Perhaps most dispiriting of all is that misconduct is even more common in counties filled with wealthy, elderly people. For example, the study found that of the “5,278 advisers in Palm Beach, Florida, 18.11% have engaged in misconduct.”
These numbers become even more astounding once you understand the standards of conduct for brokers. Finra, the industry-financed self-regulating authority, only requires that brokers adhere to a so-called suitability standard -- meaning that they make recommendations that are supposed to be in the best interests of the customer. It also happens to mean that it's fine to recommend the products that are most rewarding for the broker. The tougher, better benchmark is the fiduciary standard, which requires someone to put the client's interests ahead of their own. That makes me imagine what would happen if the fiduciary standard were applied to all brokers, as it will be later this year for those brokers dealing with retirements accounts. If that were the case, I think the rate of bad behavior would be shown to be even higher than it is in this report.
How is it possible that despite all of this readily available public information about bad broker behavior, investors continue to get abused? Two possible answers are that the information is much less easily accessible than we imagined, and that the marketplace for financial advice is terribly inefficient.
This isn't a minor concern. Bad brokers cost investors billions of dollars a year, and much of the losses are never recovered because of the financial industry's private justice system. (For more on this see this and this.)
Just how much investor money is lost due to broker misconduct is, sadly, unknown. But we do have some idea of how much ethically dubious but legal behavior -- such as conflicts of interest -- costs investors: about $17 billion each year, according to a recent White House report.
One of the central rules of economics is that incentives matter. One way we can improve the behavior of brokers and others is to alter the incentives by simplifying the rules they must follow, and by raising the standards of conduct. The fiduciary standard accomplishes both and should be the guiding criterion for the industry.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.