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

Recently, there has been a debate about whether the securities industry is doing enough to get rid of bad brokers. People are also wondering if U.S. regulators are doing everything possible to accomplish the same goal.

The core of the argument is based on some recent studies that have been released, which reveal a higher percentage of misconduct than what has been reported by the Financial Industry Regulatory Authority.

It’s believed that many of these brokers can move from one firm to another while never getting in trouble for their actions. There was a recent marketing push orchestrated by FINRA, and it told investors to check broker credentials using the self-regulatory disclosure website, which is known as BrokerCheck.

A lot of people agree that this is solid advice, but they also believe that advertising doesn’t always work well. The industry is being called upon to do more. Many individuals advocate harsher punishments and would like to see the officials ban repeat offenders.

There is even a strong push to increase the transparency within BrokerCheck, so it would become much easier to identify brokers who have a record of misconduct. People would like to see each broker ranked based on their criminal background and misconduct.

There have been three recent studies that have attempted to bring attention to this controversial subject. Below, you’ll see some reviews and highlights of the studies. We’ll even give you a few suggestions, so firms and regulators will know how to handle broker misconduct disclosures.

The critics began to talk after a Senate Banking subcommittee hearing in March. During the hearing, Elizabeth Warren questioned the chairman of FINRA and asked what it’s doing to keep investors protected. After citing the important academic study that we’re about to discuss, she said that half of the brokers who engaged in misconduct were fired, but the other 44 percent were rehired within the industry.

In May, the Arkansas Republican Senator joined Warren and sent a very stern letter to Ketchum, which was designed as a follow-up to the previous hearing. They requested answers from Ketchum and tried to find out why the malfeasance by advisers doesn’t seem to be getting punished. Senators asked Ketchum what steps FINRA planned to take, aside from adding more disclosures to BrokerCheck, to address the misconduct. They even asked what FINRA was going to do about the high rates of recidivism among the advisers who have a long history of misconduct.

The Massachusetts Secretary of the Commonwealth, Willian Galvin, has also launched an investigation to gather information from 241 brokerage firms. His goal is to keep rogue agents away from his state. William sent letters to individual firms that have more than 15 percent of representatives who have one or more disclosure incidents on record. Galvin said that the sweep is being used to show how the industry is meeting vital protection responsibilities for investors while keeping rogue agents out.

The Self-Assessment of FINRA

Towards the end of 2015, the FINRA Office produced a working paper. The paper was by Jonathan Sokobin and Hammad Qureshi, and it consisted of the FINRA study. These individuals examined the real value of the information displayed within Broker-Check. It shouldn’t be surprising that the study was very favorable for industry participants. The entire study sampled around 181,000 agents, and according to the information gathered, less than 1.5 percent of the agents meet the definition for being associated with investor harm.

FINRA said that many customer claims lack suitable evidence that proves investor harm. In fact, FINRA only counted complaints that resulted in some award against the broker. We don’t agree with the wholesale exclusion of over one million agents. Below, you’ll find that the academic and consultant studies deliver much more data than the 181,000 person panel. It’s likely that the below studies paint a much more accurate picture of the industry.

According to FINRA, Broker-Check is a useful tool and can be very effective for predicting investor harm. Some critics believe that FINRA and Broker-Check offer only a small glimpse into the misconduct information.

New Academic Study Says FINRA Numbers Don’t Add Up

The Market for Financial Adviser Misconduct is the academic study, and it claims that the 1.5 percent estimate provided by FINRA doesn’t make sense. According to the academic study, the number is much closer to 7.28 percent. It also found that about 48 percent of the agents who engage in misconduct end up getting fired, and one year later, 44 percent of harmful agents can get rehired in the same industry. The study also found that the agents who get rehired are likely to suffer a salary reduction of 10 percent.

Many of the largest firms have a zero-tolerance policy for misconduct. A very unsettling part of the study shows that about a third of the agents who got disciplined for misconduct are repeat offenders. Put simply, a single event involving misconduct makes a broker five times more likely to have similar conduct in the future. The academic study found that these agents tend to be concentrated in various geographic locations. Some of the major geographies that are targeted have higher concentrations of high-income individuals and the elderly.

Some counties in Florida, New York, and California had broker misconduct rates around 20 percent. Kevin Carroll, who is the managing director for the Securities Industry and SIFMA, responded to the study, and in a blog post, he said that the academic study could be misleading.  He also stated that it makes inflated and overly broad claims concerning the amount of misconduct that occurs among financial advisers. He said that many investors get buyer’s remorse and blame their agents, which is especially true after the 2008 market collapse.

The Securities Litigation Group Study

The Securities Litigation and Consulting Group provide consulting services and works with law firms, individuals, and brokerage firms. The firm has published several research papers. In one of the firm’s latest studies, many of the findings in the FINRA and academic studies are confirmed. It highlights many of the key points, and to gather data for the study, firm researchers had to open each of the 1.2 million Broker-Check profiles individually.

Despite the warnings from FINRA, Broker-Check is limited because it only gives investors a small glimpse into a broker’s true background. If FINRA would make the information in Broker-Check public, the information could be justly ranked by third-party vendors.

Logical Suggestions

All of the firms that have a long record of expelling agents for incidents involving misconduct should be very vocal about their decisions and maintain some degree of pride. Before hiring a broker, a firm must thoroughly investigate any disclosure items found on the broker’s record.

It’s true that some customer complaints lack evidence, but they should still be investigated. FINRA has a good understanding of where bad brokers end up after they’ve been terminated. In many cases, these individuals end up at smaller firms and work with persons who have a similar background.

In response to these considerations, FINRA needs to focus their investigations of the smaller firms and maintain the industry standards. It’s also important for smaller firms to improve their compliance efforts and make Broker-Check friendly for users. FINRA should also let third parties rank agents based on individual risk levels.

These rankings could generate massive amounts of positive publicity for firms and keep the bad brokers at the bottom of the list. Investors should always check broker disclosures and ask as many questions as possible. If the broker provides unintelligible responses or becomes defensive, these responses should be viewed as red flags.