CPD: Ethics – why good people make poor choices

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Honesty, responsibility, trustworthiness and integrity can help to eliminate behaviours that conflict with ethical practice in private and professional life.

Ethical values provide a moral compass by which people live their lives and make decisions. This article, sponsored by GSFM, investigates the ways financial advice practices can support ethical behaviour to provide financial advice to clients that is always in their best interests.

Since 1994, the Ethics & Compliance Initiative (ECI) has conducted a longitudinal, cross-sectional study of workplace conduct from the employee’s perspective. This research consistently demonstrates that the quality of a company’s ethics and compliance program and the strength of the company’s ethics culture are key when it comes to achieving desired ethics outcomes[1].

This research has revealed that while a multitude of factors influence ethical behaviour, the interplay of four major ethics outcomes are tied to the daily micro decisions employees make with respect to how they behave in the workplace. The ECI has been tracking these ethics outcomes for 20 years.

These four major ethics outcomes are:

  1. pressure in the workplace to compromise ethical standards
  2. observations of misconduct
  3. reporting misconduct
  4. retaliation perceived by employees after they report misconduct.

The 2021 report collected data in 2020 and noted that organisational change often adversely affects ethics outcomes; this was particularly pronounced in 2020 because of the COVID-19 pandemic and the move to working from home or, at least, adopting different ways of working.

The case for continually improving ethics and compliance practices and policies are underpinned by two key results from the survey:

  1. The stronger the culture, the greater the impact
    • 84% of employees working for organisations with an ethics and compliance program perceive that organisation as having a strong ethics culture
  1. The higher the program quality, the stronger the ethics culture
    • 85% of employees working for organisations with a strong ethics culture indicated observing favourable outcomes

Higher-quality ethics programs are linked with strong organisational culture. According to ECI, the single most significant influence on employee conduct is culture; in strong cultures, wrongdoing is significantly reduced.

It is important that companies:

  • hold employees accountable for misconduct
  • ensure employees trust that leadership will keep their promises and commitments
  • ensure employees set a good example of ethical workplace behaviour.

Finally, the survey noted that as ethical culture strengthens, employee conduct improves: those companies with strong cultures are 467% more likely to demonstrate a positive impact on employees. This impact includes employees recognising and adhering to corporate values, feeling prepared to handle key risks and report suspected wrongdoing, and overall, reduced levels of misconduct1.

What makes good people make poor decisions?

As demonstrated by the ECI survey, a strong ethics and compliance culture is important to promote positive and ethical decision making. However, despite good intentions, some companies set themselves up for ethical problems by creating environments where people feel compelled to make choices they know, or suspect, are not right.

This can also result in ‘motivational blindness’, which is defined as the tendency to not notice unethical actions of other people and colleagues when it’s against our own best interests to notice.

There are five ways companies might unintentionally trigger good people to make unethical choices[2].

1. Create an environment where it’s psychologically unsafe to speak up

Managers and team leaders need more than an open door policy; they need to encourage their staff to raise and discuss ethical concerns. Creating a culture where your team is able to freely speak up is essential if you’re to avoid misconduct in your practice.

Importantly, you need to ensure there are mechanisms for your team to communicate and that each member is comfortable to speak up. Importantly, any issues raised must be addressed; a feeling of futility or a negative reaction to the issue do not create a supportive environment.

Failing to provide a safe environment for a team to discuss ethical dilemmas will ultimately have a negative impact on clients and could potentially breach several standards of FASEA’s Code of Ethics, including:

2. Avoid pressure to reach unrealistic performance targets

Performance targets can be financial targets such as profitability or assets under management or focus on client acquisition or retention. Research from Harvard Business School suggests “unfettered goal setting can encourage people to make compromising choices in order to reach targets[2]”.

The standards that comprise FASEA’s Code of Ethics focus on doing the right thing by clients – obey the law, act in client best interests and act professionally. The 2018 Hayne Royal Commission heard a variety of cases in which performance targets may well have influenced actions, such as those to ‘churn’ clients or lure them from industry or retail superannuation funds to self-managed super funds.

While it is common business practice to have a range of performance targets, it’s important that they are both realistic and achievable without having to compromise the advice provided to clients. Targets that are client and service centric can lead to ethical outcomes for those clients.

3. Discussing ethics once there’s been a transgression

Too many leaders assume that talking about ethics is something you do when there’s been a scandal, a client complaint or an AFCA investigation. Previous articles in this series have discussed the importance of ethics and ongoing ethics training in your financial practice – it’s not simply how you behave, but how you and all of your colleagues behave. That’s why it’s important to educate and reaffirm, on a regular basis, the importance of ethical practices in your business.

This is particularly important for those issues that don’t fall neatly into right and wrong. While the ‘grey zone’ – that area that exists on a continuum between right and wrong – can provide challenges for your business, it can also provide benefits. Being aware of the grey zone and using examples and case studies that aren’t black and white provide an excellent opportunity for training and discussion. List the situations that your team may encounter in their day-to-day work that might not be black and white. Once such situations are identified, you can take a proactive approach with training.

This grey zone reinforces the importance of all employees of a financial planning business being aligned with its values and practices. If you are transparent about how to deal with ethical issues, if you discuss them regularly and not just when there’s an issue, there’s a lower chance of breaching FASEA’s Code of Ethics and, therefore, less likelihood of facing enforcement action.

4. A positive example isn’t being set

Leadership is crucial and all leaders in your business must accept their responsibility in setting that positive example. They must be vigilant about both their intentions and how their peers and subordinates might interpret their behaviour.

Leaders must take care with how they react to external and internal factors, as these demonstrate how it’s acceptable to respond. These factors might include:

  • a client complaint or negative review on social media
  • lower than expected revenue or poor financial performance
  • losing a valued staff member to a rival practice
  • aA systems issue or breakdown
  • regulatory change or challenge.

Leaders need to model ethical behaviour. In an advice practice, this includes compliance with the standards that comprise FASEA’s Code of Ethics. Failure to do this not only sets a poor example, it could set the business on problematic path.

In his 2019 letter to investors, veteran investor Warren Buffet made the following comment:

Over the years, Charlie and I have seen all sorts of bad corporate behaviour, both accounting and operational, induced by the desire of management to meet Wall Street expectations. What starts as an “innocent” fudge in order to not disappoint “the Street” can become the first step toward full-fledged fraud…And if it’s okay for the boss to cheat a little, it’s easy for subordinates to rationalise similar behaviour.”

As with parents setting a good example for their kids, all leaders need to set a positive example for their team, particularly where an ethical dilemma that arises is not clearly defined.

5. Avoid cultural numbness[3]

Cultural numbness creates a situation that, irrespective of how principled you are, over time, the bearings of your moral compass will shift toward the culture of your organisation. Situations where an ethical leadership is lacking are often those where good people can make poor decisions. Cultural numbness is described as a state where the ‘warning bells have stopped ringing’, where a culture of ethics does not exist, and positive examples are not set by business leaders.

In an advice practice, it could be the difference between acting in your or the practice’s best interests rather than the client’s. It could be skirting legal boundaries (breaching standard one), failing to manage conflicts of interest (breaching standard three) or simply recommending products without taking into account the long-term ramifications of the client acting on your advice (breaching standard six).

FASEA notes the standards that comprise its Code of Ethics are not intended to provide definitive guidance. It acknowledges that individual circumstances will differ in practice and there is allowance for differences of professional opinion on how the ethical rules of the profession should apply in a particular case. This is where positive leadership and an ethics centric business culture will stand an advisory practice in good stead, particularly in those circumstances where you encounter ethical decision making that is not black and white. Doing what is right will depend on the particular circumstances and requires you to exercise your professional judgement in the best interests of each of your clients.

How to support ethical behaviour

In any profession, most people set out to act ethically. However, as previously noted, ethical practice is not always black and white.

As defined by the Oxford Dictionary, a grey zone is: “An intermediate area between two opposing positions; a situation, subject, etc., not clearly or easily defined, or not covered by an existing category or set of rules.

In ethics, this is where right and wrong become blurred and generally requires the application of some form of moral judgement to decide on the appropriate action. And, while most companies have ethics policies that get reviewed and signed annually by all employees, is this enough to ensure ethical behaviour?

Words are not enough. Statements and policies have to be lived, not just published and filed away. Here’s an example of a corporate statement about ethics: “Moral as well as legal obligations will be fulfilled in a manner which will reflect pride on the Company’s name.” This was published by Enron, a company famously bankrupted due to fraudulent accounting practices used by management to inflate the company’s revenues and hide debt in its subsidiaries.

Most people are confronted with a wide range of ethical dilemmas on a regular basis. While what’s right is usually clear, the circumstances can impact how each makes decisions about their behaviour and choices. The small white lie, ignoring the restaurant bill error in your favour, or having a loved one take responsibility for a driving offence are active choices. For some, the choice is easy – for others, not so.

In business, pressure to be successful, competitive and profitable may lead people to confront issues and decisions that are in the grey zone, one in which conflicts of interest can arise and good decision making may become impaired. Good people can end up acting in a questionable manner.

Ethics problems in particular are not always straightforward. Detailed codes of conduct, such as FASEA’s Code of Ethics, target what is and isn’t acceptable in providing financial advice. It aims to bring clarity to decision making and is used to examine actions when it comes to enforcement. Despite the existence of the Code of Ethics, you are likely to encounter ethics problems that aren’t definitively black or white, right or wrong, but fall into the grey zone and require professional and moral judgement to resolve.

Ethical values provide the moral compass by which people live their lives, make decisions and react to circumstances. Ethical decision making is important for financial advice practices because the wrong decisions – or decisions which have been implemented badly – can have a significant impact on the financial wellbeing of your clients and their families, as well as the reputation of your business.

Case studies

The following case studies are based on real complaints submitted to AFCA and/or investigated by ASIC; however the names of people and organisations have been changed, and some details altered. For each case study, it will be shown where the adviser has potentially breached any of the standards within FASEA’s Code of Ethics.

Case study one: A wrong move

The complainants, Bill and Kate King, received advice from their financial adviser Steve, an authorised representative of ACME Financial Planning. This advice included recommendations to establish a self-managed super fund (SMSF), rollover their existing superannuation funds into the SMSF, and borrow within the SMSF to invest in property.

Bill and Kate made a complaint to AFCA as they believed the advice was inappropriate and not in their best interests; but for the advice, they would have remained in their previous superannuation funds.

Section 961B of the Corporations Act 2001 (Cth) outlines the following “safe-harbour” steps a financial adviser should follow to comply with the best interests duty:

  • identify the objectives, financial situation and needs of the client
  • identify the subject matter of the advice
  • make reasonable inquiries to obtain complete and accurate information
  • assess whether you have the expertise, if not decline to provide advice
  • conduct a reasonable investigation into financial products that may achieve the objectives and needs of the client and assess the information gathered
  • base all judgements on the client’s relevant circumstances
  • take any other steps, at the time the advice is provided, that would reasonably be regarded as being in the best interests of the client.

Clients seeking financial advice expect their adviser will act in their best interests and that, as a result, the advice provided will leave them in a better position. Section 916G provides that the resulting advice must be appropriate to the client.

AFCA’s panel agreed with the complainants and was satisfied the advice provided was not in their best interests and was not appropriate. There was no basis for recommending Bill and Kate invest in an SMSF, the SMSF costs were disproportionate to the amount invested, gearing to invest in property within the SMSF ignored the complainants’ immediate objectives and the investment strategy was not in keeping with their risk profile.

Further, it was considered the complainants were most likely worse off as a result of the advice, although at the time of the determination, the property had to be sold to agree the exact loss.

Importantly, the adviser failed to act in his clients’ best interests. The principle guiding the application of the best interests obligation is that meeting the objectives, financial situation and needs of the client must be the paramount consideration when providing advice.

Steve’s actions potentially breached a number of FASEA’s standards, including:

Case study two: A failure to comply with AFCA determinations

A recent failure of behalf of financial planning business AAA Financials resulted in ASIC cancelling the firm’s AFSL and banning the sole practitioner. This came about for several reasons:

  • the adviser failed to act in the best interests of several clients
  • the adviser failed to ensure financial recommendations were implemented appropriately
  • the adviser refused to give effect to a determination by AFCA
  • the adviser refused to cooperate with AFCA
  • the adviser refused to pay several AFCA determinations on time
  • the business’s audited accounts were not lodged in 2019 and 2020.

AFSL holders must comply with their licence conditions and have adequate resources to provide the financial services covered by their licence.

The practitioner’s failure to meet the needs of his clients and license requirements saw him potentially breach the following FASEA standards:

Case study three: Conflicted remuneration

An advice practice of a dozen advisers left their licensee to become authorised representatives of ABC Financial Advice. As part of the transition, the advisers were strongly encouraged to move clients from Platform A, which they used under their previous licensee, to Platform B, owned by the new licensee.

For this, their business received a transition payment from the new licensee based on the revenue generated by each client moved to Platform B.

This arrangement was subject to a review by ASIC, which believed the transition payments most likely influenced the advisers to switch their clients to Platform B. This in turn caused the clients to incur unnecessary fees and charges.

In some cases, the same financial products were not available on Platform B, which required a switch of product. This situation caused some clients to incur costs and losses; in some cases, the move triggered capital gains or losses that negatively impacted clients’ overall financial position.

The review identified concerns about managing these conflicts of interest and found that clients were not made aware of it. ASIC also expressed a range of other concerns concerning the transfer to the new licensee. These included:

  • a failure to meet the requirements of a compliant dispute resolution system
  • poor monitoring and supervision of staff and representatives
  • non-compliance with the requirements of section 945A of the Corporations Act, the requirement to have a reasonable basis for advice provided to clients
  • non-compliance with section 947D of the Corporations Act, the requirements when advice recommends replacement of one financial product with another.

From the information provided in this case study, the advisers and licensee potentially breached a number of FASEA’s standards, including:

Case study four: Double gearing brings clients undone

TJ was a sole operator in regional Victoria and an authorised representative of a large licensee. She had been a financial adviser since 2009 and had worked as an authorised representative of numerous AFS licensees.

An ASIC review found that TJ failed to act in the best interests of her clients. She provided advice that was inappropriate when her clients’ relevant personal circumstances were reviewed. She repeatedly recommended her clients engage in, and continue with, double gearing strategies. She implemented and encouraged these strategies, despite knowing many of her clients struggled to service the borrowing arrangements. This approach was adopted by TJ across a number of years and several licensees.

In providing advice to her clients, TJ failed to consider their relevant personal circumstances, their cash flow position or importantly, their ability to cover margin calls. She also failed to consider an exit strategy from the gearing arrangements for her clients and did not recommend or implement appropriate personal insurance cover.

Additionally, ASIC found that TJ failed to keep proper records and that she was not adequately trained or competent to provide financial services. Her lack of understanding about her legal and professional obligations as a financial adviser created additional risks to her current and future clients.

TJ received a four year ban from ASIC with respect to providing financial services, carrying on a financial services business or controlling an entity that carries on a financial services business.

TJ’s approach to working with clients would have seen her potentially breach the following FASEA standards:

Ethics is about so many things. It’s a measure of character, the qualities that defines a person. It’s about the behaviours and judgements made by people and the decisions that drive choice. But while we all like to think of ourselves as ethical, there’s no shortage of stories that demonstrate that humans – and in a smaller universe, financial advisers – are capable of behaving in an unethical manner. This might be by committing an act, or tacitly approving the unethical acts of others, even in situations that are not at either end of the ethics continuum.

It is important to note that ethical values such as honesty, responsibility, trustworthiness and integrity help to guide people deal more effectively with ethical dilemmas. These values help to eliminate behaviours that conflict with ethical practice in private and professional life.

 

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References:
[1] ‘The State of Ethics & Compliance in the Workplace’, 2021 Global Business Ethics Survey Report, Ethics & Compliance Initiative
[2] https://hbr.org/2016/12/why-ethical-people-make-unethical-choices
[3] https://hbr.org/2019/04/the-psychology-behind-unethical-behavior

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