Mis-Selling and the Responsibilities of Consumers

(By Robert Sugden) The Financial Services Authority (FSA) is in the process of being split into two parts.  From early 2013, its consumer protection functions will be taken over by a new agency, the Financial Conduct Authority (FCA), headed by Martin Wheatley.  Last week, in an address to the British Bankers’ Association and in an interview with the Financial Times, Wheatley set out the priorities of the FCA.  His message was that the FCA would be more interventionist than its predecessor, would give more weight to the findings of behavioural economics and be less ready to assume that consumers act in their own best interests.  He is quoted as saying: ‘You have to assume that you don’t have rational consumers’.  And:  ‘But what the FCA won’t be doing is … letting the market get on with it and expecting clear disclosure and a mandated sales process to do its job’.

The idea is that a firm has an obligation to ensure that its products are genuinely valuable to the people who buy them; it’s not sufficient that the customers have been properly informed about those products and choose to buy them:

If a consumer makes a fully informed decision that subsequently goes wrong, then that is down to them.  But we have to be realistic.  And what this is about is balance.  We have to realise that consumers aren’t always in a position to take responsibility, because of their lack of financial knowledge and because we have to take a reasonable approach to what a normal person can understand about complicated products and risks.  And so I believe that balance comes from all parties – consumers, providers, intermediaries – taking responsibility for their part in each transaction. 

More bluntly, Wheatley told his audience of bankers what the FCA would expect of them:  ‘I want the culture in your firms, from your product governance to your sales, to be aligned with the best interests of your customers.  I don’t want to see any of the failings the FSA has had to deal with in the last few years.’

These ‘failings’ clearly include the recent cases of mis-selling mortgage payment protection insurance to people who did not satisfy the conditions for making claims, and of mis-selling investment bonds to finance the long term care of old people whose life expectancy made this a bad buy.  In these cases, it seems right to say that firms were taking improper advantage of consumers’ lack of financial sophistication.  The firms knew, or should have known, that the products they were selling did not have the characteristics that their customers thought they were paying for.

But this is less obvious in another of Wheatley’s examples – the sale of Lehman  mini-bonds in Hong Kong (where Wheatley was the head of the regulatory agency for financial securities).  These were high-risk, high-return financial derivatives sold on the retail market.  As a result of the collapse of Lehman Brothers, holders of these bonds were in danger of incurring large losses until a rescue package was put together.  Wheatley’s interpretation of this case is that mini-bonds were suitable only to be held as small parts of large diversified portfolios, but were sold to ‘poor people putting in their life savings’.  I can agree that the buyers of these bonds acted unwisely, but that is not to say that they didn’t understand what they were buying.  In a period when asset prices keep increasing, people are tempted by what seem to be easy gains.  This is as true of ordinary people as it is of professional traders.  Some of these people are lucky, and take their profits.  Too often, the unlucky ones blame the firms that sold them what at the time they wanted to buy, or the regulators who didn’t stop them from doing so.

I agree with Wheatley about the need to balance the responsibilities of firms and consumers.  But I am not sure that he has got the balance right.

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