Does disclosure to retail clients really work? Three regulators, three behavioural research professionals and a lawyer told a conference in October that yes, disclosure works – but not all the time, not as well as it should and not with all ages.“Disclosure is a necessary condition, but it’s not a sufficient condition,” Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC), told the conference put on by FAIR Canada and the Rotman Capital Markets Institute.

Russell agreed that disclosure will help investors take the first step in understanding the products they buy and compensation paid to advisors, pointing to the introduction of the CRM2 model. But he also noted that increased proficiency standards, industry best practices and enhanced suitability requirements will help advisors develop a better dialogue with investors.

One of the best ways to ensure that disclosure is working is to test the information that is being delivered to clients, said Mary Condon, a professor at Osgoode Hall Law School at York University in Toronto.

Natural experiment

Condon called CRM2 “a great natural experiment” to see whether investors actually make different decisions because they have received more disclosure about costs and advisor commissions.

But disclosure doesn’t always have its desired effects, said Sunita Sah, an assistant professor of business ethics at Georgetown University in Washington, D.C. Sah said research she has conducted has actually shown that investors feel pressured into following their advisor’s advice – even when advisors clearly disclose that they have conflicts of interest.

“They don’t want to signal to the advisor that they don’t trust them,” Sah told the conference. “All these studies show that there are a lot of consequences of disclosure that we are learning about right now and that are not intended. We find out more about how disclosure is working when we actually implement some things and follow up on the effects to both the advisors and the advisees.”

Susan Wolburgh Jenah, who spoke just days before her official retirement as president and CEO of the Investment Industry Regulatory Organization of Canada (IIROC), said companies are required by law to release a raft of information every year to clients.

But that doesn’t mean, she said, that they understand what’s in it. The dense language amid many pages of required regulatory pages goes to show that while there is disclosure it’s not effective.

“Classical economics assumes that all consumers will make rational decisions based on the best available information,” said Wolburgh Jenna. “What behavioural economics teaches us is that this isn’t always – or even usually – true. It adds human nature and psychology into the equation in order to better understand how behavioural biases affect us.”

This kind of awareness is the basis behind successful teaching tools and financial literacy since it is the goal of these subjects to help people make informed and rational financial decisions, she said.

Wolburgh Jenna suggested that plain-language information, delivered at “teachable moments” will best help investors gain financial literacy. She gave the point-of-sale Fund Facts as one example, saying they are short, well-designed and help investors compare different products.

Research has shown that many clients want just enough information to make a decision and be comfortable with that decision – and that’s all they want, said Ed Weinstein of the research and consulting firm The Brondesbury Group.

After that, said Weinstein, people only want to know how much they will receive for their investment and whether it’s safe.

“In research when we’ve told them about conflicts of interest and told them about fees, most people will not understand them, they will not see the conflict or they will not believe it applies to them. They simply don’t want to be troubled – they want to be comfortable,” he said.

Older investors tend to trust advisors, viewing them as experts. Younger people tend to go to websites to check out the answers to their questions before meeting with an advisor, looking for a “kernel of truth” they can believe in – and then see if the advisor substantiates it.

Graphics help investors understand what they’re buying, and so does keeping language to a grade 6-8 level, said Weinstein. “One of the complaints we often heard in interviewing people was: the problem with people in financial services is they want us to learn their language and talk about it in their way. What we really want is for somebody to explain it to us in our language so we actually know what they’re talking about.”

In addition, said Weinstein, many people overestimate their knowledge. The information they receive has only to “sound good” and they’ll believe they understand it.

Need for guidance

Russell said investors need guidance. There has been a lot of effort poured into financial literacy, but it hasn’t worked very effectively to date, he said. One place where financial literacy can get a leg up is through the CRM2 model, which will also give advisors and clients the opportunity to build better relationships.

The industry must also watch out for unintended consequences of increasing regulations. “We have to be careful as we move forward: if we eliminate things like trailer fees…it takes away a source of revenue and it means advice becomes even more expensive or non-existent. We are seeing that develop in my own industry.”

The results of CRM2 or any other initiative need to be measured against pre-disclosure surveys to determine whether there are shifts in both behaviour and the kinds of products investors choose, said Weinstein.

And he said, patience is required. “Nothing happens overnight behaviourally.”