As private-equity firms continue to invest heavily in registered investment advisory firms, a new study from the University of Oregon suggests that there is a disadvantage to this flow of capital.
The study estimates that private-equity ownership increases the percentage of misconduct of the acquired firm’s financial advisors by 147%.
Prior to private-equity purchases, the malpractice rates of the RIAs examined in the study were below average — about 40% of the average industry rate. After the purchase, their misdemeanor rates were in line with the rest of the industry.
,[W]While high PE chooses advisory firms with low malpractice as buyout targets, there has been a sharp increase in advisory misconduct, which has been measured at both the advisory and firm levels following the PE acquisition.
the study, published on December 30 at SSRN, was led by University of Oregon researchers Albert Sheen, Yuchang Wu and Yuwen Yuan. The study used individual financial advisor data from the SEC Investment Advisory Public Disclosure (IAPD) website, investment advisory firm data from the SEC, and information on private equity-backed deals from the PitchBook database.
The researchers focused on five types of incidents reported on the IAPD: civil, criminal, regulatory, customer disputes, and termination. They found that regulatory misconduct and customer disputes increased post-purchase RIA misconduct.
The study cites an increase in malpractice to post-purchase purchases with RIAs. Growth is higher among RIAs that experience higher post-purchase growth in assets under management. Additionally, an increase in post-purchase malpractices was observed only in firms whose clients included retail customers. In firms serving only institutional clients, post-purchase malpractices have actually declined.
The study concludes, “Overall, our results suggest that PE firms tend to target advisory firms with relatively clean records of misconduct and conduct their advisory business more aggressively after acquisition.” “As such, they suggest a tension between the profit motive and ethical business practices of financial advisory firms, especially when clients are financially unsophisticated.”
The researchers wrote that post-purchase malpractice may increase because the firm’s existing advisors commit more misconduct or because the composition of their advisory workforce changes. However, they found that an 89% increase in the likelihood of misconduct and a 50% increase in the number of incidents of misconduct at the consultant level were due to “behavior changes” from consultants who had worked at a firm before and after it. to buy
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