many cases, people hire financial professionals precisely because they do not feel educated in this domain. For the industry to focus its fraudulent efforts on the low-hanging fruit is absolutely despicable.

And yes, I did write “the industry.” I highlighted the failure to break down numbers between the financial and insurance industries. We know it’s not more than 7% for either, based on the sample, and despite their having a five-fold greater chance of committing misconduct again, they are able to continue working.

     > Our findings suggest that some firms “specialize” in
     > misconduct and cater to unsophisticated consumers…

This is a serious indictment.

     > Firms that employ more employees with records of
     > misconduct are also less likely to punish additional
     > misconduct.

They also said firms more likely to hire advisers previously disciplined had higher incidences of misconduct. This all suggests misconduct to be related to a firm’s organizational culture. The worst firms in terms of percentage disciplined for misconduct were Oppenheimer & Co., Inc. (19.60%), First Allied Securities, Inc. (17.72%), and Wells Fargo Advisors Financial Network, LLC (15.30%). Conversely, the best firms were Morgan Stanley & Co. LLC (0.79%), Goldman, Sachs & Co. (0.88%), and BNP Paribas Securities Corp. (1.17%).

One potentially confounding variable is the definition of misconduct. Many cases involved the suitability of investments. For example, a high front-load, aggressive mutual fund would not be appropriate for an elderly client. In 2015, the President’s Council of Economic Advisors reported on bad [unsuitable] advice without categorizing it as misconduct. The Council estimated such conflicts of interest to cost working-class and middle-class families up to $17 billion per year. I would definitely consider this misconduct but I don’t know whether it was included for purposes of the article.

To summarize, roughly 12 out of 13 advisers have no records of misconduct. Because of the one in 13 who do, I would strongly suggest anyone employing such individuals to run a background check first. Two places to start are the Financial Industry Regulatory Authority’s (FINRA) BrokerCheck database and the SEC Form ADV, which may be accessed here.