A US-based academic has advised Commissioner Kenneth Hayne to promote better “organisational norms” and remove incentives to combat conflicts of interest, instead of relying on disclosure or other measures.

Professor Sunita Sah of Cornell University, who specialises in behavioural economics and decision research, argues that conflict disclosure is only really beneficial if the adviser has no conflicts; if their advice is conflicted, disclosure can make things worse.

Written at the request of Hayne and published by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Sah’s paper addresses the question of whether forcing advisers to disclose conflicts of interest would influence their behaviour and affect the quality of advice given.

“Disclosure can have a positive effect if advisers are encouraged to take advantage of the opportunity to disclose the absence of any conflicts,” she states. “Disclosing the absence of any conflicts has been shown to (justifiably) increase trust in advisers.”

The opposite may happen, however, if the adviser is giving conflicted advice; Sah notes existing research shows that “advisers may give more biased advice with disclosure than without”.

Disclosure also has a critical flaw on the client side: when conflicts are revealed, clients have no idea how to adjust their thinking.

“Disclosure’s great promise is that it arms clients with the knowledge they need to adjust their interpretation of the advice given to them, perhaps by discounting advice or obtaining a second opinion,” Sah writes. For this to work, however, clients would have to be able to calculate exactly how much bias is present in the advice, something the professor says is “difficult, if not impossible to do”.

Plans B, C and D

The option of educating people about biases is also “ineffective”, she writes, citing disgraced former oil company Enron’s 64-page code of ethics booklet as an example of how inadequate training can often be. Sanctions don’t work either, she says. The appropriate penalties for advisers using biased recommendations are not only difficult to judge, but can encourage advisers to “view decisions in terms of cost-benefit analysis, rather than an ethical issue”.

The industry needs structural changes that prevent conflicted advice, she states, instead of ones that just mitigate the damage it causes.

“Realigning incentives for advisers to eliminate or reduce conflicts of interest will thus have a much larger effect than disclosure in encouraging higher-quality unbiased advice in the marketplace,” Sah explains.

Along with incentives, “organisational norms” – or corporate culture – also play a big role in affecting adviser bias, especially in larger institutions, Sah states. Rather than relying on ethical rules and procedures, to which people often don’t adhere, firms should look to a combination of extrinsic sources of motivation, such as monitoring, and intrinsic sources such as “integrity, objectivity and professionalism”, she writes.

Not just the bad apples

Sah’s report, published on the website of the royal commission at the start of November, states that many people have the wrong “mental model” of conflicts of interest. It’s not about corruption, she argues.

“In reality, many conflicts of interest that influence advisers occur on a subconscious or unintentional level,” she writes.

Advisers are prone to subjective interpretation of facts, fallible memories and other errors, Sah explains.

“Thus, even advisers who are ethically engaged can give biased advice,” her report states.

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