New Study Casts Doubt on the Financial Advising Industry

Posted on March 26th, 2016 at 11:31 AM
New Study Casts Doubt on the Financial Advising Industry

From the Desk of Jim Eccleston at Eccleston Law LLC:

Professors at the University of Chicago and University of Minnesota recently concluded a study examining misconduct among financial advisors. The results were troubling, showing that misconduct is widespread among both large and small firms.

The new working paper finds that 7% of financial advisers have a conduct history including recommending unsuitable investments to trading on client accounts without permission. This news is startling for an industry that relies on trust between advisors and investors. Moreover, some large firms have misconduct exceeding the industry average. Almost 20% of the representatives at Oppenheimer & Co. have misconduct records, according to the report.

Amit Seru, finance professor at the University of Chicago’s Booth School of Business, is wary of the results and posits that the misconduct can be found across the industry in firms of all shapes and sizes. Further, he suggests the results of the study are conservative. The paper focused on just 6 out of the 23 categories of violations. The study included disclosures about an “investment-related arbitration or civil suit … that resulted in an arbitration or civil judgement for the customer” and proceedings by regulators “for a violation of investment-related rules.”

A spokeswoman for Oppenheimer says that the company has directed far more investment to compliance and risk management in its private client division. In addition, she assures that the firm has made changes to senior leadership, branch managers, and other personnel to foster a more compliant culture within the firms operations. Changes include a new global compliance officer and improved surveillance.

Financial advisor misconduct is not left unchecked within the industry. About half of the advisors who have misconduct are fired from their firms. Interestingly, however, about 44% of that group are rehired by a different firm within a year. Those firms that rehire often have much higher rates of misconduct in their ranks and serve as a haven for repeat offenders. According to the paper, “Prior offenders are five times as likely to engage in new misconduct as the average financial adviser.” This suggests that some firms not only have a higher tolerance for bad behavior but may model their businesses to attract brokers who can generate high revenue at the cost of disciplinary violations. This study has been unique in its ability to generate a list of firms who have abnormally high misconduct rates, as well as those with the lowest.

FINRA representatives note the paper’s findings and plan to address the firm culture of securities firms as a top priority. FINRA also points to its permanent barring of 500 individuals and 25 firms last year as a means of cleaning up the market for financial advisers. While all misconduct is bad for investors, not all misconduct necessarily points to a malicious adviser. Some of the most common violation have to do with suitability which is often times an unintentional mistake by an adviser.

A serious area for concern lies in conflicted retirement planning advice from financial advisers. A previous report warned that financial advisers – who should act in your best interest – frequently suggest high cost, low return products rather than a quality investment for the consumer. Estimates from this report suggest that these types of conflicts of interest led to $17 billion of losses to investors annually, specifically for working class and middle class families.

Some experts feel that the solution to these poor recommendations can be found in a new fiduciary standard as put forth by the Department of Labor. That new standard would make it very difficult for advisers to recommend high-commission products, when there are low-fee alternatives. The rule is slowly moving through the political process with doubts about its manifestation into law.

Adviser misconduct records thrive as a result of lack of consumer sophistication. The advisers who have poor records are concentrated in counties with low education, elder population, and high incomes, according to the report. The study goes so far as to suggest that some firms “specialize” in misconduct and focus on unsophisticated customers.

It is surprising to Seru that this study has not been conducted earlier as the data is not only public but easily accessible. He says that his next project will focus on the effectiveness of disclosure efforts such as FINRA’s BrokerCheck in sparking improved governance. 

The attorneys of Eccleston Law LLC represent investors and advisers nationwide in securities and employment matters. Our attorneys draw on a combined experience of nearly 65 years in delivering the highest quality legal services. If you are in need of legal services, contact us to schedule a one-on-one consultation today.

Related Attorneys: James J. Eccleston

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