The Limitations of disclosure
The industrialization of advice has provided some significant advantages – more predictability, accessibility and affordability – but these have come at a cost.
Although the inherent tendency of industrialised advice to subordinate clients’ interests to the commercial interests of the licensees is now addressed by legislation, the process’ over-reliance on disclosure not only hampers the development of an advice profession but, paradoxically and perversely, works counter to clients’ interests.
Let’s unpack this a little before we get to the ‘disclosure issue’.
Industrialisation is perhaps the inevitable destination for any maturing, profitable and popular economic activity. It often occurs in parallel with professionalization but they’re separate trends. It’s more than simply the development of a methodical and replicable process, but tends to involve the emergence and eventual dominance of large consolidated entities that offer improved, scalable production methods, improved efficiency and increased consistency. Alternatives to industrialised production exist, and continue to emerge, but the fundamental nature of the industry prevails over time.
While there’s some debate over precise percentages, research consistently shows that the five big players dominate the financial planning industry and authorize or control 80% of the financial advisers operating in Australia. In addition, reports have also highlighted that the majority of product recommendations made by these advisers involve Group product. At the risk of trivializing the agency of these aligned advisers, the reality is that these large corporate players define the scope within which their advisers operate. It is the Institutional Licensees that create the measures, processes and procedures with which their agents must comply and it is they that determine the precise arrangements under which these advisers operate.
[If you're particularly interested in this aspect please read the 2018 update "It's the elephant again".]
For reasons of pragmatism, philosophy and convenience, disclosure is broadly acceptable to most stakeholders; it protects and empowers the retail client, provides businesses with an alternative to heavy-handed regulation and facilitates informed participation in the market.
Why bother with disclosure?
One adviser recently confided that he could put the vilest obscenities in the disclosure section of his Statement of Advice without any real likelihood that a client would complain. In his view, clients lose interest when they’re presented with the SoA and never read or process or appreciate the disclosures made in the document. In his view, the current disclosure regime reduces financial advice to compliance with a bureaucratic checklist and concentrates too much on the abstract to the detriment of the individual who needs personalized advice. He’s not alone in this view.
If the purpose of disclosure is to ensure that clients make informed and considered decisions about the recommendations presented to them then disclosure is an inelegant and inadequate solution. In their recent survey of retirement planning advice (REP279), ASIC identified that 86% of participants felt that they had received ‘good’ advice despite ASIC only assessing 3% of advice as good. This highlights one of the key problems with reliance on disclosure as a consumer protection measure; its success depends not only on the quality, adequacy, specificity and timing of the disclosure made by the adviser but also on the capability of the client to understand the consequences and implications of the matters disclosed.
This is the real reason why calling out “restricted” advisers will be ineffective; if the purpose is consumer protection then why not, as an alternative, simply require those advisers to clearly explain to potential clients that the adviser is more likely to recommend group products. Matthew Rowe, Chair of the Financial Planning Association, emphasizes that “the FPA believes strongly in transparency and truth in labeling” the Association opposes relabeling as a ‘band aid’ solution to managing the inherent conflicts of interest from vertical integration.
Disclosure will only be effective if the recipient of the disclosures can properly understand the real consequences and implications of the matters disclosed.
Disclosure and understanding
When relatively unsophisticated clients are presented with complex recommendations layered with sequential disclosures is it reasonable to expect informed consent? If disclosure does not guarantee understanding then is it reasonable to presume informed consent and allocate responsibility accordingly? More importantly, is this ‘buyer beware’ philosophy compatible with a profession that aspires to act in the best interests of their clients or be a trusted adviser to retail consumers?
Non-aligned adviser, Justin Brand, believes that disclosure is too often a crutch for bad advisers or a way to hide bad advice. “It’s not enough to simply disclose something and assume that’s enough. We need to make sure our client’s understand what it really means. There’s so much disclosure in an SoA that how can a client understand which matters are important, which matters are critical and which issues are largely irrelevant to the substance of the advice. If we’re serious about ensuring that clients understand our advice, we need to ensure that the disclosures we make are relevant, specific and clear. And the most important and relevant disclosures should also be made verbally.”
On a practical level, disclosure regulation and the over-reliance on formal and mechanical disclosure as a protection mechanism for both clients and advisers has led to the profusion of bloated, repetitive and incomprehensible Statements of Advice. The promise of a “clear, concise and effective” SoA promised by FSR has never eventuated. Instead, both consumers and advisers struggle with advice dense documents written by lawyers, scrutinized by risk managers and finessed by compliance; documents in which both the client and the adviser are abstractions and extras in a disclosure drama wherein information frustrates understanding.
What the research tells us
In "More Than You Wanted to Know," the authors’ analysis of mandated disclosure found little evidence that disclosure leads people to make better decisions. Consumers often don’t read the material provided to them, seldom understand the consequences and implications of the matters disclosed and, instead of being reassured, consumers experience greater anxiety – afraid of having missed problems buried in the documents provided to them. And mandated disclosure benefits those parties that chose to do so.
Instead of proving a panacea for a variety of misconduct problems, mandated disclosure is at best annoying and irrelevant but, in reality, pointless regulation that distracts policy makers from identifying effective solutions to recurring problems. After all, disclosing inherent conflicts is not as beneficial as eliminating them.
Liability has driven this approach. Licensees, and directors of Licensees, have traditionally taken a position of extreme prudence. If everything is disclosed, then nothing is omitted and the consequences of any action must rest on the fully informed consumer. It’s great in theory but it assumes that expansive disclosure drives understanding rather than frustrating it.
Even ASIC now acknowledge that disclosure has clear limits - it doesn’t necessarily promote understanding or address information asymmetries – so why is there an over-reliance on disclosure? In simple terms, and particularly for conflicts of interest, disclosure may be the “least worst” option that the Regulator can achieve. The industry grudgingly complies because as Cain, Lowenstein and Moore acknowledge, it “generally involves minimal disruption of the status quo.”
For many advisers its preferable to disclose conflicts, fees and commissions rather than forgo them. So disclosure becomes a convenience for the adviser and one often prioritized above the client’s interest or the quality of the advice. Quite apart from promoting form over substance, the emphasis on disclosure provides another significant benefit to advisers and licensees; “it diminishes [their] responsibility for adverse outcomes.”
The practical affect of a disclosure-led regime
It’s ironic, but now generally accepted, that increasing the length and detail of the disclosures and warnings in the Statement of Advice (SoA) has actually reduced clients’ capacity to understand and properly appreciate those statements. There’s been another unanticipated consequence of this “belts and braces” approach; advisers have generally approached these important elements by focussing on the form of the disclosure (and their Licensee’s checklist of required disclosures) rather than on the purpose of the disclosure – which is to assist their client to make an informed decision about the advice provided to them.
As a consequence, critical disclosures and warnings are often overlooked, marginalised or underemphasised. Unfortunately, neither Licensees, advisers or clients have had any real appreciation of the consequences and implications of this approach.
Couper (Commonwealth Financial Planning Limited v Couper  NSWCA 444) may change this dynamic because despite the structured advice template provided by the adviser, he failed to warn his client that commencing a new risk policy affords the new Insurer an opportunity to avoid the contract in the event of a claim. The right is not absolute, but, in this case, neither the adviser nor the client was aware of this risk.
Advice should be “clear, concise and effective”. While efficacy will vary, advisers should be able to ensure that their advice is both clear and concise – but doing so will require them to first recognize the limitations of disclosure; mechanistic disclosure may satisfy disclosure regulations but frustrates understanding and undermines any assertion of informed consent.
The client experience
Anthony Stedman, Principal with Advice Evolution, believes that this focus on formal disclosure has not only frustrated client understanding, but stripped humanity from the advice process. “The obsession with disclosure hasn’t improved client understanding; its just buried clear advice under pages of largely irrelevant material and made it harder for advisers and clients to focus on what really matters – why the advice will help them and what implementing it will mean for them.”
However, in a final criticism of the template nature of advice documents the Court acknowledged the “real tension between the exhortations in the Statement of Advice acknowledging the need for the client to “take full ownership” of his financial decisions, to take his time to read and understand and “feel completely comfortable” with the advice, and what actually happened.
The solution is not simply to make disclosure easier to understand. Some decisions, particularly those involving complex financial products and strategies, defy simplification and, in some cases, may simply be beyond most consumers. It is dangerously naïve to assume that disclosure alone will educate consumers and equip them to make truly informed decisions. It’s more realistic to recognise that disclosure can work counter to consumer and adviser interests beyond the bureaucracy and paperwork they encourage. Mandated disclosure not only creates additional anxiety for consumers but provides them with false reassurance that their interests are being pursued; in reality, and particularly for conflicts of interest, disclosure allows the discloser to avoid resolving the substance of the inherent conflict in favour of formally identifying the potential problem.
The limitations of disclosure
Disclosure has a more significant and perverse effect; it often leads consumers to downplay the significance of the matters disclosed particularly if presented in a laundry list of mandated disclosures. Although consumers might generally distrust financial advisers, consumers tend to trust and believe their own advisers. When advisers make concessions against their own interests, or disclose relevant conflicts, research suggests that this increases trust rather than promoting more critical consideration of the matters disclosed. If you doubt this tendency, consider the conflicts experiment run by Cain, Lowenstein and Moore. Estimators were asked to identify how many coins were in a bell jar and an adviser was present to assist them. The estimator’s reward increased depending on how accurate their estimate was; the adviser’s reward increased depending on how inaccurate the estimator’s assessment was and this conflict was clearly disclosed at the start of the experiment. The result was that “estimators earned less money when conflicts of interest were disclosed than when they were not, and advisors made more money with disclosure than without disclosure.”
This experiment suggests that disclosure benefits the providers of the information more than the recipients but there are other equally perverse effects. Disclosure can also lead to problems of “moral licensing” where the act of disclosure frees the adviser from the obligation to comply with the norms of their profession. Simply put, by disclosing conflicts of interest, for example, the adviser becomes less concerned about the partiality of their advice. In a perverse and paradoxical fashion, disclosure seems to shift the advice relationship from one of trust and reliance and asymmetric knowledge to one of equals where the client is fully responsible for the choices they make about the adviser’s recommendations. This “caveat emptor” philosophy of client responsibility sits poorly with a professional duty to one’s client, but over reliance on disclosure can have this effect. In fact, disclosure regulation can actively undermine advisers’ professionalism by encouraging them to “exhibit .. concern in a merely perfunctory way” by disclosing rather than addressing the problematic issues.
Disclosure regulation has, to some degree, shifted advisers’ focus from advice to disclosure and document production. There are clear limitations of disclosure but the problem is not disclosure per se but a failure of advisers and licensees to focus on relevance, specificity and client understanding. Given the limitations of disclosure is the only solution an even more paternalistic regulatory response such as structural reform of the industry or imposing broad restrictions on complex products and strategies? More disclosure, clearer disclosure, structural reform, regulation of terms and product restrictions are all logical responses to recognizing the limitations of disclosure but perhaps it’s time for advisers, committed to their best interest duty and broad professional duties, to eschew their reliance on mandated disclosure in favour of avoiding conflicts, embracing objectivity and prioritizing clients’ interests.