The Labor Market for Financial Misconduct.

• Author: Matvos, Gregor
• Position: Research Summary

Financial advisers in the United States manage over $30 trillion in investible assets, and plan the financial futures of roughly half of U.S. households. At the same time, trust in the financial sector remains near all-time lows. The 2018 Edelman Trust Barometer ranks financial services as the least trusted sector by consumers, finding that only 54 percent of consumers "trust the financial services sector to do what is right." (1) The distrust of finance is perhaps not surprising in the wake of the recent financial crisis and several high-profile scandals that have dominated financial news. While it is clear that some egregious fraud occurs in the financial services sector, it is less clear whether misconduct is limited to a few scandals or is a pervasive feature of the industry. Moreover, if misconduct is pervasive, why can it survive in the marketplace, and conversely, which mechanisms constrain it from enveloping the entire industry?

This summary describes our research, which is joint work with Mark Egan, on these questions. We start by describing how we measure misconduct among all registered financial advisers in the U.S. We then turn to the role of labor markets in constraining misconduct, documenting that while some firms penalize misconduct through a sharp increase in job separations, other firms are willing to hire these advisers, recycling the bad apples in the industry. We then discuss evidence that suggests this phenomenon arises because of "matching on misconduct," in which advisers with misconduct records match with firms which specialize in misconduct, and that the presence of uninformed consumers may be critical to maintaining this equilibrium. We find that similar forces may also explain gender discrimination in the labor market of financial advisers, leading to a "gender punishment gap." We conclude by discussing how academic research may help guide evidence-based policy.

Measuring Misconduct

We began our research program by documenting the extent of misconduct in the financial advisory industry. (2) To study misconduct by financial advisers, we construct a panel database of the universe of financial advisers (about 1.2 million) registered in the United States from 2005 to 2015, representing approximately 10 percent of total employment of the finance and insurance sector. Our data, which we have made available to other researchers, come from the Financial Industry Regulatory Authority's (FINRA) BrokerCheck website. The data contain advisers' complete employment history. Because the industry is heavily regulated, data on adviser qualifications provide a granular view of job tasks and roles in the industry. Central to our analysis, FINRA requires financial advisers to formally disclose all customer complaints, disciplinary events, and financial matters, which we use to construct a measure of misconduct.

We find that financial adviser misconduct is broader than a few heavily publicized scandals. Roughly one in 10 financial advisers who work with clients on a regular basis have a past record of misconduct. Common misconduct allegations include misrepresentation, unauthorized trading, and outright fraud--all events that could be interpreted as a conscious decision of the adviser. Adviser misconduct results in substantial costs: In our sample, the median settlement paid to consumers is $40,000, and the mean is $550,000. These settlements cost the financial industry almost half a billion dollars per year. A substantial number of financial advisers are repeat offenders. Past offenders are five times more likely to engage in misconduct than otherwise comparable advisers in the...