The ProMarket blog seeks to provide indexes that make markets work better. The data on brokers’ misconduct supplied by FINRA is very detailed, but also very difficult for the general public seeking financial advice to read and understand. Academic work can dramatically increase their ability to use it.
Competition works best in markets that are not concentrated and have products or services that are relatively homogeneous and simple. The more complicated the service, the more questionable the ability of competition to work its wonders.
Two of the largest sectors in the economy–finance and healthcare–suffer from these phenomena: the services are very complicated, understanding them thoroughly requires specific education, and the sellers usually have much more information than the buyers. In these markets reputation is supposed to be the mechanism that weeds out poor providers of services.
In order for reputation to work, consumers should be able to easily access information on the real costs and quality of the providers, yet many times information about the quality and prices of the sellers falls in the definition of a “public good”: no one has enough of an economic incentive to provide the information to the public while the total social benefit from such diffusion of information might be very high.
Last month, the ProMarket blog at the Stigler Center at the University of Chicago reported on a new study by Chicago Booth’s Gregor Matvos and Amit Seru, and the University of Minnesota’s Mark Egan, that examined the cost of misconduct for financial advisers who have been caught.
The study revealed not only the pervasiveness of misconduct in the financial adviser market but also disclosed for the first time a “rating” of the brokers’ firms according to the percentage of their advisors that are involved in misconduct.
Today we bring here an extended data set taken from this study that included 30 brokerage firms in the U.S with the highest rate of misconduct. This information, if diffused, can be a useful public good for tens of millions of Americans. A survey of consumer finances from 2010 shows that 56% of all American households sought advice from a financial professional. The study by Egan, Matvos and Seru examined 1.2 million financial advisors that operated in the U.S between 2005 and 2015. These advisers help manage over 30 trillion dollars in investable assets.
The raw data on the disciplinary records of financial advisers are public record, collected by FINRA (the Financial Industry Regulatory Authority, Inc.), a private corporation that acts as a self-regulatory organization.
The new data, shown here in the table, shows that Oppenheimer & Co, which had 2,275 advisers in the last 10 years, is the firm with the highest rate of misconduct in the country: 19.6% of advisers. Second in this rating is First Allied Securities. Third is Wells Fargo Advisors Financial Network, LLC , an affiliated company of one of the biggest financial institutions in the country, with 15.3% of brokers involved in misconduct. Another affiliate of Wells Fargo that did not fare well in the misconduct rating is Wells Fargo Advisors, LLC, with 26,308 advisers, of which 12.06% were involved in misconduct. Among large players in the financial advisory business 3 more companies stand out in the table: Morgan Stanley, with 23,618 advisers (13.1% misconduct), LPL financial with 18,093 advisers and 9.21% had misconduct, and the largest of them all was Merrill Lynch, Pierce, Fenner & Smith Incorporated with 32,107 advisers, of which 8.40% were involved in misconduct.
The ProMarket blog seeks to provide, along other commentary and analysis, indexes that make markets work better. The data on brokers’ misconduct supplied by FINRA is very detailed, but also very difficult for the general public seeking financial advice to read and understand, therefore academic work can dramatically increase their ability to use it.
Egan, Matvos, and Seru raise the question of how is it that competition among advisers and reputation does not drive out bad advisers and firms. One potential explanation is that some customers may not be very sophisticated and either do not know that such disclosures even exist, or do not know how to interpret them. If there are differences in consumer sophistication, then the market can be segmented. Sure enough – the study finds that some firms may be potentially engaging in a strategy of targeting the less sophisticated consumers.
Retail investors, who are not high net worth individuals, are generally considered less sophisticated, and the study finds that that misconduct is more common among firms that advise retail investors. The geographic distribution of advisory firms is also consistent with market segmentation along the lines of investor sophistication. The study documents substantial geographic differences in financial misconduct. In many counties in Florida and California, roughly one in five financial advisers have engaged in misconduct in the past. Misconduct is more common in wealthy, elderly, and less educated counties (Gurun et al., 2013). The latter two categories have generally been associated with low levels of financial sophistication. These results, while not conclusive, suggest that misconduct is targeted at customers who are potentially less financially sophisticated. Publishing this data after its compilation by economic scholars can be a very useful tool for these segments of the market.