“I’m just a soul whose intentions are good
Oh Lord, please don’t let me be misunderstood”
— The Animals, “Don’t let me be misunderstood”
Conflicts of interests and duties
In previous articles we’ve addressed the limitations of disclosure, RG181, s961J and the seemingly inevitable tendency for advice businesses to subordinate their clients’ interests to their own. Conflicts exist in all commercial enterprises but the challenge for businesses providing financial advice is the effective and efficient management of these conflicts.
The question seldom asked is whether these conflicts can ever be effectively and efficiently managed.
Conflicts of 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.
In the interim Report, Commissioner Hayne repeatedly (but subtlely) reframed Conflicts of Interests to Conflicts of Interests and Duties. Essentially, the Commissioner was highlighting the reality that the problem is not the conflict between the interests of the advice provider and the interests of their client but rather the conflict between the adviser’s self-interest and their duty to their client.
We think reframing CoI as an existential crisis for the advice provider will be quite effective in the long term. In the short term, we suspect that advice providers will continue to consider COI as external issues that can be disclosed, rationalised and balanced.
In reality, they are internal challenges whose effective resolution is the heart of professional practice.
The death of disclosure
“In a world of perfectly rational people, disclosure would probably be an effective remedy
for conflicts of interest: Advisees would discount advice, and advisers, knowing that their
conflicts would be disclosed, would attempt to manage or avoid conflicts to increase the
likelihood that their advice is trusted. However, disclosing conflicts of interest can have
surprising unintended consequences, due to several psychological factors that affect both
advisees and advisers. Therefore, disclosure should be implemented carefully; otherwise,
it may fail to adequately protect advisees and could even backfire.”
— Professor Sunita Sah, p12
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.
We’d previously predicted that ASIC and the Courts would progressively move beyond formal disclosure to focus, instead, on the context, circumstances and consequences of the conflict. Those predictions seem accurate following the Royal Commission’s release of Professor Sunita Sah’s research paper on “Conflicts of Interest and Disclosure”.
Download research paper
If you’re an advice professional, or generally interested in the provision of advice, we recommend you read the research paper. Professor Sah’s detailed and dispassionate deconstruction of information asymmetries, biases, moral disengagement and ‘ethical fading’ present a somewhat bleak view of advice and advisers. Unfortunately, her observations are supported by research, observation and the conduct exposed by the Royal Commission.
For financial advisers, moral disengagement may focus on sanctifying harmful activities by social, moral and economic justifications or obscuring personal accountability by diffusion and displacement of responsibility, so that advisers do not hold themselves accountable for the harm that they may cause
Conflicts of Interests are so insidious, Professor Sah asserts, that neither ‘professionalism’, self regulation nor ‘education’ can eliminate their effect.
These results demonstrate that a belief in one’s invulnerability to influence does not protect one from subconscious bias and may actually make matters worse. This stream of research highlights that strategies to eliminate conflicts are critically important rather than relying on intrinsic values of professionalism and impartiality.
Further, the regulatory failsafe of disclosure is manifestly inadequate. Professor Sah observes on page 15 that
not only is disclosure likely to fail as a discounting cue for biased advice, it may even make matters worse. Disclosure can often have the opposite of its intended effect on advisees.
So what are the solutions and how can advisers and licensees better manage these conflicts?
We suggest that you read the paper and then contact us to discuss practical solutions to these insidious problems.
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