Is time up for mandated disclosure?

14 March 2019

Guest author Professor Lauren Willis calls time on disclosure as a tool to regulate complex transactions and argues that there’s a better way to keep confused consumers informed.

Imagine a video game that rewards players for finding hidden fees as players travel through the maze of a broadband supplier’s form contract. Or a media campaign storyline that features frustrated consumers running up against limitations on the benefits provided by an insurance policy they have purchased. Or perhaps a mobile phone text alert that warns cardholders when a debit transaction in which they are about to engage will cause them to go overdrawn on their account and informs them exactly what they will end up paying for that coffee.

Imagine these not as government public education campaigns, but as methods developed by marketing professionals, in conjunction with product and service designers, to ensure that the customers who enroll in that broadband service, buy that insurance policy, or go overdrawn on those accounts know the true costs and benefits of their transactions.

This could be the future if regulators adopted performance-based regulation.

So why do we need a new approach? Currently, consumer confusion about the complex transactions in which they engage is widespread. The primary response to this news has been to double down on disclosure. Regulators may laboriously tweak wording, font size, and graphics in their search for disclosures that are well-understood by consumer research subjects in the lab. But comprehension in the lab is not comprehension in the field, where we are busy, distracted, and influenced by marketing and sales talk.

consumer confusion about the complex transactions in which they engage is widespread

The U.S. Consumer Financial Protection Bureau spent three years in the lab perfecting new mandated home mortgage disclosures, but when academics added idle salesperson banter to a simulated mortgage sales process, consumer comprehension of the disclosures used in the sales process plummeted. The detailed nutrition facts label on the side of U.S. food packages likewise took years to develop, but consumers hurrying through the grocery store rely on the industry-sponsored “healthy choices” checkmark, that on the heels of the new nutrition labels graced the fronts of packaging for even Fudgesicles and Fruitloops, sugary treats hardly known for their healthy properties.

Consumers’ bounded rationality – the biases we are all subject to - and firms’ ability to frame consumer reception of mandated disclosures doom the disclosure project. No matter how well disclosures perform in the lab, or even in field trials, many firms run circles around these disclosures when the experiments end. Even without any intent to deceive, firms not only will but must leverage consumer confusion to compete with other firms that deceive customers. As elucidated by Nobel laureates George Akerlof and Robert Shiller, without effective regulation, markets in equilibrium will produce manipulation and deception.

Even without any intent to deceive, firms not only will but must leverage consumer confusion to compete with other firms

What we need is a policy tool that unites the interests of firms with the goals of regulators, redirecting the creative potential of the private sector much as emissions standards do for pollution reduction. Just as we use emissions caps rather than chimney design specifications to control pollution, we should use “customer confusion caps” rather than mandated disclosures and allow firms to meet those caps in whatever way they see fit.

More particularly, firms should be required to demonstrate through periodic independent third-party expert testing of representative samples of the firm’s actual customers that a good proportion of its customers know, at the time the customers can make use of this knowledge, the key pertinent costs, benefits, and risks of the products and services the firm has sold them.

Firms that fail these “confusion audits” would face motivating repercussions, such as fines or prohibitions on enforcing terms that their customers do not understand. Confusion audits and caps would thus incentivize firms to implement marketing campaigns that educate rather than obfuscate and to develop simple and intuitive product terms that align with rather than defy consumer expectations.

Firms have staggering advantages over regulators in developing product and service designs, sales processes, and marketing campaigns to minimize their customers’ confusion. Businesses today operate with a hyper-segmented, rapid, iterative, even machine-learning-driven, testing approach.  The CEO of Capital One has described the credit card business as “a scientific laboratory where every decision about product design, marketing, channels of communication, credit lines, customer selection, collection policies and cross-selling [can] be subjected to systematic testing using thousands of experiments.” Regulators can perform but a few disclosure experiments at a time.

The goal of twenty-first century marketing is real time hyper-segmentation. Big data and algorithmic analytics allow firms to target the individual by channel, time of day, week, or year, and real-time geolocation and activity. Advertising content in online gaming varies not only on the identity of the player, her known needs, location, and time of day, but also on whether she is winning or losing the game. Banks could meet customer confusion caps on overdraft products by warning some debit cardholders by mobile phone text, others by a phone call, and others with a pop-up warning, depending on where, when and how the customer is about to go overdrawn.

Further, the speed with which firms can respond to changes in consumer beliefs, or beliefs among segments of consumers, vastly outpaces the speed with which regulators can intervene.  If a scandal about variable annuities hits the news, firms can start calling these something else ("income-stream products," anyone?).  An insurance firm that changes the terms of its policies could immediately change the storyline of its media campaigns so as to continue to comply with a cap on customer confusion about limitations on insurance policy benefits.

the speed with which firms can respond to changes in consumer beliefs, or beliefs among segments of consumers, vastly outpaces the speed with which regulators can intervene

There will be some practically unintelligible products and services that are better for consumers than simplified, comprehensible versions of the same. And there will be times when effectively teaching consumers about a product or service is more costly than channeling consumers to transactions that are in the consumer’s best interests. In these situations, firms should be required to demonstrate that the products and services they have sold their customers are suitable for those customers’ circumstances.

There is a precedent.  A few regulatory schemes already use consumer confusion audits and caps. In the U.S., third-party expert consumer confusion testing is used in enforcement proceedings to demonstrate unfair, deceptive, or abusive practices and in private litigation to prove false advertising and trademark infringement. The U.S. Food and Drug Administration requires pharmaceutical firms to show that actual purchasers understand the usage and dosing directions for a medication during a trial of over-the-counter sales before the firm can broadly sell the drug directly to consumers. Consent orders (enforceable undertakings, in U.K. parlance) in cases brought by U.S. public enforcement agencies routinely require independent third-party testing to ensure that firms are complying with the substantive terms of the orders. This includes at least one case where a firm could escape other requirements of the order once it demonstrated that consumers no longer believed the false messages the firm had previously disseminated in its advertising.

But customer confusion audits and caps could be part of any consumer or competition regulator’s toolbox. A market system depends on consumers to understand products and services well enough to demand those that are in their own best interests. When consumers cannot perform this role, competition takes place over which firm can confuse consumers into buying a product or service, rather than over transaction quality, terms, and true price. Firms offering high-quality products on fair terms cannot compete. Consumer confidence weakens, and the consumer market as a whole suffers.

Lauren E. Willis is Professor of Law at Loyola Law School, specialising in consumer law and policy, including consumer finance, privacy, contracts, education, disclosure, and litigation.

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