In today’s overhyped world, we often seem way more interested in “doing something” than actually solving—or even addressing—the problem in question. Sadly, it seems to me that in our haste to act we often do more harm than good. I suspect this is, at least in part, because many of us who want to make things better avoid considering that there may be peoplewho don’t—and want to get paid handsomely for not doing so.
A good example of this is our current mania over “disclosure” to financial consumers. Professor Michael Finke of Texas Tech University wrote an important piece on the subject of disclosure in the April issue of AdvisorOne sister publication Research that should be required reading for anyone interested in financial regulation. In it, he convincingly argues that financial disclosure, as it’s currently practiced, not only often fails to help financial consumers but can serve to decrease the quality of the products and advice they receive. He then gives examples of how disclosures can be used to actually help people.
Many of us are well aware of the first disclosure challenge that Prof. Finke talks about: Knowledge Limits. Many people simply do not possess the background knowledge of financial services to understand and apply much of the “information” that is currently disclosed to them. “For disclosure to work, he wrote, “those who get the information need to know what to do with it…And more information makes the problem worse.”
Then Finke gets to the heart of the matter, citing a 2011 study by Sunita Sah of Duke and Carnegie Mellon Universities that found that disclosure can actually be counterproductive to helping consumers in at least two ways. First, Sah found “that advisors were more likely to give self-serving advice if they first disclosed a conflict of interest to their client. The advisor now feels less pressure to make a recommendation that isn’t self-serving.”
To make matters worse, after an advisor disclosed a conflict, “the client now feels that if they don’t accept the recommendation they are admitting they don’t trust the advisor—something that is taboo in human interactions,” he wrote. The bottom line is that Sah “found that recommendations given by participants in the role of advisor were significantly worse for the consumer if they had to disclose conflicts of interest.”
Finke isn’t totally against disclosure. In fact, he cites a number of examples in which disclosures have made consumer markets dramatically more effective. The key is simplicity. “The most effective financial disclosure laws have given consumers a little bit of very important information that is easy to use…Many financial markets such as 30-year fixed rate mortgages, savings accounts, and property insurance are much more competitive because it is easy for consumers to compare one number for products that have similar characteristics.” He also cites the “consistent interest rate in banking products—the APR” and gasoline prices: “That’s why gas stations go out of business if they charge $4 for a gallon of gas that costs $3 down the street,” he wrote.
Of course, even the simplest disclosures are still dependent on the widespread knowledge of acceptable ranges. Remember in the 1990s, when Wall Street jumped into retail asset management with “wrap accounts,” some of which charged trusting investors up to 400 bps? It wasn’t until the financial media finally got the word out that those fees fell into a more reasonable range (if still on the high end). While AUM fees still range from, say, 0.5% to 2% or so, it’s fair to say the market is far more efficient than it used to be. At the same time, blanket disclosure of mountains of financial information clearly doesn’t have the consequences intended. I’ve often thought that our solutions to problems should be accompanied by something like the doctors’ Hippocratic oath: First, do no harm. This would be especially helpful when it comes to financial disclosures.
Read Professor Michael Finke’s article on disclosure in the April 2013 issue of Research.