Financial services is one of the least trusted industries in the economy. But how prevalent is misconduct among financial advisers?
Harvard Business School Associate Professor Mark Egan analyzed a decade of employment, qualifications, and disclosure records and found that approximately one in 15 financial advisers in the US—6.6 percent—had a record of misconduct as of January 2024. These advisers were required to disclose criminal charges, regulatory actions, and customer disputes that resulted in settlements, for example.
For his article “The Problem of Good Conduct Among Financial Advisers,” Egan built on his previous research to analyze whether “naming and shaming” advisers who break rules could combat misconduct. In 2016, he ranked firms with the highest share of advisers with disclosure records registered with the Financial Industry Regulatory Authority, the nonprofit that licenses and regulates advisers.
At the time, the names of the top 20 firms grabbed national media attention. However, companies ranked 21-40 weren’t publicly named—providing a control group for Egan’s new analysis. In his latest research, published in the Journal of Economic Perspectives, Egan and his coauthors found that the share of advisers with misconduct records declined by 1.3 percentage points, or 10 percent, among publicly shamed firms. However, the rate was little changed for the next 21-40 companies, which remained out of the spotlight.
“Overall, the ‘naming and shaming’ disclosure policy appears to have made the product and labor markets function more efficiently,” according to the paper.
The authors note that the frequency of new misconduct disclosures has fluctuated in the past decades. Before the Great Recession of 2007-2009, about 0.5 percent of advisers logged new disclosures annually. That figure reached 0.9 percent during the financial crisis but has “steadily declined” to about 0.3 percent.
Egan, the Mark Kingdon Associate Professor of Business Administration, worked with Gregor Matvos, a professor at Northwestern University’s Kellogg School of Management, and Amit Seru, a professor at the Stanford Graduate School of Business.
A matter of information asymmetry
Despite the lack of confidence in the industry, the research notes that the share of households hiring financial advisers increased from 20 percent to 30 percent between 1995 and 2024. Financial adviser use has also expanded beyond the wealthy and financially sophisticated to all types of households in the US.
At the same time, much like auto mechanics, financial advisers often know more about the necessity and quality of the service than the client. Did you really need the air filter change recommended at the auto shop? Can you tell if the mechanic actually replaced it? This “information asymmetry” makes it more difficult for households to avoid fraud and misconduct, the researchers wrote.
According to the paper, “households often do not know what advice they need or how to judge the quality of the advice they receive.”
Contagious misconduct?
The rate of adviser misconduct varies widely by location and is concentrated within specific firms. In general, it is “more prevalent in areas with wealthier, less educated, and older populations,” such as Florida counties that are popular among retirees, the authors write.
The team also reviewed early 2024 data from about 450 firms with at least 1,000 financial advisers. Among firms in the highest decile for misconduct, 18 percent of advisers had disclosure records, which reached 36 percent for the most egregious companies. In contrast, less than 2 percent of advisers had a history of misconduct among firms in the bottom quartile.
“This concentration of misconduct appears to result from firm-adviser sorting or firms and advisers-matching on misconduct’,” the researchers wrote. In other words, depending on their behavior, advisers either sought out or avoided firms known for violations.
It doesn’t help that the term “financial adviser” isn’t legally defined, and not all agents have the same oversight. In fact, many are registered as dual agents, serving as both advisers and brokers. They provide financial advice but also receive commissions from companies whose securities they sell.
“The dual role can create confusion for households, as the adviser’s legal obligations change depending on whether they are operating as a broker or an investment adviser representative,” the authors warn.
In addition to “naming and shaming” misbehaving advisers, the researchers call for additional training and outreach to ensure that advisers understand industry regulations. Education might also reinforce advisers’ ethical responsibility, preventing the “learned behavior” that spreads among colleagues flouting the rules.
Image by HBSWK with asset from AdobeStock/kitidach.
