In this presentation, he explored how fear of retaliation limits the effectiveness of whistleblower laws and policies. There are hundreds of whistleblower laws in the United States that provide incentives for people to report misconduct and prohibit retaliation against them for doing so. While recoveries from laws like the False Claims Act are significant, the perception — and often the reality — of what happens to whistleblowers who do come forward is that they pay dearly for their actions. In addition to trying to reward whistleblowers, why are we not also looking for better ways to help people address workplace conflict or misconduct without having to be a whistleblower? Howard argued that an organizational ombudsman can help an organization address this gap between encouraging the reporting of misconduct and protecting those who raise issues.

Several of my students’ comments about the talk are below: 

When a classmate asked me about the Chuck Howard presentation, all I could say is that “the system has failed, and I have no idea how to fix it.”  Howard argued that the current whistleblowing procedures are ineffective.  Businesses have inadequate internal procedures for whistleblowing, which is why the claim makes it to the legal process.  However, Howard spent most of his time explaining that the whistleblowing laws are also ineffective.  The main flaw is that it is still too easy for employers to retaliate against whistleblowers.  Because we live in an adversarial system, once an individual blows the whistle on misconduct in the workplace, he or she will inevitably soon find themselves in a lengthy, expensive, and stressful litigation process.  Howard painted a dark picture of how this litigation process tragically changed the lives of many whistleblowers. He concluded the presentation by offering the ombudsman model as a solution to the problems of whistleblowing laws, but, while good in theory, it would seem that the model’s success will depend on a firm putting forth sound internal rules and procedures around the ombudsman position.  Do firms have the right incentives to adopt such a model?

Is whistleblowing an ethical obligation to ruin your career? After last week’s talk, it is frightful to think that at some point, I may be in the same situation that many unfortunate, yet dutiful, employees have found themselves in. Many careers mandate that certain unethical or unsafe conduct be brought to the higher-ups’ attention. This is exactly what many people have done. In fact, had they not, they would have faced consequences with their own employers or professional associations. That being said, it is remarkable that some whistleblowers are prosecuted, or threatened with prosecution, after choosing to do the moral and legally correct thing. If the laws are not actually protecting what is most important to a professional, reputation, then what is the incentive to blow the whistle, particularly in matters where someone is unsure if a violation or wrongdoing is actually occurring?

Cross posted at Indisputably.

I view this no differently than the signs I saw as a kid walking into restaurants: “No Shirt, No Shoes, No Service.”  A private company has a right to enforce a dress code on patrons.

Those calling for a lawsuit may have their trigger fingers a bit too itchy.  This was by no means a restriction based on race, ethnicity, gender, etc.  This was a company seeking to enforce a public dress code.

Perhaps this is a potential market opening for any of you with millions just looking for something to do with it – open an airline that allows passengers to wear their pants sagging.

Here are the facts of Omega v. Costco.  Omega maintains a tight grip on its authorized distribution channels.  Omega attempted to gain control of its watches’ distribution by engraving a design on the back of its watches (pictured below) and registering this design at the U.S. Copyright Office. Omega sold watches with these designs to their authorized distributors.  Somewhere along the distribution line, however, the watches ended up in the hands of distributors outside of Omega’s authorized channels abroad.  As the Ninth Circuit recognized, this is a paradigm gray market importation scheme, in which products meant to be sold in one territory are imported into another, usually for cheaper prices. One of Costco’s suppliers based in New York imported watches from these unauthorized distributors and eventually transferred the watches to Costco, which then sold these watches to its customers in California. One of those purchasing customers turned out to be a plant employed by Omega.

Omega then sued Costco for violating their exclusive right to distribute  its copyrighted works and for importing them without Omega’s authorization.  Costco asserted the first-sale defense, arguing that Omega’s right to control the distribution of its watches under both the distribution and importation statutes ends with its first transfer to its authorized distributors.  Costco v. Omega’s ending at the Supreme Court was a bit anticlimactic, with the U.S. Supreme Court evenly divided 4-4 (Justice Kagan didn’t take part in the non-decision).  This led to a summary affirmance of the Ninth Circuit’s decision below and no rule from the Supreme Court resolving the statutory tension in the Copyright Act.

In the midst of the statutory construction issues dominating the Supreme Court briefs, Costco suggested that Omega’s distribution controls might pose antitrust problems.  This issue popped up very briefly; in one sentence and in one footnote, Costco’s first merits brief surmised that Omega’s distribution controls might qualify as a vertical restraint of trade sanctionable under the antitrust laws.  The issue was mentioned only in passing, but how briefly it appeared should not downplay the importance of the issue.  As noted above, to the extent that gray market importation is still a subject of debate, other litigants may very well challenge practices meant to stamp out gray markets under the antitrust laws.

Following Costco’s argument, Omega’s authorized distributor agreements could be characterized as vertical territorial restraints.  These distributor agreements might also involve vertical pricing fixing or vertical refusals to deal, but for the sake of brevity, this post will consider Omega’s practice as a vertical territorial restraint.  Vertical territorial restraints occur when companies up and down a distribution chain enter into agreements that limit the geographic areas into which they will sell their products.

These restraints used to be treated as per se illegal under the antitrust laws, but they are categorically unlawful no longer.  Taking the per se position on vertical territorial restraints was United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1967).   Justice Fortas, writing for the majority, believed that limiting to whom distributors may transfer a manufacturer’s products is “so obviously destructive of competition that their mere existence is enough.”  Drawing upon other vertical restraint cases, the Supreme Court in Schwinn expressed concern that allowing manufacturers to dictate how their products move down the distribution chain “would violate the ancient rule against restraints on alienation and open the door to exclusivity of outlets and limitation of territory further than prudence permits.”  The Supreme Court in Schwinn skirted a number of lingering questions.  One question was explicitly left off the table: how the principle of protecting the free alienation of property would apply to patents.  Other matters left out were robust analyses of the economic efficiencies hampered or harnessed by vertical territorial restraints.  A majority of the Supreme Court concluded as much ten years after Schwinn in Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36, 54 (1977).  GTE Sylvania overruled Schwinn, noting how untethered the nature of a manufacture-to-distributor transaction is to the economic efficiencies and effects on different markets. The GTE Sylvania Court also flagged and examined the economic literature regarding how vertical restraints reduce intrabrand competition among retailers but allows manufacturers to enjoy new efficiencies in their interbrand competition with other manufacturers.  In other words, while there is a possibility that harm to intrabrand competition might be serious enough to warrant antitrust scrutiny, not all vertical territorial restraints are per se illegal.

The Supreme Court’s decision in GTE Sylvania to step away from per se illegality is not limited to vertical territorial restraints.  In like sense, the U.S. Supreme Court once treated resale price maintenance — whereby a manufacturer commands that distributors not set retail prices at, above, or below set figures — as per se illegal.  Albrecht v. Herald Co., 390 U.S. 145 (1968) (maximum resale price maintenance); Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911) (minimum resale price maintenance).  Both of these cases have since been overruled.  State Oil v. Khan, 522 U.S. 3 (1997); Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S. Ct. 2705 (2007).  As GTE Sylvania, Khan, and Leegin indicate, there are pro-competitive reasons for manufacturers to agree with distributors to limit the scope of distribution, whether through prices or geographic regions. And these reasons carry enough weight that the Supreme Court believes it imprudent to penalize every single one of these agreements.  Moreover, these cases signal that hostility toward vertical restraints as potential antitrust problems is subsiding.  In fact, the IP and Antitrust treatise authors argue that “the rule of reason for purely vertical nonprice restraints has resulted in something approaching automatic legality for such arrangements.”  Herbert Hovenkamp et al., IP and Antitrust, § 24.3b1.

The antitrust analysis does not end with the Supreme Court’s treatment of vertical restraints in themselves. Adding another wrinkle is that the territorial restraint here was enforced using a copyrighted design, calling forth the ongoing confusion around how intellectual property and antitrust law should coexist.  For decades, courts and academics have been confounded by the tense intersection between intellectual property and antitrust law.  In fact, they cannot even agree on how to name it: In a lecture before the Antitrust Committee of the New York City Bar Association, Professor Mark Lemley listed several of these names: the relationship, conflict, tension, interaction, interface, or collision between intellectual property and antitrust policy.

That the antitrust laws and intellectual property rights are hopelessly mired in irreconcilable doctrinal conflict is far from being a necessary or inevitable conclusion.  Hovenkamp et al., supra, § 1.3.  In fact, Ward Bowman, Jr. argued that both intellectual property and antitrust promote wealth maximization and prevent restrictions on output.  Ward Bowman, Jr., Patent and Antitrust Law: A Legal and Economic Appraisal (1973), reprinted in part in Hovenkamp et al., supra, § 1.3; Mark A. Lemley, Milton Handler Lecture: The Intersection Between Antitrust and Intellectual Property Part 1-3.  They both have their own roles in accomplishing these ends: antitrust law protects the overall free market environment while intellectual property rights create incentives to innovate.  Hovenkamp et al., supra, § 1.3; Lemley, supra.  Without intellectual property, the argument goes, the market will stagnate.  Hovenkamp et al., supra, § 1.3; Lawrence A. Sullivan & Warren S. Grimes, The Law of Antitrust: An Integrated Handbook § 15.1 (2d ed. 2000); Lemley, supra.

That being said, intellectual property’s economic justifications do not give intellectual property owners carte blanche to enforce their intellectual property rights abusively nor in bad faith.  To be sure, some courts treat certain intellectual property enforcement practices, such as tying agreements and possibly others, as pernicious enough to the competitive process that they should not be tolerated under the antitrust laws, even if the intellectual property laws alone would allow them.  Image Technical Servs. v. Eastman Kodak Co., 125 F.3d 1195, 1216, 1218 (9th Cir. 1996); Data General v. Grumman Systems Support, 36 F.3d 1147, 1182 (1st Cir. 1994); but see In Re Independent Service Organization Antitrust Litigation, 203 F.3d 1322, 1327, 1327-28 (Fed. Cir. 2000) (“[A] patent owner may not take the property right granted by a patent and use it to extend his power in the marketplace improperly, i.e. beyond the limits of what Congress intended to give in the patent laws.” (quoting Atari Games Corp. v. Nintendo of America, Inc., ); SCM Corp. v. Xerox Corp., 645 F.2d 1195, 1206 (2d Cir. 1981) (“[C]onduct permissible under the patent laws cannot trigger any liability under the antitrust laws.”).  After all, the point of intellectual property in the United States is the economic quid pro quo of granting a property right in exchange for enriching society with new artistic and utilitarian creations; intellectual property does not, however, exist only to shower creators and innovators with pecuniary benefits or to further the Lockean notion that labor makes property.  Feist Publications v. Rural Telephone Services, 499 U.S. 340, 352-60 (1991); Mazer v. Stein, 347 U.S. 201, 219 (1954).  In the final analysis, innovation and antitrust policy coexist best when they are balanced: bad faith and baldly anticompetitive intellectual property enforcement should be sanctioned, while the antitrust laws simultaneously allow intellectual property owners to reap the fruits of their patents, copyrights, and trademarks, among other rights.  Herbert Hovenkamp, Federal Antitrust Policy § 5.5a (3d ed. 2005).

Applying this complicated and sometimes conflicting set of legal rules, one can plausibly find pro-competitive reasons for allowing Omega to control its distribution channels this tightly.  In terms of interbrand competition — such as may be the case with other luxury watch designers, like Tag Heuer, Breitling, Movado, and Rolex — constraining distribution channels can protect a company’s brand reputation.  In economic terms, limited distribution to authorized sellers prevents free riding by low-end discount stores that can sell goods for cheaper prices while shirking the customer service and presentation of higher end shops.  Cf. Leegin, 127 S. Ct. at 2715.  This is especially true for a luxury designer like Omega.  With the risk of free-riding by discount stores, a niche market for luxurious goods and the luxe shopping experience could become endangered.  Cf. id. at 2715-16.  If Omega’s fine watches can be had at lower prices than Omega would prefer at stores like Costco, then its brand may very well lose some of its exclusivity and cachet, a key asset to Omega’s ability to compete with other luxury designers.

Furthermore, the circuit decisions cited above demonstrate that the courts have been reluctant to extend antitrust liability to intellectual property enforcement when the underlying intellectual property right is legitimately and duly granted. For its part, the Federal Circuit has limited antitrust liability for patent infringement to the serious cases of fraud before the USPTO, objectively baseless sham litigation, and other situations in which a patent is extended beyond its statutorily granted property right, such as tying agreements. In Re Independent Serv. Org. Antitrust Litigation, 203 F.3d 1322, 1326-28 (Fed. Cir. 2000).  The Federal Circuit thus imposed a high burden on patent infringement defendants to show that intellectual property is being used in such an unduly exclusionary fashion as to warrant antitrust liability.  Id. at 1327.  In the copyright arena, the U.S. Supreme Court has demonstrated support for copyright owners realizing the value of their intellectual property.  Broadcast Music, Inc. v. Columbia Broadcasting System, 441 U.S. 1, 19 (1979) (“Although the copyright laws confer no rights on copyright owners to fix prices among themselves or otherwise to violate the antitrust laws, we would not expect that any market arrangements reasonably necessary to effectuate the rights that are granted would be deemed a per se violation of the Sherman Act.”).  In the First and Ninth Circuits, there is still a doctrinal presumption that intellectual property rights are being used legitimately.  Furthermore, there is close to explicit authorization in the Copyright Act for copyright owners to control their protected products’ distribution.  Hovenkamp et al., supra,  § 24.3b1.  Each of these doctrines heavily weigh against the already hard antitrust case to win.

Challenging Omega’s use of its copyrights as an antitrust violation thus would likely prove to be a daunting uphill battle.

This state-centric arrangement has come under fire in the last couple of decades, with the federal government staking its ground regulating insurance first around the periphery and then increasingly at the core of the insurance industry.  Some federal statutes make certain practices with certain aspects of an application for or policy of insurance illegal, whether proscribing genetic discrimination, as the Genetic Information Nondiscrimination Act (GINA) does, or limiting the pre-existing condition as the Health Insurance Portability and Accountability Act (HIPAA) did.  Also regulating health insurance at the federal level is the monumental Patient Protection and Affordable Care Act of 2010 (PPACA or “Obamacare” as it is more popularly known).  The PPACA statutorily mandates that some health insurance policies and group health plans eliminate certain provisions altogether, such as lifetime limits on health benefits and the pre-existing condition limitation.  Perhaps even more radically, the PPACA delegates authority to the Department of Health and Human Services to regulate the contents of health insurers’ and plans’ summary of benefits and even the policies themselves.

All the while, a bigger proposal for federalizing insurance laid under the surface.  Something else was being debated amid the political grandstanding accusing conservatives of callously turning a blind eye to the poor’s unmet health care needs and liberals of fashioning monstrous “death panels.”  These debates considered repealing the McCarran-Ferguson Act.  Timothy Noah, Busted Trust, Slate (Oct. 14, 2009), http://www.slate.com/id/2232443/ (last visited Jul. 10, 2011).

Though there would be significant symbolic import to repealing a statute prescribing a policy of federalism, as Professor Kenneth Abraham suggested in Insurance Law & Regulation, favoring state regulation in an era of increasing federal commercial regulation, some commentators posit that McCarran-Ferguson might not have much of an effect on its own, with other theories and defenses that can take up its slack. According to Phillip Areeda’s and Herbert Hovenkamp’s treatise, the antitrust laws might already apply to the insurance industry’s collaborative activity in situations lacking sufficient state regulation or to activities that are sufficiently interstate;  might not create antitrust liability in the first instance; or would be saved by the defense of state action immunity under Parker v. Brown, 317 U.S. 431 (1943).  Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law § 219d (2000).  Nonetheless, Professors Areeda and Hovenkamp also maintain there may be some ways in which McCarran-Ferguson may add something to the overall mix of antitrust liability, such as providing a more expansive defense than does Parker immunity. Id.

Let’s flesh this out a bit, first by examining the first-level statements of each defense’s elements.  The Parker Court exempted from federal antitrust scrutiny acts of government and public officials implementing a state law that requires anticompetitive conduct.  Parker v. Brown, 317 U.S. 341, 352 (1943).  That being said, states may not confer Parker immunity simply by allowing private parties to engage in anticompetitive conduct.  Cantor v. Detroit Edison Co., 428 U.S. 579, 592-93 (1976).  ”It is not enough that . . . anticompetitive conduct is ‘prompted’ by state action; rather, anticompetitive activities must be compelled by direction of the state acting as a sovereign.”  Goldfarb v. Virginia State Bar, 421 U.S. 773, 791 (1975).  The Midcal Aluminum case gave further definition to Parker immunity, stating that “the challenged restraint must be ‘one clearly articulated and affirmatively expressed as state policy’ [and] the policy must be “actively supervised” by the State itself.”  California Liquor Dealers v. Midcal Aluminum, Inc., 445 U.S. 97, 105 (1980) (citing City of Lafayette v. Louisiana Power & Light Co., 435 U.S. 389, 410 (1978) (Brennan, J.)). 

By contrast, the relationship between state insurance regulation and acquiring McCarran-Ferguson immunity can be much looser; to qualify, “[the states] do not have to expressly authorize a specific activity, or proscribe it, for the exemption to apply. . . .  It is enough that a detailed overall scheme of regulation exists.”  Klamath-Lake Pharmaceutical Ass’n v. Klamath Medical Service Bureau, 701 F.2d 1276, 1287 (9th Cir. 1983).

To make this abstract comparison more concrete, let’s next look at a hypothetical.  For a situation similar to FTC v. Ticor Title Insurance Co., 504 U.S. 621 (1992), imagine that a group of liability insurance providers conspired to fix the prices they charge for premiums.  Without any defenses available, price-fixing between and among competitors may be per se illegal under the Sherman Act.  United States v. Socony-Vacuum Oil Co., 310 U.S. 150 (1940).  Enter McCarran-Ferguson; because state insurance commissions regulate premium setting, McCarran-Ferguson immunity may save the cartelizing insurance companies from antitrust liability.  There may be some room for debate whether the price-fixing scheme somehow is an effort to “boycott, coerce, or intimidate,” 15 U.S.C. § 1013(b) (2006), but otherwise, immunity is fairly easily found.

Now consider this same scenario under Parker immunity.  Whether state action immunity will lie depends on the nature of various state insurance agencies’ methods of premium ratemaking.  Some actually make rates, though that approach is rare.  Abraham, supra, at 136.  Other regulatory programs for setting premiums require prior approval by an insurance commission before an insurance company can use them or agency approval after proposed premium rates have been filed with the state commission beforehand.  Id. at 137.  Others still allow insurers to increase and decrease rates within an allowable range, a practice called “flex rating.”   Id. And some agencies will just let private insurers prescribe rates through market competition.  Id. Many of these regulatory schemes would not form a basis for Parker immunity, especially those that require insurer competition in the market.  Furthermore, that state insurance commissions mandate regulatory approval of premium rates as a general matter does not excuse anticompetitive means by insurers to create these rates.  Cf. FTC v. Superior Court Trial Lawyers Ass’n, 493 U.S. 411, 424-25 (1990) (holding that even though private parties may petition the government to allow them to engage in anticompetitive conduct, an antitrust violation may occur if their methods of petitioning are unreasonable restraints on trade in themselves).  Even if an insurance commission allows these practices, as noted above, such authorization of private-party collusion does not necessarily qualify for Parker immunity.

Professors Areeda and Hovenkamp recognize that there is such a the gap between Parker and McCarran-Ferguson.  And for them, that gap might justify a repeal.  Their treatise states:

To the extent these three reasons do not apply to a practice, repeal seems desirable, for the effective impact of McCarran is to immunize activities (1) that would normally be antitrust violations when engaged in by private parties, and (2) where there is inadequate public supervision to qualify for Parker supervision.  Thus the residual impact of repeal would be to force states either to regulate more actively themselves or else leave provable antitrust violations to the antitrust tribunals rather than the unsupervised discretion of private firms.

Areeda & Hovenkamp, supra.

But such unsupervised discretion might ultimately be more favorable to consumers of insurance.  Subjecting the insurance industry to the antitrust laws would mire insurance companies’ in-house legal departments in additional legal research and drive them away from other matters of corporate policy-making.   To the extent that an insurance company wishes to place these legal issues on the desks of outside counsel, the insurance industry may then spend millions in the aggregate on legal fees.  And this says nothing of the possible liabilities for treble damage suits under the federal antitrust laws.  See Abraham, supra, at 189.  As per a discussion on this topic I had with Professor Kircher, the effects could be even more painful for small, local insurers.  In any case, the risk thus arises that these additional costs would be placed on the shoulders of insureds through higher premiums.

Such would be the result if a new law swamped an entire industry with new regulations, but the insurance industry’s antitrust exemption is especially valuable given the history of collaboration among insurance companies, from standard ISO policy forms to data pooling.  Abraham, supra, at 32-34, 189-90.  These collaborative practices allow insurance companies to assess their risk and liability exposures more efficiently.  To the extent such pooling might pose antitrust problems–whether they actually would is a different question–insurance companies may then be forced to endure additional uncertainty as to actuarial data and underwriting.  This too creates a risk of rising premiums.

Imposing even greater costs still is the system variability and unpredictability of the antitrust laws themselves.  The line between antitrust liability and no antitrust liability for a given trade practice is a blurry and moving one.  To be sure, the default rule under the Sherman Act for antitrust violations in section 1, which relates to conspiracies and agreements to restrain trade, is the Rule of Reason.  Texaco Inc. v. Dagher, 547 U.S. 1, 5 (2006). The rule’s name speaks for itself:  it is an overall reasonableness test.  State Oil Co. v. Khan, 522 U.S. 3, 10 (1997) (recognizing that the ”Court has long recognized that Congress intended to outlaw only unreasonable restraints” on trade).  Reasonableness tests are notorious in other areas of the law for their lack of predictability.  Cf. Ira E. Williams, First, Do No Harm: The Cure for Medical Malpractice 52 (2004) (“A legal definition for an acceptable standard of care found in many state statutes is ‘one used by a reasonably prudent practitioner.’  This is so vague as to be meaningless.”).  Even the categories of per se illegal restraints on trade do not inject much certainty into the antitrust analysis, with the Supreme Court’s move away from per se illegality for some trade practices toward more case-by-case reasonableness inquiries and characterization analyses. Lawrence A. Sullivan & Warren S. Grimes, The Law of Antitrust: An Integrated Handbook (2d ed. 2006); accord, e.g., FMC v. Svenska Amerika Linien, 390 U.S. 238, 250 (1968) (“Under the Sherman Act, any agreement by a group of competitors to boycott a particular buyer or group of buyers is illegal per se.”); Northwest Wholesale Stationers, Inc. v. Pacific Stationery and Printing Co., 472 U.S. 284 (1985) (limiting per se illegality to some and not all horizontal group refusals to deal).  And so, Professors Areeda’s and Hovenkamp’s second point–that some practices may not violate the antitrust laws in the first instance–is exceedingly difficult to quantify.

These considerations all demonstrate that McCarran-Ferguson does pull some weight in the antitrust and trade regulation fields, whether as an objective doctrinal matter or in terms of creating expectations upon which insurance companies can rely in their own internal legal compliance programs.

Alright, the law of subrogation is fairly simple.  If one who is secondarily liable pay a debt that should have been paid by the primarily liable person, the one who pays the debt steps into the shoes of the creditor to pursue the one primarily liable.  Subrogation also applies to an indemnity insurance situation.  An insurer paying on its policy when its insured sustains a loss caused by a tortfeasor may pursue the tortfeasor for the amount the insurer paid.  It thus becomes the alter ego of its insured, the tort victim, as to the tortfeasor.  In this context both insurance and tort law concern themselves with indemnity.

A wrinkle has been added to the basic context in Wisconsin and elsewhere.  The Wisconsin Supreme Court determined that an insurer’s subrogation rights remain inchoate until its insured is “made whole” by the tortfeasor for the losses sustained. [Garrity v. Rural Mut. Ins. Co., 77 Wis.2d 537, 253 N.W.2d 512 (1977); Rimes v. State Farm Mut. Auto. Ins. Co. 106 Wis.2d 263, 316 N.W.2d 348 (1982).]  No real problem with that, as the insurer is a commercial risk-taker while its insured is not and a pecking order here should favor the latter over the former.

But ah, here comes the rub!  In Koffman v. Leichtfuss, [246 Wis.2d 31, 630 N.W.2d 201 (2001)] the court was confronted with a case in which the plaintiff received medical treatment for injuries sustained in an accident.  The total amount billed by health care providers was $187,931.78.  However, through certain contractual relationships with the plaintiff’s health care providers, the plaintiff’s insurers received the benefit of reduced “contracted rates” and were able to satisfy the amounts billed by the providers with total payments of $62,324.  The plaintiff personally paid $1,869.43 in deductibles, co-payments, and out-of-pocket expenses.  The court, nevertheless, held that the plaintiff was entitled to seek recovery of the reasonable value of medical services, the amount billed, without limitation to amounts paid.  That ruling would make sense if the medical services had been provided gratuitously.  That would be no more than an application of the collateral source rule.  But in Koffman, the ruling impacts not only upon the tortfeasor’s liability but, because of the “made whole” rule, the insurer’s ability to advance its subrogation rights.

Even though the two dissenters did not say so in Koffman I will.  If the law says that, the law is an ass! [Charles Dickens, The Adventures of Oliver Twist 399 (Oxford Univ. Press 1981 (1838)]

That was the overall theme of the 2011 Public Service Conference held at Eckstein Hall. The conference, New Directions in Consumer and Community Financial Protection, brought together prominent federal and state authorities on the subject and provided an up-to-the-minute look at the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

“Dodd-Frank created a floor, not a ceiling, for consumer protection” noted Kathleen Keest, an expert on consumer protection law from the Center for Responsible Lending.  The new law reverses some of the federal preemption rules that were in effect prior to its passage, providing state attorney generals with increased enforcement authority with respect to many consumer protection laws.   

One of the focal points for discussion was where the balance will be struck between federal and state regulators as the new law is implemented. Gregory Zoeller, attorney general of Indiana and co-chair of the National Association of Attorneys General Consumer Protection Committee, told the audience that he was working with federal regulators to make sure that states have an important role in making decisions about prosecutions and other actions.

“When you consolidate authority in Washington, it often has trouble written all over it,” said Zoeller, a Republican.  “Even things that started off well sometimes come back to haunt you.”

He said while he was skeptical of some parts of the Dodd-Frank law, he agrees it is an improvement. But he fears what the impact of  lobbyists may be in shaping rules for carrying out the law that are just beginning to be shaped. 

Zoeller said attorneys general are supposed to have a relationship with federal enforcers that involves cooperation and consultation, but sometimes they end up feeling like the federal officials want to own and operate them. It will be better for carrying out Dodd-Frank if the relationship is a healthy one, he said. He said attorneys general are collaborating well in working on the course they want to take in response to the law.

Charles Harwood, deputy director of consumer protection for the Federal Trade Commission, struck an optimistic note in describing the role FTC has played, and will play, in protecting consumers in cases involving lending  practices and in describing relations between federal and state enforcement efforts.

“In my experience, the states and the federal government have no problem co-existing in the consumer protection area,” he said. He said even when attorneys general decide they prefer to prosecute a matter using state laws, they benefit from having federal regulations or enforcement tools as practical help to them.

The FTC will move some of its power over regulating consumer financial instruments to the new Consumer Financial Protection Bureau, being created within the Treasury Department, Harwood said. Recounting all the FTC went through to create rules for disclosing information on energy consumption to consumers who buy appliances, Harwood cautioned that it can become very complicated to determine ways to give consumers information. 

The Dodd-Frank law is intended to prevent the kind of abuses and excesses in lending and credit practices that were major contributing factors in the mortgage and foreclosure crisis of recent years. Nine months after its passage, the practical aspects of Dodd-Frank are still in formation. The Public Service conference allowed about 150 lawyers and others to get top quality information on where that enforcement process is headed – and to consider major questions that remain to be answered in determining  the law’s effectiveness.

GRADES: Would you give Ben Wallace a C? I wouldn’t give Ben Wallace a C. What possible good could come from giving Ben Wallace a C? EDGE: Ben Wallace

Amen to that!  By the way, given the strength of our sports law program, I hope Wallace will be giving Marquette a serious look.  And, as a defensive specialist, he shouldn’t mind too much that our local NBA franchise can’t seem to find the hoop.

Mystal’s post imagines Wallace heading to a lucrative big-firm job, which does point to the more serious issue addressed by my next post: the ease with which wealth can be used to generate more wealth, producing an inequality spiral in society.  

As the gap between rich and poor grows in the U.S., I find it fascinating that no serious political movement has emerged advocating a real redistribution of wealth in this country.  Yes, Democrats favor some policies that have (or would have) redistributionist consequences, but I don’t hear anyone anywhere near the political mainstream in either party advocating for direct, large-scale wealth redistribution, e.g., by restoring the top marginal income tax rates to what they were a generation or two ago.  Why is that?

Seeking to provide some answers to the question, Frank Pasquale has a fascinating post at Balkinization on the politics of inequality.  I found this passage especially intriguing:

Everyday experience also helps explain the trend. In Griftopia, Matt Taibbi interviews members of the US Tea Party. He reports that their views of government arise out of their interactions with officials at the IRS, DMV, TSA, zoning boards, or similar agencies: stressful, one-shot interactions with bored, inattentive, or hostile bureaucrats. They project that experience onto places like the SEC, CFTC, FCC, or Fed—assuming that the world of DC agencies is just as exasperating for the multinational corporations regulated by these agencies as local government is for them. They have little sense of the revolving door of high bureaucracy, where the regulators are often on the lookout for jobs at regulated entities. An IRS auditor has no prospect of one day working for a middle class auditee, but MMS staffers have often been smitten with the companies they inspect. (As one report puts it, “The cozy ties included workers who moved between industry and government jobs ‘with ease’— friends who’ve ‘often known each other since childhood.’”)

So a Tea Partier exasperated by DMV incompetence may vote for a party committed to making the MMS inspectors even poorer and more reliant on an eventual big payday at a company they regulate. Lower government wages will likely provoke the TSA/DMV/IRS crowd to be ever surlier to the public, while making the SEC/CFTC/FCC crowd ever more dependent on a big private sector payday. And so the cycle continues.

Pasquale identifies the implementation of the Dodd-Frank bill as a current example of how existing political dynamics diminish the extent to which regulatory initiatives are capable of restraining the inequality spiral:

[A]s Farrell notes, “There are many very influential organizations pushing the interests of business and of the rich . . . . [and] they typically trump voters (who lack information, are myopic, are not focused on the long term) in shaping policy decisions.” Already the implementation of Dodd-Frank appears to be going in this direction, as “3,659 lobbyists worked for companies that explicitly lobbied on the Dodd-Frank bill” in the first nine months of 2010. Over half of voters are unaware that the Republicans just won the House of Representatives; it’s hard to imagine them pressing either party for, say, better derivatives regulation.

Staying on the subject of Dodd-Frank, Jeff Schwartz has some interesting commentary at The Conglomerate on the regulation of hedge funds under the new law.  He is skeptical that registration requirements will actually do much to rein in hedge funds:

The idea that registration could help protect investors from fraud is reasonable.  It might deter fraud or make it easier to detect.  But the Madoff scandal gives reason for pause.  Madoff was registered as an investment adviser and his operations had raised red flags with the SEC.  Yet the agency failed to uncover the far-reaching misconduct.  What this shows is that registration alone is insufficient, and perhaps secondary.  More importantly, the SEC needs to right the ship in terms of enforcement.  If this happens, then perhaps the rule will prove to be a useful investor-protection tool.  While the Act does beef up the SEC’s powers in this regard, my intuition is that the problem is cultural rather than regulatory.

He concludes:

Rather than clearly reflecting any specific normative goal, perhaps hedge-fund registration is a populist response to the unease caused by the vast accumulation of capital in secretive, profitable, and risky endeavors.

Although there may indeed be some lingering feelings of fear and resentment towards wealthy private entities, Pasquale’s analysis suggests why populist fear and resentment of government agencies may be even greater.

There are many important Supreme Court tax cases.  However, few are identifiable just by reference to a footnote number.  Tax scholars and academics will easily recognize the Supreme Court’s decision in Crane v. Commissioner simply by reference to footnote 37.  In my opinion, Crane is the most important case in tax history, and footnote 37 is the most famous footnote.

The issues presented in Crane arose when the taxpayer inherited an apartment building from her husband.  The taxpayer took the apartment building subject to a mortgage.  There was no equity in the apartment building because the outstanding balance of the mortgage debt and interest in arrearage equaled its appraised value.  During her seven years of ownership, the taxpayer claimed depreciation deductions.  Eventually, the taxpayer sold the apartment building to a third party for $3000 with the taxpayer paying $500 for expenses on the sale and the third party taking the apartment building subject to the mortgage.  The taxpayer claimed that her adjusted basis in the apartment building was zero and her amount realized on the sale was $2500 resulting in a $2500 gain.  As noted by the Court, this argument was inconsistent with the taxpayer claiming depreciation deductions on the apartment building.

The IRS assessed a deficiency against the taxpayer claiming that the taxpayer’s adjusted basis in the property at the time she inherited it was the fair market value of the physical property rather than her equity.  Under the tax code, the adjusted basis of property acquired from a decedent was its fair market value at the time of the decedent’s death.  The IRS also claimed that the taxpayer’s amount realized upon her disposition of the apartment building included the outstanding balance of the mortgage debt.  The Tax Court decided the issue in favor of the taxpayer, but the Court of Appeals for the Second Circuit reversed.

In a 6-3 decision, the Supreme Court held in favor of the IRS. The majority first concluded that the property that the taxpayer acquired for purposes of determining her adjusted basis was the physical property rather than its equity.  The majority then held that the taxpayer had to include the debt relief in her amount realized even though she was not personally liable on the debt.  It was already established as a principle of tax law that had the taxpayer been personally liable on the mortgage debt, the debt relief would have been included in her amount realized.  The Court’s rationale was based on an economic benefit theory that the taxpayer would pay the debt simply to protect the equity in the property.  Hence, assuming that the fair market value of property was $100,000 and it was encumbered with a $20,000 nonrecourse mortgage debt, the taxpayer would pay the debt in order to protect the $80,000 of equity.  In the famous footnote 37, the Court indicated that there might be a different result where the fair market value was less than the outstanding balance of the mortgage debt because there would be no economic incentive to pay it; rather, it would make more economic sense for the taxpayer to abandon the property rather than to pay the mortgage debt.  Thirty five years later in Commissioner v. Tufts, 461 U.S. 300 (1983), the Supreme Court addressed footnote 37 and determined that because a nonrecourse debt was true debt, a taxpayer being relieved of that debt must include the debt relief in the amount realized.  As true debt, it was not included in gross income at the time the obligation was incurred because of the obligation to repay.  If the debt relief was not included in gross income, the taxpayer would have received an untaxed accession to wealth.

On the surface, it does not appear that Crane can realistically be categorized as one of the most important tax cases in history.  However, the significance of the case be explained by reference to two words—tax shelter.  The Crane decision established the foundation for the onslaught of tax shelters by allowing a taxpayer to claim depreciation deductions exceeding the amount of the taxpayer’s true investment in the venture.  These tax shelters made unprofitable ventures viable because of the tremendous potential for tax savings.  The taxpayer in Crane, for example, claimed about $25,000 in depreciation deductions even though she had not repaid any of the mortgage debt.

The enormous impact of the Crane case materialized upon Congress’s enactment of the accelerated depreciation rules (ACRS) under the Economic Recovery Tax Act of 1981, allowing for depreciation over a much more compressed timeframe than in the past.  For example, under ACRS, a taxpayer could acquire certain types of equipment for $10,000 cash and a $90,000 nonrecourse note and claim $20,000 in depreciation deductions for the taxable year.  The taxpayer’s tax savings would have already exceeded the $10,000 investment.

The vehicle of choice for holding depreciable assets during the tax shelter craze was a limited partnership because the limited partners enjoyed limited liability but could claim their distributable share of depreciation deductions and losses on their individual tax returns.  The limited partners became less concerned with whether the asset generated income because the primary goal of acquiring the asset was the sheltering of income earned from other sources, such as wages.  A typical limited partner might have invested in a limited partnership that was formed to develop office buildings.  These buildings were being constructed even though unoccupied office buildings were in the vicinity.  The problem worsened during the early 1980s as taxpayers invested in unprofitable ventures and took advantage of the accelerated depreciation deductions created under ACRS.

The ability to invest in these types of tax shelters spiraled out of control until Congress enacted the Tax Reform Act (TRA) of 1986.  Prior to the enactment of the TRA of 1986, the government lost billions of dollars in revenue resulting from tax shelter abuse.  The TRA of 1986 essentially prevented taxpayers from reaping the benefits of many of these tax shelters.  Under IRC § 465, a taxpayer could only claim a loss or deduction up to the amount that the taxpayer had at risk—generally cash or personal liability loans.   The TRA of 1986 expanded the scope of these rules to include real estate activities but allowed for the inclusion of nonrecourse indebtedness in the amount that a taxpayer had at risk if certain requirements were met. While the at-risk rules limited the benefits of investing in tax shelters, Congress’s enactment of the section 469 passive active limitation (PAL) rules under the TRA of 1986 essentially closed the door on these types of tax shelters. Under the PAL rules, a taxpayer was prohibited from using losses from passive sources, such as limited partnerships and rental activities, to offset income from active sources, including wages, interest and dividends.  If the majority in Crane had concluded that the taxpayer was prohibited from claiming depreciation deductions based on the facts in the case, these reforms would have been unnecessary.

Significantly, the 1986 tax reforms were partially responsible for the savings and loan crisis in the late 1980s.  The real estate market became depressed in several states after the TRA of 1986 resulting from the number of unoccupied real estate.  After the enactment of the PAL and at-risk rules, investors began abandoning these properties.  They no longer had a tax incentive to own unprofitable depreciable property.  Because the investors lacked personal liability, the banks were unable to recover deficient judgments against them.  The federal government insured the deposits under the Federal Deposit Insurance Corporation, and the government (and therefore taxpayers) had to bail out the savings and loan associations.  Although there were many additional causes for the savings and loan crisis, the inability of investors to continue claiming the tax benefits created by Crane was a critical factor.  It is unlikely that many of these investors would have invested in unprofitable real estate holdings without the tax benefits.

Consequently, Crane is the most important case in tax history.  It created the foundation for tax shelters, and the resulting tax reforms were partially responsible for the savings and loan crisis in the 1980s.  The government technically prevailed in the Crane case, but as history showed, it was a very hollow victory.

Last spring in American Needle, Inc. v. National Football League, 130 S. Ct. 2201 (2010), the United States Supreme Court reversed two lower court decisions and held that under Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752 (1984), National Football League Properties (NFLP) was not a single entity but rather a collection of different entities with “independent centers of (business and economic) decision-making.” In Copperweld, the Court held that parties within a corporate entity or closely held affiliate (e.g. a wholly owned or controlled subsidiary) are to be treated as a single entity under the antitrust laws (despite the possible treatment as separate entities under corporation law) and therefore not subject to Section 1 of the Sherman Antitrust Act. By its decision in Copperweld, the Court in effect invited parties that might otherwise be treated as more than one entity under the Sherman Act to assert that they fall under the “single entity” category. Historically, despite efforts by many sports leagues to try various business arrangements to fit under the single entity category, courts have denied regularly these assertions based on the understanding that the arrangements were really vehicles controlled by multiple parties with different corporate and economic interests.

The origin of the single entity analysis is drawn from the face of the Sherman Act itself. Section 1 of the Sherman Act states that “every contract, combination or conspiracy in restraint of trade is illegal.” Therefore, the wording of Section 1 of the Sherman Act requires that two or more parties participate in order to find illegality. In contrast to Section 1, Sherman Act Section 2 addresses monopolization (acts by one party) or conspiracy to monopolize (acts by two or more parties to reach a monopoly). Because illegal monopolization under Section 2 requires proof of an abuse of monopoly position, it can be very difficult to prove a Section 2 violation (“Section 1 treat[s] concerted behavior more strictly than unilateral behavior,” Copperweld at 768). Moreover, there are other shelters for unilateral activity beyond the monopolization issue (e.g. since the Supreme Court’s decision in United States v. Colgate & Co., 250 U.S. 300 (1919), the Court has protected absolutely the right of a manufacturer to refuse to deal with whomever it wishes as long as it acts unilaterally).

The National Football League (NFL) is an unincorporated association of 32 separately owned professional football teams. Through National Football League Properties (NFLP) the NFL develops, licenses and markets certain intellectual property owned by the NFL teams. Until December 2000, the NFLP licensed its intellectual property to many different apparel manufacturers (including American Needle). In December 2000, NFLP agreed to provide an exclusive license for the production of its apparel to a single company Reebok, International Ltd. American Needle challenged the NFLP’s use of an exclusive license as a Section 1 Sherman Act violation. In response, the NFL and NFLP asserted that NFLP is a single entity, so a claim of anticompetitive activity can only be brought under Section 2 of the Sherman Act.

The Court faced the primary question raised by the Copperweld decision: were the acts by NFLP group action (contract, combination or conspiracy in restraint of trade) or the acts of a single entity?  In American Needle, the Supreme Court observes, once again, that despite the appearance that the NFLP is a single entity or joint venture, real-world factors rather than appearance will be the basis of the Court’s analysis. In analyzing the nature of the NFLP, the Court notes that “we have repeatedly found instances in which members of a legally single entity violated Section 1 when the entity was controlled by a group of competitors and served, in essence, as a vehicle for ongoing concerted activity” (citing United States v. Sealy, Inc., 388 U.S. 350 (1967)). The Court concludes that the members of the NFL (a collection of franchises owned by separate entities) that makeup the NFLP are independent centers of (business and economic) decision-making and therefore the NFLP is not a single entity. Although the Court resolved the single entity argument in American Needle, the Court remanded the case to the lower courts to determine whether the acts of the NFL and the NFLP that were asserted as Section 1 Sherman Act violations by American Needle were anticompetitive.

The NFL raised a secondary issue in American Needle. The NFL asserted that, based on the decision in National Collegiate Athletic Ass’n v. Board of Regents, 468 U.S. 85 (1984) (NCAA) (wherein the Court applied the rule of reason even in a horizontal price-fixing case because in order to have a league at all there must be some coordination between and among the individual competitors), the NFLP’s actions were part of the approved coordination necessary to operate as a league. In response, the Court reaffirmed its holding in NCAA that some actions by a sports league require that there be coordination in order to have a league at all (e.g. rules of the game, scheduling). However, what role the NCAA decision will play, as to the rule of reason standard, is a matter to be considered on remand.

*The United States Supreme Court has overturned many of its own antitrust decisions over the past 30 years. It has done this directly (see e.g., Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36 (1977), State Oil Co. v. Khan, 522 U.S. 3 (1997)), and most recently it overturned an almost 100-year-old doctrine in Leegin v. PSKS (2007). It has also done this indirectly (see, e.g., Monsanto Co. v. Spray-Rite Service Corp., 465 U.S. 752 (1984)). It has set new and difficult standards of proof (see, e.g., Bell Atlantic Corp. v. Twombly, 550 U.S. 554 (2006)) and even ignored administrative law doctrines (see, e.g., California Dental Ass’n v. F.T.C., 526 U.S. 756 (1999)).

The obvious starting point might be Butch Cassidy’s (or Paul Newman’s) famous question, “Who are those guys?”  Amy Gardner at the Washington Post tries to answer that question here (hat tip to Steven Easley).  Despite her best efforts, a definitive picture of the Movement remains elusive:

[A] new Washington Post canvass of hundreds of local tea party groups reveals a different sort of organization, one that is not so much a movement as a disparate band of vaguely connected gatherings that do surprisingly little to engage in the political process.

The results come from a months-long effort by The Post to contact every tea party group in the nation, an unprecedented attempt to understand the network of individuals and organizations at the heart of the nascent movement.

Seventy percent of the grass-roots groups said they have not participated in any political campaigning this year. As a whole, they have no official candidate slates, have not rallied behind any particular national leader, have little money on hand, and remain ambivalent about their goals and the political process in general.

Jonathan Haidt does some psychoanalysis of libertarians, liberals and conservatives, and tries to show that it is not a love of liberty that unites Tea Partiers, but rather a belief in karma:

The notion of karma comes with lots of new-age baggage, but it is an old and very conservative idea. It is the Sanskrit word for “deed” or “action,” and the law of karma says that for every action, there is an equal and morally commensurate reaction. Kindness, honesty and hard work will (eventually) bring good fortune; cruelty, deceit and laziness will (eventually) bring suffering. No divine intervention is required; it’s just a law of the universe, like gravity.

The whole article is at the Wall Street Journal.  I am not sure that I buy the argument, but the image of Sarah Palin wearing a sari and banging a tamborine is an appealing one. 

The issue that seems to unite the Movement more than any other seems to be the Obama administration sponsored Affordable Health Care Act.  Litigation over the individual mandates contained in the legislation is being closely watched.  Theresa Weisenberger gathers the cases and issues in one location over at the JET Law Blog (the Vanderbilt Journal of Entertainment & Technology Law).  Meanwhile, over at Balkinization, guest bloggers Gillian Metzger and Trevor Morrison provide constitutional commentary.  Their opinion of the Florida District Court case:

In short, the court’s declaration that the individual mandate cannot be deemed an exercise of Congress’s tax power is built upon a hostile reading of the record. If the presumption of constitutionality means anything, surely it is that in areas not subject to a Supreme Court-mandated clear statement requirement, courts should give Congress the benefit of the doubt.

Meanwhile, the issue of immigration seems to confound the Tea Party.  Stewart Lawrence at the Daily Caller examines the contradictions in this post:

Will the Tea Party Movement expand beyond the borders of the United States and become an international movement?  Anna Leutheuser at the Heritage Foundation thinks it will:

The principles that precipitated the first Tea Party – a respect for the rule of law, and desire for limited government and individual liberty – are universal; and they are just as threatened now as they were at the time of the American founding.  This time, however, the United States is not alone in coming to their defense.

Finally, we go back to Balkinization to give Jack Balkin the last word on the Tea Party Movement: 

What changed during the 1960s and afterwards was the creation of a New Right, and the joinder of social conservatives, business conservatives, anti-welfare state conservatives, anti-regulatory conservatives, anti-tax conservatives and foreign policy conservatives. That alliance made it possible for the rich and for corporations to bankroll a wide range of conservative causes, in the belief that a rising tide (of anger) would lift all conservative boats. Corporate interests could ally themselves with the Republicans’ form of populism as long as social conservatives would keep voting for candidates who would favor business interests and seek to lower taxes on the wealthy and corporations.

This basic feature of modern American conservatism has not really changed with the emergence of the Tea Party, even though the Tea Party presents itself as a new form of political organization, alienated in part from the mainstream of the Republican Party. The Tea Party, however differently it may be organized, is just the latest incarnation of the most conservative elements of the late 20th century conservative coalition, this time featuring a special emphasis on opposition to the size of government and government taxation. That emphasis makes the Tea Party a natural object of corporate support, albeit mostly hidden corporate support, because many in the Tea Party also are not that fond of the Wall Street bailout either.

That’s all for now.  As Craig Ferguson says, “I look forward to your letters.”  Please remember our comments policy:

We hope that this blog will be a robust forum for civil and well-informed discussion of important issues and ideas. To that end, we welcome the submission of comments from readers in response to posts. We reserve the right not to publish comments based on such concerns as redundancy, incivility, untimeliness, poor writing, etc. All comments must include the first and last name of the author and a valid e-mail address.

Taking pride of place among the “long-ago texts” highlighted in the article is Friedrich Hayek’s 1944 book The Road to Serfdom.  Hayek is often cited by the movement’s followers for his argument that a government that intervenes in the economy will inevitably intervene in every aspect of its citizen’s lives.  If one accepts this premise, it is easy to understand why members of the Tea Party Movement reacted with hostility to the Troubled Asset Recovery Program (TARP), health care reform, and the bailout of the domestic auto industry.  For Tea Party followers, these separate policies – when viewed together — comprise a centrally planned economy reminiscent of the Soviet Union’s infamous Five Year Plans.

As I have explained elsewhere, some of Hayek’s devotees even argue that we should interpret the Constitution’s Commerce Clause as if the founders of our nation sought to maximize market competition free from government restraint along the lines of Hayek’s theories.

Defenders of the federal government’s intervention in the economy rely upon their own “long-ago text,” the writings of John Maynard Keynes.  Keynes argued that counter cyclical public spending could be used to counteract economic downturns.  His theories hold that in times of high unemployment the government can use deficit spending in order to stimulate demand (i.e., through public works projects) and that this spending will increase employment.

While Hayek and Keynes have traditionally been placed at the two ideological extremes of economic theory, the views of both men suffer when their major premises are exaggerated by their followers.  Keynes himself admitted that his views evolved over time and that he no longer agreed with some of his writings.  It is fair to say that Keynes was something of a slippery target when it came to being pinned down on specifics.

Some evidence that the views of Keynes and Hayek may not be as diametrically opposed as their followers often allege can be seen in the letter that Keynes wrote to Hayek after the publication of the The Road to Serfdom.  In the letter, Keynes claims to agree with almost everything that Hayek wrote.  In fact, several complimentary sentences from the letter were used as a blurb on the back cover of the paperback edition of Hayek’s book.     

Essentially, Keynes agreed with Hayek that a completely centralized economy would be undesirable, while noting that Hayek himself accepted some forms of government regulation as permissible.  His main criticism of The Road to Serfdom was that Hayek never explained how much government regulation was too much regulation:

You admit … that it is a question of knowing where to draw the line. You agree that the line has to be drawn somewhere, and that the logical extreme is not possible. But you give us no guidance whatever as to where to draw it…. As soon as you admit that the extreme is not possible … you are, on your own argument done for, since you are trying to persuade us that so soon as one moves an inch in the planned direction you are necessarily launched on the slippery path which will lead you in due course over the precipice.

(This famous portion of Keynes’ letter is quoted in an excellent 2006 essay by Robert Skidelsky which, among other strengths, draws interesting parallels between Hayek and George Orwell).

Hayek attempted to answer Keynes’ question on where to draw the line with his book The Constitution of Liberty published in 1960.  It is this book, more than The Road to Serfdom, which strikes me as a major influence on the intellectual arguments of the Tea Party Movement.  It is difficult to read The Constitution of Liberty today without observing the many ways in which its arguments have been carefully extracted and used to deny that the federal government has any legitimate authority to regulate health care or the financial markets.

[As someone who teaches Constitutional Law, Securities Regulation, and Immigration Law, I would be greatly pleased if Hayek used his opposition to excessive government regulation of the economy as a basis for criticizing government control over immigration.  Had Hayek advocated in favor of open borders, as some of his self-professed followers have subsequently done, then I could critique his theories across all three of my primary teaching areas.  Alas, Hayek defended the role of the government to pick and choose among potential immigrants as a means of favoring persons who (government planners believed) would be more likely to acculturate.  By waffling on immigration, Hayek deprived me of a consistent theory that would tie all three of my subjects together.] 

Perhaps because Hayek is forced to be more specific in outlining his theories in The Constitution of Liberty, rather than relying upon generalities as he did in The Road to Serfdom, I do not believe that the later book has aged as well.  Lest anyone be tempted to stop reading immediately on the grounds that any critic of Hayek must be blinded by a “liberal bias,” I will link here to a critical review of The Constitution of Liberty by Jacob Viner, an economist often cited as having helped to inspire “the Chicago School” of economics theory.

In my opinion, Hayek’s weakness is that he sees the world he lives in very clearly, but that he errs in deriving eternal principles from what is in essence a transitory stage in the evolution of global markets (of course, one could criticize Karl Marx on the same basis).

For example, he argues that an economy that develops free of government control will naturally come to incorporate beneficial social arrangements, through the free choices of its participants.  These naturally occurring arrangements will of necessity be preferable to state-planned social arrangements, he argues, because state planners will never have information regarding the wants and needs of the public that is comparable to the information available to market participants.

Of course, we now appreciate the fact that the economy of the United States during the 1950s blithely supported tobacco companies and industrial polluters who were imposing unseen and long-term health costs on the population (call this the “Mad Men” economy).  The regulation of tobacco products by the federal government, and the passage of the Clean Water Act and the Clean Air Act, constituted significant restrictions upon the free choices of market participants.  We are all better off because of these government interventions.  Would a similar result have occurred without government intervention?

Similarly, Hayek argues that the economic progress of the masses is only possible if we allow an elite minority to amass significant material and financial wealth.  He argues that economic progress occurs when a small vanguard stimulates demand for material goods among the broader population, who naturally desire the comforts that they observe the elite enjoying.  The increased demand will lead to a greater production of material goods and more jobs for the masses, which will allow an increase in wealth to expand throughout the society.  Hayek’s economic “story” only works, however, if the increased production jobs stay in the United States.  When companies ship production jobs overseas, it is the living condition of foreign workers that gets raised and not domestic workers (call this the “Outsourced” economy).

Most importantly, Hayek’s argument that optimal social benefits can result from an evolutionary process of free competition amongst firms, rather than through central government planning, elevates gradualism over decisive government action.  This leaves us with no options when financial markets seize up, short-term credit becomes unavailable, and, in the memorable words of John McCain, “the economy is about to crater.”  It may be true that the existing system of financial regulation has failed to keep pace with changes in the marketplace and with a growing element of systemic risk among inter-connected markets.  I believe that regulation needs to change and evolve in response to changes in the industry that it oversees.  However, even conceding the inadequacy of current law, it is difficult to see how the complete absence of financial regulation would have prevented the Financial Meltdown of 2007.       

Hayek’s observations on the risk of centralized government planning were timely in the face of the rising influence of the Soviet Union and China as viable economic models.  His focus on the expansion of material wealth in the United States as an example of the benefits of mildly regulated competition is, in retrospect, an example that reflects the post-World War II boom domestically and the shambles of Europe’s post-war economy.  Hayek made important contributions to our understanding of economics, of course, but many of the arguments that his followers have adopted as undeniable truths seem to me to be inextricably linked to their particular time and place.

By the end of The Constitution of Liberty, Hayek reveals himself to be much less of an absolutist in defense of unregulated competition than his followers.   This should come as no surprise.  In the Road to Serfdom Hayek telegraphed his acceptance of a state role in regulating the economy.  Far from advocating a laissez faire approach to regulation, Hayek actually justifies a role for the state as the enforcer of a legal framework designed to control competition – he defends laws that mandate safe work environments and minimum wages, defends laws that prevent polluters from externalizing their costs onto their neighbor, and defends laws that penalize fraud and deception.  He argues that state regulation is legitimate if it promotes competition, and illegitimate if is it is designed to stifle competition.  It turns out that there is some middle ground between Hayek and Keynes after all.

One of the arguments in favor of health care reform and financial markets reform is that the prior legal regimes did not prevent market participants from externalizing their costs onto others.  We can argue over whether that is true or not, and over whether the legislative reforms enacted under the Obama administration do a better or worse job of forcing competitors to internalize their costs, but it is a misreading of Hayek to argue that the very attempt to regulate the market is mistaken.

In fact, as I read The Constitution of Liberty, Hayek would likely have agreed with Theodore Roosevelt, who wrote the following about the industrial age in his Autobiography:

[A] few men recognized that corporations and combinations had become indispensable in the business world, that it was folly to try to prohibit them, but that it was folly to leave them without thorough-going control . . . They realized that the government must now interfere to protect labor, to subordinate the big corporation to the public welfare, and to shackle cunning and fraud . . .

Yet somehow Friedrich Hayek has come to symbolize an extreme form of hostility towards government economic regulation.  As often happens (see, e.g., Adam Smith), Friedrich Hayek has become more important for the principles that he supposedly stands for than for what he actually said.

Well, a lot has happened since my past post:

• Central bank governors and regulators finalized a package that will recommend that banks more than triple the amount of top quality capital they must hold to withstand shocks without state aid (the so-called Basel III requirements);
• Six banks in the U.S. collapsed, bringing the total to 124 this year as the ramifications of the credit crises continued to take a toll (including one right here in West Allis, Wisconsin); and
• Gordon Gekko plans his return as the movie Wall Street: Money Never Sleeps premiers in theaters this Friday – I am sure that you will remember the speech from the first movie: 

The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA.  (http://www.youtube.com/watch?v=7upG01-XWbY)

First, we should discuss the new Basel III Accord and what that means in this new regulatory structure.  The Basel Committee  (the group responsible for the Basel Accords) consists of representatives of all of the G-20 countries (plus other important banking centers).  The Committee does not have the authority to enforce recommendations, although most member countries as well as some other countries tend to implement the Committee’s policies. This means that recommendations are enforced through national laws and regulations — so, while an important milestone, it throws us back to what is happening back here in the U.S.

President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21.  Among other things, the law will:

• Establish a new council of “systemic risk” regulators to monitor growing risks in the financial system, with the goal of preventing companies from becoming too big to fail and stopping asset bubbles from forming, such as the one that led to the housing crisis.
• Create a new Consumer Protection Bureau that is charged with writing and enforcing new rules that target abusive practices in businesses such as mortgage lending and credit-card issuance.
• Allow the government in extreme cases to seize and liquidate a failing financial company in a way that protects taxpayers from future bailouts.
• Give regulators new powers to oversee the giant derivatives market, increasing transparency by forcing most contracts to be traded through third-parties instead of only between banks and their customers.

The first prong of this, in my mind, is the most critical.  The new Financial Stability Oversight Council will have an incredibly broad and difficult mandate – essentially, its assignment is to monitor the entire financial landscape for risks that could spark another crisis, identify and supervise firms that could pose those systemic risks, and make sure they never grow so large, complex, and leveraged that their failure can wreak havoc across the globe.  In many ways, it is designed to play the role of the “voice of reason” that I discussed in my last blog.  The group will be led by the Treasury Secretary and will include the heads of the financial regulatory agencies. The 10 voting members include the heads of the Federal Reserve, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency. 

The Council will have the authority to direct regulators to issue new rules regarding capital, liquidity, and leverage levels and to impose more onerous rules on firms that it deems to be systemically important.  As a last resort, the Council can agree by a two-thirds vote to break up large, complex firms if members agree that they pose a grave threat to the country’s financial stability.  Finally, Council members will have at their fingertips another new entity, the Office of Financial Research, which will be staffed with economists, accountants, and other specialists to help collect and analyze real-time data, in hopes of identifying emerging threats to the financial system.

The creation of the Council reflects at least one important policy change.  The strengths of the Securities and Exchange Commission (SEC) are in the areas of disclosure and anti-fraud enforcement – but not as a financial regulator that imposes capital requirements or sets leverage restrictions.  [1]

So, can the new Financial Stability Oversight Council be more effective in this role and can it effectively play the role as the “voice of reason” that will prevent future crises?

Unfortunately, I believe that the answer is no.

I believe that there are 5 key reasons for this:

1. Washington, by its nature, is a reactive and not proactive type of decision-maker.  The creation of the Council was a political compromise and its decision-making structure (representation coming from many different agencies with different agendas) will not provide for an efficient and effective means of decision-making.  Greed, at the end of the day is a very difficult thing to regulate.  A council created by political compromise is not likely, in my mind, to be able to effectively control it.
2. Without the ability to influence monetary policy (i.e., interest rates) – a key ingredient in risk-taking and overall speculative behavior – the Council will be the tail wagging the dog.  A better approach, in my mind, would have been to give a single agency – the Fed – the mandate to do the Council’s job.
3. International competitive pressures will limit effectiveness.  Over the next decade (and remember that this new law will not be completely implemented until 2015, or later) some of the largest financial organizations in the world are likely to be outside of the U.S.  The largest banks will be in Asia or Latin America where the reach of the new legislative provisions will not apply.  This practical reality poses two problems:  (1) the Council will be under intense pressure to ensure that its requirements do not place U.S. institutions in an anticompetitive posture; and/or (2) due to the inter-connectedness of the world, the next financial crises may be caused by institutions in other regions.
4. Policy-makers and regulators will have great difficulty in keeping up with the pace of financial engineering.  Notwithstanding the creation of the Office of Financial Research, I have a very hard time in believing that this group will be able to keep pace with Wall Street.
5. The next crisis is likely to look much different than the one we just lived through (we may be prepared for the last one, but we are not likely to be prepared for the next one).

So, with all of that, I will stop for now.  But, I will leave you with a final reminder.  That is, if “Congress did not take away from the citizen his inalienable right to make a fool of himself” and simply “attempted to prevent others from making a fool of him” – please do not be foolish.

I think that some of my former colleagues over at Stark Investments are thinking that they created a blogging monster (while at Stark I maintained a blog and I bet that some are thinking that I have taken things to a new extreme….).  While on that topic, I did want to mention a couple of tidbits about Stark Investments (it seems that some folks are still interested in what I have to say on the topic).

The original founders of Stark – Brian Stark and Mike Roth – were true pioneers in the hedge fund industry and played an important role in the evolution of this space and in paving the way for all those that followed into the business (including myself).  At its core, the hedge fund business (or “alternatives business” as it is commonly referred to) is based on the goal of providing absolute returns in an uncorrelated fashion (providing more attractive risk-adjusted returns than can be found from other investment techniques and strategies).  As they say about sports and hitting a baseball, achieving these objectives is one of the hardest things to do in any profession.  In any event, Brian and Mike have been doing this as long as anyone in the business.   I had a great 10 years working for the two of them and I learned much from both of their styles.

 Ok, enough of that stuff.  Let’s talk about financial regulation.  The last major overhaul of the regulatory structure of our financial markets, not surprisingly, occurred following the Great Depression.  The regulatory reaction to the stock market crash was the adoption of two cornerstone pieces of legislation which still provide the backbone of our regulatory structure — the Securities Act of 1933 (the “’33 Act”) and the Securities Exchange Act of 1934 (the “34 Act”). The 33 Act, administered by the then newly created Securities & Exchange Commission (the “SEC”), provides for the registration of the initial distribution of most securities and the 34 Act imposes ongoing reporting and disclosure requirements.

 The policy behind the Acts was that disclosure of material facts and overall transparency in the activities of the securities exchanges would provide confidence in the markets and in the companies issuing securities.  Increased transparency, in turn, would promote much-needed liquidity which makes the markets function in an orderly fashion (the pre-Depression markets were characterized by insider dealing and a significant laissez-faire attitude towards regulation).  This “sunlight theory of regulation” is based on the assumption that if investors are given all of the necessary information they will make wise investment decisions. Commentators have characterized the ’33 Act as follows (these quotes, some of my personnel favorites, can also be found on the State of Wisconsin Department of Financial Institutions website):

• Congress did not take away from the citizen his inalienable right to make a fool of himself. It simply attempted to prevent others from making a fool of him.
• As to its efficacy in regulating securities issuers, the sunlight theory may be summed up by a saying: Those who are forced to undress in public will presumably pay some attention to their figures.

Please remember these quotes because I believe that they are instructive in thinking about the role of regulation in light of the current environment.   Notably, it is my view that “full and fair disclosure” was not a major problem during our most recent financial crises – in my mind, the much bigger issue (as noted in my first blog) was excessive risk-taking and greed:  in short, too many people made fools of themselves….

My father recently guided me to some sections of Tony Blair’s newly released memoirs A Journey: My Political Life, which were of interest to me on the topic of financial regulation.  The Prime Minister had this to say of the markets, government and regulation:

 First, “the market” did not fail. One part of one sector did. The way sub-prime debt was securitized, spliced and diced and sold on with no real appreciation of underlying risk or value was wrong, irresponsible and immensely damaging. Some of the rewards, the huge payouts for shuffling around securities, the bonuses, are not just presentationally awful; they can’t be justified and, at worst, have helped create a propensity to “do the deal” whatever the long-term merits for short-term gain, in a way that significantly contributed to the crisis. All this is correct and should be acted on. However, such practice should not define or represent the whole of the banking sector, let alone the whole financial sector, let alone “the market.”

Second, government also failed. Regulations failed. Politicians failed. Monetary policy failed. Debt became way too cheap. But that wasn’t a conspiracy of the banks; it was a consequence of the apparently benign confluence of loose money policy and low inflation. The responsibility for the crisis should be shared, not borne by the market alone or even by the banks alone.

Third, the failure was one of understanding. We didn’t spot it. You can argue we should have, but we didn’t. Furthermore—and this is vital for where we go now on regulation—it wasn’t that we were powerless to prevent it even if we had seen it coming; it wasn’t a failure of regulation in the sense that we lacked the power to intervene. Had regulators said to the leaders that a huge crisis was about to break, we wouldn’t have said: There’s nothing we can do about it until we get more regulation through. We would have acted. But they didn’t say that.

My own beliefs flow from a similar line of thinking.  That is, our financial system has failed by not having a natural governor of its activities.  One of the interesting ironies, in my experience, is that during the creation of bubble-like conditions all of the players in the financial system act as if their interests are aligned.  Investors, speculators, bankers, and policy-makers all tend to act in a manner that is designed to “let the good times roll.”   The markets need a voice of reason in these environments – someone or something that can provide balance in recognizing the signs of a bubble, in recognizing where we are in terms of the investment cycle, in acting as a counter-balance to the “this time its different” mentality, and in ensuring prudent action during these periods.  If we do not find a way to do this then we will repeat these cycles – and in my mind they will occur with even more frequency and ferocity.

So, it will be in the next blog post where I will discuss whether the currently proposed regulatory overhaul can help mitigate against these risks.  That is, can the prevention of “too big to fail,” increased capital ratios among large banks, and the 2,315-pages of financial regulatory system legislation act as the “voice of reason” which will prevent future financial crises….and what does this all mean from an underlying policy perspective?

So, first a bit about me. I have been very fortunate to have had a fantastic fifteen-year career in the hedge fund business (which does make me a bit of a dinosaur in the industry). Most recently, I was the President and Chief Operating Officer of Stark Investments (one of the oldest hedge funds in the world). During my career working in the business, I have done about everything – from providing legal counsel, to co-managing a large portfolio, to ultimately taking responsibility for the execution of the strategic vision and the overall administration of a large organization. I am a 1993 graduate of the Marquette University School of Law (and have to say that I am thrilled at all of the very positive developments at the Law School – kudos to Dean Kearney and his team!). All of that being said, I have had the fortune (or misfortune as the case may be) of having had a front-row seat throughout this period of financial crises.

It is with this background in mind that I will spend my month at the podium discussing the markets, the financial crises, financial regulation, and the evolving nature of some of the key players in the markets (investment banks, hedge funds, and other investors). 

I will start with some perspectives on the cause of the crises, the historic regulatory environment, and overall human behavior.

Earlier today (Thursday, September 2) – nearly three years after the first signs of instability became visible — Federal Reserve Chairman Ben Bernanke told lawmakers that a lack of regulation in the banking system was one of the key triggers in the 2008 economic and financial crisis. Speaking at a hearing before the Financial Crisis Inquiry Commission in Washington, D.C., Bernanke said that “the shadow banking system, as well as some of the largest global banks, had become dependent on various forms of short-term wholesale funding,” and that “the reliance of shadow banks on short-term uninsured funds made them subject to runs, much as commercial banks and thrift institutions had been exposed to runs prior to the creation of deposit insurance.” The Fed chief said that the Federal Reserve had no authority to regulate the shadow banks and address their liquidity problems until the crisis had already decimated the economic and financial system.

Although there is no doubt that the shadow banking system did act to exacerbate the instability in the markets, it is just one of many contributing factors (and, in my mind, was one of the more immaterial factors). The more significant factors, in my mind, were: (a) the policy decisions encouraging a low-rate environment in early 2000 (following the bursting of the tech bubble and the 9/11 attacks), which encouraged excessive risk-taking and speculation; (b) the corresponding development of bubble-like conditions in the real-estate market; (c) poor decision-making by consumers, underwriters, appraisers, and lenders, which allowed the real-estate bubble to continue to expand; and (d) Wall Street’s involvement in this party, which fueled the growth of new products (subprime mortgages and all of their derivative by-products which exploded on the scene) that magnified the consequences of the bursting of the bubble. This all resulted in a credit bubble of epic proportions — a bubble that will have lasting consequences for years to come.

To boil it all down, the primary culprit, in my mind, was a simple human behavioral characteristic: Greed.

Over the next few posts, we will explore the policy and purpose of our historic regulatory framework and that of the newly proposed environment. However, the question that we will come back to is: What is the best way of policing greed and excessive risk-taking?

Matt Mitten reviews the history of litigation addressing this issue in a new paper on SSRN.  His analysis concludes with a discussion of the Supreme Court’s most recent pronouncement on the question, American Needle, Inc. v. National Football League, 130 S. Ct. 2201 (2010).  In American Needle, the Court held that the NFL’s grant of an exclusive trademark license to a headwear manufacturer was not immune from § 1 scrutiny.  The Court wrote, “Common interests in the NFL brand partially unite the economic interests of the parent firms, but the teams still have distinct, potentially competing interests.”  Although the question is a difficult one, Matt argues that Court reached the right result.  The paper is entitled “American Needle v. NFL: U.S. Professional Clubs are Separate Economic Threads When Jointly Marketing Intellectual Property.”

Paul objects to federal policies regulating business due to his reading of the U.S. Constitution.  His political philosophy might best be characterized as extreme libertarianism.  Following the objectivist principles of Ayn Rand, he argues that the public should be left to their own devices and that greater social benefits will accrue naturally over time from the enlightened (and rational) self-interest of individuals.  Ironically, Paul’s embrace of self-interest as a moral good in itself is directly at odds with the view of the Framers of the Constitution.  The people who designed our constitutional system spent much time criticizing the biases, prejudices, and self-interested motivations of the general public.  The system of government that they created was intended to ameliorate the very aspects of human nature that objectivists like Rand Paul celebrate.

In fact, it is difficult to find a historical basis for Rand Paul’s vision of the U.S. Constitution.  In 1789, the Framers believed that state legislatures had been captured by parochial commercial interests who wielded power in favor of a self-interested and growing “middling” class.  It was the hope of James Madison that “disinterested” elites would come to dominate politics in the federal government, where they would promote policies that promoted the common good rather than narrow economic interests.  John Adams seemed resigned to the idea that an aristocracy of sorts would become necessary in the new republic in order to ensure that laws were enacted in the public interest and that the machinery of representative democracy was not corrupted for selfish ends.  Neither man was optimistic that any good would result if the general public was left to its own devices.  

The Framers would have had little difficulty accepting the idea that the federal regulation of business entities promotes the common good of the nation, in ways that state laws or the private market do not.  In a recent post, Professor Michael McChrystal discussed the classic objective of tort law to ensure that responsible parties will bear the economic costs for injuries that they cause.  However, at best tort law is an attempt to remedy injuries that have already occurred.  In contrast, the federal regulation of business entities is often intended to prevent business entities from imposing costs on third parties in the first place.

Economic theory is helpful here.  As defined by Professor Paul Johnson in A Glossary of Political Economy Terms, “[a]n externality exists whenever one individual’s actions affect the well-being of another individual — whether for the better or for the worse — in ways that need not be paid for according to the existing definition of property rights in the society. “

Business entities can maximize their profitability to the extent that existing law allows them to externalize their costs, thereby forcing third parties to bear some of the costs of production for the business’ good or service.  For example, a cardboard box producer that dumps chemicals used in the manufacture of its boxes into the environment, without paying for the safe disposal of those chemicals, has externalized its costs of production to the extent that the community surrounding the factory is impacted by the dumping.

 When political commentators charge that liberals believe that the government is capable of solving problems, whereas conservatives believe that government is the problem, they are referring to the fact that political liberals tend to see government regulation of the marketplace as a vehicle for reducing the negative externalities that would exist in an unregulated market.   Liberals accept the premise that society in general has an interest in limiting externalities through government regulation of the marketplace.  It follows, therefore, that liberals tend to view deregulation with suspicion as little more than a policy preference designed to allow business entities to externalize their costs. 

Politics is the realm of interest groups, not economists, so it is a given that any attempt to limit externalities through government regulation will at best approximate the identification of the precise costs imposed by externalities and the exact identity of those third parties who would otherwise bear those costs.  To recognize that a system of regulation is imperfect in economic terms is not the same as saying that deregulation would be preferable.  Rather, what is important is to never lose sight of the fact that all government regulation of the marketplace is essentially a political act.  The voters ultimately get to define what constitutes an externality, not economists.

Justice Jackson made this point in Wickard v. Filburn, the seminal case relating to the power of Congress to pass New Deal legislation (and espousing a limited role for the Supreme Court in second guessing Congress’ regulatory choices):   

“It is of the essence of regulation that it lays a restraining hand on the self-interest of the regulated, and that advantages from the regulation commonly fall to others. The conflicts of economic interest between the regulated and those who advantage by it are wisely left under our system to resolution by the Congress under its more flexible and responsible legislative process.  Such conflicts rarely lend themselves to judicial determination.”

Rand Paul is fond of criticizing the Wickard v. Filburn decision in his stump speeches at tea-party gatherings around the country.

None of us should be surprised if business interests selfishly try to push externalities off on others.  Nor should we be surprised if the general public pushes back, and adopts federal regulation as a means to force business interests to bear their own costs.  We see this policy debate unfold before us every day.  Consider three recent examples:

The financial reform bill soon to be signed by President Obama seeks to address externalities in the financial services industry.  During the financial meltdown in 2008, the federal government was forced to use taxpayer dollars in order to prop up investment banks and insurance companies because those financial firms had made disastrous market bets that put their future survival at risk.  Had the federal government failed to act, the result would have been a collapse of the credit markets, the inability of homebuyers to get mortgages, and the lack of buyers for the commercial paper that large employers rely on to fund current operations.  The freedom of financial institutions to make overleveraged market bets clearly imposed external costs on the credit markets and, by extension, on everyone who relies upon credit.       

The congressional overhaul of financial regulation does not go so far as to reinstitute the Glass-Steagall Act, as some had advocated.  That would have forced investment banks to segregate funds held by commercial banks, so that bankers could not use the public’s savings accounts as a source of funds to play the market.  Whether or not the repeal of Glass-Steagall in 1999 was a mistake, the consolidation of integrated financial services companies that has occurred over the last decade makes unscrambling this particular egg an impractical task.

Instead, the final version of the overhaul bill will increase minimum capital requirements, so that investment banks must keep a larger cash “cushion,” and will also likely include the “Volker Rule” banning proprietary trading (the practice where investment banks use their own money to make market bets), thereby limiting financial firms to trades made on behalf of clients.  Derivatives trading is now viewed as so risky an enterprise that the Senate version of the bill bans banking companies from derivatives trading altogether while the House stops at requiring such trades to be insured and to take place on public exchanges.  If anything, critics charge that the overhaul bill does not go far enough to reduce the risk of a future financial meltdown.        

Health care reform, as enacted this past March in the Patient Protection and Affordable Care Act, is another example of federal regulation intended (at least in part) to address externalities.  The requirement that all individuals purchase private health insurance is often cited by critics as an example of the federal government overreaching its constitutional bounds.  However, supporters of an individual mandate argue that it is helpful in reducing the public cost incurred when the uninsured use expensive emergency room services rather than the cheaper alternatives available to the insured population.  Opponents of the individual mandate dispute the relative significance of these externalities in the context of the size of the entire health care market.  However, if the general public believes that these externalities are contributing to the rising cost of health care for the insured, then it is difficult to argue that their representatives are powerless to address them.        

Even the ongoing debate over illegal immigration in Arizona can be viewed as a local reaction to the federal government’s failure to deal with the externalities imposed by the employment of undocumented workers.  The current system of immigration legislation tolerates the existence of an undocumented workforce that some estimate at over 11 million people.  Employers (and consumers) across the nation take advantage of the cheap labor that these workers provide.  However, taxpayers in the states along the U.S.-Mexico border bear the economic brunt of this toleration, in the form of higher costs for education, emergency health care, and public safety.  Arizona’s choice to make an individual’s illegal presence in the state a crime is born out of a frustration that the current federal immigration laws do not spread the social costs of illegal immigration on an equal basis to employers and taxpayers across the nation.    

As Justice Jackson alluded to in Wickard v. Filburn, lawmaking through the political process is how the public allocates the costs of behavior in order to reduce externalities.  When voters argue over the best way in which to allocate these costs, they are engaging in a policy debate.  Rand Paul and his fellow “Constitutionalists” seek to turn this policy debate into a more basic constitutional question.  What is left unaddressed is the moral dimension of this debate: do we as a society have a moral obligation to use the political process in order to reduce externalities that powerful interest groups would otherwise impose on the less well organized (and less well funded) segments of our society?  A liberal might answer “yes” to this question; I suspect that an extreme libertarian along the lines of Rand Paul would answer “no.”

Tech nerds and media junkies have been buzzing lately about Google’s announcement that it will soon rollout Google-TV — a new device/platform that will turn people’s televisions into portals for online video and other web content.

Google representatives unveiled the project last week at a developers conference where they staged a Steve Jobs-like showcase that included animated demonstrations and bold statements about the end of TV as we know it.

Much of this was puffery, of course, but there is no denying Google’s determination to expand its dominion over the communications universe, nor the inevitability of the web’s eventual absorption of traditional television.

These two things terrify broadcast and cable executives. But the advent of web television might benefit traditional TV businesses –- particularly cable companies –- in one important category: First Amendment protection.

Even though the courts have long acknowledged that cable television is a First Amendment-protected medium, they have assigned it a kind of second-class constitutional status, based on the premise that cable markets are not sufficiently competitive.

In 1994, the U.S. Supreme Court held in Turner Broadcasting v. FCC that cable companies operate as effective monopolies, creating bottlenecks for the dissemination of video content in the communities where they operate. As a result, most government regulation of cable is subject to only an intermediate level of First Amendment scrutiny.

In Turner, the Court upheld the constitutionality of the must-carry rules, which require cable operators like Time Warner and Comcast to add the signals of local broadcast stations to their channel lineups. In addition, cable operators must set aside channels for leased-access by third parties, and they can be compelled to subsidize and disseminate public, educational and governmental (PEG) programming, among other things.

These regulations are constitutional only because of the lack of competition that existed when the laws were adopted in the early 1990s. But a lot has changed since then.

Phone companies, such as AT&T and Verizon, now offer cable service (which they were not allowed to do until 1996), DirecTV and Dish Network offer DBS service to nearly every home in the country, and video content is now ubiquitous on the web, even without the seamless packaging of Google-TV. The bottleneck, in short, has broken.

The disconnect between these policies and their underlying premises is not merely a public policy problem; it is a constitutional problem. All of these regulations interfere with the expressive autonomy of cable operators and put special burdens on them that are not imposed on newspapers, magazines or web communicators. (Imagine how quickly the courts would strike down a must-carry law requiring newspapers to set aside a few pages of each issue for use by competitors).

These problems are acute when the government moves from what are arguably structural regulations to more content-based restraints and mandates. There are several of these, most of which target the programming practices of the cable networks (e.g., Comedy Central, ESPN, Nickelodeon).

The federal courts have shot down attempts by the government to regulate indecent content on cable, applying something close to strict scrutiny in those cases. But there are many other content-based restrictions that remain in effect.

Cable networks cannot accept tobacco advertising. They must limit the amount of advertising time during children’s programs. They must provide equal opportunities to political candidates whose opponents appear on those networks in non-exempt programming. And they must abide by the payola rules, which prohibit non-disclosed payments made by third parties in exchange for airtime.

None of these restrictions would be tolerated if imposed on print or web communicators. Yet they continue to be enforced against cable communicators, despite the absence of a cogent regulatory rationale.

It is probably hard for most people to get exercised about the rights of giant cable companies, with their ever-expanding rates and outsourced customer service. But they are constitutionally protected speakers, and the claim that they are differently situated than their competitors using other media just isn’t credible anymore.

It is time for Congress and the FCC to scrap the current regulatory scheme and for the courts to reconsider cable’s constitutional status in light of the new technological and market realities.

Maybe Google-TV will provide the impetus for the end of cable regulation as we know it.

PIPE deals have drawn negative comments from other scholars and the SEC, but Douglas thinks the critics have failed to appreciate the important benefits of PIPE financing. His paper, entitled “Quagmire: Is the SEC Stuck in a Misguided War Against PIPE Financing?,” will be published in Transactions: The Tennessee Journal of Business Law.  The abstract appears after the jump.  

A popular non-traditional capital formation option is the “PIPE” deal: Private Investment in Public Equity. Over the last ten years, companies raised more than $100 billion using PIPE transactions. The Securities and Exchange Commission (“SEC”) has increased its regulatory oversight of PIPE transactions as they have become more popular. The SEC believes that some PIPE investors who take a short position in a PIPE issuer’s publicly traded shares violate Section 5 of the Securities Act by selling unregistered securities, and that PIPE investors who trade on knowledge of an impending PIPE transaction are guilty of insider trading. The purpose of this article is to demonstrate that the SEC’s aggressive enforcement against PIPE deals is misguided both because it is based on flawed interpretations of the law and because it ignores the benefits of PIPE financing. Although most of the existing scholarship on PIPE financing shares the SEC’s negative views, these articles have ignored the benefits and exaggerated the risks associated with PIPE financing. This article makes the case for PIPE financing by fully considering its benefits and risks.

The action against Goldman Sachs comes from their arrangement and sale of mortgage backed collateralized debt obligations (CDOs).  In 2006, John Paulson, approached Goldman Sachs with an interest to short housing prices.  Paulson clearly believed at the time, correctly, that housing prices were at unsustainable levels; he believed that there was a bubble in the market, and he wanted to make a bet that prices would decrease.  In order for Paulson to make a bet against housing prices, there needed to be somebody on the other end to make a bet that housing prices were going to increase.  The very essence of a CDO is that there necessarily must be two opposing parties to take different views on a future direction of a product or market. 

Goldman Sachs worked with ACA Capital Management and Paulson to put together the basket of mortgages within the portfolio on which the two sides would bet.  ACA was also the largest investor betting that the basket would increase in value. 

The main issue in the SEC’s case seems to be that Goldman Sachs misled investors by not disclosing to them who was on the other end of the CDOs, Paulson.  The SEC does not contend that the investors were unaware that there was someone on the other side, as they were experienced in financial tools, but rather these investors needed to know that Paulson specifically was on the other side. 

It seems almost a moot point of determining who is on the other side of a bet.  If you are making a bet that you believe to be beneficial, it shouldn’t matter who is on the other side, as long as they are financially sound.  If you believe you are making a good bet, the person that is betting against you really shouldn’t matter. 

For example, if someone approached you and asked you if you would like to make a bet that the winning horse in this year’s Kentucky Derby will have a final time of two minutes or greater, you might be inclined to take that bet. (Only two winning horses, three total horses, have in the history of the race finished in less than two minutes.)  Would you need to know who was betting on the other side that the winning horse would finish in less than two minutes?  More than likely you wouldn’t care, as long as you were paid if your bet turned out to be right. 

Further, think about the absurdity that would go along with having to introduce all market participants to each other.  Investor Y, this is in Investor X, you two are betting against each other, it just doesn’t seem necessary.  Another example, when you sell a stock online, or through a broker, someone else is buying that stock, otherwise you wouldn’t be able to sell it, you have no idea who that person is, should the brokerage firm introduce the two of you before the deal is allowed to go through?  It seems like it might be more than a little inconvenient, and you probably don’t care who is on the other end of that trade. 

Had the investment turned out to be a good one for those investing in the CDOs believing that housing prices would increase, would the SEC still have brought the charges?  Nothing would have changed, except that the other side would have made the money.  The investors betting for housing prices would have made close to $1 billion and Paulson would have lost close to $1 billion.  I would hope, for consistency that the SEC would have brought the same action in that situation if the SEC truly is unhappy about the disclosures that Goldman made about the parties involved in this deal.

Shelley argues that contracts of adhesion played an important role in creating the subprime mortgage mess, as consumers took on ruinous financial obligations without fully understanding the terms of the deals.  She suggests that courts should create stronger incentives for the drafters of contracts of adhesion to make the key terms comprehensible to ordinary consumers.  Thus, she would relax the normal presumption that the terms of the written contract will be strictly enforced where there is reason to doubt whether a reasonable person would have read and understood those terms.  If the “reasonable person” test is not satisfied, and extrinsic evidence fails to establish that the consumer actually received notice of the disputed term, then the court would not enforce the term as written, but would instead treat the case as a “missing term” case.

The article, entitled “Reforming the Law of Adhesion Contracts: A Judicial Response to the Subprime Mortgage Crisis,” is forthcoming in the Lewis and Clark Law Review.  The abstract appears after the jump. 

This Article examines the role of contracts of adhesion, in the form of home mortgages, installment sale agreements and other standardized contracts that impose future financial commitments on consumers, in causing the subprime mortgage crisis and the Great Depression. By shifting the focus to these “financial adhesion contracts” the Article suggests that the harm from the absence of mutual assent in adhesion contracts extends beyond specific terms that are unduly burdensome for consumers generally to economic risks that vary from consumer to consumer. When millions of consumers are convinced to sign unsuitable financial adhesion contracts, their collective risk-taking can undermine the stability of the entire financial system. The most common cures for the nation’s economic ills – free markets, monetary policy, and regulation – are found insufficient to resolve this challenge based on a review of the largest of country’s financial disasters, the Great Depression, the Savings & Loan crisis of the 1980s, and the subprime mortgage crisis. The Article then discusses why current doctrine and the proscriptions offered by scholars do not resolve the threat posed by financial adhesion contracts, and proposes a new method for salvaging mutual assent in adhesion contracts for the benefit of consumers and the security of the economy.

Today, Brandies’s “curse of bigness” is incorporated into the less pejorative term for large U.S. companies — companies that are “too big to fail.”  Certainly in light of the recent U.S. financial crisis, people are well aware of the influence that these large U.S. companies have on U.S. politics and its economy.   But these “too big to fail” companies may also be creating moral hazards in business operations, and the U.S. has yet to establish a unified system for dealing with the business of bigness. 

Amidst the recent financial crisis, deeming companies “too big to fail” legitimized the government’s bailouts of large U.S. companies facing financial ruin.   The U.S. feared that the failure of a “too big to fail” company would not only affect the company and its immediate stakeholders, but such a failure could also bring down the country’s broader economic system.  Accordingly, companies invoked the “too big to fail” exception to financial demise, imploring the government to save a company to avoid far-reaching adverse affects on the U.S. economy if the company should be allowed to fail.  In less than five years, the U.S. Department of Treasury has committed almost $590 billion to bailing out 833 companies.  To date, less than a third of that money has been returned.

The “curse of bigness” is also present in the context of corporate compliance monitoring of large U.S. businesses.  At Marquette Law School’s recent Hallows Lecture, former U.S. Deputy Attorney General Mark R. Filip cautioned against aggressive monitoring of U.S. corporations.  Filip noted that an indictment of a company is essentially the death knell for that company.  In his discussion, Filip pointed to the example of the prosecution of Arthur Andersen, which at one time was one of the “Big Five” accounting firms.  Despite a guilty verdict that was ultimately overturned by the Supreme Court, Arthur Andersen had lost its business reputation and has never returned as a viable business.   Filip noted that 28,000 employees in the U.S. lost their jobs ultimately because Arthur Andersen was simply indicted, but never found guilty of any wrongdoing. 

So how should the United States deal with these large companies that constitute U.S. “bigness”?  Should we be inclined to bail them out when they face financial collapse?  And do we likewise hesitate to prosecute them for potential wrongdoings in order to avoid another Arthur Andersen?  Given that the demise of such large companies — even as result of a mere indictment — potentially has significant adverse effects on jobs and the U.S. economy,  the sensible approach may be to bail out certain companies and to proceed with caution when investigating those same companies for non-compliance.

But if the U.S. takes such a position, it may also create moral hazards in business operations.  Many commentators have recognized that these mega-companies may be more inclined to make risky business decisions knowing that the government is willing to bail out the companies to avoid the effect of companies’ collapse on the broader U.S. economy.  Likewise, companies may be less willing to toe the line of legality in their business operations knowing that the government would hesitate in indicting them for any potential wrongdoings.

Not surprisingly, some believe that if a company is “too big to fail,” then it is “too big to exist.”  In fact, Senator Bernie Sanders of Vermont introduced the “Too Big to Fail, Too Big to Exist Act of 2009.”  Briefly, the bill seeks to have the Secretary of Treasury identify the “too big to fail” companies and break up those entities.

Yet that approach seems like a knee-jerk reaction to a crisis situation, if not fundamentally against an economic system that encourages economic growth.  Undoubtedly, outside the financial crisis, large businesses have benefited the U.S. economy.

Other more conservative approaches view the “too big to fail” companies as a secondary problem.  Rather, the problem is that the U.S. has failed to establish a uniform system for monitoring and restructuring the large U.S. businesses if they should face collapse.   

Yet, at least with respect to increased monitoring, such an approach may lead to undesirable results similar to the Arthur Andersen result.  And if Congress allocates money to increased monitoring, there would most likely be increased pressure for results in the form of cases brought and indictments — the exact result that former U.S. Deputy Attorney General Mark R. Filip cautioned against.

China’s approach is simply to refuse to recognize companies as “too big to fail.”  Yet that approach seems overly simplistic, and may in fact lead the broader U.S. economy into financial collapse.

Certainly, the “curse of bigness” still presents significant problems to the United State almost 100 years after Justice Brandeis coined the term.  And perhaps the greatest dilemma is finding a cure that is not worse than the curse.

As such, Citizens United v. FEC stands with District of Columbia v. Heller, the Second Amendment case decided in 2008, as an example of the Justices slapping the “originalist” label on a profoundly un-originalist interpretation of the Bill of Rights.  It is appropriate to view the two cases together.  Both are exercises in raw political power employed in order to accomplish conservative objectives.  Both ignore hundreds of years of understanding about the meaning of the relevant constitutional provisions, in favor of a meaning derived by taking the words of the Amendment out of context.  And both embrace interpretations of the constitutional Amendment at issue that are inconsistent with the meaning ascribed to that same language by the intellectual father of originalism, Robert Bork.  In the same way that modern scholars deride the “Lochner era” as a misguided period in American Constitutional Law, I believe that future scholars and judges will recognize and reject the intellectual dishonesty of the “Heller era.”

We begin, as we so often do, with John Marshall.  Justice Marshall’s reading of the Constitution was clearly a reading that respected the rights of property.  As R. Kent Newmyer succinctly summarized it, in his book “John Marshall and the Heroic Age of the Supreme Court,” Marshall understood the rights of property ownership to include an individual’s right “to acquire property and deploy it creatively as he saw fit and to enjoy its fruits without hindrance.” (Newmyer p. 264)  But this does not mean that Marshall embraced Adam Smith’s theory of completely free markets, where private business enterprises act completely free from government regulation.  First of all, not even Adam Smith advocated for markets that were sealed off from all government regulation.  Second of all, while the Framers of the Constitution were aware of Adam Smith, there is little evidence that Smith’s economic theories influenced the Constitution.

John Marshall’s understanding of how the Constitution protected property rights was, characteristically, derived from his understanding of federalism.  Justice Marshall struck down state laws that interfered with private property rights, for example in Fletcher v. Peck and Dartmouth College v. Woodward, because those laws violated the Contract Clause of the Constitution.  However, Marshall’s motivation was not to protect private economic activity from all forms of government regulation.  His motivation was to protect national economic interests from protectionist state laws.  Marshall viewed the states less as political units and more as local interest groups that would pass legislation favoring parochial economic interests over interests from out of state.  If the young United States of America was to build a truly nationwide economy, private enterprise had to be able to grow free from the constant parade of protectionist legislation being passed by the states.  As stated by Newmyer: “What he feared . . . was state legislative meddling with contracts, either by passing laws that undercut contracts between individuals or by reneging on its own.” (Newmyer p. 265)

Marshall’s protection of the rights of property, therefore, is not inconsistent with the idea of uniform, federal regulation of private enterprise when in the public interest.  (Kutler, infra, p. 67) Marshall simply never faced this issue.  The corporations in existence at the time of his opinions were not national in scope, and corporate activity that exploited labor or endangered consumers would not become common until the industrial revolution.  Marshall used the text of the Contracts Clause to clear local state laws from the path of private enterprise, and no more.  He sought to support a system of federalism where national interests could act free from state constraints.  He did not seek to completely immunize private enterprise from all government regulation. (Kutler, infra, p. 179)

Those who put their faith in the “invisible hand” of the marketplace often assert that the owners of a private enterprise have a natural law right to use their property as they see fit, free from any government interference.  The Supreme Court rejected this argument shortly after John Marshall’s death when, in 1837 the Court decided the Charles River Bridge Case.  The majority of the Court held that the Massachusetts legislature, by granting a charter to the proprietors of a toll bridge, did not violate the Contract Clause of the Constitution by subsequently chartering the construction of a competing (and free) bridge.  As explained by University of Wisconsin law professor Stanley Kutler in his classic book, “Privilege and Creative Destruction,” the case strongly affirmed the power of government to regulate the use of private property.  In the words of Chief Justice Taney, “The continued existence of a government would be of no great value, if . . . it was disarmed of the powers necessary to accomplish the ends of its creations; and the functions [government] was designed to perform, transferred to the hands of privileged corporations.” (Kutler p. 91)  The Constitution has never been interpreted to preclude government regulation of a private business enterprise for the public good.

The specific treatment of corporations under the Constitution is entirely consistent with this treatment of private property in general.  There is no evidence that the Framers’ generation understood corporations to have any rights under the Constitution separate from the rights of the persons who owned the corporation.  In fact, for most of our nation’s history, the Supreme Court denied the existence of any rights for corporations under the Constitution at all.

This history is usefully summarized in a forthcoming article by David Gans and Douglas Kendall.  In 1809, Justice John Marshall wrote in Bank of U.S. v. Deveaux that corporations were not “citizens” as that word was used in Article III of the Constitution.  Unfortunately, the result of the ruling was that corporations evaded the jurisdiction of the federal courts in order to avoid paying their debts.  Therefore, the Court quickly overruled Deveaux and adopted the legal fiction that corporations could be deemed “citizens” for purposes of suing or being sued in federal court.  The Court’s motivation in adopting this legal fiction, however, was to preserve the ability of natural persons harmed by a corporation to avail themselves of the diversity jurisdiction of the federal courts.

In 1839 the Court specifically ruled that the treatment of corporations as “persons” for diversity jurisdiction purposes did not grant corporations any of the other rights that the Constitution granted to natural persons.  The Court never extended any of the individual rights provisions of the Constitution to corporations until the end of the 19^th century.  Nor did the Court ever suggest that the federal government lacked the power to regulate corporate activity, so long as the government did not violate the literal terms of the corporate charter.

The first case extending constitutional rights to corporations came in 1897, under the Equal Protection Clause of the 14^th Amendment, and it ushered in the Lochner era when the Supreme Court used theories of substantive due process to assert that the Constitution protected corporations from federal economic regulation.  It is significant that this innovation came via an interpretation of a Reconstruction-era constitutional amendment, and not from a purported interpretation of the original text.  Moreover, in non-economic areas, such as the rights of self-incrimination, the Court continued to refuse to recognize any constitutional right for corporations.  Also, during this era, two giants of the law, Oliver Wendell Holmes and Louis Brandeis, dissented often and aggressively from all extensions of constitutional rights to corporations.

The Lochner era ended in 1937, after President Roosevelt threatened to pack the Supreme Court.  The Supreme Court retreated from its Lochner line of cases and once again began to uphold the federal power to regulate corporate affairs.  Over time, however, the Supreme Court began to hold that this power to regulate corporate activity was tempered by the existence of constitutional rights for corporations under the 14^th Amendment and under the criminal procedure provisions of the Constitution.

The true revolution occurred in 1978, when the Supreme Court ruled in First National Bank of Boston v. Bellotti that a state law limiting the ability of corporations to spend money on referenda elections that didn’t affect their property was unconstitutional.  The ruling did not explicitly hold that corporations had a First Amendment right, but it did say that the protection of speech was so important that it didn’t matter who was doing the talking.  This ruling was revolutionary because it was a departure from precedent that, with the exception of the Lochner era, had held that the distinction between the regulation of corporations and the regulation of individuals is an important distinction under the Constitution.

However, the Bellotti opinion was careful to preserve the power of the government to regulate corporate spending in the context of candidate elections, as opposed to referenda.  The Court continued to recognize this power to regulate corporate money in FEC v. National Right to Work Committee, in Austin v. Michigan Chamber of Commerce, and in McConnell v. FEC.  These latter two cases contained spirited dissents from Justices Scalia and Kennedy arguing that the First Amendment right that protected corporations in Bellotti should be extended to the context of candidate elections.

In Citizens United v. FEC, these dissents become the majority opinion, and the Austin and McConnell decisions were overruled insofar as they allowed the federal government to prevent corporations from making independent expenditures on behalf of candidates for office.  Not only are these prior cases overruled, but the history of the Court’s treatment of corporations under the Constitution is ignored.  Ignored, as well, is the Court’s pre-Lochner understanding that the Constitution permits the government to regulate corporate activity when it is contrary to the public interest.

Instead, what we get in the Citizens United opinion is the textualist assertion that the language of the First Amendment does not distinguish between whose speech is being regulated, so the government must therefore lack the power to makes a similar distinction.  We are told that the benefits of political speech are the same, whether the source of that speech is an individual or a corporation.  And we are told that media corporations, that report the news, might be subjected to government control if we do not recognize a First Amendment right for corporations.

Similar arguments were rejected by Robert Bork.  Bork clearly did not understand the First Amendment to require a complete absence of government regulation over speech.  For example, in his 1971 Indiana Law Journal article, Bork argued that the First Amendment does not prevent the government from regulating speech outside of the political context if that speech causes public harm.  Bork wrote that the Framers “displayed a determination to punish speech thought dangerous to government.”  For him, it was the impact of the speech at issue on the political process (positive or negative) that determined whether the speech was protected under the First Amendment, and not an absolutist interpretation of the text.

Justice Kennedy’s arguments were also rejected by Justice William Rehnquist, who dissented in Bellotti. Rehnquist stressed that “early in our history” the Supreme Court had declined to extend constitutional rights to corporations.  He viewed the Bellotti majority as acting inconsistently with this original understanding.  Therefore, the so-called “orginalism” that Justice Kennedy says requires us to depart from longstanding precedent is in fact contrary to earlier interpretations of the First Amendment by two notable originalists.

Justice Stevens’ dissent in Citizens United contains a devastatingly accurate characterization of Justice Kennedy’s argument:

As a matter of original expectations, then, it seems absurd to think that the First Amendment prohibits legislatures from taking into account the corporate identity of a sponsor of electoral activity.  As a matter of original meaning, it likewise seems baseless – unless one elevates the First Amendment’s ‘principles’ or its ‘purpose’ at such a high level of generality that the historical understandings of the Amendment cease to be a meaningful constraint on the judicial task.  This case sheds a revelatory light on the assumption of some that an impartial judge’s application of an originalist methodology is likely to yield more determinate answers, or to play a more decisive role in the decisional process, than his or her views about sound policy. 

What does support the majority’s interpretation of the First Amendment in Citizens United?  We are left with Justice Kennedy’s personal preference that corporations should have a voice in the political arena.  Except what is this “corporate voice” that needs protection?  It is most assuredly not the voice of the shareholders.  State law provides them with no mechanism to approve in advance the use of corporate funds for political activity, and under state law shareholders have little prospect for successfully punishing management after the fact for the use of corporate funds to sponsor political activity that they disagree with.  In addition, given that during 2009 the average share of stock was bought and sold two and one half times, shareholders will probably not own their shares long enough to care what management does with corporate money.  With the turnover in corporate ownership today, we do not have share-holders, we have share- renters.  In this context, the corporate voice is reduced to the voice of top management, who will use corporate money to fund political views that these highly compensated individuals are fully capable of funding out of their own pocket.

When it comes to the First Amendment, therefore, it seems that an ideological preference for free markets trumps traditional notions of federalism and free speech.    

Note:  The photo accompanying this post depicts the cover of Harper’s Weekly January 21, 1888 and is entitled “Not Even-Handed Justice: Crushing the Scorpion of Anarchy But Sparing the Octopus of Monopoly.”  A framed copy hangs in my office.

While no blog post can truly capture all that this conference will entail, here is a preview of the panels and topics.  The first morning panel, entitled “Ripples of a Water Ethic in Wisconsin” will set the tone of, and overall theme for, the conference by exploring Wisconsin’s water law tradition and its efforts to protect its water resources.  Building off Wisconsinite Aldo Leopold’s seminal work detailing an ethic for land conservation, this panel will look at fresh water’s special place in Wisconsin’s ethos and address how our society might balance the demand for water today by public and private, agricultural and industrial, and rural and urban interests. 

The second panel of the morning will address the false dichotomy between economic development and environmental protection.  The panel will discuss how many Wisconsin businesses have embraced a strong regulatory framework and developed profitable businesses.  The panel will also address how environmental advocates, regulatory agencies, business, agriculture, and other stakeholders can work together more effectively to ensure that water is available and used in a purposeful fashion.

Following the lunchtime keynote address by Mr. Davis, conference attendees will have the opportunity to attend one of four breakout panels on a variety of topics: water pricing, access to water and the Great Lakes Compact, ground water use and land planning, and water quality.  The second afternoon panel will be another plenary session that highlights examples from other jurisdictions — California; Massachusetts; Minnesota; and Ontario, Canada — and how they are attending to water law and policy.  The final panel of the day will be two experts on water law — Professor Bradley C. Karkkainen of the University of Minnesota Law School and Professor David M. Uhlmann of the University of Michigan Law School — who will reflect on the day’s events and discuss how Wisconsin might continue to move forward on water law and policy.  There will a reception following the last panel.

If you are interested in attending this event, please visit the conference website at http://law.marquette.edu/cgi-bin/site.pl?2130&pageID=4303 where you can register.  You can also contact Assistant Dean for Public Service, Dan Idzikowski at daniel.idzikowski@marquette.edu or me, Professor Matt Parlow, at matthew.parlow@marquette.edu.

The answer for many populists was easy—the veterans should not be swindled by greedy money men.  However, Treasury Secretary Alexander Hamilton knew that the price of the government breaking a contract was far more costly to a young nation’s character than the ephemeral outrage that many veterans felt.  As Hamilton told President Washington, “[t]he general rules of property, and all those general rules which form the links of society, frequently involve in their ordinary operation particular hardships and injuries.  Yet the public order and the general happiness require a steady conformity to them.  It is perhaps always better that partial evils should be submitted to than that principles should be violated.”

Because history has a way of repeating itself, it should come as no surprise that the debate over contract rights versus populist sentiment has returned with a vengeance.  The first sign of trouble came last March when President Obama urged Congress to sever the retention bonuses owed to several AIG derivative traders.  The outrage was understandable: AIG had gone belly up and was only kept afloat by the public dole.  However, the retention bonuses were agreed to before the TARP bailout; abrogating them would violate a clear contractual obligation.

This did not stop some members of Congress from seeking to pass a Bill of Attainder to recoup the bonuses via the tax code.  Congressman Barney Frank even threatened AIG CEO Edward Liddy with a subpoena if Liddy did not hand over the names of the AIG employees who received the bonuses.  Just what, pray tell Congressman, did you intend to do with those names? 

Not to be outdone on the outrage meter, Republican Senator Charles Grassley stated “I would suggest the first thing that would make me feel a little better toward them [the AIG executives] is if they follow the Japanese example and come before the American people and take that deep bow and say, ‘I am sorry,’ and then either do one of two things: resign or go commit suicide.  And in the case of the Japanese, they usually commit suicide.”  Goodness.

But the low moment came in May during the Chrysler bankruptcy proceedings.  The Obama administration was attempting to spare Chrysler from bankruptcy court by selling Chrysler’s assets to a new company owned by the United Auto Workers (UAW) and Fiat.  The only problem for the administration was that a group of plucky Chrysler bondholders refused to sell their assets on the grounds that they could get a better deal in bankruptcy court.  Because these bondholders were secured creditors, they were entitled to first priority under bankruptcy law rules.  These bondholders rightly pointed out that they owed their shareholders the fiduciary duty to hold out for the best deal possible.

But bankruptcy court would have been bad for the UAW (as it was a junior creditor), so the Obama administration brought out the brass knuckles.  Thomas Lauria, the attorney for the group of bondholders, stated that his clients were threatened by the Obama administration into taking a haircut.  For a brief moment, it appeared as if the bondholders would fight it out in court, but eventually they relented in the face of governmental pressure.  Lauria said that his clients decided against a legal battle once they concluded they could not “withstand the enormous pressure and machinery of the U.S. government.”  Bankruptcy Judge Redfield T. Baum quipped that the bondholders had about as much of a chance of winning against the federal government as “the gentleman in Tiananmen Square when the tank came rolling in.”

As we dig ourselves out of the Great Recession, investors must cope with an additional risk: the threat of government abrogation of legal rights for political reasons.  Even Warren Buffet bemoaned the Chrysler situation: “If we want to encourage lending in this country, we don’t want to say to somebody who lends and gets a secured position that the secured position doesn’t mean anything.”

 Russell Kirk once noted that “[u]pon the foundation of private property, great civilizations are built.”  Ignoring these rights is how they fall.

Yet many analysts argue that these spikes are temporary.  The growth in construction spending amounted to a measly 0.04%, and the rise in pending sales contracts over the last nine months is attributable to the homebuyer tax credit, which the Obama Administration and Congress recently extended.

I suppose time will tell which analysis is correct.  But while commentators continue to debate, real estate investors have shifted their focus from traditional residential and commercial endeavors to a sector less affected by the downturn: healthcare properties.

Multi-tenant senior living, assisted living, and hospice facilities have not experienced the vacancy rates that multi-tenant residential, industrial, and commercial facilities have.  In fact, with the Baby Boomer generation reaching retirement, the market for such accommodations continues to grow.  And while banks have foreclosed upon some facilities, federal regulations require the continued operation of such facilities (for obvious reasons), making the purchase of such properties at foreclosure a better gamble than, for example, a vacant apartment complex.  Of course, the specter of national healthcare reform only adds to this investment’s mystique.

A primary beneficiary of this growing market?  Real estate funds that sell interests in Real Estate Investment Trusts (REITs).  While the economic downturn has wiped out the profitability of many existing REITs, funds have turned to healthcare properties to develop appealing prospectuses.  Yet were it not for a decade-old federal enactment and a recent statutory modification, these funds (and their attorneys) would be hard pressed to find deals worth making.

First, some background.  The REIT acts like a mutual fund by providing individuals or institutional entities with a passive investment opportunity.  A corporation with REIT status can avoid corporate tax liability and thus funnel most of its income to investors.  A typical REIT acquires diverse pieces of property with investor money.  The REIT—typically via a subsidiary—cares for these properties, with the goal of turning a net profit through rental streams and appreciated land values.  If and when any income develops, the REIT distributes at least 90% of it among the trust’s investors.  REITs have become a common component of large investment portfolios.

However, REITs had a significant shortcoming for many years.  Until 1999, a REIT could not acquire a facility that provided services to tenants.  Under IRS rules, properties with a rental income stream arising from services provided—like hotels—were considered active investments, thus subjecting the acquiring entity to corporate tax liability on those rents.  That tax liability destroyed the profitability of investment in a REIT.

That limitation was partially removed by the REIT Modernization Act of 1999.  Passed by Congress and signed by President Clinton, the Act allowed for the expanded use of taxable REIT subsidiaries, or TRSs.  As explained by the National Association of REITs, the statute allows a corporation seeking REIT status to create a subsidiary to manage service-providing property.  That subsidiary is taxable like a standard corporation.  In turn, the REIT may hold up to 100% of the TRS’s stock without disqualifying rents received by the REIT from special tax treatment, so long as the TRS does not compose more than 20% of the REIT’s total assets (this limit was raised to 25% in 2008).

While the Act laid the groundwork for heavy investment in service facilities, the Act stopped short of authorizing such investment in healthcare facilities.  In fact, it expressly prohibited the use of this TRS model to manage healthcare properties.  However, as part of the Housing and Economic Recovery Act of 2008, Congress expanded the definition of “TRS” to include subsidiaries that manage healthcare properties.

Those real estate funds and their attorneys riding the wave of healthcare property investment would confirm that these legislative enactments have paid dividends (literally and figuratively) in an otherwise moribund real estate investment sector.