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Tuesday, August 02, 2016

Guest Blogger | Ben Edwards - Doing Due Diligence on a Financial Adviser

First, thank you to the folks at at PrawfsBlawg for the invitation to join as a guest blogger for August. PrawfsBlawg has been an incredibly valuable resource.   I'm grateful for the opportunity to write for this audience.  I recently finished my first year as an Assistant Professor of Law at Barry University Dwayne O. Andreas School of Law in currently sweltering Orlando, Florida.   I teach Business Organizations, Securities Regulation, Securities Litigation, & Professional Responsibility and write about securities litigation, financial products, and retail investor protection.  While at PrawfsBlawg, I plan to write about the the retail side of securities law with a focus on providing some useful information.  There are new and interesting things going on in this space that should be fun to talk about.  I'll also try to cover topics of interest to the community generally.

Turning to that front, I want to talk about doing basic due diligence on a financial adviser.  It's a common problem.  Imagine:  a beloved and trusting relative comes to you and tells you about the "really sharp" financial adviser encountered at an educational seminar.  Plus, this adviser even sprang for the meal!  What a nice person!  More, your relative plans to turn over a good chunk of retirement money to this market-savvy professional.  What sort of vetting can you do when all you have is the financial adviser's name?  The first thing to know is that the term "financial adviser" lacks any real meaning.  The title appears on business cards for con artists, stockbrokers, registered investment advisers, insurance salespeople, financial planners, and others.  Fortunately, there are some relatively easy ways to get more information.

If you don't do anything else, you should run an adviser's name through the BrokerCheck portal provided by the Financial Industry Regulatory Authority (FINRA).  If the financial adviser is registered as a stockbroker or as an investment adviser, BrokerCheck will pull up some of their information or redirect you to an SEC website with detailed information.  It'll tell you whether the person is registered, some employment history, and will reveal certain "disclosures"  -- often red flags that would indicate that a particular financial adviser may be associated with problems.  FINRA has even run ads advertising the importance of checking a financial adviser's background.  If the person claims to be stockbroker and doesn't show up in the database, it's either the wrong name or a con artist.

While BrokerCheck can get you started, FINRA doesn't tell you the whole story.  There may be things you should know that have been expunged or otherwise obscured that you can still find out fairly quickly.  After the jump, I cover how to see get the rest of the picture and look like a wizard to your friends.

It helps to have context to evaluate whether to use a particular financial adviser.  Should it trouble you that three complaints have been filed in a fifteen year career?  How common are complaints?  FINRA does not provide any of this information.

Fortunately, some business school professors have provided some useful context.  It turns out that about 7% of brokers have misconduct records.  These brokers may be five times as likely to have future misconduct show up on their records.  This means that the easiest way to cut risk may be to avoid brokers with misconduct histories.  While a lot of brokers lose their jobs for misconduct, almost half will be rehired at less reputable firms.  The distribution of problematic financial advisers also provides some interesting information.  Even though only 7% of brokers have potential misconduct disclosures, some firms have higher concentrations among their ranks.  For example, about 15% of the brokers associated with UBS Financial Services have misconduct disclosures.  Oppenheimer & Co. has even more with about 20%.  A follow-up study found that particular firms may pose even higher risks: 

These six firms - Aegis Capital, Summit Brokerage Services, National Securities, Centaurus Financial, Independent Financial Group and Kovack Securities employ a far higher percentage of brokers associated with investor harm events than other firms. These six highest-risk firms are also among the top ten firms ranked by percentage of current brokers who were previously fired by other firms after customer allegations of misconduct. 7.71% of the registered brokers in these six high risk firms have been fired at least once by a previous employer after allegations of misconduct, 10 times the average of 0.78% of the remaining 204 brokerage firms.

If an otherwise upstanding financial adviser is associated with a particularly high-risk firm, it may make sense to pick a different adviser.  

You should also know that these studies work off compromised databases.  BrokerCheck only shows a partial picture because many financial advisers have managed to have complaints expunged from their records.  In instances where an investor settles an arbitration claim against a financial adviser, FINRA arbitrators routinely agree to expunge the existence of the complaint from the public record.  One study found that FINRA arbitrators granted 90% of these requests for expungement.  In some instances, state regulators have even struggled to block the expungement of complaints from the public record.

Like Harry Potter's Mad-Eye Moody, you too can see the invisible.  You can uncover whether (and possibly how many times) a financial adviser has used this process to scrub records by checking a different database.  FINRA makes its arbitration awards available.  While complaints may not show up on BrokerCheck, you may find whether a financial adviser has had complaints expunged by running their name or registration number through this awards database.  The arbitration award granting expungement still shows up in that database.  Wizardry.  

 Of course, some financial advisers may have used the expungement process to remove truly frivolous complaints.  Still, you probably want to know if a particular financial adviser regularly attracts complaints from disgruntled customers.  

Posted by Benjamin P. Edwards on August 2, 2016 at 10:07 AM in Blogging | Permalink


A stockbroker is a salesman. Like the guy down at the car dealership or the mattress store. They aren't your fiduciary and they don't have your best interest at heart; on the contrary. They may call themselves something other than a stockbroker like wealth manager or financial advisors. What you want is an investment advisor with a fiduciary duty to put your interests first. Ask that question explicitly, most people probably won't lie.

Beware of dual registration. This will allow them to open up multiple accounts and act as your fiduciary for some of them but not for others. Beware of "fee-based" which is a weasel phrase to indicate that they will charge you and yet still get kickbacks by steering you to bad investments. What you want is "fee only".

Posted by: brad | Aug 2, 2016 1:19:53 PM

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