What Can Go Wrong When People Get Financial Advice?

Today we look at professionalism in the financial planning industry as explored in the paper “Ethics in financial planning: Analysis of ombudsman decisions using codes of ethics and fiduciary duty standards” in the Australian Journal of Management. Lead author Daniel W. Richards, assistant professor in the School of administrative Studies at York University, describes the research that he and coauthors Abdullahi Dahir Ahmed, an associate professor in the College of Business and Law at RMIT University, and Kenneth Bruce of the School of Accounting, Information Systems and Supply Chain at RMIT, undertook in examining wrongdoing and mitigation in workaday misconduct in the industry.

Most misconduct in the finance sector doesn’t end up in an executive being led off in handcuffs, as Bernie Madoff is in the Elizabeth Williams drawing above. So what happens when less dramatic and more commonplace misconduct has allegedly taken place? (Image: Elizabeth Williams/Library of Congress)

Misconduct occurs in professional financial advice and leaves the unaware investors in dire situations. Common perceptions of misconduct for unwitting investors are Ponzi-schemes, embezzlement, or funding a financial adviser’s holiday to a tropical paradise. Despite such occurrences grabbing newspaper headlines, they do not reflect what is involved with the bulk of financial misconduct.

Our research investigated financial ombudsman cases where customers of financial advisers have their complaints about misconduct adjudicated by an independent body. By analysing 212 decisions, we can ascertain what occurs when those getting financial advice feel they have been wronged by the financial adviser providing it.

We find that multiple factors occurred in each instance of wrongdoing, with over half of the misconduct involving:

  • a lack of diligence
  • a failure to act in the client’s best interest, and/or
  • having no reasonable basis for the advice given. 

A lack of diligence, or not taking due care, resulted in financial advisers not doing what was required to provide correct advice. This impedes an adviser’s knowledge of their client and inhibits an ability to act in their best interest. However, sound financial advice should always be based on the client’s goals and personal financial circumstances.

Interestingly, some clients may perceive that financial advisers have conflicts of interest and are not being fair. However, when fairness and conflicts of interest are raised by the client as a complaint, financial advisers are more likely to win the outcome of the financial ombudsman decisions than the clients. This may occur as conflicts of interest are hard to prove or that clients perceive conflicts which are not there.

How do you know if an adviser is acting in a client’s best interest?
There are certain steps that a financial adviser should be undertaking to ensure they are working in the best interests of their client. Of these steps, two are most pertinent. A financial adviser needs to identify a client’s objectives, situation or needs and they need to base all judgements on client information. When getting financial advice, a client should expect to share and communicate a lot of their personal situation, both financial and actual, with their financial adviser. If this has not occurred, clients should be cautious about the financial advice they receive.

What should be done to improve ethics in financial advice?
Improving ethics in financial advice is a difficult topic. Our research finds that diligence and communication are two facets that need to improve. Giving financial advisers both the environment and time to competently undertake financial advice and the expertise to communicate with clients, are areas of importance for policy to address.

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Daniel W. Richards

Daniel Richards is an assistant professor in the School of Administrative Studies at York University. He teaches personal financial planning. His research interests are behavioral finance, financial planning and investment decision making.

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