As the old saying goes, one bad apple spoils the bunch. And although the vast majority of brokers are upstanding individuals with clean records and their clients' interests at heart, bad brokers are nonetheless a well-known phenomenon in the financial advice industry. Stories seemingly abound of brokers stealing, exploiting, and manipulating clients. Research shows these so-called bad brokers can be found all around the country. And whenever a bad broker story breaks, RIAs often take the high ground. But lawyers say this phenomenon doesn’t only apply to broker dealers; bad actors can just as easily be found at RIA firms.
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Broker-dealers are regulated by self-regulating body Finra, whereas RIAs are governed by SEC rules. And even though Finra is sometimes criticized for its enforcement activity, lawyers admit the watchdog nonetheless shines a harsh spotlight on the bad actors it finds. All suspensions and bars are publicized, and Finra's BrokerCheck database makes it easy for clients and prospects to search broker-dealer records for disclosures.
Yet former brokers marked by Finra for misconduct are in some cases still allowed to become RIAs, Stafford says. “Just because you drop the brokerage business doesn’t mean you can’t register as an RIA,” she says. “Individuals are playing oversight arbitrage for least oversight,” Lazaro says.
Funding deficiencies for both federal and state regulators have also added to the misbehaving RIA phenomenon, lawyers claim.
Advisors with over $110 million in assets under management must register with the SEC according to the Dodd-Frank Act. RIAs below the $110 million mark fall under individual state regulation. At both the federal and state levels, funds to pursue bad actors are not limitless.
On the federal level, the SEC has received criticism for several years for not having “sufficient” examinations of investment advisors above the $110 million threshold, Laura Posner, partner at law firm Cohen Milstein, says. The SEC's response to the criticism has been that it cannot conduct enough advisor examinations “due to funding and staffing issues,” Posner says.
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State regulators face funding issues as well, although their effectiveness varies by political agenda, lawyers say.
Each state has individual resources and structures their regulator differently, so enforcement policy is always “a little funding, a little political,” Lazaro says.
The effectiveness of each state’s advisor regulation is “often connected to the states’ governor, who appoints state commissions,” Stafford says. Some states have larger budgets and concentrate more on regulating RIAs than others, she says. “Even though states try to mimic the SEC, they each have their own agendas.”
But some state regulators “are doing a good job” regulating RIAs, Posner says.
New Jersey has implemented an electronic advisor examination program to work around issues “like a lack of funding and a lack of staffing,” Posner says.
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