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Modern Day Alchemy?


In "The IOLTA Program: The Invisible Hand" (Summer 1992), Cassandra Chrones Moore leaves the reader with the impression that IOLTA programs operate secretively to fund liberal political causes, but she builds her case on limited anecdotal evidence and erroneous information. There is much more to IOLTA than Ms. Moore presents--and it is all very visible.

Interest on Lawyers' Trust Accounts (IOLTA) programs began in Australia in the 1960s and spread to Canada and other common law countries before starting in the United States. The premise underlying IOLTA is ingenious and compelling--nominal and short-term client trust funds constitute an economic resource that can be used to create income that would not otherwise exist. The revenue created funds a variety of law-related public service programs such as civil legal services for the poor, alternative dispute resolution programs, client security funds, court-appointed special advocate programs, and law school scholarships.

Over 815,000 individuals had access to our justice system last year because of IOLTA grants providing either representation or self-help assistance. Contrary to Ms. Moore's assertions that money subsidized the "political causes of the liberal left," hundreds of state grants totaling over $150 million provide assistance to the elderly, children, crime victims, the homeless, the disabled, those in need of medical care, and victims of domestic violence. Approximately 85 percent of all IOLTA grants were earmarked for programs that provide direct representation to individual low-income clients. Many of these programs have increased their efficiency by using the volunteer or pro bono services of private lawyers in the community.

Until the 1980s, client funds had been held by lawyers in non-interest-bearing checking accounts. Since the funds were usually nominal in amount or held for a short term, lawyers routinely commingled client funds in one account, as it would have been prohibitively expensive to open and maintain a separate account for each client. Interest realized on those accounts did not inure to the benefit of the client, but rather to the financial institution. A client benefitted only if money was placed in a separate interest-bearing account because of its particular potential for producing income above the amount of bank fees and administrative charges.

The result of placing those nominal and short-term funds in an IOLTA account is the creation of income in a manner described by former Florida Supreme Court Justice Arthur England as "modern day alchemy." Income is created, but nothing else is changed--the lawyer has satisfied his or her ethical and fiduciary duties to place client funds in a secure account; there is on-demand access to the client's money; and, as in the past, the client realizes no income because each individual client's share of interest produced is offset by permissible charges and fees.

Ms. Moore expresses concern because individual lawyers have the "discretion" to determine which funds should be placed in an IOLTA account because they are nominal in amount or held for a short period of time. Even before IOLTA programs, lawyers had to decide whether funds were sufficient to justify opening a separate interest-bearing account or whether the funds could be commingled in a trust account because they could not generate net income. The decision is not so mysterious as Ms. Moore would want us to believe, since the interest rates and service charges of a particular bank would indicate how much money would have to be held for what period of time before net income could be generated. Again, nothing has changed for the client with an IOLTA program in place.

Ms. Moore claims that IOLTA funds are controlled by "state bar associations, in which membership is generally compulsory." That is false. IOLTA programs exist in forty-nine states and the District of Columbia. Programs have been established by either court rules or state legislative enactment, not by bar associations. IOLTA programs are administered by independent bar foundations and independent commissions created especially for the purpose of administering the program.

State IOLTA programs determine the purpose for which grants will be made based on the needs and priorities of the state. Most IOLTA programs have developed criteria for grant applications. Among those criteria commonly used in the grant-making process are:

o IOLTA programs are very interested in providing direct services to clients.

o IOLTA programs tend to encourage cooperative efforts between IOLTA grantees and other service delivery programs, such as the local legal services program or local bar association.

o IOLTA programs encourage grantees to have other sources of revenue or receive matching grants.

o IOLTA programs seek to avoid providing duplicate service and encourage cooperation among existing service providers.

o IOLTA programs normally prefer to fund programs that allow for a broad geographic distribution of their funds within their own jurisdiction.

o IOLTA programs tend to fund projects that address the needs of citizens within the jurisdiction more so than programs with a regional or national focus.

Given the philosophy expressed by the Cato Institute and its publications, it is surprising that Ms. Moore advocates federal regulation of IOLTA grants through such measures as the defeated McCollum-Stenholm bill in Congress. A hallmark of state IOLTA programs is local control and independence from outside regulation. Grants address the pressing legal needs of the citizens of each individual state.

Ms. Moore dwells on a recent unsuccessful legal challenge to the constitutionality of the Massachusetts IOLTA program. No state or federal court has ever held that an IOLTA program violates the due process or free speech provisions of the U.S. Constitution. Courts have unanimously held that IOLTA programs do not amount to a taking under the due process clause because they create interest income that is not within the reasonable expectation of the owner of any of the principal amounts.

Contrary to Ms. Moore's statements, new arguments raised by the Washington Legal Foundation have been unsuccessful. It is argued that IOLTA "takes" the beneficial use of the funds deposited. Arguing that clients should retain some form of control of the funds put on deposit ignores well-established banking law. If the argument prevailed, chaos would ensue. For example, a bank would not be able to make a loan without the approval of the depositors who had retained control over their money while in the bank.

Ms. Moore is also concerned that clients are not given notice on the end use of the interest generated from the pooled accounts. Is she suggesting that a bank must disclose how its shareholders are spending their income? For example, when a customer purchases traveler's checks, the bank temporarily holds and invests the cash. The traveler's check purchaser does not receive interest income, but rather it benefits the bank's shareholders. Would Ms. Moore require the bank's shareholders to disclose to all traveler's check purchasers how their earnings were spent?

Since 1983, the American Bar Association has officially supported the creation and development of state IOLTA programs funding law-related public service projects that reflect the needs and priorities of the individual states. IOLTA and its grantees have made great strides to fulfill the hope of the ABA's theme for 1992--Justice for All, All for Justice.

Doreen D. Dodson
ABA Commission on Interest on Lawyers' Trust Accounts
Chicago, Ill.

IOLTA: Expropriating and Appropriating Private Property

MOORE replies:

The response of Noreen D. Dodson, chair, ABA Commission on Interest on Lawyers' Trust Accounts, to "The IOLTA Program: The Invisible Hand" (Summer 1992) is fully as ingenious as IOLTA itself. For much of her letter she sidesteps the substantive ethical and constitutional issues raised--preferring instead a verbal smokescreen.

The long list of causes and criteria, which we are to take on faith as meritorious, begs the question. The dollars so generously utilized by the IOLTA program, with the sanction of the American Bar Association, belong to the clients--not to the bench, nor to the bar, nor to the partisan attorney. The clients, not the attorney, should have the "discretion" to determine their disposition.

To have options, clients must have knowledge; and it is this knowledge that the legal profession knowingly withholds. If a lawyer as trustee "has satisfied his or her ethical and fiduciary duties" simply by placing a client's funds in a "secure account," without telling the client of the uses to which the funds may be put, then my understanding of ethics and fiduciary duty is sadly lacking.

An attorney acting as a trustee has a double duty--to act solely in the interest of the client/beneficiary and to disclose fully all matters relating to the fiduciary relationship. To say that ";obi;cbnterest is created, but nothing else is changed" when attorneys are acting in concert to keep their clients in the dark is to vitiate that relationship and to sap the ethical foundations of the law.

The disquisition on banks simply confuses the issue by ignoring well-established principles of trust law. The attorney and his or her client establish a trust relationship to which trust law applies; a bank and an attorney acting as trustee enter into a contractual relationship governed by banking law. Ms. Dodson has skipped over the fiduciary relationship between attorney and client to make it appear that there is a contractual relationship between the client and the bank. In fact, there is no such relationship. The point at which a client gives funds to an attorney, thereby establishing the trust relationship, constitutes "the point at which the right of the client to prevent his funds from being used for purposes to which he objects comes into play" (Washington Legal Foundation v. Massachusetts Bar Foundation). Bank shareholders and traveler's checks have nothing to do with the matter.

The charge that the case against IOLTA is built on "limited anecdotal evidence and erroneous information" I find wryly amusing. The American Bar Association itself provided the main factual source. Its IOLTA Updates, published by the ABA's IOLTA Clearinghouse, furnish figures on funds collected and grants made, tally "conversions" to opt-out or compulsory status, and detail local program activities. Although IOLTA operates generally in the dark, releasing selected information to the organized bar promotes the program.

The Updates also outline IOLTA's efforts to defend its turf against legislative incursions proposed in New York and Maryland as well as its bitter opposition to measures limiting IOLTA activities, such as the Legal Services Reform Act of 1991 (McCollum-Stenholm: H.R. 1345) and its 1990 predecessor (McCollum-Staggers-Stenholm: H.R. 5336). Although those measures focused primarily on the Legal Services Corporation, they did try to curb the use of IOLTA funds for legislative advocacy by directing that legal services programs receiving grants from both the Legal Services Corporation and IOLTA be subject to similar restrictions on the political uses of those funds. That is hardly the heavy hand of federal regulation decried by Ms. Dodson but its opposite, an attempt to keep the judiciary from expropriating private property. The statutes intended to maintain a separation between public and private funds and thus left decisions on the uses of the private funds in the hands of their owners, where they belong. If enacted, the legislation would also have made it more difficult for the Legal Services Corporation to circumvent congressional limitations on its political activities.

Although Ms. Dodson seems happy to trace IOLTA's historical development, she avoids dealing with specifics. She mentions three times the use of "nominal" and "short-term" client funds to establish IOLTA programs but never defines nominal or short-term. My analysis emphasized that failure to define, an anomaly for a profession so concerned with the precise use of language.

The claim that clients would realize no income "because each individual client's share of interest produced is offset by permissible charges and fees" is patently untrue. As my article points out, recent advances in data-processing technology have made it possible to track small sums deposited for very short periods of time, to compute interest, and to credit individual accounts with those amounts. Were it not for IOLTA, the client could obtain interest, net of administrative expenses, even on the small sums deposited.

According to Ms. Dodson, I assert that bar associations established IOLTA. That is clearly false. I noted carefully that the IOLTA programs were ";obe;cbnacted generally by the rule of state supreme courts but occasionally by state statute." Nor are the bar foundations and commissions that disburse IOLTA funds so "independent" as she claims. Rather, in connection with IOLTA, they are disbursing agents of the judiciary. Moreover, many of the state IOLTA administrative committees are also creatures of the judiciary. What is worse, the judiciary has untrammelled power to enforce compliance by disbarring or suspending attorneys who prove recalcitrant to the program.

As agents of the judiciary, all of those organizations operate without check, for there are no independent mechanisms to monitor the judicial branch. Having created the program, the judiciary has thus been able to act as both judge and jury, arrogating unto itself the power to expropriate and appropriate private property, that is, clients' funds. In the face of this inherent conflict of interest, it is disingenuous of Ms. Dodson to cite a lower court ruling upholding the IOLTA concept.

Indeed, far from being "unsuccessful," the legal challenge to the constitutionality of the Massachusetts IOLTA program, brought as plaintiff by the Washington Legal Foundation, is going forward on appeal to the U.S. Court of Appeals for the First Circuit. Seventy-seven state and municipal bar associations have filed a joint amici brief in support of the appellees. The rallying of the pro-IOLTA troops would suggest that the legal community views the challenge with alarm.

The constitutional questions involved, in particular, the taking of the equitable interest in and beneficial use of the principal and the violation of due process, are far more complex than Ms. Dodson would suggest. In 1990 Charles E. Rounds, Jr., analyzed those issues in detail in "Social Investing, IOLTA and the Law of Trusts: The Settlor's Case against the Political Use of Charitable and Client Funds" (Loyola University Chicago Law Journal). Nor is it certain that the courts will uphold IOLTA. The program is especially vulnerable on the taking clause issue, a point made clear by Mary O'Byrne Sinibaldi in 1985 in "The Taking Issue in California's Legal Services Trust Account Program" (Hastings Constitutional Law Quarterly).

Despite Ms. Dodson's protestations, the essential point remains: by means of IOLTA the legal profession is taking and spending money belonging to private citizens without their knowledge or consent. Justifying that procedure by characterizing the causes funded as socially useful suggests that, in her view, the end justifies the means, an argument deeply suspect. Moreover, she represents an IOLTA bureaucracy dependent on IOLTA's national income stream for employment. In short, the readership should be aware that Ms. Dodson's letter constitutes self-serving propaganda rather than scholarship.

Cassandra Chrones Moore
Adjunct Scholar
Competitive Enterprise Institute
Washington, D.C.

Protecting Eastern Europe from Antitrust


Messrs. Boner and Langenfeld of the Federal Trade Commission and Messrs. Ordover and Pittman of the Justice Department have criticized my suggestion that East European countries might have better things to do than drafting and enforcing antitrust laws for their fledgling economies (Regulation, Winter 1992). I argued that the antitrust laws East European countries adopt may do more harm than good. Since those four gentlemen have been instrumental in advising Eastern Europe on the need for antitrust laws, they have an interest in attacking my position.

I argued that free trade is essential to those emerging economies and that free trade reduces the need for antitrust. On that subject, Messrs. Boner and Langenfeld put themselves in the awkward position of economists arguing against free trade. They point out that development success stories--Hong Kong, Singapore, and Taiwan--do not practice pure free trade and thus that "the best place for liberal trade policies may well be the developed nations rather than developing ones." That is dangerous advice. Let us recognize that those three countries are free traders compared with other developing countries. Small, less-developed countries stagnate without relatively open borders. Large, developed countries can more readily afford the ill-effects of trade restrictions.

All four of my critics argue that antitrust is needed in case free trade does not arrive or at least until it does. They also say that one of the primary roles of the antitrust authorities will be to act as agents of free trade. My favorite observation on this relationship between the antitrust and the trade authorities comes from Jan Tumlir's Protectionism: Trade Policy in Democratic Societies: "The antitrust implications of import quotas, for example, bring into focus a curious symbiosis of two large bureaucratic establishments in contemporary democratic governments. One, the antitrust establishment, is trying to enforce competition at home; the other, the trade policy establishment, is trying to stop it at the border. They are busily making work for each other, taking in each other's washing."

As I stated before, free trade is essential to those countries; without relatively free trade it will matter little what else they do. Perhaps the countries of Eastern Europe can adopt some genuine guarantee of free trade, such as constitutional protection. If the antitrust authorities were to spend their time on that endeavor, so much the better. But let us recognize that lobbying for free trade is unlikely to be either the mandate or the focus of antitrust authorities. After all, free trade would reduce the demand for their services.

Of course, antitrust laws can encourage competition and prevent collusive efforts. Messrs. Ordover and Pittman ask, "How much more of a tendency to collude will exist in economies where competition, far from being encouraged for a hundred years, has been illegal?" I do not know. After all, profits have been illegal too, as well as markets, for that matter. Voluntary exchange was a capital offense in some of those countries. It is frightening to imagine what aspects of the free market antitrust officials might find excessive. In any case, East European countries will have ample opportunity to rein in the excesses of rampant capitalism, if they should be so fortunate as to find themselves in that situation.

I spoke of ease of entry in small, local markets as mitigating antitrust concerns. Messrs. Ordover and Pittman note that markets are not easy to enter where there is a lack of "functioning markets for capital, labor, and land, and the existence and enforcement of commercial and contract laws." That is true. It is also precisely why these governments should focus their efforts on regenerating the prerequisites of markets, rather than prosecuting those who overcome the entry costs.

Messrs. Ordover and Pittman base a good deal of their argument on the following thesis: "In fact, there is every reason to believe that both freedom of international trade and ease of market entry are to a great degree endogenous with other political and economic conditions in a country, and that effective antitrust policy can assist in the introduction and preservation of these desirable conditions."

The first belief is true, but I know of no empirical support for the second. Casual observation suggests the opposite. Countries that have developed most successfully have eschewed statist tendencies in general and antitrust laws in particular. Again, Hong Kong, Taiwan, and Singapore come to mind, as do the historical experiences of most developed countries. Japan's antitrust policy is much more limited than ours, and it allows for virtually no private enforcement.

Messrs. Boner and Langenfeld make a more explicit mistake. They suggest that the beneficial effects of antitrust laws are demonstrated by the fact that the true economic powerhouses, such as the United States and Germany, have such laws. That argument is dangerously misleading. Eastern Europe cannot afford the regulatory strictures of the developed countries. To emulate the United States with regard to regulatory policies in general or antitrust laws in particular would be a huge error.

All of those gentlemen point to the progress the United States has made in the rational application of its antitrust laws. They ought to show some reservation after the experience of the past four years. The FTC pursues vertical cases and continues to harass the quintessential American entrepreneur, Bill Gates, and his Microsoft Corporation, apparently for being excessively efficient. I trust that those gentlemen have also read the economic nonsense in the Supreme Court's recent Kodak decision. It is amazing how fast progress can be reversed. What role did stricter enforcement of antitrust policy play in the stifling of the American economy over the past four years? And in which direction is President Clinton's administration likely to go?

(Both letters reveal a perplexing sympathy for the concept of class conflict arising out of capitalism. Messrs. Ordover and Pittman imply that without antitrust policy the "fruits of the newly free economies ;obwill accrue;cb to a small class of producers." Messrs. Boner and Langenfeld state that "antitrust ensures that commercial opportunities, and the fruits thereof, are available to the many rather than to a select few." Do those gentlemen really hold such a constricted, divisive view of capitalism? As further evidence of how interested parties can lose their perspective, writing an editorial and allowing it to be reprinted in Regulation, according to Messrs. Ordover and Pittman, constitutes my being "obsessed" by the subject.)

Both letters conclude with the argument that we should be advising Eastern Europe because they asked us to and because they are going to do something anyway. So be it. Given that those countries are going to have antitrust policies, what form should they take? Do those gentlemen advocate investigations of predatory pricing, price discrimination, vertical foreclosure, monopolization in the absence of mergers or collusion, and the rest of the excess baggage in our antitrust laws? The problem is that the U.S. model cannot be appropriate for newly emerging economies--much of it is not appropriate for the United States--but our government representatives probably will not say that. As I have said before, the antitrust laws in theory can be beneficial for an economy. But the theory itself is controversial and far removed from the practice. The U.S. experience is rich in examples of anticompetitive antitrust enforcement. (Mr. Ordover has in the past been sensitive to that issue. See "Use of Antitrust to Subvert Competition," Journal of Law and Economics, May 1985, by William Baumol and Janusz Ordover.) It is unfortunate if our antitrust envoys feel obliged to defend the U.S. model as a guide for Eastern Europe.

That the antitrust laws can in theory be beneficial is irrelevant. The relevant issue is whether the antitrust laws as they will actually be applied will be beneficial or harmful. If any antitrust policy is appropriate for a newly emerging economy, it would be extremely minimalist. It would recognize the huge costs and limitations of gathering information, the potential for abuse by private parties and by the government, and the inappropriateness of the developed countries as a model. Will antitrust stifle the newly emerging economies? It might, and that would be a tragedy.

Paul Godek
Senior Economist
Economists Incorporated
Washington, D.C.

Regulation Vol. 15 No. 4, 1992 by the Cato Institute.

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