FINRA targets repeat brokers, but its reach does not extend far

WWhen it comes to protecting investors from broker misconduct, all eyes are on whether the SEC will change Regulation Best interest, which requires brokers to act in the best interests of their clients when making recommendations. Meanwhile, FINRA, the self-regulatory body for investment dealers, has itself taken lesser-known steps to protect investors from repeat brokers.

A die new rules, implemented in September, effectively requires FINRA approval for a company to hire a broker with a significant history of misconduct. FINRA defines a serious fault as at least one “final criminal case” or two “specified risk events” within the past five years, such as investment-related civil judgments or arbitral awards of at least $ 15,000.

FINRA’s mandate is to design rules to prevent future wrongdoing, and it refers to two studies supporting the new rules. A 2015 to study by its own economists shows that a broker’s disciplinary record and certain other disclosures have “significant power to predict future investor harm” and a Academic study 2019 finds that one in four brokers with a history of misconduct was a repeat offender.

“Former offenders are five times more likely to commit misconduct than the average advisor, even compared to other advisers in the same firm, in the same place and at the same time,” according to the university study. “The high presence of repeat offenders suggests that consumers could avoid a significant number of misconduct by avoiding counselors with a history of misconduct.”

Every industry has bad apples, but they seem particularly prevalent in the financial industry. Over 600,000 registered brokers, the university study found that one in 13 people (7.28%) had a history of misconduct (and that only counts those caught).

Surprisingly, however, brokerage houses are quite strict on broker behavior. Almost half (48%) of brokers found guilty of misconduct lose their jobs. But other brokerages then hire 44% of those licensed brokers within the year. New businesses pay less and have a relatively high share of brokers with a history of misconduct. In other words, these brokers are matched with companies with a higher tolerance for misconduct.

This model suggests a two-speed system. Clean businesses do not tolerate malpractice and they rely on their reputation to attract knowledgeable customers. Other companies and their advisers, on the other hand, consistently engage in wrongdoing and appear to target vulnerable customers. Misconduct is most prevalent in places where older and less educated populations live, two groups often associated with less sophisticated investors. Misconduct is also more common in higher income countries, an attribute that generally serves as an indicator of investor sophistication. The study suggests that criminals target the rich because it pays off.

Firms with higher percentages of broker misconduct have significantly less revenue and assets under management. But why doesn’t reputation do more to weed out bad companies? After all, the disciplinary files of financial advisers are accessible to everyone on two websites: the FINRA one. BrokerCheck and the SEC Investor Advisor Public Disclosure Website– who combined their search results. FINRA requires brokers to notify clients of BrokerCheck, and the SEC has conducted public service campaigns to “consult your investment professional”.

Nevertheless, some investors do not use or even do not know the sites. By focusing on these unsophisticated investors, companies can mitigate the consequences of a bad reputation.

This suggests a market failure. Firm discipline, reputation, market forces and years of increasing pressure from FINRA were not enough to protect investors. Hence the new FINRA rules. The message for the brokerage industry? Hear a memorable headline from a law firm note: Thanks to the issuance of new rules for repeat brokers and the companies that hire them, FINRA is loud and clear to its members Can you hear me now ??? “

But FINRA and strong surveillance cannot go further. Brokers with a history of serious misconduct are 25% more likely to move into other areas of the financial services industry beyond the scope of FINRA. Once there, former brokers with a history of misconduct are over 40% more likely to commit new misconduct compared to brokers with a history of misconduct who remain in the brokerage industry. These disturbing findings come from a 2021 study, “Wandering financial advisersCo-authored by former SEC Commissioner Robert J. Jackson Jr. and two other academics.

“Wandering advisers who already have a history of misconduct when they leave the FINRA regime are much more likely to reoffend than brokers currently registered with FINRA who also have a history of misconduct,” the study concludes. .

The study highlights the insurance industry, where there is a disproportionate number of former brokers with a history of misconduct. Of the more than 50,000 ex-brokers who work as insurance producers, more than 13% have a history of serious misconduct. (These numbers shouldn’t tarnish the majority of ex-brokers working in the insurance industry who have blank records.)

The study paints a picture of “highly fragmented” insurance regulation at the state level. Many insurance agents operate independently, and insurance companies have much less control over insurance agents than brokerage and investment advisory firms exercise over their employees. There is also no user-friendly website with a national database of insurance producer records.

None of this is intended to disparage FINRA’s new rules designed to protect investors from repeat brokers. But the rules won’t extend to financial advisers changing hats in a regulatory arbitrage game. It will take Congress to develop a more comprehensive solution.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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