Why a Conflicted Adviser Doesn’t Help You by Disclosing His Conflict of Interest

Who knew such a thing existed?

“Let us ever remember that our interest is in concord, not in conflict; and that our real eminence rests in the victories of peace, not those of war.”
–William McKinley

For those of you who are married, you probably, at some point, had that talk where you confessed all of the skeletons in your closet to your presumed soon-to-be spouse. After all, you didn’t want that crazy ex-boyfriend to show up on reality television one day screaming “I still love you, [WHATEVER YOUR NAME IS]!” and catch your spouse completely off guard about the three dates you went on with Mr. Whacknuts. It’s no wonder that you dropped him like a bad habit. He thought that your name was [WHATEVER YOUR NAME IS] when it’s clearly not. Wise move!

After you had that discussion and full length tour of the closet full of skeletons, you probably felt both quite relieved and closer to the person with whom you had the discussion. That’s because, as Yale’s Daylian Cain and others revealed in their research, whenever you come clean, you build trust with the person to whom you’re disclosing your dirt. Not only does the disclosure create a closer bond between discloser and person to whom the disclosure is made, but it also gives the discloser a feeling of moral latitude to stretch the truth a little bit in the future.

Of course, all of you are full of integrity and would never let your Monkey Brains convince you to stretch the truth, so we won’t need to discuss that part, will we?

So, when an “investment advisor” from a strip mall franchise “advisory firm” discloses to you that when he’s selling you a front-loaded mutual fund that he’s going to pocket a significant sum of the commissions from the sale, that’s supposed to make you run for the hills and seek someone who will give you unbiased advice, right?

Unfortunately, the answer is no.

By requiring disclosure, drafters of the statutes that make planners disclose conflicts of interest in their Form ADV (the marketing document that all financial planners and investment advisers are required to submit to regulators and provide to potential customers) thought that it would have two benefits. First, it would make recipients of the disclosure more educated and, thus, where necessary, change their minds about taking conflicted advice. Secondly, they reasoned, it would cause the people who would be giving conflicted advice to act in a way which removed the conflict in the first place.

It turns out, according to Cain et al’s research, that neither happens.

How does a disclosure of a conflict of interest affect the discloser?

Unsurprisingly, financial advisors who have a conflict of interest have Monkey Brains just like the rest of us. Monkey Brain is inherently lazy. He doesn’t want to do any more work than necessary. In the case of the financial advisors who have a conflict of interest, their Monkey Brains tell them that, rather than doing the hard work of actually coming up with a means of making money that doesn’t involve giving conflicted advice, they can simply “come clean” about the conflicts and all is well.

It doesn’t stop there. Somewhere in his trunk full of toys, Monkey Brain has a scale of justice. Because they actually admitted to the conflicts of interest, the Monkey Brains of these advisors see the scales as unfairly tipped against them. As a result, they engage in activity called “moral licensing.” As Stanford’s Anna Merritt and others explain, moral licensing happens when we reduce the feelings of guilt that we have about doing something which we know is wrong because we’ve done something else which we know is right. In this case, the advisors, because they’re able to tip the scales on one side with the disclosure of conflicts of interest, feel the moral leeway to exaggerate their claims about the applicability of their advice. Furthermore, they don’t feel like they’re misleading or being unethical because of the ethicality and morality of the disclosure; they’re merely balancing the scales of justice and, in their minds, leveling the playing field.

I daresay, this is probably how certain well-known radio personal finance gurus feel the justification for telling their listeners that they need to go see “investment advisers” in a network who have paid the gurus a fee for such recommendations and who recommend front-loaded mutual funds to the listeners.

How does a disclosure of a conflict of interest affect the person receiving the disclosure?

There are two main effects of disclosure of the recipients of such disclosure, and, unfortunately, neither of them are good.

First, we fall for the fallacy that giving biased advice could happen to anyone else, but would never happen to our advisor. We place our advisors in a position of trust, and because we put them on a pedestal, no matter how short or high, we give them a higher level of credibility than we would give any random person off of the street. Thus, we rationalize that while other conflicted “investment advisors” may be profit-mongering and raiding the pocketbooks of poor, unsuspecting souls, ours would never do such a thing because he’s…so…trustworthy! Additionally, due to a relative of the anchoring bias called “the curse of knowledge”, it is very difficult for us to change our minds about what we believe is true, even if we’re given incontrovertible evidence that what we’d previously believed was false. Go ask that fellow Galileo about how the anchoring bias works in the face of heliocentric evidence.

Secondly, because we want to believe our advisors so much, even when presented with evidence that the advice might not be in our best interests, we still fail to discredit the advice enough. Therefore, when hearing the advice that is clearly conflicted and probably not in our best interests, we go through the Monkey Brain equivalent of saying “maybe we ought not do this…nah!” The anchoring effect is so strong in us that even being shown that we might be walking down the road to perdition is not enough to dissuade us from the path.

Ugh. This conflict of interest stuff stinks. What should we do?

Up until you read this article, it might have been easy enough to brush off a conflict of interest. After all, with such a blue sky policy, how could our “investment advisors” lead us astray?

The best advice I can give is to find someone who has no conflicts of interest. As the previously cited Yale research shows, even when the person disclosing the conflicts has the best moral intentions, there’s a tendency to shift the balance in the other direction in a way that is self-serving and doesn’t serve you, the customer.

Not all conflicts of interest are inherently bad. When I had my knee operated on, all of the orthopedic surgeons in the office I went to owned a share of the outpatient hospital where they all did surgery. Was there a minor issue with the potential conflict? Yes. He could have sent me there instead of another hospital even though the other hospital could have had even newer, shinier equipment because he’d get a little bit bigger slice of my insurance money. However, the medical practice is highly regulated, so there was a minimum standard of healthcare that I could expect, and it was a very routine practice that my doctor had done, literally, thousands of times.

The financial planning and investment advice industry, while regulated, does not regulate that all advice givers live up to a fiduciary duty, meaning that they can provide you with advice whose sole purpose is to line their pockets while living under the guise of helping you out.

So, when it comes to receiving financial planning and investment advice, the prudent course is to go with someone who has no conflicts of interest. If you use someone who has a disclosed conflict of interest, Monkey Brain will try to throw out the anchor to drag you down and keep you with whomever you’ve been using previously because of your psychological biases. He’ll come up with reasons why you shouldn’t leave. Don’t listen to him. Go with someone who has no conflicts of interest. That way, you don’t run any risks of getting advice that is not in your best interest.

If you’re curious, here’s what my Form ADV has to say about my lack of conflict of interest:

Because we do not have the pressure or incentive to sell or recommend products, we have no conflicts of interests.

Published by

Jason Hull was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business. He held a CFP certification from 2015 - 2021. You can read more about him in the About Page. If you live in Johnson County, Texas or the surrounding areas, he and his wife are cash buyers of Johnson County, Texas houses.

6 thoughts on “Why a Conflicted Adviser Doesn’t Help You by Disclosing His Conflict of Interest

  1. It’s a pretty interesting conundrum. I do think that consumers should know what they’re getting into, but you don’t want to fall into the trap of encouraging the behavior you’re actually trying to discourage. Maybe if we require disclosure in a non-personal way, such as making it part of the company’s logo? Kind of a ridiculous example, but if the information comes from from somewhere other than the advisor, maybe it would be more effective.

    I do have to disagree with the concept that there are advisors without any conflicts of interest. I’m all for fee-only advisors and think that’s the best route for most people, but there are conflicts of interest in every business model. With the AUM model, you want to manage as much money as possible. With the flat-fee model, you want to provide services as quickly as possible. With an hourly model, you want to charge more hours. Obviously each individual will respond to these potential conflicts in their own way, some better than others, but they definitely exist.

    1. Matt–Yeah, I don’t know the way out of the conflict trap. Maybe a logo would work. Paging Daylian Cain…

      Using your example could increase the analogy writ large to the entire for-profit world. You want to pay as little as possible for a widget/service/experience/whatever. A capitalist wants to extract as much money as possible out of you (e.g., the term rent extraction). There’s an inherent conflict right there.

      For financial planning, the key to minimizing the conflicts is fiduciary duty. The commissioned advisor legally can’t sell you that front-loaded mutual fund because it’s going to underperform its no-load counterparts. The AUM advisor can’t overtrade try to to get you outsized returns because in a significant portion of the time, he’ll wind up earning less for you (which has been proven to be the case in studies). The hourly financial advisor has to be quick and efficient because billing the client unnecessarily is not in the client’s best interest. The flat fee provider has to provide more (which may wind up being fluff); otherwise, the client is paying for services not rendered.

      I think the best approach is to think of a relative. How would you want a relative to engage in financial planning? I would only want the relative to get what he/she needs when he needs it at a price that reflects fair value for services rendered, without additional, unnecessary crap thrown in. Then it’s a matter of asking questions of a potential financial advisor to suss that out.

      Thanks for sharing my article, too!

      1. Don’t get me wrong, I completely agree that advisors with a fiduciary duty are in a much better position to offer objective advice than a commissioned salesman. I’m all for the fee-only, fiduciary route and couldn’t imagine trusting a different type of advisor with my money. I just think it’s inaccurate to characterize those advisors as having no conflicts of interest. While I understand the point and I think it’s a good one, that kind of wording is, to me, unnecessarily inaccurate. I think that fee-only planners would come across a little better if they painted themselves simply as the better option, not as the saintly option.

  2. Interesting. I had heard this just last week in passing (that a disclosure builds trust) and I wanted to know where that came from. Thanks for the link to the research.

    I think you’re right that a fiduciary is the only way to avoid problems. Even in an AUM model, an advisor could be tempted to suggest investing in accounts under his or her management instead of putting the money elsewhere (like an investment property, paying off debt, etc). But if the advisor is a true fiduciary, they really have to advise whatever is in your best interests, even if that means taking money out of accounts that they manage.

    1. Hi Pat – thanks for commenting!

      You bring up an excellent point about alternate investments that I didn’t cover and should have. An AUM advisor has no interest in telling you to invest in rental properties or in entrepreneurship. What if you’re exceptionally handy, could and would put in the sweat equity, and have the skills to increase the value of an investment property? An AUM advisor gets $0 for teaching you how to find those investments and how to appropriately budget for and manage the repairs. Great point!

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