July 08, 2014
For-Profit Public Enforcement
Posted by Max Minzner

I blogged yesterday about administrative enforcement, an area that lies at the intersection of criminal and administrative law.  Among other topics, my scholarship has considered the civil penalty process.  In particular, what are the inputs and incentives that shape administrative agency penalties?  

A standard model used to describe the penalty process emphasizes economic theories of deterrence.  Financial penalties are a mechanism to raise the price for violations either to make misconduct completely unprofitable or, in the alternative, to force violators to internalize the costs of violations.  I’ve pointed out one way that this theory may break down – administrative agencies might not focus on deterrence at all.  Instead, their penalties may be crafted to achieve retributive ends. 

In our recent Harvard Law Review article, For-Profit Public Enforcement, Margaret H. Lemos and I looked at penalties from another perspective: public enforcers may have self-interested reasons to maximize civil penalty recoveries.  These incentives are widely recognized in private enforcement.  Class action lawyers, for example, operating on a contingency fee basis have straightforward reasons to maximize recoveries.

Perhaps less obviously, public enforcement lawyers can have comparable incentives to impose large penalties.  These incentives work most clearly in cases where enforcement agencies keep a portion of the civil penalties imposed.  This structure is common in the asset forfeiture process used in connection with many criminal cases and also exists in other state and federal enforcement contexts.   Even when penalties are turned over to the general treasury, enforcers may have reputational incentives to maximize penalties.  Both agencies as a whole and individuals working in enforcement agencies may seek to build a reputation as an aggressive enforcer for reasons other than deterrence.   

Assuming that these claims are right and that civil penalties can be driven by retributive or self-interested goals, is this a problem?  Perhaps, perhaps not.   Self-interested public enforcement may push enforcers to emphasize financial recoveries over other tools of regulatory control, such as injunctive relief.  However, if our default assumption is that administrative agencies underenforce and usually do not impose adequate penalties, the pressure of self-interest may correct this trend to some degree.  

The presence of retribution in civil penalties has similarly mixed effects.  Of course, if penalties are supposed to be carefully calculated to deter, retributive ends will hamper this goal.  On the other end, we now widely recognize the role of norms in shaping compliance behavior.  Retributive punishment done well can shape and reinforce industry norms.  

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July 07, 2014
Retribution and Administrative Law
Posted by Max Minzner

Erik, thank you for that introduction.  It is a pleasure to join the Conglomerate for a week.  My scholarly interests have recently focused on federal administrative enforcement – enforcement actions by agencies like the SEC, the CFTC, as well as a host of lower profile entities. This is a fascinating area of public law combining two scholarly literatures.  Administrative enforcement actions share much in common with criminal cases.  They are brought by public entities to vindicate public wrongs.  However, the administrative context deeply shapes this type of enforcement.  For example, unlike most prosecutor's offices, administrative enforcement bodies tend to be industry-specific.      

As a result, administrative enforcement can go wrong in two different ways– the “criminal law” way or the “administrative law” way.  Administrative agencies face the challenges of regulatory capture, inadequate or incorrect information, or simply the wrong incentives to engage in appropriate regulatory action.  Criminal enforcement, though, often struggles with procedural fairness as well as the difficult task of assigning the correct level of punishment to different forms of misconduct.

Take, for example, this last issue: the fundamental question of penalty levels. Administrative agencies commonly use financial penalties to punish regulatory violations.  How should these penalties be set?  Which cases require the largest penalties and which only need more modest sanctions? 

Criminal law scholars will recognize this question as an inquiry about theories of punishment.  Speaking broadly, criminal law considers a couple of approaches.  Utilitarian theories of punishment (e.g., deterrence, rehabilitation, incapacitation) seek to punish conduct to produce beneficial social outcomes.  Retributive theories emphasize desert – punishment occurs because the violator deserves punishment, not because it produces a social benefit. 

So what do federal agencies do?  As I argue here, administrative agencies almost uniformly talk about deterrence, but usually engage in retribution.  When setting penalty levels, agencies move penalties up or down in response to facts that justify retributive punishment but do not adjust penalties in the way deterrence requires.  For instance, building on Gary Becker’s justifiably famous work, Crime and Punishment: An Economic Approach, most deterrence theories emphasize the role of the probability of detection in setting penalty levels.  To deter appropriately, penalties need to increase when violations are harder to detect and punish.  In practice, though, administrative agencies place little weight on this issue.  Instead, agencies are deeply concerned with issues like mens rea, a topic far more central to retributive theories of punishment.

Is this retributive bent in administrative enforcement surprising?  Perhaps not.  A large literature suggests that most people are intuitively retributive when making punishment choices.  In social science experiments, study participants set penalties based on retributive concerns, but do not adjust punishment levels in ways that would be required to deter appropriately.  In this way, administrative agencies look like the rest of us.  We mostly care about desert even when we talk about deterrence.  

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June 28, 2014
Why the Government Should (Sometimes) Help Companies “Cheat” on their Taxes
Posted by Ted Sichelman

For this last guest post, I decided to eschew IP (well, to some degree, see below) and focus on a recent article of mine and Leandra LedermanEnforcement as Substance in Tax Compliance—that (in my biased opinion) deserves more press. (Though, to be certain, Leandra would strongly disagree with my catchy title—see more on that below.)

In the article, we argue that the failure of the tax authorities to perfectly enforce the tax laws in effect can alter the substance of the tax laws, at least to the extent that taxpayers know the penalties for non-compliance and can reasonably predict how often the tax authorities conduct audits for certain classes of taxpayers.

This claim is quite different from the one that audit rates merely affect the propensity of taxpayers to “cheat.” Rather, the effective tax rate can be intentionally adjusted downward (and not just to zero) by the taxing authorities from the nominal tax rate, in effect, yielding an entirely new substantive law.

For instance, suppose there is a sales tax of 5% and that given current audit strategies, the effective tax rate is 4% in all industries, because 20%  of the taxes go unpaid in each industry. Based upon the elasticity characteristics of the products in a given industry—in other words, the propensity of purchasers to continue buying as the price of a good increases—under certain circumstances, the tax authority can adjust its audit rates in one industry relative to another to change the compliance by taxpayers in each industry. This adjustment, in turn, can change the effective tax rates paid by a given industry. For instance, the tax authority might audit more heavily in an industry selling luxury cars than in one selling textbooks, yielding effective tax rates of 4.5% in the luxury car industry and 3.5% in the textbook industry.

The ability of the tax authority to generate different effective tax rates from the same nominal tax rate is an example of what we call “enforcement as substance,” namely the ability of differential enforcement strategies to effectively change the substantive law. A broader (and much less studied) question is whether “enforcement as substance” can be intentionally harnessed to improve social welfare.

Drawing upon work of mine in IP and others that shows that imperfect enforcement can decrease deadweight losses stemming from the issuance of patent rights, we show in our article that a “measured enforcement” policy (i.e., a conscious strategy to differentiate enforcement among different legal actors) can improve social welfare. In the tax context, measured enforcement can similarly be used to decrease deadweight losses caused by taxation, specifically by placing more of an onus on those industries with lower elasticities. Additionally, tax authorities can implement a quasi-Pigouvian tax on activities otherwise imposing negative externalities by upping enforcement of taxes on those activities.

Importantly, we show that under a variety of conditions, measured enforcement can yield welfare benefits while maintaining or even increasing the government’s total tax revenue. Some of these conditions are that the taxpayers be sophisticated and informed and respond rationally to incentives provided by the tax authority’s publicizing of its enforcement strategy. Generally, we believe large, sophisticated corporations—at least as an initial matter—would fit this bill.

Additionally, contrary to the title of this post—such a system should not be billed as one promoting “cheating.” Rather, like prosecutorial discretion in the criminal law context, here the tax authority would use its on-the-ground enforcement discretion to achieve optimal deterrence—namely, the use of its resources in those areas that most need it not solely to increase the public fisc, but to improve overall social welfare. Such allocation of resources of course is not tantamount to promoting cheating in the conventional sense (hence, the quotes around “cheat” in the title of this post).

One potential concern with such an approach is the possibility of abuse on the part of the taxing authority—adjusting enforcement not to benefit society, but as a means of political reward and punishment. Yet, our proposal yields no more room for abuse than under the current system. Indeed, under our framework, the taxing authority would publish its audit rates (otherwise, how could taxpayers adjust their behavior?), making its audit scheme much more transparent than it is now.

Of course, other potential concerns arise in such a scheme, such as separation of powers and horizontal equity (“treating like taxpayers alike”).  We address these and other potential issues in detail in the article, concluding (of course) that none are fatal.

On a final note, thanks again to Gordon Smith to letting me guest blog the last few weeks—now, it’s back to the run-of-the-mill life as a law professor in the summer: writing law review articles (most of the time spent on the footnotes), lamenting the decline in law school enrollment, and enjoying the World Cup, Wimbledon, and the occasional barbeque.

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March 08, 2014
Destructive Coordination in Securities Contracts
Posted by Greg Shill

Domino-effect
Image: Flickr

In my last post—also a shameless plug for my recent article, “Boilerplate Shock”—I argued that boilerplate terms governing securities could serve as a trigger that transforms an isolated credit event into the risk of a broader systemic failure. I’ll now briefly explain why I see this danger—which I call “boilerplate shock”—as a general problem in securities regulation, not just some quirky feature of Eurozone sovereign debt (the focus of the paper and post). Any market where securities are governed by uniform boilerplate terms is vulnerable to boilerplate shock.

The nature of this phenomenon—systemic risk—is of course familiar, but its source in contract language is a little unintuitive. How could private contracts unravel an entire securities market or the world economy?

Coordination around uniform standards. 

In the back of our mind most of us probably still conceive of contracting as an activity that occurs among two, or perhaps a few, individuals or firms. But when standard terms are used by virtually all actors within a given market, it’s worth considering the collective impact of those terms as a distinct phenomenon.

Coordination’s benefits are well known. Consider uniform traffic signals. But coordination can also compound the effects of bad individual decisions.

As Charles Whitehead has argued, widespread “destructive coordination” among banks during the precrisis days helped generate systemic risks. When the credit markets froze, for example, firms using the same risk management formulas reacted in the same way at the same time. This helped transform isolated events into systemic ones—e.g., Lehman, the canonical example of a failure that triggered a de facto coordinated panic.

A similar risk, I argue, is present where participants in a securities market rely on the same standardized contract terms. Whether they were intended to or not, these terms will often control what happens in the event of certain legal emergencies, like a country departing the euro or Lehman declaring bankruptcy.

For example, if an effort by Greece to pay its bonds in “new drachmas” is rejected because of Boilerplate Contract Terms A and B, the market will surely be concerned that Terms A and B also govern the bonds of similarly situated borrowers, like Spain, Italy, etc. You’ll see that the borrowing premium the “peripheral” euro countries (the uppermost five lines: Ireland, Italy, Greece (biggest spike), Portugal, Spain) paid versus richer euro countries (Germany, France, the Netherlands, the three lowest lines) zoomed higher as worry over a Greece exit gripped markets in late 2011/early 2012, and again (to a lesser extent) because of Cyprus exit talk in early 2013:

Eurozone Debt Chart 1-1-10 - 7-13-13

Bloomberg. Click to enlarge.

Moreover, this panic occurred against a backdrop of unduly rosy assumptions (namely, that a departing euro country could convert its bonds into a new currency and thereby avoid default, a likely contagion trigger). I argue that the uniformity of boilerplate across these bonds would intensify these problems significantly since it’s likely to result in a declaration of default.

To my mind, this demonstrates that boilerplate securities contracts, in the aggregate, can be systemically significant. “Boilerplate Shock” introduces this concept and offers a modest proposal to mitigate its dangers in the Eurozone.

Beyond the euro, what about the risks of boilerplate shock in general?

Boilerplate shock is probably an inherent and permanent risk in any securities market.

Securities contracts are quintessential candidates for boilerplate. They are used by sophisticated parties for repeat or similar transactions and are drafted quickly—sometimes in three and a half minutes. The (correct) assumption is that they are more efficient for the parties that use them.

I’d like to begin thinking about how contracts can be drafted with a view to systemic risk mitigation, or at least to avoid exacerbating existing risks. But I think this is a hard problem that lacks an off-the-shelf solution:

  • The risk is also an externality: it is severe because of its collective impact. The parties do not bear the primary risk that uniform contracts will result in a meltdown, and in the unlikely event a crash happens (1) no individual party will be to blame and (2) at least one party to the initial transaction (the initial purchaser of a bond, for example) will probably no longer hold the asset, because most systemically significant securities are actively traded on the secondary market.

But banning or discouraging boilerplate is not the answer:

  • The risk that a bunch of assets governed by the same terms will plummet in value is not only an externality. Risk allocation among parties might improve if scrutiny of existing securities boilerplate improves. The terms can evolve.

  • A requirement to craft unique, artisanal terms—disclosures, subordination provisions ("flip clauses"), choice of governing law—for each individual securities transaction would be criminally inefficient.

  • A requirement to craft unique contract terms might even be unjustified on risk-management terms alone, because it would increase drafting errors.

It's tricky to mitigate the risks of securities boilerplate.

Some options for places to start:

  1. Validation by third parties: perhaps issuers could use risk-rated contract templates. For example, see credit ratings…but see credit ratings.
  2. Culture: inculcate systemic risk mitigation as a professional norm among private sector lawyers? In principle, this could work. The number of lawyers who draft these contracts is pretty small. In practice, one could envision many complications.
  3. Insurance: encourage the development of derivatives to account for the possibility of boilerplate shock? Like some of the other solutions, this one presumes some agreement on what terms create the risk of boilerplate shock. It could also encourage new forms of moral hazard.
  4. Mandatory regulation: some public entity could be tasked with the mission of proactively identifying and combating the risk of boilerplate shock in contract practices. Arguably a natural choice given that the risk is an externality. Nevertheless, I’m a little skeptical. First of all, who would do it? A domestic regulator, like the SEC or CFTC, that might be dodged on jurisdictional grounds? An international institution, which is arguably more subject to capture? More generally, regulation seems like a heavy-handed first choice.

In sum, when standardized and aggregated, choices that determine legal risks—e.g., contract terms designating governing law, payment priority—can create the same hazards as choices about business risks. This suggests that contract terms should be taken seriously as possible sources of systemic risk alongside more familiar sources, like leverage and credit quality.

Securities contracts as a source of systemic risk—what do you think?

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March 07, 2014
More Monies, More Problems
Posted by Greg Shill

Duck tales    

 

 

 

 

 

 

 

© Disney, “Duck Tales”

I expressed concern in my last post that uniform contract terms could destabilize securities markets in unexpected ways. In a recent paper, I dub this risk “Boilerplate Shock.” The paper uses boilerplate terms in Eurozone sovereign bonds as a case study, but I argue that any market in which a lot of securities are governed by uniform contract terms is vulnerable to boilerplate shock. In this post, I will focus on the Eurozone and my proposed solution to the risk of boilerplate shock there.

One major problem is that no one really knows how to deal with sovereign debt obligations denominated in a currency that still exists but is no longer used by the debtor. A partial breakup of the European Monetary Union would trigger some question marks in commercial law and private international law (among other things).

In the Eurozone sovereign lending market, bond contracts typically contain standardized language specifying:

(a)  choice of governing law (often foreign), and
(b)  currency of payment (euros).

The combined effect of these clauses, I argue, is to render any country that departs the euro more likely to default on its debt. Whatever the impact of the departure itself, a forced default would make things much worse for Europe and the world economy.

Leading scholars have concluded or strongly suggested that a sovereign that changes currencies can redenominate (convert) its bonds to its new currency even where the contract is governed by foreign law (e.g., Philip Wood (p. 177), Michael Gruson (p. 456), Arthur Nussbaum (pp. 353-59), Robert Hockett (passim)). As a descriptive matter, I believe this to be a mistaken interpretation of New York (and probably English) private international law and commercial law (see “Boilerplate Shock” pp. 47-67). But normatively, I agree: a sovereign should be able to redenominate its bonds under certain circumstances. Among other things, the alternative would make currency union breakups far more dangerous than they already are.

In brief:

  • The prevailing consensus underestimates the risk that a departing Eurozone member’s attempt to redenominate its sovereign bonds into a new currency will be ruled a default.

  • Since the bonds of other struggling euro countries are largely governed by the same boilerplate terms ((a) and (b) above), this misapprehension has the potential to be particularly damaging. In addition to surprising the market (which appears to incorporate this consensus), it is likely to spread beyond the immediate debtor to the bonds of similarly situated countries that have issued under the same terms.

  • Same for CDSs (which are likewise often governed by foreign law, usually New York).

  • Thus, given the widespread use of terms (a) and (b), a ruling that a departing country cannot pay its euro-denominated contracts in a new currency could cause the market to demand unsustainable premiums from other weak debtors.

  • This could cause Eurozone countries to lose market access. Greece is not TBTF in any sense, but some of its neighbors are—and are also too big for the EU (including the ECB) and IMF to bail out. Italy (the world’s 9th largest economy) and Spain (13th) come to mind.

Thus, if my commercial law/private international law analysis is right, these boilerplate contracts could end up playing quite a big role in the event of any euro breakup. 

To mitigate this risk of boilerplate shock, I suggest a new rule of contract interpretation. The proposal is detailed at pp. 67-71 of the article. I suggest commercially significant jurisdictions adopt it by statute. Here is a quick summary.

Any sovereign that:

  1. Belongs to an international monetary union, and
  2. Issues bonds in the currency of that monetary union subsequent to the adoption of this rule, and
  3. Leaves the monetary union and introduces its own currency,

shall retain the right to redenominate its bond obligations into its new currency, UNLESS the sovereign has affirmatively waived the right to redenominate its bonds.

You’ll notice this is a default rule—merely a presumption of the right to redenominate—not a mandatory rule. It is also prospective-only: it does not apply to existing issuances. It also does not protect sovereigns that issue in foreign currency (e.g., Argentina), only those that are monetary union members and issue in the common currency (e.g., France).

The reason for these limitations is to minimize unintended consequences and near-term disruption to the market, but also to embody the relatively modest objectives of the rule. It is an information-forcing default rule that is intended to facilitate better risk management by parties. It is not a “save the world” rule.

The challenge, as I’ll discuss in my next post on the paper, is not that redenomination would be ruled impermissible when it ought to be available (otherwise, that might suggest a mandatory “pro-redenomination” rule). It is that the likely effect of these boilerplate terms—to prohibit redenomination—was almost certainly not bargained for and is largely unknown to parties. This market failure has, in turn, created latent risks to the broader financial system and the existing legal tools are poorly suited to address them.

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March 03, 2014
The Risks of "Boilerplate Shock" in the Eurozone and Beyond
Posted by Greg Shill

By now, the risk that a distressed European nation such as Greece might leave the Eurozone and thereby spark global economic calamity is well known. Regular readers of this blog may even privately relish the prominence of the issue. Not since the days of the gold standard has international monetary policy come so close to being a socially acceptable topic of dinner conversation.

As I noted in my first post, observers rightly perceive the Eurozone sovereign debt crisis to be driven by political and economic forces. But many consequences of a euro breakup would be determined by law, including sources of American (specifically New York) private law.

This is a complex issue. I try to address it more fully in a new article, "Boilerplate Shock," which I've just posted on SSRN.

In brief, and to continue picking on Greece, one key question in the event of a euro breakup would be: would a court recognize an attempt by Greece to convert its euro-denominated debt into its new currency, or would it instead insist that Greece pay in euros, the currency of contract? The answer is important because, as a practical matter, requiring payment in euro would be tantamount to forcing a default.

That's the familiar narrative, anyway. And I agree. But I believe that the ubiquity of boilerplate terms in these bonds—specifically, clauses selecting governing law (usually foreign) and currency of payment (euro)—is likely to make any dispute over redenomination even more damaging than this suggests.

In the article, I argue that the sparse literature on the question of redenominating sovereign bonds overlooks some sources—especially cases interpreting New York contract law and private international law—that, if extended to Eurozone sovereign bonds, could surprise the market and cause serious global repercussions. I argue that the reason for this is not only that the dominant view overlooks what are likely controlling sources of law. It is that standardization of contract terms across the Eurozone sovereign lending market makes the stakes of surprise that much higher.

If Greece's attempt to redenominate its bonds is declared a default, then the fact that the operative terms in Italian, Spanish, Irish, etc. sovereign bonds are the same or similar makes markets likely to demand unsustainable premiums from those countries. Capital and investor flight could be very rapid. We have seen several previews of this movie over the past few years in the Eurozone, and each time official-sector bailout institutions have saved the day. But the European Union/European Central Bank and IMF probably do not have the resources to stop a broad-based bank run of this nature, to say nothing of the political support necessary to attempt it.

Maybe none of that will happen. Nevertheless, the potential for uniform contract terms to create risk not just to individual third parties but to securities markets seems likely to grow at least as fast as those markets. Using Eurozone sovereign bonds as a case study, I introduce the term "boilerplate shock" to describe the potential for standardized contract terms—when they come to govern the entire market for a given security—to transform an isolated default on a single contract into a threat to the market of which it is a part, and, possibly, to the economy in general. My larger objective here is to foster a discussion of the potential for securities law and private-sector securities lawyers to manage (or alternatively, to contribute to) systemic risk.

I've posted an abstract below and will be returning to the subject. I look forward your comments.

Boilerplate Shock abstract:

No nation was spared in the recent global downturn, but several Eurozone countries arguably took the hardest punch, and they are still down. Doubts about the solvency of Greece, Spain, and some of their neighbors are making it more likely that the euro will break up. Observers fear a single departure and sovereign debt default might set off a “bank run” on the common European currency, with devastating regional and global consequences.

What mechanisms are available to address—or ideally, to prevent—such a disaster?

One unlikely candidate is boilerplate language in the contracts that govern sovereign bonds. As suggested by the term “boilerplate,” these are provisions that have not been given a great deal of thought. And yet they have the potential to be a powerful tool in confronting the threat of a global economic conflagration—or in fanning the flames.

Scholars currently believe that a country departing the Eurozone could convert its debt obligations to a new currency, thereby rendering its debt burden manageable and staving off default. However, this Article argues that these boilerplate terms—specifically, clauses specifying the law that governs the bond and the currency in which it will be paid—would likely prevent such a result. Instead, the courts most likely to interpret these terms would probably declare a departing country’s effort to repay a sovereign bond in its new currency a default.

A default would inflict damage far beyond the immediate parties. Not only would it surprise the market, it would be taken to predict the future of other struggling European countries’ debt obligations, because they are largely governed by the same boilerplate terms.  The possibility of such a result therefore increases the risk that a single nation’s departure from the euro will bring down the currency and trigger a global meltdown.

To mitigate this risk, this Article proposes a new rule of contract interpretation that would allow a sovereign bond to be paid in the borrower’s new currency under certain circumstances. It also introduces the phrase “boilerplate shock” to describe the potential for standardized contract terms drafted by lawyers—when they come to dominate the entire market for a given security—to transform an isolated default on a single contract into a threat to the broader economy. Beyond the immediate crisis in the Eurozone, the Article urges scholars, policymakers, and practitioners to address the potential for boilerplate shock in securities markets to damage the global economy.

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February 27, 2014
The Risks of Finding a Father for Your Child on Craigslist
Posted by Greg Shill

Before returning to the legal boundaries of monetary policy, I wanted to briefly highlight some interesting contract and regulatory issues lurking just beneath the surface of an unusual Kansas state court order declaring a sperm donor to be the legal father of a child, against the wishes of all persons involved.

The facts of the case, decided last month and covered nationally (news accountorder (PDF)), are straightforward and undisputed:

In 2009, a Topeka man answered a Craigslist ad soliciting sperm donations. The ad was placed by a lesbian couple, Jennifer Schreiner and Angela Bauer. The man supplied a donation. Schreiner became pregnant and delivered a baby. Schreiner began receiving Kansas welfare benefits for the child. Seeking child support payments, the state sued the sperm donor to establish paternity. The state argued that the donor—who lacks any relationship with the child or the couple (now estranged) beyond supplying the donation—was the child’s legal father, and therefore must pay child support.

This is where the case gets interesting as a matter of private ordering and trade regulation.

Prior to the donation, all persons involved—the donor and both members of the couple—signed a non-paternity agreement in which the donor waived his parental rights and was released from his parental obligations.

Both mothers opposed the state’s campaign to declare the donor the child's legal father.

Nevertheless, the court granted the state’s paternity petition, which means it can now seek to compel the donor to provide child support. The paternity finding also appears to give the donor a good shot at asserting parental rights (though he seems unlikely to try).

Justifying its decision to ignore the wishes of both parents and the donor, the court intoned:

A parent may not terminate parental rights by contract, however, even when the parties have consented.

Well, maybe this case is a morality tale about those who would seek a father for their child on Craigslist. A warning from a heartland state to those who would selfishly try to contract around their sacred parental obligations. A sign that courts place the welfare of the child above all else. Right?

Haha, of course not!

Kansas law makes it easy to conclusively terminate the parental rights and obligations of sperm donors by contract. Care to guess what you need to do, besides sign a contract?

Pay a doctor.

The court explained:

Through K.S.A. 23-2208(f) [PDF], the Kansas legislature has afforded a woman a statutory vehicle for obtaining semen for [artificial insemination] in a manner that protects her and her child from a later claim of paternity by the donor. Similarly, the legislature has provided a man with a statutory vehicle for donating semen to a woman in a manner that precludes later liability for child support. The limitation on the application of these statutory vehicles, however, is that the semen must be “provided to a licensed physician." [FN1] (emphasis added)

The parties failed to do this.

So, the upshot is that you are free to find a father for your child on Craigslist—and you can even count on the State of Kansas to keep him out of your child’s life in the future—so long as you hire a doctor to do the procedure. Similarly, you can spend your free time fathering children on Craigslist without losing sleep over child support suits—as long as you kick some of the action upstairs to an M.D.

It’s not just Kansas; California, Illinois, and as many as 10 other states [FN2] follow the same law, the Uniform Parentage Act of 1973.

I’m not a family law expert, but it seems to me that a complete list of legitimate and unique public policy concerns that are implicated when a couple and a third-party sperm donor settle their parental obligations by contract looks something like this:

  1. Ensuring that the state can identify who can be held legally responsible for supporting the child.

Nevertheless, let’s assume there are also truly compelling public health reasons to involve a physician in artificial insemination. After speaking with a few doctors, I’m skeptical that this is the case, but even if it were here are ten points that I think are worth considering:

  1. Should a mother who became pregnant by artificial insemination be forced to share parental rights with a stranger who donated sperm simply because she decided not to hire a doctor for the procedure?

  2. Conversely, should the scope of a sperm donor’s rights and responsibilities as a father turn on the decision whether to enlist a doctor to oversee the procedure?

  3. Should the adequacy of a child support scheme turn on whether couples using sperm donors choose to hire a doctor?

  4. There are sound public policy reasons to be concerned about voluntariness in agreements that waive paternity. But if this case is really about ensuring voluntariness, why is enlisting doctors the solution? Establishing consent during contract formation is not some novel problem. Hiring a doctor is a novel solution, but as an evidentiary device it is not very probative.

  5. Hiring doctors for artificial insemination is not cheap. A single attempt through a physician’s office costs about $3,000, and sometimes multiple attempts are necessary. Unsurprisingly, the American Fertility Association (a trade group for the fertility industry) applauded the court’s decision.

  6. This rule looks even more like an attempt to extract rents when you consider that for many people, the price of artificial insemination without physician assistance may be zero.

  7. If the state interest in the use of doctor-assisted artificial insemination is so compelling, maybe the law should simply require it on penalty of criminal sanction. I have never even heard this idea floated, probably because it would be perceived (rightly) as an excessive intrusion on various important freedoms…

  8. yet while they do not provide criminal sanctions, about 13 states are willing to provide unbelievably harsh "family-law sanctions." If a woman declines to hire a doctor, she is placing herself and her child in eternal jeopardy; at any time, the donor or the state can move to declare the donor to be the legal father, which would put the donor in a position to seek full parental rights—even if he is a stranger. (The same is true in reverse re: child support.) It is unsurprising that both mothers opposed the state’s petition.

  9. Although facially neutral, this rule is almost certainly discriminatory in practice. It means that lesbian couples must either hire a doctor or adopt—there is no other way they can safely preclude the donor from being granted parental rights. And of course this is just one of many unofficial taxes gays and lesbians must pay, especially in states like Kansas that do not allow them to marry. It seems to me that there’s a good argument the law should fail rational basis or equal protection review, but I will leave that brief to the con law scholars.

  10. Finally, beyond any constitutional infirmity, this law should serve as a reminder that protectionist regulations—which often take the form of onerous occupational licensing restrictions and NIMBY zoning rules—frequently have regressive distributional consequences, because they tend to favor powerful incumbents. And although probably not the case here, such laws can harm the broader economy as well by stifling innovation.

I welcome your comments. And I hope my doctor friends still talk to me.

* * * *

[FN1] It should be noted that under the letter of the statute as well as a 2007 Kansas Supreme Court decision (PDF) on this issue, the court did not have an obvious alternative to finding for the state. The problem, such as there is one, is with the statute.

[FN2] An accurate count is not possible without doing a full 50-state survey. As I have written about previously, the Uniform Law Commission’s Enactment Status Maps are often unreliable or imprecise (see FNs 163 & 188).

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February 24, 2014
Should Legal Scholars Refrain from Writing about Macroeconomics?
Posted by Greg Shill

Yellen_janet Draghi

Greetings, Glommers! (and hello, Janet and Mario*!)

It’s an honor to join this extremely sharp and thoughtful community of corporate and commercial law scholars for the next two weeks.  The Conglomerate has long been one of my favorite law blogs and it’s truly a privilege to walk among these folks for a time (if a bit daunting to follow not just them but Urska Velikonja and her excellent guest posts).  Thanks to Gordon, David, and their Glom partners for inviting me to contribute.

By way of biographical introduction, I’m currently a Visiting Assistant Professor at the University of Denver Sturm College of Law, where I teach International Business Transactions and International Commercial Arbitration.  Last year, I did a VAP at Hofstra Law School (and taught Bus Orgs and Contracts).

In the next few weeks, I’ll be exploring a number of issues related to law and global finance.  I have a particular interest in currencies and monetary law, or the law governing monetary policy.  Two of my current projects (on which more soon) address legal aspects of critical macroeconomic policy questions that have emerged since 2008: U.S. monetary policy and the Eurozone sovereign debt crisis.

Without further ado, I will take a page from Urska and kick off my residency here with a somewhat meta question: should scholars refrain from writing about legal issues in macroeconomics, specifically monetary policy?

One thinks of monetary policy decisions—whether or not to raise interest rates, purchase billions of dollars of securities on the secondary market ("quantitative easing"), devalue or change a currency—as fundamentally driven by political and economic factors, not law.  And of course they are.  But the law has a lot to say about them and their consequences, and legal scholarship has been pretty quiet on this.

Some concrete examples of the types of questions I’m talking about would be:

  • Pursuant to its dual mandate (to maintain price stability and full employment), what kinds of measures can the Federal Reserve legally undertake for the purpose of promoting full employment?  More generally, what are the Fed’s legal constraints?
  • What recognition should American courts extend to an attempt by a departing Eurozone member state to redenominate its sovereign debt into a new currency?

When it comes to issues like these, it is probably even more true than usual that law defines the boundaries of policy.  Legal constraints in the context of U.S. monetary policy appear fairly robust even in times of crisis.  For example, policymakers themselves often cite law as a major constraint when speaking of the tools available to the Federal Reserve in combating unemployment and deflation post-2008.  Leading economics commentators do too.  Yet commentary on “Fed law” is grossly underdeveloped.  With the exception of a handful of impressive works (e.g., by Colleen Baker and Peter Conti-Brown), legal academics have largely left commentary on the Fed and macroeconomics to the econ crowd.

A different sort of abstention characterizes legal scholarship on the euro crisis.  Unlike the question of Fed power, there is a burgeoning literature on various “what-if” euro break-up scenarios.  But this writing tends to focus on the impact on individual debtors and creditors, not on the cumulative impact on the global financial system.  Again, the macro element is missing.

It is curious that so many legal scholars would voluntarily absent themselves from monetary policy debates.  The subtext is that monetary policy questions are either normatively or descriptively beyond the realm of law.  If that is scholars’ actual view, I think it is misguided.  But maybe the silence is not as revealing as all that.

  1. One issue is sources.  You will not find a lot of useful caselaw on the Fed’s mandate or the Federal Reserve Act of 1913, and the relevant statutes and regulations are not very illuminating.  Further, it’s a secretive institution and that makes any research (legal or otherwise) on its inner workings challenging.

  2. Another issue is focus.  Arguably the natural home of legal scholarship on domestic monetary issues, for example, should be administrative law.  But the admin scholarly gestalt is not generally as econ-centric as, say, securities law.  Meanwhile, securities scholars tend to focus on microeconomic issues like management-shareholder dynamics.

  3. A final possibility, at least in the international realm, is historical.  After World War II, Bretton Woods established a legal framework intended to minimize the chance that monetary policy would again be used as a weapon of war.  The Bretton Woods system collapsed over forty years ago, the giants of international monetary law (Frederick Mann, Arthur Nussbaum) wrote (and died) during the twentieth century, and now even some of the leading scholars who followed in their footsteps have passed away.  At the same time, capital now flows freely across borders and global financial regulation has become less legalized in general.  These factors plus the decline of exchange-rate regulations (most countries let their currencies float) may have undermined scholars’ interest in monetary law.  But as the ongoing euro saga demonstrates, international monetary law and institutions remain as critical as ever.

These are some possible explanations for why legal scholars have largely neglected questions of monetary law, but I’m sure I’ve overlooked others.  What do you think?

*Pictured are Janet Yellen and Mario Draghi, chiefs, respectively, of the Federal Reserve and the European Central Bank.

Permalink | Administrative Law| Comparative Law| Economics| European Union| Finance| Financial Crisis| Financial Institutions| Globalization/Trade| Law & Economics| Legal Scholarship | Comments (5) | TrackBack (0) | Bookmark

February 15, 2014
Speech v. Economic Activity
Posted by Gordon Smith

Ronald Coase had some ideas about why speech is given more protection from government intervention than economic activity:

The paradox is that government intervention which is so harmful in the one sphere [speech] becomes beneficial in the other [economics activity].... What is the explanation for the paradox? ... The market for ideas is the market in which the intellectual conducts his trade. The explanation of the paradox is self-interest and self-esteem. Self-esteem leads the intellectuals to magnify the importance of their own market. That others should be regulated seems natural, particularly as many of the intellectuals see themselves as doing the regulating. But self-interest combines with self-esteem to ensure that, while others are regulated, regulation should not apply to them. And so it is possible to live with these contradictory views about the role of government in these two markets. It is the conclusion that matters. It may not be a nice explanation, but I can think of no other for this strange situation.

Ronald H. Coase, The Economics of the First Amendment: The Market for Goods and the Market for Ideas, 64 AM. ECON. REV. PROC. 384, 386 (1974).

There are some powerful counters to this argument (e.g., speech is a public good that is likely to be underproduced, especially if not protected vigorously), but I just thought it was interesting that Coase had written this article on the First Amendment.

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January 15, 2014
My new book: Law, Bubbles, and Financial Regulation
Posted by Erik Gerding

After over four years of work, my book Law, Bubbles, and Financial Regulation came out at the end of 2013.  You can read a longer description of the book at the Harvard Corporate Governance blog.  Blurbs from Liaquat Ahamed, Michael Barr, Margaret Blair, Frank Partnoy, and Nouriel Roubini are on the Routledge’s web site and the book's Amazon page. The introductory chapter is available for free on ssrn.

Look for a Conglomerate book club on the book on the first week of February!

Permalink | Books| Comparative Law| Corporate Law| Economics| Finance| Financial Crisis| Financial Institutions| Law & Economics| Legal History| Legal Scholarship| Securities| White Collar Crime| Wisdom and Virtue | Comments (0) | TrackBack (0) | Bookmark

October 02, 2013
Chicago Gets A Law And Business Gift
Posted by David Zaring

Dan Doctoroff is giving $5 million to the law school in Hyde Park to develop a law and business curriculum, which isn't exactly a vast amount of money, but congratulations to UC nonetheless.  Like Wharton, Chicago has a 5-years-in-4 MBA-JD program already; there is a lot of happiness about the program in these parts, but it does require students to pay a ton of tuition, and compresses their schedule flexibility massively.  It sounds the Doctoroff donation will permit law students to take classes at Booth, or maybe buy out some Booth teachers to teach a class exclusively comprised of law students on asset valuation, managerial economics, and &c.

One bridge that must be crossed for such classes concerns the basic level of knowledge of the law students.  Some Wharton students are coming from the army or Teach For America, but most have been spending a few years working on spreadsheets and going through quarterly statements.  This sort of thing provides a critical background (and a culture spreadable to those who are abandoning their careers in ballet or publishing) that just being smart and eager does not, and my case study for that would be the accounting for lawyers classes you might have taken in law school, and promptly forgot about.  Good luck to Chicago as it seeks to deliver classes that law students can find instructive; oddly enough, it might be easier to focus on undergraduate finance offerings rather than on the MBA program.

Permalink | Accounting| Finance| Law & Economics| Law Schools/Lawyering | Comments (0) | TrackBack (0) | Bookmark

May 23, 2013
The Law and Economics of Tornado Shelters (and Angelina Jolie)
Posted by Christine Hurt

Here is my disclaimer:  I'm from "tornado alley."  Here is "my tornado."  The Lubbock tornado was 43 years ago (gulp), when I was an infant.  I have no memories of it, just the story that my parents told me.  We went down the street to a neighbor's storm cellar; the tornado didn't come that close to our neighborhood; we left the dog in our kitchen.

This week, as the history of the Moore, Oklahoma tornado is being written, I have read articles and heard radio stories asking why more residents in tornado-prone areas don't have storm cellars or safe rooms in their houses, schools, etc.  Not only why don't residents take more precautions, but why doesn't the law require new houses have tornado protection (similar to earthquake building requirements). 

I never had a basement until I moved out of Texas to the Midwest.  In West Texas, and it seems Oklahoma and maybe further north, basements aren't really necessary.  Land is flat and available.  If you want more square footage, building out is cheaper than digging a basement in the really, really hard soil.  I remember having two friends my entire childhood that had basements, and everyone was really, really jealous of them (mostly because there seemed to be a lot more kissing in basements than in main floor family rooms).  Basements would also be handy in the case of a tornado, but are rare.  Instead of digging a basement, the law could require a separate storm cellar in a backyard or attached.  The NYT article estimated this cost as $4k, which seems like a low estimate to me.  So, is adding $4k to every newly constructed home prohibitive?  Is it wise?

The problem is that everyone doesn't need their own cellar, and most people will never need one.  If  you think of all the homes that are situated in tornado alley, the probability of a particular home needing a cellar is really, really low.  And the cellar doesn't save your house.  It saves you, if you happen to be at your house.  At least in the Lubbock tornado, many victims were in cars, or fleeing their cars.  (Here are some pretty interesting tornado data.)  The reporters seen to think the probability of needing a cellar is really high in Moore, which also had a tornado in 1999 (no fatalities, but property damage).  In a perfect world, there would be one storm cellar, safe room or basement per block, not per house.  That's pretty hard to regulate.  But, having a storm cellar or safe room per school or office building doesn't seem like a bad idea.  (I haven't heard anyone talk about mobile homes/trailer homes, which are even less stable than a home with a shallow foundation.)

Interestingly, this same week, commentators in the news have questioned Angelina Jolie's choice to have genetic testing for breast cancer (that costs $3-4k, a little less than a storm shelter), then have a double mastectomy when she learned a rare gene gave her probability of getting breast cancer was 87%.  Well, no one in tornado alley has an 87% chance of dying in a tornado.

The other variable, besides the probability that a tornado will hit not only your town, but your block, is whether you would go into the storm cellar.  Here, the NYT article and the NPR story seemed to suggest that there is a low level of panic for residents of tornado alley.  That may be true.  The summers of my childhood seemed to be filled with tornado warnings and tornado watches, which we soon began to ignore.  These warnings would shoot across our broadcast TV channels, and some families had storm radios in case the electricity went off.  But, after awhile, you get a little desensitized to the daily tornado warning.  And, of course, there are stormchasers, a category of thrill-seekers that I still don't understand.  But even non-stormchasers can be mesmerized on their way to the cellar watching the sky, which looks really awesome in the middle of a storm.

But I guess what bothers me about these "why don't you have a cellar" questions is an underlying sense that people in tornado alley are stupid, so we should regulate their housing.  I disagree.

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March 22, 2013
Discretion
Posted by Gordon Smith

One of my colleagues said that my latest article (written with one of my excellent students, Jordan Lee) sounds like an R-rated movie. The title is Discretion, and here is the abstract:

Discretion is an important feature of all contractual relationships. In this Article, we rely on incomplete contract theory to motivate our study of discretion, with particular attention to fiduciary relationships. We make two contributions to the substantial literature on fiduciary law. First, we describe the role of fiduciary law as “boundary enforcement,” and we urge courts to honor the appropriate exercise of discretion by fiduciaries, even when the beneficiary or the judge might perceive a preferable action after the fact. Second, we answer the question, how should a court define the boundaries of fiduciary discretion? We observe that courts often define these boundaries by reference to industry customs and social norms. We also defend this as the most sensible and coherent approach to boundary enforcement.

I wrote an article about a decade ago called "The Critical Resource Theory of Fiduciary Duty" that still gets downloaded and cited a fair amount, at least for a fiduciary duty article. It is about the structure of fiduciary relationships, and I wanted to do a follow on article about how courts know when someone has breached a fiduciary duty. I actually had a fairly long draft of an article that was just horrible, and I never published it, but I kept thinking about and teaching about this problem. Earlier this year, I had a brainstorm about the subject, and the result is this new article. 

By the way, interest in fiduciary law seems to have exploded in the past decade. Some of that interest stems from Tamar Frankel's book and the accompanying conference at Boston University. Some of the interest stems from the fact that fiduciary law is interesting in many countries outside the United States, where much of the best writing on this subject is found (see Paul Miller, for example). I look forward to a new surge in interest this summer, as Andrew Gold and Paul Miller have organized an excellent conference on The Philosophical Foundations of Fiduciary Law, to be held in Chicago. I am writing a paper entitled "True Loyalty" for that conference and very much looking forward to reading the other contributions.

Permalink | Business Organizations| Contracts| Corporate Law| Fiduciary Law| Law & Economics| Law & Entrepreneurship | Comments (0) | TrackBack (0) | Bookmark

November 24, 2012
2012 Books for your Favorite Corporate and Financial Law Aficionado
Posted by Erik Gerding

Here are a few gift suggestions culled from books published this year if your special someone is a lawyer who associates Modigliani and Miller with capital structure and not paintings with elongated faces and the Tropic of Cancer:

Even the non-lawyers and non-academics in your life might enjoy Frank Partnoy’s Wait: The Art and Science of Delay. Of course, the target audience might never get around to buying the book.

Permalink | Books| Corporate Governance| Corporate Law| Crime and Criminal Law| Law & Economics | Comments (0) | TrackBack (0) | Bookmark

July 16, 2012
Do Banks Have an Interest in Catching Bank Robbers?
Posted by Christine Hurt

Our local newspaper had a front-page story yesterday highlighting the fact that in a number of recent bank robberies (yes, they still rob banks here), the security photos were so blurry and grainy that they were simply useless.  In fact, one bank still used a system that shot only black and white photos.  Why would banks have less photographic technology than your cell phone?  The article went on to describe state-of-the-art systems a bank might want to install from $2,000 to $14,000.  My first thought was "Why wouldn't a bank install a $10k security system?"  And my second thought was "Why would a bank spend $10k on a security sytem?"

The answer to these questions would depend on the difference between the costs to the bank of a "cleared" bank robbery versus an "uncleared bank robbery.  Banks obviously have an interest in deterring bank robberies and avoiding employee and/or customer victimization and trauma, violence, and loss of customers.  But once the robbery takes place, does it matter to the bank if the robber is caught?

I found a DOJ report on bank robbery, although it's a few years old.  From this report, I learned that in 80% of robberies, the money is never recovered, and that 20% number includes robbers who are apprehended on the spot.  So, once the robber is out the door, the chances of avoiding a loss is pretty low, even if your photo is incredibly clear.  Also, most bank robbers get caught anyway -- 1/3 in 24 hours, and 1/2 in a month.  If not caught quickly, the chances of the robber being caught rapidly diminish, probably reflecting the difference between amateur robbers and professional robbers.  So, if you are a small-town bank, you may not feel that investing a lot of money in security cameras when the amateur robber will probably be caught anyway, and then even empty-handed.  If you are a big, national bank with a presence in urban centers that might be attractive to professionals, then you might want to be on the forefront of security.

Also, the average robber gets away with $4000, and most banks have a 50% chance of being robbed over 10 years.  So, the probable costs of the robbery, disocunted over time, may just not add up, even if you thought you could recover the $4000.  Other costs to the bank, trauma therapy, employee time off, etc., would not be recoverable anyway.

But, do security cameras deter thieves?  According to the DOJ report, no.  Professionals wear disguises or disable cameras.  Amateurs don't seem to figure them into the calculation.  There are other ways to try to deter theft or minimize it, but some of them are expensive (security guards) or put off customers ("bandit barriers").  It may be that some banks just consider the occasional robbery as a cost of doing business.

Finally, bank robberies are not covered by FDIC insurance, but are covered by private insurance.  Unless the insurer gives discounts or requires additional security measures, similar to smoke detectors or sprinkler systems, then the bank's incentives are even smaller.

But what about convenience stores?  According to our newspaper, these stores have state-of-the-art equipment.  Are convenience store owners' incentives different?  First, 6% of robberies occur at convenience store, as compared to 2% at banks.  Independent stores may not be as well-insured and so may more directly bear the costs of robberies.  Also, convenience stores who are robbed have a greater chance of being robbed again if the robber isn't caught.  In addition, these cameras work better because they have to cover smaller areas and are usually well-positioned.

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