The Dodd-Frank Act charged the Consumer Financial Protection Bureau with ensuring that consumers “understand the costs, benefits, and risks” associated with financial products and services. Despite this ambitious mandate, and despite the Bureau’s self-branding as a “21st century agency,” the Bureau’s pursuit of consumer comprehension has thus far focused on 20th century tools that have proven ineffective at regulating financial transactions: disclosure requirements and deception prohibitions. No matter how well the Bureau’s “Know Before You Owe” disclosures perform in the lab, or even in field trials, firms will run circles around disclosures when the experiments end, confusing consumers and defying consumers’ expectations. Even without any intent to deceive, firms not only will but must leverage consumer confusion to compete with other firms that do so. Firm need not themselves sow misunderstanding to reap its benefits. (Consider that nearly half of Americans believe that buying a single company’s stock usually provides a safer return than a stock mutual fund.)
If the Bureau wants to ensure that consumers understand the financial transactions in which they engage, then to meet the challenge posed by the velocity of today’s marketplace, the Bureau must induce firms themselves to promote consumer comprehension, either by educating consumers or by simplifying products and services. To generate this change in firm behavior, I propose that the Bureau employ a form of performance-based regulation plainly authorized by the Dodd-Frank Act: consumer comprehension requirements.
Specifically, the Bureau should require financial services firms to demonstrate through third-party testing of random samples of their customers that their customers understand the material costs, benefits, and risks of their financial transactions. Rather than attempting to perfect price disclosures, for example, the Bureau should require firms to prove that their customers understand the price at the moment when the customers are deciding whether to take the actions that will trigger it, whether those actions be taking out a mortgage, overdrawing a checking account, or calling customer service to inquire about the balance on a prepaid debit card. Where consumers are confused about benefits rather than costs, such as the benefit of signing up for a credit repair service, buying credit life insurance, or paying off a debt that is beyond limitations, firms should be required to show that their customers understand the actual benefits the firm is offering before the consumer commits to the purchase or action.
The key elements of the performance-based comprehension regime I propose are:
- measuring the quality of a valued outcome (consumer comprehension) rather than of an input that is often pointless (mandated or pre-approved disclosure);
- assessing actual customer comprehension rather than imagining what the “reasonable consumer” would comprehend;
- testing customers in the field rather than volunteer subjects in the lab;
- requiring firms to bear the costs of consumer testing, rather than relying on the Bureau’s limited staff and resources;
- giving firms the flexibility to create consumer comprehension through whatever means they see fit, not necessarily through a disclosure;
- demanding customer comprehension as conditions change over time rather than pre-approving disclosures based quickly outdated comprehension tests; and
- placing responsibility for educating consumers and simplifying products, and for determining when to use each of these approaches, on firms, which are well-suited to these tasks, rather than regulators, who are not.
Consumer comprehension requirements could be deployed in various ways. Demonstrating widespread comprehension could be a precondition a firm must meet before enforcing onerous terms or charging opaque fees. Firms could be sanctioned (or rewarded) for demonstrating low (or high) comprehension levels. A modest step would be for the Bureau to demand that firms that have engaged in deception agree to comprehension performance requirements as a part of any settlement.
Performance-based regulation is not new. Environmental and building code regulations have long employed it. Rather than the law dictating the scrubber a factory smokestack must use or the material a builder must use, the law sets emissions limits or imposes strength and durability requirements, and the factory owner or builder can determine for itself how to meet those limits or requirements.
Comprehension performance requirements are already used in discrete ways in consumer law. As a condition of selling a drug over-the-counter, pharmaceutical firms must engage in a limited retail release of the drug and then demonstrate that the consumers who bought the drug understood its usage and dosing directions. Consumer comprehension testing is used by regulators to establish deception claims and by competitors to prove false advertising claims. The Federal Trade Commission has used comprehension performance targets as a remedy for deception. The Securities and Exchange Commission applied an investor comprehension standard in the oft-cited 1948 case In re Arleen Hughes, which found that Hughes’s failure to ensure that her clients understood her conflict of interest violated the anti-fraud provisions of the 1933 and 1934 Acts. The Commission explained:
(emphasis added).
Consumer comprehension requirements capitalize on firms’ greater knowledge of and access to their own customers, and greater ability to experiment, segment, and innovate. A photo, tweet, or cartoon might far better inform than a text-based or scripted disclosure, and different approaches are likely to be effective for different consumers. Comprehension requirements would incentivize firms to educate rather than obfuscate and to develop products and services that align with rather than defy consumer expectations.
The Bureau is already engaging in efforts authorized by Dodd-Frank that step beyond disclosure and even tiptoe towards comprehension rules. The Bureau has moved from lab-based testing to field testing of disclosures, although for now on only a trial basis. It has been trying to stimulate firm innovation in disclosure methods by encouraging firms to engage in trial disclosure programs, which Dodd-Frank permits the Bureau to exempt from existing disclosure rules. It is performing its own consumer comprehension testing of arbitration clauses and class action waivers. These steps implicitly acknowledge that (a) disclosures that do well in experimental conditions do not necessarily work in the field, (b) firms are better situated than regulators to innovate to achieve consumer comprehension, and (c) valid and reliable consumer comprehension testing is possible. What is needed now is for the Bureau to pull these insights together and see that they collectively suggest applying a performance-based regulation model to attain consumer comprehension.
The effect of successful regulation through comprehension rules would be to bring financial products and services into alignment with consumer expectations, whether because consumers become more educated or because products and services become less complex and more intuitive. Greater simplicity and usability would reduce demands placed on consumers’ attention, time, and effort in selecting and using products and services and boost consumer confidence in the marketplace. The ultimate direct benefit of comprehension rules is increased consumer decisional autonomy; consumers would get what they think they are getting, not whatever hidden features firms can slip into the transaction.
Yet when consumer comprehension becomes legally required, what we may find is that decisional autonomy is overrated. Comprehension may oftentimes be neither necessary nor sufficient to produce welfare-enhancing transactions. Educating consumers may be so costly that it would be cheaper for firms to directly channel consumers to suitable transactions. Consumers and firms might find that some confusing products and services, when sold only to consumers for whom they are suitable, improve consumer welfare over simplified, comprehensible versions. Moreover, consumers might rather not have to understand much about the financial transactions in which they engage. They might prefer that regulators rather than their own actions discipline the marketplace. Substantive design regulation thus might produce more consumer welfare and be truer to deep consumer autonomy, including the autonomy to decide not to become an expert on financial matters. But without trying comprehension rules, we cannot know when and where truly informed consumer decision making is worth its price.
The preceding post comes to us from Lauren E. Willis, Professor of Law at Loyola Law School. The post is based on her recent article “The Consumer Financial Protection Bureau and the Quest for Consumer Comprehension,” available here.