Private equity funds invest heavily in independent financial advisory firms, putting billions of dollars into the fastest growing wealth management industry. Along the way, the investments create war treasures for advisers to buy from competitors and inject Wall Street-style business and management practices into a fragmented industry.

But private equity also brings something else to the darling of the financial planning industry, according to a recent academic article. Advisors from registered independent consulting firms, or AIR, to professional investors are more likely to make mistakes with clients.

The document entitled “Private Equity and Financial Adviser Misconduct” was published last week by researchers at the University of Oregon. He revealed that in RIAs owned either majority or minority by a private equity fund, misconduct rates increase when those advisory firms have a higher growth rate of assets under management per advisor.

“While PE tends to choose consulting firms with less misconduct as buyout targets, there is a sharp increase in advisor misconduct measured at both the advisor and company level after the takeover. of PE, ”wrote the article’s authors Albert Sheen, assistant professor, Youchang Wu, associate professor, and Yuwen Yuan, graduate student, all at the university’s Lundquist College of Business. “Our results suggest a tension between the profit motive of consulting firms and ethical business practices, especially when clients are not financially savvy.” Clients refer to the retail investment clients of a company.

The article, which has yet to be published in a peer-reviewed journal, adds a new layer of scrutiny to the perennial problem of dishonest brokers plaguing the financial planning industry. A revised 2018 to study found that 7% of advisers of all stripes had a history of misconduct, with the share exceeding 15% at some of the largest consulting firms.

For at least two decades, RIAs have been associated with a higher standard of care for their clients, who pay fees instead of commissions on products their advisors are financially incentivized to sell. Consultants of independent firms are held to the fiduciary standard, which requires that the best interests of the client always come first and that conflicts are not only disclosed but also avoided. In contrast, advisers who work in brokerage houses, also known as brokers, fall under a lower standard known as best interest regulation, in which they are only required to recommend products. and services deemed “suitable” for a client. Advisors who work in independent firms that also offer brokerage services may be held to either standard, depending on the products and services they sell through their “hybrid” AIRs. The Oregon study covers both types of counselors.

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Advisors to independent firms are on average 40% “cleaner” in terms of misconduct before selling to a private equity fund, the researchers said. But after a sale, these advisors become “on par with the industry average.”

Last year, the RIA job their eighth consecutive record year of mergers and acquisitions, with the biggest deals made by giant companies with private lenders. So, when these EP-backed behemoths buy another RIA, the seller essentially goes into the arms of that private equity fund. The strategy has given private equity funds indirect stakes in hundreds of RIAs, according to Mercer Capital, a valuation and financial advisory firm in Memphis, Tennessee.

The Oregon paper examined data for the period 2000-2020 from the SEC, which regulates RIAs, and BrokerCheck from the Financial Industry Regulatory Authority, or FINRA, which regulates brokers, as well as data on merger and d PE-backed acquisition of research firm Pitchbook. The researchers analyzed the data through the lens of five types of disclosed misconduct events that were resolved: civil proceedings, criminal proceedings, regulatory events, customer disputes, and termination. In total, 57 AIRs, each with an average of 250 advisers, met the study’s criteria, meaning it covers around 14,250 advisers, said Wu, one of the authors.

Private equity funds typically support large “consolidator” RIAs which, in turn, attract smaller competitors. These large companies are generally “hybrid” companies. The 25 largest brokers with advisers control 68% of all retail client assets, according to Cerulli Associates’ U.S. Broker and Dealer Market Report for 2021. The Oregon paper cited internal research from DeVoe & Co., a consulting and valuation firm for wealth managers, as showing that while private equity funds participated in only 5% of all RIA transactions during 2013-2019, they accounted for 26% of all transactions measured by client assets.

The study found that misconduct increased in companies in which a private equity fund took a stake without completely buying out senior executives and partners. Embezzlement, he said, is “concentrated” in transactions involving takeovers of companies by non-managers, “in which acquirers are probably less familiar with the advisory business than in the case of direction “.

The paper postulates that private equity can be bad for a RIA.

“Our results indicate that PE chooses companies that are cleaner in terms of misconduct as their takeover targets. After the takeover of PE, however, companies make more mistakes. These results suggest implications for the value of misconduct. The document concluded that “PE firms choose targets with ‘an untapped lack of misconduct and exploit this opportunity for profit, perhaps to the detriment of customers.’

Private equity funds focus on investing in promising companies and then returning them five to seven years later for a profit. The industry has gained a reputation for taking money from solid companies. Anne Marie Stonich, co-founder and CEO of Paracle Advisors in Seattle, called him “Financial engineering” that elevates dollars above customers and culture. But some senior RIA officials argue the picture is wrong.

In a webinar on December 16, David Barton, the leader of mergers and acquisitions and former CEO of Mercer Advisors, a $ 36.5 billion RIA in Denver majority-owned by New York-based private equity firms Oak Hill Partners and Genstar Capital, said, “There is this misconception that private equity is that puppeteer pulling the strings of management. It isn’t.” He added that “we are the ones who manage the clients. We are the ones who run the business. We lead the decision-making process.