Anchoring and Earnings Estimates
A constant theme here has been the clash between the techniques of compliance, which rely upon psychological mechanisms, and the law of due diligence, which regulates fraud relying upon the fictitious rational person. The statutory law of due diligence, as opposed to the common law on misrepresentation or deceit, has developed two techniques to deal with those who lie to the public for profit: the seller has not registered with the appropriate authorities, or the seller cannot use as a defence to its deceit to the public that the public did not rely upon what the seller said.
One good example of this clash was discovered by Daniel Kahneman, a Nobel Prize winner in Economics and the late Amos Tversky. In a very clever and compelling experiment, Kahneman and Tversky showed that individuals will treat irrelevant information as an important anchor. If we don't know anything about a subject, we will use even random information to "help" us make a decision.
What does anchoring have to do with business opportunities frauds or scams? How do scammers take advantage of anchoring? How does the law of due diligence deal with anchoring?
Here is a typical use of anchoring. This seller of a vending distributorships has an "earnings" estimate on their website. The ordinary purchaser has no idea whether 10 machines will sell 2 servings a day - but, it sounds reasonable.
So the purchaser anchors on 20 sales per day and so the representation that they will earn25% return on investment seems reasonable. But even if the purchaser typically decides to play it "safe" and reduces the 20 sales by 1/2 or a 1/3 -to a 12.5% or 8% return, it still sounds pretty reasonable.
But, the reality is that a purchaser is should equally subjectively indifferent to whether the sales are 20/day, 20/week, or 20/month. Do the math as if those three states of nature were of equal probability.
Unfortunately, the scammer knows that purchaser will anchor on the sales per day and make the decision accordingly. The law of due diligence requires earnings estimates to have a reasonable basis but in general the law has no requirements on how this information is presented to the public.
But, in an important change, the FTC has proposed to make this type of earnings estimate subject to the new Business Opportunity Rule and has proposed that a certain version of anchoring be deemed an deceptive marketing practice.
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