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​Wall Street’s watchdog is obscuring data that could protect investors

Published on: 03-Mar-2020

Every year, thousands of Americans face the same weighty decision. With cash piling up in a no-yield bank account, they determine it’s time to entrust their wealth to a pro. But how do they ensure they’re not handing over their hard-earned savings—and their hopes of paying for college, perhaps, or enjoying a financially secure retirement—to the next Jordan Belfort or Bernie Madoff?

To help investors vet brokers and the firms they work for, the private regulator that supervises US financial advisers offers BrokerCheck. It’s an online database of work histories, credentials, and disclosures of possible past misconduct, serving as the lone portal through which customers can check up on advisers’ records. The site reports past customer complaints of misconduct, covering everything from excessive trading to outright fraud.

Every year, thousands of Americans face the same weighty decision. With cash piling up in a no-yield bank account, they determine it’s time to entrust their wealth to a pro. But how do they ensure they’re not handing over their hard-earned savings—and their hopes of paying for college, perhaps, or enjoying a financially secure retirement—to the next Jordan Belfort or Bernie Madoff?

To help investors vet brokers and the firms they work for, the private regulator that supervises US financial advisers offers BrokerCheck. It’s an online database of work histories, credentials, and disclosures of possible past misconduct, serving as the lone portal through which customers can check up on advisers’ records. The site reports past customer complaints of misconduct, covering everything from excessive trading to outright fraud.

Starting a few years ago, a handful of pioneering academics were able extract the critical firm-related data from individual profiles. It’s thanks largely to these analyses, which offer vastly more complete data on firm behavior, that we’re starting to see how little investors are being told—and how much the ignorance costs them.

The bustling business of selling investing advice

To grasp the significance of the new research, it helps first to know what, exactly, brokers do and how they’re supervised.

US households have roughly $90 trillion in total financial assets, about a third of which is held in retirement accounts. Around 17% of households use a financial professional to manage their money, according to a 2019 survey conducted by CNBC, Acorns, and SurveyMonkey. Among retirees, that share is higher, around 30%. In other words, the wealth of tens of millions of households—in particular, the ability of older Americans to retire comfortably—depends on the wisdom of their financial advisers’ actions.

Collectively, those actions could have far broader economic consequences. Savings are, in a sense, a public resource. The willingness of households to sink their savings into stocks and bonds provides a massive pool of capital available to companies, and helps dictate funding costs for businesses. Household consumption drives nearly 70% of US economic output; the financial security that encourages people to keep spending, instead of holding cash, is crucial to sustaining the current pace of growth.

In 2018, the last year for which there is data, the brokerage industry managed $24 trillion in client wealth, according to Aite Group, a research and consultancy firm. That same year brokerage firms generated $367 billion in revenue, and $45 billion in profit (pdf).

To directly trade stocks and other securities for clients, a financial adviser must be registered as a broker. In addition to securities listed on mainstream exchanges, brokers have access to a menu of financial products that, whether because of legal restrictions or exoticism, are generally beyond the reach of retail investors. These include complicated annuities, specialty bonds, unlisted real estate investment trusts, whiz-bang derivatives products, and private placements.

Most of the finance industry falls under the regulatory purview of the US Securities and Exchange Commission. Brokers and their firms, however, are directly policed by a membership-based group called Finra (a loose acronym of Financial Industry Regulatory Authority), a private, nonprofit corporation created in 2007. With the American Bar Association and the American Medical Association, Finra is among the biggest, most prominent self-regulating industry organizations in the US. Its stated goal is to protect investors and promote market integrity in a way that “facilitates vibrant capital markets.”

One way Finra strives to fulfill its mission is through policing firms and their representatives, issuing fines for violations and, in severe cases, referring criminal activity to the Feds. The organization takes an active role in investigating brokers and firms for misconduct. It also oversees the arbitration process between customers and brokerage firms—those who think their broker’s lousy choices lost them money must lodge their complaints with Finra.

Finra reported an average of around 3,050 customer grievances a year between 2014 and 2018. Many disgruntled customers wind up settling with brokerages. Those who don’t are legally required, in nearly all cases, to resolve disputes through arbitration. Settlements tend to work out better for customers. For example, as the New York Times reported, of the 2,772 complaints filed in 2013, some 2,173 were settled, with complainants receiving monetary or non-monetary relief 84% of the time. In the 499 cases that went to arbitration, 42% of customers were awarded monetary or non-monetary damages. Each of these data points reflects an event stored in BrokerCheck (or is supposed to, anyway—more on that shortly).

Finra is meant to equip “retail investors with access to unbiased financial resources and information,” according to Finra’s website. But even though the information in the BrokerCheck profiles of individual brokers might itself be unbiased, bias can emerge in the presentation and interpretation of data. And the way Finra presents data on BrokerCheck keeps key information off-limits to all but the most sophisticated and tech-savvy of users.

What BrokerCheck tells you…

BrokerCheck shows credentials and work histories of Finra’s 625,000 registered advisers, including records of past complaints, misconduct, disciplinary actions, and settlements.

These individual profiles are vitally helpful in a few key respects. Google searches seldom turn up much about individual brokers—there’s no Yelp-style archive of customer reviews to peruse. So BrokerCheck certainly fills a gap in giving customers a sense of brokers’ reputations. And it presents disclosures about misconduct allegations prominently and in an easy-to-understand format. That makes it fairly obvious when brokers have lots of red flags. (Note that disclosures don’t necessarily indicate wrongdoing; the complaints are sometimes dismissed by arbitrators.)

But the language of the disclosures is often vague, jargon-filled, and light enough on details that it can be impossible to tell whether a misconduct charge reflects a truly reckless streak or simply a bit of bad luck. Even more confusing, in the case of settlements, brokers may dispute their blame or involvement in the complaint—and the disclosures provide few clues as to the merits of such protests.

Source: Quartz | 3 March 2020

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