“Dealing with complexity is an inefficient and unnecessary waste of time, attention and mental energy. There is never any justification for things being complex when they could be simple.”
— Edward de Bono
It should come as no surprise to anyone that we believe Ms Levy’s focus on the form and format of the advice document, misrepresents the real problem; it’s not the advice document that’s the problem, but regulator’s unreasonable reliance on disclosure as either a means of presenting risk or of securing “free, informed and prior consent”.
To be clear, mandated disclosure is not an effective consumer protection mechanism.
Advice professionals have legal and ethical obligations to craft recommendations based on their considered assessment of their clients’ relevant personal circumstances (their financial goals, risk preferences, and needs) and equip their clients to make informed decisions about those recommendations. Traditionally, and somewhat naively, advisers follow an exhaustive disclosure process that both demonstrates their competency and secures their clients’ free, informed and prior consent.
Unfortunately, disclosure doesn’t necessarily satisfy either goal. Nor does it address the root cause of the issues at the heart of most claims about inappropriate advice. Disclosure neither improves clarity nor minimises biases, it simply shifts responsibility for making complex decisions from trained and experienced professionals to consumers who often lack background knowledge and expertise to even interpret the disclosures made. Perversely, there is considerable research demonstrating that not only does mandated disclosure not guarantee that advisers act in the best interest of their clients, but it can conceal the real impact of an adviser’s failure to do so. In reality, despite these mandated disclosures, they still often make decisions that lead to negative outcomes.
Even if we accept that disclosure benefits consumers who actively seek out and understand the information provided to them, it still leaves a greater proportion of consumers in the dark and provides advisers with unjustified confidence in their clients’ “informed consent”. In fact, the reasonableness of this presumption is undermined by consumers’ limited financial literacy and numeracy skills and the sheer volume of information provided in disclosures. Practically, these elements not only prevent consumers from fully comprehending the implications of the investment decisions they make but often overwhelmed or mislead them.
The real challenge for advice professionals is to provide recommendations that are clear, concise, and comprehensible without underestimating the complexity of the content or the obvious information asymmetries.
Complexity and engagement
“Simplicity is hard to build, easy to use, and hard to charge for. Complexity is easy to build, hard to use, and easy to charge for.”
— Chris Sacca,
An asymmetrical information relationship exists where one party has more, or better, information than the other. In the context of an advice relationship, most retail clients will have far less specific and relevant knowledge than the person from whom they seek advice. For example, advisers may have access to information that clients do not, such as industry insights or technical knowledge, and this creates or exacerbates the power imbalance between them and their client. In fact, this asymmetrical relationship (including the client’s vulnerability to, and reliance on, the advice) creates the need for the obligations and duties outlined in the Code and the Standards. Professional advisers recognise the limitations of disclosure and try to actively mitigate this imbalance in various ways; most start by prioritising the information actually needed to make informed decisions, by fostering open communication with clients, providing education on industry terms and concepts and engaging third-party experts when necessary.
Disclosure is a passive and ineffective path to understanding. In our experience, the best way for advisers to reconcile complexity with their clients’ financial literacy, numeracy, and experience is commit to collaborative education; the mutual exchange of knowledge and understanding, intended to empower clients and provide them with the insight and understanding they need to make informed financial decisions. This process is not always intentional. In fact, many advisers seem to unconsciously, and patiently, explain complex concepts in simple language – including risks, consequences and implications – to equip their clients with the knowledge and confidence they need to make positive financial decisions. This approach is both more likely to secure the best possible outcome for clients but also build the trust necessary to sustain long-term engagement.
Another strategy for achieving this is through education and empowerment, by allowing the client to actively participate in the decision making process.
In fact, there are numerous benefits to moving beyond compliance and a slavish devotion to formal disclosure. First, advisers are better able to build trust with their clients, resulting in long-term relationships that are beneficial to both parties. Second, clients benefit from improved financial literacy and increased confidence in making financial decisions. Finally, the industry as a whole benefits from positive reviews and referrals, highlighting the importance of providing high quality advice to clients. By prioritising understanding over disclosure, advisers can ensure that the industry continues to grow and prosper.
Moving beyond disclosure
Every client, and every client situation, is unique so it’s problematic to prescribe universal cures. However, there are enough commonalities to suggest general treatments. Given that a client’s level of numeracy and financial literacy are key obstacles to their understanding, a prudent adviser should simplify complex financial concepts and assumptions to ensure their clients can make informed decisions.
In fact, this is critical because it is only by tailoring advice to their clients’ individual needs and understanding, that an adviser can be reasonably confident that their clients can comprehend the implications and consequences of their choices. Unsurprisingly, while this expectation is enshrined in the Code and the Standards, it’s too frequently overlooked in the templated advice documents. The review data also suggests that the parameters of “free, informed, and prior consent”, while intuitively understood, are seldom effectively operationalised.
Although applicable to financial services, it’s not a concept specific to financial services. It wasn’t developed in response to misconduct or specific failures but was, instead, appears to have been appropriated from human rights law and, specifically, the United Nations Declaration on the Rights of Indigenous People. In that context, indigineous peoples’ provision of free, prior and informed consent is the essential pre-requisite for any project that may affect them or their territories.
It’s eminently transferrable and clearly applicable to the advice relationship; building on the fiduciary-like duties and imposing an obligation on the dominant party to actively secure a clients’ informed consent. It assumes, and reflects, a client’s right to:
- receive clear and accurate information about the advice being given to them, and
- understand and assess it before making a decision.
Take a moment to consider how this compendious obligation extends beyond securing a client’s signature on the Authority to Proceed or Application.
Free, informed and prior
Consent will not be free if it’s not given voluntarily or is secured on the basis of misrepresentation, misconduct, manipulation, omission, coercion or intimidation. So, if a reasonable person would consider that a client’s consent was obtained as a result of high pressure sales techniques, compressed timeframes (same day sales) or external impositions (such as expectations or reciprocity), it would likely not satisfy this element. Consent obtained when, or after, a transaction occurs (or consent obtained insufficiently in advance) would not likely be considered to be prior. Likewise, if information relevant to the recommendation was withheld, delayed, omitted or misrepresented, the clients consent cannot be informed. Furthermore, consent requires an active and considered decision; a reflexive response to recommendations, passivity or a failure to “opt out” would, in all probability, undermine the reasonableness of their engagement and understanding.
None of these elements can be satisfied by disclosure alone.
Instead, the enforceable Code requires an adviser to take (more than) reasonable steps to ensure that their client is aware of the relevant risks, benefits, and options and that the information is not only presented in a manner that the client is likely to understand but is, in fact, understood. This requires and adviser to consider, inter alia, their client’s specific needs and circumstances including their:
- level of financial literacy
- understanding of conflicts;
- reading/comprehension level;
It would be dishonest to suggest that every adviser considers, and addresses, all these factors in their advice. It is seldom formally addressed, but our data suggests that professional advisers have become significantly more attuned to these elements. Further, the intuitive approach many took has, since the commencement of the Code, become more considered and consistent. It may be a consequence of the decline of institutional advice/integrated distribution models, but advisers now seem more inclined to take time to clearly explain risks, benefits, and alternatives to their clients.
The real benefit
While disclosure is an important aspect of informed consent, it is not enough to protect those consumers who lack financial literacy, numeracy, and relevant experience. The law and ethics require advisers to take an active role in providing clear and comprehensible advice that actually takes into account their clients’ individual needs and capacities. Instead of relying on templated text and isolated client signatures, the better advisers have adopted new strategies that combine comprehensive and personalised financial planning, with financial education, and ongoing support. Beyond the obvious benefits this approach provides to the adviser, embracing transparency and education helps their clients make better informed decisions and commit to, and maintain, strategies that are more likely to lead to positive financial outcomes.
Providing personalised advice, and securing a client’s informed consent, is the foundation of every consistently profitable advice business. It may require more effort to do so but the benefits of providing clear and concise advice tailored to a client’s level of financial literacy, numeracy and experience, far outweigh the immediate inconvenience. The complexity of financial products, coupled with clients’ varying levels of financial literacy and experience mean that disclosure is neither an adequate nor sufficient mechanism for consumer protection. Thankfully, advisers are driving the industry forward and embracing transparency and ethics in advance of a tired regulatory regime mired in disclosure and a backward looking perspective of advice.