Topic: Regulatory Studies

Courts Should Stop Approving Unfair Class Action Settlements

Class actions play a vital role in our legal system. These lawsuits are often the only vehicle for injured plaintiffs to receive compensation when a defendant’s wrongs are widely dispersed and it would be impractical for a single individual to sue.

Yet the process of settling these suits is subject to perverse incentives on the part of the lawyers representing the injured parties. Class counsel often will seek the largest portion of the settlement award for themselves—structuring the settlement to maximize attorney fees—at the expense of class members.

Sadly, this sort of self-dealing on the part of class counsel is exactly what happened in Blackman v. Gascho. The case centers on a consumer class action filed against Global Fitness Holdings LLC, alleging that the between 2006 and 2012, the company sold gym memberships and incorrectly charged fees pertaining to cancellation, facility maintenance, and personal-training contracts. A group of plaintiffs sued Global Fitness over the fees, and the parties entered into a “claims-made” settlement.

This type of settlement allows the defendant to make a large amount of money “available” to class members, but in order for the members to collect, they must jump through the hoops of correctly filing claims. Because of the low response rate in such settlements, the defendants will end up paying much less than the funds made available. Indeed, of the $8.5 million made available to the class members, Global Fitness paid only $1.6 million—a payout of approximately 10 percent of the settlement funds. Despite this low payout to plaintiffs, class counsel are still paid a certain rate based on the funds that were made available—not the funds that were actually paid out—in some instances giving them attorney fees larger than the class members’ damages award!

The class counsel here were paid $2.4 million, nearly $1 million more than the class members collected. Josh Blackman, also a Cato adjunct scholar, just happened to be one of the class members. He challenged the settlement, arguing that the agreement was giving the class attorneys preferential treatment over the class members who did not collect. The district court approved the settlement, however, and the U.S. Court of Appeals for the Sixth Circuit agreed with the district court by a 2-1 vote.

Cato has now filed an amicus brief urging the Supreme Court to review the case. Federal Rule of Civil Procedure 23(e)(2)—and fundamental tenets of due process—require that a settlement that binds class members be “fair, reasonable, and adequate.” In this case, the Sixth Circuit upheld approval of a settlement that provided zero compensation for over 90 percent of class members, and in the process broke with the Third, Seventh, and Ninth Circuits. 

The Supreme Court will likely decide by the end of the year whether to take up Blackman v. Gascho.

A Constitutional Amendment to Re-Empower the States

When the Framers designed our federalist system, they assumed that the federal government would be limited to those powers actually enumerated in the Constitution and that it would exercise those powers only when authorized by statute. Further, to give the states some say in the drafting of these statutes, one half of the federal Congress—the Senate—was elected by the state legislatures themselves and designed to reflect the interests of the state governments.

Today, none of these elements of our original design remain. The Supreme Court has allowed the federal government to control nearly limitless activities, supposedly as an exercise of its power to regulate interstate commerce. The executive branch acts as its own de facto legislative branch, “interpreting” statutes through executive actions and agency rulemaking to unilaterally give itself the powers it wishes to exercise. And after the passage of the Seventeenth Amendment, senators are now elected by popular vote, meaning there is no longer any direct link between the state and federal governments. The result of these three changes is that states have less power than ever – and there’s not much they can do about it.

To solve that problem, Representatives Rob Bishop (R-UT) and Cathy McMorris Rodgers (R-WA) recently introduced the “Re-Empowerment of the States Amendment,” a proposal that would allow two thirds of the state legislatures to repeal any “Presidential Executive order, rule, regulation, other regulatory action, or administrative ruling issued by a department, agency, or instrumentality of the United States.”

Importantly, this amendment would not allow states to repeal the text of statutes that have duly passed both houses of Congress. This isn’t an amendment to change the system of bicameralism that the Framers designed; instead, it’s an amendment to restore the checks on the executive branch that existed before the massive expansion of the administrative state. As the amendment’s creator David Hemingway has explained, “The practical result would be to enhance the power of Congress since it would encourage the president to work with Congress rather than govern by issuing executive orders.”

There’s No Constitutional Right to a Taxi Monopoly

On Friday, the U.S. Court of Appeals for the Seventh Circuit handed down a pair of rulings rejecting the argument that taxi companies somehow have a protected property right in their monopolies. The opinions—both penned by Judge Richard Posner—are perhaps the courts’ strongest rebuke yet of taxi cartels’ desperate attempts to stay relevant in an Uber world, with Posner describing their claims as having “no merit” and “border[ing] on the absurd.” It’s nice to know that—in the Seventh Circuit at least—losing your monopolistic cartel due to technological disruption is not considered to be a constitutional violation.

In one case, Illinois Transportation Trade Association v. City of Chicago, incumbent taxi companies sued Chicago for allowing app-based ridesharing companies such as Uber and Lyft to operate, asserting that the city’s decision to allow such companies to enter the market without being subject to the same regulations covering traditional taxis constituted an unconstitutional taking of their property without just compensation (and also somehow violated the Fourteenth Amendment’s Equal Protection Clause).

In the other case, Joe Sanfelippo Cabs, Inc. v. City of Milwaukee, taxi companies sued Milwaukee for eliminating the hard cap on the number of taxi medallions in circulation, opening the market up to any applicant who met the requirements. Like in the Chicago case, the plaintiffs argued that the loosening of regulations to allow new market entrants violated the Takings Clause.

In both cases, the plaintiffs’ arguments more-or-less boiled down to: “We made a deal with the city years ago where we were promised monopoly control over this market. The government’s failure to protect that monopoly constitutes an eminent domain-style taking.” This is, of course, as the court described, an absurd argument. “‘Property’ does not include a right to be free from competition. A license to operate a coffee shop doesn’t authorize the licensee to enjoin a tea shop from opening.” No one is entitled to a government grant of monopoly power.

Yes, Your Honor, the CFPB Is Indeed Unconstitutional

I wrote only yesterday about the Consumer Financial Protection Bureau’s (CFPB’s) regulatory overreach with regard to payday loans, and it seems the D.C. Circuit Court was on the same wavelength.  Judge Brett Kavanaugh, writing for the court, handed down a stinging condemnation of the Bureau’s structure, labeling the single-director model unconstitutional.  Although the court’s remedy is somewhat limited – changing the agency from independent to one within the executive branch, with the director serving at the pleasure of the President – the opinion itself is a full-throated indictment of the CFPB’s structure and repeated overreach.  Even given its limited application, it is a win for those who have long questioned the many defects in the CFPB’s design.

The case before the court arose out of an enforcement action brought by the CFPB against the mortgage lender PHH Mortgage.  The action was initially brought before one of the agency’s own in-house adjudicators, who imposed a fine on the company.  (Although not explicitly addressed in this case, these internal administrative proceedings, led by administrative law judges or ALJs, present their own issues, similar to those at the SEC that I have discussed here and here.)  Director Richard Cordray apparently thought the $6.4 million fine imposed by the ALJ was insufficient and added another $102.6 million to the bill.  PHH Mortgage appealed the Director Cordray’s decision to the D.C. Circuit.

The court’s decision turns principally on the magnitude of the director’s power.  Unlike the heads of agencies such as the Department of Justice or Department of the Treasury, the director of the CFPB can be removed by the President only for cause.  That is, the President could remove Cordray only for inefficiency, neglect of duty, or malfeasance.  In fact, the court called the Bureau’s director the “single most powerful official in the entire United States Government, at least when measured in terms of unilateral power” after the President himself.  And the President is at least accountable to the people through the democratic process.  Other powerful positions within the federal government – Speaker of the House, Senate Majority Leader, heads of other independent agencies – have greater checks on their power.  The Speaker cannot act without persuading and cajoling a large number of colleagues.  Independent agencies such as the SEC and FTC are comprised of multi-seat commissions, and no one commissioner can act alone, making the commissioners themselves the checks on each other’s power.  The director of the CFPB faces no such constraints.

Money Laundering Laws: Ineffective and Expensive

Beginning in the 1970s and 1980s, the federal government (as well as other governments around the world) began to adopt policies based on the idea that crime could be reduced if you somehow could make it very difficult for criminals to use the money they illegally obtain. So we now have a bunch of laws and regulations that require financial institutions to spy on their customers in hopes that this will inhibit money laundering.

But while the underlying theory may sound reasonable, such laws in practice have been a failure. There’s no evidence that these laws, which impose heavy costs on business and consumers, have produced a reduction in criminal activity.

Instead, the only tangible result seems to be more power for government and reduced access to financial services for poor people.

And now we have even more evidence that these laws don’t make sense. In a thorough study for the Heritage Foundation, David Burton and Norbert Michel put a price tag on the ridiculous laws, regulations, and mandates that are ostensibly designed to make it hard for crooks to launder cash, but in practice simply undermine legitimate commerce and make it hard for poor people to use banks.

Oh, and these rules also are inconsistent with a free society. Here are the principles they say should guide the discussion.

The United States Constitution’s Bill of Rights, particularly the Fourth, Fifth, and Ninth Amendments, together with structural federalism and separation of powers protections, is designed to…protect…individual rights. The current financial regulatory framework is inconsistent with these principles. …Financial privacy can allow people to protect their life savings when a government tries to confiscate its citizens’ wealth, whether for political, ethnic, religious, or “merely” economic reasons. Businesses need to protect their private financial information, intellectual property, and trade secrets from competitors in order to remain profitable. Financial privacy is of deep and abiding importance to freedom, and many governments have shown themselves willing to routinely abuse private financial information.

And here are the key findings about America’s current regulatory morass, which violates the above principles.

The current U.S. framework is overly complex and burdensome… Reform efforts also need to focus on costs versus benefits. The current framework, particularly the anti-money laundering (AML) rules, is clearly not cost-effective. As demonstrated below, the AML regime costs an estimated $4.8 billion to $8 billion annually. Yet, this AML system results in fewer than 700 convictions annually, a proportion of which are simply additional counts against persons charged with other predicate crimes. Thus, each conviction costs approximately $7 million, potentially much more.

By the way, the authors note that their calculations represent “a significant underestimate of the actual burden” because they didn’t include foregone economic activity, higher consumer prices for financial services, lower returns for shareholders of financial institutions, higher financial expenses for unbanked individuals, and other direct and indirect costs.

And what are the offsetting benefits? Can all these costs be justified?

The CFPB Should Learn That No Means No

Despite professing a desire for “financial inclusion,” usually understood as better access to financial products for lower income people, the Consumer Financial Protection Bureau (CFPB) has taken aim at a product used extensively by low- and moderate income Americans: the short-term, low value loans known as “payday” loans.  What is even more striking about the proposed rule, however, is the fact that it works as an end-run around an express limit on the CFPB’s power.  The CFPB has spent its short life pushing the bounds of its authority in numerous directions, going so far as to incur a slap from a federal court when it trod on the toes of another agency.  The CFPB could be excused for thinking that at least some members of Congress desired such expansion, given the broad and amorphous authority the Dodd-Frank Act grants the new agency.  But it is hard to justify evading an express prohibition.

Although the CFPB is given the authority to proscribe unfair, deceptive, and abusive practices, the Dodd-Frank Act explicitly withholds from the CFPB the authority to “establish a usury limit.”  The proposed rule does not set a rate cap, but it does make lending at any rate above 36 percent so onerous as to be infeasible.  In fact, it is not clear that it would be even be possible to comply with the rule.

On Friday, I submitted a letter to the CFPB, expressing concern over the agency’s authority to enact the rule as proposed.  In particular, the letter notes that the underwriting process required for loans with an effective annual interest rate higher than 36 percent are not only onerous but require the lender to make determinations that may be impossible to make.  For example, under the proposed rule a lender would be required to “forecast a reasonable amount of basic living expenses for the consumer – expenditures (other than debt obligations and housing costs) necessary for a consumer to maintain the consumer’s health, welfare, and ability to produce income[.]”  This amount can be difficult for individuals to determine for their own households.  My husband and I have an estimate we use to help us save for an emergency, but I couldn’t swear to its accuracy given the vagaries of life with small children.  I couldn’t guess what the right number might be for any other household in my acquaintance.  If I am uncertain what my own family might need, it is difficult to see how a storefront lender could make this determination for a prospective borrower who walks in off the street.  Certainly this level of underwriting, which surpasses even what is required for most mortgages, is not cost-effective for a loan of only a few hundred dollars.

Obama’s Housing Toolkit: A Mixed Bag

Something striking happened last week: the Obama White House released its Housing Development Toolkit and Obama’s economic advisor, Jason Furman, wrote a follow-on op-ed about land use regulation’s negative consequences. While White House reports tend to be geared toward partisan political objectives, these two publications could have been written by non-partisan economists. Nevertheless, although the honest application of economic theory is welcome, libertarians will still find points of disagreement.

What’s good? The report highlights zoning policies’ influence on increasing housing prices, immobilizing workers in job deserts, creating costly uncertainty for developers, increasing inequality and racial segregation, and suppressing economic growth. These negative outcomes were attributed to “excessive barriers,” “unnecessarily slow permitting processes,” and “arbitrary or antiquated” zoning and land use regulations.

The White House even went so far as to say that “even well-intentioned land use policies” can have negative impacts. So far, so good.

What’s bad? The worst part of the report is the declaration that the President’s 2017 HUD budget includes a $300 million proposal for grants to help cities “modernize their housing regulatory approaches.” Since when does it cost $300 million to reduce regulation, which is all the “modernizing” that needs to be done?