Can mandatory disclosure work?

Gail Pearson, The University of Sydney

Omri Ben-Shahar and Carl E. Schneider More Than You Wanted To Know: The Failure of Mandated Disclosure, Princeton, Princeton University Press, 2014 (240 pp). ISBN 9-78069116-170-9 (hard cover) RRP $45.95.

Have you ever felt the hot, impatient breath of the person behind you in a foreign airport car rental queue as you try diligently to read the fine print in the agreement before signing? Have you ever put your hand up at a presentation when asked who does not read the disclosure document or contract? In More Than You Wanted To Know: The Failure of Mandated Disclosure, Ben-Shahar and Schneider tell us that whether we read the documents or not makes little difference to our decisions. The ambition for mandatory disclosure about products and services is that, with information, we will make better decisions. The authors argue against this, saying that disclosures are not properly made, we don’t want them and we don’t read them. They tell us that improving disclosure will not change matters as we do not make decisions rationally. We would be better off, they say, if what they call ‘consultants’ helped us make decisions.

These American authors know about financial services and health; I know about financial services and credit. The book is timely for an Australian audience wanting to consider the implications of the Murray Report on the Financial System Inquiry (2014b). This book is seductive, echoing Oren Bar-Gill’s title, Seduction by Plastic (2012, 2004). Just as Bar-Gill argues credit providers induce us to borrow more, Ben-Shahar and Schneider might persuade us to opt out of regulatory models predicated on disclosure.

WHY MANDATED DISCLOSURE DOES NOT WORK

Ben-Shahar and Schneider tell us why mandatory disclosure does not enable individuals to make good choices. The first set of reasons is directed towards the communication of information. Put simply, the quantity of disclosure is too great. People are overloaded with extensive, complex information which accumulates as more and more disclosures are required for daily living. Simplifying disclosures means the information provided is not thorough, such that complex issues are omitted and distorted. These reasons are about data; another set of reasons why mandatory disclosure does not work is about how people actually make decisions. Many people are functionally illiterate and innumerate. Information itself is not an answer when individuals lack the skills to evaluate it. In any case, individuals do not necessarily make decisions on the basis of information. They may avoid decision-making or make decisions based solely on a single factor. A final reason is the regulatory burden of providing and reading information. Disclosure documents are expensive to produce and dealing with them extremely time consuming. Disclosure, particularly as it expands due to legalistic approaches, is costly and its costs are borne disproportionately by disclosees, particularly the poor.

Overall, with mandatory disclosure, there is simply too much information disclosed for people to attempt to understand it all. There are some wonderful pictures of disclosure documents in the book. One depicts a scroll being unrolled from the two-storey ceiling in the lobby of the University of Chicago Law School. The scroll is printed with the iTunes new terms. Ben-Shahar and Schneider provide an account of accepting these terms: after scrolling through 55 pages on an iPhone, then resorting to accepting them unread, but emailing them to themselves for later reading, the authors found that the terms comprised 32 pages of 8 point font. Another picture depicts the differences in disclosure documents between 1961 and now. Mandatory disclosure of information for a retail instalment sale agreement, such as buying a car on credit, used to take one page. It is now over twice the length with many more boxes of information and is referred to by the authors as a ‘bedsheet’. They refer to another study in the book that found that the median length of consent forms for human subject research had increased from seven to eleven pages in five years.

The book sets out varieties of disclosure that proliferate and overload us all.

It is not only the extent of disclosure for a single transaction that is at issue. There is also the problem of the sheer quantity of disclosure associated with daily living. As the authors say, if one person read all the associated disclosures prior to making each decision, that person would do nothing else. The book sets out varieties of disclosure that proliferate and overload us all—for borrowing, saving, investing, buying or leasing, shopping for and taking out insurance, informed consent for medical procedures, health warnings, pharmaceutical disclosures, privacy notices, food labels, advertising disclaimers, refund policies and more. Some libraries have a ‘continue to use’ function which indicates that, by continuing, the individual has agreed to comply with the requirements—without having actually read them. Many systems do not allow an individual to proceed without first going to pages with the required disclosure—about risks of various types. This makes little difference. Marotta-Wurgler (2011) showed people read ‘forced to click terms’ at about the same rate as optional linked terms.

HOW DO PEOPLE MAKE DECISIONS?

Disclosure cannot work if individuals cannot read or understand. The problem of illiteracy and innumeracy is often addressed with arguments for more and more financial literacy. Lauren Willis (2008), referred to in the book, and others have been arguing for years that financial education programs do not work and may lead people to make worse decisions, in part due to over-confidence bias.

Ben-Shahar and Schneider acknowledge the literature in social psychology and behavioural economics, which suggests we are not rational economic actors maximising our utility. Rather, we think ‘fast and slow’, to use the title of Daniel Kahneman’s famous book (2011). We think quickly when we make intuitive decisions, sometimes prompted by the way information is framed to appeal to our biases. Ben-Shahar and Schneider say this system of thinking does not rely on mandated disclosures. We are hedged by our biases and heuristics—in particular over-optimism, over-confidence and over-attention to the dramatic. Risk disclosures are often misunderstood. Our false assumptions can distort accurate risk disclosures. Forms of disclosure can also deliberately exploit our biases. As Bar-Gill’s work shows, lenders can construct documents around our irrational decision-making and take advantage of our biases such as under-estimation of the future.

ALTERNATIVES

Are there solutions to the failure of mandatory disclosure? What information do individuals need to make a good decision in complex unfamiliar situations? Ben-Shahar and Schneider say these are the wrong questions. They say there is no regulatory panacea to the failure of mandatory disclosure and they refuse to support an approach that does not work and may do more harm than good. The second question about improving information assumes that if disclosure as practised does not work, a different form of information disclosure may work. They see no basis for this, particularly as simplified disclosure may distort or omit key pieces of information. But they do not tell us if there is a right question or what it might be. This is where the authors appear to fudge the argument, for elsewhere in the book they state they have never argued that all disclosures fail, just that people do not use disclosures in the way its proponents expect.

What information do individuals need to make a good decision in complex unfamiliar situations?

Ben-Shahar and Schneider do explore some alternatives to mandatory disclosure, including simplifying disclosure, smart disclosure and default products that do not require an individual to make a choice. The authors’ argument against simplified disclosure is that it is too hard. It is too difficult to achieve the right compromise between information that someone may look at and information that is useful. They give an account of leading American approaches—to test simplified disclosure empirically; target disclosure; work out which contract terms are the biggest surprise; get the courts to judge if the disclosure effectively communicates the required information; use even more simple language; present information in an accessible fashion; and assign a score or rating instead of using words. Food labelling is a case in point requiring special skills to decipher its content.

One regulatory alternative to disclosure for individual choice is default products—if the person does not choose, there is a mandated default choice. Ben-Shahar and Schneider explain that individuals can be persuaded through disclosure and marketing to opt out of default products which benefit them and opt in to products that are more profitable for the provider and cost the acquirer more in fees. For these reasons, Willis (2013) says default products can be ‘slippery’.

ARE CONSULTANTS AND ADVISERS (INTERMEDIARIES) A SOLUTION?

What Ben-Shahar and Schneider do advocate is mandatory disclosure to sophisticated intermediaries. They are influenced by Thaler and Sunstein’s view that individuals can be ‘nudged’ towards better decisions (2008). I find their faith in ‘consultants’ touching, though they do recognise ‘consultants’ can be unreliable. This is a weaker part of the book than the earlier demolition of the current state of mandatory disclosure to consumers. Perhaps it has something to do with a residual belief that most professionals and fiduciaries refrain from acting in their own interests and do put the interests of the patient or client first. Their index does not have an entry for brokers or advice, although this area of disclosure is discussed.

The authors describe a study that illustrates the pitfalls of ‘consultants’ and decision-making. A laboratory study was designed to test responses to disclosure of conflict of interest. Advisors who disclosed their conflict of interest gave inflated, distorted advice. Decision-makers relied more on the advisors who disclosed a conflict of interest and gave distorted advice. The result was worse decisions when a conflict of interest was disclosed than when it was not disclosed.

LESSONS FOR AUSTRALIA?

The problem of ‘regulatory burden’ is an ongoing mantra in Australian public life.

The problem of ‘regulatory burden’ is an ongoing mantra in Australian public life and the source of government enquiry, especially following the Rethinking Regulation report by the Productivity Commission (2006). How much is mandatory disclosure red tape and how much is the appeal to a ‘burden’ an attempt to avoid responsibility to act fairly? The Productivity Commission’s pioneering report highlighted one submission that argued: ‘Rather than drowning consumers with vast amounts of disclosure, a far better alternative would be to ensure that fundamental protections are built into the legislation itself. Consumer advocates themselves are now publicly questioning what protection disclosure in fact provides and whether or not detailed and prescriptive disclosure actually improves consumers’ understanding’ (Productivity Commission 2006, p. 8). Other submissions pointed out how legalistic procedures had replaced customer relationships and how the unscrupulous could manipulate mandatory disclosure of, for example, interest rate comparisons (Productivity Commission 2006, p. 13).

We have simplified many disclosure practices in Australia such as short form Product Disclosure Statements in financial services. We have undertaken sophisticated reviews intended to improve consumer credit disclosure. Paul O’Shea (2010) said, in essence, that better disclosure is early disclosure and simple disclosure. O’Shea’s experiments found that early disclosure, preferably at first contact, increased confidence and the accuracy of comprehension and there was a lower risk of an individual selecting the wrong product. There is a caveat in his findings. The study also found that early disclosure does not work without short form disclosure, hence an additional single page document. The concept of layered disclosure, whereby short-form disclosure is followed by access to more information has been actively canvassed in the Financial System Inquiry interim report (Murray 2014a). The Final Report says ‘mandated disclosure is not sufficient to allow consumers to make informed financial decisions’ (Murray 2014b, p. 193).

Australia has extensive financial literacy programs backed by government and industry. I am not opposed to education, but this is not ‘the’ solution, and the Murray Report agrees (Murray 2014b, p. 193). Education programs by community organisations and in schools can teach individuals to understand more about money, and persuade them to get on board one of the greatest social transformation projects of the turn of the century which turns individuals into financial citizens. But I defy anyone to fully understand complex derivative products even after reading the contracts and reading judgments such as ABN Amro Bank NV v Bathurst Regional Council [2014] FCAFC 65.

Default products such as MySuper are designed to help individuals save for retirement. But because Australians can choose which fund holds their superannuation savings, they may be persuaded out of such funds and into more expensive funds. Misleading advertising has been an ongoing issue since ‘choice of fund’ was introduced. This year the Australian Securities and Investments Commission (ASIC) has issued at least three infringement notices for misleading advertising of the administration cost structures for self-managed funds.

In Australia, any suggestion that mandated disclosure to consumers could be simply replaced intermediaries helping individuals to make decisions flies in the face of widespread evidence of bad behaviour. In Australia, the financial advice industry has caused devastation for many. The model for the misnamed ‘distribution’ or sales of financial products is through mortgage brokers and financial planners. An overwhelming proportion of these are tied to big financial institutions and their recommendations are limited to the products of those institutions.

In Australia, the financial advice industry has caused devastation for many.

Financial planning scandals keep unfolding. The Westpoint collapse in 2006 involved promissory notes; the Storm Financial collapse in 2009 involved margin loans, reverse mortgages over family homes and sales of managed funds. Both involved promises of above market returns and delivered above market commissions to financial advisers. The Opes Prime collapse in 2008 involved margin lending and confusion over whether shares were lent or transferred to the lender. Both Storm Financial and Opes Prime involved margin calls on the margin loans so that when the value of the shares fell below a predetermined amount the borrower had to provide more money to the lender. These margin calls were not communicated by intermediaries to clients in a timely fashion so that accounts fell into negative equity and some clients lost not only their retirement savings but also their homes. Both Storm Financial and Opes Prime involved relationships with one or other of Australia’s largest banks.

The Opes Prime and Storm Financial collapses led to a parliamentary enquiry in 2009 (Parliamentary Joint Committee on Corporations and Financial Services 2009). Some of those giving evidence said they would never have made a decision to enter the agreements if there had been better disclosure. They had expected disclosure of the risk of what they were doing, they believed the intermediaries had not understood the risk and they said that any disclosure documents they received were lengthy and confusing and they should have been given short plain English documents. The latest round of financial planning scandals include Macquarie Group’s ‘toxic sales culture’, in which planners are alleged to have put clients into extremely high-risk foreign investments when the client stated they wanted conservative investments, and the Commonwealth Bank’s planners, who are alleged to have forged signatures and given inappropriate advice (Senate Economics References Committee 2014). Even without these recent scandals, the problem of poor quality advice has been found to be widespread. Studies conducted by ASIC (2003, 2011, 2012) show that few financial advisers provide high-quality advice. In 2003, 51 per cent of the advice was found to be ‘borderline’; by 2011, despite money spent training advisors, only 58 per cent of the advice was found to be adequate. It is not only planners as intermediaries who have been a problem. Many people organise a housing loan through a mortgage broker, not directly with a bank. Brokers have been found to have changed information on loan applications, falsely inflated the income of loan applicants, falsely declared the purpose of a loan to escape regulation, and misrepresented savings from changing to a different loan (Senate Economics References Committee 2014). And this is before one takes account of the fees charged by intermediaries and the commissions they receive, all adding to the cost to the consumer of financial services and products.

Would disclosure have worked to forestall these bad practices? Why didn’t the then current disclosure regime work? There were extensive mandatory disclosure requirements in place during this time to protect retail clients and those obtaining loans for domestic purposes. Service providers were required to provide clients with a Financial Services Guide with information about the provider, a Statement of Advice setting out the basis for the advice, and a Product Disclosure Statement that included risks. Statements of Advice themselves might be 125 pages long. There was also mandatory disclosure for consumer credit products. Borrowers received pre-contractual disclosure that could have been the contract itself and was required to set out matters including the annual percentage rate and the total interest charges.

There have been changes to the law regulating financial advice, consumer credit and margin lending. These now require planners to take defined steps in the best interests of the client and give appropriate advice. They require the broker and the lender to assess if a loan or a margin loan is suitable for a particular person. These changes require intermediaries to take into account the objectives, requirements and personal circumstances of individuals.

SHOULD WE SAVE DISCLOSURE?

Of course disclosure has its place and in many domains needs improving: one area of currently limited disclosure which could do with a requirement for upfront disclosure is telemarketing. If we have to have any disclosure at all, why not an immediate mandatory disclosure: ‘I am a telemarketer’?

Ben-Shahar and Schneider do not have a solution for better decision-making.

One of the suggestions to improve disclosure as a way to assist individuals to make better decisions is what is called ‘personalised disclosure’. This is a form of smart disclosure; that is, user-friendly electronically based disclosure (Task Force on Smart Disclosure 2013). Personalised disclosure can operate by requiring suppliers to disclose to a consumer the information they have about the consumer, such as their patterns of use and the relationship between use and cost. This form of ‘smart disclosure’ might also predict future behaviour and use patterns. We already do this in a limited way with information about past usage—think utility and phone bills. The argument against this is that past usage is no necessary predictor of future usage. Ben-Shahar and Schneider also argue against more sophisticated personalised disclosure saying that although it might reduce too much disclosure to a particular person, the individualised data to help people make rare, complex decisions is unlikely to exist. When there is such data, an individual’s experience is probably as useful a guide as the information generated from a smart disclosure algorithm.

I’m not 100 per cent convinced by this dismissal of smart disclosure, as it has the potential to move on from the mere provision of information. We have suitability requirements for consumer credit where the supplier must assess if a product is ‘not unsuitable’, using a combination of data generated from the supplier and data from the individual. This sets a standard that assists a decision rather than just disclosing complex, simple or personalised information that might be used in making a decision.

At the end of the day, Ben-Shahar and Schneider do not have a solution for better decision-making. Referring to the Spanish conquest of the Americas with its disclosure statement—convert or else there will be war and slavery—they say the goals of contemporary disclosure are far more admirable. Why are we worried about the failure of disclosure? It costs a lot and it fails to prevent bad decisions, bad decisions that for some individuals have severe consequences. Is there anything to ensure we all make suitable decisions? Ben Shahar and Schneider suggested this is the wrong question. Many are decision-averse. I’m not brave enough to advocate no disclosure—but—should we have penalties for over-disclosure and over-warning?

REFERENCES

Australian Securities and Investments Commission 2003, Survey on the Quality of Financial Planning Advice, Report 18, Commonwealth of Australia [Online], Available: https://dv8nx270cl59a.cloudfront.net/media/1310341/Advice_Report.pdf [2014, Dec 9].

Australian Securities and Investments Commission 2011, Review of Financial Advice Industry Practice, Report 251, Commonwealth of Australia [Online], Available: https://dv8nx270cl59a.cloudfront.net/media/1343702/rep251-published-13-September-2011.pdf [2014, Dec 9].

Australian Securities and Investments Commission 2012, Shadow Shopping of Retirement Advice, Report 279, Commonwealth of Australia [Online], Available: https://dv8nx270cl59a.cloudfront.net/media/1343876/rep279-published-27-March-2012.pdf [2014, Dec 9].

Bar-Gill, O. 2004, ‘Seduction by plastic’, Northwestern University Law Review, vol. 98, no. 4, pp. 1373–1434.

Bar-Gill, O. 2012, Seduction by Contract, Oxford University Press, Oxford, United Kingdom.

Task Force on Smart Disclosure 2013, Smart Disclosure and Consumer Decision Making: Report of the Task Force on Smart Disclosure, Executive Office of the President National Science and Technology Council, Washington DC [Online], Available: http://www.whitehouse.gov/sites/default/files/microsites/ostp/report_of_the_task_force_on_smart_disclosure.pdf [2014, Dec 8].

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Marotta-Wurgler, F. 2011, ‘Will increased disclosure help? Evaluating the ALI’s “Principles of the law of software contracts”’, University of Chicago Law Review, vol. 78, no. 1, pp. 165–186.

O’Shea, P. 2010, Simplifying Disclosure in Consumer Credit; Empirical Research and Redesign, Ministerial Council for Consumer Affairs, Commonwealth of Australia, Canberra.

Parliamentary Joint Committee on Corporations and Financial Services 2009, Inquiry into Financial Products and Services in Australia, Commonwealth of Australia, Canberra [Online], Available: http://www.aph.gov.au/binaries/senate/committee/corporations_ctte/fps/report/report.pdf [2014, Dec 8].

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Thaler, R. & Sunstein, C. 2008, Nudge: Improving Decisions about Health, Wealth and Happiness, Yale University Press, New Haven, Connecticut.

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Willis, L. 2008, ‘Against financial literacy education’, Iowa Law Review, vol. 94, no. 1, pp. 197–285.

Willis, L. 2013, ‘When nudges fail: Slippery defaults’, University of Chicago Law Review, vol. 80, no. 3, pp. 1155–1228.