“Although only a small fraction of financial advisors ever commit fraud, many of the advisors who do are linked through their career paths. We ask why this pattern occurs — does misconduct spread like a disease?”
That question has been raised by University of Kentucky Gatton College of Business and Economics Assistant Professor of Finance Will Gerken, who is emerging as a national expert on the subject of fraud in the financial advisory industry. His latest research paper, “Is Fraud Contagious? Career Networks and Fraud by Financial Advisors,” is soon to be published in the prestigious Journal of Finance.
“A big challenge for researchers trying to identify contagion is that people often choose to associate with others that have similar characteristics,” Gerken said. “Typically, it’s hard to disentangle contagion from a ‘birds of a feather’ explanation. We looked at mergers of financial firms that exposed some, but not all, employees to new co-workers with a history of misconduct.”
A key finding by Gerken and his co-authors, Steve Dimmock, associate professor at Nanyang Technological University, and 2016 UK doctoral graduate Nathaniel Graham, is that individuals in the financial advisory industry are more likely to engage in misconduct if they work with others that have engaged in misconduct in the past.
“We find stronger contagion effects among co-workers of similar ethnicity, a proxy for the strength of their peer relationships. Importantly, we also still find significant effects across co-workers of different ethnicities,” Gerken said.
Gerken recently presented his findings to the U.S. Securities and Exchange Commission’s (SEC) Division of Economic and Risk Analysis in Washington, D.C.
“The SEC is quite interested in understanding the determinants of misconduct and identifying high-risk advisors,” Gerken said. “Given the significant ongoing regulatory change in this industry, it is important for researchers like us to disseminate our findings to policymakers.”
For the investing public, one complication when looking at the issue of fraud is the vast array of terminology that people offering financial advice use to describe themselves. According to Gerken, “The term ‘financial advisor’ can be used by individuals under a multitude of regulatory standards.”
A simple way for customers to become better informed about their financial advisors is to use FINRA’s (Financial Industry Regulatory Authority) Brokercheck and the SEC’s Investment Advisor Public Disclosure website. These tools enable customers to gain a greater understanding about the background of their advisors, particularly the exams they have passed and any history of misconduct.
While Gerken’s current research specifically focuses on the behavior of financial advisors, there are potential implications for other industries.
“We typically think about peer pressure affecting young people. Previous studies had focused on identifying peer effects among youthful offenders of street crime. Our study documents peer effects among white-collar professionals. Though we focused on financial advisors, I would not be surprised to see similar influence exhibited among other types of professionals such as doctors and lawyers,” Gerken said.
Gerken joined the faculty of Gatton’s Department of Finance and Quantitative Methods in 2012 following three years at Auburn University.
He started out his academic career pursuing a doctoral degree in biomedical engineering, taking some business classes along the way and earning his MBA degree.
“I accepted a position with a major financial services firm. It was an eye-opening experience. A big money, high pressure environment,” Gerken said. “I found it an interesting contrast to my laboratory work.”
It was after that experience that Gerken decided to go after his doctoral degree in finance at Michigan State University, completing that phase of his journey in 2009.
“While it may seem like a big career switch, there are actually many similarities,” he said. “The terminology and methodology may be different. But ultimately, I’m still just trying to get a deeper understanding of how the world works.”
Gerken also brings his research to life in the classes he teaches in the Gatton College.
“My research on financial misconduct is quite relevant to my students. Students are often accustomed to holding an unquestioned belief in the set of facts they are presented,” Gerken said. “I try to get them to consider the source of the data they receive and their motivations. Often the challenge in financial decision making is not the decision itself, but obtaining quality, unbiased numbers. Life doesn’t always provide us with textbook examples.”
Gerken credits the Institute for Fraud Prevention (IFP) with providing support for his research, which continues to gain increasing attention not only in this country, but internationally.
Awards earned by Gerken for his work over the years include: Commonfund Best Paper Award at the European Financial Association Meeting; Networks Financial Institute Best Paper Award for Financial Services Regulatory Reform; Finance Down Under (Melbourne, Australia) Best Paper Award; and Mid-Atlantic Research Conference Best Paper Award.
“Peer effects among co-workers can also be positive. For example, the entire finance department at Gatton has experienced significant recent success,” Gerken said. “When I travel to professional conferences, other researchers recognize the quality work being done here at the University of Kentucky.”