The real effects of the PCAOB's new auditing standards on financial advisor misconduct

Financial advisors play a crucial role as gatekeepers to the financial markets for the investing public. However, when financial advisors engage in misconduct, their actions can cause significant financial harm to their clients. Despite expectations that labor market discipline and reputation effects would drive advisors with misconduct records out of the industry, prior research has shown that many such advisors persistently find employment at different broker-dealer firms. This study investigates whether the new auditing standards for broker-dealer audits issued by the Public Company Accounting Oversight Board (PCAOB) in 2014 are associated with a reduction in financial advisor misconduct. Our findings indicate that the new auditing standards are indeed associated with such a decrease. Moreover, this association is stronger for smaller broker-dealer firms and specialist auditors. We also find that the new auditing standards promote greater auditor independence, result in higher turnover for advisors with past misconduct, and diminish the influence of reputation matching between auditors and broker-dealer clients who tolerate misconduct. Together, these results suggest that the PCAOB's new auditing standards have a positive impact in deterring financial advisor misconduct within the broker-dealer industry.