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Risk of Financial Advisor Misconduct

Posted in Individual Investing, Investing Expertise

How should investors assess the risk of financial advisor misconduct? In their March 2016 paper entitled “The Market for Financial Adviser Misconduct”, Mark Egan, Gregor Matvos and Amit Seru investigate the recent extent of misconduct among registered financial advisors (“advisors”) and financial advisory firms in the U.S. Their data include employment history, customer disputes, disclosed investigations and disciplinary events (civil, criminal and regulatory). Using information on 1.2 million registered financial advisors (644,277 current and 638,528 former) during 2005 through 2015, they find that:

  • 7.3% (about one in 13) advisors have misconduct-related disclosures on their record.
  • After misconduct:
    • Most remain employed in the financial services industry, with about fifth switching firms. 
    • Nearly half lose their jobs, but 44% of these are re-employed in the industry within a year.
    • Those changing firms tend to move to less reputable ones.
  • About a third of advisors with misconduct records are repeat offenders. Past offenders are five times more likely to exhibit new misconduct than the average advisor. 
  • Risk of encountering an advisor with a record of misconduct varies widely across firms.
    • More than one in seven advisors at Oppenheimer & Co., Wells Fargo Advisors Financial Network, First Allied Securities and UBS Financial Services have a record of misconduct.
    • Fewer than one in 100 advisors at Goldman Sachs & Co. and Morgan Stanley & Co. LLC have a record of misconduct.
  • Firms that hire advisors with misconduct records have higher rates of past misconduct, and such firms are less likely to fire advisors for new misconduct.
  • Misconduct concentrates in firms with retail customers and in counties with low education, elderly populations and high incomes. In many Florida and California counties, one in five advisors have a record of misconduct.

In summary, evidence suggests that the naive risk of encountering a registered financial advisor with a record of misconduct is about 7%, with this risk varying across firms and with local demographics.

Cautions regarding findings include:

  • As illustrated by the study, investors can check for misconduct by specific registered financial advisors.
  • Investors can also mitigate risk of damage from advisor misconduct via self-education.
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