Misconduct Synergies from Mergers

By: Emmanuel Yimfor & Heather Tookes (CLS Blue Sky Blog)

Like many sectors in the U.S. economy, the registered investment advisory (RIA) industry has seen a recent increase in consolidation through mergers and acquisitions (M&A). The RIA industry has also experienced widespread and well-documented misconduct among employees.  For example, Egan, Matvos and Seru (2019) report that 7 percent of financial advisors have misconduct records.  Beyond the traditional cost and revenue synergies, what is the potential impact of M&A transactions on employee behavior? Mergers can increase value if they improve monitoring and disciplinary mechanisms that reduce employee wrongdoing at the combined firm.

In a new paper, we use the RIA industry as a laboratory to test for evidence of “misconduct synergies” (i.e., reductions in disclosures of employee misconduct) following M&A transactions. Consistent with misconduct synergies, we find that disclosures of new disciplinary events in the combined firm drops by between 25 and 34 percent following mergers. This reduction is driven mainly by ”separations” – employees leaving companies voluntarily or involuntarily – of target firm employees with past incidents of misconduct. Layoffs following mergers are a well-documented source of cost savings in M&A (e.g., Bhagat et al. (1990); Haleblian et al. (2009); Lee et al. (2018)); however, the question of whether the “right” employees leave is an open and important question on which our research sheds light.

While the hypothesis that M&A disciplines rank-and-file employees is plausible, it is also difficult to test because employment records and instances of fraud and misconduct are generally unavailable for individual employees.  Reporting requirements in the investment advisory industry make it a particularly useful setting because we are able to observe disciplinary and regulatory events at the firm level through the SEC’s Form ADV.  We also observe registered advisers’ individual employment and disciplinary histories through data made available to the public via FINRA’s BrokerCheck system.  We use the term “All Employee Disclosures” to describe any disclosure across the 23 categories of disciplinary events in the FINRA BrokerCheck data.  These include customer disputes, regulatory investigations and actions, certain criminal and civil proceedings, and bankruptcy filings. It is important to emphasize that not all of these disclosures are evidence of employee wrongdoing.  To account for this, we separately analyze the six categories of disclosures that Egan, Matvos and Seru (2019) consider to be most indicative of employee misconduct. We use “employee misconduct (EMS)” to describe this subset of less ambiguous disclosures, and we conduct all of our analyses using both disclosure measures…

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