Wealth managers and regulators aiming to crack down on bad actors should take a closer look at brokers who lose their FINRA license but keep other registrations, a new study suggests.
“Wandering financial advisors” with records of misconduct are much more likely than others to commit it again, and they “disproportionately end up in the highly-fragmented state insurance regimes,”
The study follows
“Rob and I were at the SEC and we would hear about these types of individuals from investors and investor advocate groups — we realized that we just didn't have what we needed to be able to really see how systematic this was,” Hu said. “Initially we had thought about just looking at brokers and advisors. It became clear to us over time that the real issue was brokers wandering into the insurance regime.”
Hu and the other researchers are calling for greater cross-referencing of the bad actors among the SEC, FINRA, the Commodity Futures Trading Commission, the National Futures Association, state securities regulators and state insurance commissioners. In addition to a central BrokerCheck-style database for regulatory disclosures of all kinds in just one place, they propose that state insurance regulators set up a dispute resolution forum like FINRA arbitration and seek to hold insurers more accountable for brokers’ misconduct.
“It varies by state, but some states just bring very few actions,” Honigsberg says. “We spoke to a lot of securities regulators who said they refer people for enforcement to the insurance divisions and the insurance divisions never do anything. We heard this repeatedly from regulators.”
Insurance regulators say they’re aware of the wandering reps. FINRA and the National Association of Insurance Commissioners share licensing data, and, in 2019, the insurance regulators’ organization updated its State Producer Licensing Database to match individuals with their BrokerCheck records, according to NAIC spokeswoman Alana LaFlore.
“State commissioners are steadfast in their commitment to protect consumers from bad actors and those who believe they can escape regulation by moving to the insurance industry will be sorely disappointed,” she said in an emailed statement. “The NAIC is currently reviewing this study and will take a deeper look at the issue.”
Representatives for FINRA cited a recent
“FINRA uses a combination of tools to reduce the risk of harm to investors from member firms and the brokers they hire that have a history of misconduct,” the notice states. “For several years, FINRA has been taking steps to strengthen its tools for responding to brokers with a significant history of misconduct and the firms that employ them.”
Representatives for the North American Securities Administrators Association referred an inquiry about the study to NAIC. The SEC, CFTC and NFA didn’t respond to email requests.
The new study drew praise from Teresa Verges, director of the Investor Rights Clinic at the University of Miami School of Law. The organization often hears “ugly stories” about formerly licensed brokers retaining other registrations and harming their clients, Verges says.
“It lays bare everything we see, and I had 13 years at the SEC before coming to Miami,” she says. “I have a lot of friends in the financial industry and I think that many people really want to do what's right for their clients. But there are bad actors out there who make it really difficult sometimes.”
More than a third of the 395,000 representatives leaving BrokerCheck between June 2010 and June 2020 kept their RIA, insurance producer or National Futures Association registrations, according to the study. Although 68% of the wandering brokers maintained SEC registrations and a higher share of them than the total exiting group have misconduct on their records, the rates are significantly larger among NFA members and more than 50,000 registered with state insurance registrations.
“The baseline rates of misconduct and serious misconduct among all FINRA brokers more than double for those who wander away from the FINRA regime but continue providing financial advice as insurance brokers and NFA members,” the paper states. “These trends are concerning, as they suggest that ‘bad’ advisors in the FINRA broker regime exit but continue to provide consumer financial services. In particular, the data show, many become insurance producers.”
The authors define “misconduct” as payouts from client complaints, terminations after allegations, and criminal, civil or regulatory cases. They designate criminal or regulatory infractions, civil judgements and employer dismissals after allegations as “serious misconduct.”
They scraped the data from BrokerCheck and filed public information requests to obtain data from state insurance agencies — only three of which make this information available online, Honigsberg says.
“To get a list of registered insurance producers and to get the misconduct associated with them really should not be so difficult,” she says. “The fact that you wouldn't provide this information to consumers easily shocks me.”
With data on 1.2 million representatives across four regulators over the span of a decade, the researchers found that a former FINRA broker with a history of misconduct has a 2.64% chance of committing it in the future, compared to 0.24% for those without disciplinary history.
“The evidence shows that wandering advisors with a history of misconduct are more likely to be recidivists in the future,” the report states. “Our data also show that, among wandering advisors, those with the most serious history of misconduct are disproportionately likely to end up in state insurance regimes.”
The findings are likely conservative, according to Hu, since the data from insurance regulators reflect only current registrants and BrokerCheck’s requirements on disclosures last only two years after they drop their FINRA licenses. A unified database and more accountability could help clients grasp their advisors’ multiple hats, the researchers say.
“All they have to do is drop one registration and continue to work in another,” Hu says. “We think that more could be done to improve that process.”
