Rogue Brokers and the Limits of Agency Law

Abstract

Rogue brokers and their counterparts among registered investment advisers—overall a relatively small but persistent cohort among securities-market professionals—defraud their clients, execute unauthorized transactions, or otherwise betray the trust clients necessarily repose in them. Many rogues are recidivists: fired by one firm, they move to another and often engage in new misconduct. Firms that appear to welcome rogues may enhance the risks of harm imposed on clients as well the adverse reputational consequences that follow for the industry and its regulators. This paper, written as a chapter for a forthcoming book, introduces the vocabulary and structures of common law agency as a framework to examine structural features that underlie the challenges posed by individual rogues. This framework is also helps to situate the distinct role of securities-market regulation. The paper incorporates the results and implications of other scholars’ recent quantitative inquiries into securities-market rogues as well as other cohorts daunted by recidivists, in particular law-enforcement officers and insurance producers. A securities-market rogue links two distinct types of agent-principal relationships: (1) between an individual representative and the firm with which the professional is associated; and (2) between the firm, its representative, and the clients or customers with whom the representative interacts on the firm’s behalf. Both types of relationships are characterized by asymmetries that work to the disadvantage of investors, especially so for unsophisticated retail investors. This is because an individual rogue and the firm represented by the rogue have access to material information unavailable to the investor, in particular textured information about the rogue’s history and present propensities as well as the firm’s own practices. Separately, a firm’s powers of control over its representatives exceed an investor’s powers of control as a principal in an agency relationship once the investor engages the broker or adviser. Although agency-law doctrine accounts for both asymmetries, its responses operate only retrospectively once a client suspects problems with an account. In contrast, regulation can facilitate several distinct strategies for proactive intervention; it also can expand liability to encompass personnel charged with supervisory responsibilities. Within this framework, the paper examines recent proposals from FINRA to address persistent concerns with individual rogues and broker-dealer firms that employ them.