Life Insurance Consumer Advocacy Center

A working paper released in 2021 and soon to be published in the Stanford Law Review, entitled Regulatory Arbitrage and the Persistence of Financial Misconduct, shows that financial advisors who exit the broker-dealer regulatory regime because of misconduct frequently become (or remain licensed as) insurance producers, where they are more than ten times as likely to commit misconduct as insurance producers who exited the broker-dealer regulatory regime without a history of misconduct.

The paper was written by Colleen Honigsberg, Associate Professor of Law at Stanford University, Edwin Hu, research fellow at New York University School of Law, and Robert Jackson, Professor of Law at New York University School of Law and Director of the New York University’s Institute for Corporate Governance.  Professor Jackson is a former commissioner for the Securities and Exchange Commission.   The paper is available at

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3769653

Honigsberg, Hu, and Jackson analyzed data from four different regulatory regimes applicable to financial advisors: broker-dealer regulation by FINRA,   investment advisor regulation under the Investment Advisors Act of 1940, regulation of commodity and futures dealers by the Commodity Futures Trading Commission, and regulation of insurance producers by state insurance departments.  The analysis focused on financial advisors who left the broker-dealer regulatory regime and then migrated (or “wandered,” as the authors and other researchers have put it) to other parts of the financial advice business.

Not surprisingly, the analysis finds that bad advisors tend to migrate to the area with the least stringent oversight  — selling life insurance.  For example, the study finds that among individuals with a history of serious misconduct in the broker-dealer world, the largest number become (or remain licensed as) insurance producers subject to state law insurance regulation; by contrast, among individuals with no history of serious misconduct in the broker-dealer world, the largest number become (or remain licensed as) investment advisors subject to SEC oversight under the Investment Advisors Act of 1940.

Between 2010 and 2020 over 50,000 financial advisors exited the regulatory regime applicable to broker-dealer representatives but then became licensed, or remained licensed as, insurance producers.  Those who had a history of misconduct in the broker-dealer world were more than ten times more likely to engage in further misconduct than those who exited the broker-dealer world without a history of misconduct.

The authors suggest a variety of potential policy changes for regulators to consider, including 1) creation of a single, searchable database of persons who provide financial advice in the United States in order to make it easier for regulators and consumers to identify malfeasant advisors; 2) requiring FINRA to identify wandering advisors for state regulators – and to track whether, and how, regulators respond to those referrals; 3) requiring regulators to review the licenses of already-licensed advisors who choose to exit another financial advisory regime; 4) imposing obligations on insurance companies to deter misconduct by their producers, for example, by disclosing information about their producers in a straightforward manner, by requiring their producers to be insured, and, most significantly, by making insurance companies liable for misconduct by their producers; and 5) creating an arbitration dispute resolution system applicable to insurance producers that is similar to that used by FINRA.

LICAC believes these are all good ideas (although any system of arbitration must be at the option of the consumer and should not prevent consumers from bringing class actions where the wrongful conduct at issue affects more than one person).  These proposed policy approaches should help protect consumers from being victimized, though they are not a complete solution.  Additional protections need to be adopted as well, including requiring insurance agents to act in the best interests of their customers and requiring disclosure of agent commissions, for the reasons set forth in the Our Issues pages of this website.

 

The LICAC Team