Financial-advisor misconduct often has devastating consequences, leading lawmakers to seek tightened investor protections at the federal level. But many advisors can choose whether to be regulated under the federal regime or instead be overseen by state insurance regulators, giving advisors with a history of misconduct reason to select the laxer state-level regulatory environment. Despite extensive debate over the regulation of financial advice, no prior work has examined those incentives.

Using a novel dataset, this Article identifies thousands of financial advisors who have committed serious misconduct and exited the federal regulatory regime—yet continue to advise investors, often using state insurance licenses. Because lobbying has blurred the line between financial advice and insurance sales, current law lets wayward advisors continue to provide similar services under state insurance regulators’ light touch. We show that advisors who do this are disproportionately likely to harm investors in the future. And they are overwhelmingly male: Women who have committed serious misconduct are more likely to exit financial services entirely.

Our analysis identifies a limit of federal lawmaking in this area. Federal regulators necessarily rely on state regulators, who may become beholden to the interests of the insurance industry itself rather than the public. We show that more than one in ten state legislators who oversee insurance regulation are now, or were previously, in the business of selling insurance. We argue that existing tools for federal regulation of advisor misconduct risk the unintended consequence of pushing the worst advisors into poorly regulated state regimes.

Note: An updated version of this Article was posted on August 30, 2022.

* Colleen Honigsberg is an Associate Professor of Law, Stanford Law School. Edwin Hu is a Research Fellow, New York University School of Law Institute for Corporate Governance and Finance. Robert J. Jackson, Jr., is the Pierrepont Family Professor of Law, New York University School of Law, and Co-director of the New York University School of Law Institute for Corporate Governance and Finance.

We thank Abbye J. Atkinson, Robert Bartlett, Brian Brosnahan, Jacob Goldin, Henry T. Greely, Joseph A. Grundfest, Matthew Kozora, Michelle M. Mello, Manisha Padi, Frank Partnoy, Sarath Sanga, Daniel Schwarcz, Jonathan S. Sokobin, and Steven Davidoff Solomon for their insightful comments. We also thank participants at the Berkeley Business Law Workshop, NYU Law & Economics Workshop, Oxford Business Law Workshop, Texas A&M Faculty Workshop, Tulane Corporate and Securities Law Roundtable, Stanford Law School Faculty Workshop, and University of Frankfurt LawFin Seminar. We are grateful to Rolando Hernandez Gomez, Niki Patel, and Charlotte LeBarron for excellent research assistance, and to the Stanford Institute for Economic Policy Research and the Arnold Foundation for financial support.