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February 2014 Archives

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

The Manhattan Institute's Center for Legal Policy has just released a new report detailing the expanded use of deferred and non-prosecution agreements by the federal government against various companies, entitled "The Shadow Lengthens: The Continuing Threat of Regulation by Prosecution." The report can be found here.

While the federal government justifies the increased use of DPAs and NPAs by pointing out that they allow a company to re-shape its corporate structure without formal charges being filed against them, this contention ignores the fact that the lack of transparency behind the pre-charge agreements can breed governmental abuse by allowing the government to utilize their leverage in crafting the agreement to create desired outcomes.

For example, if a company is threatened with federal charges by the government, it will naturally find it more desirable to enter a DPA or NPA to stave off bankruptcy, avoid radical corporate structure changes, and the bad PR that comes with being charged with wrongdoing. If the government, however, has unmitigated authority to craft DPAs or NPAs as it wishes, the company would have no choice but to accept the agreement in whatever form it may come, or risk formal charges. Ultimately, there needs to be a premise of fairness behind these agreements, i.e. companies having some way to make sure prosecutors do not go too far. Otherwise, it appears that too much power is being left in the hands of prosecutors to determine the corporate shape of entire industries.

Advice with Borders
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The Securities and Exchange Commission settled with Credit Suisse for providing financial services to U.S. clients without having registered with the SEC. The Swiss firm's efforts at winning American business were successful enough to generate more than 8,000 U.S. client accounts with more than $5 billion in assets. The firm took inadequate steps to ensure that it was in compliance with U.S. law and, even after deciding to stop offering cross-border advice, the firm took several years to close U.S. accounts. The settlement includes an admission of wrongdoing and a $196 million payment consisting of disgorgement of the firms' fees, plus interest and a $50 million penalty.

That kind of money suggests that clients were really harmed, but the complaint does not reveal any investor harm. Indeed, the delay in shutting the cross-border program down appears to have stemmed in part from reluctance of clients to part with their advisers. Contrast the Credit Suisse settlement with a settlement last year with a registered adviser that the SEC alleges stole more than $3 million from a police and firefighter pension fund to buy shopping malls. The settlement consisted only of requiring the adviser to repay the money it had allegedly stolen. A sophisticated global firm like Credit Suisse has the wherewithal to understand and comply with registration requirements, but the SEC's disproportionately large settlement in a case without discernible investor harm will dissuade other foreign firms from registering to serve U.S. investors. Such a result is not good for investors, who ought to be able to seek advice overseas.

C-SPAN has broadcasted video footage of Manhattan Institute's recent forum on the topic of class action litigation.

Participants talked about class action lawsuits and why some critics argue they benefit no one except attorneys. Following James Copland's introductory explanation of class action lawsuits, Ted Frank, a leading tort reform advocate and a leading critic of class action suits, described major cases his Center for Class Action Fairness organization got overturned. Panelists in the discussion afterward talked about various aspects of class action suits, including the reasons why big corporations settle and policy changes needed to address the ethical problems with these cases

Robert Panzenbeck
Legal Intern, Manhattan Institute's Center for Legal Policy

The Wall Street Journal notes a particularly interesting case out of federal bankruptcy court in North Carolina, where Judge Roy Hodges handed down a decision that strikes a blow against deceptive practices in asbestos litigation.

Garlock Sealing Technologies,a manufacturer of gaskets and packing,entered into bankruptcy in 2010 under the weight of pending and future asbestos claims. When manufacturers like Garlock file Chapter 11 in the face of asbestos claims, these firms are granted immunity on the condition that they meet a number of requirements. Among these requirements is the establishment of an asbestos trust, which establishes payments to be made to past and future victims based on the severity of their illness.

In this case, plaintiff's attorneys demanded that Garlock set aside 1.3 billion dollars for the settlement of mesothelioma related claims. Garlock believed the figure should be much lower, and earlier this month, federal judge Roy Hodges agreed, reducing their liability 90 percent, to 125 million dollars. This is significant, because for years, critics of this system have pointed out an exploitable information gap between the legal system and the trusts. In his opinion, Judge Hodges criticized the plaintiff's attorneys and their methods, noting that the larger number of 1.3 billion dollars was based on various forms of deceit by plaintiff's lawyers and clients, including the deliberate concealment of evidence that might suggest that plaintiff's injuries were the result of exposure to products other than Garlock's asbestos lined gaskets. The Journal notes one particularly poignant incident illustrating the extent of plaintiff misconduct:

Garlock had paid $9 million dollars in a California case involving a former Navy machinist mate. Garlock had attempted to show that the plaintiff had been exposed to asbestos-containing insulation, Unibestos, made by Pittsburgh Corning. The plaintiff denied exposure to insulation products, while his lawyer told the jury there was no Unibestos insulation on the ship. But Judge Hodges found that after the $9 million dollar verdict, the lawyers for the machinist filed 14 claims with other asbestos trusts, including several against insulation manufacturers. The same lawyers who told the Garlock jury there was no Unibestos exposure had claimed in the Pittsburgh Corning bankruptcy that the same plaintiff had been exposed to Unibestos. Judge Hodges wrote that the plaintiffs lawyers "failed to disclose" in court that their client had been exposed to 22 other asbestos products.

The Garlock case is a textbook instance of double dipping, a practice common in the asbestos litigation world. For years, critics of the system have alleged that plaintiff's attorneys "double dip," making claims to multiple asbestos trusts for the same injury. In this case, plaintiff's attorneys distorted or withheld facts while making claims with multiple asbestos trusts, even making allegations that were, as noted above, wholly inconsistent with the basis for rewards in prior decisions. As expected, companies forced into bankruptcy have decided to take action. Prior to this decision, EnPro Industries, Garlock's parent company, filed suit against four prominent asbestos law firms alleging they had concealed evidence about exposure to other products in litigation against Garlock. Judge Hodges' opinion provides significant ammunition for this claim.

The verdict is viewed as a major victory for Garlock, and is not without its critics. Paul Barrett of Bloomberg notes that the decision "obfuscates the long term wrongdoing by companies that didn't swiftly own up to the unintended harm caused by asbestos," while acknowledging that the circumstances present evidence that "influential members of the plaintiff's bar have lost their moral bearings."

It's not just companies like Garlock who have taken note. Congress, in an effort to solve the double dipping problem recently moved on the issue. In November, the House passed H.R. 982, the Furthering Asbestos Claim Transparency (FACT) Act, by a vote of 221 to 191. As BusinessWeek notes, the bill would require asbestos trusts around the country to file quarterly reports about who receives payments and how much they get. The bill is specifically designed to limit double dipping, and ensure that funds set aside for legitimate claims aren't unjustly dispersed to fraudulent claimants.

Suing for Settling
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Advocacy group, Better Markets, filed suit in federal district court today to challenge the settlement between JPMorgan and the Department of Justice last November related to JPMorgan's crisis-era sales of residential mortgage-backed securities. The complaint alleges that the DOJ violated the law when it entered into a settlement that was shielded from judicial review and the details of which remain a mystery. As Better Markets paints it, the deal was negotiated by a politically connected bank with a department officials scrambling to show themselves tough on too big to fail institutions. The complaint suggests that the large settlement numbers served as a smoke screen to conceal DOJ's gentle slap on JPMorgan's brutish wrist. Better Markets, itself a confidant of regulators, likely overstates DOJ's deference in this matter, but correctly points out the settlement's troubling lack of transparency. When it was announced, I objected that the settlement's large dollar figures were not accompanied by any clear explanation of the violations being punished.

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

As the overcriminalization problem has garnered more and more attention, the calls for reform have become increasingly audible in various aspects of federal, state, and local governments. The latest example comes to us from the Texas Public Policy Foundation. Vikrant Reddy, TPPF's Senior Policy Analyst for the Center for Effective Justice, has just released a report detailing salient changes that should be made to the Foreign Corrupt Practices Act to make it more reliable and efficient. Ostensibly, the purpose of the statute is to minimize U.S. complicity in international corruption, but its ancillary effects tend to stifle any beneficial effects of the additional regulation:

The act is emblematic of all the worst aspects of creeping federal overcriminalization, the tendency of Congress to use criminal law to regulate behavior not traditionally considered criminal. The FCPA's most important terms are vague and provide limited guidance for potential defendants; it is enforced in a way that limits critical mens rea protections; and the law does not provide for a "compliance defense" that would allow corporations to demonstrate that violations were a result of rogue employees, rather than inadequate compliance regimes.

The general problem stems from the fact that the premise of the legislation does not account for the creation of a skewed incentive structure. In theory, the FCPA will deter U.S. corporations from using potentially illegitimate means to court business in countries that are deemed "high risk" by using the threat of exorbitant fines and penalties. In order for this linear-style logic to hold, legislators either did not consider the negative externalities involved, or simply deemed them minimal in relation to the benefits of the legislation. Either way, the FCPA has proven to cause significant problems in terms of increasing the uncertainty involved in a given investment, and thus diverting U.S. resources from economically and socially productive uses:

Ironically, in fact, there is evidence that the FCPA has had the counter-productive effect of discouraging American firms from investing in impoverished nations. There is also evidence that the FCPA has stunted the growth of U.S. companies by forcing them to maintain costly compliance regimes. Ironically, these regimes may not even be useful becasue prosecution ultimately depends on how a particular U.S. Attorney will choose to interpret a particular term.

An improved piece of legislation would take into account these proven negative effects, while maintaining the core corruption-preventing purpose of the FCPA.

In other overcrim news, the Manhattan Institute's Center for Legal Policy will soon be releasing a report detailing the changing nature of Deferred and Non-Prosecution Agreements, especially in relation to the increasing number of agreements being utilized by the DOJ and, recently, the SEC. It will also examine the scope and adequacy of judicial review over these agreements.

Striving for Justice
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Mark Cuban has not forgotten the agency he defeated in court. He has embarked on a plan to post Securities and Exchange Commission trial transcripts on his blog. SEC lawyers make mistakes just as everyone else does, so this project will undoubtedly bring some embarrassing moments to light and laughter. The first episode of candid courtroom commenced on a more serious note. Federal district court judge William S. Duffey, Jr. chides the SEC for "looking at a case late and finding an issue and evidence that they want to admit and trying to find a rationalization for it." As the judge explains, the SEC's objective should be for "a just result and not just for a result." The judge may have put his finger on the hardest part of an SEC enforcement attorney's job. There is an understandable thrill in making a wrongdoer pay for violating the law. Carrying out investigative and trial responsibilities in order simply to achieve a just result is much less satisfying. Justice may demand that a case get dropped or that a particular tactic for securing victory be avoided. The SEC and other government agencies must do their part by rewarding good lawyering even if it does not result in a checkmark in the government's win column.

On January 29th, the Court of Appeals for the Second Circuit dealt Hank Greenberg another blow in his challenge of the federal government's crisis-era AIG rescue. Greenberg's company, Starr International, a large AIG shareholder, alleged that the Federal Reserve Bank of New York had violated state fiduciary duty law at multiple points in the government's prolonged rescue effort. Starr objected to the government's initial intervention in September 2008, but the challenge focused on later events not barred by the statute of limitations. Starr alleged that the government, without regard for AIG's best interests, had used the company to funnel bailouts to other financial companies. The court affirmed the lower court's verdict and held that Delaware fiduciary duty law could not stand in the way of the actions that the Federal Reserve Bank of New York took to fulfill its public duty to stabilize the financial system. The district court hinted that there might be some remedy under federal law if Starr could show, for example, that the Federal Reserve Bank of New York, "having attained control of AIG in the course of an emergency rescue, then forced AIG to purchase a photocopying machine from a bank in Utah for $1 billion, solely to subsidize the Utah bank in the interested of the banking system." Even absent a billion dollar copier, the Federal Reserve is not completely off the hook; another case is proceeding at the Court of Federal Claims.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.