Review of the Redress and Enforcement Provisions of Consumer Protection Law - Initial Think Piece

• Regulatory Design
• Types of Punishment (Punishment as a Catalyst for Compliance)
• Enforcement and Securing Compliance
  • Enforcing the Letter of the Law
  • Compliance Strategy
  • The Need for Both Strategies
  • The Enforcement Pyramid
• Trader and Consumer Behaviour and Awareness
  • Why Do Traders Comply?
  • Trader Awareness and Understanding
  • Attitude
  • Impact of Consumer Awareness
  • Effective Access to Redress

Consumer protection legislation places restrictions or requirements on traders and often contains redress and enforcement provisions that can be used when a transaction goes wrong. The enforcement provisions may not need to be used for the legislation to be effective. The threat of the enforcement provisions may be all that is needed to secure compliance.

The desired policy outcome for consumer protection legislation in New Zealand is consumers transacting with confidence. Transacting with confidence in this context means that consumers' reasonable expectations of transactions will be met. In those instances where they are not, consumers will have ready access to appropriate redress.

Therefore, the specific outcomes for consumer protection legislation in this country are that:

• traders comply with the legislation
• consumers have effective access to redress; and
• consumers seek redress when a transaction is unsatisfactory.

For the redress and enforcement provisions in consumer protection law to be effective, there is a need to have an understanding about the impact of each of the following factors and the dynamic way in which they interact with each other:

• regulatory design - where the rules are targeted in the market and the size and type of penalties
• enforcement and compliance strategies of the regulator
• trader awareness and behaviour; and
• consumer awareness and behaviour.

This section of the paper reviews some of the available theoretical literature on securing compliance with business-related (including consumer protection) legislation, enforcement and punishment methods and the impact that informed consumers have on the effectiveness of consumer protection legislation. This literature will assist MCA in its analysis of the effectiveness of the redress and enforcement provisions in the FTA and the CGA.

Regulatory Design

The aim of consumer protection legislation is to protect both the consumer and the honest trader

(Cartwright, 2001)

In New Zealand, consumer protection legislation protects the consumer and the honest trader in three broad ways. These measures, however, should not be seen as mutually exclusive. They can be broadly categorised on the basis of where they are imposed on the market: pre market controls, market controls and after market controls or rules.

Pre market controls impose rules on products and services before they are made available for sale. They generally include the need for products or service providers to have a license, approval, permit or statutory declarations. If products do not have the pre-requisites for sale they generally can be immediately seized or the service discontinued.

Pre market controls are usually applied when there are important safety issues that need to be managed or when the technology involved is complex and pre market intervention is the most economically efficient way of achieving the desired policy outcomes. An example of this can be seen in the Weights and Measures Act 1987 that requires instruments used for measuring goods sold in trade to be approved before they are used in trade. Intervention at this level goes directly to providing accurate measurement for consumers and traders without involving all the market participants in the need to verify individual transactions.

Market controls are rules that are generally imposed on goods and services at point of sale. These rules are often expressed as product or service specifications that have to be met and are enforced by market surveillance activities, or in response to complaints to an enforcing agency. Non-compliance may lead to offenders being prosecuted. Goods may be seized at this point or be required to be withdrawn from the market or recalled.

In New Zealand, the FTA applies not only to the sale of goods but also to their supply when imported. Market controls in regard to the FTA, therefore, are supplemented by border control activity, blurring the line between pre market and market control intervention.

The FTA is enforced by the Commerce Commission which may take enforcement action through the courts for breaches of the FTA. The New Zealand Customs Service can take action under section 36 of the FTA by way of prohibition orders under section 54 of the Customs Act. Individuals and corporations also can take private action under the FTA.

After market rules generally relate to action that can be taken when a transaction has gone wrong.

The Consumer Guarantees Act probably provides the clearest example of after market intervention through its post sale remedies. Unlike the FTA, the CGA does not take a punishment approach. Instead it has a "make it right" approach, that is, when a good is not of acceptable quality the consumer involved can take the good back to the trader who is obliged to repair or replace the good or to refund the consumer's money. If a consumer suffers a consequential loss as a result of purchasing a defective good or service (for example, when a faulty appliance causes a fire) then the trader can also be held liable for any associated cost.

The CGA is commonly referred to as self-enforcing. There are no agencies charged with taking action under the CGA. However, if a trader attempts to contract out of their obligations under the CGA, this represents a breach of the FTA. In such a circumstance the Commerce Commission can take action.

This review will need to consider whether the current consumer protection legislation imposes rules at the right part of the market.

Types of Punishment (Punishment as a Catalyst for Compliance)

Law breaking imposes costs on society and therefore is to be discouraged

(Yeung, 2004)

Regulatory design also involves penalties and enforcement mechanisms. These, however, will only be effective if they are of a kind that will actually affect the behaviour of traders in a way that achieves the objective of the legislation. A number of scholars have tried to explain how compliance with legislation can be accomplished. Attempts have also been made to identify which enforcement and punishment methods provide the most effective deterrent.

The threat of punishment may be enough. The threat, however, has to be a real threat and has to be targeted at that part of the market (pre market, market, or after market) where it can be most effective. The threat of punishment also has to be sufficiently robust (coercive or persuasive) to achieve the behaviour altering outcomes that are desired. Finally, it is important that the penalties associated with offences under consumer protection law reflect society's view of the offence.

Five approaches to punishment have been identified. They are deterrence, incapacitation, rehabilitation, retribution and restoration.[2]

Deterrence punishment is designed to impact on both the individual offender and others who may be tempted to offend. This type of punishment aims to deter the individual from committing a similar offence in the future. It may also deter others from committing similar offences.[3]

Deterrence types of punishment assume that the offender makes a rational decision before they act. It is assumed that a person "… will only undertake a particular act if the estimated benefits to the [person] of so acting will exceed the estimated costs to the [person] of engaging in it".[4] Increasing the financial size of a penalty, increases the potential cost to the offender. It is therefore assumed that increasing the size of the penalty will provide a greater incentive to the offender or a potential offender to comply with the law.[5]

The two main types of deterrence punishment models are the injury to others (or optimal deterrence) model and the unlawful gain model. The injury to others model relies on punitive fines. The unlawful gain model aims to achieve absolute deterrence. Under the unlawful gain model, the size of the penalty is set at a level that is at least that of the financial gain resulting from the illegal activity.[6] If the financial gain to the offender is low even if the harm to the victims is high the subsequent penalty will be low under this model. Such a response may not be viewed favourably particularly by the community.[7]

Incapacitation punishment is based on making the offender incapable, or at least less capable, of offending. A severe type of incapacitation punishment is imprisonment. It is assumed that that the offender will not change their behaviour by any lesser means and that consumers need to be protected against continuing non-compliance. In consumer protection legislation, incarceration is rare. Punishment of this sort is usually reserved for offences that threaten physical harm or repeat fraudulent behaviour. The main form of incapacitation under consumer protection is the revocation of a licence and the banning of a person from performing a service or engaging in a commercial activity.[8]

Rehabilitation types of punishment involve an attempt to persuade offenders to comply with the law while finding a way to integrate them back into society. Part of this process involves recognition of wrongdoing. In consumer protection legislation, the closest approximation to this type of punishment would be undertakings given by a company, when caught breaching the legislation. Compliance programmes or improved complaints procedures are examples of undertakings that may be made.

Retribution involves a "just desserts" approach to punishment,[9] that is, wrongdoers should be punished because of the crime that they committed. Instant fines and infringement notices are examples of this type of punishment. Individually these punishments may not be of sufficient magnitude to alter behaviour. However, the cumulative effect of them, particularly if used in a future prosecution, may have a deterrent effect.

Restoration punishment involves compensating the victim rather than requiring the offender to pay their debt to society as a whole. An obvious example of this type of punishment is the repair, replace and refund provisions in the CGA. Further examples of restoration punishments are compensation orders and requirements to meet a consequential loss.

The punishment approaches assume that all offences are detected and more importantly offenders are penalised. These assumptions are not realistic. Not all violations are detected. The probability of detection and the behaviour of firms need to be considered when setting the penalties. If firms are risk averse, penalties can be lower and still be effective. Conversely if the potential offenders are risk takers there will be a need to have a penalty at such a level that they are deterred from offending[10]. However, there are some difficulties with this approach. A relatively minor offence may attract a high penalty because of a low detection rate whereas a more serious offence may attract a lower penalty because the chance of the offence being detected is a lot higher.[11] Such a response may be at "…odds with the community's perception of fairness and morality".[12]

A penalty scheme must not be too out of step with the intuitive conceptions of fairness and justice lest it lose the support of the regulated parties and the general community it is intended to serve

(Yeung, 2004, 90).

This review will need to consider whether the penalties in the current consumer protection legislation are of the type and/or magnitude that encourage traders to comply.

Enforcement and Securing Compliance

Punishment is expensive; persuasion is cheap

(Cartwright, 2001, 220)

Agencies responsible for the enforcement of consumer protection legislation tend to use persuasive techniques and warnings in an attempt to gain compliance. A flexible approach to enforcement can prevent harsh penalties being imposed for an unintended or accidental breach of the legislation. Such an approach can also be cost effective for the enforcement agency.[13]

The punishment approaches assume that there are no costs associated with enforcing the legislation. This is not realistic. Enforcement agencies will assess the cost of enforcing the law before taking action. Costs will certainly be a factor in their decisions about the type of action they take.

Cartwright (2001) has identified two approaches that can be taken by enforcement agencies in order to secure compliance. They are the deterrence strategy and the compliance strategy.

Enforcing the Letter of the Law

As discussed, the deterrence strategy involves securing compliance with the legislation by detecting breaches and penalising those found to be responsible for the breach.

A study by Bardach and Kagan[14] found that the deterrence strategy was more effective than the compliance strategy; "… strict enforcement brings reduced risks and improved standards …"

Adoption of the deterrence strategy can lead to a consistent approach to enforcement if the regulatory agency has a policy of always taking prosecution action when they discover a breach. The adoption of such an approach also reduces the likelihood of unfairness. However, the cost of taking prosecution action can be very high and may even be prohibitive.[15]

Compliance Strategy

A compliance strategy on the other hand aims to seek compliance with the legislation by way of an educative approach that is, preventing harm rather than punishing an evil.[16]

The use of a compliance strategy by an enforcement agency in order to secure compliance can be a cost-effective way of achieving compliance. It will not always, however, be apparent to the public at large why a particular approach has been taken by the enforcement agency with a specific company at any particular time.

Individually negotiated settlements also may appear to raise natural justice concerns. Agencies responsible for enforcing consumer protection legislation sometimes use negotiated settlements rather than taking court action. Such an approach is cheaper for the state and the accused parties. Both the guilty and the innocent benefit from lower costs and a smaller amount of bad publicity associated with a court case. For the guilty there is an incentive to enter into negotiations because they will receive a lower penalty. The innocent, however, may also decide to plead guilt rather than face the uncertainty and cost of a trial.[17]

The Need for Both Strategies

Attempts have been made to model how regulatory enforcement agencies go about trying to secure compliance with their legislation. Most of these models indicate that effective enforcement agencies use a combination of persuasion and punishment techniques.

Ayres and Braithwaite[18] argue that because traders are "… bundles of contradictory commitments to values about economic rationality, law abidingness, and business responsibility", there is a need for enforcement agencies to operate using strategies of both compliance and enforcement. "Strategies based purely on compliance are likely to be exploited where actors are motivated by economic rationality, while strategies based mostly on punishment will undermine the goodwill of those who are motivated by a sense of responsibility".[19]

One of the most straight forward models that has been developed to replicate how enforcement agencies attempt to secure compliance is Scholz's tit-for-tat (TFT) enforcement strategy model. Under this model it is assumed that there is an equality of power between the enforcement agencies and the firms they seek to regulate. It is assumed that enforcement agencies and firms cooperate with each other in a mutually beneficial way until such time as one of the parties stops cooperating. If for example, a firm decides to take advantage of the cooperative response by the regulator, then the rational response by the enforcement agency is to adjust their behaviour and to take a deterrent approach against the firm. If the deterrent approach taken by the regulator leads the firm to once again cooperate with the enforcement agency, it is assumed that both parties will again cooperate with each other. It is assumed that the benefits of mutual cooperation for both the firm and the regulator outweigh the costs and that both parties recognise that this is the case.

The assumption that there is an equality of power between the enforcement agency and the firm may be misguided. There will be some instances where the enforcement agency may confront a company that has virtually unlimited access to legal support. In other instances the agency's resources may completely overwhelm the resources of a small fledgling business.

For the TFT strategy to be effective there is a need for the enforcement agencies to have adequate enforcement sanctions available to them.[20]

The Enforcement Pyramid

Braithwaite (2000) states that enforcement agencies are most effective when they can escalate the sanctions used in response to a firm's level of cooperation. He claims that enforcement agencies are most likely to achieve compliance with their legislation when a mixture of persuasion and punishment techniques are able to be used. Enforcement agencies that can employ a hierarchy of sanctions, commencing with persuasion and culminating in a severe penalty such as licence revocation, are the most effective at achieving compliance. Non-compliance is less attractive for firms if the enforcement agency is able to escalate the sanction should persuasion be ineffective or inappropriate given the nature of the breach.

Enforcement agencies that have only one deterrence option available to them are less effective than those that have a range of sanctions they can use. This is particularly true when the only deterrence option available is extremely severe. For example, a regulatory agency may have the power to withdraw or suspend licences but when this is the only option available it may be ineffective. "The problem is that the sanction is such a drastic one … that it is politically impossible and morally unacceptable to use it with any but the most extraordinary offences. Hence, such agencies often find themselves in the situation where the implied plea to "cooperate or else" has little credibility".[21]

Diagram One: Enforcement Pyramid (for a Single Firm)

(Braithwaite, 2000, 102)

Braithwaite (2000) has used an enforcement pyramid diagram to depict the enforcement approach of an effective enforcement agency. Although different agencies have different sanctions available to them, the basic premise of the enforcement pyramid remains the same. The most frequently used and least severe sanctions are found at the bottom of the pyramid while the most severe and least frequently used sanctions are found at the peak.[22]

An enforcement agency that has a number of sanctions available to it at different levels of severity is represented by a tall enforcement pyramid. Enforcement agencies that are able to use a wide range of sanctions are more effective than an agency that only has a limited range of sanctions. "A flat pyramid (with a truncated range of escalations) will exert less downward pressure to keep regulation at its base than a tall pyramid. A tall enforcement pyramid can apply enormous pressure from the heights of its peak to motivate 'voluntary' compliance".[23]

Diagram Two: Enforcement Pyramid (Industry Associations)

(Braithwaite, 2000, 103)

It is not only enforcement agencies that can persuade traders to comply with legislation. Industry associations can also assist with legislation compliance. Sometimes industry associations encourage their members to comply with regulatory requirements as non-compliance may lead to the adoption of more interventionist type regulation.[24] Braithwaite (2000) also has an enforcement pyramid diagram that represents the enforcement approach that can be taken by enforcement agencies when industry associations attempt to secure compliance from their members.

Self-regulation can be effective in protecting consumers and can be a very cost-effective means of regulation. But according to Braithwaite (2000), to be effective there must be a willingness on the part of the state to escalate the degree to which it will intervene should the industry group choose not to comply. Cartwright (2001) makes this point in a stronger way. He claims that self-regulation should not be viewed as an alternative to public policy. Rather self-regulation is most effective when it is used in combination with more formal methods of regulation.[25]

For enforcement of consumer protection law to be effective, the action of the enforcement agencies and the enforcement tools and penalties available need to be of a kind and magnitude that will actually influence traders to comply with the legislation. Effective enforcement can only occur when there is a genuine desire to comply with the law or where there is fear that the enforcement agency will take effective sanction.[26]

Trader and Consumer Behaviour and Awareness

There can be little doubt that ignorance of the law is one of the principal impediments to consumer protection and that measures to eradicate this ignorance will be an important part of an effective consumer policy

(Cartwright , 2001, 17)

To be effective, consumer protection legislation is not only dependent on compliance with the legislation by industry groups and detection and enforcement by enforcement agencies it is also dependent on trader and consumer awareness. Consumers have to be aware of their rights and be prepared to seek redress under consumer protection legislation for it to be effective. Traders must also be aware of their obligations.

Why Do Traders Comply?

There is a need to understand why traders comply (or not) with consumer protection law. Often it is assumed that legislation can be made more effective by increasing penalties or increasing the enforcement presence. While these measures may encourage some traders to comply, and heighten their awareness about their rights and obligations on a case by case basis, such an approach may not be effective overall.

The trader survey that MCA is conducting later this year will seek to gather information about trader knowledge, awareness and attitudes to the FTA and CGA. It is hoped that the information collected will assist MCA to understand why traders comply with this legislation. An assessment will be then be made as to whether there is a need to consider amending the legislation or whether there is a need for traders to be better informed about their obligations.

Trader Awareness and Understanding

How much knowledge traders have of their rights and obligations under consumer protection legislation is of paramount importance to achieving compliance. It is difficult for a trader to comply if they are not aware of their obligations. Similarly if traders are not aware of the financial penalties under the consumer protection legislation, increasing the size of the penalty will not make this provision more effective.

Exploratory research conducted by MCA in 2004 indicated that some small traders were unaware of their legal obligations but nevertheless met the broad outcomes of the legislation because they perceived putting it right was good business practice.

Traders may be aware that they have obligations under the FTA and the CGA but the way that the legislation is written and the lack of plain English guides to the legislation may make it difficult for them to understand its relevance to their business.

Providing adequate information to traders about their obligations is one way of improving their understanding of consumer protection law.

Attitude

Compliance with consumer protection legislation may not always be achieved because traders are aware of their obligations under the legislation. Compliance may be achieved through a best business practice approach by traders, which is not underpinned by actual knowledge of the legislation.

In other instances traders will be making a conscious choice about whether or not to comply. Whether risk averse or risk taking, compliance in this situation is a risk management tool and is an expression of the company's attitude to the legislation. In this situation, regulatory design including the point of intervention, the size of penalties and the chances of getting caught are much more significant.

For the penalty provisions in consumer protection legislation to be effective there is a need to have some understanding of the risk profile of traders. Such a profile may change as a result of enforcement action being taken.

Impact of Consumer Awareness

For consumer protection legislation to be effective, consumers also have to be aware of their rights and be willing to exercise them.

If consumers are unaware of their rights and obligations under consumer protection law, increasing the enforcement tools available to enforcement agencies or increasing the penalty sanctions in consumer protection legislation may not make it any more effective. As a result, consumer protection policy has often been concerned with the provision of information to consumers.

As well as the state providing information to consumers about consumer protection legislation, the other main source of information is the market. The market provides some information to consumers particularly on the nature of the goods. The information provided by traders, however, may not enable consumers to make the best choice.[27] This is not only because traders have an incentive to supply information which they deem most effective in maximising profits but also because such information has some of the characteristics of a public good. This means that it is not only the traders who produce the information that benefit from it. Some traders can "… benefit at no cost, to themselves. Such free riding can lead to under provision of information by traders".[28]

To overcome these potential problems, some consumer protection legislation requires traders to disclose particular information. It is presumed that the provision of such information will allow consumers to make rational choices. While disclosure information may be designed to reflect the needs of particular consumer groups (for example, vulnerable consumers), critics have argued that the major problem with this type of regulation is not with business compliance but rather that "… consumers are unaware of the information disclosed, do not appreciate its significance or simply do not employ the information provided in the market place".[29]

Effective Access to Redress

Increased consumer awareness and understanding of consumer protection legislation can make it more effective. However, consumers affected by breaches, may still not receive effective redress.

A successful prosecution by an enforcement agency may lead to a change in trader behaviour. Such a change may benefit the community as a whole but does not provide specific redress for the consumers that have been affected by the illegal behaviour. When the Commerce Commission takes action under the Fair Trading Act, for example, the action is primarily targeted at changing the behaviour of the trader concerned. It is assumed that such action will act as a deterrent for other traders. Compensation for individual consumers detrimentally affected by the action of the trader is generally not part of the action. Thus the consumers concerned may feel that they have not received any redress for any losses sustained. While consumers are able to take private action under the FTA, the costs of doing so may act as a deterrent.

Under the Consumer Guarantees Act, consumers are required to take their own action. The individual consumer concerned benefits from any redress that is gained. It is possible that as a result of consumers seeking redress, a trader may decide to change their behaviour and therefore all consumers that transact with that trader will benefit.

As evidenced by the exploratory research conducted by MCA last year, some consumers did not seek redress because of the time involved. In other instances, consumers were unwilling to make a complaint or were unaware of how they could escalate their complaint if they were unsuccessful in securing redress when they contacted the trader directly.

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[2] Cartwright (2001, 75) [LINKS]

[3] Cartwright (2001, 75)

[4] Yeung (2004, 64)

[5] Yeung (2004)

[6] Yeung (2004, 66)

[7] Yeung (2004, 71)

[8] Cartwright (2001, 78, 79)

[9] Cartwright (2001, 80)

[10] Yeung (2004, 67)

[11] Yeung (2004, 66, 67)

[12] Yeung (2004, 70)

[13] Cartwright (2001, 70, 113, 213)

[14] Cited in Cartwright (2001, 219)

[15] Cartwright (2001, 219, 220)

[16] Cartwright (2001, 214)

[17] Yeung (2004, 110)

[18] Cited in Cartwright (2001, 221)

[19] Cartwright (2001, 222)

[20] Cartwright (2001, 243)

[21] Braithwaite (2000, 102)

[22] Cartwright (2001)

[23] Braithwaite (2000, 105)

[24] Braithwaite (2000)

[25] The MCA review of self-regulation is examining whether self-regulation is an effective means of creating confident consumers.

[26] Cartwright (2001, 222)

[27] Cartwright (2001)

[28] Cartwright (2001)

[29] Cranston cited in Cartwright (2001, 51)