Influence and control
In previous articles we’ve addressed the limitations of disclosure and the inherent tendency of industrialised advice businesses to subordinate clients’ interests to their own.
This conflict was formally addressed by 961J – the client priority rule – but the success of legislation to mitigate conflicts first requires the licensee/adviser to recognise that a conflict or potential conflict exists.
Simon Longstaff, Executive Director of the St James Ethics Centre, recently said “Much of what constitutes conflicts of interest is common sense.”
His is a definitive view, but one, if true, should not require ASIC’s continued focus on structural conflicts, and conflicted remuneration. An alternative position might be that some conflicts, whether of interests or duties, either aren’t obvious or simply aren’t recognised as such.
For a recent presentation, Sean Graham, wrote:
Some licensees understand Conflicts of Interest (COI) as poorly as they understand ‘independence’. Institutional Licensees do not have a monopoly on conflicts. In fact, conflicts of interests in privately owned licensees can often be more insidious and more frequently rationalised away.
We understand his point. Conflicts exist in all commercial enterprises and, in businesses providing fiduciary-like services, can manifest in ways apart from group product recommendations and preferential remuneration. Referral arrangements, APL construction and service choices (for example, managed accounts) can, and often are, situations where the interests of the licensee conflict with the clients’ interests. New or small businesses, even those not vertically integrated, can be both more conflicted and less likely to identify those conflicts.
Identifying and appropriately managing conflicts of interest is not simple, but we’ve identified three international resources that might help you identify and then manage conflicts:
The FCA Handbook (Chapter 10) that links conflicts to damage to a client or their interests. If your arrangements, choices or actions benefit you, but possibly disadvantage a client, a conflict of interest exists that needs to managed, disclosed or avoided.
The circumstances which should be treated as giving rise to a conflict of interest cover cases where there is a conflict between the interests of the firm or certain persons connected to the firm or the firm’s group and the duty the firm owes to a client; or between the differing interests of two or more of its clients, to whom the firm owes in each case a duty. It is not enough that the firm may gain a benefit if there is not also a possible disadvantage to a client, or that one client to whom the firm owes a duty may make a gain or avoid a loss without there being a concomitant possible loss to another such client.
The FCA’s definition is provided to help you recognise real or potential conflicts. It’s not ASIC’s definition in RG181 “Licensing: Managing Conflicts of Interest” but it’s a useful working premise for compliance managers. For clarity, ASIC note
conflicts of interest are circumstances where some or all of the interests of people (clients) to whom a licensee (or its representative) provides financial services are inconsistent with, or diverge from, some or all of the interests of the licensee or its representatives. This includes actual, apparent and potential conflicts of interest.
It’s not always easy to manage conflicts or to know what to do about them.
Disclosure is a popular way of managing conflicts of interest, but one that seldom benefits the people to whom the conflicts are disclosed. Read Cain, Lowenstein and Moore – “The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest”
They found that disclosure can 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. (If you’re sceptical of this effect read “Influence: The psychology of influence” by Robert B Cialdini, PHD).
In addition, we recommend “The Burden of Disclosure: Increased Compliance With Distrusted Advice”. In this research, Sah, Lowenstein and Cain found that
Although disclosure can decrease advisees’ trust in the advice, it can also increase pressure to comply with that advice if advisees feel obliged to satisfy their advisors’ personal interests. Hence, disclosure can burden those it is ostensibly intended to protect
In our view, ASIC and the Courts will progressively move beyond formal disclosure to focus, instead, on the context, circumstances and consequences of the conflict. Accordingly, advice leaders need to find, and implement, better solutions to inevitable conflicts.