The Market for Financial Adviser Misconduct

Abstract

We construct a novel database containing the universe of financial advisers in the United States from 2005 to 2015, representing approximately 10% of employment of the finance and insurance sector. We provide the first large-scale study that documents the economy-wide extent of misconduct among financial advisers and the associated labor market consequences of misconduct. Seven percent of advisers have misconduct records, and this share reaches more than 15% at some of the largest advisory firms. Roughly one third of advisers with misconduct are repeat offenders. Prior offenders are five times as likely to engage in new misconduct as the average financial adviser. Firms discipline misconduct: approximately half of financial advisers lose their jobs after misconduct. The labor market partially undoes firm-level discipline by rehiring such advisers. Firms that hire these advisers also have higher rates of prior misconduct themselves, suggesting "matching on misconduct." These firms are less desirable and offer lower compensation. We argue that heterogeneity in consumer sophistication could explain the prevalence and persistence of misconduct at such firms. Misconduct is concentrated at firms with retail customers and in counties with low education, elderly populations, and high incomes. Our findings are consistent with some firms "specializing" in misconduct and catering to unsophisticated consumers, while others use their clean reputation to attract sophisticated consumers.

Is Fraud Contagious? Coworker Influence on Misconduct by Financial Advisors

“…(), Chalmers and Reuter ()). The paper most directly related to ours is Egan, Matvos, and Seru (), who use similar data and show that misconduct by advisors is common and that certain firms specialize in misconduct. Given these dismal empirical findings, Gennaioli, Shleifer, and Vishny () and Georgarakos and Inderst () argue that a key function of advisors is to convince households to trust the financial system enough to participate in the market.…”

“…As some states do not provide Meridian‐IQ with certain personal information (e.g., date of birth), we fill in missing variables using data provided by state regulators. Our data set, summarized in Table , is generally similar to that of Egan, Matvos, and Seru (), who provide a detailed summary of the financial advisory industry in their study of the labor market for advisors who commit misconduct.…”

“…First, coworker groups are endogenously formed, as individuals select to work with others who share similar characteristics. Egan, Matvos, and Seru (), for example, show that dishonest financial advisors choose to work together. Second, within a firm, coworkers face similar economic incentives and monitoring procedures.…”

Vague lies and lax standards of proof: On the law and economics of advice

“…There is a growing evidence that in many markets both honest and “strategic” sellers coexist. For example, Egan, Matvos, and Seru (), analyzing the universe of financial advisers in the United States in 2005–2015, find that “…firms and advisers with clean records coexist with firms and advisers that persistently engage in misconduct” (p. 3). Another case in point is the mortgage market, see Griffin and Maturana () and Piskorski, Seru, and Witkin ().…”

“…As a result, Egan et al. () find that “some firms specialize in misconduct and attract unsophisticated customers, and others cater to more sophisticated customers, and specialize in honesty…” (p. 4).…”