RIA advocates cry foul after international media pick up on U. of Chicago study labeling shady stock brokers as 'investment advisers'

It should have been a red-letter day for RIAs.

Finally, a prestigious study highlighting the misdeeds of brokers catches fire in the mainstream press, once and for all clarifying the yawning chasm between the pure fiduciary practices of investment advisors and the lame-at-best, fraudulent-at-worst, suitability standard of commission-based broker-dealers.

Instead, as if in a bad dream, the release of a new study late last month exposing corrupt stockbrokers and complicit regulators prompted a deluge of damning headlines about “investment advisers.”

Virtually all the offenders identified under this IA moniker were stockbrokers. See: Part II: Tick, tick … How FINRA tramples on 'settled’ principles of the Supreme Court, and even Adam Smith, in its sanctification of two-hatted advice Industry observers say the academics were either lethargic in their reporting or uneducated in the nuances of the industry.

It’s new twist on the same old — and incredibly frustrating — story as RIAs are lumped in with — or, worse, mistaken for — broker-dealer reps.

'Rotten advice’

Since the study was published it’s been picked up in general interest news magazines nationwide and even internationally, complete with alarmist headlines that paint unwitting IAs as shady, not-to-be-trusted characters.

“This is How Unethical Financial Advisers Can Get Away With It,” screamed the Washington Post.

“A New Reason to Check your Financial Adviser’s Record Right Now,” was the anxious-making top of a Money magazine article.

“Does Your Financial Adviser Specialize in Misconduct?” inquired Newswise, a newswire for journalists, in its headline.

And, harshest of all, from The Economist — regarded as the gold standard for financial news for the mass public — “Bilking Investors: Rotten Advice.”

After five days straight of excoriating headlines, the Investment Adviser Association issued an unprecedented impromptu press release asking the media to correctly identify the “advisers” in the study as “brokers.”

“The title’s unfortunate because the study is focused exclusively on broker misconduct — the researchers use the term “financial adviser” to refer to investment professionals registered with FINRA and used FINRA’s BrokerCheck database to collect their data,” the statement said.

'Misinformed or lazy’

Brian Hamburger of MarketCounsel Inc. says the authors of the study were either lax in their reporting or uneducated in the nuances of the industry.

“Among the most significant issues that plague investors is that of investor confusion. They simply don’t know whether they are working with fiduciary investment advisers or brokers. Unfortunately, the impact of this confusion is incalculable. And while one can understand brokers’ use of the term (akin to the motivations of the wolf in sheep’s clothing), its use by the media and, in this instance, academics, is either misinformed or lazy.” See: Top RIA lawyer explains to the SEC why 'harmony’ is a harsh misnomer and why the price of its false spin is paid by investors

The misnomer is front and center in the study’s title: The Market for Financial Adviser Misconduct, written by Mark Egan, assistant professor of finance at the Carlson School of Management for University of Minnesota; Gregor Matvos, associate professor of finance at the University of Chicago Booth School of Business; and Amit Seru, a fellow at the University of Chicago Booth School of Business.

Released Feb. 26, the study shows finds that 7% of “advisers” have misconduct on their records, delves into that misbehavior and shows that it’s not uncommon for “advisers” to get shown the door for their misdeeds or to get re-hired within a year of being canned for bad behavior.

(The term “adviser” also lays bare a not-so-roiling controversy between the industry publications, firms and studies that spell advisor with an “o” — like us — as opposed to adviser with an “e.”)

False ID

In fairness, there is clarity to be had in the study — but only if one is willing to peruse the fine print, which in this case resides in the first footnote on page one:

“We will use the term 'financial adviser’ throughout the paper to refer to investment professionals registered with FINRA. All brokers in the United States are registered with FINRA and are defined in the Securities and Exchange Act 1934 as 'any person engaged in the business of effecting transactions in securities for the account of other.’” See: How many RIAs are there? No, seriously, how many?

One person who did not seem confused by the semantics of the study was Sen. Elizabeth Warren (D-Mass.) who scolded FINRA’s chairman, Richard Ketchum about the issue.

But that’s cold comfort to an RIA industry whose probity and investor-first ethos is the very bedrock of its value proposition. See: What is the value proposition of a financial advisor — and how is a budding RIA culture upping the ante?

Lumped in

The study’s authors chose to use the term “financial adviser” because the data includes 640,000 FINRA representatives, 250,000 of whom are also with firms registered as investment advisors.

Co-author Egan says his team went out of its way to dispel confusion and define its term of “financial adviser” in the first page of the 60-page report. He points to the section that reads: “We collect data on firms’ customer base and fee structure from Form ADV, which investment advisory firms file with the SEC. We match this data to BrokerChceck data exactly.”

Expanding on that point, Egan adds: “Our data set includes brokers and individuals who are dually registered as brokers and investment advisers. We know the data includes both and we decided to be clear what we’re talking about right away. We’re trying to be as clear as possible about who we’re referring to. Even a lot of brokers refer to themselves as a financial adviser. That’s why we define it because we didn’t want to contribute to confusion and we wanted to be very specific about what the definition is.”

The data in the study was collected from FINRA’s BrokerCheck database. The study reviewed brokers from 2015 to 2015. The data set contains 1.2 million “financial advisers.”

Hamburger doesn’t find Egan’s explanation satisfying.

“It’s a shame that the authors chose such a vague term when attempting to make a persuasive data-backed presentation designed to help the public. The study exclusively evaluates registered representatives of broker-dealers, commonly referred to as brokers. That is, unless they are trying to confuse investors.” See: Advisor vs. Advisor: Two RIAs and two brokers advocate [a total of] four different ways of earning fees and caring for clients

Directly from FINRA

Egan takes issue with Hamburger’s assessment that his team was either lax or confused in reporting its findings.

“We do not see how the research could be either lazy or misinformed. We clearly define who we research, providing an explicit definition of what we mean by financial adviser, which is the object of our study.”

He adds: “Our data set includes registered representatives as well as 250,000 investment advisors. As discussed in detail in our paper our data comes directly from FINRA’s BrokerCheck database where they accordingly label some of the registered representatives we study as “Investment Advisers” and define the term “Investment Adviser” on each investment adviser’s BrokerCheck webpage. This number does include Investment Adviser Representatives. We are being consistent with the labeling in our data source.”

But Hamburger points out that even the authors’ small print definition of “advisers” is flawed.

“The author told you that their review 'includes registered representatives as well as 250,000 investment advisors.’ Yet, that is flat-out incorrect. First, the author does not define 'investment advisors.’ Keep in mind, there are not 250,000 registered investment advisers in the United States, so I can only speculate that the author’s claim is that, of 640,000 FINRA representatives, 250,000 of them are separately registered as investment adviser representatives. But again, this unclear use of titles is significant and cannot be overlooked.”

Don’t let me be misunderstood

Among the unamused at this turn of events is the Investment Adviser Association. IAA’s general counsel Bob Grohowski says said he was coming across so many stories about the study that he decided to dig further.

“I saw it in my morning news feed and clips and all of the blogs I like to read. I wanted to take a look at the study itself. As soon as you see the way they’re defining financial advisors, you realize it’s broker-dealer reps. We in the industry know that but the general public distinction is lost on the public.”

IAA was careful not to say that the authors were purposefully misrepresenting the phrase but that the organization is convinced the study will perpetuate confusion about the term financial advisor. See: The 10 biggest threats to the RIA business heading into 2014

The IAA added in a prepared statement: “Financial Adviser” is not a term of art and it’s not a regulatory designation. Professionals across the financial services industry use the term to describe themselves. Our concern is that this study will be misunderstood by many people. While it’s clear to us that FINRA only regulates broker-dealers, it’s anything but clear to financial consumers. And financial professionals outside the broker-dealer segment of the broader industry will be unfairly tarnished by reports of the study’s findings,”

The statement also urged the media to make it clear that the study highlights broker representatives and not other financial professionals.

Old news

The data findings in the study are eye-catching to laypersons but likely not that much of a surprise to anyone familiar with the reputation of brokers. For instance, the study shows that one in 13 “financial advisers” or brokers (as RIABiz and industry defines them) have a misconduct-related disclosure on their record.

The study also finds that 44% of brokers who lost their job after misconduct are hired elsewhere in the industry within a year. This was the detail that on which came down hardest on Ketchum.

But the report suggests that certain firms are to blame for bad brokers reappearing under new brands.

“Why are some firms willing to hire advisers who were fired following misconduct? If firms had identical tolerance toward misconduct such rehiring would not take place. We find that advisers with misconduct switch to firms that employ more advisers with past misconduct records when compared with other advisers who are looking for jobs,” the study states.

The study also shows that the broker misconduct is higher in areas populated by the wealthy, elderly and less educated, and that unscrupulous practitioners run rampant — roughly one in five brokers — in many counties in Florida and California.

Ironically, the report got it right when it referenced a Wall Street Journal headline: “Brokers are Trusted Less Than Uber Drivers, Survey Finds.”

But the headline was only included as a footnote.