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March 2014 Archives


Robert Panzenbeck
Legal Intern, Manhattan Institute Center for Legal Policy


Last week, the NLRB issued a ruling that could potentially transform the landscape of college sports. In a 24 page opinion, NLRB regional director Peter Orh recognized Northwestern football players as employees of the university with the right to form a union and collectively bargain. Ohr imposed a three-part test that considered the amount of time players spend on non-academic pursuits, the nature of control exerted by non-academic coaches over the players, and the non-academic nature of the scholarships themselves. If the decision is upheld by the NLRB in Washington, it would mean that players could choose a union to bargain with the university on their behalf. That union would likely be the College Athletes Players Association, a labor organization founded with a focus on allowing college athletes to bargain for basic scholarship and injury protections. Kain Colter, the former Northwestern quarterback who initiated the petition, is a founding member.

The media response has been mixed. During the hearings, Northwestern cited its rigorous focus on academics, and its 97 percent football player graduation rate as indicative of a commitment to student athlete education. Bloomberg economist Allison Schrager has defended the current model, noting in her recent piece "In Defense of the NCAA", that from an economic perspective, the current system is preferable to a minor league for most athletes, providing them with an education and the opportunity to earn a degree that is far more valuable than any compensation they would likely get participating in any minor league. NCAA President Mark Emmerich somewhat echoed this sentiment recently on CNBC, noting that while a change might benefit 3 or 4 percent of the players who make it to the NBA, the opportunity for an all-expenses paid degree provides a greater incentive than a paycheck to the vast majority of players.

Even those who criticize the NCAA model are quick to point out the shortcomings of this ruling. Writing at Bloomberg, Megan McArdle writes that "given the realities, it's hard not to cheer the NLRB, but it isn't clear how much allowing football players to unionize will accomplish, as long as the NCAA is still allowed to make rules against paying them. Point of Law contributor Richard Epstein, who has in the past argued that "the NCAA enforces a cartel that denies earned benefits to college athletes," criticized the decision, noting Ohr's failure to examine the absence of the application of the common law standard for "employees" in any other labor related context, and takes Ohr's opinion to task for its notable vagary on issues like who is covered, the extent of negotiations, the conflict between choosing individual schools as bargaining agents and the coherent obligations of a league, and the chaos that might ensue.

Over the last decade, the NCAA has grown s to become a multi-billion dollar cash cow, driven primarily by lucrative television contracts related to BCS Football and March Madness. As the pot has grown without accompanying reform in the realm of player compensation, many have taken notice, and suits have been filed calling into question amateurism policies. The Northwestern ruling is the first to suggest a sea change is afoot. In February, U.S. District Court Judge Claudia Wilken allowed allowed a case brought by former UCLA player Ed O'Bannon challenging the NCAA's ability to profit off the likeness of current and former players without just compensation to move forward. Last week, anti-trust attorney Jeffrey Kessler filed suit against the NCAA seeking an injunction against enforcement of limits on financial aid available to athletes, which if successful would allow players to be paid for their performances. Even if NLRB in Washington should reverse the ruling, as some have suggested is likely, one thing is clear: this is just the beginning.


Vinny Sidhu
Legal Intern, Manhattan Institute's Center for Legal Policy

In a general, political sense, people tend to characterize "populism" as a movement against corporate marauders who are perpetually searching for a way to fleece the unsuspecting average citizen. In order to curtail this supposed abuse, government should step into various facets of the corporate/individual relationship to make sure that there remains what it considers a proper balance of interests.

In a larger, economic sense though, populism is better characterized as a movement of capital from government to government-favored enterprises. The latest example comes to us from Maryland. Steve H. Hanke, professor of applied economics at Johns Hopkins University, and Stephen Walters, a fellow at JHU's Institute for Applied Economics, Global Health, and the Study of American Business, have written an op-ed examining the manner in which the Maryland government is misallocating capital by dispersing it amongst projects that it believes will become profitable, rather than allowing that capital to remain in the market and flow to its most productive uses. As a result, those entities or people that are closely connected to the government would naturally have more influence in determining how the money would be allocated. Hanke and Walters highlight a recent example:

A small but telling example is in Towson, a thriving suburb of Baltimore, where the proprietors of a sports-themed chain restaurant called the Greene Turtle recently built a rooftop bar so patrons could imbibe at altitude. Just good old American enterprise at work, except for the fact that, according to the Baltimore Sun, $505,000 of the $890,000 cost came out of taxpayers' hides as low-interest government loans, much of which will be forgiven if the enterprise meets modest "employees added" targets and stays open five years.
At the grand opening on Jan. 2. Maryland's First Lady, Katie O'Malley, presented a governor's citation to the bar's proprietors, who happened to be childhood friends. It's remarkable how often development dollars trickle first to cronies or political donors.

Besides the obvious ethical conundrums involved in these sorts of deals, the economic impact is ultimately devastating. As this money flows to government-favored projects, the importance of economic viability studies and projections concomitantly lessens. Instead, the judgment of the executive and legislative branches replaces any institutionalized process. The ad hoc nature of this routine ultimately leads to ad hoc results:

In 2006, Martin O'Malley --then Baltimore's mayor, now the state's governor and a presidential aspirant--decided that the Baltimore Convention Center needed an adjoining hotel. Private investors disagreed, so City Hall "invested" $300 million to enter the hospitality industry. Since opening its doors in August 2008, the Hilton Baltimore--city-owned but managed by the global hotelier--has recorded more than $50 million in operating losses.


Baltimore's relentless and much-applauded campaign of subsidized development along its waterfront provides another example. Tax breaks of more than $200 million for a $1 billion project on a former industrial site called Harbor Point--justified with the usual claims that this will create thousands of jobs--have provoked demonstrations by citizens who now realize that these promises are empty. Since 2001, the city has bled 49,000 jobs.

As the failure of these projects begins to increase in frequency, the government will be forced to either cut spending, raise taxes, or increase borrowing to make up for the revenue shortfall. As Hanke and Walters note, Maryland has opted for the second one, raising taxes on personal and corporate income, while adding a slew of excise taxes to the mix. Even still, Maryland faces a structural deficit of $166 million over the next two years, while dealing with the exodus of 66,000 residents and $5.5 billion in taxable income from 2000-10. Consequently, the government will have to increase taxes again to make up for the shrinking of the tax base. This vicious cycle of tax-and-spend will continue until Maryland realizes that economic viability must be the primary criterion utilized when making investments, and that the market is in the best position to make consistent, wise investments.


Our latest column from Professor Richard Epstein:

The Improbable Fate of the Durbin Amendment in the Circuit Court of Appeals for the District of Columbia
A Learned Court Makes Intellectual Hash of an Ill-Conceived Statute

The 2010 enactment of the Durbin Amendment as part of the Dodd-Frank Act set into motion an extensive round of administrative rulemaking and litigation that may well have run its course with the recent unanimous opinion of the Circuit Court for the District of Columbia, written by Judge David Tatel for himself and Senior Judges Harry Edwards and Steven Williams in NACS (formerly National Association of Convenience Stores) v. Board of Governors of the Federal Reserve. The outcome of the case was to sustain the decision of the Federal Reserve to allow the banks that issue debit cards to recover $0.21 cent on average in debit card transitions. In so doing, the Court reversed the decision below by Judge Richard Leon, which was openly contemptuous of the arguments of the Fed that carried undue weight in the Court of Appeal. It is a long saga in which no one is covered with glory. To set this in context, it is therefore regrettably necessary to review some of Durbin's tangled history.

The Durbin Amendment The debit card was one of the great commercial innovations in American banking. Starting from a standing start in 1995, it managed by 2009 to become the dominant form of payment in the United States, eclipsing the venerable credit card both in number of transactions and in dollars transferred. One might have thought that this enviable record of success would have won plaudits across the board, for no program can enjoy such success if it does not create net gains to all the parties who contribute to the system.

In this case, those parties numbered five. In the middle of the picture lay the credit card companies, chiefly Visa and MasterCard, which orchestrate transactions between two sides of the market. On the one side lie the credit card holders who received their cards from issuing banks. The key feature of the pre-Durbin arrangement was that the debit card holder paid no monthly or swipe fee for the use of the card. Instead the cost of servicing and recruiting the debit card holders was funded by an interchange fee that was paid to the issuing banks from the retail merchants who accepted the cards. These merchants also paid a fee to the acquiring banks that serviced their accounts, and a smaller fee to the credit card companies that orchestrated the transaction from the middle.

In NACS, Judge Tatel accepted the Durbin fairy tale that this entire arrangement reeked of market failure because of the high level of interchange fee charged for the occasion. But at no point does he explain what the correct fee ought to be, for his only account of market failure is that merchants discovered that they could not do without the card, from which, however, it does not follow that they will pay anything to get it. Rather, what happened was that the credit card companies in discharge of their contractual obligations set the interchange fees at a level that allowed all parties to prosper. The use of that payment in these two-sided markets in effect put the cost of running the system on the parties for whom demand was inelastic (i.e., relatively unresponsive to price changes). The lower prices offered to cardholders thus increased the number of card users, which in turn allowed the fixed costs of running the system to be amortized over a larger customer base. And those interchange dollars funded the special benefit packages that kept debit cardholders coming into the system. In a word, the system was not broken, and the Durbin Amendment did not fix it.

More specifically, the Amendment introduced its own novel inefficiencies by its government command. The relevant text has to be set out in full in order to understand the bizarre nature of the Circuit Court's decision. It reads as follows:

Section 920 (2) Reasonable interchange transaction fees The amount of any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction shall be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.

In prescribing regulations under paragraph (3)(A), the Board shall--

(4) (B) distinguish between--

(i) the incremental cost incurred by an issuer for the role of the issuer in the authorization, clearance, or settlement of a particular electronic debit transaction, which cost shall be considered under paragraph (2); and

(ii) other costs incurred by an issuer which are not specific to a particular electronic debit transaction, which costs shall not be considered under paragraph (2).

The correct reaction to this sorry provision is that it is both clear and misguided. The initial material in subsection (2) is deeply uninformative because setting fees that are "reasonable and proportional to the cost incurred by the issuer with respect to the transaction" gives no hint of the horror to come. That capacious phrase clearly covers all costs, both variable and fixed, associated with the transaction. On this view, the provision does not put any constraint on the fees that could be charged above and beyond those found in a competitive market, which would lead to that result.

The entire sense of the provision takes on a darker meaning in the light of Section (4)(B), which gives a definition that is far more restrictive than the general statement above. It divides the world into two kinds of costs and makes it clear that only the "authorization, clearance, or settlement" costs for a particular electronic transaction should be considered under paragraph (2) while all other costs are removed.

Judicial Obscurantism in the Court of Appeals It does not take a genius to conclude that the listing of these three transaction-specific costs excludes all the overall costs needed to design, operate and maintain the system. By design, those were to be cast back on the issuing banks to recover from their own debit card customers. Try as one might, it is not possible to see any gaps in the statutory structure. The only way in which this could have been made clearer is to have inserted the word "all" before "other costs" in paragraph (ii). But it is hard to resist the conclusion that Senator Durbin, perverse though he be, knew exactly what he was doing with his own Amendment. The Senator was devoted beyond all measure to Walgreen's and other retailers and equally intransigent with respect to the banks, so it is a virtual certainty that he meant what he said--and said what he meant. The retailers had excellent lawyers to help Senator Durbin along his appointed path. Judge Tatel called the Durbin Amendment a badly drafted statute, but that charge is surely wrong. Incompetently conceived, surely, but accurately drafted, regrettably, is a much better account of Durbin's regulatory calamity.

At this point, the contrast between the learned obscurity of Judge Tatel and the blunt clarity of Judge Leon's opinion below is a sight to behold. The key argument of Judge Tatel is that this text could "easily" be regarded as ambiguous so that it is correct for the Board to allow "issuers to recover, equipment, hardware, software and labor costs since [e]ach transaction uses the equipment, hardware, software and associated labor, and no particular transaction can occur without incurring these costs." Judge Leon rightly dismissed that claim in one word: "Please."

Leon's terse view of statutory interpretation makes infinitely more sense than the tendentious reading Judge Tatel, who relied on this identical passage to incorporate the semiotics of Jacques Derrida or the post-structuralism of Michel Foucault into modern administrative law. Finding, or inventing, ambiguity where none existed, he gave the views of the Federal Reserve undeserved prominence under the regrettable Chevron doctrine that has courts defer to agencies when statutes are found ambiguous.

To conjure up that needed ambiguity, Judge Tatel launches into an extended, prolix, and tedious discussion of restrictive and nonrestrictive clauses, which, he claims, allows the Fed to infer this third class of expenses lurking in the shadows that the Fed by rule recover through debit interchange.

We are in an ethereal world. These unspecified objects might be called "fixed, variable costs". But suppose that these costs, like the Loch Ness monster, do exist. It nonetheless remains true that the impatient Judge Leon offers the only tenable reading of the Durbin Amendment: these fixed costs of running the computer network were excluded along with every other business cost needed to keep the program going, without which any particular transactions would not happen.

Economic Redemption, of Sorts As a matter of statutory interpretation, Judge Tatel's opinion is an intellectual train wreck. But functionally, it supplies a most welcome result, because of the hopelessly confiscatory nature of the Durbin Amendment, which on its face would have make made it impossible for the banks to recover their extensive invested costs in their operational system through interchange, without supplying them any alternative. To be sure, there was extensive talk of how banks should charge their own customers monthly or swipe fees. But those were never collected, after they were buried in an avalanche of abuse, starring the ubiquitous Senator Durbin who wrote the heads of Bank of America and Well-Fargo gratuitously nasty letters asking that they rescind the fees that only months before were supposed to be their salvation.

The net result was that the banks could not recover their invested capital sunk in these debit card systems. This whole statutory system borders on the farcical because it overlooks its long-term stability and success. In many places I have urged that the entire statute should be struck down as a confiscatory taking. That decision was resisted in the earlier and misguided 2011 decision of the Eighth Circuit in TCF National Bank v. Bernanke (on which I worked as a consultant to TCF through the trial stage) that suggested that the issuing banks could make up their lost revenue somehow by charging their own customers, which never happened.

As an economic matter, it is clear that the higher the allowable debit interchange fees, the less disruptive the Durbin Amendment is to the operation of the debit card interchange market, and in that sense at least the decision in NACS performs a useful public service that was no part of its intention. Indeed, I suspect--or just hope--that Judge Tatel's misguided bit of statutory interpretation will not be challenged down the road.

Remember that the panel decision was unanimous, and it may prove unlikely that either the entire District of Columbia Court of Appeal or the Supreme Court will have any appetite to untangle the tortured arguments that persuaded so distinguished a panel of the Court of Appeals. And if they did look at this statute, they should start by revisiting the constitutional issues from TCF, which were decided on an assumption that has proved false, namely, that the debit card companies can recover their lost fees from their own customers.

That seems highly unlikely at present, so at present the best achievable resolution for this issue is a large dose intellectual bed rest after all the legal twists and turns of the past four years. But who am I to say? I thought that the chances that Judge Leon's decision would be overturned were close to zero. And never in my most fevered moment could I have imagined the grotesque and improbable way in which the Court of Appeals saved the bacon of the Federal Reserve, and yes, of the issuing banks. Wonders never cease.

Bidding Bye to the Bank
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The Wall Street Journal reported yesterday that senior JPMorgan executive, Michael Cavanagh, is leaving for private equity firm Carlyle. As the article explains, people are surprised, because Mr. Cavanagh was thought to be in the running for Mr. Dimon's job. No doubt the offer from Carlyle was enticing, but the Journal reported that there was also something he was running away from at JPMorgan--the prospect of winning the CEO job only to find that it consists primarily of dancing deftly with droves of regulators. So he will leave JPMorgan for the regulatory safe haven of private equity, where he'll be able to concentrate on lending instead of regulatory fights, at least until the regulators turn the brunt of their focus on private equity. Meanwhile, the bankers who stay behind will be too busy mastering the art of compliance to have time for their customers and business plans. As our recent small bank survey shows, this is not a uniquely big bank problem. Executives at small banks are also finding out that a job that used to be about making good loans is now about regulatory compliance.

CFTC's Aimless Budgeting
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In the wake of the financial crisis, the Commodity Futures Trading Commission convinced Congress to expand its mission and its powers. It is now working on a substantial budget increase to go with its increased authority. Congress should not hand more money over to the agency until the CFTC produces a reasonable plan for how it will spend the money and an explanation for its recent spending choices.

Letting Nonbanks Be Nonbanks
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Two recent speeches by financial regulators are the latest entries in an ongoing discussion about regulating nonbank financial institutions and financial stability. Decisions made in this area will have significant consequences for the health of our financial system.


A federal district court recently ruled against John Chevedden in his bid to get a shareholder proposal included in Express Scripts' proxy materials. The company did not want to include the proposal because it contained material facts that directly contradicted statements in the company's public filings. After Express Scripts filed suit, Mr. Chevedden agreed to correct some of the errors--something he apparently had not offered in response to earlier requests from the company. The court held that the company could exclude the Chevedden proposal because, "[e]ven if Chevedden's revised proposal was timely, which it clearly is not, there are still substantial inaccuracies in the revisions to the supporting statement that render the revised proposal subject to exclusion" under the SEC's rules.

Mr. Chevedden is an experienced crafter of shareholder proposals. The Manhattan Institute's Proxy Monitor reported that just under a quarter of shareholder proposals between 2006 and 2013 "were sponsored by just two individuals, John Chevedden and Kenneth Steiner, and their family members and trusts." In a 2007 comment letter to the Securities and Exchange Commission, Mr. Chevedden explained that "[t]he current resolution process ensures that management and the Board focus a reasonable amount of attention to the issue at hand as they must determine their response to the shareholder proposal." The shareholders footing the bill might not agree that companies should be forced to spend time and resources responding to proposals that contain material inaccuracies.


Securities class actions often follow close on the heels of major announcements by public companies. These class actions have been portrayed as a shareholder's weapon against corporate wrongdoing, but too often that weapon inflicts harm on the very shareholders it is intended to protect.

 

 


Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

 

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.