Financial Advisor IQ ( August 1, 2019) - 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.
“RIAs can be as bad as brokers, if not worse,” Jane Stafford, an attorney at Stafford Law Firm, says. And cases against RIAs more often tend to be instances of fraud and are harder for clients to recover from, Stafford says.
Misbehaving RIAs can be a “very bad issue” for the perception of the wealth management industry, Stafford says. The RIA space “certainly” has some issues with advisors stealing from clients or not acting in their best interest, according to Christine Lazaro, president of the Public Investors Arbitration Bar Association.
One case brought by the SEC against advisory practice Fieldstone Financial Management Group and its principal Kristofor R. Behn is a good example.
Under the direction of Behn, Fieldstone Financial Management Group advised 40 retail clients to invest more than $7 million dollars combined in asset management firm Aequitas Securities, which was recently charged with defrauding investors. The case was settled for $234.6 million dollars, Oregon Live reports.
Chicago-based attorney Andrew Stoltmann, of Stoltmann Law Offices, says such cases are not isolated events.
RIAs might well be seen as “the gold standard” of wealth management, but Stoltmann has increasingly seen investors come forward against RIAs.
In 2012 Stoltmann Law had not seen any cases against RIAs, but now the firm has close to 100 misbehaving RIA cases under its belt, he says.
Stoltmann attributes the rise of bad RIAs to “some of the bad broker tactics transfer[ing] to the RIA space.”
And enforcement action data from the North American Securities Administrators Association shows Stoltmann’s experience may not be an anomaly.
In 2017, 377 enforcement actions were brought against RIA firms and investment advisor representatives combined, NASAA enforcement reports show. In comparison, about 270 were brought against brokers and brokerage firms in the same year. In the previous two years, enforcement actions between advisors and broker-dealers differed by about 40, NASAA figures show.
Lawyers also attribute the growth in RIA misconduct to both the growing number of RIAs and the regulator’s lack of funding.
More assets are going to the RIA channel as brokers move towards becoming registered investment advisors, Stoltmann says. And with such movements come “the infection of the RIA pool by former brokers,” he says.
Lazaro agrees there are “definitely” more advisors today than five years ago. And it makes sense that the RIA industry is seeing more misconduct as migrating brokers transfer their conduct from the brokerage side, Lazaro says.
Regulation of RIAs also isn’t as robust as it is for brokers, Stoltmann claims.
“Scheming brokers” who want to decrease the regulatory spotlight on themselves “bathe” themselves in the pool of RIAs, Stoltmann says. Advisors are being pushed out of brokerage firms because of book size demands, and while the “great majority” of brokers are “okay, a lot aren’t,” Stafford claims.
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.
The SEC has been “complaining for years” that it needs additional funding for advisor exams, Stafford says. “There is always a line item on [the SEC] budget requesting more money for advisor examinations,” she claims.
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.
Stoltmann agrees.
“States are doing a good job of regulation and keeping their eyes on RIAs,” he says. But “the SEC hasn’t done a robust job of regulating RIAs,” Stoltmann says.
Changing markets, however, may push regulators to monitor the RIA space.
“The 10-year bull market is going to eventually end with a crash of 20 to 30 percent,” Stoltmann says. And a “parade of horribles will be exposed” with the drop, warns Stoltmann.
“That’s when the SEC, and to lesser extents, states will begin crashing down on RIAs,” he says. Regulation at the state and federal levels “tends to be reactionary rather than proactive,” Stoltmann claims. And “there is nothing like a bear market” to spark further enforcement, he says.