Category Archives: Law-related

2012 Year in Review

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I haven’t been updating this blog much recently. But in the tradition of year-end roundups that I’m seeing on Twitter, I’ve decided to collect a few personal favorites from the things I’ve written over the last year.

This last piece was a personal favorite, and I hope to build on these ideas in the coming year. I hope to get a few long form things written this next year too and to finish another law review piece, this time on federalism.

Happy holidays. Thanks to everyone who has read and responded.

Freedom, Revisited [Part 1]

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[ I started this intending to write a short essay on the need for liberals and the left to develop new theories of liberty. My basic view is that both for legal advocacy and to “reclaim the politics of freedom” more generally, progressives need a fuller theoretical response to the limitations of the right’s vision of freedom as a system of negative rights and economic liberty. This is the first of several posts, in which I hope to discuss theories of negative liberty, positive liberty, and civic republicanism as potential ways to revitalize common understandings of freedom that embrace the United States' tradition of democratic governance and the need for broadly inclusive economic structures. ]

I want to start by agreeing with Corey Robin’s conclusion in Reclaiming the Politics of Freedom. Freedom needs to be contested and understood at the level of first principles if an alternative is to emerge to counter the anti-statist, pro-private power vision that dominates American discourse and helped dismantle public services and the regulatory structures that limit corporate power.

The need to reconceptualize liberty is particularly urgent given that the conservative members of the US Supreme Court have imported a negative liberty theory of freedom into their interpretation of the Constitution and the First Amendment specifically. This impoverished notion of liberty has become a barrier to a variety of democratically enacted regulations and, in the 2010 Citizens United case, served as the basis for eliminating reasonable campaign finance laws. The constitutionality of the Affordable Care Act’s insurance mandate, similarly, will turn on the Court’s willingness to read this theory of negative liberty into the text of the Commerce Clause.

The theory of freedom that informs the American right’s “small government,” “get the government out of x” rhetoric is, as Charles Taylor and others have noted, a mostly negative theory of liberty. The idea being that freedom means the absence of coercion or interference, or as Ayn Rand said, “to be free, a man must be free of his brothers.” It’s important to point out that historically negative liberty has inspired leftists and liberals as intensely as it currently moves the American right. The theory of negative liberty was first described (albeit unpraisingly) by the liberal theorist and socialist Thomas Hill Green, and in the Twentieth Century, the idea moved liberals like Isaiah Berlin. In his essay Two Concepts of Liberty, Berlin described negative liberty as “the area within which a man can act unobstructed by others.”

The recent revival of interest in Ayn Rand’s writings and libertarianism more generally speaks to the level to which this notion has informed the way millions of Americans continue to understand themselves politically. I think it would be a mistake not to take such commitments seriously. Rather than entirely abandon a theory that has proven enormously inspiring and deeply rooted (at least among Americans), I think it’s worth asking what other liberals have found inspiring here and looking at where conservatives have sold their own theory short.

There is one extremely important difference between the negative liberty described by Berlin and the liberty celebrated by libertarians and the contemporary American right. Berlin’s definition of negative freedom means the absence of coercion from all others, whereas the right’s definition means only the absence of coercion from the state. As Corey Robin noted, the way conservatives managed to recast negative freedom in this way was “to locate this notion of freedom in the market.” By focusing primarily on the tension between private industry and government regulation, conservatives have advanced a view of freedom that largely ignores both the mass incarceration state and the various ways private industry can impinge on individuals’ rights.

As Bernard Harcourt’s scholarship has helped highlight, there is something enormously paradoxical about a view of negative liberty that locates freedom entirely in the market but turns a blind eye to police enforcement and national security. The United States has been gradually sacrificing civil liberties to the exigencies of law enforcement and counter-terrorism over the past decade. We have become the most incarcerating nation in world history, with more than six million people imprisoned and many of them for nonviolent offenses. As Harourt recently wrote, “The rise of neoliberal thought since the 1970s has left us with a frightening union, one in which there is both free-market ideology (which militates against universal healthcare) and mass incarceration (with the attendant excesses like generalized strip-searches).” The unwillingness of American courts to see liberty outside the economic sphere is, to quote Harcourt again, “pushing the country, inch-by-inch, in the direction of a police state.”

Beyond the paradoxes of the mass incarceration state, the problem of private power exposes another important oversight in the right’s operative theory. If negative liberty is genuinely about protecting spaces of individual autonomy, it has to mean being free to act without coercion from from private parties as well as from government and law enforcement. That means that businesses that can turn phone records over to the police, websites that sell an individual’s search history, prospective employers who ask for facebook passwords, and employers who meddle in their employees private lives are just as capable of interfering with people’s negative liberties as state agents. Private individuals unconstrained by the state provided the foundations of both slavery and debt servitude, indisputably two of the most unfree systems in human history. The failure of the right to address the excesses of corporate power and the various risks created in the private sector is precisely what is least liberating about that view — it is a vision of freedom that is willing to accept coercion and domination as long as they are committed by private actors.

In contrast to that view, a more thorough acceptance of negative liberty would be far more radical (and complicated) than simply shrinking the state at every opportunity. It would also mean liberating the spheres where individuals may act and opening up spaces for people to act democratically or collectively to shape the conditions of their own lives. To protect their own liberty, people would have to be able to resist not just coercion from the state but also to resist coercion from extractive economic structures and private actors who do not share their interests. Indeed, one might even expect the champions of negative liberty in a democracy would be far more concerned with coercion from private powers than the government, because government, arguably, is already accountable to the people through elections.

Negative theories of liberty could once again carry some emancipatory potential if expanded to embrace individuals’ authority to free of both unwanted private encroachments as well as intrusions by law enforcement and other state actors. That is not to say that a more expansive concept of negative liberty would not be without shortcomings of its own. Some of these shortcomings should become clearer when contrasted to the positive and civil republican theories of liberty [I'll save that for another post]. Nonetheless, negative liberty has been an inspiring and enduring vision of freedom that has moved millions of people across history and continues to speak to Americans’ self-understanding. For the current moment, a vision of negative liberty that takes private power into consideration still offers a powerful critique to those who think keeping the government out of the market is a sufficient guarantee of individual freedom.

Dog Shows & the Illusion of Order

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I spent two nights last week watching the Westminster Dog Show with several other contributors to this blog. There were a few conversations about how immoral and sometimes cruel dog-breeding can be and that here are so many other ways in which this spectacle can be found offensive: You have to be a certain kind of rich to even partake. And it’s a kind of objectification that most of its viewers would find objectionable in any other context. The most analogous “sport” or contest I can think of has to be the child beauty pageant. But I won’t go into that or into the ethics of the breeding.

What I really want to write about is how this contest purports to sort and rank among the thousands of dogs that are escorted around that stage every year.

How does the contest presume to compare across dog breeds? How do you put a purebred, one hundred and twenty pound Great Dane next to a Pekingese or a chow chow and then determine that one is more deserving of the coveted “Best in Show” title than all the rest? The answer, obviously, is that you create some kind of frame and superimpose it onto the animals. You devise a sorting system to ignore the messy and incomparable details of reality, and if you designed it right, the system provides outcomes that humans care about (such as telling you which dog is “best”). Humans do this kind of nonsense all the time, and fortunately we have things like dog shows to remind us just how ridiculous it is.

According to the Judging and Standards section of the Westminster Dog Show’s webpage, the specimens of different breeds are evaluated against one another according to the following system:

Each breed’s parent club creates a STANDARD, a written description of the ideal specimen of that breed. Generally relating form to function, i.e., the original function that the dog was bred to perform, most standards describe general appearance, movement, temperament, and specific physical traits such as height and weight, coat, colors, eye color and shape, ear shape and placement, feet, tail, and more. Some standards can be very specific, some can be rather general and leave much room for individual interpretation by judges. This results in the sport’s subjective basis: one judge, applying his or her interpretation of the standard, giving his or her opinion of the best dog on that particular day. Standards are written, maintained and owned by the parent clubs of each breed.

To get around the fact that these dogs are in a sense incommensurate, a system has to be designed that can, nonetheless, compare them. And the result, in short, is something of a contest of Platonic ideals. The closer a French Bulldog, say, comes to what people have collectively identified as its essence, the better it will fare against other Frenchies, and the better it will “perform” against other dogs who don’t so perfectly embody their breed’s ideal characteristics. This is a contest to best embody the quintessence of one’s kind, a step removed from asking which dog is most like its ideal self.

Which is absurd, except that we do it all the time. People compare athletes across sports, musicians across genres, and writers across eons. We compare the utility or “costs and benefits” of vastly different government policies, and we feel comfortable assigning dollar values to just about anything.

Westminster Kennel Club logo

Westminster Kennel Club logo

I’ve been reading a terrific book by Pierre Schlag, The Enchantment of Reason, that I want to tie in here. Schlag basically argues that reason is a system of belief that requires faith, and that while it can consistently answer some questions, often it’s just the language in which people express their interests and preferences. In other words, the institutions that rely on “reason” (e.g. law, economics, etc.) always depend on the same circularity and hypocrisies as the dog show. The outcomes are just the delayed realization of their axioms. And like the dog show rules, these axioms we live by are a decision that can never be fully grounded in reason.

One of the most interesting chapters in Schlag’s book points out that “reason” breaks down most obviously when it’s asked to compare things that are incommensurable. To use his example, how can you reasonably conclude whether eating apple pie or reading Wittgenstein is a better use of your time? Which provides more utility? Or more happiness? Or satisfies a more important desire? Which time horizon is more appropriate — short-term or long-term interest? And whose interests, yours or society’s? The answer to which activity is “better” is simply a function of which system you use to ask the question. All it does is hide the ball and give the appearance of reason to an arbitrary choice that does all the work.

It’s one thing if the system is one for evaluating dogs to gratify the economic desires of dog breeders and the egotistical yearnings of wealthy dog owners,  but what if this same problem really plagues the systems that underlie most of our public institutions? Why do we pretend that law is an orderly, rule-determined game, when the referees and agenda-setters can often pick whatever criteria they want? Or that we can put prices on lives or on art or on our health? The glib answer is that it’s necessary to make society work, but that only goes so far.

As with the dog show, it certainly appears more legitimate to pick a set of rules than for someone to arbitrarily pick winners. But picking rules itself can be thinly veiled exercise of arbitrary power. (Like Bush v. Gore which essentially picked rules after the fact as a pretense to pick the President in the 2000 election). It’s not an uncommon observation to say that if the dog show mattered at all, these rules would be intolerably vague. They do nothing to constrain the whims of the decision-makers. There’s no basis for thinking that a dog that does well one year would do as well under a different set of judges, etc.

To risk comparing the incomparable, these are precisely the same problems that plague the operating rules in the economics profession, courtrooms, insurance companies, and countless other public and private institutions where allegedly disinterested judges or observers apply allegedly objective criteria. These systems are just slightly better at hiding their arbitrariness (at least most of the time). They are more opaque and cryptic about how fundamentally unreasonable their assumptions are, and they enjoy positions of power that provide a patina of authoritativeness. So in the end maybe the dog show isn’t so bad after all. It’s not any less reasonable than these other institutions, and the stakes, at least, are not quite as high.

Reexamining Corporate Governance after Citizens United

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This entry was originally posted at Policy Shop.

Earlier today, Demos, along with a broad coalition of organizations, asset management groups, and elected officials sent a letter to the Senate Banking Committee calling for a public hearing to consider corporate governance solutions to Citizens United. While large numbers of democracy advocates continue working to overturn Citizens United and restore meaningful campaign finance restrictions, there are a number of important battles happening on the corporate law front as well that could significantly increase transparency and restore accountability over corporate political spending.

Corporate governance has been underutilized as an arena to empower the broader public against the unrestricted flow of corporate money in our democracy. Senator Menendez, for instance, recently reintroduced the Shareholder Protection Act, which would require full disclosure of any political spending by publicly-owned corporations and further require shareholder authorization of corporate political spending. Similar shareholder protection laws have been proposed in California, Massachusetts, and New York. And a petition was filed with the SEC in 2011 (File No. 4-637) requesting a rule to require public companies to disclose their political spending to shareholders. As today’s letter to the Senate Banking Committee observed:

“[c]orporate disclosure and the raised voices of shareholders can help provide a framework to rein in some of the damage to our democracy in this troubling new political landscape.”

Beyond the well-documented distortive and corrupting effects that corporate spending has in the electoral and legislative arenas, there are also several compelling economic reasons that corporate political spending should be made more open and responsive to investors.

First, the influence and access of corporate lobbyists means that corporations or affiliated groups often draft the laws and regulations that most affect them. Rent-seeking of this form undermines competitiveness and makes the market less accessible to new entrants. As the American Independent Business Alliance (AMIBA)’s amicus brief in Citizens United noted, “large corporations have converted their economic power into political favors that extract subsidies from taxpayers, stifle enforcement of anti-trust laws…and other rules that disadvantage small business.”

Second, corporate political activity also has the potential to alienate investors and consumers in ways that are bad for business. In 2011, for example, Target donated $150,000 to an anti-gay-rights Minnesota gubernatorial candidate. Their political spending sparked a massive public backlash that included calls for boycotts and ended with a shareholder resolution asking the company to rethink its policies on political donations. While this incident led to Target’s eventual adoption of policies requiring greater transparency, the potential for consumer and shareholder backlash makes political spending enormously risky, particularly in our increasingly polarized political environment.

Finally, a system where management is spending money that belongs to shareholders creates potential conflicts of interest that will affect people’s willingness to invest. Some investors will choose to avoid businesses whose political stances they find objectionable. But even more systemically, the interests of shareholders and managers do not always perfectly align, and shareholders have reasonable concerns when their money is going to support political activity. As the coalition noted in its letter:

In corporate governance, there are no rules or procedures established in the United States to ensure that shareholders – those who actually own the wealth of corporations – are informed of, or have the right to approve, decisions on spending their money on politics.

Beyond the agency problems, the lack of transparency and shareholder feedback has the potential to chill investment.

Corporate governance solutions to Citizens United need a more prominent place in our politics. Holding management accountable is important both for the strength of the larger democracy and to limit the disabling impact that self-dealing and rent-seeking are having on our economy.

Reimagining the Corporate Form: Toward a More Democratic System of Corporate Governance

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This entry was also posted at the HLPR Blog: Notice & Comment.

Occupy Wall Street has, in the words of John Paul Rollert, “come to embody a common sense that something is wrong with American capitalism.” The problem Rollert points to is not with capitalism itself, but with a particular American version that has ceased to work for broad cross-sections of its population. Given America’s Depression-level income inequality and near-record levels of private indebtedness, it is extremely tempting to focus on bad outcomes as the problem. But the real issue is that many of the economic and political structures that we take for granted repeatedly produce unequal, undesirable outcomes. If reformers seek to make American capitalism more inclusive, the focus needs to be on fixing these structures and getting the rules right.

It has been a steady mantra of Occupy Wall Street not to make demands of existing political leaders and institutions. But as Matt Langer explained, “the reasoning behind not making demands most certainly does not preclude making demands of our collective imagination.” Whether people prefer to work within existing structures or not, the next essential step is to understand how broken institutions and flawed incentives created this mess and to start imagining what structures can be built in their place. Where better to start than with corporations?

Current Governance Structures and Their Shortcomings

Consider the role that our system of corporate governance has played in producing some of our current imbalances. Excessive risk-taking, stagnating wages, and the spike in executive compensation can all be linked back to a system of corporate governance that privileges management’s interests at the expense of other actors.

It’s by no means an original observation to say that boards are under the sway of management. Indeed, the US is something of a global outlier in allowing a business’ president/CEO to appoint its board of directors, and in some cases the president/CEO actually serves dually as the chair of the board. Not only is the composition of the board not reflective of its owners, employees, or investors, boards are only subjected to a relatively relaxed legal standard. As a result, directors often find that their interests (i.e. staying on the board) are best served by taking a passive role and letting management make most of the choices. In light of this structural failure to limit conflicts-of-interest, it should be unsurprising then that the interests of employees, shareholders, and other stakeholders are, at best, secondary to those of executives. As Harvard Law Professor Mark Roe succinctly phrased it, “the US is managerialist, not capitalist.”

Current governance arrangements have had an enormous impact on the larger economy and on the distributive features of American capitalism. To begin with, the existing corporate governance system (in conjunction with other regulatory failings) has proven inadequate to keep excessive managerial risk-taking under control. Despite the Enron disaster, the fall of Bear Sterns and Lehman Brothers, and the near-collapse of many of America’s overleveraged financial firms in 2008, we appear to have done nothing to address this issue. These risk-induced failures were repeated last week in the near-overnight fall of MF Global. As though nothing was learned, the star-studded MF Global board sat by and, in Steven Davidoff’s words, “gave executives []free rein to take tremendously risky bets that brought the house down.”

In 2008, Martin Lipton and his colleagues at Wachtell prepared an excellent memoranda on boards’ responsibility over risk-management which was posted at the HLS Forum on Corporate Governance. In discussing the legal framework for risk-management, they advised corporate boards to go beyond the minimal requirements created by the leading state law case, In re Caremark. Nonetheless, this is how they summarized the state of the law: “These cases demonstrate that it is difficult to show a breach of fiduciary duty for failure to exercise oversight; these cases do not require the board to undertake extraordinary efforts to uncover non-compliance within the company.” Federal laws like the Sarbanes Oxley Act do require auditing and increased oversight from the board, but the overall implications remain: the decision-making center of gravity remains largely with executives, whose personal incentives to post short-term profits can fuel excessive risk-taking, and current law gives boards few incentives to keep that risk-taking in check.

The problem is not just that boards are passive and deferential, but that those who want risk limited cannot make themselves heard. These high-risk strategies often run counter to the interests of other stakeholders, including bondholders and shareholders, whose interests are not reflected in the board’s composition and thus are not sufficiently represented. The idea that the broader public or the employees whose jobs are on the line would have a say is, under current thinking, not even a remote possibility.

The resultant proximity between Boards and management has a lot to do with runaway executive pay. Board members usually have a stake in their position, and because they are appointed by management, it’s often not in a director’s interest to start ruffling the CEO’s feathers. As Lucian Bebchuk and Jesse Fried argue in their excellent book Pay Without Performance, “structural flaws in corporate governance have produced widespread distortions in executive pay.” Their argument, briefly, is that boards have too many incentives to go along with management and are therefore unable to contract with executives at arm’s length. This broken feedback loop is at the root of the ridiculous pay packages, bonuses, and golden parachutes we’ve seen over the past decade.

The wage stagnation that’s affected the remainder of the workforce shares a common origin: all stakeholders other than executives are systematically excluded from decisions that determine compensation. The fact that corporate profits remain at near record highs suggests that the problem is indeed structural and not attributable simply to changes in the labor market. The absence of a voice for employees either in management or on the board of directors, in conjunction with weakening collective bargaining rights, means that the record profits businesses have been posting get funneled mostly to executives and do not translate into gains for the average American worker. The rules that determine who gets to cut the pie, in other words, have a lot to do with the fact that CEOs went from making 24 times what the average worker did in 1965 to making 185 times as much in 2009.

http://www.stanford.edu/group/scspi/cgi-bin/fact2.php

Ratio of CEO compensation to of average worker’s compensation.
Source: Economic Policy Institute, 2011, via SCSPI.

More Inclusive Alternatives to Minority-Rule Governance

Corporations do not have to be organized in this way in order for the private sector to prosper or for the economy to grow. Recent events should make it clear that keeping down transaction costs is not the only concern here. A number of compelling alternatives exist. I start with the more moderate reform proposals and conclude by proposing that we look to the German corporate model or other structures that afford investors and employees a role in a company’s management.

Calls are frequently made to enhance the role of shareholders in decisions involving executive compensation and risk-management that happen at shareholders’ expense. Bebchuk and Fried have argued that it’s possible to improve transparency and accountability by giving shareholders a greater say on pay, by strengthening shareholders’ ability to unseat and replace directors, or by increasing the number of independent directors (i.e. directors not employed by or doing business with the company). Another proposal they describe would allow shareholders the ability to amend the corporation’s charter. Any long-term solution to these agency problems entails providing investors and owners with a permanent vote or some structural role in decisions that affect them.

An increased role for employees is also necessary to prevent some of imbalances that have arisen between management and the average member of the workforce. Randall Thomas and Kendell Martin, for example, have argued that labor unions and related entities should be allowed to make shareholder proposals. It would be possible to go even further by affording both investors and labor a role on the board and a larger say in major decisions that affect a company’s future. This is precisely what the German corporate governance system does. The German Codetermination (Mitbestimmung) system provides employees a role in the company’s management and has proven remarkably successful across a number of economic sectors. And although German income inequality has grown in recent years, “income inequality in Germany is a long way from reaching US proportions.”

I point these out not to advocate any particular corporate form, but to observe that there are alternatives that can address failings of the existing system. It’s important also to observe that things were not always this way. The internet has fostered an explosion in new forms of social organization, and cooperative membership structures are another potential source of ideas. There’s no reason that running a successful business means accepting a one-size-fits-all corporate model, particularly when that model marginalizes a company’s most committed participants—its investors and its employees.

Capitalism isn’t a single thing or a system of natural laws. It is a system whose rules are shaped by political—and ideally democratic—choices. Nowhere is this more obvious than in the reified legal fiction of the modern corporation. The absence of democracy within corporations is a central reason that the US has seen such a proliferation of high-risk investment strategies, and an unprecedented divergence in incomes. The concerns of both investors and employees have been systematically subordinated to the interests of America’s managerial class. The failure to create an inclusive economy is fundamentally a failure to build inclusive institutions. And the first step to fixing this problem is remembering that the rules that govern institutional decisions can be different.

Disclosure is not the cure-all liberals want it to be

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This entry was originally written for HLPR Online: Notice & Comment.

Disclosure rules have become a kind of last resort for policy makers looking to reduce institutional corruption. There have been proposed disclosure rules for economists, particularly those who had strong ties to the financial sector. Others have called for general transparency for any academics who receive private funding for their research or who testify before Congress. The Affordable Healthcare Act imposed new disclosure requirements for physicians, and Dodd-Frank requires increased transparency into executive compensation. And until recently, disclosure had reasonably broadbipartisan support as a partial fix to the torrent of campaign spending that was opened up by the now infamous Citizens United decision.

The motivating idea behind all these proposals is that by revealing funding sources and other conflicts of interest, corruption will become apparent and the most egregious activities will be driven from the marketplace. Politically, these regulations probably owe much of their support to the fact that they’re generally viewed as consistent with free market principles. Recently, even that has come into question. Conservatives and industry insiders have expressed worries that disclosure rules add costs and stymie speech. There’s plenty to read aboutthat debate, but it basically boils down to the fact that Republicans benefit more by keeping disclosure rules lax.

Before Democrats go on championing disclosure laws as the solution to all forms of institutional corruption, however, they should recognize its limits. While transparency is a crucial element of anti-corruption regulations and is necessary to police many of our public and private institutions, it would be a terrible mistake to stop pursuing substantive conflict of interest regulations and accept disclosure as the solution to all forms of corruption.

As Cain, Moore, and Loewenstein phrased it, that there are times “when sunlight fails to disinfect.” Treating disclosure as an end-in-itself requires a misplaced faith in the ability of markets to answer all of society’s problems. And there is emerging empirical support that disclosure rules often fail to accomplish their purported goals. I’ve tried to separate out at least two reasons to be skeptical about disclosure’s ability to eliminate conflicts of interest:

1) Because disclosure often comes into play when there are significant information asymmetries, more information does not enable policymakers, voters, or consumers to make better decisions. If a patient goes to a doctor who says he met with a drug rep before prescribing a certain medicine, the patient is not able evaluate whether or not to take the medication. He’s not going to ask another doctor or know how to assess the risks involved. Similarly, when an economist is testifying during a financial crisis before the Senate, how is a Senator to properly discount testimony that has industry support? The element of duress makes the ineffectiveness of disclosure rules even more pronounced.

2) Disclosure in many ways legitimates conflicts of interest by telling politicians and professionals, in effect, ‘so long as you told everyone what you’ve done, whatever questionable activity you engaged in was presumably acceptable.’ It might even be making behavior worse. As research by Cain, Moore, and Loewenstein revealed, disclosure seems to give experts the impression that they have dealt with the ethical problems posed by their conflict of interests and can sometimes exacerbate the extent to which expert statements become self-serving. As Courtney Humphries at the Boston Globe noted, policymakers may be treating disclosure as a panacea and refusing to address the conflicts of interest that are the real source of corruption.

Beyond this, disclosure reinforces the patently false norm that markets self-regulate. And naively supporting disclosure legislation risks lending weight to the deregulatory ideology that has already produced so many harmful conflicts of interest at the core of our political and financial systems. There are certain arrangements, that no matter how transparent, are simply incompatible with good government or a stable financial system.

 

Forget About Your House of Cards

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This entry was originally written for the HLPR Blog: Notice and Comment.

On Friday of last week, the Department of Justice issued an indictment charging the founders of Full Tilt Poker, PokerStars, and Absolute/UB Poker, as well 8 other individuals in the online poker industry, with bank fraud, money laundering, and illegal gambling offenses. The government also announced $2 billion in civil money laundering charges and in rem forfeiture actions against the defendants and their assets and issued injunctions that would seize 5 online domain names and 76 bank accounts. The DOJ’s press release is here (pdf).

The online poker community is still reeling from the government’s move. The domains for UB.com, Poker Stars, and Absolute Poker have already been seized and now display a notice from the DOJ.  Many players found that they could not get access to money they had in their online accounts.  Less than a day after the indictment, Full Tilt and Poker Stars issued announcements that customer account balances were safe and that they would continue processing customer withdrawals. But not everyone has been able to recover their money. Online poker has become a major, if not the primary, income stream for thousands of Americans in recent years, and the indictments have a number of people worrying about where their next paycheck will come from.

The indictment filed by Preet Bharara, U.S. Attorney for New York’s Southern District, contains nine counts. Of the charges, four are alleged violations of the Unlawful Internet Gambling Enforcement Act of 2006 (or UIGEA) (31 U.S.C. §§ 5361–5367), and three are in connection with a federal prohibition on “illegal gambling business” (18 U.S.C. § 1955). The eighth count is for conspiracy to commit bank and wire fraud (18 U.S.C.§ 1343), and the ninth is for money laundering conspiracy (18 U.S.C.§ 1956).  A breakdown of which defendants were charged with which of these violations can be found here.

The theory behind the UIGEA and “illegal gambling business” charges is that poker is gambling.  The merits of these charges could hinge on whether courts determine that poker is a game of skill or chance. Freakonomics had a series of posts on the question, and Harvard’s own Charles Nesson discussed the issue a few years back with the Wall Street Journal (pdf).  At the moment, courts around the country remain split on the issue, but most people who’ve spent any time playing recognize the skill-component involved. Poker is arguably more a game of skill than much of what goes on in our financial sector, which is perhaps why Congress provided a statutory exemption to all SEC-regulated activities in the UIGEA.

The other claims are more straightforward allegations of fraud.  According to the indictment, “defendants…arranged for the money received from U.S. gamblers to be disguised as payments to hundreds of non-existent online merchants purporting to sell merchandise such as jewelry and golf balls.” The DOJ further has alleged that the online poker companies incentivized banks to cooperate in these payments by paying bribes. These disputes will probably turn on the particulars of the payment arrangements involved and the degree of transparency and honesty that existed between parties.

There is a longstanding movement for the legalization of poker that’s probably about to pick up some steam. A lot of the criticisms speculate that Congress only acted against online poker because of pressure from physical casinos (consider Reid’s proposal to move online poker into the hands of U.S. casinos during the Dec. 2010 tax debate). But the arguments for legalization are most powerful when they emphasize that poker is a safe, consensual arrangement between adults. It’s hard to find principled reasons why online poker should be illegal.

But what, to me, remains the most remarkable about these prosecutions is this:

Why is the DOJ using bank fraud and money laundering statutes to go after poker websites but not any of the most significant participants in a multi-trillion dollar financial crisis? Poker is arguably more a game of skill than stock and derivatives trading, and any negative social utility is nothing compared to the financial crisis or the risks associated with speculation in housing or commodities markets. There is one explanation that relies on the political influence of domestic casinos who want less competition, but part of it might be that online poker offers prosecutors easy targets and low-hanging fruit.

The New York Times and Matt Yglesias have questioned the DOJ’s inaction regarding the financial crisis, and they give the most weight to the Obama Administration’s fears that financial prosecutions could derail the economic recovery. That explanation proves too much and, as Bill Black observed, it ignores the fact that not prosecuting derails public confidence in our government and erodes the rule of law. Maybe going after online poker companies helps preserve the appearance that the government has an interest in prosecuting financial crimes.

 

Action-Omission

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I had to miss a panel discussion yesterday that I really wanted to see called Moral Biology? What can biology and the mind sciences teach us about law and morality?.  I saw one of the panelists, Joshua Greene, present some of his research at a SALMS event a few weeks ago.

This isn’t the exact topic of the talk I saw, but here’s a short video of Joshua Greene presenting some research on the psychological origins of the action-omission distinction.

His finding, basically, is that we are psychologically predisposed to find stronger causal connections between the consequences of an active behavior than between the consequences of a failure to act.  That is, we feel more responsible if we push someone than if we stand by and let them fall when we could have easily prevented it.  He provided neurological data to suggest that the parts of the brain used in determining causation show greater activity when evaluating the active behavior than when evaluating the failure to act.

What’s fascinating is that the action/omission distinction is replicated all over tort and criminal law, and it often defines the line between what’s punishable and what’s not.  We tend to punish people who intentionally harm other people, but if you saw someone drowning, for example, you would have no legal obligation to save them, even if it could be done at no risk to you.  (There are a few crimes of omission — such as the failure to take care of your child, or the failure of doctors to provide medical care, which Greene discusses in the video).

If we were only concerned with outcomes, it’s not clear why this distinction should be so pervasive in the law.  Although there are also some persuasive evidentiary reasons for the action/omission distinction (e.g. how can you prove you could have safely saved someone who drowned after the fact?), I think Greene’s findings explain a lot.  One very plausible reason this distinction is so deeply entrenched in law is that psychologically, we just don’t feel like failing to help is causally connected to harm in the same way an active push is.  It has more to do with how we’re hard-wired than it does with any rational theory of causation.

Even accepting this explanation for the action/omission distinction in the law, it still remains unclear whether these findings say anything about what the law should be.  On one hand, the action/omission distinction may be an inescapable component of how humans parse and understand their social world.  If that’s the case, the law might only be perceived as legitimate when it fits within people’s reasonable understanding of human behavior.  On the other hand, we might see this impulse to divide actions into acts and omissions as completely unprincipled and irrational, an outgrown vestige of our biological inheritance.  In that case, we could strive to be more utilitarian or otherwise consequentialist in designing institutions than we might naturally be inclined toward.

It’s not clear to me that understanding the psychological mechanism behind the legal distinction really pushes one way or the other.  For one thing, there could easily be a lot of cultural variation even with that as the psychological baseline.  It’s easy to imagine some groups wanting to take a stricter stance on crimes of omission, even if doing so is more in conflict with people’s psychological impulses.  Simply observing that this legal distinction ultimately originates from the way our brain attributes causation doesn’t really answer how malleable this distinction might be or how it would respond to different incentives.

The costs of being wrong are not evenly distributed throughout the population

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Judge Richard Posner spoke at a Federalist Society event on campus back in the fall of 2009 about why it’s a bad idea to react too quickly to regulate the financial sector.  The HL Record coverage of the event is here.  Here is a (slightly long-winded) disagreement I wrote back in December.

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During the introduction, the Fed. Soc. President called Judge Posner the only intellectual whose name comes up in every law school class, and I have to agree this has held true for me as well.  However, since the economic crisis in 2008, it’s hard to deny how intensely political his positions are and just how much law this man has made up.

Richard Posner

Posner was arguing against the Treasury Department’s proposed regulations, but the talk turned into a critique of financial regulation in general.  My outline doesn’t precisely match the outline he was following, but I did number several of his major arguments against financial regulation, and my disagreements follow.

1. Regulation will decrease confidence and predictability in the markets.

Posner made the Keynesian point that during an economic crisis, a lot of the problems are purely psychological.  Companies hoard money out a fear that if they invest it, the investments will just decline in value because consumers aren’t spending.  People become more afraid to invest and save more, and that eventually leads to further layoffs and slowdowns.  If nobody starts spending money, this problem spirals.  You need to create confidence to get money flowing again.  That’s the standard Keynesian argument (which Bush famously grasped) — you need people to spend.

Posner’s next step from there is to say new regulations add uncertainty to the market and discourage investment and spending — right now we want money flowing, and any regulation would only restrict that flow.  This is an empirical question which Posner gave no evidence to support.  Saying regulation creates uncertainty is just begging the question.

His position is only true if we choose regulations that create uncertainty or instability.  You could just as easily claim the opposite — we will choose regulations that make the markets more predictable (by increasing transparency, making sure that liabilities are on the books and not in SPVs, setting capital requirements, etc.).  Not regulating leaves also the looming specter of regulation in the air.  During the Great Depression, the government saw regulation as the precise way to recreate consumer and investor confidence, which is what led to the 1933 Glass-Steagall Banking Act and the creation of the FDIC.

Posner acknowledges that financial organizations are sitting on nearly a trillion dollars beyond their capital requirements, yet they are not yet confident enough to reinvest.  Consumers are saving more because they don’t feel secure in their employment.  The claim that regulation would diminish confidence in the market is an unfounded, primarily political statement.  Regulation has provided a confidence boost in the past, and it’s not clear that it couldn’t do it again.

2. We don’t have a good account of the crisis yet, so any proposed regulations would be premature.

I agree that we need to come up with a clearer version of what went wrong before we start tinkering too much with the market.  But rather than concluding we should do nothing, this point could also justify a modest approach to regulation.  For instance, it’s widely agreed that teaser-rate mortgages are problematic, that credit rating agencies face impermissible conflicts of interests, that certain leverage ratios are unacceptably high, etc.  Regulation can be narrowly tailored.

Secondly, the government has already injected itself into this situation.  Further action is not premature.  The notion that we should not regulate, but that we are willing to make taxpayers responsible for an undefined, astronomical line of credit is misconceived given the current extent of government involvement.

Markets are typically characterized by the idea that companies who can’t pay their debts are driven out of the market place.  We have currently created a situation where defaulting on one’s loans is no longer grounds for bankruptcy — even if this was the correct or necessary decision, it’s pure semantics to say that government involvement of this magnitude is not ‘regulation’.

Posner is right that there is a problem with our current efforts at reaching an authoritative account of the crisis.  The Financial Crisis Inquiry Commission (FCIQ) is a 10-person commission charged with investigating the lead up to the current debacle.  Posner pointed out that it’s understaffed, politically not very important, and that it doesn’t have any economists on it (this last point at least is untrue).  But he’s right in that understanding what happened in the financial markets should be one of the highest priorities in the country right now, comparable to the responsibilities charged to the 9/11 Commission.

3. The people in charge (esp. Greenspan) are responsible for the crisis and the way it unfolded.

Disapproving of some of the people in charge is unrelated to the question of whether or not regulation is needed.  Additionally, naming a few individuals as scapegoats does nothing to create confidence that future crises of this sort will be averted.  Even if certain individuals do bear a disproportionate share of the responsibility, this points to an underlying structural problem.  One justification for regulating would be to prevent individuals from being able to exercise this kind of catastrophic influence in the future.

Posner believes the crisis was that it was primarily fueled by Greenspan’s decision to push interest rates to near zero and leave them there for years. This cheap credit powered the consumer and housing bubbles. In addition, he believes that treasury secretary and the head of the Fed. were largely responsible for the crisis because they allowed Lehman Brothers to go under.  The point being, that if the government had prevented Lehman from collapsing by extending a low or guaranteeing a sale, that other financial companies would not have tried to increase their capital reserves and credit markets would not have frozen up.

Even if this account is true, and a handful of people at the treasury were in a position to prevent the credit freeze in the fall of 2008. This should not mean that the only governmental agencies capable of offering regulations ought to be disqualified from doing anything. If anything, it should compel us toward greater transparency and toward figuring out what powers these entities should in fact be able to exercise.

4. Financial markets are international, and regulation will have to be international.

This is something I agree with entirely, and I think it’s the most persuasive point that Posner made.  If we regulate financial markets here in the US, and even if Western Europe regulates too, any other country on earth could choose to have more liberal economic regulations. And given the global nature of financial markets, nothing would stop money and financial talent from shifting to whatever country has the loosest restrictions.

His concern is that the US is only going to be hurting itself by losing financial talent by regulating preemptively, and that if we do too much, we will bind our hands in a way that will only hurt us. Financial markets are already completely international, and I agree that broad cooperation would be the most desirable solution.

However, a lot of American citizens/consumers have been hit hard by this crisis, and domestic regulation should not be off the table.  We’d be waiting forever if complete global cooperation is necessary.  It should be possible to write domestic legislation that addresses specific problems. And given the global nature of the crisis, there are good reasons to think other places will follow a U.S. lead in trying to restore lending and reduce the risk of future financial crises. A broken financial system hurts everyone.

Like I said at the outset, none of the reasons he gives for not regulating are very persuasive.

Photo credit: Siyuan Chen