Improving the Culture of Ethical Behavior in the Financial Sector: Time to Expressly Provide for Private Enforcement Against Aiders and Abettors of Securities Fraud

By Mark Klock.

116 Penn St. L. Rev. 437.

Financial markets do not function well when fraud is pervasive. It has been well documented that financial fraud has increased following changes in securities law that occurred in the 1990’s. Also around September of 2009, the investigations into the SEC examinations of Bernard Madoff Investment Securities, LLC were completed and released to the public. The simple facts reveal an alarming level of incompetence and lack of financial literacy on the part of the guardians of the integrity of our financial markets. I suggest two important tools for addressing these problems. One is to supplement enforcement of anti-fraud rules with more private attorney generals by expressly creating a private right of action for aiding and abetting violations of securities laws. This will foster a stronger culture of integrity and ethical conduct in the auditing profession. An additional tool is to increase financial literacy in our law schools which supply the regulators of our markets.

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Government Prediction Markets: Why, Who, and How

By Tom W. Bell.

116 Penn St. L. Rev. 403.

This paper describes how prediction markets can make governments smarter, cheaper, and more responsive to changing conditions. A prediction market resembles a stock exchange where traders buy and sell not shares of companies, but claims about various future events. Academic and commercial use of prediction markets indicates that they offer a useful tool for encouraging, collecting, and quantifying widely scattered expertise. Government administrators have begun experimenting with prediction markets, too. Many questions remain, however, about the proper way to implement government prediction markets. This paper opens with a brief survey of the costs and benefits of government prediction markets. It then turns to ironing out the statutory and regulatory wrinkles occasioned by government prediction markets in general, and by federal executive prediction markets in particular. The paper begins by asking who should run government prediction markets and who should trade on them. The short answers: Government agencies should outsource the provision of prediction markets and let employees and outside contractors trade on them. The paper then turns to mitigating the legal risks raised by government prediction markets—especially those offering cash or other valuable consideration—and advocates such prophylactics as hosting spot transactions in negotiable conditional notes, offering traders seed funding, and contractually mandating a minimum level of trading. The paper concludes by describing a three-step plan for putting prediction markets to work for the United States government and, through it, the People.

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Convictions Based on Lies: Defining Due Process Protection

By Anne Bowen Poulin.

116 Penn St. L. Rev. 331.

The corrupting impact of false testimony on the justice system is profound and corrosive. The Supreme Court has long-since held that the due process clause protects against convictions based on testimony that the prosecutor knew or should have known was false.

Despite this precedent, courts have undermined that constitutional protection by imposing demanding requirements of prosecution knowledge, narrowing the definition of false testimony, and holding defendants to an inappropriate standard of materiality. As a result, the law does not provide adequate protection from conviction based on lies.

Courts must reinvigorate this area of the law. To provide appropriate protection, the requirements a defendant must meet to receive relief based on the use of false testimony must be clarified in the following ways. First, the prosecution should be deemed to have knowledge of the falsity not only if an individual prosecutor had actual knowledge, but also if the prosecution did not meet its duty to discover that the testimony was false or if the prosecution had knowledge of contrary information possessed by other government actors and therefore imputed to the prosecution. Second, the false testimony need not rise to the level of perjury. Third, the courts should apply the more lenient standard of materiality defined for false testimony cases by asking how the revelation that the witness had testified falsely would have influenced the jury in the initial trial rather than asking what would have occurred had the witness simply given truthful testimony.

In addition, the courts should revisit the law that applies when a defendant discovers that the prosecution unknowingly presented false testimony. If the falsity was material, the courts should conclude that the conviction violates due process despite the lack of prosecution knowledge. Even if the courts do not extend due process protection to the unknowing use of false testimony, they should grant the defendant a new trial more readily than with other types of newly discovered evidence. The corrupting impact of false testimony calls for at least this level of protection.

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Governmental Data Mining and its Alternatives

By Tal Z. Zarsky.

116 Penn St. L. Rev. 285.

Governments face new and serious risks when striving to protect their citizens. Of the various information technology tools discussed in the political and legal sphere, data mining applications for the analysis of personal information have probably generated the greatest interest. Data mining has captured the imagination as a tool which can potentially close the intelligence gap constantly deepening between governments and their targets. Data mining initiatives are popping up everywhere. The reaction to the data mining of personal information by governmental entities came to life in a flurry of reports, discussions, and academic papers. The general notion in these sources is that of fear and even awe. As this discourse unfolds, something is still missing. An important methodological step must be part of every one of these inquires mentioned abovethe adequate consideration of alternatives. This article is devoted to bringing this step to the attention of academics and policymakers.

The article begins by explaining the term “data mining,” its unique traits, and the roles of humans and machines. It then maps out, with a very broad brush, the various concerns raised by these practices. Thereafter, it introduces four central alternative strategies to achieve the governmental objectives of security and law enforcement without engaging in extensive data mining and an additional strategy which applies some data mining while striving to minimize several concerns. The article sharpens the distinctions between the central alternatives to promote a full understanding of their advantages and shortcomings. Finally, the article briefly demonstrates how an analysis that takes alternative measures into account can be carried out in two contexts. First, it addresses a legal perspective, while considering the detriments of data mining and other alternatives as overreaching “searches.” Second, it tests the political process set in motion when contemplating these measures. This final analysis leads to an interesting conclusiondata mining (as opposed to other options) might indeed be disfavored by the public, but mandates the least scrutiny by courts. In addition, the majority’s aversion from the use of data mining might result from the fact that data mining refrains from shifting risk and costs to weaker groups. This is yet one of the ways the methodology of examining alternatives can illuminate our understanding of data mining and its effects.

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State Damage Caps and Separation of Powers

By Jeffrey A. Parness.

116 Penn St. L. Rev. 145.

In 2010, the Illinois Supreme Court invalidated certain statutory caps on noneconomic damages in medical cases because they “unduly” infringed “upon the inherent power of the judiciary” theretofore recognized (albeit in judicial dictum). Such judicial authority originated within the separation of powers clause of the Illinois Constitution. The caps were deemed to “encroach” on the judiciary’s “sphere of authority” because they impeded “the courts in the performance of their function.”

Elsewhere, American state statutory damage caps have also been challenged on state constitutional separation of powers grounds. These challenges included setting where the caps operate for nonmedical cases and where the limits extend beyond noneconomic damages.

Are there core separation of powers principles guiding all American state statutory damage caps? If so, do they apply similarly to all types of cases and all forms of damage caps? With or without such core principles, are there other doctrines that better speak to damage caps when conflicts arise between the legislative and judicial branches?

This paper first explores the Illinois precedents on damage caps and separation of powers. It then explores other state precedents, finding they usually involve state constitutional allocations of procedural lawmaking powers. It also finds that caps on “statutory causes of action” or during “special proceedings” are often treated differently, as are caps on punitive damages. The paper then posits that separation of powers analyses should usually be replaced in damage cap cases with judicial rulemaking analyses. It finds no core principles involving separation of powers provisions that implicate damage caps. Interstate differences in constitutional allocations of procedural rulemaking authority (and, at times, justiciable matters) should be recognized more often in damage cap settings. These observations have implications beyond damage caps. Other civil litigation issues prompt tensions between the judicial and legislative branches, such as evidence privileges. Here, too, separation of powers analyses should generally not be employed, and often should be replaced by judicial rulemaking analyses.

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The Great Spill in the Gulf . . . and a Sea of Pure Economic Loss: Reflections on the Boundaries of Civil Liability

By Vernon Valentine Palmer.

116 Penn St. L. Rev. 105.

What has been called the greatest oil spill in history, and certainly the largest in United States history, began with an explosion on April 20, 2010, some 41 miles off the Louisiana coast. The accident occurred during the drilling of an exploratory well by the Deepwater Horizon, a mobile offshore drilling unit (MODU) under lease to BP (formerly British Petroleum) and owned by Transocean. The well-head blowout resulted in 11 dead, 17 injured, and oil spewing from the seabed 5,000 ft. below at an estimated rate of 25,000-30,000 barrels per day.

The Deepwater Horizon is technically described as “a massive floating, dynamically positioned drilling rig” capable of operating in waters 8,000 ft. deep. In maritime law, such a rig qualifies as a vessel; yet, as a MODU, the rig also qualifies as an offshore facility that may attract higher liability limits under the Oil Pollution Act of 1990 (OPA). Under these provisions the double designation as vessel and/or MODU potentially raises the liability limits to as much as $75 million. The operator and principal developer of this well is BP, which owns a 65% interest. Various attempts at stemming the initial flow of oil failed. The oil spread on the surface and in the depths over a very wide area, killing marine life and water birds, entering estuaries, and polluting shores. The National Oceanic and Atmospheric Administration closed commercial and recreational fishing in a very wide area of the Gulf, and the federal government declared a moratorium on exploratory drilling for six months, thus idling about 33 drilling operations in progress. Meantime, BP, after meeting with President Obama, agreed to establish a $20 billion compensation fund, which would be independently administered by a nongovernmental agency led by Kenneth Feinberg. BP carried very little or no third party liability insurance and reportedly operated on a self-insured basis. Given the minimal insurance, questions arise as to whether BP’s pockets are deep enough to meet its overall liabilities which, in addition to the compensation fund already discussed, may include $21 billion further in civil fines under the Clean Water Act (CWA). The compensation fund, after an initial $5 billion deposit in 2010, would receive quarterly installments of $1.25 billion until the full amount is reached in mid-2013. The fund would pay for damage to natural resources, state and local response costs, and individual economic losses (whether in the form of civil judgments or settlements with the fund), but it will not be used to cover any fines and penalties incurred by BP. The right of individuals to seek compensation through the courts instead of the Fund remains open.

The flow of oil was finally arrested on July 15, 2010, 87 days after the blowout. By then more than 200 million gallons of oil had poured into the Gulf, which was nearly 20 times more than the Exxon Valdez emptied into Prince William Sound (11 million gallons) and 60 million gallons more than the Ixtoc I disaster in the Bay of Campeche (140 million gallons). The environmental, economic, and social impacts of the spill are staggering, and long-term effects will be unknown for much time to come.

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KABOOM! The Explosion of Qui Tam False Claims Under the Health Reform Law

By Beverly Cohen.

116 Penn St. L. Rev. 77.

Since its inception in 1863, the federal False Claims Act (the “Act”) has included provisions whereby citizens can assist in the detection and enforcement of frauds against the government. To increase fraud recoveries, the Act authorizes private citizens (“relators”) to sue on behalf of the government (“qui tam” lawsuits) when they detect a fraud that is not already the subject of a federal enforcement action.

Periodically, Congress has adjusted the Act’s qui tam provisions in order to balance its dual goals of creating, on the one hand, sufficient incentives for private parties to detect and pursue frauds, but to discourage, on the other hand, qui tam actions where the federal government already has the ability to discover and prosecute the fraud on its own. Over the years, Congress aimed to attain the “golden mean”—an equitable balance between encouraging private fraud detection that increases federal fraud recoveries but discouraging “parasitic” qui tam actions where the relator merely asserts fraud claims that have already been made public.

The most recent adjustments to the qui tam provisions of the Act occurred with the enactment of health reform, the Patient Protection and Affordable Care Act. Amidst a national recession that ballooned the ranks of the uninsured and reports of rampant health care frauds that were robbing millions of dollars from federal health care programs, Congress sought to expand incentives for private citizens to detect and report health care frauds.

However, by eliminating the two predominant statutory limitations to qui tam jurisdiction, the PPACA has enormously broadened the ability of relators to commence qui tam lawsuits under the Act. First, the PPACA revised the Act’s “public disclosure” provisions to dramatically increase the sources of public information that relators may utilize as bases for their qui tam actions. And second, the PPACA revised the Act’s “original source” rule to eliminate the “direct knowledge” requirement, formerly the most stringent requirement that relators needed to satisfy to maintain their suits. Thus, the PPACA’s reforms signal a new age of extremely broad qui tam authority.

This Article will examine these recent amendments to the qui tam provisions of the False Claims Act, focusing on the enormous expansion of relators’ ability to commence qui tam actions, and changes to the qui tam bar that are likely to result.

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Don’t Panic! Defending Cowardly Interventions During and After a Financial Crisis

By Brett McDonnell.

116 Penn St. L. Rev. 1.

How should we regulate the U.S. financial system after the financial crisis when we face the task with a radically inadequate understanding of what went wrong and what effect proposed regulations will likely have? This paper explores three quite different approaches to regulating in the face of severe uncertainty: the libertarianism of Friedrich Hayek, the conservatism of Michael Oakeshott, and the liberalism of John Maynard Keynes. Each man thought deeply about the problem of how uncertainty affects human affairs, but each came to different conclusions about how to address such uncertainty. The paper outlines the core, immensely useful insights of each theorist. The paper then outlines the even more useful and persuasive critiques that each launches at the other two. From this collision of viewpoints, the paper outlines a hybrid general approach to regulating the financial system which it (rather tongue-in-cheek) labels “cowardly interventions.” This approach accepts the basic insight of Keynes that unregulated financial markets will be deeply unstable, causing periodic destructive depressions. Thus, fairly strong regulation of finance is needed. But following the insights of Hayek and Oakeshott, I argue that new regulations should be cowardly. We should as much as possible heed the wisdom embedded in markets and existing institutions. We should identify as best we can the biggest problems that current markets pose, and address those problems with new rules that are measured, limited, market-friendly, and subject to evaluation and pruning.

This framework supports a three-part response to the crisis. First, the New Deal structure for regulating banks should be extended to the shadow banking system which was at the heart of the crisis. (What is “shadow banking”? Read the paper.) In that structure, the government acts as a lender of last resort to forestall panics while using resolution authority and prudential regulation to replicate much of the discipline of an unregulated market. Second, more specific limited rules should address glaring problems in the mortgage securitization chain. Third, regulatory agencies should be prodded to constantly re-evaluate existing regulation in light of new circumstances. Using this framework, this paper gives a guarded defense of the Dodd-Frank Act. All three elements of a proper response are there in the Act. There are major concerns, however. Most importantly, the Dodd-Frank Act does not do enough to address the largely unregulated shadow banking system. The Act should also have begun the process of eliminating Fannie Mae and Freddie Mac. Even legislation without these weaknesses would not end financial crises forever. However, if the many regulations implementing the Dodd-Frank Act are largely done well, they may postpone the next big crisis for a decade or two, as well as make the next crisis shorter and less severe when it does occur. The Dodd-Frank Act is imperfect even by the standards of a philosophy which emphasizes inevitable imperfection, but on balance it does pretty well under the circumstances.

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Models of Subnational Constitutionalism

By Jonathan L. Marshfield.

115 Penn St. L. Rev. 1151.

In 1977, a group of Nigerian constitution makers asked an astute question. Following a gruesome civil war, Nigeria began the task of crafting a federal constitutional democracy. Although the constitutional delegates agreed on a decentralization of political power, they nevertheless asked a separate question: should the Nigeria states be permitted to adopt their own constitutions? The proceedings from the 1977 Constituent Assembly show that the delegates gave careful consideration to that question as a distinct institutional choice. They decided that although Nigeria was committed to a federal arrangement, the states should not be permitted to adopt their own constitutions. State constitutionalism, they concluded, had proven too “divisive” during Nigeria’s prior constitutional regime, and it “was inimical to the unity of the country.”

The Nigerian experience begs a deeper question that theorists have largely neglected. Although scholars and constitution-makers have developed various theories regarding the utilities of federalism, they have not separately considered how subnational constitutions can uniquely serve (or undermine) those same purposes. Nor have they searched for any independent purposes that subnational constitutionalism may serve. In short, theorists have largely failed to consider the independent normative justifications for introducing subnational constitutionalism into federal systems. As the Nigerian experience illustrates, that theoretical question is not without serious practical consequences.

This Article takes up that important but neglected question. The goal is to move towards a systematization and critical analysis of possible justifications for introducing subnational constitutionalism into federal systems. The Article first offers a description of subnational constitutionalism that is derived from rational-choice theories of political institutions and a survey of the world’s federal systems. It concludes that subnational constitutionalism is best described as a series of rules (both formal and informal) that protect and define the authority of subnational units within a federal system to exercise some degree of independence in structuring and/or limiting the political power reserved to them by the federation. Building upon that working description, the Article argues that there are at least three coherent justifications for subnational constitutionalism. First, it can deepen a federal system’s ability to accommodate multiple political communities within a single constitutional regime. Second, it can uniquely contribute to federalism’s liberty-protecting, check-and-balances function. Third, the Article argues that scholars have largely overlooked the possibility that subnational constitutionalism can improve the deliberative quality of democracy within subnational units and the federal system as a whole.

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Explaining Sub-national Constitutional Space

By G. Alan Tarr.

115 Penn St. L. Rev. 1133.

Every federal system is structured by a federal constitution that divides power, establishes central institutions, prescribes the rules for resolving disputes, safeguards rights, and provides a procedure for its own alteration. In some federal systems, the federal constitution prescribes the political institutions and processes for the country’s constituent units as well, thus furnishing the constitutional architecture for the entire federal system. This is the case in Belgium and Canada, for example. But in most federal systems, the federal constitution is an “incomplete” framework document in that it does not prescribe all constitutional processes and arrangements. Rather, it leaves “space” in the federal system’s constitutional architecture to be filled by the constitutions of its sub-national units, even while it sets parameters within which those units are permitted to act. However, those federal systems that recognize a place for sub-national constitutions differ markedly in the extent to which the federal constitution is incomplete, that is, in the amount of space that they allocate to constituent units to define their own goals and establish their own governmental institutions and processes. In previous research, I have focused on the range of discretion (“constitutional space”) available to constituent units in designing their constitutional arrangements and on how the boundaries of that space are policed. In this article, I extend the inquiry into sub-national constitutional space to consider what factors influence the scope of sub-national constitutional space in various federal systems, why sub-national units have occupied or failed to occupy the constitutional space available to them, and what consequences sub-national constitutionalism has had on horizontal and vertical relations within federal systems.

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