It seems that ASIC’s Christmas present to investors is to get them to undertake an exam to see if they really know what is in the product disclosure statements that they agree to. Well, not exactly, but ASIC chairman Greg Medcraft has suggested that disclosure, on its own, may not be enough to protect consumers from making poor (as opposed to risky) investments.
And to some degree, Medcraft’s suggestion that product disclosure documents are not working for some investors is correct. So, it is important to come up with alternative ways to ensure that investors know what they are getting in to.
If the goal of a product disclosure statement (PDS) is to help consumers make the most appropriate choices, we have to begin with the consumer, rather than the document. So, the best place to start would be to understand how people decide, and how they process complex information. As part of this, it is also probably the right time to reconsider how we approach consumer protection, and the disclosure of information.
We know, for example, that all people (even investors) will use a range of shortcuts when they are making a decision. We know that people are busy. We know that people take risks. We know that taking risks is not always a bad thing. And as Medcraft says, we know that most people don’t read the PDS, or terms and conditions, or the fine print.
So, the first step is to put the consumer back into consumer protection. But, I am not suggesting a revisiting or re-engineering of the PDS. That wouldn’t solve any problems. Because the focus is still on the document, not the consumer.
So how would this look?
Firstly, it is important to understand that there are always going to be mistakes, and there are always going to be people who make mistakes. And the reality is that we don’t want to completely remove the opportunities for people to make mistakes or take risks. If people don’t take risks, there won’t be innovation, nor will there be investment growth.
But somehow we have to find a balance between risk and disaster.
One way is to include experts outside of the law contributing to regulation and the setting of standards. Regulation needs alternative perspectives that consider the reality of human behaviour. This has to happen as legislation, policy, standards or regulation is being drafted, and as financial products are developed. What this might mean is that a regulator has to be more proactive, rather than reactive, one thing that Greg Medcraft has suggested in the past.
Perhaps regulation and standards should go through a due diligence or stress-testing process with behavioural specialists, so that we know that it is going to achieve what the lawyers are hoping it will achieve.
And on the supply side, products should also go through a due-diligence process or a product piloting. In the same way that a marketer would go through a piloting process to see if people would buy their product, maybe some financial products should go through a piloting process to see if they might cause harm.
And not just harm in the context of legal process – what I am suggesting is that harm has to be considered in the context of potential consumer behaviour. In the same way that we seek legal advice about consumer policy, we should also seek consumer behaviour advice. Maybe not all products, but perhaps products that have more potential for harm.
Perhaps we need to make sure that before people sign a PDS (or whatever we end up with), they undertake a knowledge test; not asking them what they think they learned, but actually seeing what they did learn from the PDS. This is the nub of Medcraft’s argument – his suggestion is not to get people to do an exam, but to test whether the person who read the PDS, actually understood the PDS.
Not to necessarily rule out risk, but simply to understand the risks.
And there are other ways we can get to a point where consumers are better placed to make appropriate decisions.
One way is related to how the PDS is framed. Some refer to it as “choice architecture”. If we already know that most people are unlikely to read all of the detail in a PDS, we can use language to get people to at least engage with some of the material provided to them, which is something that I suggested in my speech at the ASIC Summer School in 2011.
We know that polite and formal language signifies and creates psychological and personal distance. In other words, the use of normative, polite language – the language used in business and law – rather than colloquial, less polite language, leads participants to believe that the target of the communication (them) is spatially and temporarily distant.
Research by Stephan, Liberman and Trope published in 2010 found when participants read or heard a formal statement such as “My brother is taking our family car, so the rest of us will stay at home” they believed that that the person who was being addressed was not them, in a more remote location, and the conversation referred to something that might happen in the future. A better way to put the same statement would be, “My brother is taking our family car, so the rest of us will be stuck at home”.
We also know that hypothetical language, such as “this may happen to you” affects the perception of distance, and concreteness, in that people don’t expect hypothetical events to occur, at least to them, and in the near future.
So, if we want people to take notice, language needs to be direct, immediate, and personal.
In the same vein, the layout and format of information should be more about comprehension, and less about formality. The most important information should be upfront, rather than following a more formal, traditional structure. The things that you want people to read should be early and in bold.
All of this requires a new way of thinking. Or what Medcraft suggests, which is that we “have to think more creatively to make sure that people actually know what they are buying.”
And, without oversimplifying the issue, we have to stop being so formal, and become more strategic about the realities of human behaviour.
In order to achieve this, Rational Choice Theory – the Homo economicus concept – must be abandoned in favour of a more realistic view of the individual, as an agent endowed with imperfect knowledge of the factors and risks involved in a decision, and subjected to a myriad of potentially influential stimuli entering his or her decision making process.
In a nutshell, let’s start with the premise that we are all less rational than we think we are, and work from there.