Topic: Regulatory Studies

Financial Regulators Are Not Above the Constitution

As protestors across America condemn Wall Street for its greed and corruption, the Supreme Court has an opportunity to examine a ruling that holds some of Wall Street’s biggest regulators immune from suit.

In 2006, the National Association of Securities Dealers and the regulatory arm of the New York Stock Exchange consolidated to form the Financial Industry Regulatory Authority (FINRA). NASD and FINRA are “self-regulatory organizations” (SROs), because the Securities and Exchange Commission charges them with regulating their own members — a set-up that is supposed to protect investors and the public. But NASD officers may have achieved the consolidation (and thereby received huge bonuses) by misstating material facts on a proxy solicitation, which induced member firms to give up some of their voting powers in exchange for a payout.

Remarkably, the Second Circuit held that a lawsuit against NASD for the alleged fraud could not proceed because the defendants had sovereign immunity. Yes, SROs should be immune for their actions as quasi-government regulators. For example, immunity is appropriate for government actors like judges, who must have some protection from private suit to do their jobs properly. But judges are not immune for things they do in their private lives — they can be sued just like anyone else. The Second Circuit, however, held that SROs, which have expansive and varied powers, enjoy absolute immunity even for actions that are merely “incident to” their regulatory duties. That is, suits involving private corporate actions cannot proceed if they are incident to actions taken in a governmental capacity.

In this case, the court found that the voting-rights changes were “incident to” FINRA’s regulatory activities because they were part of a plan to make a larger entity that would also have regulatory duties. This case raises serious constitutional issues about the role the judiciary plays in ensuring that SROs remain faithful to their delegated duties of protecting investors and the public. Because SROs are quasi-private actors, they have incentives to act in their own best interests — rather than in the public interest — and they do not have to be as transparent as fully public agencies.

Further, the executive branch, including the SEC, has failed to hold SROs accountable for their self-serving behaviors. As we see from this case, the judiciary provides the sole opportunity for SRO accountability. Cato, joined by the Competitive Enterprise Institute, has now filed a brief urging the Supreme Court to review Standard Investment Chartered, Inc. v. NASD. Accountability among branches of government — the separation of powers and checks-and-balances — is a central tenet of our constitutional structure, and is especially important for SROs, which exercise great power over financial markets. Our brief argues that the judiciary remains the last check on SROs’ unbridled power and that the Second Circuit erred in failing to hold these SROs accountable.

Clifford Winston on Lawyer Licensure

Brookings senior fellow Clifford Winston is in today’s New York Times arguing the position (as does his new book with Robert Crandall) that state licensing rules governing who can enter the legal profession are “barriers to entry” that should simply be “done away with.” As I observed last month as part of a symposium on the idea at Truth on the Market, I wish Winston had done more to develop the distinction between lawyers’ everyday role in, say, drafting wills and closing real estate transactions (for which the de-licensing approach he favors might indeed hold out hope of wider choice and reduced cost for consumers) and lawyers’ powers to pursue litigation, subpoenas, and other compulsory process against unwilling opponents and third parties. The latter is a type of coercive, indeed quasi-governmental, weaponry and it is by no means obvious that it should be delegated to all comers. As I argued last month:

The coercive powers wielded by private lawyers [when they wear their litigators’ hats] are more akin to the powers wielded by prosecutors and other government officials than to the powers wielded by, say, optometrists or dentists….

The way forward might be to split the tasks of a lawyer in two, moving to deregulate the advisory and document-preparation functions (which could indeed be a way of saving consumers large sums) while continuing to apply appropriate scrutiny to those in the profession who presume to wield coercive litigation powers. Although the British separation of highly regulated barristers from less highly regulated solicitors does not precisely track this distinction, it is worth keeping in mind as a possible model for a division between an “outer” legal profession whose operation might be entrusted to general business principles and an “inner” group of professionals of whom more is expected, as we expect more ethically and legally from judges themselves, public prosecutors, and others cloaked in public authority.

My full symposium contribution is here.

Should You Need a License to Hang Curtains?

The latest example of liberty-reducing occupational licensing schemes comes to us from Florida, where a law restricts the practice of interior design to people the state has licensed. Those wishing to pursue this occupation must first undergo an onerous process ostensibly in the name of “public safety.”

In reality, the law serves as an anti-competition measure that protects Florida’s current cohort of interior designers. Our friends at the Institute for Justice have pursued a lawsuit against the law but lost their appeal in the Eleventh Circuit.

Cato has now joined the Pacific Legal Foundation on an amicus brief asking the Supreme Court to review that ruling. The lower court got it wrong not just with respect to the right to earn a living, however, but also on First Amendment grounds.

That is, interior design, as a form of artistic expression, is historically protected by the First Amendment. Indeed, interior designers are measured primarily on the value of their aesthetic expression, not for any technical knowledge or expertise. This type of artistry is a matter of taste, and the designer and client usually arrive at the end result through collaboration and according to personal preferences. Thus, the designer-client relationship has little in common with traditionally regulated professions such as medicine, law and finance, where bad advice can have real and far-reaching consequences—but even then, the Supreme Court has emphasized the First Amendment implications of placing “prior restraints” on expression through burdensome licensing schemes.

Instead of following that precedent, however, the circuit court carved out a constitutionally unprotected exception for “direct personalized speech with clients.” Florida’s “public safety” justification is similarly weak, given that the state has presented no evidence of any bona fide concerns that substantiate a burdensome licensing scheme that includes six years of higher education and a painstaking exam—instead relying on cursory allegations that, for example, licensed designers are more adept at ensuring that fixture placements do not violate building codes.

Finally, the Eleventh Circuit’s ruling disregarded the infinite array of auxiliary occupations the Florida law subjects to possible criminal sanctions: wedding planners, branding consultants, sellers of retail display racks, retail business consultants, corporate art consultants, and even theater-set designers could all get swept in. The state has already taken enforcement actions against a wide spectrum of people who are not interior designers, including office furniture dealers, restaurant equipment suppliers, flooring companies, wall covering companies, fabric vendors, builders, real estate developers, remodelers, accessories retailers, antique dealers, drafting services, lighting companies, kitchen designers, workrooms, carpet companies, art dealers, stagers, yacht designers, and even a florist. This dragnet effect also suggests that the law is too broad to survive constitutional scrutiny.

The Court will likely decide by the end of the year (or early 2012) whether to take this case of Locke v. Shore.

Another Romneycare/Obamacare Similarity: Earning Their Sponsors Insurance-Company Love

I’ve been meaning to post this article from that sheds light on the claim that either Obamacare or its twin, Romneycare, somehow “get tough” on insurance companies:

Health Insurance Industry Opens Check Books for Mitt Romney, Barack Obama

Research by the Center for Responsive Politics shows that President Barack Obama and his GOP rival Mitt Romney, the former governor of Massachusetts, are the only two presidential candidates to have raised more than $40,000 from the health insurance industry so far this election cycle…

Both men have favored health care policies that include an individual mandate for people to purchase private insurance plans. Romney did so as governor of Massachusetts, and Obama did so as part of the health care reform package he signed into law last year…

Such mandates are supported by the insurance industry, which stand to benefit from increased customers as well as from government subsidies that help enroll people who could not otherwise afford insurance.

Romney, in fact, has received more than five times as much money from the health insurance industry than any other GOP presidential candidate, according to the Center’s research.

That should weigh on the minds of states that are considering whether to create the health insurance “exchanges” that will implement Obamacare’s individual mandate and subsidies for insurance companies.

How Much Homeland Security Is Enough? Monday Book Forum

At noon Monday, Professors John Mueller and Mark Stewart will be here to discuss their new book: Terror Security and Money: Balancing the Risks, Benefits and Costs of Homeland Security. Register here.

The question in this post’s title is the book’s. It quantifies Mueller’s skepticism about the utility of homeland security spending with cost-benefit analysis, which is Stewart’s specialty. They use this analysis, which is employed by various federal agencies as part of the regulatory review process, to show that little of what the Department of Homeland Security does is a good investment. That is, the bulk of its activities cost more—measured in lives or dollars— than they save. In the conclusion, where you find most of the book’s political science, Mueller and Stewart discuss why DHS avoids this sort of analysis—neither it nor its political advocates have much reason to advertise its wastefulness—and why that should change.

Alan Cohn, Deputy Assistant Secretary for Policy at DHS, has boldly agreed to join the proceeding. DHS rules prohibit him from commenting directly on the book, but he will presumably defend his department and discuss how it considers policies’ cost and benefits, or what it calls risk management.

That all sounds very wonky, I know. Here is why the book and forum should interest those not particularly concerned with homeland security or risk analysis: the book calls a bluff. One of the great myths about U.S. national security is that it aims to maximize safety. Almost everyone speaks about security as if this were so.

The truth is instead that every security policy, indeed every government policy, is a choice among risks. Most policies aim to mitigate risk in some way and by expending resources expose us to other risks. Our policy preferences and ideologies are largely beliefs about which risks to combat socially and which to leave to individuals, or least how much attention we should pay to competing risks. Our society, it turns out, is willing to pay far more to save lives from terrorism than most other dangers. That is, we value lives lost from it far more highly than those lost in other ways. We trade small gains in protection from terrorists for substantial losses in our ability to combat other troubles.

By asking what U.S. homeland security would look like it if truly aimed to maximize safety against all dangers, Mueller and Stewart’s book makes plain that we have chosen to do otherwise. People that disagree about the merit of that choice should agree at least that it is one we should make openly. Democracies make better choices when they perceive them.

Wham-O! There Go ‘Patent False Marking’ Suits

It’s fun to be on the winning side of a fight, even if someone else gets to land the knockout punch. Yesterday the U.S. Court of Appeals for the Federal Circuit dismissed as moot the case of FLFMC, LLC, v. Wham-O, in which I and Cato’s Center for Constitutional Studies had entered an amicus brief on the side of toymaker defendant Wham-O. The Western District of Pennsylvania federal court had agreed with our position that the qui tam (bounty-hunter) provision of the false marking statute was unconstitutional; the Federal Circuit heard argument on the issue, but before it could rule the U.S. Congress resolved the controversy by wisely acting, as part of its patent reform bill, to do away with the whole cottage legal industry of bounty-hunting litigation over false patent marking.

For those who came in late, federal law had long provided that anyone could sue a manufacturer that wrongly claims patent protection for its product, and collect a minor award ($500) so as to help defray the cost of bringing the action. In a 2009 case, a federal court shocked the business world by ruling that the $500 bounty should be construed as per mismarked item sold – meaning that a company that had mismarked a million paper cups or mascara applicators might owe hundreds of millions of dollars. Entrepreneurial lawyers rushed to file more than a thousand lawsuits, most of them aimed at companies that had gone on selling products with a marking after a given patent had expired. (More background here, here, and generally here at my Overlawyered site.) The constitutional issue arose because the overall setup, like the unlamented “independent counsel” scheme, delegated to private attorneys too much of the government’s distinctive law enforcement authority, an authority that in this case is essentially criminal rather than civil in nature, given the Powerball penalties to be applied with no showing of harm to either consumers or competitors.

It would have been nice to get the Federal Circuit on record agreeing with this line of reasoning, which had persuaded a number of lower courts. But what happened instead was in its own way equally satisfying. Congress specified in its patent bill last month that wholly uninjured bystanders do not have standing to pursue false marking cases, and that expired markings, without more, are not “false.” It also explicitly applied these principles to pending cases, generally seen as a choice that is within its discretion to make in cases in which, as here, no one is suing over an privately vested property right.

Around the country, many a manufacturer can now heave a sigh of relief at not having to sign its future over to lawyers. And Cato can move on to more fights over classical liberal principle in its very successful amicus program, about which you can learn more here.

P.S. Almost forgot to thank the real heroes of the adventure, the ones who wrote and edited the Wham-O brief: Paul Wolfson and Pamela Bookman at Wilmer Hale, and Ilya Shapiro and Michael Wilt at Cato.

Cato Study: Malpractice Insurance Markets Promote Quality Care, Mandatory Damage Caps Could Undermine Same

Today, the Cato Institute releases a new study:

Could Mandatory Caps on Medical Malpractice Damages Harm Consumers?

by Shirley Svorny

Shirley Svorny is an adjunct scholar at the Cato Institute and professor of economics at California State University, Northridge.

Supporters of capping court awards for medical malpractice argue that caps will make health care more affordable. It may not be that simple. First, caps on awards may result in some patients not receiving adequate compensation for injuries they suffer as a result of physician negligence. Second, because caps limit physician liability, they can also mute incentives for physicians to reduce the risk of negligent injuries. Supporters of caps counter that this deterrent function of medical malpractice liability is not working anyway—that awards do not track actual damages, and medical malpractice insurance carriers do not translate the threat of liability into incentives that reward high-quality care or penalize errant physicians.

This paper reviews an existing body of work that shows that medical malpractice awards do track actual damages. Furthermore, this paper provides evidence that medical malpractice insurance carriers use various tools to reduce the risk of patient injury, including experience rating of physicians’ malpractice premiums. High-risk physicians face higher malpractice insurance premiums than their less-risky peers. In addition, carriers offer other incentives for physicians to reduce the risk of negligent care: they disseminate information to guide riskmanagement efforts, oversee high-risk practitioners, and monitor providers who offer new procedures where experience is not sufficient to assess risk. On rare occasions, carriers will even deny coverage, which cuts the physician off from an affiliation with most hospitals and health maintenance organizations, and precludes practice entirely in some states.

If the medical malpractice liability insurance industry does indeed protect consumers, then policies that reduce liability or shield physicians from oversight by carriers may harm consumers. In particular, caps on damages would reduce physicians’ and carriers’ incentives to keep track of and reduce practice risk. Laws that shield government- employed physicians from malpractice liability eliminate insurance company oversight of physicians working for government agencies. State-run insurance pools that insure risky practitioners at subsidized prices protect substandard physicians from the discipline that medical malpractice insurers otherwise would impose.

This study’s findings suggest that supporters of market-based health care reform should ditch their support of mandatory damage caps, and embrace better med mal reforms. It also suggests that government should abandon direct regulation of health care quality, such as through medical licensing.