Is FINRA doing enough to steer investors clear of bad brokers?

August 9, 2016

By Todd Ehret, Regulatory Intelligence

(Thomson Reuters Regulatory Intelligence) – A recent debate has emerged as to whether U.S. regulators and the securities industry have done enough to rid themselves of bad brokers. At the core of the argument are recent studies showing that the percentage of those engaged in misconduct is much higher than that claimed by the Financial Industry Regulatory Authority, and that such brokers are often able to move unimpeded from firm to firm.

While a recent television marketing push by FINRA telling investors to go to the self-regulator’s disclosure website FINRA BrokerCheck and check out their broker’s credentials is seen as a step in the right direction, critics claim advertising isn’t enough and some are calling for the industry to do more. Many are calling for harsher punishment including expulsion for repeat offenders. There is also a push for more information and transparency in BrokerCheck where brokers with records of misconduct can be more easily spotted and perhaps ranked or rated based on their history of misconduct or criminal backgrounds.

A trio of recent research studies on broker misconduct have brought attention to the subject. Below, we review the studies and highlight some of the findings. We also offer some suggestions that regulators and firms should do related to broker misconduct disclosures.

Critics speak up

At a Senate Banking subcommittee hearing in March, Massachusetts Democratic Senator Elizabeth Warren, a leading Wall Street critic, questioned FINRA chairman and chief executive Rick Ketchum on what FINRA was doing to protect investors. She cited the academic study we discuss below, that indicates that half of brokers with ethical lapses get fired but 44 percent of them are rehired in the industry within one year.

A couple of months later in May, Arkansas Republican Senator Tom Cotton joined Senator Warren in sending a stern letter to Ketchum following up on the hearing, requesting answers about why widespread malfeasance by advisers appears to be going unpunished. The senators asked Ketchum what “specific steps” FINRA is taking to address advisor misconduct beyond more disclosures in BrokerCheck. They also asked how FINRA will “address the problem of high rates of recidivism among advisers with a history of disciplinary misconduct.”

Massachusetts Secretary of the Commonwealth, William Galvin, also launched an investigation in June seeking information from 241 brokerage firms in an effort to keep “rogue” brokers out of his state. The Secretary sent letters to firms in which more than 15 percent of their current representatives have at least one disclosure incident on their records. Galvin stated, the sweep “is intended to establish how the industry is meeting this critical investor protection responsibility of keeping the rogue broker out of the industry.”

FINRA’S self-assessment

In August of 2015 the FINRA Office of the Chief Economist published a working paper by Hammad Qureshi and Jonathan Sokobin (the FINRA Study) where they examined the value of information available through BrokerCheck.

It should come as no surprise that the FINRA study painted a favorable picture of its industry participants. The FINRA study created a sample of approximately 181,000 brokers out of the 1.2 million total registrants and found that “less than 1.5 percent of the brokers in our sample meet this definition of being associated with investor harm in the fourteen-year panel.”

FINRA claimed that “since customer complaints may lack merit or suitable evidence of investor harm. We only count complaints that led to awards against brokers or settled above a de minimis threshold.” Although there is some merit to this argument that there are a fair number of frivolous complaints, the wholesale exclusion of nearly one million brokers because complaints were below a threshold, that they were registered in fewer than 4 states (one of the other criteria), or were first registered prior to the year 2000 (a second criteria ), makes little sense.

The consultant and academic studies below provide significantly more data from a much larger dataset than FINRA’s 181,000 person panel. The consultant study in particular attempts to replicate and reconcile both FINRA’s and the academic numbers and likely paints a more accurate picture of the industry.

In the FINRA study, the regulator boasted of its disclosure website saying, “We find that BrokerCheck information, including disciplinary records, financial disclosures, and employment history of brokers has significant power to predict investor harm.” The report also stated: “Our findings suggest that investors have access to valuable information that allows them to discriminate between brokers with a high propensity for investor harm from other brokers.”

FINRA’s claims that BrokerCheck is a useful tool and has significant power to predict investor harm may be accurate. However, many critics claim that FINRA and the site only offer a small peek at the misconduct information and painfully one broker at a time.

Academic study claims FINRA’s numbers are too low

Another study titled, “The Market for Financial Adviser Misconduct” (the academic study) authored by Mark Egan from the University of Minnesota, and Gregor Matvos and Amit Seru from the University of Chicago, disputes FINRA’s estimate of 1.5 percent, claiming that the number is actually 7.28 percent of advisers who have at least one disclosure in their industry records for a settled consumer complaint, or worse, such as criminal convictions or personal bankruptcies and liens.

The academic study found that after misconduct is found 48 percent of brokers get fired, and after being fired, as Senator Warren complained, a whopping 44 percent get rehired in the industry within a year.

The good news, or bad news if you are one of those fired brokers, is that the study found that brokers who switch firms after a misconduct event see on average a 10 percent reduction in compensation. Often the largest and most well-known firms have nearly zero-tolerance policies toward brokers when such events occur. Therefore, what essentially happens is that the brokers end up going to the smaller, less prestigious firms after misconduct events.

The end result of moving down a rung on the career ladder is that brokers, although they are making less with each move, remain in the industry. The study indicates that as a result of this movement by brokers there is essentially a congregation of prior bad actors, largely at smaller firms. At some firms, the study claims that as many as 15 to 20 percent of the brokers have prior misconduct disclosures.

The study also found that a subset of firms disproportionately hired brokers with a history of misconduct, and that these firms “specialize” in supporting brokers with a history of misconduct. Such firms are also less likely to fire a broker for misconduct.

The findings imply that some firms may have a culture more permissive of misconduct and is perhaps what FINRA referred to, or is targeting with its’ sweep exam initiative announced earlier this year when they announced targeted exams surrounding firm’s cultures.

Perhaps the most upsetting finding in the study to Senator Warren is that of those brokers who have a misconduct disclosure in their disciplinary records, approximately one-third are repeat offenders. This means that a broker with one misconduct event is five times more likely to have another incident in the future.

The study also shows that bad brokers are highly concentrated in certain geographic locations. Such areas include a higher concentration of the elderly and higher concentrations of high-income individuals. With the overall misconduct rate of about 7 percent, some counties in California, New York and Florida had broker misconduct rates as high as 20 percent.

Compared to the FINRA study which included approximately 181,000 brokers, the academic study included 644,277 currently registered brokers, plus another 638,528 who were previously registered at some point between 2005 and 2015.

In response to the study, Kevin Carroll, managing director and associate general counsel at the Securities Industry and Financial Markets Association (SIFMA) wrote in a blog post that the study is misleading and that it also, “makes overly broad and inflated claims regarding the level of misconduct among financial advisers.” Carroll wrote, “plenty of investors with buyer’s remorse blame their brokers, even when they signed off on risky investments themselves, especially after the stock market collapse in 2008 and early 2009.”

Securities Litigation & Consulting Group Study

The Securities Litigation & Consulting Group is a financial economics consulting firm based outside of Washington, D.C. It provides consulting services and expert witnesses to law firms, brokerage firms, and individuals involved in complex litigation and regulatory investigations and arbitrations. The firm has published many finance, risk, and market-related research papers which are available on the firm’s website.

The firm’s most recent study, titled “How Widespread and Predictable Is Stock Broker Misconduct,” (the McCann study) pulls no punches in its critique of the FINRA study. The study confirms some of the findings in both the FINRA and academics’ studies, but also reconciles the wildly diverging estimates of broker misconduct between them.

Like the academic study, the group points to evidence that there is significant risk a broker will commit misconduct if he or she works with co-workers who have previously committed misconduct. Also, investors should be informed of the average misconduct history of a brokers’ firm as well as the co-workers around them.

The study was led by Craig McCann, PhD, CFA, and his associates Chuan Qin, PhD, and Mike Yan, PhD, CFA, FRM. McCann told Regulatory Intelligence that “FINRA arrived at their low estimate of misconduct by excluding 85 percent of all brokers, including brokers most likely to have engaged in misconduct.”

In order to mine the data to conduct their study on BrokerCheck, McCann and his colleagues had to open each of the approximate 1.2 million individual BrokerCheck records of every broker and pull the data. Such a task is nearly impossible for most, so the unshackling of the database is one of the things McCann and his firm are advocating.

Despite FINRA’s marketing efforts to warn the public about bad brokers, the BrokerCheck website offers only a peek at a broker’s background and possible misconduct. According to McCann, the BrokerCheck database is “worthless in its current hobbled form, but that it could easily be modified so that market forces might substantially reduce broker misconduct.”

According to McCann, If FINRA were to make BrokerCheck information truly public, researchers and third party vendors, and ratings companies like Lipper, Morningstar, and news outlets like US News and World Report could rank brokerage firms based on their misconduct and risk of fraud. McCann said, “Morningstar rates mutual funds, why not rank the brokers and firms that sell them?”

McCann found that their own research, an effort to replicate FINRA’s study, and the academic study, turned up the same firms with the highest percentage of brokers associated with harm events. McCann identified six brokerage firms that employ a far higher percentage of brokers associated with investor harm events than others. The six firms include Aegis Capital, Summit Brokerage Services, National Securities, Centaurus Financial, Independent Financial Group and Kovack Securities.

According to the study, “These six highest-risk firms are also among the top ten firms ranked by percentage of current brokers who were previously fired by other firms after customer allegations of misconduct. 7.71% of the registered brokers in these six high risk firms have been fired at least once by a previous employer after allegations of misconduct, 10 times the average of 0.78% of the remaining 204 brokerage firms.”

McCann said: “A lot of attention has been given to Oppenheimer, (the largest and most well-known firm and number 7 on his list), but they have been very open and forthcoming and claim they are working to address the issues.”


Firms with a record of expelling brokers for misconduct and not hiring brokers with disclosure events should be vocal and proud of their professionals. Firms must thoroughly investigate all disclosure items on a broker’s record before hiring them. Although some customer complaints may be defensible or lack merit, every instance must be thoroughly investigated before hiring.

FINRA knows where the bad brokers wind up after being terminated. According to these studies, they often end up congregating with other bad actors at smaller firms. In order to satisfy critics like Senator Warren, FINRA should focus its sweep investigations on these firms in its attempt to clean up the industry. These firms must also strengthen their compliance efforts particularly by placing brokers with prior misconduct on a heightened level of scrutiny and surveillance.

McCann’s suggestion that BrokerCheck needs to be more user friendly to allow third parties such as Morningstar or U.S. News to rate or rank brokers based on risk levels should be welcomed by the industry. Firms with the lowest levels of bad brokers such as Goldman Sachs would likely welcome such a move. Such rankings would generate substantial publicity for the top firms and those on the bottom of the list.

Individuals should regularly check if their brokers have disclosures and ask questions. If responses are unintelligible or defensive it should be seen as a major warning sign. Ultimately, it’s up to everyone to help get rid of the bad actors. McCann’s and the academic studies are incredibly beneficial in such an effort.

(Todd Ehret is a Senior Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence. He has more than 20 years’ experience in the financial industry where he held key positions in trading, operations, accounting, audit, and compliance for broker-dealers, asset managers, and hedge funds.)

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Aug. 8. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters)

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