The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Commission) has commissioned a research paper by Professor Sunita Sah, from Cornell University in New York, on the impact of conflicts of interest and their disclosure on the behaviour of financial advisers.

Importantly, the Research paper appears to be the only piece of research commissioned by the Commission to date that provides advice on future policy measures to be considered by the Commission, rather than mere background on the Australian financial services sector.

The paper draws conclusions about the role of bias in financial advice that, if accepted by the Commission, appear to favour structural (including cultural) changes as a means of addressing conflicts of interest.

We have set out each of the questions posed to Professor Sah by the Commission, and her corresponding findings, in detail below. 

Subconscious and unintentional nature of biases – Observing that advisers routinely deny being influenced by financial and non-financial inducements despite data demonstrating the opposite, Professor Sah concludes that many conflicts of interest influence advisers on a subconscious and unintentional level. Professor Sah attributes this, in part, to a gradual process of moral disengagement whereby the advisers minimise, distort, or even deny the harm that flows from their activities on both an individual and collective level. Relevantly, Professor Sah draws on a range of studies to show that education and training does not reduce subconscious bias, and instead only succeeds in making individuals more aware of biases in others (but not themselves).

Self-serving and subconscious rationalisations – Professor Sah relies on a study of physicians to demonstrate the capacity of humans to accept self-serving rationalisations. In the relevant study, reminding physicians of their medical training burdens and working conditions more than doubled their willingness to accept conflicts of interest. For similar reasons, Professor Sah suggests, it is easy for financial advisers to persuade themselves that the products that they receive commissions for really are the best and the clients they recommend investments for really will benefit from those investments. 

Sense of invulnerability to biasing effects – Professor Sah examines the testimony of American CEOs before the US Securities and Exchange Commission in 2000, noting that a ‘sense of professionalism’ — while regularly relied upon in CEO testimony to counter claims of improper influence — does not reduce subconscious bias and can in fact exacerbate matters by creating a false sense of individual and/or institutional invulnerability. The studies cited by Professor Sah show that those who believe they are invulnerable are more likely to accept conflicted remuneration. 

Two safeguards for encouraging impartiality – Two safeguards for encouraging impartiality: In assessing potential safeguards that can encourage impartiality, Professor Sah presents two strategies:

• avoiding the conflict entirely
• self-regulation after accepting a conflict of interest. 

In a possible indication of the Commission’s future direction on this question, Professor Sah concludes that avoiding the conflict entirely is more effective than self-regulation strategies.

While Professor Sah acknowledges that the disclosure of conflicts in expert domains (i.e. financial and medical advice) appear to reduce bias in advice, she also observes that in sales-based professions (i.e. real estate) advisers may give even more biased advice with disclosure than without.

Importantly, Professor Sah also observes that disclosure has been shown to increase trust in advisers in circumstances where the adviser is conflict-free. Because of this, companies that remain conflict-free may have a competitive advantage over those that do not if they disclose the absence of any conflicts. 

Professor Sah evaluates the psychological impacts of conflict of interest disclosure on consumers, noting that due to the following reasons even the clearest and boldest disclosure may fail to protect consumers:

• ‘insinuation anxiety’ – whereby consumers distrust the advice but still feel pressured to take it for fear of signalling that distrust to the adviser
• the ‘panhandler effect’ – a tendency for consumers to feel pressured to satisfy their adviser’s personal interests
•  ‘disclosure’s expertise cue’ – a tendency for consumers to interpret an adviser’s disclosure of bias as an indication of their professional expertise, rather than a warning.

However, Professor Sah adds that disclosure can be made more effective if:

• consumers are allowed to make their decisions in private
• consumers have a chance to change their mind via a mandatory ‘cooling off period’ and
• disclosures are given by an external third party (prior to receiving advice) rather than by the advisers themselves, with consumers also being encouraged to deliberate on the disclosures.
  

Professor Sah considers, and then appears to dismiss, each of the following mechanisms for addressing conflicts of interest:

• education and training – which increases awareness of bias in general, but generally fails to reduce subconscious basis
• sanctions – which only works to reduce bias when it is clear to advisers that their advice is biased and
• second opinions – which can be counter-productive by encouraging primary advisers to adopt a profit-maximising frame and give even more biased advice.

Significantly, Professor Sah’s paper appears to favour structural changes (through organisational norms and incentives) as a means of addressing conflicts of interest.

In relation to organisational norms, Professor Sah notes that:

• an ethical organisational culture can serve as a powerful defence against conflicts of interest
• changing norms within institutions requires a shift in prescriptive (what we should do) and descriptive (what others actually do) signals and
• vocal authority figures are particularly important and that even conflicting authority commands (one ethical and one unethical) have been shown to reduce unethical behaviour within an organisation.
  

On the question of incentives, Professor Sah observes that:

• realigning incentives for advisers to eliminate or reduce conflicts of interest
• restricting interactions between product sellers and financial advisers and
• separating advising from deal-making/selling both within organisations and wider networks

will have a much larger effect than disclosure in encouraging higher quality unbiased advice in the marketplace.

The Commission’s Final Report is due to be submitted to the Governor-General by 1 February 2019.

For those with questions on Professor Sah’s paper, or the Royal Commission more generally, please do not hesitate to contact a member of our team.

Further information on the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, including a full copy of Professor Sah's paper is available from 
https://financialservices.royalcommission.gov.au and below:

• Conflicts of Interest and Disclosure (PDF 458KB)
  Professor Sunita Sah
  Cornell University
  November 2018