ALPHA PROTECTION FOR BETA CONSUMERS: EVALUATING BEHAVIOURAL FINANCE RECOMMENDATIONS FOR FINANCIAL ADVISERS

Abstract

Behavioural finance takes the realistic view that individuals are never completely rational, which supports the regulatory objective of protecting vulnerable investors. Academic recommendations in this field can also facilitate better-informed decision-making in the financial markets and thus have potential value for regulators. In this paper, I use a multidisciplinary legal and business approach to evaluate the utility of these recommendations (see Agarwal et al., 2009; Thaler & Sunstein, 2008) given the law on financial advisory relationships in Singapore. I outline a legal framework for analysing the applicability of behavioural finance recommendations: the substance of the recommendation must first be in line with the micro-level regulations; and second, in line with the macro-level legal approach. Last, the recommendation must be translatable into the language of regulatory obligations, whether by prescriptive rules or outcomes-focused principles. I therefore reject the academic recommendation of imposing a general fiduciary duty as being inconsistent with the micro-level regulations. I also reject the academic recommendation of requiring regulatory approval, as its merit-based nature is inconsistent with the present disclosure-based approach in Singapore. In addition, I propose an alternative approach that is a hybrid of the merit-based and disclosure-based approach. Finally, I recognize that other recommendations can help banks meet existing legal obligations, but must be applied judiciously to avoid over-exposure to legal liability. Salience can potentially be used to show that a bank has discharged its duty of skill and care, but an imprudent application could expose a bank to legal liability under the law of misrepresentation. Yet these can only be translated from theory to application through regulatory provisions. The true measure of their potential thus depends on the certainty and flexibility with which they are drafted.