Financial Planning (September 29, 2021) – Questionable brokerages with rogue salespeople deservedly get slammed for routinely failing to pay regulator-ordered money to investors whom they’ve cheated.

But independent advisory firms with sketchy financial planners are equally bad when it comes to not ponying up required awards — a problem that’s both murkier and getting worse, according to a report released Wednesday by a prominent group of lawyers who represent investors in claims and lawsuits against financial firms.

The Public Investors Advocate Bar Association report focuses on brokers and brokerages, which are overseen by the Financial Industry Regulatory Authority, the industry’s self-regulating watchdog. At the same time, PIABA’s findings on advisors, who aren’t required to be FINRA members, flag an emerging hot-button issue for the wealth management industry: a mistaken perception that advisors are “safer” than brokers.

“It is fair to conclude from regulatory actions and discipline that RIAs are misbehaving at the same rate as brokers,” the report said, referring to registered independent advisory firms.

Harder to collect

Independent advisors, who are held to the more stringent fiduciary standard in which the client’s best interest must always come first, are seen as less likely to defraud customers. The standard requires that conflicts of interest not only be disclosed but avoided. Advisors and their firms are overseen by the SEC or, if they manage less than $110 million in client assets, state securities regulators.

By contrast, brokers are held to the lesser “best interest” standard, in which the investments and money management services they recommend have to be merely “suitable” for clients. Brokers are supposed to disclose conflicts of interest, but they’re not required to actually avoid them.

The COVID pandemic shut down FINRA’s in-person arbitration hearings last year and thus depressed the number of awards it made when compared to 2019.

Still, PIABA found that more than $5 million of the nearly $21 million that FINRA ordered brokers and brokerages to pay swindled investors in 2020 went unpaid. Investors never received nearly one in four awarded dollars, up from one in five dollars in 2019. Likewise, the percentage of awards that went unpaid last year rose to nearly 30% from around 27% in 2019.

FINRA hasn’t yet published awards data for 2020, so PIABA crunched the numbers for itself, using data scattered across the watchdog’s website.

14 cents a year

Grim as they may be, PIABA said its findings likely downplay the broader problem of cheated investors recouping at least some of their money. That’s because many investors “don’t bring cases where they know there’s no chance of getting paid,” Michael Edmiston, the president-elect of PIABA and a securities lawyer in Studio City, California, told a Zoom conference on Wednesday. The problem will get worse if markets slide and investors’ retirement plans are hit, he said.

Industry-funded FINRA, which is overseen by the SEC, tracks monetary awards that it requires its members to pay after mandatory arbitration proceedings that it holds. While a brokerage or broker risks suspension by FINRA if an award isn’t paid in 30 days, what PIABA called “reprobate (and often destitute) brokers” and their firms can avoid paying their fines by filing for bankruptcy — leaving cheated investors with nothing. Most brokerages require their clients to sign agreements saying they will handle any disputes through FINRA’s arbitration process, but even if they don’t, aggrieved brokerage clients can take their complaints to FINRA.

FINRA argues that by the time it makes awards, an offending firm or broker has often already been suspended, expelled or otherwise severely disciplined — or moved on to another firm where they continue to cheat clients, a practice known as “cockroaching.” As such, the watchdog says it “is constrained in its ability to help enforce collection of an unpaid award against an inactive firm or individual.”

PIABA countered that FINRA needs to establish a $24 million — for now — “recovery pool” of money for cheated investors, something it could do if ordered to by Congress or by the SEC under the Dodd-Frank Act, the law that overhauled financial regulation after the 2007-08 financial crisis. One way to fund that pool, PIABA said: Have member firms pay around $6,300 a year; or have individual advisors shell out around $107 a year; or charge investors 14 cents a year. PIABA computed the sums based on award data, and firm and investor numbers in prior years.

A FINRA spokesperson said in a statement that the self-regulator “is committed to reducing the number of arbitration awards that go unpaid to customers, which typically result from respondents declaring bankruptcy or going out of business.” FINRA, the statement said, has taken recent steps “to reduce the risks to investors from brokers and firms who may be less likely to pay awards.”

PIABA also called on the SEC to “conduct a sweep of the advisory firms and IAs registered with the Commission and then report statistical summaries concerning where IA arbitrations are being heard.”

The SEC didn’t immediately respond to a request for comment.

‘No way to quantify’

Aggrieved investors typically settle disputes with their advisors in alternative dispute resolution services or lawsuits; unlike FINRA, the SEC doesn’t have its own in-house arbitration process to settle disputes.

The issue is that while FINRA has a database of awards that brokers are required to pay, there’s no central depot of data for awards through private settlements with bad advisors. Which means that there’s “no way to quantify unpaid IA (investment advisor) awards in a statistically meaningful manner,” the PIABA report said.

That hides the problem of bad advisors who settle client claims through private dispute resolution forums, such as the American Arbitration Association or JAMS.

PIABA citeddata from the North American Securities Administrators Association showing that state securities regulators disciplined or barred 200 broker-dealer firms and 391 individual brokers in 2020. Meanwhile, those same regulators brought enforcement actions against 193 investment advisory firms and 434 advisors. That’s nearly as many advisory firms as brokerages, and more advisors than brokers.

‘Abhorrent dereliction’

PIABA’s findings come amid massive changes in the wealth management industry.

Brokers have been ditching their wirehouses and independent brokerages to set up or join independent advisory firms. At the same time, brokerages have expanded into wealth management services by hiring financial advisors. More than 13,800 RIAs large enough to be registered with the SEC held nearly $110 trillion in client assets at the end of 2020, according to the Investment Advisor Association, a trade group and lobby. When a “hybrid” brokerage also offers independent advisory services, the lines of fiduciary responsibility can get blurred for investors.

But even pure fiduciary advisors can cause problems, especially when they sell private securities and “promissory notes”, a tactic about which the SEC warns investors.

David Meyer, PIABA’s president and a lawyer in Columbus, Ohio, who represents defrauded investors, cited the case of a retired widow. Meyer said his client lost her life savings to a fraudulent advisor at Fisher Wealth Management, a small RIA in Dublin, Ohio, with 70 clients and $12 million in assets under management.

Meyer and the firm’s ADV detailed how advisor Bradley Fisher sold the woman, Barbara Gelderloos, speculative private securities that lost all their value. Last May, a private arbitration forum ordered Fisher to pay Gelderloos $621,500, but the award still has to be confirmed in civil court. Meanwhile, Meyer said, he’s not optimistic that his client will actually see any money because the firm, also known as Rockpointe Financial, is small.

Ten years ago, Meyer told the Zoom, 90% of his law firm’s cases involved rogue brokers. Now, around half of them involve investment advisors and their firms, half of them smaller, state-regulated entities.

Whether from brokers or advisors, the report said, unpaid awards are “an abhorrent dereliction of responsibility by a securities industry that profits massively from its ‘trust your advisor’ encouragement.”

PIABA also faulted both FINRA and the SEC for not requiring brokers or advisors to maintain liability insurance that could compensate robbed clients.