FILE - In this file photo taken Feb. 2, 2011, a wallet containing cash and a Visa card is displayed in Surfside, Fla. In a week-long series of stories beginning Monday, March 28, The Associated Press, will debunk some of the myths that can keep you from developing a sound financial plan for managing your money wisely. (AP Photo/Wilfredo Lee, file)

Harold Pollack is the Helen Ross Professor at the School of Social Service Administration at the University of Chicago and co-author of The Index Card: Why Personal Finance Doesn't Have to Be Complicated.

How widespread is misconduct within the financial advice industry?

Economists Mark Egan, Gregor Matvos, Amit Seru released a sobering working paper last week that explores this question. These authors conduct an ingenious analysis of a unique BrokerCheck dataset that covers 644,277 currently-registered financial advisors in the United States, and an additional 638,528 who have left the industry between 2005 and 2015.

Their paper documents disturbing patterns involving some of the nation’s most prominent names in retail financial services.

More than 7 percent of registered advisors have been disciplined for misconduct or fraud. Many such cases involved placing clients into unsuitable or overly-risky investments. Misrepresentation and omission of key facts were other large categories. The misconduct was also financially significant. In cases involving settlements, the median was $40,000. Many cases involved products such as variable annuities, which are notorious for their complexities and hidden fees.

Perhaps the most surprising finding is the high proportion of repeat offenders still present in the industry. Among advisors with documented misconduct, 38 percent were repeat offenders. Those who commit misconduct and remain in the financial advice industry were five times more likely than their peers to commit subsequent misconduct. Just in the year immediately following a documented misconduct case, perpetrators exhibited an 11 percent probability of another documented case, compared with a rate of just 0.6 percent within the overall industry.

Advisors who commit misconduct do suffer career penalties. Forty eight percent leave their current jobs within a year. Yet almost half of those who leave (44 percent) find employment in the industry within the year, typically at a less prestigious firm with a pay cut, but still in a position to harm someone again.

Advisor misconduct is also clustered by geography and by firm. Firms with a high concentration of sanctioned advisors include some of the most familiar names in the financial industry. More than 15 percent of financial advisers at Oppenheimer & Co., Wells Fargo Advisors Financial Network, and First Allied Securities had previously documented misconduct cases.


Meanwhile, at Goldman Sachs & Co. and Morgan Stanley & Co. LLC, the comparable figures were less than 1%.


Advisers working for firms whose corporate leaders had more widespread records of misconduct were more than twice as likely to engage in misconduct. Firms that employed advisors with misconduct records were also less likely to fire those found to commit subsequent misconduct.

These patterns point to perhaps the most concerning finding of this paper. As the authors put things:

A poignant feature of these tables is that several firms with the highest misconduct levels share a parent company with firms that have among the lowest misconduct levels. For example, approximately one in seven advisers at UBS Financial Services have been reprimanded for financial misconduct. At UBS Financial Services affiliate, UBS Securities, the share is ten times smaller: only one in seventy employees have been disciplined for misconduct. One source of differences between these UBS subsidiaries may be their customer base. Advisers at UBS Financial Services help retail customers with personal investment decisions. Advisers working for UBS Securities likely work on a trading desk and deal with institutional rather than retail clients.

Put slightly differently, firms doing business with sophisticated investors employ few advisors with histories of documented misconduct, because such sanctions are likely unacceptable in that market niche. Meanwhile, firms that employ conspicuously high proportions of advisors with checkered pasts are in a different niche, serving ordinary retail investors.  Consistent with this picture, Egan, Matvos, and Seru document that financial advisors with histories of misconduct are especially common in parts of California, Florida, and Arizona that include high proportions of wealthy retirees with limited educational credentials.

The problem is stark. Unsophisticated investors have the greatest need for judicious advice. They are often the most vulnerable to unscrupulous behavior. Most of these investors require simple products such as low-fee index funds, term life insurance, and simple annuities. Yet as this market evolved, these are precisely the people who face the greatest risk of encountering financial professionals with histories of ethical and legal lapses.

Maybe this is a coincidence. I share the authors’ fear and belief that it isn’t. As they put things:

That misconduct is targeted at unsophisticated, less educated, and elderly consumers, is troubling, because these are the segments of the population that the existing regulation is already trying to help. Our findings suggest that a natural policy response to lowering misconduct is an increase in market transparency and in policies helping unsophisticated consumers access more information. Several recent efforts by regulators, such as the establishment and promotion of FINRA's BrokerCheck website, have been along these lines.

The authors’ comments are sensible. I do hope we can implement something stronger. Luigi Zingales attracted attention last year for his presidential address to the American Finance Association, in which he bluntly stated: “I fear that in the financial sector fraud has become a feature and not a bug.” Shame and exposure may also help. For starters, the outlier-firms in this paper might explain what they plan to do to protect and reassure their customers.