On October 9, the Australian Securities and Investments Commission (ASIC) released a damning review of the insurance advice provided by some financial advisers. The common theme was that the client was worse off, while the adviser pocketed a large benefit by way of an up-front commission.
Financial advice tended to be much better in circumstances where the adviser received a different form of commission (hybrid or level) or fee for service.
What should we conclude? Given the extent of advice that was poor, is it time to stop blaming a small minority of “bad apples”? Do the statistics tell us that there is actually a large segment of financial advisers lacking the moral standards that the rest of the community shares and expects each other to live up to?
Certainly there can be no excuse for some of the egregious examples of poor advice provided in ASIC’s report. However, I argue the answer to these broader questions is “no”. No, because research suggests that advisers act no differently than others would if faced with similar circumstances.
Most people take small liberties
In searching for solutions to the problems uncovered by ASIC, we should recognise that advisers are human too. If we allow incentives that differ from clients’ best interests, we should expect that some advisers who have otherwise good moral standards may be influenced by those incentives.
As humans, we all struggle to live our lives the way we would like to. Whether it is breaching our diet to indulge in the occasional piece of chocolate cake, splurging on a new pair of shoes instead of saving for our retirement, or not living up to the moral standards we set ourselves.
Experiments performed by leading Behavioural Economist, Dan Ariely, found that given the opportunity and incentive, most people tend to stretch moral norms a little. For example, when study participants “self-checked” their marks on a test (for which they paid per correct answer) they scored 36.2. This was 3.6 marks higher than the score achieved by a control group who were not provided the same opportunity to massage their results. It is unlikely that the self-checkers were any smarter!
Importantly, the average wasn’t boosted just by a handful of people who cheated wildly. Everyone tended to boost their scores a little. Unless you are a monk, to think that we are perfect all the time is disingenuous.
However, as financial advisers play an important role in many people’s financial futures, it is right that our tolerance for these indiscretions should be very low. So what can we do to reduce the risk?
Simple measures can be effective
Making people think about a relevant moral standard can help. For example, when Ariely asked participants to think about the 10 Commandments, they completely resisted the urge to artificially enhance their scores. This worked even if they couldn’t remember many of the Commandments!
The structure of incentive payments also matters. Immediate cash payments seem to be sacrosanct, but other forms of remuneration open the door for dishonesty. Not many of us would reach into the petty cash box at work when we are short of loose change, for example. But we tend not to be so self restrictive when it comes to absconding with small amounts of office stationery.
In the experiments where participants were being asked to self-check their tests, even tokens that were almost immediately transferable for cash promoted greater dishonesty than direct cash payments did.
The search for solutions
Up-front commissions provide the greatest incentive and therefore create the greatest risk. Removing these commissions may go a long way toward remedying the problem, although it may not be the only answer.
We could also require advisers to acknowledge that they will act in their client’s best interest immediately prior to providing any advice that may be conflicted by a commission. Ariely’s experiments suggest that even prompting advisers to think about their relevant industry code of ethics at this time may work. Social commitments tend to have a strong influence, so having conflicted advisers explicitly make this commitment to clients may be most effective.
Changing payment arrangements to flow directly from clients may provide another level of protection. This would probably remove the conflict of course. But even if it didn’t, it could still be effective. Like the tokens in the experiment, commissions from a third party leave the door ajar for even a morally vigilant adviser to fall victim to subtle self-serving rationalisations, where direct cash payments from a client may not.