Topic: Regulatory Studies

Kokesh v. SEC: A Penalty By Any Other Name

This week, the Supreme Court issued a unanimous opinion finding what should have been obvious from the start.  That when a government agency requires someone to turn over money to the U.S. Treasury as a result of the person being found guilty of wrongdoing, that constitutes a penalty. 

In Kokesh v. SEC, the Securities and Exchange Commission argued that disgorgement is not a penalty or forfeiture and therefore, due to a particular law’s limitations, the SEC is entitled to bring cases that are even decades old.  Disgorgement is a remedy that requires the defendant to pay back something that was obtained through unlawful means.  Under 28 U.S.C. § 2462, the federal government has five years in which to bring any “action, suit, or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise.” The SEC has held that disgorgement falls into none of these categories and therefore there is no limit on how long the agency has to bring a case in which it is seeking disgorgement.

As we argued in our amicus brief filed on behalf of Charles Kokesh, it is a well-established principle in law that cases must be timely to be just.  When actions are fresh, access to evidence will likely be robust.  Witnesses’ memories are more likely to be clear.  Both sides will likely have the relevant documents at hand.  The court will have the best chance of getting to the truth.  But when a case is stale, memories will have faded, documents will have been lost or innocently destroyed, and it will be uncertain whether the existing evidence will present the most accurate picture of what really happened.

In ruling in favor of Mr. Kokesh a unanimous court found that disgorgement is indeed a penalty.  In writing for the Court, Justice Sotomayor announced two factors that determine whether a payment is a penalty.  First, it must be determined whether the payment has been imposed to redress a wrong to the public, or a wrong to an individual.  A penalty is imposed to redress the former, not the latter.  “This is because penal laws, strictly and properly, are those imposing punishment for an offense committed against the State.”  (internal quotations omitted.)  The second question is whether the payment was imposed to deter future wrongdoing.

Trump Pursues Air Traffic Control Reform

The Trump administration will highlight its infrastructure agenda this week. As outlined in its recent budget, the administration plans to reduce regulations on construction projects and attract private investment to traditionally government activities, such as air traffic control (ATC).

Trump will “deliver remarks in the White House Rose Garden about his vision for separating air traffic control from the federal government,” and Transportation Secretary Elaine Chao will testify to Congress on the issue. The administration has just released principles for ATC reform.

The Hill says that ATC reform has run into a “buzz saw of opposition on Capitol Hill,” but that is not a fair characterization. There is always opposition to any legislation that reduces the government’s role in anything. That’s Washington. But ATC reform has momentum, and a bill has been passed out of the House transportation committee to move ATC operations from the bureaucratic Federal Aviation Administration (FAA) to a private, nonprofit corporation.

The airlines are for it, the key labor union is for it, aviation experts are for it, and the second-largest nation on earth did it. Canada privatized its system in 1996, and today the nonprofit Nav Canada is on the leading edge of ATC efficiency and innovation. The image below shows Iridium satellites that will form the basis of an advanced navigation system for aircraft called Aireon. Nav Canada leads the revolutionary project in an international partnership—a partnership that does not include the FAA. The system will generate “more efficient use of airspace, substantial fuel savings, fewer delays and significantly enhance safety over large parts of the world.”

What is the opposition The Hill refers to? The corporate jet lobby—the National Business Aviation Association (NBAA)—is against reform, and it raises the spectre of higher fees under a privatized system. But aircraft charges under the privatized Canadian system have fallen, not risen. The latest data show that “Nav Canada has seen its inflation-adjusted user fees fall 45 percent lower than the aviation taxes they replaced,” notes Marc Scribner of CEI.

The opposition of NBAA’s leadership to reform is short-sighted. Over the long term, NBAA members will be best served by an advanced and dynamic private ATC system, not one mired in bureaucracy and unstable government funding. NBAA members should research the successful Canadian reforms themselves because the record is clear.

Kudos to President Trump and Secretary Chao for rebuffing the special interests on this issue, and pursuing reforms to the overall benefit of the aviation industry and flying public.

For an overview of ATC reform, see here. For Reason’s resources on the issue, see here.

Federal Role in Infrastructure

As part of its 2018 budget proposal, the Trump administration has introduced a plan to improve the nation’s infrastructure. The administration intends to reduce regulatory barriers on infrastructure projects and encourage greater private investment. It has also proposed increasing federal spending on infrastructure by $200 billion over 10 years.

A new Cato study provides input to the debate by examining infrastructure ownership and funding. Some people assume that the federal government plays the main role in infrastructure, but the states and private sector own 97 percent of U.S. nondefense infrastructure, and they fund 94 percent of it.

However, the federal government is the tail that wags the dog—its regulations, taxes, and subsidies affect the level and efficiency of state, local, and private infrastructure investment. The study argues that reforms to these federal interventions and privatization are the paths to higher-performance infrastructure.

Can Regulation Keep Up with Accumulating Knowledge?

What some doctors say about regulating the treatment of sepsis has much broader application. Sepsis, an often lethal reaction to infection sometimes called blood poisoning, is the leading cause of death in hospitals, Richard Harris reports for NPR. Understandably, then, some doctors and regulators have a typical reaction: “A 4-year-old regulation in New York state compels doctors and hospitals to follow a certain protocol, involving a big dose of antibiotics and intravenous fluids.”

Other doctors aren’t so sure about the rush to regulation. 

Dr. Jeremy Kahn at the University of Pittsburgh believes that regulations can prod doctors to follow the latest protocol. But “The downside is that a regulatory approach lacks flexibility. It essentially is saying we can take a one-size-fits-all approach to treating a complex disease like sepsis.” Harris continues:

That’s problematic, because doctors haven’t found the best way to treat this condition. The scientific evidence is evolving rapidly, Kahn says. “Almost every day another study is released that shows what we thought to be best practice might not be best practice.”

Kahn wrote a commentary about the rapid changes earlier this month for the New England Journal of Medicine.

For a while, medical practice guidelines distributed to doctors called on them to use one particular drug to treat sepsis. It turned out that drug did more harm than good. Another heavily promoted strategy, called goal-directed therapy, also turned out to be ineffective.

These are concerns that economists often raise about regulation: that government mandates may be rigid, inflexible, and frozen in time. They don’t change easily in response to new information. They may require a specific protocol that may turn out not to be the best practice:

And a study presented last week at the American Thoracic Society and published electronically in the New England Journal of Medicine finds that one of the steps required in New York may not be beneficial, either.

The regulations call for a rapid and substantial infusion of intravenous fluids, but that didn’t improve survival in New York state hospitals….

In fact, some doctors believe that most patients are better off without this aggressive fluid treatment. There’s a study getting underway to answer that question. Dr. Nathan Shapiro at Harvard’s Beth Israel Deaconess Medical Center hopes to enlist more than 2,000 patients at about 50 hospitals to answer this life-or-death question.

But that study will take years, and in the meantime doctors have to make a judgment call.

“It is possible that at present they are requiring hospitals to adopt protocols for fluid resuscitation that might not be entirely appropriate,” Kahn says.

Somehow this reminds me of the phenomenon noted in the 1980s when Canada banned cyclamates and the United States banned saccharin. Presumably one country had banned the less dangerous sugar substitute.

Economists Gerald P. O’Driscoll Jr. and Lee Hoskins wrote about the problems with regulatory mandates in 2006:

Coercion may bring uniformity of product or conduct, but only at the expense of innovation and flexibility. Merchant law suffered when the hand of the state took it over: “Many of the desirable characteristics of the Law Merchant in England had been lost by the nineteenth century, including its universal character, its flexibility and dynamic ability to grow, its informality and speed, and its reliance on commercial custom and practice” (Benson 1989: 178).

Markets excel in adapting to changing circumstances, while legislation and government regulation are notoriously rigid. That is perhaps the strongest case for market self-regulation over government-mandated regulation.

Regulation seems to substitute the judgment of a small group of fallible politicians or bureaucrats for the results of a market process that coordinates the needs and preferences of millions of people. It sets up static, backward-looking rules that can never deal with changing circumstances as well as voluntary decisions by people on the ground, whether entrepreneurs, customers, scientists, or doctors.

Cut the Corporate Tax Rate; Drop the BAT.

We will never achieve a good tax reform by trusting bad revenue estimates.

According to Wall Street Journal reporter Richard Rubin, “Each percentage-point reduction in the 35% corporate tax rate cuts federal revenue by about $100 billion over a decade, and independent analyses show economic growth can’t cover all the costs of rate cuts.”

Economic growth does not have to “cover all the cost” to make that $100 billion-per-point rule of thumb almost all wrong.  If extra growth covered only 70% the cost of a lower rate, the static estimates would be 70% wrong.  Yet the other 30% would be wrong too, because it ignores reduced tax avoidance.  Mr. Rubin’s bookkeepers’’ rule-of-thumb implicitly assumes zero “elasticity” of reported taxable profits. Corporations supposedly make no more effort to avoid a 35% tax than to avoid a 25% tax.

Acceptance of this simplistic thumb rule – which imagines a 35% corporate rate could raise $1 trillion more over a decade than a 25% rate – explains why Ways and Means Committee Chairman Kevin Brady still insists a big new import tax is needed to “pay for” a lower corporate tax rate. 

In this view, a border adjustment tax (BAT) is depicted as a tax increase for some companies to offset a tax cut for others.  No wonder the idea has been ruinously divisive – with major exporters lobbying hard for a BAT and major retailers, refiners and automakers vehemently opposed.  Mr. Rubin declares the BAT “dead or on political life support,” while nevertheless accepting that it would and should raise an extra $1 trillion over a decade – assuming no harm to the economy and no effect on trade deficits.

Like Mr. Rubin, Reuters claims “Trump could have trouble getting the rate much below 30 percent without border adjustability.”  That is false even on its own terms because the Ryan-Brady plan would eliminate deductibility of interest expense, which is enough to “pay for” cutting the rate to 25% on a static basis.  Adding a BAT appears to cut the rate further to 20%, but the effective Ryan-Brady rate is really closer to 25% because the import tax and lost interest deduction are not a free lunch.

In any case, the entire premise is wrong. There is no need to “pay for” cutting a 35% corporate “much below 30 percent” because nearly every major country has already done that and ended up with far more corporate tax revenue than the U.S. collects with its 35% tax.  

The average OECD corporate tax rate has been near 25% since 2008, and revenue from that tax averaged 2.9% of GDP.  The U.S. federal tax rate is 35% and revenue averaged just 1.9% of GDP.  Ireland’s 12.5% corporate rate, by contrast, brought in 2.4% of GDP from 2008 to 2015.

Sweden cut the corporate tax rate from 28% to 22% since 2013 and corporate tax revenues rose from 2.6% of GDP in 2012 to 3% in 2015 according to the OECD. Britain’s new 20% corporate tax in 2015 brought in 2.5% of GDP according the same source, unchanged from 2013 when the rate was 23%. 

Pushing Back on an Anti-Social Network

Power Ventures, Inc. offers a service to amalgamate various social-media platforms into one system; each user gives the company his usernames and passwords, including for Facebook. Facebook objected to Power Ventures’ use of Facebook in this manner and sent a cease-and-desist letter. When Power Ventures refused to comply, Facebook sued under the Computer Fraud and Abuse Act (“CFAA”).

The CFAA was designed to prevent hackers from accessing a computer system “without authorization” and has criminal penalties of up to five years in prison. The district court found that Power Ventures had indeed accessed Facebook without authorization and the U.S. Court of Appeals for the Ninth Circuit affirmed that decision. Power Ventures has petitioned the Supreme Court to review the case; Cato has filed an amicus brief supporting that petition.

We explain that there’s a split among the circuit courts as to the legal basis for an entry to be “authorized” under the CFAA. The Fifth and Seventh Circuits use agency law (scope of employer permission), the First and Eleventh Circuits use contract law (established policies), and the Second, Fourth, and Ninth Circuits use property law (the common law of trespass). The ideal resolution would involve an analogy to physical trespass, which various members of Congress involved in drafting the CFAA used to discuss the computer crimes that the law was designed to prevent.

In applying trespass law here, the facts begin to look like a landlord-tenant dispute over a third-party guest. A landlord typically can’t prevent a tenant from inviting guests to access the tenants’ property by using the common areas of the building, without a limitation in the lease. Here, Facebook’s users own the data (information, pictures, etc.) they put on the social network, as Facebook acknowledges, and there’s no guest-access restriction in the terms of service.

Many people share social-network, email, or other passwords without considering such actions to be criminal and the common law is presumed to conform to the customs of the people unless there’s explicit statutory text to the contrary. Otherwise millions of people could unwittingly be made criminals.

This is also the reason why the “rule of lenity” applies in Power Ventures’ favor, because an (at best) ambiguous statute cannot be used to punish someone.

The final reason that the Supreme Court should take the case is its importance to the online economy. Power Ventures is trying to compete with Facebook and Facebook’s ban prevents the market from being able to determine who has the better product. Many other companies, including Google, use a method of automated access similar to that which Power Ventures uses and could be imperiled by the lower court’s ruling. Internet companies need clear legal rules so they know what they can do nationwide without the threat of civil liability or criminal prosecution.

The Supreme Court may decide whether to take Power Ventures v. Facebook before it breaks for its summer recess at the end of June, or it could hold the decision over till the start of the next term in the fall.

Lucia and PHH: Two Cases, Two Arguments for Constitutional Principles

It’s not often an appellate court agrees to re-hear a case en banc—that is, reexamine a decided case with all active judges participating—and when it does, usually it’s because the case is of particular importance.  Today the federal appeals court in D.C. heard two such cases, and both address fundamental issues of due process and constitutional integrity.  Heavy and exciting stuff.  Cato filed amicus briefs in both cases, given their potential impact on core principles of liberty and the rule of law.

The first case, Lucia v. SEC, considers the role of the Administrative Law Judge (ALJ).  While the case was nominally about whether ALJs are inferior officers, and therefore subject to certain constitutional appointment and removal proceedings, at its heart is the question: what makes a judge a judge?

Most Americans expect that if the government is going to haul them in for alleged wrongdoing, they’ll at least have their case heard by an impartial judge, with all the usual legal protections.  And this is what Americans should expect.  Unfortunately, some federal agencies operate differently, using their own internal administrative proceedings, with their own ALJs, to determine if someone has broken the rules, and to impose a fine or other punishment.

The vast majority of ALJs work for the Social Security Administration, determining whether individuals are eligible for benefits.  As Lucia’s lawyer pointed out in argument today, there is a big difference between ALJs determining whether someone will receive something from the government, as the Social Security Administration’s ALJs do, and determining whether the government will take something from someone.