Private Equity and Financial Adviser Misconduct

Abstract

Does ownership by private equity firms encourage or deter financial misconduct? We examine this issue by analyzing the records of individual financial advisers around buyouts of investment advisory firms by private equity. Our estimates suggest that private equity ownership leads to an increase of 147% in the percentage of the acquired firm's financial advisers committing misconduct. While the misconduct rate of the acquired firms is only about 40% of the industry average before the buyout, it becomes on par with the industry average after the buyout. Within-adviser variation accounts for 89% of the increase in the adviser's misconduct probability. The increase in misconduct is stronger in firms with higher post-buyout growth in assets under management per adviser and is concentrated in firms whose clients include retail customers. Our results suggest a tension between advisory firms' profit motive and ethical business practices, especially when customers are financially unsophisticated.

Keywords: Financial adviser, financial misconduct, private equity, asset management, fraud, ethics

JEL Classification: G11, G20, G23