Conflicts of interest play a “substantial role” in influencing the behaviour and attitudes of advisers when dealing with customers, often with the advisers unaware of the influence, according to Professor Sunita Sah of Cornell University, who was tasked by the Hayne royal commission to research the impact of conflicts of interest and disclosures on the conduct of financial advisers.
In a research paper submitted to the royal commission, the professor cited research that examined the difference in conduct between conflicted and unconflicted advisers, much of which concluded that “advisers subject to such conflicts give significantly more biased advice, to the detriment of their advisees”.
Dr Sah’s own experiment, the findings of which were published in 2013, found that 93 per cent of advisers recommended the superior product when they were under the impression that they would receive a bonus regardless of which product they recommend. But the figure dropped to 18 per cent when they were informed that they would only receive a bonus if they recommended the inferior product.
Another study found that primary advisers who were aware that their clients could be seeking a second opinion adopted a “profit-maximising frame”, subsequently providing “even more biased advice”.
Dr Sah noted the issue of “moral disengagement” where people “[sanctify] harmful activities by social, moral and economic justifications or [obscure] personal accountability by diffusion and displacement of responsibility”. This could result in “unethical business practices being perpetuated if those who engage in questionable practices are rewarded and seen to rise in the organisation”.
The professor also claimed that a number of psychological factors and misbeliefs about the nature of conflicts of interest have contributed to advisers “routinely denying being influenced by financial and non-financial inducements despite data demonstrating the opposite”.
People are often unaware of their biases, use self-serving rationalisations to explain them, and see the existence of biases in others more than themselves, according to Dr Sah.
“They sincerely believe they are remaining objective and impartial when asked about a possibility of influence,” the professor stated in her submission to the royal commission.
“Many people have the wrong mental model of conflicts of interest and believe that succumbing to such conflicts is a matter of corruption: deliberate favouring of self-interest over professionalism.
“In reality, many conflicts of interest that influence advisers occur on a subconscious and unintentional level.”
Once advisers are conflicted, she claimed that data demonstrates that “it is near impossible to give a truly fair and balanced view”.
Disclosure could lead to “even more biased advice”
While disclosing conflicts of interest could encourage advisers to improve the quality of their advice, it could also “fail to adequately protect advisees” or “backfire” if disclosures are not implemented carefully, according to the professor.
Previous research has shown that such disclosures could lead to people thinking it is “less morally reprehensible to give biased advice intentionally”, and that advisers could even increase the bias in their advice to “counteract anticipated discounting of their advice by their audience”.
One potential way to improve the effectiveness of disclosures in deterring inappropriate conduct, according to the professor, is by providing advisers the ability to choose to avoid conflicts and to “take advantage of the opportunity to disclose the absence of any conflicts”.
“In my research, I show that mandatory and voluntary conflict of interest disclosure can deter advisers from accepting conflicts of interest so that they have nothing to disclose except the absence of conflicts,” Dr Sah said.
“An elegant feature of this type of disclosure is its self-calibrating quality. Advisers who wish to appear unbiased and ethical will opt to reject conflicts of interest, thus protecting even naïve consumers as the market for unconflicted advisers increases.”
She also noted the role that “norms” play, referring to research that shows that disclosures are more effective in sectors wherein placing the customer’s interest first is deemed the norm.
Sanctions for providing biased advice not necessarily effective
While chair of the Australian Competition and Consumer Commission Rod Sims previously suggested that raising fines is key to deterring poor conduct, Dr Sah is less convinced of the effectiveness of sanctions in reducing bias, especially if it’s not clear to the adviser that their advice is biased.
The other downside of introducing fines is that it could encourage businesses or employees to view decisions “in terms of a cost-benefit analysis rather than an ethical issue”.
“Sometimes, the size of such penalties may not be large enough to prevent self-interested behaviour, and institutions may accept such fines as the ‘cost of doing business’,” the professor stated in her submission, reiterating that bias is often subconscious and unintended and that rationalisations can make it difficult to prove the existence of bias.
The submission supported the removal of incentives that create conflicts of interest, and suggested that separating “advising” and “deal-making” within financial institutions could reduce conflicts of interest.
The professor’s submission is in line with the Governance Institute’s claim that “conduct is the manifestation of culture” and that an “ethical framework should sit at the heart of a company’s governance structure to serve as a common and authoritative point of reference for all decision makers and give shape to culture”.
Similar to the Governance Institute’s belief that company boards have a role to play in “setting the ‘tone from the top’”, and the Finance Sector Union’s view that one of the prerequisites to improving bank culture is “buy-in” from management, Dr Sah suggested that “institutional signals are particularly powerful and include the behaviour of leaders, other employees, and the formal (codes, sanctions, surveillance) and informal (ethical culture, climate, communication) infrastructure”.
Noting the power of ethical organisational culture, Dr Sah said that when professionals are regularly reminded of ethical norms — such as that putting customer’s interest first is the right thing to do — it could be an effective deterrent even in the presence of weak laws or limited bias awareness.
“Any proposed policy action to manage conflicts of interest should ideally undergo further testing in the field in which it will be implemented to assess the likely real-world impact,” the professor said.
Tas Bindi is the features editor on the mortgage titles and writes about the mortgage industry, macroeconomics, fintech, financial regulation, and market trends.
Prior to joining Momentum Media, Tas wrote for business and technology titles such as ZDNet, TechRepublic, Startup Daily, and Dynamic Business.