Longtime readers of InvestmentNews know that a target of the publication and this column in particular has been identifying the second or third lives of brokers who get booted from the securities industry for causing havoc with investors only to continue working in the financial planning or investment advice industry carrying an insurance license.
Some call such financial advisors bad brokers; some liken them to cockroaches. They come in all shapes and sizes, but new research shows that a default career path is selling insurance, particularly annuities, where they can mask themselves as financial advisors and continue to cause harm to potentially thousands of clients.
The insurance industry is much more lightly regulated than Wall Street, regional and small broker-dealers and registered investment advisors, which all must answer to either FINRA or the Securities and Exchange Commission.
Those two institutions have plenty of shortcomings – think back to their incompetence when dealing with Bernie Madoff and Allen Stanford. But the insurance industry stands apart as a haven for salespeople of financial products who have malice in their hearts, according to a new industry analysis written by a team of legal scholars.
Indeed, “insurance seems to attract FINRA brokers with a history of misconduct,” and bad brokers “flow to insurance,” are two of the conclusions of the paper, titled “Regulatory leakage among financial advisors: Evidence from FINRA regulation of “bad” brokers” and just published in the Journal of Financial Economics.
Colleen Honigsberg, Edwin Hu, Robert J. Jackson Jr. are its authors, and after digging through a decade – 2012 to 2022 - of FINRA, SEC and insurance industry data, these professors conclusively show that bad brokers hide out in the insurance business, which is regulated by the states and not on a national or federal level like the sales of securities.
“Because 98% of the 'bad' FINRA brokers who withdrew from FINRA registration remain in insurance, where most continue to have authority to sell investment products, bad actors and regulators appear to engage in an ongoing game of whack-a-mole,” according to the paper. “Although there is variation across states, it is common for insurance producers to be subject to lower standards of conduct than either FINRA brokers or investment advisers.”
Gary Anderson, the CEO of the National Association of Insurance Commissioners, did not return a call on Wednesday to comment. A spokesperson from FINRA declined to comment about the report’s findings.
Financial advisors wandering from selling securities to insurance products is similar to other professions where bad behavior occurs, including teachers, clergymen and police officers; they may leave one job after misconduct for another down the road or in a different state, according to the paper.
The report counts 127,865 financial advisors who left FINRA’s BrokerCheck database over 10 years, with 65,384 remaining as insurance producers or salespeople. Of those agents, close to 10.3% have histories of “serious misconduct,” or five times the percentage who work as SEC registered investment advisors who drop their FINRA licenses.
Serious misconduct includes criminal or regulatory infractions, civil judgments, and employer terminations after allegations of improper conduct.
Take, for example, Texas.
“Most insurance producers in Texas do not have any customer complaints filed against them; less than one in one-hundred and fifty have any record of complaints,” according to the paper. “Instead, a small number of individuals, many of whom are repeat offenders, account for nearly all complaints in the data” and “former FINRA brokers are both more likely to have customer complaints filed against them than currently registered FINRA brokers and to be repeat offenders.”
What’s the purpose of the state insurance commissioners, to keep an eye on bad actors or facilitate sales of as much insurance product as possible?
The commissioners should begin a new effort by focusing on FINRA’s high-risk profile of financial advisors who engage in serious misconduct, which FINRA has been working on since 2018.
Bad brokers can be identified and love to sell insurance. The states' insurance commissioners need a better brand of bug spray and use it on the cockroaches.
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