When private equity firms look for target acquisitions among financial advisors, they tend to favor practices with lower-than-average histories of advisor misconduct—60% lower, in fact.
But after a buyout, advisor misconduct at firms that have been bought out rises 147%, and the increase in misconduct is stronger in firms that see higher post-buyout growth in assets under management per advisor and concentrated among firms that cater to retail customers.
These are among the findings of a new study on the impact of private equity deals in the advisory community, conducted by three academics at the University of Oregon—Albert Sheen, Youchang Wu and Yuwen Yuan.
“Initially, we had no idea what the results would be. But we saw so many news articles on private equity going into the financial advisor industry, we knew we wanted to look in that area,” Wu said. “In my prior study, I’ve looked at kickbacks and revenue sharing between financial advisors and fund managers, and Albert Sheen was very much interested in private equity, so we decided to combine those interests.”
In many industries, private equity dollars can lead to streamlined operations and cost-saving synergies among acquisitions, but in markets with opaque product and service quality—like financial advisors—the benefit of a private equity investor to the customer is less clear.
Yet private equity firms have shown increased interest in acquiring advisory practices over the years (accounting for 5% of deals and 26% of AUM transfer from 2013 to 2019), compelling the trio to study the effect private equity dollars have on an advisory firm in the aftermath of an acquisition.
“Overall, our results suggest that PE firms target advisory firms with a relatively clean record in terms of misconduct and operate their advisory business more aggressively after the takeover to maximize profits,” they wrote. “As such, they suggest a tension between financial advisory firms' profit motive and ethical business practices, especially when clients are financially unsophisticated.”
To look at how a buyout affects financial advisor misconduct, the researchers identified all the private equity backed buyout deals where the target was a U.S.-based financial advisory firm, matched those firms to their SEC records through their ADV, and also the individual registered investment advisors to their records as well.
In total, the registered advisor universe from 2000 to 2020 included 14,383 firms and 540,370 advisors, of which 275 firms were targets of private equity acquisitions. More specifically, only 173 target firms had an ADV filing for the year prior to the acquisition, and then only 57 firms also had firm- and advisor-level data for a least one post-buyout year, the study said.
When analyzing these four groups (the total advisory firm universe, the targets of acquisitions, targets with one year of pre-buyout data and targets with one year of data both pre-buyout and post-buyout), it became clear that a set of behaviors within advisor misconduct significantly reduced the probabilily of a buyout to begin with. Those were civil, criminal and regulatory misconduct, as well as misconduct-related job terminations. Surprisingly, the one infraction area that did not influence whether a private equity firm was interested in making a deal was the number of customer disputes, according to the study.