Academics Investigate Financial Adviser Industry Misconduct

Steven Lofchie Commentary by Steven Lofchie

Academics provided the first large-scale study that documents the economy-wide extent of misconduct among financial advisers and financial advisory firms. In a paper titled "The Market for Financial Adviser Misconduct," Mark Egan, Gregor Matvos and Amit Seru argue that consumers could avoid a substantial amount of misconduct by avoiding financial advisers that have existing misconduct records.

Misconduct is too concentrated to be driven by random mistakes, according to the study. One in thirteen financial advisers have a misconduct-related disclosure on their record, and approximately one-third of advisers with records are repeat offenders. Moreover, the study found that past offenders are five times more likely to engage in misconduct than the average adviser. Large differences in misconduct across firms were found. Some employ substantially more advisers with records of misconduct than others. Differences across firms are persistent: firms and advisers with clean records coexist with those that persistently engage in misconduct.

The study found that firms do discipline misconduct, with approximately half of financial advisers losing their job after misconduct. However, the authors found that the labor market partially undoes firm-level discipline of these advisers; 44% are reemployed in the industry within one year. Additionally, firms that rehire these advisers tend to have higher rates of misconduct themselves, the study found.

Although many American households rely on financial advisers for financial planning and transaction services, the authors found that misconduct is more common among firms that advise retail customers and in wealthy, elderly, and less educated countries. Finally, the study provides evidence that some firms "specialize" in misconduct and cater to financially unsophisticated consumers, while others use their reputation to attract sophisticated consumers, allowing misconduct to persist.


This paper raises several important public policy issues. One may reasonably conclude from the findings that any violation of the securities laws that involves fraud should result in an individual's permanent suspension from the industry. Alternatively, one may conclude that the penalties for adviser misconduct are in fact quite severe; the fact that 44% of advisers fired for misconduct find a new job within one year also means that 56% do not. This does not seem trivial. Yet another possible takeaway is that firms hiring advisers that have been subject to disciplinary problems ought to be required to institute more stringent supervisory procedures. Firms should take the report as another good reason to examine their own hiring and supervisory practices.

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