June 25, 2007
Third Annual Conglomerate Junior Scholars Workshop: David Friedman's Reinventing Consumer Protection
Posted by Christine Hurt

Welcome to the first paper to be presented in the Conglomerate 2007 Junior Scholars Workshop.  Today's paper is Reinventing Consumer Protection by David Friedman.  David is currently a visiting assistant professor at Willamette and has as his teaching and research interests consumer law, contracts, commercial law and business associations.  Commentators for David's paper include Larry Garvin, Bob Lawless, Adam Levitin and Ronald Mann.  Throughout the morning, I will post the comments of these experts below this post.  We invite readers to comment on the paper (and the comments) in the comments section of this post.  In the interest of running this workshop like a physical world conference, no anonymous commenters, please.

Here is the abstract for Reinventing Consumer Protection:

Consumer fraud presents a continual puzzle for society. We have significant enforcement and education mechanisms, yet we continue to endure ever-evolving consumer fraud. I contend that the incidence of consumer fraud can be reduced through creative, efficient, non-traditional instruments of deterrence.

This article proposes a plan for re-approaching consumer protection through selection of a protected group and a concentrated reallocation of resources. Specifically, I argue that enhancing sanctions for a vulnerable, reluctant-to-report consumer group will shift fraud perpetrators toward targets that are better able to defend themselves. Additionally, fraud perpetrators will have to operate with extra caution in their schemes to ensure that they will not inadvertently ensnare a member of the protected class. This measure would accomplish further protection of the selected group and moderately increase deterrence throughout the rest of the economy.

However, I argue that this measure should be supplemented with another initiative. If we create a group consisting of randomly selected consumers and provide the members of that group with significant extra protection through higher sanctions and concentrated consumer education, fraud incidence will drop even more significantly. The concealed nature of the randomly protected consumer creates a general aura of deterrence. In this environment, fraud perpetrators never know whether a potential victim carries specially protected status- this elevates the risk of detection and the expected sanction for all consumers.

Group protection enables enforcement to achieve deterrence without having to provide incremental, expensive protection to the entire population. Understanding how the perpetrators and consumers make decisions about engaging in transactions is the key to unlocking efficient methods, like those described, for achieving the objective of efficiently reducing incidence of consumer fraud.

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Comments (11)

1. Posted by David Friedman on June 25, 2007 @ 12:20 | Permalink

First, thank you to Christine Hurt and Bob Lawless, Ronald Mann, Larry Garvin and Adam Levitin and all those who took time to read my paper and offer candid and valuable critiques. As a new entrant to this arena, these comments will prove invaluable to me as I revise the paper and go on the market.

I’ll start with a response / reaction to some of the major points raised by Professor Lawless, as many are echoed in the Mann, Garvin and Levitin critiques.

1. LoJack and Chop Shops: I concede the point (a point that Ayres & Levitt make and that I will acknowledge) that LoJack’s power and effectiveness was significantly attributable in part to the destruction of chop-shops. Shutting down the chop shops destroyed a large part of the industry structure / value-chain for auto theft. While I do focus in the article on the “invisible deterrent” component of LoJack (for the front-end of the theft) as applied to a consumer fraud mechanisms, “the chop shop” piece of the LoJack effect does not translate well- and I should not oversell the LoJack analogy. I will have to qualify it.

While consumer fraud does not require a physical location like auto chop-shopping, sometimes it does involve a focal point, especially in the corporate consumer fraud context (e.g., the fraudulent freecreditreport.com scheme recently resolved by the FTC or the crackdown on the company that sells Enzyte). Sometimes fraud involves a network of connected people. For example, a point could be made that a highly-educated LoJack consumer could lead enforcement to certain more organized, more elusive “consumer fraud chop shops,” like identity theft rings. (Though I am reluctant to cite an example from television reporting, NBC News recently followed an educated consumer’s interaction with a complex Nigerian 411 scam right into the den.) I still agree, however for the purposes of measuring potential impact, we would not see results approaching that of LoJack, which was regarded as one of the most effective anti-crime “programs” measured in the literature.

2. Deterrence: W&A did note (and I should not have ignored) that when prison time was factored in, “crime did not pay” for any category of crime. Aside from that… the data that I rely upon from Wilson & Abrahamse (9 Crim. Just. Q 359, 367 (1992)) shows that for high-rate offenders, criminal earnings per year (1988 dollars) illustrated from burglary and theft were $5,700 vs their legitimate earnings alternative of $5,500. Earnings from swindling were $14,800 vs their legit earnings alternative of $6,200. If you use my linear equation, a swindler would need to discount the expected value of crime a whole lot more than the burglar to look less attractive. Even if fraudsters are “temperamentally disposed to overvalue the benefits of crime,” there would be comparatively more benefits to discount in their case. Even factoring in the prison time component, my revised point here is that this is a group that is perhaps especially over-rewarded for their brand of crime relative to other criminals- and an extra measure of deterrence here would help diminish that net reward or enhance costs further. It’s also support for an argument for diverting more white collar crime deterrence resources here. I will admit that there is some conjecture here. Crime doesn’t pay, but this holds less so for the fraudster. Given these qualifications, will this fly?

3. Effectiveness of Multiple Agencies: I resubmit my hypothesis (which admittedly, is just a hypothesis) that structurally, multiple agencies with limited jurisdiction drives up the cost of reporting and resolving fraud for the consumer. Does the consumer with a phone rate problem call the state attorney general? If so, does the volunteer staffed hotline know that only the FCC can address such a complaint? How much do the consumer and the person receiving the complaint know about which phone complaints are pre-empted from resolution and which are not? Does the complaint get dropped? Or does the consumer confront the additional costs of contacting the other agency, if the consumer knows which agency it is? I can’t empirically prove that this diffuse system is more costly or less effective- my question is…do I have enough of a hunch to present a stronger hypothesis than Prof. Lawless’ counter-hypothesis (which I must acknowledge) that more agencies = more reporting mechanisms? Or is the unified complaint window a better alternative?

The United States may have a comparatively low incidence of consumer fraud, but I tried to stay away from the question of “what is the optimal amount of fraud?” for the reasons Professor Levitin noted. I do know that the FTC’s Consumer Sentinel has reported that fraud complaints have remained stable, but the median dollar amount “paid” as part of that reported fraud doubled from 2004-2006. This data can be interpreted multiple ways. Is fraud growing or is reporting improving? (The Sentinel is a multi-source database.) What are the proper benchmarks for this? As we look forward at our demographics, will our aging population raise the overall level of susceptibility? We do see the FTC and the states, etc. concerned with growing pockets of fraud, whether they are new scams or simply bumps in target populations. If we don’t think addressing fraud is a problem worth prioritizing, based on what I’ve presented or presumed, that’s a big issue I must address.

4. Constitutional Problems: If Constitutional issues obstruct the practicality of protecting a group with enhanced sanctions, I would switch toward enhanced education. (acknowledging the inherent problems to which Professor Garvin alludes…) Further, I may be a victim of the limited nature of data availability- the best research we have is broken out by ethnic group, region and age. If there are better ways to get the job done without tripping a constitutional wire, I’d go there.

Curious to get your feedback. I’m still in digestion mode, but will get back to the other commentary.


2. Posted by David Zaring on June 25, 2007 @ 14:36 | Permalink

This may echo Adam L's comments, but would super-educating a group of random consumers be efficient? Is that a good use of anti-fraud resources? Cheaper than educating everyone, I suppose, but one wonders if education is really the answer.

And I too wonder if fraud prevention capacity isn't already randomly distributed among the population. A regime of reverse stings, in fact, might look to fraudsters exactly like Friedman's proposal.

But that's not a knock against it. Seems like a neat project.


3. Posted by David Friedman on June 25, 2007 @ 17:24 | Permalink

Hi David,

I agree with your observation that pure education alone is probably not the answer. I think you have to give these random consumers something extra, like a unified complaint window that shepherds the fraud complaint to the right area. The complaint window both lowers the cost of the complaint (time efficiency) and gets the complaint to the right desk (enforcement efficiency). Further, I would also provide for an enhanced sanction for ensnaring this special-status random, hidden-status consumer in the net.

Concentration of education would be but one pillar of that effort. Thank you for helping me clarify that point.


4. Posted by David Friedman on June 25, 2007 @ 18:28 | Permalink

Professor Mann’s point about improving the information flow to authorities about broader deceptive practices had not occurred to me. It is amazing how deceptive practices can hide in plain sight before they are detected. (I am researching “free offer” regulation right now and his comments ring true in that arena.) Indeed, deceptive practices are more widespread and require more sophistication to even detect. This certainly requires more investigation on my part.

It is true that businesses develop offerings that separate sophisticated customers from unsophisticated customers. (I don’t know why, but the now near-defunct practice of door-to-door sales of rip-off dread-disease insurance in poor areas of rural towns comes specifically to mind.) Almost by definition, where that strategy works, only the unsophisticated are hurt. Sophisticated customers are not in the kill zone- by design. How could my proposed approach help? I would first turn to the protected group approach. If someone has the contextual external profile of “unsophistication,” but has assigned protected group status (let’s say low-income people in towns classified as rural), we have elevated the risk for cheating these individuals as a group. Let’s assume for this illustration that local law enforcement could assist in educating people about group status- and perhaps even assist in their individual capacities as residents in reporting fraud.

A detour: I will note, just out of pure irony, and returning to Professor Mann’s point about deceptive practices, that many of the early recorded complaints about deceptive free offers grew out of schemes that targeted the sophisticated. Encyclopedia sales and book club offers were targeted at literate (of course) people, who fell hard for free offer sales tactics. (The tactics heavily relied on flattering consumers that they were leaders and intellectuals who were specially chosen to receive a free encyclopedia…with a $69 (1930s $$) loose leaf supplement attached.) The so-called sophisticated aren’t even always such, which raises the bar for any scheme designed to protect the public as a whole. Although the sophisticated may be more likely to report…

How would the “artificially-educated” consumers differ in the marketplace from sophisticated consumers? How would we make them more resistant to deception and better reporters of fraud? It would likely require a great deal of tinkering to figure that out. Maybe they will not be significantly more resistant to deception on the front end- just better able to report it after being educated to use a set of streamlined tools for reporting deception. I’ll be giving Professor Mann’s question more thought.


5. Posted by Ronald Mann on June 26, 2007 @ 9:58 | Permalink

I think your reaction is spot-on, and love the example about encyclopedia salesmen. {We had such an encyclopedia on the shelves of my home when I was a child.} I did not mean to suggest that the “sophisticated” are more impervious to product design than the unsophisticated. Merchants just use different products to sort them out. For an example from the cards industry, wealthy sophisticates are too “smart” to pay high interest rates on credit cards, but they are happy to pay large annual fees for affinity cards on which they never use the rewards. Indeed, because the wealthy tend to value their time more highly they may be even less likely than those in financial stress to study the terms of their card agreements.

The concern about deterrence that others have raised does not trouble me as much, in part because of my view that the best application of this idea is to large-scale routinized conduct. If hardened fraudsters at one end of the spectrum are poor candidates for rational-actor analysis, large multinational merchants and financiers are ideal candidates. This is why I encouraged you to think carefully about the different types of conduct that come under the FTC’s domain.


6. Posted by David Friedman on June 26, 2007 @ 10:43 | Permalink

Ron, thank you for the clarification. That point will certainly guide my revisions.


7. Posted by David Friedman on June 26, 2007 @ 11:06 | Permalink

I owe Professor Garvin a thank you for pointing me toward a variety of literature that I need to incorporate into my analysis.

I think all of the commenters agree that the fraud commission risk / rationality component of the paper needs to be addressed. I was especially grabbed by Garvin's comments about the psychology of the swindler- and I need to explore that area in more detail. My take would absolutely benefit from acknowledging and applying those nuances. For the broader questions around the econ of law & punishment, I will take look at Polinsky and Shavell's survey and what has happened since, and see what I can apply.

As far as consumer psychology, I agree that qualifications need to be made and literature explored. Indeed, in many areas of the economy, strange behaviors pop-up when you over-protect a group of people or insulate them from harm. (Anyone who has been around a free-range child intuitively can see the results from insulation from consequences.) There is a fantastic body of literature there that I'm delving into now for my next project. Thank you specifically for pointing me toward Greg Mitchell's work on the cognitive psychology of subpopulations.


8. Posted by Susie Morse on June 26, 2007 @ 12:13 | Permalink

Perhaps another group-targeting strategy (in addition to education and a unified complaint window) that skirts Constitutional problems might be focused, branded publicity of successful government efforts to catch consumer fraud perpetrators that preyed on members of vulnerable groups. It would be nice if such publicity, and public education generally, could break out of the bland form that often characterizes public education messages. One recent paper, Medill, 92 Cornell L Rev 323, discusses principles of public interest advertising drawn from a successful youth-targeted anti-smoking campaign.


9. Posted by David Friedman on June 26, 2007 @ 12:25 | Permalink

Professor Levitin raises many helpful points, and his four questions at the end about the bases for certain assumptions I make are especially important.

The first two questions I would fold into the aforementioned problems about criminal rationality. Epistemic constraints on rational actors are real. I would address them by adding as much certainty about punishment into their personal equation as I possibly can. Our baseline is a system where penalties are much more vague and, as Levitin notes, the path from detection to prosecution is also opaque. The solution is to make "X + Y" (probability) as visible as possible, in every cost-effective way. Perhaps I'm understating the need for scammer "education" (and the difficulties with scammer absorption of that education), given my focus on consumer education.

Granted, some actors may undervalue (or overvalue) X + Y. Some may value it perfectly and discount it heavily. As the saying goes, stupid is forever, and changing the rules doesn't fix that. We're hoping for a good net result.

Levitin's third point about the shape of the deterrence curve is one I concede. The only way it could be 1:1 would be through sheer coincidence- and it is an oversimplification to represent it as such. As per Levitin's suggestion, the assumption should be relaxed. (It would take quite an empirical effort to derive it.)

In sorting through the points raised about efficiency, I found the idea of inserting "least cost avoiders" of consumer fraud into the equation quite intriguing. I'm not sure what the impact has been from banning US credit card issuers from abetting US residents in online gaming, but it's worth looking at as an analogy. There might be a way to include LCAs into a comprehensive approach.

Returning to the beginning of Adam's comments about addressing diffusion, the questions about "Why not a 311 system for everybody?" instead of a limited-access complaint window, and "why not a unified federal consumer protection agency?" are good ones. My answer to the first is that this proposal tries to ensure that the complaint window embodies a concentration of well-honed anti-fraud resources- a concentration that would be diluted if spread broadly. I also speculate that a national 311 would be more costly to implement than a focused complaint window program. (I say speculate, because it all depends on the assumptions.) I surmise that the complaint window will wind up creating an information flow, similar to the one to which Professor Mann refers, that can be leveraged to benefit the whole.

As far as creating a unified federal consumer protection agency... it may be ironic, given my proposal to say this... I think it might prove impractical. We have the FTC right now- could you strip out the consumer complaint components from the myriad of agencies and put them in a new integrated agency? We could. It might resemble the Department of Homeland Security if we're not careful, though, in terms of integration and implementation. Also, for one example, you may need to keep the expertise about banking consumer issues close to the bank regulation entity- and use the complaint window as the guiding mechanism for a consumer to get their beef to the desk where it belongs.

Adam, there's a lot for me to chew on with your other comments. There's a great deal to re-think and I will be doing just that.


10. Posted by David Friedman on June 26, 2007 @ 12:33 | Permalink

Susie,

Thank you for sharing that idea and the accompanying cite. Branded, focused publicity could work on multiple fronts: the consumer, the potential scammer (in terms of warning them about new potential consequences) and the community.

For example, there is an effort to protect members of the Spanish-speaking Mexican-American and migrant community from something called "notario" abuse. (Notaries in Mexico have a status similar to that of a certain grade of lawyer. In the U.S., some individuals get a notary stamp, and confuse members of the community into thinking that they are American lawyers, with the power to clear up immigration problems, negotiate real estate transactions, etc.)

Here, a focused, branded publicity effort could have a reverberating impact on consumers of such services, providers, and can turn the community at-large against such activity.

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