The existence of several regulatory regimes, particularly at the federal versus the state level, means that brokers with a history of misconduct can continue working under other regimes — and in fact are more likely to, according to a recent report.
Among advisors who commit “serious misconduct” and exit the federal regulatory regime, “thousands” continue working as advisors “under more lenient state-level regulation,” Colleen Honigsberg, Edwin Hu and Robert Jackson, Jr. wrote in an article published in the Stanford Law Review.
In a study of around 1.2 million financial advisors — representing all individuals who appeared in the Financial Industry Regulatory Authority’s BrokerCheck database in any year from 2010 to 2020 — the authors matched the advisors’ information to the Securities and Exchange Commission’s Investment Advisor Public Disclosure Database, the National Futures Association’s Basic database and state insurance.
The authors found that out of the 395,887 individuals who exited BrokerCheck during the decade, 133,827, or 34%, remained registered in another regulatory regime.
Among those who exited BrokerCheck during the 10-year period, 7% have a history of misconduct, the authors wrote.
Among those who left BrokerCheck, 8% remain registered as an Investment Company Act of 1940 advisor.
Among those who left BrokerCheck but remained in other regulatory regimes, the percentage of advisors with past misconduct was 10.7%.
The authors also found a correlation between staying on as an insurance provider or member of the NFA after exiting BrokerCheck and a history of misconduct.
Among those who were registered as insurance producers after exiting BrokerCheck, 16% had a history of misconduct, and among NFA members who left BrokerCheck, 17% had a history of misconduct, according to the report.
The authors wrote that the existence of two regulatory regimes means stricter conduct standards under one would incentivize advisors to move to the other.
The authors also brought attention to the relationship between many state lawmakers and the insurance industry.
“We argue that any regulatory policy must consider not only the risk that increased federal oversight will push bad actors toward state-level regulation, but also the risk of regulatory capture at the state level,” they wrote.
“For example, we show that 7.5% of state lawmakers who sit on legislative committees overseeing insurance regulators are currently insurance producers, and that 11% of state lawmakers are now, or once were, in the business of selling insurance — a far higher fraction than for comparable professions,” they added.
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