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Wall Street’s watchdog is obscuring data that could protect investors

May 8, 2023 Broker Complaints

Finding good advice is not an easy task. Obtaining advice that is beneficial is not an easy undertaking. Investors could be safeguarded if the FINRA would make data accessible, however, this is not the case.

Wall Street’s watchdog is hiding data that could safeguard investors. FINRA is obscuring brokerage data that could protect investors.

Every 12 months, a number of people in the U.S. are presented with an important decision. Their accounts have plenty of cash in them, but no return, so they conclude that it is time to trust a professional with their assets. Nonetheless, how can they be certain that they are not entrusting their hard-earned money – which could be used for college tuition or a comfortable retirement – to someone who will take advantage of them, like Jordan Belfort or Bernie Madoff?

To enable investors to evaluate brokers and the companies they work for, FINRA, a private regulator overseeing US financial advisers, has created BrokerCheck. This online database provides work histories, credentials, and possible misconduct history. It is the only access point that allows customers to view the records of their advisers. The information listed includes customer complaints of unethical actions ranging from excessive trading to deceitful behavior.

Promotions can be seen everywhere these days, from television to the Internet. It is an effective way to attract attention and draw in customers.

The goal of BrokerCheck is to supply customers with the most pertinent data that might forecast the conduct of brokers in the future. Still, the image it provides is far from absolute.

The online archive holds data that could give users insight into the behavior of individual money managers. However, the data is presented in a format that makes it difficult to get a comprehensive view of the firm’s misconduct.

Academics have noted that this type of information is essential to aiding people in selecting a broker that is less likely to mismanage their money. This is because the hiring process and the culture of an institution are both important elements that can be used to forecast potential misconduct.

The repercussions of misconduct are severe. On average, according to Quartz’s review of BrokerCheck data, brokers and brokerage firms paid nearly $800 million annually from 2014-2016, with the majority of that sum being settlements ($600 million), fines ($175 million), and damages ($25 million). Research indicates this data only represents a minor portion of customer losses. The White House Council of Economic Advisers reported in 2015 that families lost an estimated $17 billion a year (equivalent to $18.3 billion in present-day figures) due to financial advice of doubtful quality.

The regulator in charge of running BrokerCheck has the capacity to manipulate markets and increase the profits of financial firms. We are only aware of this because its hold on the information is gradually loosening.

A few years ago, several trailblazing scholars began to succeed in pulling out vital company-associated information from single profiles. It is essentially due to these examinations, which provide significantly more thorough information on company behavior, that we are beginning to recognize how little investors are informed of–and how much their lack of knowledge costs them.


The active trade of investment guidance being offered

In order to comprehend the importance of the new research, it is beneficial to have knowledge of the role of brokers and how they are regulated.

Around 17% of US households entrust their money to a financial professional, and that number jumps to 30% for retirees, according to a survey conducted in 2019 by CNBC, Acorns, and SurveyMonkey. This means that the total financial assets of households in the country – amounting to $90 trillion – and the retirement prospects of tens of millions of people depend on the decisions taken by their financial advisors.

The collective impact of those actions could potentially have sweeping economic repercussions. Savings represent a public asset in a sense. It is the readiness of households to invest their savings into stocks and bonds that provides a substantial pool of money to firms and helps determine their financing costs. Domestic expenditure accounts for about 70% of US economic production; thus, the monetary assurance that encourages people to continue spending, as opposed to just hoarding cash, is essential to sustaining the present rate of expansion.

In 2018, based on Aite Group’s research and consultancy findings, brokers managed $24 trillion in customer assets. That same year, those same firms earned $367 billion in revenue and $45 billion in profit (pdf), according to SIFMA.

In order to facilitate stock and other security trades on behalf of their clients, a financial adviser must be registered as a broker. Along with securities listed on standard exchanges, brokers are able to access a variety of financial products that are usually not available to retail investors due to legal constraints or complexity. These products can include intricate annuities, special bonds, unlisted real estate investment trusts, advanced derivatives, and private placements.

The United States Securities and Exchange Commission is responsible for most of the oversight of the financial sector. However, brokers and their companies are monitored by Finra (Financial Industry Regulatory Authority), an organization that was founded in 2007. Along with the American Bar Association and the American Medical Association, Finra is one of the most renowned self-regulating associations in the US. Their aim is to promote market trustworthiness and to help ensure investors’ safety, which they believe will enable flourishing capital markets.

In order to meet its objectives, Finra plays an active role in examining brokers and firms for any wrongdoing. Fines are issued for violations and serious cases are referred to federal authorities. Furthermore, the organization oversees the arbitration process between customers and brokerage firms. Those who feel their broker has caused them financial losses are encouraged to submit their grievances to Finra through their complaint process.

According to Finra, over the course of 2014 to 2018, there was an average of 3,050 customer complaints yearly. In most cases, these grievances are settled by the brokerage, which is usually beneficial to the customers. The New York Times reported that out of 2,772 complaints in 2013, 2,173 were resolved, granting the complainant’s relief 84% of the time. Of the 499 that went to arbitration, 42% of the customers were awarded some form of compensation. Each of these events is supposed to be stored in BrokerCheck.

The mission of Finra is to provide “unbiased financial resources and information” to retail investors, as stated on their website. However, although the data in the BrokerCheck files of brokers is impartial, bias can be presented and understood in different ways. Finra’s presentation of data on BrokerCheck makes it difficult for average users to access important information.


BrokerCheck provides the following information…

Finra’s 625,000 registered advisers are all listed on BrokerCheck, where one can view their credentials, work histories, as well as any past complaints, misconduct, disciplinary actions, and settlements.

Promotion can be seen everywhere, and it has become an everyday part of our lives. Companies are utilizing various marketing tactics to get their message out there, and it is having a huge effect on our culture.

BrokerCheck is a great resource for customers to gain insight into brokers’ reputations, as Google searches often don’t turn up much. It also provides disclosures regarding misconduct allegations in a straightforward and simple way, making it simpler to recognize when brokers have several warning signs. However, it is worth noting that these disclosures do not always signify wrongdoings; sometimes they are disregarded by arbitrators.

However, the language utilized in these disclosures is frequently unclear, containing a lot of professional terminology and lacking enough information to be able to determine whether the misconduct charge was a result of negligence or just a stroke of misfortune. To complicate matters further, brokers may contest their accountability or involvement in the complaint and the details provided by the disclosures do not help to assess the legitimacy of such claims.

In 2017, one broker’s disclosure profile was as follows:

  • Allegations: The customer claimed that a transaction in his account was not authorized.
  • Damage Amount Requested: $17,228.90
  • Settlement Amount: $14,000.00
  • Broker Comment: The customer’s allegations lack any evidence and are an attempt to recoup losses from a purchase that decreased in value. All trades were previously agreed upon, and the customer acknowledged this in a phone call with the Branch Manager, though changed their story when they realized they could get money back.

The wording of this statement, which is typical of a broker disclosure, makes it difficult to determine whether the customer’s assertion was accurate since companies sometimes resolve disputes to avoid legal costs. BrokerCheck offers no additional details. (In this particular case, the complaint might not have been that unreasonable. Within a couple of years of filing, the accused broker had more accusations of “churning” accounts, or executing too many trades to bring in more fees.)

The disclosures usually do not provide a clear indication of who is responsible – whether it be the broker’s fault for acting recklessly or fraudulently, their firm for recommending inappropriate products, the customer’s false allegations resulting in a settlement to reduce legal costs, and so on. For example, this disclosure is an actual case.

  • Amount Requested for Damages: $13,800.00
  • Settlement Amount Approved: $13,800.00

BrokerCheck offers a streamlined way to analyze the behaviour of a single broker, which is simpler than attempting to decode a firm’s profile.

Advertising has been used as a way to get people to purchase certain products. It is a method of communication used to persuade potential customers into buying goods or services. Through promotion, companies make consumers aware of their products and the benefits they can bring.

Users cannot see firm-level disclosures on the website itself and must instead download or open a pdf file, which can be quite long. BrokerCheck makes it even more difficult to access the arbitration award history, as it is placed at the bottom of the linked-to pdf, between countless company facts and regulatory penalties. As a result, particularly for larger firms, people could have to scroll through hundreds of pages of text, much of which is written in all-capital letters and is visually unpleasant.

The decision to award a broker is shown on their online profile and on pages 282 and 283 of a linked-to pdf belonging to the firm. The following screenshot captures this information.

Those who are very astute in researching quarrels may come across Finra’s arbitration awards site, where their dedication is rewarded with pdfs that are typically scant on case facts and packed with legal terminology. Brokers, on the other hand, can ask arbitration committees to erase disclosures from their BrokerCheck record.

Ads are an effective way to promote products and services. Companies use them to attract attention to their offerings, reach potential customers, and inform the public of goods and services. Furthermore, they are a great way to encourage consumer engagement with a brand and its products.

Still, there is an even more significant issue that gets to the heart of the major defect of BrokerCheck. Profiles of firms are extremely deficient, leaving out data that is fundamental to aiding clients in making informed decisions.


What elements are absent from BrokerCheck?

On BrokerCheck, both person-centered and business-related profiles list disputes that ended up in arbitration rulings that were in favor of the client. The individual broker’s history contains outstanding claims as well as concluded settlements, but the firm-level reports do not. Whether a company was partially or fully to blame for a situation, the complaint will only appear in the broker’s file – not the company’s profile.

The various disclosure regulations incentivize firms to settle rather than going through the arbitration process which would reveal a disclosure on their profile. This should, in theory, be of benefit to customers if the settlement gives them a higher recovery rate than arbitration. Nevertheless, it is noticeable that these uneven disclosure standards allow firms to make their records look better than they actually are. Additionally, brokers can use the settlement of their firm as a reasonable defense against any disclosures of their individual profile, pointing to the firm’s payment of the arbitration decision as evidence.

To obtain a complete understanding of any wrongdoing occurring at a certain firm, it is not enough to simply look up the company’s profile data. In addition, the disclosure records of all 625,000 active brokers and many more who have left the industry must be gathered, extracted, and formatted in order to analyze them.

Although it may be that a lack of firm-level misconduct data has no influence on a person’s inclination towards risk-taking or unethical behavior, we cannot be certain unless we have a look at the firm-level data. Unfortunately, Finra has always prevented any attempts to access this information.

Recently, the SEC made a slight change to its regulations, allowing computer scripts to be used to access BrokerCheck data for non-commercial purposes. This restricts third parties from reselling the data in a more consumer-friendly format, such as rankings based on misconduct rates. This change only came about after a few scholars figured out how to use software to pull the data out, as well as after researchers filed records requests with state regulators.

It is only now possible for researchers to analyze this data in its entirety, resulting in a small but quickly increasing number of studies. What is being uncovered through these hard-to-obtain, individual-company data?

The results are quite consistent. Personal records provided by BrokerCheck may only be so beneficial. To really understand the danger to one’s financial assets when working with a certain broker, the key factor is the institutional setting–the misconduct records of the broker’s peers.

Promotion for products or services can be seen everywhere. It is done in a variety of forms, such as through television, radio, newspapers, and even online. Companies have to make sure that their ads stand out and get the attention of their target audience.


What Lies Concealed within the Data

The average amount of money spent by brokerage firms (and, occasionally, brokers) on settlements and awards between 2005 and 2015 was approximately $500 million annually, as reported by Mark Egan, Gregor Matvos, and Amit Seru–academics of Harvard Business School, Northwestern’s Kellogg School of Management, and Stanford Business School, respectively–in a study from last year in the Journal of Political Economy.

Our own research into court cases from 2014-2016 revealed the industry pays out approximately $600 million in settlements and another $25 million in damages every year. The true amount lost by customers is likely greater, as settlements with brokers or their firms often amount to less than the initial claim. Furthermore, arbitration rulings typically favour the industry and BrokerCheck does not require disclosure of misconduct cases involving losses under $5,000.

Egan, Matvos, and Seru conducted research based on the profiles of 1.2 million US brokers registered between 2005 and 2015. Their findings revealed that only 0.6% of these brokers were charged with misconduct; this misconduct being defined as criminal or regulatory issues that were ultimately adjudicated against them.

As Egan and his research team observed, the rate of broker misconduct in comparison to medical malpractice is comparable, and this is to be expected with any service that involves a considerable amount of risk.

Promotion materials are a great way to get the word out about a particular product or service. Commercial advertisements can be found in different media forms, and are an effective way of informing potential customers about the features and benefits of an offering.

Advertising is an excellent way to spread the word about an item or service. Advertisements can be encountered in various mediums and are an efficient way to educate prospective buyers about the qualities and advantages of a given product.

It’s peculiar that, per a 2017 survey conducted by Medscape, more than half of physicians have dealt with a medical malpractice case in their career. This suggests that there is a roughly 50/50 chance that a doctor will make an error of a degree necessitating a malpractice suit.

Egan and his team have reported that only a meagre 8% of brokers have ever been accused of misconduct. However, a more current analysis of the BrokerCheck data has revealed that approximately 7% of registered brokers have a record of misconduct.

It can be said that a small fraction of continuous wrongdoers are accountable for the majority of issues reported in the brokerage sector. According to the economists’ research, a broker with a past misconduct record is five times more likely to commit a subsequent offense compared to the average consultant. How are these professionals able to keep finding customers?


A sector transformed from the inside

Examining the patterns on a firm-by-firm basis makes the scope of the problem simpler to understand. To illustrate, from 2005-2015, 18.8% of the brokers at Oppenheimer were reported to have misconduct allegations according to researchers, however, the firm declined to comment. Meanwhile, during the same period, fewer than 1% of the brokers at Morgan Stanley and Goldman Sachs had such records. This could be attributed to the fact that the larger firms usually hire more brokers who specialize in trading, which reduces the chance of any direct customer contact with the brokers and thereby reduces the probability of any misconduct claims. Additionally, brokers working for bigger firms have a higher likelihood of getting their alleged misconduct removed.

Our newest examination of the BrokerCheck figures–a batch that contains the backgrounds of individuals and companies listed when we gathered the data during multiple weeks starting in the end of July 2019–displays comparable imbalances. (The searchable chart below incorporates information for all companies with more than 500 brokers; use the > page-forwarding feature in the upper right of the table to scroll through the list.)

Nearly half of advisers with recent disciplinary issues departed from their employers shortly afterwards, in contrast to the job turnover rate of 19% among advisers with no such history, as observed by Egan, Seru, and Matvos. Despite this, those who have committed misdeeds still manage to find new jobs, due to the lack of consequences from the firms.

Despite the fact that 44% of brokers who lost their jobs due to misconduct disclosures were able to find another firm in the following year, which is slightly lower than the 52% of advisers without such a disclosure, the overall statistic is that around 75% of advisers who have been associated with alleged misconduct are working in either their original firm or a new one by the end of the year. This implies that even though the vast majority of advisers and firms provide excellent customer service, repeat offenders still manage to remain active.

The oddness of these trends is evident. If the laws of economics held true, then consultants who continually bring losses to their clients should be quickly removed from their positions. But in actuality, something is obstructing the market power from eliminating the bad practitioners.


The process of apples becoming spoiled

It is seen that around 80% of brokers working in companies with poor track records still maintain a clean record. However, this begs the question of whether they will remain like this. It appears that there is a higher probability of brokers in this situation not staying clean, which is why it would be beneficial for investors to have data on the firm level.

A team of economists and mathematicians at Securities Litigation and Consulting Group (SLCG), a Virginia-based firm which provides expert witness services for financial-industry disputes, argues in two analyses (pdfs) that while it may be beneficial for unsophisticated investors with access to BrokerCheck information to avoid brokers with disclosure events, it is not enough.

SLCG analysts suggest that it is likely another broker at a firm with no prior customer complaints will cause harm to investors in the future if 20% of the other brokers at the same firm have a disciplinary record. Thus, it is important for investors to be aware of the disciplinary history of their broker’s co-workers.

SLCG’s analysis suggests that if Firm A and Firm B had one and two advisers with misconduct disclosures respectively last year, then Firm B would be 30% more likely to have misconduct disclosures the following year. This information is essential for those looking to decide which firm to work with, as SLCG puts it, “The BrokerCheck reports for most of the brokers at [the six highest-risk firms] should prominently display a skull and crossbones warning.”

The work of Stephen Dimmock and William Gerken, finance professors at Nanyang Business School in Singapore and the University of Kentucky’s Gatton College of Business, respectively, in their 2018 article published in the Journal of Finance, sheds light on how the behaviour of firms is indicative of individual integrity. To assess the effect of financial advisers on each other’s behaviour, they looked at trends in advisor misconduct prior to and after mergers between financial advisories (with misconduct being defined as a customer complaint resulting in the settlement of a minimum of $10,000 or an arbitration decision in favour of the customer).

The researchers discovered something unexpected: when a financial adviser encountered a fellow employee with a past of impropriety, they were 37% more likely to perpetrate unethical actions. This “contagion effect” was much more potent when the two were of the same ethnicity, possibly due to the fact that those with similar backgrounds are more likely to interact more.

It is clear why inappropriate conduct can often be found in the same areas. However, one may question why some businesses choose to take risks on advisors who have previously exhibited misconduct.


Places where bad advice abounds

Advisers could be penalized for their propensity to be risk-takers, which may result in more benefits for their clients. While there is no concrete proof of this, it is a plausible idea.

Egan and his team uncovered something more disturbing in their study; their data suggests that areas populated by older, wealthier, and less-educated citizens experience a higher rate of misconduct. It is believed that those who are less financially knowledgeable are being targeted by unethical individuals.

An announcement to encourage people to purchase a product or service is known as an advertisement.

A separate inquiry has shown that some brokerages tend to have strategies in place that negatively effect their clients’ finances. According to the 2017 SLCG report, “these firms are known to have adopted a hazardous business strategy, which leads to the sale of dubious products and the employment of questionable brokers.”

The analysis of SLCG has uncovered some alarming trends. One of the major causes of customer complaints, it appears, is due to investments that are not easily liquidated, such as non-traded real estate investment trusts (REITs), tenants in common (TICs), equipment leasing, variable and indexed annuities, and other private placements. In fact, firms that have the worst records are five times more likely to obtain complaints regarding illiquid investments than the typical firm, as per the SLCG.

Complaints related to equities products, such as stocks on public exchanges and OTC securities, comprise a significant portion of customer grievances. The companies accused of deceitful trading involving these products generally involve allegations of over-trading or unapproved trading in customers’ accounts.

It’s unlikely that improving the transparency of BrokerCheck would be able to alter the current situation; understanding of investments is acquired over an extended period of time, and a website cannot be expected to have a considerable effect.

Colleen Honigsberg, a professor at Stanford Law School, believes that Finra’s approach of relying heavily on BrokerCheck “assumes markets work and that markets will police bad actors, [which] does work to some degree.” However, she also insists that “[t]he market does discipline, but not fully.”

It is important to note that the Financial Industry Regulatory Authority (FINRA) requires brokers to make investments that are “suitable” for customers. This means that brokers are legally able to choose products that financially benefit them, such as by selecting mutual funds with transaction fees passed on to the broker instead of no-fee funds. However, these trades must be appropriate for the client’s overall financial situation. This issue is at the center of a current political discussion concerning whether brokers should be held to a “fiduciary duty” of doing what is best for the client, a standard to which other licensed investment advisers are currently subjected.


Who has the power to shape the history?

Misconduct complaints are an important factor in identifying future problems, yet they are not always visible. Finra offers a way to erase such incidents from a broker’s BrokerCheck profile, as well as the related corporate record, known as “expungement.”

This system is said to offer unjustly blamed advisors the opportunity to clear their names. As a collective, this expungement should make BrokerCheck more precise, meaning advisors with erased records should, on average, maintain their integrity.

Honigsberg and Jacob, both members of the economics department at Stanford and Harvard, respectively, utilized the recently available BrokerCheck data to evaluate the frequency with which financial advisers accused of misconduct took advantage of the “expungement” process to remove the incident from their records–and how many of those successful in having their records cleared continued to allegedly commit offenses.

From 2007 to 2016, Honigsberg and Jacob discovered that 6,660 requests for expungements were made out of a total of 53,000 reported cases of misconduct. Of those requests, 84% were eventually expunged and hidden from BrokerCheck. This accounts for almost 6,000 episodes of alleged misconduct that were not visible to prospective clients, Finra’s personnel, and state enforcement agencies.

Honigsberg and Jacob suggested that brokers who are able to have their misconduct disclosures expunged from their records have a higher likelihood of being charged with future misconduct than those who have their request denied — being 2.5 times more likely than the general average to engage in future misconduct.

Honigsberg and Jacobs highlight that the process of expungement can be costly, likely requiring brokers to pay between $25,000 and $50,000 for each incident. Therefore, even though the public is not as informed as the industry, brokerages still end up paying a large sum of money in order to improve their BrokerCheck reputations. This is indicative of the worth of the disclosure system put in place by Finra, yet its customers are not able to benefit from it.

According to a Finra spokesperson, the regulator is taking steps to improve the process of expungement. This involves proposing a minimal fee for requests, assembling a special group of arbitrators with more qualifications and training to deal with expungement requests, and reducing the amount of time allowed to file the request. These reforms were conveyed to Quartz in an email.


A Major Advancement

It should be noted that this does not mean Finra is facing issues of industry takeover or malfeasance, nor that private regulators are less reliable than their public counterparts. (Honigsberg has pointed out, for instance, that Finra is more proactive in looking into its members than some government financial regulators.)

Maintaining tight control of the data can be justified for a number of reasons, like keeping the privacy of brokers and customers intact. Since BrokerCheck is updated on a daily basis, any data extracted over an extended period of days could be misleading. This is why Finra has only recently allowed automated extraction of data from its web pages, and only for non-commercial purposes, according to Finra.

Finra, through a spokesperson, revealed to Quartz via email that BrokerCheck’s information has been, and will remain, free and accessible to the public. This is done in order to provide investors with insight into whether they should engage or carry on working with a particular broker or establishment. After some deliberation, both within and outside the organization, it was decided to permit scraping of the website for investor safeguarding, regulatory, academic and compliance purposes.

In spite of the changes, the public still does not have easy access to bulk data, due to Finra’s policy of limiting access to those with advanced programming abilities. For example, when Quartz asked for the data, Finra said they could only attain the information by extracting it from their website. Even if these data were available, it is unlikely that many people would be able to analyze it to find essential details about companies and advisors.

Gerken from the University of Kentucky believes that it is unfortunate that the regulations under the terms of use for BrokerCheck data prohibit commercial firms from utilizing the data. She goes on to suggest that the analysis and services offered by companies such as Morningstar and Barron’s would be extremely beneficial to investors.

Gerken points out that it is not practical for each individual investor to look into business sector data alone. He suggests that there is a great potential for other organizations to come in and do that work, either as a public service or by selling the data, provided it is accessible.

When questioned concerning the absence of a Finra ranking of companies based on their past misconduct, a spokesperson provided the following response:

As a self-regulatory organization, FINRA furnishes investors with data on firms and registered people to assist them in making more enlightened decisions when it comes to selecting who they wish to do business with. Rankings are subjective and individuals can have varying perspectives on the significance of different factors. By offering the core factual information, FINRA gives investors the ability to make their own educated decisions.


Upholding integrity when faced with misguided motivations

It’s not just savers who get hurt when it’s difficult to distinguish reliable brokers from those with more risk associated with them. Reputable financial advisors suffer the same consequences.

It is remarkable to discover that the majority of brokers are consistently upholding a high standard of professional behavior, regardless of the length of time they have been in the profession.

In spite of the temptations that drive unethical behavior, there are still those who stay true to their morals. Making the process more transparent could help to foster this virtuousness and create a cycle of good behavior – drawing in brokers who practice integrity to businesses that operate with the same standards and pushing away those with a less reputable past.

In order to properly address the issues that are plaguing the financial advice industry, making the hidden data of BrokerCheck available to the general public is seen as a critical step forward. This view is based on research that demonstrates how firms which are prone to misbehavior are favored over the American public. This action would help to ensure that market forces operate as they were intended.

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