FINRA rules pushed sketchy brokers toward insurance registration: Study

FINRA rules for greater scrutiny of brokers with misconduct records may have simply nudged those individuals into insurance registrations with more lax supervision, a new study found.

The study, published in this month's issue of The Journal of Financial Economics, shed light on what its title refers to as the "Regulatory leakage among financial advisors: Evidence from FINRA regulation of 'bad' brokers." Researchers Colleen Honigsberg of Stanford Law School, Edwin Hu of the University of Virginia School of Law and Robert Jackson of the New York University School of Law probed deeper into the issue they first described in 2022 as "wandering advisors." But the "leakage" of brokers with disciplinary histories into less regulated spaces — which contributes to cases of fraud and other misconduct by financial professionals who are repeat offenders — has been playing out for a long time. 

FINRA adopted rules in 2021 that required firms seeking to hire brokers with substantial disclosures on their records to get its approval. The rules also designated firms that have many of these individuals as "restricted" brokerages. Subsequently, thousands of brokers left FINRA. But 98% remain registered with state insurance regulators as insurance producers, the study said. 

"Assuming that the rules were effective at pushing bad actors out of FINRA's regime, it is unclear whether the effect of the rules would be to force bad actors out of financial services entirely — or to force bad actors into less regulated areas of financial services," it said.

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A documented, if unsolved problem

Representatives for the Securities and Exchange Commission and FINRA declined to comment. In response to an email inquiry, a representative for the National Association of Insurance Commissioners provided a statement and referred Financial Planning to the NAIC Producer Licensing Model Act, which the organization said "helps create and maintain standards for licensing insurance producers" in the states that have adopted the legislation.

"The NAIC maintains the national Regulatory Information Retrieval System, a database that tracks regulatory actions taken by state insurance departments," according to the organization's statement. "Each state contributes to this system by reporting the regulatory actions they take under their respective authorities. The NAIC system ensures that information is accessible across jurisdictions and that coordination between states is supported. In addition, FINRA provides the NAIC and state insurance regulators with its monthly disciplinary reports, further enhancing regulators' ability to review. State insurance regulators also retain broad authority to take regulatory action against licensed producers when necessary."

Regulators have known about the problem of recidivist brokers for years, regardless of whether they acknowledge this or prior research documenting it. The question remains whether they have ever had the resources necessary to crack down on bad actors who drop one form of registration only to commit misconduct under another. That's especially relevant in an era in which enforcement actions are falling drastically and President Donald Trump just commuted the prison sentence of convicted fraudster David Gentile of the infamous alternative investment manager GPB Capital.

For consumers, much is at stake

FINRA's BrokerCheck database is "a useful and valuable tool" for checking the background of current or former registered representatives, but most clients "find out about BrokerCheck once they've had a problem" already, said Michael Bixby, the president of the Public Investors Advocate Bar Association, a consumer legal advocacy group, and founder of Bixby Law. 

Any solutions will come from "rigorous enforcement and review" of so-called financial advisors who present sales of complicated insurance products, such as indexed universal life insurance, as investment advice. Most people don't know the distinctions between registrations or comprehensive planning versus insurance sales — no matter if the financial professional has been banned by FINRA, the SEC or any other agencies. The names of the bad actors' businesses and their marketing generally don't help to clarify matters.

"I can go sell insurance, basically as investments," Bixby said. "If you looked on the website, you'd be hard-pressed to find the difference, especially for your average retail consumer."

Some technology firms such as AdvisorCheck are trying to use databases like BrokerCheck and the SEC's Investment Adviser Public Disclosure website to track brokers who move into other jurisdictions. But disclosure gaps, information buried deep in regulatory websites and misunderstanding of fundamental aspects of the industry like the nature of firm registrations, licenses and examinations add to the difficulty, according to Michael Fox, AdvisorCheck's chief operating officer, and Alex Rowell, its community and digital marketing lead.

"Our big focus right now is education," Rowell said, citing the licensing exams. "The average consumer doesn't know what that means, so even if they see the data it has to be contextualized in a meaningful way."

Broker expungements and private arbitrations that have spotty public reporting add to the factors that make it "very, very hard as a general consumer" to locate relevant details, Fox said.

"You have a lot on the line with this stuff," he said. "It's really hard to find this information."

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The key findings

The researchers set out to find that information by compiling what they characterized as "the most comprehensive overview of the financial advisor industry" through scrapes of BrokerCheck, the IAPD database and, where available, that of state insurance regulators. In all, out of the more than 456,000 brokers who withdrew their FINRA licenses in the 10 years that ended in 2022 and never regained their registration, over 26% still have current licenses in another financial jurisdiction. They found examples like one Florida insurance agent who was still operating in 2022, despite bans by FINRA in 2008 and the Commodity Futures Trading Commission in 2010 amid allegations of false account statements and other violations of the law.

"On the one hand, allowing 'wandering' in financial services may be efficient if individuals preserve their human capital and skill in selling financial products but transition to lower-risk work," the authors wrote. "On the other hand, 'wandering' could reflect a form of arbitrage that allows bad actors to continue working in a similar function while evading market discipline. The overlapping and fragmented legal regimes for financial advisors also raise questions about regulators' ability to discipline bad actors."

Notably, the vast majority (92%) of former FINRA brokers who remained in insurance kept their license to sell annuities, with 76% authorized to sell variable annuities in particular. Fewer than 15% had licenses to sell home insurance products such as casualty policies.

"In sum, these former FINRA brokers appear to be operating on the asset management side of insurance rather than the traditional risk-reduction side," the authors wrote. "Second, we show that individuals with a history of insurance misconduct continue to commit misconduct in insurance. Further, individuals are more likely to withdraw their FINRA registration and work in insurance when the state insurance regulator is more lenient (as measured by the regulator's budget and total fines relative to the number of producers in that state), and in states with a smaller salary gap between brokers and insurance producers (brokers typically earn more than insurance producers). Jointly, these tests suggest that former brokers with a history of misconduct who transition to insurance continue to engage in similar behavior."