25% of Financial Advisors With Misconduct Records Reoffend — And Many Stay in the Industry

When it comes to choosing the right financial advisor, one of the most important things to consider is whether they have any disclosures on their record. Not all disclosures are created equal — sometimes, they exist because a disgruntled client filed an unfounded complaint that was dismissed. Or maybe they didn’t file paperwork correctly (it can happen).

What Is Financial Advisor Misconduct?

Financial advisor misconduct refers to any unethical, illegal, or deceptive actions by a financial advisor that violate regulatory rules or harm clients. This can include fraud, misrepresentation, unauthorized trading, excessive fees, conflicts of interest, or breaches of fiduciary duty.

But quite often, a disclosure is a warning that a financial advisor committed misconduct that lost their clients money through dishonest practices. Needless to say, this isn’t the type of person you want to entrust your financial future with.

Fortunately, people involved in major misconduct (like Bernie Madoff) will usually have significant regulatory action taken against them that bars them from ever offering financial services again.

Unfortunately, this isn’t always the case. In fact, a full 25 percent of financial advisors with a misconduct record are repeat offenders. And if you only rely on resources like BrokerCheck to look at their history, you could be completely missing out on some key pieces of information.

“A lot of people who leave financial services due to misconduct go straight into working in a career that is financial services adjacent, as the industry is what they are most familiar with,” says Dan Hattori of AdvisorCheck. "As a result, it is important to always try to verify the reputation of the people who you are working with."

Why the Financial System Enables Repeat Offenders to Keep Working

A big part of the challenge comes from the fact that there isn’t one single regulatory body for financial advisors. There are several. As Colleen Honigsberg, Professor of Law at Stanford Law School and Advisor to AdvisorCheck, explains in the report, "Regulatory Leakage Among Financial Advisors: Evidence From FINRA Regulation of ‘Bad’ Brokers’”:

“Financial advisors are commonly registered with multiple distinct regulatory regimes simultaneously — potentially facilitating an individual’s ability to remain employed as a financial advisor even after being disciplined, or even barred, by one regulator.”

A big part of the problem comes from the ways different types of advisors are defined and regulated — often in ways that don’t seem all that different to the everyday consumer who is simply looking for someone to help them manage their money.

As Honigsberg explains, “Broadly stated, broker-dealers buy and sell securities on behalf of clients after obtaining permission, and investment advisers are wealth managers who provide their clients with advice and recommendations. The line distinguishing these functions is increasingly narrow. Yet, broker-dealer representatives are regulated primarily through FINRA, while investment adviser representatives are regulated through the SEC.”

In her research paper, Honigsberg and her team argued that these systems set up a type of “self-selection” in the industry that incentivizes bad advisors to seek work under whichever regulatory body is the most lax — where they can more easily get away with misconduct.

This was actually found to be the case in Honigsberg’s research. Despite FINRA’s efforts to get bad advisors out of the industry, many continue to practice — just under a different capacity than they originally did.

As the report explains:

“In 2018 and 2019, FINRA proposed rules designed to nudge ‘bad’ brokers out of the industry. We show that these proposals caused thousands of high-risk brokers to exit the FINRA broker regime, but that the majority of these individuals did not leave financial services — 98 percent are currently registered with state regulators as insurance producers. Thus, the net effect of the rule is unclear, as its primary effect was arguably to cause the targeted set of brokers to be subject to lower levels of monitoring than before.”

A murky and sometimes contradictory regulatory setup all too often gives sketchy advisors the ability to continue practicing in finance. Without a comprehensive look at their background, it is far too easy for investors to get fooled into working with someone who doesn’t necessarily have their best interests in mind.

The Dangers of Financial Advisor Expungement and What It Means for Investors

Another issue that can put investors at risk is the fact that BrokerCheck allows advisors to submit requests to expunge their records. Once again, research from Honigsberg helped unveil the potential risks to investors. While many in the financial industry argue that the ability to expunge their records helps clean up issues such as illegitimate allegations, expungements actually put investors at greater risk.

In fact, “prior offenders are more than five times as likely to engage in new misconduct as the average broker” — and expunging records makes the problem worse.

As Honigsberg explains, “Relative to a broker denied expungement, a broker granted expungement might increase recidivism and expungement requests due to increased risk-taking with client assets, overconfidence that he can obtain another expungement, and/or more frequent incidences of unethical behavior, as the broker has received external signals that his initial behavior was appropriate.”

A big part of the problem is that when a broker is granted expungement, the costs of any potential penalties they would be assessed for future infractions is reduced. The consequences of getting caught for future misconduct will be less severe than if their records hadn’t been expunged, making them more likely to engage in risky behaviors.

Honigsberg also offers this warning: “It is possible that expungement increases recidivism because it improves career outcomes, allowing expunged brokers to remain in the industry for longer periods and thus have more opportunity to commit misconduct.”

Basically, expungement creates a vicious cycle that enables bad brokers. Not only can they have records of some of their previous issues removed so that the public can no longer find them, but they essentially get a clean slate that gives them more opportunities to engage in bad behavior.

This also shows the limits of relying exclusively on a single resource like BrokerCheck for background info on financial advisors. While these resources can definitely be helpful, they’re not necessarily going to give you the full picture.

What a Bad Financial Advisor’s Career Path Really Looks Like

For investors, these industry issues illustrate several potential dangers from bad financial advisors — mainly because for the most part, “bad” advisors can continue to practice in some form.

That said, even when an advisor who engages in unethical conduct has their records expunged, they are still likely to face consequences at their current firm. After all, the firm doesn’t want to have its reputation hurt — and hopefully, it doesn’t want to continue working with a shady advisor.

Because of this, bad financial advisors may frequently hop from one firm to another as a result of their misconduct. Notably, when misconduct becomes so severe that an advisor faces regulatory action from an organization like FINRA, they begin to self-select to areas where they will be less likely to get caught or face strict scrutiny.

Here’s how this usually works: a repeat offender will start at a large firm. After experiencing some trouble, they will transition to working at a regional firm that is less heavily regulated. As they continue to run into trouble, they will go to a small firm. And finally, even if they are pushed out of FINRA entirely, they will go to an insurance carrier.

And despite this, they will still sometimes call themselves a financial advisor — even if they are now mostly trying to convince clients to buy costly insurance or annuity products that they don’t actually need.

Basically, their career path goes in the opposite direction of how you would expect a successful advisor’s career to go. But if you’re just looking at an advisor’s public-facing profile, you’re probably not going to see this information. Chances are, they’ll play up their extensive industry experience without going into specific details.

How to Protect Yourself From Untrustworthy Financial Advisors

All this information can feel a little disheartening if you’re still trying to find someone you can trust to help you achieve your money goals. The good news is that while the financial industry certainly has its fair share of problems, there are enough patterns that we can see to make it easier to spot repeat offenders.

Written by Lucas Miller, Entrepreneur Magazine Contributor

Fact checked by Billy Quirk

Reviewed by KJ Kim

Disclosure

The information provided in this article was written by the research and analysis team at AdvisorCheck.com to help all consumers in their financial journeys, by providing the resources and the insights to help improve one’s financial health, make it through recessionary and inflationary periods of time, and save their earnings to use them towards building a secure financial future. 

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