Tag: liability

Liability Is ‘Wrong’ Solution for Rating Agencies

Last week, while America was occupied with elections, an Australian court found Standard & Poor’s liable for “misleading” local council governments by awarding AAA rating to derivatives that later lost value (more detail on the case here). Not surprisingly, after the financial crisis, dozens of suits were filed in the United States, Europe, and elsewhere claiming investors were “misled” by the rating agencies. Most of these suits were quickly dismissed or withdrawn. The Australian case is one of the few to find liability.

First, as I documented in a recent Cato Policy Analysis, the regulatory structure for the rating agency is fatally flawed and was without a doubt a contributor to the financial crisis. That said, subjecting rating agencies to legal liability would make the situation worse, not better. From that analysis:

[A] risk from subjecting rating agencies to liability for either their statements or processes is that, in order to protect themselves, the agencies would adopt a “reasonable man” approach. For instance, if the agencies used government forecasts of house prices in their mortgage default models, then it is likely that any court would deem such assumptions “reasonable”; after all, these are the assumptions that regulators rely upon. If such assumptions are, however, grossly in error, as were the housing price forecasts used by various federal agencies, then the value of information created by the rating agencies would also be reduced, if not compromised. A reasonable-man approach would also encourage rating agencies to utilize “consensus forecasts” of key economic variables. Yet the consensus could be dangerously off. The economic forecasting profession does not exactly have a great record at predicting turning points, and it also missed the decline in house prices. A system of liability would likely destroy whatever additional information the rating agencies bring to the market, as the agencies would face tremendous pressure to simply mimic widely held beliefs, which themselves would already be priced into the market.

Another problem would be that rating agencies would most likely face litigation risk from those being downgraded, especially by governments. Witness the abuse Standard & Poor’s received from the SEC right after it downgraded the U.S. federal government. Do we truly believe that we would have more accurate ratings if a Greek court were able to decide if a downgrade of Greek government debt was accurate? I would also go as far to argue that ratings of sovereign debt should be considered politically protected speech (but then I’m also for protecting most, if not all, speech).

Federalism and Med-Mal Reform

Thanks to star libertarian lawprof and Cato senior fellow Randy Barnett for pointing out something that has needed saying for a while: most proposals in the U.S. Congress to address medical malpractice law run into serious federalism problems.

Most medical malpractice suits go forward in state courts under state law. If the U.S. Congress wishes to impose a nationwide rule on these suits, such as by limiting damages for pain and suffering, it first needs to answer the question: under which of the federal government’s constitutionally prescribed powers is it acting? Even if it can identify such authority, it should also ask: is it a wise idea—consistent with what one might call a prudential federalism—to gather yet more power in Washington at the expense of the states?

Unfortunately, the backers of the current federal med-mal bill have chosen to rely on the Supreme Court’s very expansive “substantial effects” doctrine, which as Barnett explains:

allows Congress to regulate any economic activity in the country that can be said, in the aggregate, to have a “substantial effect” on interstate commerce. This doctrine was unknown before the 1940s, and goes far beyond the original power to regulate trade between states. This is how most of Congress’ regulatory power has been justified since then.

Although it is followed even by conservative justices, Justice Clarence Thomas has long criticized the Substantial Effects Doctrine on the ground that it exceeds the original meaning of the Constitution.

Let’s step back for a moment to review what’s not at issue here. First, this is not an argument over whether liability reform of some sort is a good idea: in fact Prof. Barnett “strongly support[s] reforming our malpractice laws to protect honest doctors from false claims and out-of-control state juries.” (So do I.)

Nor is this an argument over whether the federal government should simply leave the state courts alone as a general proposition, as some late-blooming friends of federalism on the left side of the aisle seem to suggest. Our constitutional scheme of government is entirely consistent with federal-level supervision of state courts when those courts behave in certain ways, as by violating litigants’ due process, impairing the obligation of contract, or abridging the privileges and immunities of citizens of other states, to name but a few. Article IV, Section 1 confers on Congress a broad charter to prescribe to states “by general Laws” how they are to accord full faith and credit to other states’ enactments. That’s not even counting Congress’s genuine interstate commerce power (as opposed to the on-steroids New Deal version) or various other powers.

But observe the pattern. Again and again, the Constitution contemplates federal supervision of state courts when they reach out to assert power over transactions and litigants outside their own boundaries. It has far less to say about intruding upon the authority of those courts over disputes that arose between their own residents and are unmistakably under their own law. That general game plan—oversee the interstate but mostly not the intrastate doings of state courts—comports well with the insight of public choice scholars who point out that states face an ongoing temptation to stack liability proceedings so as to enrich their own citizens at the expense of out-of-state litigants obliged to appear in their courts.

Where does this leave federal-level liability reform? It suggests a very real difference between areas like product liability and nationwide class actions—in which suits ordinarily cross state lines, and the majority of runaway verdicts are against out-of-state defendants—and more conventional kinds of tort litigation arising from car crashes, slip-and-falls, and medical misadventure, where cases are mostly filed against locally present defendants. As a rough rule of thumb, it’s worth presuming that most of the local suits do not externalize heavy costs across state lines and should accordingly be left alone by Congress unless it is itself vindicating some constitutional right or coordinating the functioning of some constitutionally authorized federal government activity.

That doesn’t mean federal policymakers are to be left with no role at all. For example, if Washington is paying for a large share of hospital stays, it may make sense as a cost containment measure for it to steer beneficiaries into lower-cost ways of resolving disputes over care quality, or even to ask beneficiaries as a condition of treatment to agree not to file certain suits at all. But that would require stepping back toward a more careful—and more Constitutionally appropriate—view of the federal role.

Chinese Drywall Maker Held Accountable without Congressional Meddling

This summer, the House Energy and Commerce Committee approved a bill that would require foreign companies that import goods to the United States to appoint a legal representative in the United States who could be sued if their products caused injury. Exhibit A in the push for the bill was the case of contaminated drywall from China.

Advocates of the bill, titled the “Foreign Manufacturers Legal Accountability Act,” say it is necessary to ensure compensation for American consumers injured by faulty foreign-made products. Without a designated domestic agent, foreign companies could escape liability by dodging efforts to serve them with papers in a lawsuit. Hearings earlier this year highlighted the case of the drywall, in which damaged homeowners were finding it difficult to sue the Chinese producer.

The trouble with this approach, as my colleague Sallie James and I pointed out in a recent Cato Free Trade Bulletin, is that it would impose an additional burden on importers without adding significantly to the ability of consumers to gain compensation. We argued that sufficient remedies exist without adding a new law that looks suspiciously like a non-tariff trade barrier designed to protect U.S. manufacturers from foreign competitors.

As Exhibit A on our side, it was announced this week that a group of affected homeowners has struck a deal with the Chinese drywall company for compensation. As The Wall Street Journal reported in today’s edition:

Knauf Plasterboard Tianjin, along with suppliers and insurers, agreed to remove and replace the company’s drywall, as well as all the electrical wiring, gas tubing and appliances from 300 homes in four states.

They also agreed to pay relocation expenses while the houses, in Alabama, Mississippi, Louisiana and Florida, are repaired. The cost of fixing the houses, expected to take several months, is estimated from $40 to $80 per square foot per home. At $60 per square foot for a 2,500 square-foot home, the cost would be about $150,000.

Although the settlement involves a fraction of the homeowners who have file claims over the past few years, it is seen as a possible model for the resolution of other pending state and federal lawsuits …

The deal for compensation shows that the existing system works reasonably well for foreign-made as well as domestic-made goods. Congress should give up its efforts to place needless obstacles in the way of imports in the name of solving a problem that does not exist.

Google Execs Convicted in Italy

Google executives who had nothing to do with the creation, uploading, review, or display of a video have been criminally convicted in Italy for its brief appearance on a Google site.

The video, which showed Italian children taunting an autistic schoolmate, was promptly taken down after Italian authorities notified Google. The company assisted the authorities in locating the girl who uploaded it, according to Google’s account. (Her subsequent conviction makes it safe to assume that Google was cooperating with a criminal investigation as required by Italian law.) But four Google employees were charged with criminal defamation and failure to comply with the Italian privacy code.

That can’t happen here—unless we let it happen here.

This is a good time to review and extoll the Communications Decency Act—not because it attempted to censor Internet speech (that part was overturned), but because it protected providers of interactive services (like Web sites) from having to become gatekeepers over Internet content.  The law shielded them from liability for what users of their services do.

I believe common law would have eventually reached that result had the statute not been passed, but without protections like that in the CDA’s section 230, the wide-open, rollicking, soapbox-for-all Internet we know would not exist—it would be just a plussed-up television because everything uploaded would have to get a professional’s review for potential liability.

That’s what Italy stands to end up with if it allows liability against providers of interactive services. It’s what we stand to end up with if the many threats to CDA section 230 get traction.