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November 2013 Archives

100 Days at the SEC
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The Securities and Exchange Commission's newest commissioners--Kara Stein and Michael Piwowar--gave speeches last Friday to mark their first three months in office. These speeches provide useful insight into the direction the new commissioners would like to take their agency.

On November 22, 2013, the Food and Drug Administration flexed its regulatory muscle by sending a warning letter to a genetic-testing company that goes under the stylish name of 23andme. The object of FDA scorn was a diagnostic kit that the tech company, backed by among others Google and Johnson & Johnson, sold to customers for $99. The kit contained an all-purpose saliva-based test that could give customers information about some 240 genetic traits, which relate to a wide range of genetic traits and disease conditions. The FDA warning letter chastised 23andme in no uncertain terms for being noncooperative and nonresponsive over a five-year period in supplying information that the FDA wanted to evaluate its product as a Type III device under the Medical Devices Act.

Legal Regulation of 23andme There is no doubt that the FDA is on solid legal ground. This case is not like the processes involved in Regenerative Sciences, LLC v. United States, where the FDA asserted that physicians' use of certain stem-cell procedures for joint disease involved the use of a drug that required FDA approval before it could be approved for use. In an earlier essay for the Manhattan Institute, I argued that this classification was in fact both legally incorrect and socially mischievous. In this case, the legal arguments are not available to 23andme because the current definition of "medical devices" covers not only those devices intended for use on the human body, but also those used for the diagnosis of disease. The Type III classification means that this device has to receive premarket approval from the FDA, which in turn requires that it be shown to be safe and effective for its intended use. Getting approval under this standard is arduous business, because any such approval must be for each of the tests separately. 240 tests thus require that number of approvals. The costs are prohibitive, and the delay enormous.

The FDA Warning Letter is significant both for what it says and for what it does not say. On the former, it details all the various steps that the FDA has taken in order to help shepherd 23andme through the FDA's processes, including the types of warning that the products should contain, and the various modifications that could be introduced in order to mitigate the risks of its use. It then notes that 23andme has done little to take advantage of the assistance offered to it. Indeed, worse, it has simply gone about its business selling the kits, without so much as a bow in the direction of the FDA.

JPMorgan's Unsettling Settlement
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After much anticipation, JPMorgan and its government negotiating partners emerged this week from their diet-Coke-filled backroom (smoke-filled backrooms are passé) to announce "a $13 billion settlement with JPMorgan--the largest settlement with a single entity in American history." The federal and state claims against JPMorgan were grounded in failures to be fully forthcoming about the quality of the mortgages backing securities the bank was selling. The press release explained that JPMorgan's actions "along with similar conduct by other banks that bundled toxic loans into securities and misled investors who purchased those securities, contributed to the financial crisis." Such a broad, unfocused accusation against multiple banks cannot alone justify a $13 billion settlement with JPMorgan, but the eleven-page statement of facts does not provide much more insight. We are told that "a number of the loans included in at least some of the loan pools" that JPMorgan bought and securitized did not conform to the bank's representations to buyers. We are further told that Bear Stearns and Washington Mutual--which JP Morgan purchased during the crisis--withheld information about the poor quality of certain mortgages from purchasers of their securities. The settlement documents include what appears to be a comprehensive list of the residential mortgage-backed securities issued or underwritten by JPMorgan, Bear, and WaMu, but there is no indication of which of these included mortgages that the banks knew did not comport with their representations to investors. Nor is there any indication of the basis upon which the entities split the $13 billion among themselves and the seemingly arbitrary group of consumers and other non-parties to the settlement that will receive a piece of the $13 billion. The government accused JPMorgan of hiding behind generalizations about the types of mortgages backing the securities it was selling. Yet, in settling the case, is the government hiding behind generalizations too.

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

Following on the heels of its passage of the FACT Act last week, the House took up the issue of lawsuit abuse more broadly:

On Thursday, November 14, the Lawsuit Abuse Reduction Act (LARA), H.R. 2655, was passed by the U.S. House of Representatives on a 228-195 vote. LARA is designed to curb the filing of frivolous lawsuits by restoring mandatory sanctions (e.g. payment of attorney fees) where a court determines a claim to be frivolous. It would amend Rule 11 of the Federal Rules of Civil Procedure to provide for mandatory sanctions and also eliminate the "safe harbor" provision which currently allows parties to withdraw a frivolous claim within 21 days without consequences.

From a procedural standpoint, this bill would streamline the Rule 11 process by delineating a bright-line rule for remedies if a claim is deemed frivolous. This would allow for increased judicial economy in the decision-making process, because judges would not have to spend additional time determining whether sanctions are appropriate for a given case. Instead, the focus would shift strictly towards determining the appropriate size and scope of the sanctions.

From a substantive standpoint, the Rule 11 reform would create greater certainty of consequences for the claimant. Because the claimant knows that an initial ruling that a claim is frivolous leads to mandated sanctions, the subjectivity of the judge's view on whether sanctions should be applied becomes irrelevant.

At the same time, because the judge retains subjectivity as to the breadth of the sanctions, the claimant does not have the variables necessary to measure whether it still might be worth it to bring a claim or group of claims. As a result, the claimant would naturally be reluctant to bring a substandard claim in the first place, especially because the removal of the safe harbor provision would make it even riskier to do so.

The CFPB, the consumer protection watchdog created by the Dodd-Frank Act, is coming after debt collectors.

Early this month the agency issued a notice of proposed rule making on the topic of debt collection practices.

The CFPB views debt collection as a significant part of the economy with substantial effects on consumers, noting that, "The use of debt collection litigation to recover on debts has grown to become a critical part of the debt collection industry, with collection law firms having an estimated $2.4 billion in revenues from collections in 2011."

Debt collection, however, is already the subject of extensive federal regulation through the Fair Debt Collection Practices Act, or "FDCPA". The CFPB, however, views consumers complaints and lawsuits against debt collectors under this law as indicating the need for additional regulation:

"Despite the enactment and enforcement of the FDCPA and other measures, protection problems related to debt collection have persisted. For many years, consumers have submitted more complaints to the FTC about debt collectors than any other single industry."

According to the CFPB, "Consumers most commonly complain to the FTC that collectors harass them, demand amounts that consumers do not owe, threaten dire consequences for non-payment, or fail to send required notices."

The CFPB writes that, "Not only do consumers complain about debt collectors, but they also file thousands of private actions each year against debt collectors that allegedly have violated the FDCPA. The number of these actions filed in Federal district court increased from 3,215 in 2005 to 11,811 in 2011, with increases observed each year."

With an administration that is struggling to change the topic away from healthcare and towards topics that can be managed without further Congressional action, look for the administration to shine a light on the CFPB's rulemaking activity and its emphasis on additional consumer protection regulations.

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

In the midst of the myriad political battles going on in Washington, there is some good news:

On Wednesday, November 13th, the Furthering Asbestos Claim Transparency (FACT) Act, H.R. 982, was passed by the U.S. House of Representatives on a 221-199 vote. The FACT Act is designed to curb fraud and abuse in asbestos litigation by addressing the problem of false and/or inconsistent claims submitted to asbestos bankruptcy trusts and in the civil justice system.

The legislation would amend federal bankruptcy law to require asbestos bankruptcy trusts to submit quarterly reports to the overseeing bankruptcy court which detail each demand made against the trust by a claimant. The Act would, therefore, provide a link between the separate personal injury compensation systems of the bankruptcy trusts and the civil justice system.

The House's passage of the bill serves as an admirable first step in redirecting trust funds to those who are rightfully entitled to them. The Senate should take this signal from the House and pass the bill with all deliberate speed. The interests of the plaintiffs' bar cannot take precedence over justice for aggrieved individuals with legitimate claims. The interests of commerce and the worker are in perfect alignment. The only loser here would be those lawyers who can no longer make fraudulent claims and get away with it.

Banking on Wind
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As we await the next iteration of the Volcker ban on investments deemed excessively risky for banks, other regulations continue to incentivize selective risk-taking by banks. Last month, for example, the Office of the Comptroller of the Currency issued a bulletin encouraging bank investments in wind energy.

Banks are permitted by statute to "make investments directly or indirectly . . . designed primarily to promote the public welfare, including the welfare of low- and moderate-income communities or families (such as by providing housing, services, or jobs)." There are some constraints on these investments, including a prohibition against banks taking on unlimited liability. Certain renewable energy investments qualify as public welfare investments. These investments give banks access to renewable energy tax credits to offset taxable income, allow banks to benefit from renewable energy subsidies, and can be qualified investments under the Community Reinvestment Act.

Last month's OCC fact sheet reminded banks of the benefits of investing in wind projects. One of the two approved projects highlighted by the OCC was a fund that would finance six windmills and thus would purportedly benefit low- and moderate-income "individuals and areas by allowing students at a technical college to pursue careers in the renewable energy sector." The OCC cautions that "the bank should have the requisite expertise and risk management capabilities to make these investments." As the last crisis reminded us, when regulators tip the scale in favor of a particular type of investment, it tends to dull bankers' risk management faculties.

Update on BAMN
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Earlier this year I posted a blog about the case the Supreme Court was set to hear concerning Michigan's ban on affirmative action, pointing out what I viewed as some significant flaws in the plaintiffs' arguments. Moreover, I analyzed the issues in a more thorough manner in a recent law journal article here. On October 15th of this year, the Supreme Court heard oral arguments in that case, under the title Schuette, Attny. Gen of Mich., v. BAMN, et al. Central to the BAMN case is the assertion that Michigan's Proposal 2, which amended the state constitution to outlaw affirmative action, inter alia, at the state universities, set up a different political process for lobbying for racial preferences than the process for lobbying preferences based on alumni status, athletic ability, etc. Thus, under the Hunter/Seattle line of cases, Proposal 2 arguably violates the federal Equal Protection Clause.

As is often the case, both listening to the oral arguments, and reading the transcripts thereof, provides the observer with a very brief glance at what the attorneys presenting consider the most important aspects of the case. Actually, what the transcripts probably show is the issues that the competing attorneys think are both central to the issue, and on which certain Justices are still persuadable. They only have a brief time, the issues are very complex, and so choices of time and energy must be made.

The written briefs, along with briefs from amici, lay out the arguments in more detail. They show that Justice Kennedy, once again, is perceived as the swing vote, as arguments in the briefs are clearly designed to convince him, not so subtly, often reminding him of his own words from other cases. But despite this strategy, Shuette, who as Michigan's Attorney General was defending Proposal 2, spent most of his time answering questions by Justices Ginsburg & Sotomayor. In contrast, and perhaps not surprisingly, the attorneys for the two defendant groups were grilled pretty thoroughly by Justices Roberts, Scalia, and Alito. With all the usual cautionary caveats about predicting what the Court will do, the interactions with Justices Kennedy and Breyer may be most relevant. Both seemed somewhat skeptical of the defendants' arguments. Obviously, only time will tell how the Court will rule. But based on the arguments expounded in the oral arguments, it would be difficult if not impossible for the Court to rule in favor of the defendants. Otherwise, as Justice Scalia suggested, the federal Equal protection clause would contradict itself.

SAC Capital's Offense
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This afternoon SAC Capital entered a guilty plea in court as part of the largest insider trading settlement ever. In connection with the five criminal counts of wire and securities fraud, SAC Capital agreed to pay approximately $1.2 billion (in addition to a $616 million SEC penalty already paid) and pledged never again to manage anyone else's money. U.S. Attorney Preet Bharara characterized the record-breaking penalty as "steep, but fair." According to Bharara, the penalty is "several orders of magnitude larger than the identified avoided losses and gains made by" SAC and is in excess of the maximum under the sentencing guidelines.

The government's complaint provides a little context for understanding the penalty, but not much. Over approximately a decade, eight SAC employees allegedly traded an unspecified number of times on information about companies that they got from employees at the companies or knowledgeable third parties. SAC allegedly encouraged this behavior, and, as the complaint explained, "the encouragement by [SAC] to pursue aggressively an information 'edge' overwhelmed limited SAC compliance systems." The government has obtained guilty pleas from some of the individual insider traders, but the complaint is a bit slim on specific facts to support a penalty of the size imposed. Some of the cited examples of offending conduct are not particularly incriminatory: for example, an SAC employee spoke with a tech analyst who had spoken to a Microsoft employee who had seen some of his colleagues at Microsoft talking to Yahoo employees, thus foreshadowing a partnership between Yahoo and Microsoft.

As Bharara noted, part of the purpose of the tough settlement with SAC was to act as a deterrent. That purpose would have been more effectively accomplished if the government had provided more details about the specific conduct it was trying to deter.

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

One of our fundamental rights as citizens is the ability to seek redress of our grievances. Over time, this practice spread from government to private industry, as workers' rights against their employers in abusive or harmful situations were codified in legislation.

The establishment of the asbestos bankruptcy trust was meant to offer a compromise path through which employees could achieve restitution for their asbestos-related injuries, and employers could avoid cost overruns and premature bankruptcies.

However, the surreptitious manner in which the trusts have been run has allowed for opportunistic lawyers to take advantage of them by submitting frivolous, fraud-riddled claims.

The goal of the trusts stand as the fulfillment of just compensation for injured workers, but the main beneficiaries are turning out to be lawyers who make claims on behalf of "clients."

To remedy this injustice, the FACT Act was meant to mandate quarterly reporting of claims made on the trust, as well as allow for more compliance with third-party discovery requests made on the trust.

Because there are no compliance costs or other significant burdens associated with the law's passage, we can assume the asbestos industry's opposition to the FACT Act stems from a desire to lessen transparency. If there is no transparency, the industry can continue to make baseless claims and reap fraudulent profits.

Lisa A. Rickard, president of the U.S. Chamber Institute for Legal Reform, has written an op-ed detailing the reasons for the asbestos industry's continued obfuscation.

Wisconsin Governor Scott Walker is reportedly heading to Madison, Wisconsin to sign that state's crowdfunding bill.

With this new law Wisconsin will become the third state in the U.S. (along with Georgia and Kansas) to permit intrastate crowdfunded securities offerings.

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

Ever so often, the Supreme Court hears a case that has ramifications for our very constitutional structure.These cases reach into the heart of our government to see what strictures remain between the founding generation and our own.

The Court is currently hearing oral arguments in Bond v. United States, a case dealing with fundamental issues of federalism and separation of powers. Specifically, the issue deals with the extent to which Congress can abrogate state police powers pursuant to the mandates of Congress's treaty obligations.

But in a larger sense, this case speaks to the validity of the framework of analysis the Court has employed since its inception. The presumption of constitutional analysis has always begun on the side of federalism and separation of powers; that is, the Constitution created certain enumerated powers to delegate to the federal government and left the majority to the states, so we begin our analysis from where the nexus of the power was meant to lie. In other words, our underlying premise is always to begin with federalism, and inch towards increasing federal power as circumstances might necessitate.

The Bond court has a chance to take another step towards maintaining the presumption of our Constitution by reaffirming the states' role in criminal prosecutions.

The Wall Street Journal has further details on the salient issues here, and the New York Times has more on the oral arguments here.

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

A couple of weeks ago, the California Supreme Court decided a potentially very impactful case dealing with the enforceability of arbitration agreements made between companies and their consumers/employees.

In Sonic-Calabasas A, Inc v. Moreno, the court ostensibly agreed with the U.S. Supreme Court's rulings in Concepcion and Italian Colors Restaurant that federal preemption applied over any state rulings that attempted to control the scope of consumer arbitration agreements under a specific formulation of the unconscionability doctrine.

However, the Sonic court then opened up the door to the potential introduction of a new unconscionability standard that would be substantively similar to the previously-discredited standard.

In the prior U.S. Supreme Court rulings, the Court specifically overruled the Discover Bank rule, which mandated that consumer arbitration agreements that did not include clauses allowing for class action suits were effectively unenforceable. The Supreme Court has held that the Federal Arbitration Act's mandates apply, regardless of any state "substantive or procedural policies to the contrary," including any any specific state standards for arbitration applicability.

Andrew J. Pincus and Archis A. Parasharami of the Mayer Brown law firm have written an op-ed discussing the various issues involved.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.