Those who think CRM2’s disclosure requirements will lead clients to make more rational choices could be in for a nasty surprise.

Enhanced disclosure could cause clients to make irrational choices, says Sunita Sah, assistant professor of strategy, economics, ethics and public policy at Georgetown University in Washington, D.C.

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“Virtually all policies intended to mitigate the negative effects of conflicts of interest…include, or are limited to, disclosure. It’s become almost a gold standard,” she said during a Capital Markets Institute event at the University of Toronto’s Rotman School of Management.

The idea is that disclosing useful information—such as trailers paid to advisors—decreases the information gap between advisor and client. But research shows some clients don’t know how to react to this information, Sah says. They either ignore it or remain confused about how it should colour their perceptions of the advice they get.

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She ran a series of experiments showing that some clients who were told their advisors had conflicts of interest still felt pressure to follow the advisor’s recommendations – even though they also reported that they trusted the advisor less.

“Although disclosure [of a conflict] is intended to communicate the idea that, ‘I personally gain if you do X rather than Y,’ instead the consumer could interpret the [advisor] as suggesting, ‘Please do X because it will benefit me.’ So, disclosure becomes tantamount to a favour request.

“The implicit request pressures the consumer to comply with the advice, much in the same way we relent to requests from charity. So instead of being a warning, disclosure can actually increase the pressure to comply with the advisor’s recommendation.”

Clients are caught in a bind: On the one hand, when they hear about conflicts, they lose faith in their advisors; on the other, they feel more pressure to comply. “Whatever effect is stronger determines whether [clients] take that advice or not,” Sah says.

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Her experiment’s numbers are startling. About half the time, clients followed biased, poor advice when conflicts weren’t disclosed; but they followed that same advice 81% of the time when the conflict was disclosed.

Clients who received disclosure “reported they were significantly less pleased with their decisions, they had less trust in the advisor, and they liked the advisor less. And these things should indicate that they should reject the advice; but at the same time, they felt pressure to help the advisor, and they felt much more uncomfortable [turning] down the advice with disclosure than without.”

She notes other studies have shown that when a third party makes the disclosure, rather than the advisor, it decreases the pressure clients feel to follow the advice. That means clients are more likely to reject it. Having a cooling-off period between when the client gets the advice and when she decides what to do also means she’s more likely to reject biased advice.

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Disclosure can also have unintended consequences for advisors.

“Research shows advisors tend to give even more biased advice with disclosure than without. And this is because they either feel less guilty about giving biased advice – they’ve disclosed their conflict of interest, so buyer beware – or they…recommend even more [strongly] the advice they’ve given to counteract the effect of the disclosure [of a conflict].”

Sah has replicated these results through her experiments. She also found advisors “felt less responsible with disclosure than without, and felt it was more appropriate to give self-interested advice.”

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