Requiring financial advisors to disclose potential conflicts of interest has actually resulted in worse advice being given to investors. That was the insight delivered by McCombs School of Business professor Robert Prentice and other experts at a gathering of lawyers, regulators, advocates, academics and industry leaders recently.
Prentice joined other business and law professors, including Daylian Cain, a professor of organizational behavior at the Yale School of Management, speaking at the Fiduciary Forum 2010 in Washington, D.C., addressing the question of how to apply fiduciary standards to investment brokers-dealers. The U.S. Securities and Exchange Commission is currently looking at how to write regulations that would protect investors in relationships with investment advisors. According to the experts who have studied the issue, disclosure actually puts investors at more risk.
From a conference recap by Elizabeth MacBride at RIA Biz:
- Most investors don’t read written disclosures, Prentice said, pointing out that about 40 million Americans are illiterate and 50 million more have marginal skills. Even those that are among the most educated don’t read the reams of fine print that accompany financial products. “I sign contracts all the time that I don’t read,” said Prentice, who also pointed out that the Truth in Lending laws that require extensive disclosures did not protect consumers whose mortgage borrowing helped bring on the financial crisis.
- Oral disclosures are more effective than written ones, Prentice said.
- People have a strong bias to be more positive than is realistic. They have a “personal positivity bias.” This bias causes them to ignore disclosures and conflicts of interest. People tend to be over-confident and to believe that contracts are better than they are, Prentice said. “A majority of people think they are better than average. The only people who are really well-calibrated are the chronically depressed.”
- Cain did one study that looked at four advisors, with two that were honest and two that had a conflict of interest. They were offering advice on lotteries that were structured advantageously or not for investors and advisors. Cain found that advisors with conflicts give worse advice. He said this can happen even while advisors sincerely believed they were giving good advice. “You believe your own side,” Cain said.
- The advisors that disclosed the conflict gave even worse advice, steering investors toward an investment that benefited the advisor more, Cain said.