Regulatory Arbitrage and the Persistence of Financial Misconduct

Financial advisor misconduct often has devastating consequences, leading lawmakers to seek tightened investor protections at the federal level. But many advisors can choose whether to be federally regulated or instead overseen by state insurance regulators, giving advisors with a history of misconduct incentives to select the more lax, state-level regulatory environment. Despite significant debate over the regulation of financial advice, no prior work has examined those incentives.Using a novel dataset, this Article identifies thousands of financial advisors who have committed serious misconduct and exited the primary federal regulatory regime—yet continue to advise investors, often using state insurance licenses. Advisors who exit are disproportionately likely to harm investors in the future. And advisors who do this are overwhelmingly male: women with a history of serious misconduct are more likely to exit financial services entirely. Our analysis identifies a limit of federal lawmaking in this area: federal regulators rely on state regulators, who may be captured by the insurance industry. We show that more than one in ten state legislators who oversee insurance regulation are now, or were previously, in the business of selling insurance. We argue that existing tools for federal regulation of advisor misconduct risk the unintended consequence of pushing the worst advisors into poorly regulated state regimes. with tools to address this phenomenon