Matthew SmithBarrister

Thorndon ChambersPO Box 1530Wellington 6140New Zealand

Tel: (64 4) 499-6040Fax: (64 4) 499-6118

6th Floor10 Customhouse QuayWellington

e-mail: matthew.smith@chambers.co.nz

DISCLOSURE-BASED REGULATION

Law & Economics Association of New ZealandWellington Seminar, 20 May 20131

1. INTRODUCTION AND CONTEXT

1.1. Information disclosure is a regulatory device which provides users of a

good or service (‘consumers’) with relevant information about the

consequences of using it.2 Its purpose will often be to warn consumers

about possible negative effects of using a particular good or service, so that

those effects can be taken into account before they ‘transact’. Seen in this

way information disclosure (when it is effective) can lessen the need for

regulators to resort to a blunter regulatory device, such as an outright ban of

a good or service, or the specification of minimum design standards for it.

1.2. Disclosure-based regulation comes in many forms. Examples include

prescribing standard test protocols, the results of which must be published

(eg, at the point of sale in terms which can be compared with other goods

1 I wish to acknowledge Assistant Professor of Law Yesha Yadav from the Vannderbilt Law School, who offered helpful comments and suggestions on an earlier draft of this paper. All errors are however mine and mine alone.

2 Tobias Maugg, “Out of the dark: the role of information disclosure regulation in New Zealand”, (Oxera paper, Sept. 2002), available online: http://www.oxera.com/Oxera/media/Oxera/downloads/Agenda/Information-disclosure-regulation.pdf?ext=.pdf (last accessed 9 May 2013), at 1. See similarly David Weil, “The Benefits and Costs of Transparency: A Model of Disclosure Based Regulation” (17 July 2002), available online: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=316145 (last accessed 15 May 2013), at 2 (“disclosure policy involves a government authority requiring the collection and dissemination of standardized information from identified businesses or other organizations at regular intervals for the purpose of changing the behavior of the information disclosers as well as in some instances information users”).

of the same type or model); producing comparative information and

publishing ratings; requiring a label warning, list of contents, or summary

of legal rights associated with a good or service; and publishing special

materials to convey technical information more simply to the public, such

as by way of ‘fact books’ explaining information that may be difficult for a

non-expert to understand or that is otherwise unavailable in one place.

1.3. Set out in an Appendix to this paper is a summary of statutes currently in

force in New Zealand and which provide for disclosure-based regulations.

They show that our common approach is to provide in primary legislation

for regulations to be made requiring the disclosure of specified information,

such regulations being backed up in turn by criminal sanctions in the event

of non-disclosure, or in the case of false or misleading disclosures. In these

statutes one can see a helpful template, at least as a starting point, for the

design and operation of future disclosure-based regulations.

2. REASONS TO USE DISCLOSURE

2.1. The (economic) incentives associated with greater information flows are

likely to improve the operation of markets and, in doing so, stimulate

competition and innovation – all good things. Disclosure-based regulations

can also provide helpful information to regulators, which can be used to

further refine regulatory policies and practices, or to raise public awareness

of issues hitherto off the (political) radar. These potential benefits of

disclosure-based regulation are expanded on below.

(2A) To correct market flaws (information asymmetries)

2.2. For markets to operate efficiently, all parties need reliable information.

Ideally, normal market forces govern how producers and suppliers of goods

and services (‘sellers’) disclose information.3 But while competition might

induce sellers to publish information about the positive qualities of their

goods or services, the negative qualities like potential defects or risks are

unlikely to be referred to by sellers in their advertising materials.4 This

causes ‘market failures’ which are characterised by the poor flow of

3 But note that although economic analysis of markets often assumes ‘perfect’ information, “clearly the phenomenon never exists in the real world; some degree of uncertainty as to present or future facts must always be present”: Bronwen Morgan and Karen Yeung, An Introduction to Law and Regulation: Text and Materials (Cambridge: Cambridge University Press, 2009 reprint), at 24.

4 Morgan and Yeung, at 25.

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information. These failures can result because the effects of poor product

choices are ambiguous or hidden, because gathering data is costly (not

profitable),5 or because no sellers have a sufficient incentive to disclose.

2.3. Where a market is characterised by sub-optimal information, disclosure

requirements can help to strengthen the flow of information from sellers to

consumers to correct the imbalance of information, encourage informed

choices and promote market efficiency.6 Disclosure is designed here to

generate the ‘optimal’ amount of information, and may in doing so address

external costs (‘externalities’) which may be efficiently dealt with by

informing consumers about the externality to enable them to take steps to

avoid it, rather than by prohibiting or restricting the regulated activity.7

(2B) To improve management and firm performance

2.4. Information disclosure might be intended to improve the performance of

managers, by providing information that can be used to monitor agents, by

creating information that managers would otherwise not have available to

them, or by forcing firms to confront facts by making them gather data – on

the theory that managers will pay attention to things they are forced to keep

track of.8 Information disclosure might also help to improve corporate governance more generally, the reasoning here being that:9

It provides directors more information by which they can evaluate the strength of the company and the performance of the officers; it strengthens the role of auditors in their own watchdog role; it enhances the effectiveness of shareholder voting and shareholder litigation as constraints on corporate governance; and it permits the governmental oversight agencies to perform more effectively.

(2C) To regulate lawful conduct (behavioural ‘nudges’)

5 Mary Graham, “Information as Risk Regulation: Lessons from Experience” (HKS Regulatory Policy Program, May 2001), available online: http://www.hks.harvard.edu/m-rcbg/research/rpp/RPP-2001-04.pdf (last accessed 13 May 2013), at 10. See also Paula J Dalley, “The Use and Misuse of Disclosure as a Regulatory System”, (2007) 34 Florida State University Law Rev 1089, at 1109.

6 Graeme Austin, “The Regulation of Consumer Credit Products: The Effects of Baseline Assumptions”, in Susy Frankel (ed.) Learning from the Past, Adapting for the Future: Regulatory Reform in New Zealand (Wellington, LexisNexis, 2011), at 296; Graham, at 10; Dalley, at 1109; Zohar Goshen, “The Essential Role of Securities Regulation”, (2006) 55 Duke Law Journal 711, at 740 (“disclosure duties subsidize search costs and facilitate a competitive market for information traders. As competition among information traders intensifies, the ability of each individual information trader to exploit informational advantages diminishes”).

7 Morgan and Yeung, at 96. Mandatory disclosure may have positive synergies. In the securities context, for instance “a competitive information market generates increased demand for firm-specific information, which in turn provides managers with incentives to make timely and elaborate disclosures beyond what is mandated by law, in an attempt to capture the benefits of increased coverage by information traders”. See Goshen, at 739.

8 Dalley, at 1111, 1130. See similarly Weil, at 6. 9 Dalley, at 1099 (quoting Robert B. Thompson, “Corporate Governance After Enron”, (2003) 40 Houston Law

Review 99, at 111).

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2.5. A further possible benefit of disclosure-based regulation is that it may be

used to alter lawful behaviour, such as the level of production or

consumption of a good or service, in a beneficial way.10 Graphic warnings

on cigarette packets is arguably one such example, it being intended to

highlight the health effects of smoking and thereby reduce its incidence

without the need to take the drastic step of banning cigarettes.11 Related

goals may be to improve the quality or reduce the price of a good or

service,12 or allow cooperation amongst firms by making information about

innovations available for further development and challenge and testing.13

(2D) To make fraud or misrepresentation harder

2.6. Information disclosure can also be justified as a requirement which

increases the effort required to commit fraud or misrepresentation.14 In

anonymous markets, where it can be easier for sellers to deceive,

information disclosure requirements can prevent harms like insider

trading.15 In order to satisfy the market’s demands where there are

disclosure requirements, defrauders must also construct fundamental

aspects of business and “present a veneer of plausibility”.16 Common sense

suggests that as the amount of information available in marketplaces

increases the likelihood that individual pieces of false information will be

able to mislead anyone decreases.17 Disclosure requirements should in

theory also provide earlier warning that things are going wrong.18 This has

application for instance to the Christchurch Rebuild, as concerns grow

about fraud and possible secret commissions.19

2.7. Note that as a related but incidental benefit, mandatory disclosure

requirements in helping to make fraud and manipulation harder to commit,

also help to preserve the value of services offered by intermediaries like

10 Dalley, at 1110.11 See Barak Orbach, Regulation: Why and How the State Regulates (New York: Foundation Press, 2013), at 778

(stating that tobacco companies “have never voluntarily disclosed information about the negative effects of smoking and effectively denied them for decades”).

12 Dalley, at 1110.13 Dalley, at 1130.14 See Morgan and Yeung, at 96; Dalley, at 1099.15 Goshen, at 738 (“the more information that is disclosed, the lower the risks associated with both insider trading

and estimating the fundamental value of the firm”).16 Dalley, at 1099.17 Dalley, at 1099.18 Dalley, at 1099.19 Refer for instance to Tamlyn Stewart, “Rebuild fraud targeted in initiative”, The Press (19 October 2012);

Hamish Fletcher, “Get tough on corruption – SFO”, NZ Herald (14 May 2013).

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financial analysts and protect the reputations of intermediaries. This point

is helpfully made by Goshen in the context of offerings of securities:20

Because fraudulent and misleading statements distort analysts’ predictions and dilute the value of their analysis, investors who purchase the financial analysis are clearly adversely affected by the misstatements. Realizing that analysts’ predictions could be skewed by fraud or misstatements, investors will trust analysts less and adjust downward the price they are willing to pay for their services. Worse yet, the distortions caused by fraud and manipulation will tarnish the analysts’ reputation, making it harder for them to recover their costs. Restrictions on fraud and manipulation protect the value of analytical products and the reputation of analysts. Like mandatory disclosure duties, restrictions on fraud and manipulation also create a virtuous cycle. By reducing information traders’ precaution costs, restrictions on fraud and manipulation facilitate entry into the information traders market and thus increase competition among information traders. The enhanced competition will, in turn, increase the probability of detecting misstatements and fraud, and thereby reduce the incentive for corporations to engage in fraud or manipulation. The reduced incentive to release misleading information to the market will further decrease information traders’ precaution costs, and so on.

(2E) To provide information for regulatory use

2.8. Information disclosures can also be intended to be used by and to improve

the operation of government itself.21 As regulators need information to

design and enforce direct regulation systems, and as this information may

not be broadly published, disclosure-based regulation can change that.22

This thinking seems to be behind information disclosure in terms of Part 4

of the Commerce Act 1986, where disclosure helpfully provides a set of

standardised regulatory accounts and non-financial information the

CommComm can use as part of its price-quality regulation.23 The

information also allows the CommComm to evaluate the effectiveness of

the system, which helps in turn in assessing whether further regulation may

be required as well as to refine the approach to regulation over time.24

(2F) To increase public awareness of an issue

2.9. Finally, information disclosure may be used in an attempt to generate

interest in the information itself.25 To take an example from the U.S., it has

been suggested that the Security and Exchange Commission’s continuing

attempts to improve the disclosure of executive compensation packages

may reflect its hope that eventually investors will start paying attention to

20 Goshen, at 742-43.21 Dalley, at 1110-11.22 Dalley, at 1111.23 Maugg, at 3. 24 Maugg, at 3 25 Dalley, at 1112.

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the matter.26 Similarly, national garment labels such as the “New Zealand

Made” label27 are generally intended, at least in part, to raise consumer

awareness of the conditions under which particular goods are produced.28

3. UPSIDES TO DISCLOSURE-BASED REGULATION

3.1. Information disclosure is often attractive to regulator and regulated parties

(‘regulatees’) alike. Three common reasons for why this is so are, first, the

relatively lower costs entailed in disclosure-based regulation when

compared to other types of regulation; second, the potential information

disclosure has to stimulate competition and innovation for the net benefit of

society; and, third, the personal empowerment aspect of disclosure. These

potential upsides are considered in more detail below.

(3A) Less expensive

3.2. If information disclosure can displace or supplement more ‘substantive’

regulation, such as design standards or prohibitions, compliance costs will

almost always be lower. This is because substantive regulations often

require the redesign of a good or of a production process, which will mean

costs and disruption for regulatees. While the costs of disclosure are not

zero (costs are involved in creating, compiling, and publishing information,

for instance),29 they are normally lower than mandatory specifications – for

instance, a regulatory requirement to retrofit a particular technology to

existing plant in order to achieve reduced carbon emissions.

3.3. Administrative costs should also be lower with disclosure-based

regulations, including for the reason that information disclosure might

remove the necessity for more regular plant inspections or regulator

investigations and audits, with associated costs to regulators and regulatees.

3.4. On top of cost savings for regulatees and regulators, disclosure-based

regulations offer cost savings for consumers.30 Mandatory disclosure

requirements reduce search costs because it is cheaper for regulatees to

26 Dalley, at 1112.27 See http://www.buynz.org.nz/.28 Dalley, at 1112.29 A point noted for instance by Morgan and Yeung, at 97; Cass R Sunstein, Risk and Reason: Safety, Law, and

the Environment, (Cambridge: Cambridge University Press, 2004 reprint), at 260-61.30 See Goshen, at 758-59.

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disclose than for outsiders to unearth regulatee-specific information.31

Disclosure by a regulatee also prevents duplicative investments in

(undisclosed) information by consumers and their advisers, in effect

subsidising search costs for all consumers. Finally, disclosure-based

regulation can have the advantage of allowing consumers to exploit

economies of scale in analysing standardised information from all firms in

a regulated market. Goshen draws on these benefits to conclude:32

[T]he public good characteristics of information produce a benefit for the market: the small investment made by the [regulatee] in disclosure of information effects enormous savings in search costs for all information traders.

(3B) Pro-competitive

3.5. In helping to stimulate competition amongst sellers of goods and services

for improved quality or performance, information disclosure can encourage

innovation – replacing centralised government decisions with informed

freedom of choice amongst many users, and stimulating competition

amongst sellers of goods and services for improved quality or performance.

It can also give the regulated sellers broad choices not only about how and

how much to change practices, but also about whether to change them.33

3.6. Take the following example.34 If a regulator requires sellers of a particular

good to publicly rate hidden factors according to a standard test procedure,

consumers of the good will be able to make better informed purchase

decisions. As consumers alter their purchasing decisions in light of this new

information, sellers have a new market incentive to compete for that

business by enhancing the rated qualities. If the rating methods are well

chosen and accurately reflect the qualities they are intended to rate, not

only should competition increase, but the overall quality of the goods and

services offered in the market should improve and further innovation

31 As Goshen notes, producing firm-specific information is an integral by-product of effectively managing a business, and the added cost of disclosing it is marginal.

32 See Goshen, at 758.33 Graham, at 11. See also Goshen, at 756 (“First, information disclosed by a corporation provides value to actual

or potential competitors, and enables them to evaluate their position vis-à-vis the disclosing corporation and respond to the disclosed information (e.g., stop or accelerate research and development, change marketing or pricing strategy, or enter or exit a market). Second, disclosure provides value to creditors, employees, suppliers and consumers of the disclosing corporation, allowing them to improve their negotiation position vis-à-vis the corporation. Third, the information provides value to prospective investors who are not current shareholders of the corporation, allowing them to better compare the corporation with alternative investments in composing a portfolio that might exclude or include the corporation’s securities.”) (internal citations omitted).

34 Taken from Project on Alternative Regulatory Approaches, Information Disclosure: A Practical Guide to the Use of Information Disclosure as a Regulatory Alternative (September 1981), at 5-6.

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should be encouraged – possibly going beyond what could have been

mandated by a regulatory intervention setting fixed design specifications.

(3C) Personally empowering

3.7. If information disclosure leads to greater innovation and higher quality

goods and services, it should in turn help to ensure that consumers have

greater choice amongst goods and services than they otherwise would.35 In

this respect information disclosure has the advantage that goods or service

choice is based on personal preference, not limited by government. This

comports with the political philosophy that individual choice should be

preserved as much as possible while avoiding direct government

interference,36 and may appeal to those whose orientation is to address

market failure without disturbing other beneficial features of the market.37

4. LIMITS TO DISCLOSURE-BASED REGULATION

4.1. While information disclosure is attractive to regulators and regulatees

(including for the reasons just noted) it does have its limits. One is the

potential for mandatory disclosure to clash with legally recognised rights to

privacy and confidentiality – a legal limit. Another is the potential for

cognitive biases consumers have to defeat the very purpose of having better

information before transacting – a practical limit. There will also be

contexts in which disclosure-based regulation in itself will not be sufficient.

(4A) Legally protected information

4.2. Starting with legal limits, mandatory disclosure has the potential to clash

with legal protections of sensitive information of a business/commercial,

personal or cultural kind, in circumstances where confidentiality may have

a claim to priority.38 This is important for regulators because clashes

between disclosure and the need to protect sensitive information can lead to

35 Note Weil, at 29 (disclosure-based regulation “is appealing to those who oppose other forms of regulatory intervention because it provides a means of changing behavior that appears more flexible and therefore less onerous than traditional command-and-control or even performance based regulatory systems”).

36 Dalley, at 1093. Further note Sunstein, “The Storrs Lectures”, at 34 (“A central argument, applicable to any kind of paternalism (soft or hard, means or ends), is that errors are more likely to come from officials than from individuals. Public officials lack the information that individuals have.”).

37 Dalley, at 1093. Although note W Kip Viscusi, “Risk Equity”, in Matthew D Adler and Eric A Posner (eds.), Cost-Benefit Analysis: Legal, Economic and Philosophical Perspectives (Chicago: University of Chicago Press, 2001), at 17 (“Policies of persuasion that attempt to browbeat individuals into changing their behaviour are often ineffective and are almost invariably undesirable from a policy standpoint. Excessive warnings stimulated by a desire to fend off liability burdens also may distort risk comparisons across products”).

38 Morgan and Yeung, at 97; Orbach, at 760.

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distortions in information disclosure which might compromise its

effectiveness as a regulatory device.39 Note in particular the potential for

legal challenges to disclosure-based regulations, at least in cases where

such regulations are not incorporated directly into primary legislation.

4.3. As to sensitive business/commercial information, some statutes do

specifically recognise that it may not be appropriate for a regulator to

publish this.40 There is however no general statute restricting the

publication of information having this character. The New Zealand Bill of

Rights Act 1990 (NZBORA) is notable here in not containing a property

rights protection per se. To the benefit of regulators, it also recognises in s

14 the freedom “to seek, receive, and impart information”. That freedom

must however be read in light of other NZBORA rights. One might argue

for instance that sensitive business/commercial information should be

protected through s 21 (freedom from unreasonable search and seizure), or

s 27 (right to justice). These NZBORA rights are available to legal persons/

companies too (s 29), and s 21 in particular has been used to protect from

search and seizure documents covered by legal professional privilege.41

4.4. Although note for interest sake Fogarty J’s observation in Dempster:42

It is common place for regulators when conducting [] enquiries to be made privy to confidential commercial practices having commercial value, by providing assurances that the practices will not be disclosed to other persons. (Ironically, the regulators can sometimes find that parties A, B and C all think they have their own special way of doing things, but their way is in fact common.)

4.5. Turning to personally sensitive information, important limits to disclosure

of information of this character are set out in the Privacy Act 1993, and in

particular in the information privacy principles in s 6 of that Act. These will

be relevant when designing disclosure-based regulations. The courts have

also recognised that while privacy interests are not as such amongst the

fundamental rights affirmed in the NZBORA, they are recognised in

international human rights law as well as in our judge-made common law.43

39 Graham, at 23.40 Examples include s 53ZG of the Commerce Act 1986; s 161 of the Animal Products Act 1999; s 30 of the

Canterbury Earthquake Recovery Act 2011; and s 47 of the Industry Training Act 1992. 41 Refer for instance to Director of the Serious Fraud Office v A Firm of Solicitors [2006] 1 NZLR 586 (CA),

particularly at [135]-[143] per O’Regan J (as he then was). 42 Dempster v Registrar-General of Land HC Auckland CIV-2005-404-3178, 2 December 2005, at [61] per

Fogarty J.43 Refer for instance to Brooker v Police [2007] 3 NZLR 91 (SC), at [122] per McGrath J.

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This might justify the courts in appropriate cases ‘reading down’

ambiguous information disclosure regulations to uphold privacy values.

4.6. Finally there is culturally sensitive information. As to this, s 20 of the

NZBORA guarantees the right of “minorities” in New Zealand “to enjoy

the culture, to profess and practise the religion, or to use the language, of

that minority”. While there is very little case-law on this right, the courts

have indicated that Māori cultural rights are protected by s 20.44 On this

footing, s 20 might be relied on to ‘read down’ ambiguous disclosure

regulations so as to limit the public dissemination of culturally sensitive

information. Such an approach finds support in that taken in the Historic

Places Act 1993 in relation to wahi tapu sites and wahi tapu areas. It is to

ensure that New Zealand’s historical and cultural heritage should “Be fully

researched, documented, and recorded, where culturally appropriate”.45

Similar approaches can be seen in the Walking Access Act 2008,46 and in

the Health (Cervical Screening (Kaitiaki)) Regulations 1995.47

(4B) Heuristics and biases

4.7. Even in the absence of legal limits to information disclosure, there may be

real practical limits on the ability of disclosure-based regulations to play

the role a regulator desires for them. Research in psychology and

behavioural economics has identified a number of mental shortcuts, or

‘heuristics’, which affect our ability to receive, store and process

information and to make objectively rational decisions based on it.48 Many

of these are relevant to disclosure-based regulation.49

44 Refer for instance to Takamore v Clarke [2012] NZSC 116, at [12], [100]-[101] and Ngati Apa Ki Te Waipounamu Trust v R [2000] 2 NZLR 659 (CA), at [82], both per Elias CJ. This position is consistent with the one taken by the UN Human Rights Committee in its decisions on the comparable right in Article 27 of the International Covenant on Civil and Political Rights, in respect of which it is accepted both that Māori qualify as a “minority” and that activities can be “cultural” even if undertaken for economic gain, provided that they are “an essential element of the culture”. See Mahuika v New Zealand (No. 547/1993: 15 November 2000).

45 Quoting s 4(2)(b)(iv) of the 1993 Act.46 Section 10(2) provides that “If the [New Zealand Walking Access] Commission is aware that a site is culturally

sensitive, it must consider whether it is appropriate to publish a map or information indicating the location of the site before doing so”.

47 Regulation 5(3)(B) provides that “In determining whether or not to grant an approval under this regulation [to disclose protected information], and in determining what conditions (if any) should be imposed on any such approval, the [National Kaitiaki] Group shall have regard to the following matters: … (b) The need for culturally appropriate protection for the taonga of protected information “.

48 Refer for instance to Daniel Kahneman, Thinking, fast and slow (London: Penguin Books, 2011); Christine Jolls, Cass R Sunstein and Richard H Thaler, “A Behavioural Approach to Law and Economics”, in Cass R Sunstein (ed.), Behavioural Law and Economics (Cambridge: Cambridge University Press, 2007 reprint), at 13-51; Cass R Sunstein, “The Storrs Lectures: Behavioral Economics and Paternalism” (29 October 2012), available online: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2182619 (last accessed 15 May 2013).

49 Although note Cass R Sunstein, “Cognition and Cost Benefit Analysis”, in Matthew D Adler and Eric A Posner (eds.), Cost-Benefit Analysis: Legal, Economic and Philosophical Perspectives (Chicago: University of Chicago Press, 2001), at 237 (“What seems to be a cognitive error may turn out, on reflection, to be a judgment of value,

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4.8. Take the ‘availability’ heuristic as an example. It leads people to respond to

information based on the ease with which instances or associations can be

brought to mind,50 leading for instance to people overestimating the risk of

a particular kind of accident after seeing or hearing about such an

accident.51 The availability heuristic means in this context that while

disclosure requirements can present novel and therefore theoretically more

available information to consumers, that information may not in fact be

used unless it is also brought to the consumer’s direct attention at or close

to the time they decide whether to purchase a particular good or service.52

4.9. A related heuristic is ‘anchoring’, which leads people to rely too heavily on

the first piece of information which comes to mind (the ‘anchor’) when

making decisions. Once an anchor is set, other judgments are made by

adjusting away from it, and there is a bias toward interpreting other

information around the anchor.53 For example, the initial price offered for a

used car sets the standard for the rest of the negotiations, so that prices

lower than the initial price seem more reasonable even if they are still

higher than what the car is really worth. Anchoring can be made worse in

turn by self-serving biases, which prevent people from accepting or

adjusting to relevant information because the information adversely affects

their personal interests or contradicts their pre-existing beliefs.54 Research

in this area has also relevantly indicated that people will often accept

information from unreliable sources, and that anecdotes are often far more

influential than statistics in decision-making.55 Behavioural studies also

show that people may engage in ‘herd’ behaviour, which occurs when

people follow what they know or perceive to be the behaviour of others

rather than engaging in independent decision-making.56

and a judgment that can survive reflection”). 50 Dalley, at 1114.51 Dalley, at 1114.52 Dalley, at 1114.53 Refer for instance to Sunstein, Risk and Reason: Safety, Law, and the Environment, at 263-64.54 Dalley, at 1114.55 Dalley, at 1114-15.56 Refer for instance to Dalley, at 1115; Timur Kuran and Cass R Sunstein, “Controlling Availability Cascades”,

in Cass R Sunstein (ed.), Behavioural Law and Economics (Cambridge: Cambridge University Press, 2007 reprint), at 374-75; Goshen, at 714, 724 (discussing “noise traders” in the securities context, who are defined as individuals “who act irrationally, falsely believing that they possess some valuable informational advantage or superior trading skills” and will act “as individuals or as a group” following “fads, rumors, and investment strategies that bear no economic rationale, such as chasing random price movements in day trading”).

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4.10. Finally, behavioural research suggests that more information is not

necessarily a good thing.57 This is reflected in the ‘information overload’

phenomenon, which occurs when an excess of information causes a

decision-maker to reject or ignore useful information and instead make an

ill-informed decision.58 Behind this phenomenon is the idea that while an

increase in the usefulness of information leads to better decisions, more

information in general leads to higher costs of processing the information.59

It follows that increasing the amount of useful information available can

actually result in people making worse decisions as the costs of processing

new information become too great.60 The volume and accessibility of

information available through the Internet, some of it being at best of

dubious quality, has the potential to add to the risk of information overload.

(4C) Overriding public good

4.11. Finally, regulators should not lose sight of the fact that in some contexts

information disclosure might be inadequate as a regulatory response to a

(policy) problem – as for example when greater safety is a public good. 61

Sunstein gives the following helpful illustration of this limit:62

Imagine, for example, that the replacement of carcinogen X with same product Y would benefit all workers simultaneously because all of them would simultaneously be exposed to Y rather than X. Imagine too that each worker is bargaining separately with the employer. In that case, no individual employee may have a sufficient incentive to decrease his demand for wages and other benefits to obtain increased safety. Because the benefits of the new substance are provided to everyone, no individual employee will ‘pay’ enough to obtain them, preferring instead to take a free ride on the efforts of others. The result will be too little safety on conventional economic criteria. Here a regulatory response is appropriate.

5. REGULATORY DESIGN CONSIDERATIONS

57 Sunstein, Risk and Reason: Safety, Law, and the Environment, at 262-63.58 Dalley, at 1115.59 Dalley, at 1115.60 Dalley, at 1115.61 Orbach, at 763. Refer also to George Loewenstein and Peter Ubel, “Economics Behaving Badly”, New York

Times (14 July 2010) (“As policymakers use [behavioral economics] to devise programs, it’s becoming clear that behavioral economics is being asked to solve problems it wasn’t meant to address. Indeed, it seems in some cases that behavioral economics is being used as a political expedient, allowing policymakers to avoid painful but more effective solutions rooted in traditional economics. … Behavioral economics should complement, not substitute for, more substantive economic interventions. If traditional economics suggests that we should have a larger price difference between sugar-free and sugared drinks, behavioral economics could suggest whether consumers would respond better to a subsidy on unsweetened drinks or a tax on sugary drinks. But that’s the most it can do. For all of its insights, behavioral economics alone is not a viable alternative to the kinds of far-reaching policies we need to tackle our nation’s challenges.”).

62 Sunstein, Risk and Reason: Safety, Law, and the Environment, at 263 (internal citations omitted).

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5.1. An understanding of the aims for any information disclosure system, as

well as the context in which it will operate, is fundamental to ensuring that

the system as designed will be effective as a regulatory measure. 63 Set out

below are four important questions persons charged with the design of

disclosure-based regulations might find it helpful to ask and answer.

5.2. In asking the questions which follow it should be borne in mind that, in

design terms, a system might involve the regulator imposing standards of

performance for disclosure and leaving the design of the most cost-

effective method and media strategy to regulatees. For instance, a

performance standard might specify the target audience that must receive a

particular message at a certain level of awareness, and leave the details of

creative execution to regulatees to develop. The advantage of such an

approach is that the means of compliance are left to the private sector (with

its incentives to innovate), so long as regulatory goals are actually met.64

(5A) Question #1: Can I use disclosure?

5.3. As noted in Section 4A above mandatory disclosure has the potential to

clash with protections the law accords to commercially, personally or

culturally sensitive information. The possibility for a regulatory clash with

these competing interests should be identified in advance, and a disclosure

system should be designed to strike an appropriate balance between the

competing interests – having regard to the particular regulatory goals.

Regulators should also ask themselves whether information disclosure will

be adequate as a regulatory response. As noted in Section 4C above,

disclosure may be insufficient where greater safety is a public good.

(5B) Question #2: Have I got clear goals?

5.4. The fact that a disclosure system may appear to be less intrusive than

substantive regulation should not excuse a regulator from stating its goal,

not least because the goal of the disclosure system will determine the

mechanisms by which it will best operate.65 If the goal of a disclosure

system is to provide more information to consumers, investors, or the

63 Dalley, at 1091, 1128.64 See Sunstein, Risk and Reason: Safety, Law, and the Environment, at 282-85.65 Dalley, at 1129.

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public, the regulatory purpose must also address why that information will

be useful to an underlying regulatory goal and why it is not currently

available.66 The answers to those questions will help to identify not only

whether disclosure will in fact be fit for purpose in the context, but how so.

(5C) Question #3: Will my ‘market’ support it?

5.5. If a disclosure system is intended to operate through a market, the market

should be identified and assessed for whether the information to be

mandatorily disclosed will be sufficiently salient and in sufficiently usable

form to reach and to have an effect on the behaviour of market participants

– either directly, or through the operation of intermediaries who can help to

collect and interpret the information which is disclosed, and in doing so

reduce its cost, or simplify information disclosed in technical formats.67

5.6. Common market-related considerations will be whether the market in issue

is sufficiently competitive that consumers have meaningful choices,68 and

whether sellers have an incentive to react to changes in demand (ie,

inquiries into product substitutability and elasticity of demand).69 In

considering whether sellers have an incentive to react to changes in

demand, an assessment might usefully be made of whether existing

technology makes demand-driven adjustments possible in fact.70

5.7. If the ‘target audience’ is firms, their common structures should also be

taken into account in designing disclosure-based regulations.71 Particular

consideration should be given here to the way in which managers in firms

are likely to receive, process, and act on new information.72 As a starting

point, individuals in a firm will be subject to all the biases and cognitive 66 Dalley, at 1129.67 For example, environmental groups in the U.S. use disclosed government data concerning toxic pollution in the

Toxics Reductions Inventory (TRI) to create factory rankings and risk profiles that are electronically searchable by zip code. See David Weil et al, “The Effectiveness of Regulatory Disclosure Policies”, (2006) 25 Journal of Policy Analysis and Management 155, at 162. This is explained further in Weil, at 7-8 (“TRI requires that manufacturers disclose the quantity of emissions of defined toxic pollutants on a quarterly basis. The provision of this information on toxic emissions by manufacturers is provided to the ‘public’ but in fact works through specific user communities who compile and use the data in their interaction with the disclosing party. These users then employ that information to demand greater source reduction from the disclosing party by means of political channels such as public pressure (e.g. via the media), use of other public regulatory authority (e.g. zoning, state environmental policies), or community organizing. Alternatively, users may act through markets, such as exerting pressure via capital markets or product choices… This in turn is intended to affect the behavior of the manufacturer and encourage efforts at source reduction or other means of pollution reduction.”). In the securities context, see to similar effect Goshen, at 738.

68 See Weil et al, at 175-76.69 See Dalley, at 1120-21, 1130; Weil et al, at 175-76.70 Dalley, at 1121.71 Dalley, at 1118.72 Weil et al, at 164.

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quirks described above. But the structure of the firm itself can also

influence decisions.73 For instance, senior managers may have an incentive

to enhance the firm’s profitability because they have invested considerable

personal capital in the firm or because their compensation may be tied to

the firm’s financial performance.74 Therefore, theoretically they have an

incentive to respond to economic stimuli such as consumer preferences. In

a large and complex organisation, however, detailed information about

consumer preferences may not be available to senior managers.75 And

employees with access to consumer information may not have the same

incentives or employment goals as employees responsible for designing the

firm’s goods or services, or determining its trading policies and practices.76

(5D) Question #4: Is my ‘audience’ influenceable?

5.8. A closely related consideration is the content and format of the information

to be disclosed. This should be carefully assessed by the regulator, with

particular regard being had to the likely heuristic biases of the target

audience and, where relevant, the biases of any intermediaries relied on.77

5.9. As set out in Section 4B above the mechanisms by which information

affects behaviour are complex.78 Information must therefore be provided in

a form accessible to and usable by the target audience.79 Timeliness,

comprehensibility and saliency of information are all relevant here.80 In

particular, information to affect decisions must be provided in a timely

manner and in a location where users can find it before they make relevant

decisions.81 Making information widely available in the public domain will

however not necessarily generate benefits.82 That is because, for many

target audiences (especially lay persons) the information disclosed will

need to be actually interesting and useful for them to take it into account.83

73 Dalley, at 1118.74 Dalley, at 1118.75 Dalley, at 1118. There may also be difficulties discerning consumer signals (behaviour change) from other

‘noise’. For instance, studies show that many retailers analyse point-of-sale data in rudimentary ways – so food manufacturers may believe that declining sales of high-sugar cereals indicate that a competitor’s advertising is more effective, whereas shoppers may actually be responding to nutritional data. Refer to Weil et al, at 164.

76 Dalley, at 1118-19.77 Dalley, at 1130.78 Dalley, at 1091.79 Dalley, at 1091.80 Refer for instance to Sunstein, “The Storrs Lectures”, at 50.81 Weil et al, at 161. As Weil et al note, availability of information at a time and place where users are accustomed

to making decisions increases the chances information will become embedded in routines (eg, fuel economy ratings on new car stickers are more accessible than rollover ratings on a government Web site).

82 Weil et al, at 157.83 Dalley, at 1120.

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5.10. All of this tells against the disclosure of incomplete or imbalanced

comparative information, overly technical information, or information that

contains too much jargon. As to these points, note that the Ministry of

Consumer Affairs has relevantly indicated (as a conservative estimate) that

45% of adult New Zealanders are functionally illiterate.84 While it should

always be borne in mind that oversimplification can lead to

misunderstanding, our high rate of functional illiteracy does suggest the

existence of a risk that use of excessive detail might make disclosure

meaningless to lay persons, at least without the assistance of intermediaries

to ‘translate’ more complex information into simpler messages.85

5.11. Note too that presentation, typeface, and design have all been found to

make a significant difference in the usefulness of information – as

advertisers well know.86 This is reflected in the FMA’s recent Guidance

Note: Effective Disclosure (2012), which emphasises the need for clear,

concise and effective disclosure documents in the offerings of securities

context.87 Research also finds that people tend to be more easily persuaded

by oral communications or communications that engage the emotions, than

by written or abstract information.88 This further suggests that techniques of

effective presentation as used in mass advertising should be considered by

regulators looking to ensure information disclosure systems are effective.

6. THE INTERNET’S IMPACT

6.1. This brings us to the World Wide Web. The Internet is obviously relevant

to any information-based disclosure system, and its potential implications

should in all cases be considered when designing a disclosure system. In

particular, the Internet can be used to promote effective disclosure of

complex information to a broad audience in three ways.89 First, it can

provide easier, faster, and more complete access to information that might

84 Austin, at 308 (footnote 69). 85 While the form of disclosure may differ depending on whether it is targeted at end consumers, or instead

directly to more ‘literate’ intermediaries, such as market professionals, who will digest and advise on the information, it should not be forgotten that heuristic biases can affect professional advisors as well as ordinary investors and consumers. See Dalley, at 1105.

86 Dalley, at 1125.87 Financial Markets Authority, Guidance Note: Effective Disclosure (2012), available online:

https://www.fma.govt.nz/media/1105126/guidance_note_-_effective_disclosure_june_2012.pdf (last accessed 17 May 2013), at 16-20. This Guidance Note helpfully sets out in table format plain language techniques to consider using in disclosure documents, as well as examples of concise presentation to consider.

88 See Dalley, at 1114, 1117; Sunstein, Risk and Reason: Safety, Law, and the Environment, at 265.89 Graham, at 11.

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influence choices or spur collective action.90 Second, it can create increased

capability to integrate information from many sources to produce a more

comprehensive picture of diffuse information.91 Third, the Internet because

it is interactive creates the potential for diverse users to customise

information to serve their particular needs.92

6.2. As one commentator has noted, the Internet might be harnessed to allow

homebuyers to use simple digital maps to pinpoint neighbourhood sources

of risk; to post real-time information about levels of lead, arsenic, and

microbes in drinking water, colour-coding health concerns for children, the

elderly, or people suffering from particular health problems; to arm job

hunters with comparisons of hazards at particular workplaces; to allow

shoppers quickly to compare the safety and reliability of children’s toys, as

well as their prices; to allow people shopping online to choose to consider

only items that meet specified health, safety or environmental criteria; or

with groceries to link through familiar barcodes information about benefits

of new disease-fighting foods with an individual customer’s medical

profile, displaying results on android devices.93 In short, the Internet offers

the potential for today’s piecemeal disclosure requirements aimed at

reducing risks to grow into a great web of reliable consumer information.94

6.3. These positive points provide interesting food for thought. But we must not

overlook the shortcomings of the Internet, most obviously the danger it

presents of information overload. In some areas already – including,

increasingly, in financial markets – information is increasingly available

from a variety of sources of questionable reliability at an astonishing speed,

much of it through the Internet.95 As one commentator sagely notes,

improved access to information may simply give people “the chance to be

foolish faster”.96 The Internet may also lead lay persons to rely less on

professional advice and to rely instead on raw or untested online data, or to

follow investment trends blindly because they are incapable of making

90 Graham, at 11; Weil, at 24 (“Lowered cost of acquiring information through new technologies, increased experience and other factors that may create economies of scale in information acquisition”), 26 (“the increasing use of the Internet as a means to deliver information represents a significant downward shift in the marginal cost function for information users”).

91 Graham, at 11.92 Graham, at 11.93 Graham, at 12.94 Graham, at 12.95 Dalley, at 1105.96 Dalley, at 1105.

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reasoned decisions in an increasingly complex environment.97 These risks

should be considered in designing and implementing a disclosure system.

7. SOME TAKE HOME POINTS

7.1. Every disclosure system must have an articulated purpose, an identified

mechanism through which it can accomplish that purpose, a design that

takes into account the operation of that mechanism, and a careful analysis

showing that the benefits of the system outweigh its costs.98 As with any

other regulatory measure, information-based disclosure systems also need

to be designed for improvement over time.99 Built-in analysis and feedback

requirements can reduce the effects of initial shortcomings, as well as

discovery and exploitation by regulatees of loopholes in disclosure rules.100

Such requirements can also keep disclosure systems up-to-date as science

and technology, markets, and political priorities evolve.101 Finally, it is

important that disclosure-based obligations are enforced.102 The

enforcement scheme, like the disclosure system, should be designed in

accordance with the goals of the system and with its operation in mind.103

Matthew SmithBarrister

Thorndon Chambers

97 Dalley, at 1106.98 Refer for instance to Dalley, at 1131; Orbach, at 757. 99 Weil et al, at 176. Also note Weil, at 14 (“Improvement in sustainability of a disclosure-based system can be

measured [over time] by three metrics: 1. Increase in use of information provided by the system; 2. Increase in the accuracy or quality of information provided by the system; 3. Increase in the scope of information provided by the system”).

100 Weil et al, at 176.101 Weil et al, at 176; Graham, at 22.102 Dalley, at 1129.103 Dalley, at 1129.

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APPENDIX: STATUTORY INFORMATION DISCLOSURE REGIMES

Statute Summary of statutory disclosure provisions1. Airport Authorities Act 1966 Section 9A provides for the making of regulations requiring disclosure of information by airport

companies. By section 9D a summary offence is committed if anyone fails, without reasonable excuse, to comply with information disclosure requirements prescribed in the regulations.

2. Apple and Pear Industry Restructuring Act 1999 Section 25 allows for regulations to be made requiring ENZA to disclose its financial statements and to publish information including in relation to its prices, terms, and conditions, pricing policies and methodologies, costs, cost allocation policies and methodologies, and performance measures.

3. Civil Aviation Act 1990 Section 99A provides for the making of regulations requiring the holders of aviation documents relating to an air traffic service to publish information in relation to the provision of that service, including information on prices, terms, and conditions. By section 99C, a summary offence is committed if anyone fails, without reasonable excuse, to comply with information disclosure requirements prescribed in the regulations.

4. Commerce Act 1986 Part 4, subpart 4 sets out an information disclosure regime the purpose of which is to ensure that sufficient information is readily available to interested persons to assess whether the purpose of Part 4 of the Commerce Act is being met. The disclosure of information, and the CommComm’s summary and analysis of that information, provide the means by which the purpose of information disclosure is to be achieved. The CommComm also has the power to apply to the High Court for an order requiring information disclosure requirement to be complied with (s 86A), and any contravention of information disclosure requirements may attract pecuniary penalties (s 86), or be the subject of a summary prosecution (s 86B).

5. Dairy Industry Restructuring Act 2001 Section 65 allows for regulations to be made requiring disclosure of information by the Livestock Improvement Corporation Limited which may include information on pricing methodology. By s 67 summary offences are committed if anyone fails, without reasonable excuse, to comply with any information disclosure requirements prescribed in regulations, or if anyone makes a false declaration when supplying any information.

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Statute Summary of statutory disclosure provisions6. Fisheries Act 1996 Section 296ZA allows for regulations requiring approved service delivery organisations to make publicly

available prescribed financial statements and to publish information on matters including prices, terms, and conditions of supply, pricing policies and methodologies, costs, and cost allocation policies and methodologies. Section 296ZC further allows the Minister of Fisheries to request by notice in writing that approved service delivery organisations supply to him specified information, data, and forecasts relating to the business, operation, or management of the organization. Failure to supply information, or the supply of false or misleading information, constitutes offences under s 252.

7. Gambling Act 2003 Sections 107-108 require class 4 operators to publish annual reports including an itemised statement of the application or distribution of net proceeds from class 4 gambling.

8. Gas Act 1992 Section 55 allows for regulations to be made requiring gas wholesalers, pipeline owners, and gas retailers to disclose specified information. By s 57 summary offences are committed if anyone fails, without reasonable excuse, to comply with any information disclosure requirements prescribed in the regulations, or if anyone makes a false declaration when supplying any information.

9. Kiwifruit Industry Restructuring Act 1999 Section 26 allows for regulations to be made requiring Zespri Group to make its financial statements publicly available and to publish information including in relation to its prices, terms, and conditions, pricing policies and methodologies, costs, and cost allocation policies and methodologies.

10. Postal Services Act 1998 Sections 60 and 61 allow for regulations to be made requiring NZ Post to disclose its financial statements and to publish information in relation to the services it provides, including information relating to prices, frequency, quantity, and quality of services. By s 56 summary offences are committed if anyone fails, without reasonable excuse, to comply with any information disclosure requirements prescribed in the regulations, or if anyone makes a false declaration when supplying any information.

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Statute Summary of statutory disclosure provisions11. Sale and Supply of Alcohol Act 2012 Sections 334 and 383 require licensing trusts and community trusts, respectively, to publish audited

financial statements on an annual basis. A failure to comply with this requirement constitutes a criminal offence.

12. Sale of Liquor Act 1989 Section 219X requires community trusts to publish audited financial statements on an annual basis, which are to include a statement of financial position and income and expenditure account and notes to them, giving a true and fair view of the financial affairs of the community trust for the financial year.

13. Telecommunications Act 2001 Sections 69ZC and 69ZD and ss 156AU and 156AV allow the CommComm to require access providers and local fibre companies, respectively, to prepare and disclose information about the operation and behaviour of specified parts of their business, including information on contracts, prices, terms, and conditions of supply, transactions with related parties, plans and forecasts, and network capacity information. By s 156A offences are committed if anyone fails, without reasonable excuse, to comply with any information disclosure requirements prescribed in the regulations, or if anyone makes knowingly provides false or misleading information. Further penalties may be imposed in the case of any continuing breaches of regulatory disclosure requirements (s 156M).

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