Many Americans rely on professionals for financial advice, but like any type of service, there is a potential for conflict. Financial advice is a hotbed for potential agency problems. The reason someone seeks advice from a financial advisor is that they are not comfortable making financial decisions without guidance. Assuming these individuals do not have a financial background, there is no way for them to confirm they are getting quality advice.
Before a potential client officially begins a relationship with a financial advisor, the advisor must file a client brochure with the U.S. Securities and Exchange Commission (SEC). Then, they must provide the client with their client brochure, which divulges a wide variety of information about the advisor. This includes education, conflicts of interest, investing philosophies and much more. To make sure the client has all the important knowledge they need to make an informed decision, this information should be easily accessible and readable, right?
The Readability of Financial Advisor Disclosures: A Summary
To explore the communication of financial advisors with clients, my co-author and I recently published the article, The Readability of Financial Advisor Disclosures. We find client brochures are difficult to read for the average individual, even requiring college-level reading skills in some cases. Worse more, since 2009, these brochures have become increasingly more difficult to read.
The SEC provides guidelines for these advisor brochures. These guidelines include writing in plain English so the audience you are targeting can understand the content. This means it is acceptable for financial advisors to write these brochures in a complicated way if the client has the knowledge to understand it. In this case, financial advisors who provide advice to knowledgeable investors can write difficult to read disclosures.
By analyzing these SEC filings, we broke down the readability metrics by client type. We found the difficult reading levels of these brochures were not restricted to advisors with clients who were considered “sophisticated investors,” or high net worth individuals or businesses. On the contrary, these brochures were written by advisors whose clients are individuals and families, as well.
So why does all this matter?
Financial advisors in the United States are not held to a fiduciary duty. In other words, they are not required to do what is in the best interest of their clients – they only have to do what is suitable for each client. This subtle difference creates a gray area that allows investment choices that are subpar to the best option for clients. To remedy this, advisors provide potential clients with a brochure, so they can learn more about the financial advisor. However, if these brochures are too difficult to read, the client cannot learn enough about the advisor. They lack the information to make a proper decision because they lack all the complete information.
The relationship between a client and their advisor is an important point of focus. Because of that, it is one that has always interested me, both as an educator and someone who researches corporate governance. When anyone puts their finances in the hands of a financial advisor, that advisor should do what is best for that client. They should also attempt to educate the client and help them achieve their financial goals.
My hope is that advisors take these findings and reconsider how they write their brochures and other client communications.
If you have any further interest in the findings or would like to view the publication please feel free to contact me.
Citation: Lahtinen, K., Shipe, S., “Readability of Financial Advisor Disclosures”. Journal of Empirical Finance. 2017