After much uncertainty and discussion, the U.S. Department of Justice has finally issued official guidance regarding who qualifies as a “foreign official” under the Foreign Corrupt Practices Act (FCPA). This guidance was published on November 14, 2012, in the Resource Guide to the U.S. Foreign Corrupt Practices Act, a broad guide to enforcement and interpretation of the FCPA that the DOJ issued jointly with the Securities and Exchange Commission.
As expected based on the DOJ’s previous interpretations of the term, the Guide provides a broad definition of “foreign official” by stating that the term encompasses “officers or employees of a department, agency, or instrumentality of a foreign government.” This definition imposes few restrictions on whom the Department will consider a “foreign official” and stretches the term far beyond its obvious and limited meaning.
Much of the confusion regarding “foreign official” status arose from government-affiliated entities that fall in the hazy middle ground between government agencies and private entities. Often this uncertainty surrounds services such as telecommunications, banking, and the aerospace industry, in which a government has some degree of ownership in the entity but may not completely own or control it. In those cases, the Guide clarifies that although the DOJ uses a multifactor test to determine whether an entity is a government instrumentality, it is most likely to pursue cases in which a government has a majority ownership stake. However, it acknowledged that there may be rare cases in which a government that owns only a minority stake nevertheless controls the entity through veto power, political appointees, or other means, in which case it will still be considered a government instrumentality.
Even though the very term “official” denotes a certain degree of authority within an organization, the Guide makes clear that the FCPA “covers cor¬rupt payments to low-ranking employees and high-level officials alike” in government departments, agencies, or instrumentalities. Therefore, corrupt payments to anyone within these organizations will bring the case within the FCPA’s bounds, regardless of their status within the organization or their ability to control or influence the instrumentality.
Although the new Guide states that its advice is “non-binding, informal, and summary in nature,” it is the best indication of how the DOJ plans to implement and enforce the FCPA. So while the content of the Guide essentially affirms the stance that the DOJ has assumed in existing cases, it does provide a foundation of guidance for organizations to rely on in their contacts with foreign entities. Unfortunately, this guidance will largely serve to dissuade companies from creating beneficial partnerships for fear that they might accidentally implicate FCPA concerns. As we have discussed previously on this blog, we hope that the courts will weigh in on this issue and find a more reasonable interpretation of what constitutes a “foreign official.”
The intersection of domain names and the First Amendment is not new. Indeed, in the early days of the domain name system, courts considered the issue of whether a domain name registrar could prohibit the registration of domain names on the basis of content – for instance, domain names containing profanities. See Nat’l A-1 Advertising, Inc. v. Network Solutions, Inc., 121 F. Supp. 2d 156 (D.N.H. 2000); Seven Words LLC v. Network Solutions, Inc., 260 F.3d 1089 (9th Cir. 2001). However, the U.S. Court of Appeals for the Fifth Circuit recently was confronted, in Gibson v. Texas Dep’t of Insurance, with a new twist on the First Amendment as it applies to domain names: whether a particular domain name is pure “commercial speech” (entitled to only limited First Amendment protection) or “expressive speech” (entitled to more extensive protection).
The Texas Labor Code prohibits the use together of the words and phrases “Texas,” and “Workers Compensation,” or similar abbreviations. Nonetheless, Gibson, a workers compensation lawyer in Texas, registered the domain name texasworkerscomplaw.com. On the associated website, Gibson discusses matters relating to Texas workers compensation law and, of course, advertises his law practice. The Texas Department of Insurance took offense to Gibson’s domain name, and sent Gibson a cease and desist letter. Gibson, being a lawyer, sued in federal court, alleging that the Texas Labor Code restrictions violated his constitutional rights.
The Fifth Circuit, in an interesting opinion, addressed the commercial speech/pure speech dichotomy inherent in domain names used by commercial enterprises, but artfully dodged the question of whether the domain name was in fact commercial speech. Instead, the court first analyzed whether, if the domain name was in fact commercial speech (which can under some circumstances be restricted), it was the sort of commercial speech that the Texas Department of Insurance could restrict.
The court found, correctly, that commercial speech can be restricted only if it is “inherently likely to deceive.” The state argued that Gibson’s domain name implied a connection with or approval of the state. The Fifth Circuit dispensed with the state’s argument, noting that since there was nothing to suggest that texasworkerscomplaw.com could not be viewed in a non-deceptive fashion (a truism), the state could not restrict the use of the domain name as commercial speech.
There is a second exception allowing a restriction on commercial speech: A state may regulate non-deceptive commercial speech if the restriction “advances a substantial state interest” and is narrowly tailored to serve that interest. On this issue, the Fifth Circuit sent the case back to the federal district court to develop a factual record. It seems unlikely that the Texas Department of Insurance will prevail in the end, as the statute on which its objection is based is vastly overreaching, and would prohibit anyone providing services relating to workers compensation in Texas from registering domain names that accurately describe what they do. For instance, a physician who performs workers compensation examinations could not register texasworkerscompdoc.com (as of this writing, this domain name is available for the taking).
Obviously, such a domain name is not misleading, and there is no legitimate basis upon which the state can restrict it. Domain names are often a form of speech. Just because they are a relatively new format of expression does not change this fact and give the government a basis to attempt to restrict their use.
Reuters recently quoted Tian Lipu, head of China’s State Intellectual Office, complaining about China’s reputation for rampant software piracy. According to Tian, “China is the world’s largest payer for patent rights, for trademark rights, for royalties, and one of the largest for buying real software . . . We pay the most. People rarely talk about this, but it really is a fact.”
Tian’s protestations are akin to the shoplifter who defends his theft of a coat by pointing out that he also bought two shirts from the same store. China, as well as other countries worldwide, needs to stop looking the other way at copyright and trademark piracy, and to crack down on this form of theft.
According to the Business Software Alliance’s (BSA) 2011 Global Software Piracy Study, 42% of PC software worldwide – with a commercial value of more than $63 billion — is pirated. The rate of software piracy in China is an astounding 77%. By comparison, the percentage in the United States is 19%, while it is 26% in the UK, 21% in Japan, and 27% in Canada. In fairness, while the value of pirated software in China eclipses all other countries (excepting, ironically, the United States, where the relatively low piracy rate still results in almost $10 billion worth of pirated software), China is not the only, nor is it the worst, offender. Among the world’s 20 largest economies, Indonesia and Venezuela have higher piracy rates than China (86% and 88%, respectively), and Russia, India, Mexico, Thailand, Malaysia and Argentina all clock in with piracy rates over 50%.
Technical means of quashing or impairing the performance of pirated software (for instance, the Microsoft Genuine Advantage program) can help. But they are not a cure-all, nor can they put a dent in the pervasive levels of piracy. A multifaceted approach is needed to protect software and application developers from this pervasive form of theft. To start, developers must incorporate anti-copying mechanisms into their software and applications and must have strong and enforceable license agreements with users. From there, it is up to the developers to take a firm stand against theft of their product. However, it is equally important that governments, starting with China, bring their intellectual property laws into the 21st century, adapting them to encompass apps and other new and emerging technologies; enforce those laws; and make clear that software and application piracy will not be permitted. Until China and other nations do this, software and app developers will continue to be the constant victims of theft and the forward march of innovation will be stunted.
Lawyers for Stephen Jin-Woo Kim, a former federal contractor employee accused of unlawfully disclosing sensitive information, recently filed a motion in the U.S. District Court for the District of Columbia criticizing the government’s withholding of information in the case and asking the court to order the government to produce the documents. The government should not be permitted to withhold this type of valuable, discoverable information from the defense in this “leak” case.
Kim was indicted in August 2010 with unlawfully disclosing national defense information to a reporter for a national news organization and making false statements to the FBI. If convicted, Kim faces up to 10 years in prison for unlawful disclosure of national defense information and up to five years in prison for making false statements. Kim was an employee of a federal contractor who was on detail at the State Department at the time of the alleged disclosure of classified information in June 2009.
Prosecutors in the case have said that Kim’s trial is not likely to occur until 2013.
According to the indictment, in June 2009, Kim knowingly and willfully disclosed to a national news reporter “Top Secret-Sensitive Compartmented Information” that concerned the military capabilities of a foreign nation and intelligence that “could be used to the injury of the United States.” The indictment further alleges that, in September 2009, Kim made false statements to the FBI when he denied having any contact with the reporter since a meeting in March 2009. The government alleges that he has had repeated contact with the reporter in the months following the meeting.
The indictment was part of a series of investigations by the federal government into unauthorized information leaks to media outlets during the Obama administration. After the announcement of the indictment, lawyers for Kim criticized the government for criminalizing an occurrence “that happens hundreds of times a day in Washington.”
Discovery in the case began in October 2010 and is continuing. Recently, without prior notice to defense counsel, the government filed a motion seeking the court’s permission to withhold otherwise discoverable classified information from defense counsel. In its motion, the government sought an ex parte review, even though lawyers for Kim all had security clearances and classified discovery had been ongoing for close to two years subject to a protective order. Counsel for Kim noted that over the past 22 months, the Department of Justice has produced over 3,000 pages of classified material to Kim’s legal team.
The government should not be permitted to withhold discoverable information without making a strong showing that there is a need to do so. Here, the government has made no showing and has “not provided defense counsel with any information about the nature or subject” of the information withheld, defense counsel say. Especially given the protective order and the security clearances of Kim’s counsel, it seems inexcusable to allow the government to continue to withhold information without justification.
On October 24, 2012, U.S. District Judge Jed Rakoff sentenced Rajat Gupta to 24 months after he was found guilty by a jury of one count of conspiracy and three counts of substantive securities fraud, in connection with providing material non-public information to convicted inside trader Raj Rajratnam. This two-year prison sentence was substantially below the applicable advisory range under the United States Sentencing Guidelines and, in the week since that ruling, much has been said about whether or not this sentence was appropriate.
But the most remarkable part of Judge Rakoff’s sentencing ruling was his unflinching analysis of the way in which the application of the Sentencing Guidelines to white collar fraud cases does not reflect empirical analysis about those offenses or those who commit them – an argument that defense counsel have been making for some time with mixed success.
Judge Rakoff began his analysis with an eloquent and incisive observation about his role as a sentencing judge and the inadequacy of the sentencing guidelines as a comprehensive tool to determine a defendant’s sentence:
Imposing a sentence on a fellow human being is a formidable responsibility. It requires a court to consider, with great care and sensitivity, a large complex of facts and factors. The notion that this complicated analysis, and moral responsibility, can be reduced to the mechanical adding-up of a small set of numbers artificially assigned to a few arbitrarily-selected variables wars with common sense. Whereas apples and oranges may have but a few salient qualities, human beings in their interactions with society are too complicated to be treated like commodities, and the attempt to do so can only lead to bizarre results.
Judge Rakoff noted that the Sentencing Guidelines were “originally designed to moderate unwarranted disparities in federal sentencing” on the theory that the Guidelines “would cause federal judges to impose for any given crime a sentence approximately equal to what empirical data showed was the average sentence previously imposed by federal judges for that crime.” Of course, as the Supreme Court has already observed, the Guidelines deviated from this goal almost from the start.
For example, based on “limited and faulty data,” the Sentencing Commission determined that an ounce of crack cocaine should be treated as the equivalent of 100 ounces of powder cocaine for sentencing purpose, even though the two substances were chemically almost identical and, as later studies showed, very similar in their effects. The result of this empirically unsupportable conclusion was an indefensible racial disparity in narcotics sentencing. Kimbrough v. United States, 552 U.S. 85, 96-98 (2007). Judge Rakoff noted that, even when the Sentencing Commission changed the ratio from 100-to-1 to 18-to-1 in 2010, that ratio was likewise not based on empirical evidence but was merely “plucked from thin air.”
Judge Rakoff went on to observe that the Guidelines applicable to white collar fraud likewise “appear to be more the product of speculation, whim, or abstract number-crunching than of any rigorous methodology,” and that this “maximize[es] the risk of injustice.” Noting the huge increases in the recommended Guidelines for fraud cases, Judge Rakoff noted that the resulting advisory ranges “are no longer tied to the mean of what federal judges had previously imposed for such crimes.” Rather, these sentences “instead reflect an ever more draconian approach to white collar crime, unsupported by any empirical data.”
In short, congressional mandates to get tougher on fraud have resulted in a singular focus on one factor – the amount of loss – that “effectively ignored the statutory requirement that federal sentencing take many factors into account, see 18 U.S.C. § 3553(a), and by contrast, effectively guaranteed that many such sentences would be irrational on their face.” The result, Judge Rakoff observed, was “to create, in the name of promoting uniformity, a sentencing disparity of the most unreasonable kind.”
Regardless of whether or not one agrees with the sentence ordered in the Gupta case, Judge Rakoff’s analysis of the way in which the Sentencing Guidelines fail to promote justice in white collar cases is sure to have significant weight in other cases going forward. As structured, federal sentencing begins with a calculation of the advisory Guidelines range, and then defendants seek a variance from that range under Section 3553(a) – a process that creates a de facto presumption that a defendant will be sentenced within the Guidelines range. A recognition that the Guidelines ranges applicable to fraud crimes are not fair is a good first step towards reforming sentencing in such cases in the interest of true justice.
A draft of the online poker bill that Sen. Harry Reid (D-Nev.) and Sen. Jon Kyl (R-Ariz.) plan to introduce was released this week. The bill, known as the “Internet Gambling Prohibition, Poker Consumer Protection, and Strengthening UIGEA Act of 2012” would legalize online poker at the federal level, a step that became possible last December when the U.S. Department of Justice released an opinion stating that the Wire Act does not apply to online poker.
The bill provides an opt-in structure, in which states have to affirmatively choose to participate in the online poker program. A state would be considered to have opted in if it has passed a law legalizing online poker. Thus far, only Nevada and Delaware have passed such laws. An Indian tribe is considered to have opted in if a designated authority of the tribe submits written notice to the Secretary of Commerce saying so. Money could only be accepted from players located in those states or tribal lands at the time they are playing.
The bill would create an Office of Online Poker Oversight within the Department of Commerce to regulate the industry. The Secretary of Commerce would need to designate, not later than 270 days after the enactment of the bill, at least three state agencies or regulatory bodies of Indian tribes that are considered qualified bodies to regulate online poker. If there are not three bodies qualified, the Secretary will designate all state bodies that fit defined criteria including:
(1) A reputation as a regulatory and enforcement leader in the gaming industry.
(2) A strict regulatory regime.
(3) Regulatory and enforcement personnel with recognized expertise.
(4) Adequate regulatory and enforcement resources.
(5) Demonstrated capabilities relevant to the online poker environment.
In making determinations under those criteria, the Secretary is also to consider the number of years that the agency has directly regulated casino gaming, the size of the gaming market that has been regulated, and the demonstrated ability to evaluate complex gaming technologies, among other things.
No game other than poker would be allowed under the bill, even if it is licensed by the state. A state could still legalize other games under their own laws, but this law would not allow them to operate those games interstate. The bill has a carve-out that allows interstate bets on horse racing to continue to operate legally, as well as an exception to allow lotteries to sell tickets online.
The bill would impose a fee of 16 percent tax on revenues generated from online poker. The money generated from this tax would go to a fund known as the “Online Poker Activity Fee Trust Fund.” Seventy percent of the money in that fund would be given to the states or Indian tribal governments where the player was located at the time he played. The other 30 percent would go to the state that issued the license to the site where the money was generated.
For five years after enactment of the bill, no person may be considered suitable for licensing if the person owned or operated an Internet gambling site that accepted bets after December 31, 2006. Such persons are referred to as “covered persons.” Additionally, no assets that were used to take bets after December 31, 2006, can be used for five years after the bill’s enactment. This provision effectively excludes all companies that were shut down by the federal government on “Black Friday” in 2011.
An individual that is considered a “covered person” may apply for a waiver from the Office of Online Poker Oversight and would need to show by a preponderance of the evidence that the person did not violate, directly or indirectly, any provision of federal or state law in connection with the operation or provision of an Internet gambling facility. A similar waiver process exists for tainted assets. The bill also states that a previous criminal proceeding will not be considered in the waiver process.
The bill would prohibit the operation of public Internet parlors where devices are made available primarily for online poker.
There is no provision in the bill that requires a licensee to own a casino, a proposal that had been considered in some online poker legislation.
Criminal penalties of up to five years in prison can be assessed under the bill to operators that violate certain provisions.
We are glad to see that legislation that would legalize online poker is being considered on Capitol Hill and has reached a draft stage. This draft could change significantly over time, but the bill in its current form may face steep opposition.
Several objections are possible. First, many states have recently explored the idea of legalizing online poker, with the intent of possibly generating significant revenue. The language of this bill would take a significant amount of that potential revenue generated from online poker away from the states.
No state other than Nevada, Harry Reid’s home state, has developed its own regulations to govern online poker, or given the criteria listed in the bill, would be considered qualified to regulate online poker. The state that issues the license gets 30 percent of the revenues generated from online poker, which would likely all go to Nevada. States may not support such a large percentage of the money generated going directly to Nevada.
In addition, the provision barring all operators who took bets after the enactment of the Unlawful Internet Gambling Enforcement Act of 2006 is too draconian and could be vulnerable to a constitutional challenge. Finally, the 16 percent fee on revenues generated from online poker is very steep and may face opposition from operators.
It also remains unclear what level of support an online poker bill would have in the lame-duck session of Congress. As Senate Majority Leader, Reid has the ability to dictate the legislative agenda to some extent, but it remains to be seen if he will be able to generate the votes needed to pass the bill. Kyl, although he will be retiring after this term, is the Minority Whip in the Senate and could also help rally support from Republicans. If it seems unlikely that a stand-alone online poker bill could generate enough support in Congress, there may still be an alternative. Perhaps the best chance of online poker legislation getting passed is to attach it to another larger bill, which is something that Reid can be influential in helping to achieve. It is a tactic that has been used in this context before, as in 2006, when UIGEA was passed as part of the SAFE Port Act, a bill that regulated port security.
On October 23, 2012, the European Commission will unveil a series of initiatives and actions that it plans to put into effect relating to online gaming with the overall goal of providing a better framework for online gambling services in the European Union.
One of the main problems that the European Commission is facing is the differences in rules and regulations among member nations governing online gambling. Currently, no EU legislation specifically applies to the online gambling industry, which generated $13.7 billion in earnings in the EU in 2010.
Sigrid Ligne, Secretary General of the European Gaming and Betting Association (EGBA), which represents companies offering online betting games, has said that this is an excellent opportunity for Europe as a whole to offer strong consumer protection in the gaming arena.
Ligne has said, “We deplore the situation today where we see 27 ‘mini-markets’ for gambling in Europe. We are calling for the introduction of European rules to ensure proper protection for consumers and maintain a crime-free environment throughout the EU, while affording open, fair, and transparent licensing conditions for EU-regulated operators.”
Private online gambling operators have expressed frustration with the EC for not forcing member states to open their online gambling markets. According to EU treaties, any business should be able to sell products and services in the EU countries as easily as it does in its own local market. The EGBA has accused the Commission of “failing in its role as guardian of the treaties” by not requiring member states to apply EU treaty rules in the online gambling sector.
Several European national governments, however, have opposed broader EU legislation because they want to protect betting monopolies that generate significant revenues for the state. The EGBA was hoping that the Commission would develop model legislation for its member states, but the Commission stated in June that it would only be developing an action plan at this stage, despite demands from the European Parliament for legislation. The action plan is expected to set out the Commission’s plan in the areas of consumer protection, fraud prevention and sporting integrity. The Commission could still develop legislative proposals in the future.
The EGBA has announced that it will file a complaint against Germany in the near future because its gambling law does not meet the criteria set forth by the EU Court of Justice or the concerns that the Commission raised. The EGBA has said the Germany’s procedure for granting licenses has led to the exclusion of non-German operators in violation of EU treaty rules. The law, which was ratified by 15 of the 16 German states in June, will only allow a limited number of sports-betting licenses and does not allow for online poker licenses. The Commission had been critical of Germany’s gambling law in the past, but gave Germany some time to test the rules before it intervened.
The EGBA is also challenging the Belgian gaming law that has been in place since January 2012, which it argues is an “opaque and protectionist system.” The EC has yet to rule on the challenge.
Time will tell what the European Union action plan will look like, but we think the European Union should strive for universal legislation across states. Universal legislation will allow for greater quality and consistency in games offered to consumers and allow for gaming operators to be more efficient in the delivery of their product by only having to focus on one set of regulations.
We have previously advocated for the Department of Justice to employ a more narrow reading of the term “foreign official” in the Foreign Corrupt Practices Act. Therefore, we were pleased to see that the DOJ recently issued an opinion that parsed the definition and came to the conclusion that a member of a foreign royal family was not a “foreign official” under the FCPA. Although this is a positive development, it somewhat conflicts with the DOJ’s prior opinions and accordingly will probably serve to further muddy the FCPA waters.
In February 2012, an American lobbying firm approached the DOJ to request an opinion regarding the FCPA implications of its proposed partnership with a foreign consulting group. The consulting group was to act as its sponsor in providing lobbying services for the unspecified foreign country’s embassy in the U.S. The lobbying firm was concerned that this arrangement might implicate the FCPA because the foreign consulting group was owned, in part, by a member of the foreign royal family.
On September 18, the DOJ issued a statement finding that the royal family member was not considered a “foreign official” under the FCPA. The DOJ stated that, “[W]hether a member of a royal family is a ‘foreign official’ turns on such factors as (i) how much control or influence the individual has over the levers of governmental power, execution, administration, finances, and the like; (ii) whether a foreign government characterizes an individual or entity as having governmental power; and (iii) whether and under what circumstances an individual (or entity) may act on behalf of, or bind, a government.”
As the DOJ explained, in this instance the “Royal Family Member holds no title or position in the government, has no governmental duties or responsibilities, is a member of the royal family through custom and tradition rather than blood relation, and has no privileges or benefits because of his status.” The DOJ concluded that, “the Royal Family Member does not qualify as a foreign official under [the FCPA] so long as the Royal Family Member does not directly or indirectly represent that he is acting on behalf of the royal family or in his capacity as a member of the royal family.”
The DOJ surprised us by undertaking a reasonable, thoughtful, and fact-intensive analysis in finding that the royal family member was not a foreign official. However, the new standard invoked by the DOJ conflicts with the broad reading of “foreign official” that the DOJ has previously applied, which encompasses even employees of state-owned communications companies. Surely a telecom employee does not exert much control or influence “over the levers of governmental power,” nor would his government characterize him as having “governmental power.” Yet the DOJ found telecom employees to be foreign officials.
We applaud the DOJ for taking a reasonable approach in determining whether the royal family member is a “foreign official.” We encourage the DOJ to apply the same three factors every time it analyzes who is, and is not, a foreign official.
In an aggressive step against businesses selling drugs online, the U.S. Food and Drug Administration, in conjunction with the U.S. Department of Homeland Security, took legal action earlier this month against more than 4,100 websites this week that led to criminal charges, seizures of illegal products, and hundreds of domain name seizures.
This year Operation Pangea V, a campaign of law enforcement agencies across the globe to counter the global international prescription trade, resulted in the shutdown of over 18,000 unauthorized pharmacy websites and the confiscation of around $10.5 million worth of pharmaceuticals in 100 countries worldwide. Operation Bitter Pill, a federal law enforcement initiative that is part of Operation Pangea V, seized 686 domain names this week as part of the operation, bringing the total number of domain names seized by the domestic operation to 1,525.
The drugs being offered on the websites included such medications as antibiotics, anti-cancer medications, weight loss and food supplements, and erectile dysfunction pills, authorities said.
The FDA had sent warning letters to the managers of 4,100 websites in late September, warning them that products for sale on their sites were in violation of U.S. law. A copy of the letter that the FDA sent to one site can be viewed here.
The agency also sent notices to registries, Internet service providers, and domain name registrars notifying them as well.
Visitors to the websites that have been the subject of domain name seizures will now see an image informing them that the site has knowingly trafficked counterfeit goods, which is a federal crime. Customers were not targeted as part of the investigation. A government spokesman said they were considered to be unwitting victims who were simply purchasing drugs that they thought would be helpful for their conditions.
We don’t endorse counterfeit drugs or trademark violations. But we are concerned that broad domain name seizures, such as those in Operation Bitter Pill, could potentially shut down legitimate businesses and leave them without an online presence for a long period of time until they are able to obtain legal relief. Companies that operate solely with an online presence could see dramatic and potentially crippling effects on their business. We have previously discussed this issue here, for example.
As digital rights groups have repeatedly noted, seizures such as these can run roughshod over the constitutional rights of website operators, including their First Amendment rights, and need to be undertaken by the government, if at all, with an understanding that a seizure of a domain name is not the same thing as the seizure of a truckload full of illegal drugs.
Previously, domain name seizures had been used in investigations by other federal agencies such as the Immigration and Customs Enforcement, the Commodity Futures Trading Commission, the U.S. Department of Justice, and the Federal Trade Commission. The practice appears to be expanding.
Only if the courts provide an adequate check on the powers of the federal government can it be assured that individuals are afforded their due process rights in cases such as this one.
Three states have joined a lawsuit to challenge the constitutionality of the Financial Stability Oversight Council (FSOC), a Dodd-Frank-created regulatory body headed by the Treasury secretary. The panel, composed of top financial regulators, is charged with overseeing broad threats to the financial system, and has the power to liquidate failing non-bank financial institutions it views as a threat to the that system. The attorneys general of Michigan, Oklahoma, and South Carolina are challenging the legality of the FSOC, arguing that the panel is too powerful and should be subject to additional checks and balances.
The states are bringing their claim as a subset of a larger suit filed by the Competitive Enterprise Institute, a conservative think tank that is also challenging the constitutionality of the power granted to the Consumer Financial Protection Bureau (CFPB). The states do not join the challenge to the CFPB but makes claims only against the FSOC. The state attorneys general argue that the FSOC’s liquidation power creates “death panels for American companies” with little outside oversight.
However, the AGs’ argument overlooks both the substance of the provision and the background against it was implemented. Far from lacking oversight, the FSOC must undergo a multi-level, multi-branch review in order to liquidate a financial institution. In order to initiate liquidation proceedings, first there must be a written recommendation for the Treasury Secretary to appoint the FDIC as a receiver for the failing company. The recommendation must contain a host of information including an evaluation of the likelihood of a private-sector alternative to prevent default. Then there must be a two-thirds vote of the Fed Board of Governors and a two-thirds vote of the FDIC or SEC, or the affirmative approval of the Director of the Office of Federal Insurance in order to appoint a receiver.
If the company does not consent to the appointment of the FDIC as a receiver, the matter goes to U.S. District Court for the District of Columbia, where a judge may strike the receivership if it determines that the secretary’s decision was arbitrary and capricious. Finally, the Government Accountability Office must review and report to Congress on any receivership appointment.
This liquidation power is not entirely new. For decades, the FDIC has had the ability to take over failing federally insured banks. The difference is that this new provision extends to non-bank financial companies. This provision was enacted in direct response to the recent financial crisis, in which the federal government had to step in to save financial institutions whose risky investments threatened to collapse the American economy. The role of the FSOC is to eliminate the expectation that the U.S. government will shield the institutions from losses in the event of a future failure, while simultaneously ensuring an orderly liquidation for failed companies.
At this time, the FSOC has not taken action to liquidate any financial institutions. It has, however, designated a number of nonbank financial institutions as “Systematically Important Financial Institutions” (SIFI). Institutions designated as SIFI are subject to more stringent oversight, including stress tests, higher capital levels and tougher liquidity requirements.
The FSOC began making SIFI designations in July of this year, with the fairly uncontroversial designation of eight financial market utilities. On Monday the FSOC announced that it is considering a number of additional non-banks for SIFI designation. AIG has confirmed that it is one of the institutions under consideration, a development that the company said it both expected and welcomes. Other non-banks rumored to be under consideration as SIFIs include MetLife, Prudential, and General Electric.
It appears that the state AG’s are contesting the FSOC’s liquidity authority out of fear that it gives too much power to federal regulators. However, history has shown how economically dangerous it is for financial institutions to be left to their own devices with little oversight or accountability. The FSOC’s powers are constitutional and within the bounds of the law. The states’ challenge should not survive judicial scrutiny, and the FSOC’s liquidation power should be upheld.