Iterative Energy Policy: Resisting An Apology (Book Review)

* Associate Dean for Public Engagement and Professor of Law, the George Washington University Law School. The author thanks Joel Eisen, Rob Glicksman, and Dick Pierce for their helpful comments.

Book Review

Steve Isser, Electricity Restructuring in the United States: Markets and Policy from the 1978 Energy Act to the Present (Cambridge Univ. Press 2015)

Most energy law scholars have a general sense of the piecemeal fashion in which energy law and policy have unfolded in the past several decades. Notwithstanding the lack of a unifying policy, markets have opened, for both natural gas and electricity; environmental policy has become increasingly intertwined with the energy sector; and natural gas prices matter.1 The laws and policies ushering in these developments can be lined up against presidential administrations, economic crises, and major domestic and world events. Indeed, that context aids tremendously in understanding contemporary energy law, and it has become part standard fare, part lore for energy law aficionados.2

In Steve Isser’s Electricity Restructuring in the United States,3 readers will find a rich resource that delves deeply into the story of energy law’s evolution. The book covers the particulars of nearly every development in U.S. energy law and policy related to electricity restructuring from 1978 until about 2014. It documents the kinds of details that are lost over time: names,4 squabbles,5 and strange bedfellows6 that contributed to energy law as we know it. For researchers, such details provide texture and an ample array of sources for further exploration. Indeed, I begin this review with an overview of the book’s descriptive project and offer a few pragmatic thoughts on the book’s utility for legal scholars in the field. Second, I briefly engage a particular issue the book raises: translating complicated scientific, technical, and economic theory into on-the-ground regulatory policy. Third, I suggest that the book’s preference for an iterative approach to electricity policy can be analogized to adaptive management, perhaps offering a way of reconciling the traditional tensions between regulatory and market-based policy approaches to electricity. I conclude with a cautionary note of my own.

I. The Details of Muddling Through

The book’s general approach is to provide a deeply descriptive account of the transition from traditional regulation to wholesale electricity markets. For the most part, Isser does not take strong normative positions, which may be unsettling for readers accustomed to such an approach. As Isser explains in the book’s Introduction, “This work is an unapologetic economic policy history that is more focused on description than theory.”7 And indeed, the monograph unfolds largely as advertised. After providing some background on the origins of the Federal Power Act (FPA) and the regulated electric industry today, the book takes the reader headlong through a tour of everything from the Clean Air Act to industry restructuring to the California energy crisis. These “main events” of energy law are accented with tidbits—like which corporation lobbied for the qualifying facility (QF) provisions in the Public Utility Regulatory Policy Act (PURPA), and which law firm provided representation.8

Isser consistently applies this exacting attention to detail throughout the book. He carefully attends to the rise of environmental regulation,9 investor responses to PURPA,10 the policy transition to economic modeling for electricity,11 and even the particulars of how electricity dispatch software works.12 As he lays out the transition to wholesale electricity markets,13 Isser makes sure to describe the politics,14 the players,15 and the phenomenal shifts in both the electricity industry’s organization and the regulatory structures that accompanied the transition.16

At the book’s conclusion, Isser does not attempt to reconcile these rich details into any overarching theory. Rather, he frames the book’s journey as an apology for “muddling through.”17 To be sure, Isser shares his opinions at the end of the book. He concludes that muddling through is superior to radical restructuring; that promises of dramatic cost savings through restructuring proved to be “so much hype and hot air”; that stronger regulation of transmission is necessary to reap the gains of restructuring; and that retail competition “has been grossly overrated.”18 Yet the book as a whole seems more detached than these strong concluding opinions suggest. Isser offers only glimpses of his own views in most of the chapters, making these concluding observations seem more an afterthought than a set of overarching themes on which a reader might engage.

This descriptive approach, however, has the benefit of inviting the reader to draw her own conclusions. Scholars wishing to support public choice theory in energy policy development, for example, will find mountains of examples permeating the book.19 Environmental law as a driving force in energy policy is also amply demonstrated.20 The interplay between natural gas prices and the electricity fuel mix is likewise shown to be a perennial issue for energy policy.21 The book’s factual richness prompts many sparks of ideas and supplies information that is otherwise difficult to find.

II. Iterative Regulation and the Fallacy of Models

An issue that Isser engages more thematically, albeit somewhat tacitly, is that of translating complex scientific, economic, and technological concepts to working regulatory models. This is perhaps best demonstrated in the chapter entitled “The Economists are Coming, The Economists are Coming.” As the title suggests, this is one topic regarding which Isser cannot really hide his own perspective. Here he explains how it was that economic theory infiltrated the public policy of electricity regulation.22 First, he notes the role of economic concepts as political “rhetoric,” stating that some of the terms are used “promiscuously,” suggesting more than can be delivered.23 “Efficient market,” for example, suggests a sort of perfection that cannot be obtained in the real world.24 Efficiency is an ideal, while a market is a “mechanism for organizing economic activity” rather than an end in and of itself.25 Nevertheless, competing economists—many of whom Isser calls biased and self-interested—engaged in a “battle of the experts” in which the winners were proposing deregulation with little supporting evidence.26 As competing academics disseminated arguments to consultants, who translated the information to lobbyists, who once again translated information to politicians, complex issues became grossly oversimplified.27

These observations dovetail with others’ criticisms of how scientific and technical information is managed by, and incorporated into, the U.S. legal system. From concerns about “hired-gun” expert witnesses at trials28 to the politicization of science in federal agencies,29 there is intuitive appeal to the view that, in order for the law to be fair, legal institutions must get the science “right.”30 From a pragmatic perspective, this is not a controversial goal; however, it is extremely limited in operation because science is neither static nor certain.31 Instead, most science is accompanied by varying types and degrees of uncertainty, making it a fallacy to state that science can provide answers.32 The decision what to do in light of science and uncertainty—and other relevant factors—is inherently a decision of policy.33

Isser’s emphasis on the weaknesses of economic models resonates with these principles. As he succinctly puts it, “It is our models that are simple, not the real world.”34 This is no condemnation of modeling; rather, it is a plea for policymakers to resist the urge to blindly rely on theory and models without explicitly confronting their accompanying uncertainties. By itself, this is a problem of transparency. Rhetorical appeals to superficially objective models often obscure the real rationales for decisionmaking, undermining participatory values at the heart of democratic processes.35 But consider also this passage from the Economists chapter:

Economists and consultants were both guilty of understating the difficulties and oversimplifying the complexity of building real-world electricity markets. This in turn encouraged politicians to support overly ambitious timelines for restructuring markets, resulting in software and market structures that contained serious design flaws. At best, this meant numerous software iterations, as market flaws were identified and desired functionality was added to stakeholder and regulator wish lists. The worst case scenario was the California market meltdown, where poor market design, rushed implementation, and a “perfect storm” of events lead to an economic disaster.36

Isser’s critique is not so much one involving democratic norms and the fallacy of models as a warning against haste. His competing-expert and uncertainty-based critiques are not borne of concerns about decisionmaking as a process so much as decisionmaking outcomes.

These observations offer a provocative lens for evaluating the recently released Clean Power Plan.37 Opponents and supporters alike have emphasized the significant changes that the Plan heralds for electricity policy.38 A fundamental building block of the Plan—replacing coal-fired power with natural-gas fired power—is sure to bring changes in the electricity fuel mix.39 Another building block anticipates further fuel-switching to low-carbon fuels.40 EPA has expressly disavowed any intention to interfere with electricity dispatch, but it has also emphasized that the fungible nature of electricity enables “shifting dispatch from steam generators” to lower-carbon units.41 Critics of the Plan argue that it will severely reduce grid reliability,42 while EPA downplays any such impacts.43 The point here is not to resolve these competing views. Rather, the point is the acute relevance of what Isser has identified: over-generalizing incredibly complex policy efforts risks significant flaws in the implementation phase.44

Adaptive Management and Iterative Policy

This note of caution brings us full circle to Isser’s framing device: the apology for muddling through. Isser suggests that the antidote to this problem of incorporating economic principles into regulatory policy is incremental change. He recognizes that such an approach is “out of fashion” given “the illusion in economics and management decision science that large complex problems can be modeled and solved.”45 But he argues the fallacy of this illusion, and supports gradual changes and incremental policy implementation.46

This view calls to mind the concept of adaptive management, which has received considerable attention in the environmental law literature. The goal of adaptive management, as described by Professors Craig and Ruhl, is to “reduce uncertainty through integrative learning fostered in a structured, iterative decisionmaking process.”47 It is an oversimplification to call this approach “learning by doing,” but its point is to permit agencies to revise their policies as new information emerges, rather than requiring an irreversible commitment to a particular course of action.48 Professors Craig and Ruh provide the example of an agency managing a river system that includes numerous impoundments and other ecological resources.49 Although there may be significant uncertainty regarding the impact of releasing particular amounts of water from the impoundments, the agency can easily control that impact by altering the releases.50 An adaptive management approach would use monitoring to provide feedback on the ecological impact of the releases and to adjust the releases before serious ecological problems arose.51

Of interest for this Review is that adaptive management is viewed as belonging on the opposite end of the spectrum from market-based regulatory solutions because the former relies on regulatory discretion while the latter seeks to minimize regulatory decisionmaking in favor of market-driven outcomes.52 The picture painted by Isser in favor of iterative decisionmaking, however, invites speculation whether adaptive management and actual (as opposed to theoretical) regulated markets are really in such opposition. The story of electricity restructuring, at least, reveals not a true open market but a collection of market-type principles being constantly tinkered with by federal and state regulators and legislatures, and other quasi-governmental actors like Regional Transmission Operators (RTOs) and Independent System Operators (ISOs).

Admittedly, a closer look suggests some mismatches. Adaptive management theory suggests that the most favorable conditions for that approach involve high uncertainty, high controllability, and low risk.53 The river system example above, for instance, meets these criteria.54 By contrast, the wholesale markets—at least those Isser describes as representing incremental change—do not fit these criteria so neatly. Although the markets in practice do involve high uncertainty, Isser contends that decisionmakers’ overreliance on economic models led to the false assumption that there was low uncertainty. In other words, it is important that a decisionmaker accurately understand the degree of uncertainty inherent in a regulatory approach.

Moreover, unlike the gates of a reservoir, the markets are not particularly controllable, as evidenced by the history of consumer worries about widely fluctuating rates and regulators’ insistence on price caps.55 Further, market design risks can be quite high—as demonstrated by blackouts costing millions of dollars.56 At the same time, the failures to which Isser points took place within regulatory contexts that were certainly not adaptive; his whole point is that state restructuring especially was undertaken too quickly.

Still, reconciling Isser’s argument for incremental change with adaptive management theory may be a worthwhile exercise57. Perhaps there is a kernel possibility for aligning the theory of regulated markets with traditional regulation in hopes of developing a more accurate model of modern regulatory theory generally. And, perhaps, there are lessons inherent in that exercise for making progress on the best way to incorporate uncertain science, economics, and technology into regulatory decisionmaking. Isser identifies the problem; adaptive management aims at least in some circumstances to account for evolving scientific knowledge rather than freezing the state of knowledge in time.58

V. Conclusion

I conclude with one additional thought, drawing from the philosophy of science. Consider Thomas Kuhn’s view: that science is normally a cumulative exercise of evolving consensus, punctuated by occasional paradigm shifts.59 A loose analogy can be made to law: there are periods of incremental, iterative policymaking, punctuated by major shifts like the New Deal and the environmental, health, and safety statutes of the late 1960s and early 1970s. The starting place for Electricity Restructuring fits neatly within the latter period and may be best viewed as such a punctuating shift. Isser’s apology for muddling through involves the long process of learning and implementing since that time. History, however, suggests that another paradigm shift may be due. Climate change may well be the motivating force; the urgency of mitigation and adaptation are only increasing. Even if incremental change is at times the best path for regulatory decisionmaking, one hopes that in the next several decades, we are not apologizing to our children and grandchildren for our inability to do more than muddle through.

  1. See Joel B. Eisen et al., Energy, Economics and the Environment 6-8 (4th ed. 2015) (briefly describing eras of energy law).
  2. See, e.g., id. at 8 (“[S]everal distinct themes recur throughout the history of energy law. . . . history often repeats itself.”); William Boyd, Public Utility and the Lowe-Carbon Future, 61 UCLA L. Rev. 1614, 1635-36 (2014) (describing changing conceptions of the public utility); Emily Hammond & David B. Spence, The Regulatory Contract in the Marketplace, – Vand. L. Rev. – (forthcoming 2016), (providing overview of changes in markets and environmental policy since late-1970s); Alexandra B. Klass & Elizabeth J. Wilson, Interstate Transmission Challenges for Renewable Energy: A Federalism Mismatch, 65 Vand. L. Rev. 1801, 1814-21 (2012) (describing history of federal authority over transmission); Richard J. Pierce, The Past, Present, and Future of Energy Regulation, 31 Utah Envtl. L. Rev. 291 (2011) (describing major developments in energy law and critiquing policy options for the future); Jim Rossi, The Political Economy of Energy and Its Implications for Climate Change Legislation, 84 Tulane L. Rev. 379 (2009) (describing how public choice theory and federalism policy in energy sphere relate to political economy of climate change legislation).
  3. Steve Isser, Electricity Restructuring in the United States: Markets and Policy from the 1978 Energy Act to the Present (2015).
  4. Often, if Isser cites a study, he will also tell you who sponsored it. See, e.g., id. at 440 n.23 (noting sponsors of reliability study); id. at 443 n.1 (describing studies and listing “self-interested” sponsors).
  5. E.g., id. at 292 (describing unwillingness of North American Electric Reliability Corporation (NERC) to real-time generation and transmission data with FERC, because NERC members “did not want FERC staff to have the data”).
  6. E.g., id. at 53 (referencing the combination of environmental idealists and industry groups that supported the Clean Air Act Amendments of 1977).
  7. Id. at 2.
  8. It was Wheelabrator-Frye Corporation, a waste-to-energy facility developer, represented by Van Ness, Feldman, and Sutcliffe. Id. at 82.
  9. Id. Ch. 2.
  10. Id. Ch. 4.
  11. Id. Ch. 5.
  12. Id. Ch. 7.
  13. Id. Chs. 8-12.
  14. Id. Ch. 11.
  15. Id. Ch. 10.
  16. Id. Chs. 13-25.
  17. Id. at 460.
  18. Id. at 461.
  19. See, e.g., id. Ch. 2 (describing environmental regulation of electricity generation), Ch. 6 (describing events leading to Energy Policy Act of 1992).
  20. See, e.g., id. Ch. 2 (describing environmental regulation of electricity generation), Ch. 25 (describing recent Clean Air Act initiatives).
  21. See, e.g., id. at 87 (“The decline in the price and the increased availability of natural gas due to deregulation made natural gas a more attractive fuel for electricity generation during a period when there were significant advances made in turbine and power plant design.”).
  22. Id. at 102.
  23. Id. at 97.
  24. Id.
  25. Id. at 102.
  26. Id. at 101.
  27. Id. at 102.
  28. See generally Peter W. Huber, Galileo’s Revenge: Junk Science in the Courtroom (1991); Edward K. Cheng & Albert H. Yoon, Does Daubert or Frye Matter? A Study of Scientific Admissibility Standards, 91 Va. L. Rev. 471 (2005) (studying admissibility outcomes under two most prominent admissibility regimes).
  29. See Emily Hammond Meazell, Super Deference, the Science Obsession, and Judicial Review as Translation of Agency Science, 109 Mich. L. Rev. 733, 744-56 (2011) [hereinafter Hammond, Super Deference] (discussing this issue).
  30. See Emily Hammond Meazell, Scientific Avoidance: Toward More Principled Judicial Review of Legislative Science, 84 Ind. L.J. 239, 242 (2009) [hereinafter Hammond, Scientific Avoidance] (“With society’s faith in science comes an inherent belief that scientific “truth” is inextricably linked to fairness.”).
  31. See Nat’l Academies Press, Responsible Science Volume I: Ensuring the Integrity of the Research Process 38 (1992) (“Although [science’s] goal is to approach true explanations as closely as possible, its investigators claim no final or permanent explanatory truths. Science changes. It evolves. Verifiable facts always take precedence.”). It is in fact difficult to find examples of courts or agencies getting scientific facts wrong (as opposed to “best science” or state-of-the-art). A possible, if disputed, example, is Wells v. Ortho Pharmacy, 788 F.2d 741, 742 (11th Cir. 1986) (upholding district court’s credibility-based determination that spermicidal jelly caused birth defects, even though scientific consensus was otherwise). See also Wendy E. Wagner, The Bad Science Fiction: Reclaiming the Debate over the Role of Science in Public Health and Environmental Regulation, Law & Contemp. Probs., Autumn 2003, at 72-87 (exhaustively demonstrating that there are very few examples of agencies getting positive science wrong).
  32. Hammond, Super Deference, supra note 29, at 744-48.
  33. Hammond, Scientific Avoidance, supra note 30, at 250-51.
  34. Isser, supra note 3, at 99; see also Robert L. Glicksman, Bridging Data Gaps Through Modeling and Evaluation of Surrogates: Use of the Best Available Science to Protect Biological Diversity Under the National Forest Management Act, 83 Ind. L.J. 465, 479 (2008) (“[Models] are capable neither of providing a completely accurate representation of reality nor of eliminating the scientific uncertainty that induces the decision maker to resort to modeling in the first place.”).
  35. See Hammond, Super Deference, supra note29, at 736 nn. 9-10 (collecting sources).
  36. Isser, supra note 3, at 109.
  37. Carbon Pollution Emission Guidelines for Existing Stationary Sources: Electric Utility Generating Units, 40 C.F.R. § 60 (2015) [hereinafter Clean Power Plan].
  38. Barack Obama, Remarks by the President in Announcing the Clean Power Plan (Aug. 3, 2015) (calling CPP “single most important step America has ever taken in the fight against global climate change”); cf. Scott Segal, Lots of Pain with Questionable Benefits, U.S. News Debate Club, Aug. 13, 2015 (“We can expect significant potential threat to the electric reliability upon which our modern way of life depends.”).
  39. Clean Power Plan, supra note 37, at 7 (listing building block 2 as “[s]ubstituting increased generation from lower-emitting existing natural gas combined cycle units for reduced generation from higher-emitting affected steam generating units”).
  40. Id.
  41. Id. at 593.
  42. E.g., Segal, supra note 38.
  43. Clean Power Plan, supra note 37, at 51.
  44. These potential flaws are the subject of a current project with co-author Richard J. Pierce.
  45. Isser, supra note 3, at 460.
  46. Id.
  47. Robin Kundis Craig & J.B. Ruhl, Designing Administrative Law for Adaptive Management, 67 Vand L. Rev. 1, 20 (2014); see generally id. (providing comprehensive review of literature and theoretical underpinnings).
  48. Id. at 16-17.
  49. Id. at 20.
  50. Id.
  51. Id.
  52. Id. at 3-11.
  53. Id. at 19-21. Some regulatory decisions, by contrast, are binary, that is, yes/no actions such as whether to grant a license or approve a tariff. Id. at 19. These are not amenable to adaptive management because they require a single decision meant to minimize uncertainty and control risk, though subsequent monitoring may be amenable to an adaptive approach. Id. at 21.
  54. Id. at 20.
  55. Cf. Richard J. Pierce, Jr., Completing the Process of Restructuring the Electricity Market, 40 Wake Forest L. Rev. 451, 482 (2005) (describing how price ceiling have negative effects on market efficacy).
  56. Isser, supra note 3, at 407.
  57. Regrettably, a full analysis here is beyond the scope of this Review. It promises instead a rich area of exploration for future work.
  58. See Robert L. Glicksman & Sidney A. Shapiro, Improving Regulation Through Incremental Adjustment, 52 U. Kan. L. Rev. 1179, 1185-87 (2004) (describing benefits of “back-end” regulatory adjustments).
  59. Thomas S. Kuhn, The Structure of Scientific Revolutions 36-42, 52 (3d ed. 1996).

How King v. Burwell Creates Tax Problems for Consumers and What The Treasury Can Do About It

* Associate Professor of Law, University of Iowa. Comments, corrections, and criticisms are welcome at

After the Supreme Court agreed to hear King v. Burwell,1 a case addressing whether taxpayers can receive Section 36B premium tax credits for health insurance policies purchased on federally established exchanges (“federal policies”), commentators have expressed concerns about a potential death spiral in the health insurance market. Under the worst case scenario, the absence of credits for federal policies will deter consumers from future enrollment. With this smaller enrollment pool, premiums will spike sharply during the 2015-2016 Affordable Care Act enrollment season, the first following the Court’s anticipated June 2015 ruling. Those price increases will further deter enrollment, and the Act will eventually collapse.2

This focus on future enrollment seasons masks the potentially harsh tax consequences for consumers who purchase federal policies during the 2014-2015 enrollment season. Many such consumers cannot pay the sticker price for federal policies and receive tax credits to assist with their monthly insurance payments. However, an adverse decision in King v. Burwell would generally require that they pay back those credits.

This conclusion might seem surprising to 2014-2015 purchasers of federal policies. Under the ACA’s advance payment mechanisms, consumers seemingly take the premium tax credit immediately upon the purchase of a federal policy.3 Unsophisticated consumers—or even sophisticated ones—can easily assume that advanced payments do not have to be paid back.4 After all, those payments go straight to insurers and never appear on consumers’ bank accounts.

But advance payments are like loans in the sense that consumers have to repay them if those payments exceed their properly allowable tax credits. The government tentatively makes an advance payment because a consumer’s premium tax credit ultimately depends on various factors, including the consumer’s annual household income, which cannot be accurately determined until the end of the taxable year.5 Consequently, anyone who receives advance payments must file a tax return to demonstrate her entitlement to the premium tax credit.6 If the advance payments exceed the allowable tax credit, Section 36B(f) requires that the consumer pay back the excess.7

Excessive advance payments commonly arise when a consumer estimates her credit using a household income lower than the actual income for the year.8 Under Section 36B, the allowable credit shrinks as income increases, so underestimation of income generally causes a consumer to overstate her anticipated credit.9 Excessive payments will also arise if the government loses King v. Burwell because any advance payment on a federal policy would necessarily exceed the proper credit of $0.

Although it might seem harsh, this result follows from the Tax Code’s annual accounting rule.10 Under the Code, transactions generally do not independently establish tax credits or liabilities. That is, a consumer does not earn a credit simply by purchasing a health policy, whether on a federal exchange or a state exchange, and a consumer does not face a tax liability simply because, for example, he sold property for a big gain.11 The year as a whole requires examination.12 And if the Court decides King v. Burwell against the government, that end-of-year examination will show that purchasers of federal policies were entitled to no premium tax credits.

However, Section 7805(b)(8) may provide some relief to consumers.13 Under that statute, the Treasury can deny retroactive effect to judicial rulings, even ones made by the Supreme Court. But any action by the Treasury will fully protect only those who purchased federal policies during the 2013-2014 enrollment season. Purchasers of federal policies during the current enrollment season will not definitively establish their right to tax credits until after December 31, 2015, approximately six months after a potentially adverse decision in King v. Burwell.14 These taxpayers would need the Treasury to deny prospective effect to the Court’s ruling, a power not contemplated by Section 7805(b)(8).

Arguably, Section 36B reflects a departure from the annual accounting concept, and the Treasury can use Section 7805(b)(8) to protect any advance payments processed before King v. Burwell takes effect. Under Section 36B, the eligibility for a premium tax credit turns on a month-by-month analysis even though a consumer’s actual tax credit or liability depends on annual household income and other factors established at the end of the year.15 Consequently, the Treasury might treat consumers as having established their right to tax credits at the close of each month and might establish some type of pro-ration regime for computing allowable credits.16

But even under this scenario, consumers face potential problems. In the months after King v. Burwell takes effect, no credit related to a federal policy would be allowable, and taxpayers would have to repay any advance payments made for those months. Alternatively, the government might stop making advance payments on federal policies in July 2015, such that taxpayers would effectively see an unaffordable spike in their monthly premium payments. Either way, trouble awaits.

Also, although Section 7805(b)(8) may provide relief for pre-King v. Burwell months, there’s no guarantee that the Treasury will exercise its authority under that statute, given the potential blowback it might face.17 If the Treasury flatly rules that King v. Burwell does not apply for the months preceding the Court’s decision, penalties on individuals and employers would follow. That is, the individual penalty for failure to obtain coverage and the employer penalty for a failure to provide coverage depend, in part, on whether Section 36B extends to consumers who purchase federal policies.18 If the Treasury broadly denies retroactive effect to King v. Burwell, then some individuals and employers will find themselves paying penalties even though they prevailed in the Supreme Court. Although it is doubtful that Section 7805(b)(8) was intended to let the Treasury rob taxpayers of judicial victories, the statute’s plain text does not force the Treasury to exercise its authority in a purely taxpayer-favorable manner.19

Arguably, the Treasury can turn off King v. Burwell only for consumers who purchase federal policies and allow it to take full effect for other individuals and for employers. Section 7805(b)(8) allows the Treasury to “prescribe the extent, if any, to which any ruling” operates without retroactive effect. The Treasury might thus deny retroactive effect to King v. Burwell only to the “extent” that it protects a consumer’s tax credits for federal policies, but no further.

However, it is not obvious that Section 7805(b)(8) allows the Treasury to slice and dice a judicial decision that way. Instead, Section 7805(b)(8) might refer solely to temporal elements, not substantive ones. That is, the Treasury can choose only the “extent” of King v. Burwell‘s retroactivity period and may prescribe, for example, that it takes effect as of June 1, 2015, or as of May 1, 2015, or as of some other date. Under this reading, the Treasury could not chop up the Court’s holding; it would have to accept the decision in toto, subject to whatever period of retroactivity it chooses.

The case law provides little guidance on the Treasury’s authority under Section 7805(b)(8) to deny retroactive effect to judicial decisions. Although the Tax Code has long provided the Treasury the authority to deny retroactive effect to its own rules, the extension of the Treasury’s authority to judicial rulings came relatively recently, via a 1996 statutory amendment. And it is not clear that the Treasury’s authority under Section 7805(b)(8) applies to judicial rulings in the same way that it applies to agency rulings. It makes sense for the Treasury to determine the retroactive effect of its own rulings (whether along substantive or temporal lines), but slicing and dicing the substance of a Supreme Court ruling appears to intrude on judicial power.20

Given the complications of the annual accounting rule and the ambiguity over Section 7805(b)(8), the Court itself might take steps to protect consumers who purchase federal policies. Although the Court seems to have adopted a “firm rule of retroactivity” for civil cases,21 commentators argue that some issues remain unsettled.22 If the Court has the power to stay or delay the effect of its decision in a statutory case,23 policy concerns may support the exercise of that power. However, issuing a decision that applies only prospectively stands in tension with the judiciary’s proper role.24

Congress, of course, could adopt a commonsense statute that protects purchasers of federal policies during the current enrollment season. But a legislative fix seems unlikely given the strained relationship between the President and Congress. It is unfortunate that the people who can most easily protect purchasers of federal policies probably will not reach a sensible compromise.

Going forward, Congress should act cautiously before it houses a public assistance program in the Tax Code. Had Congress provided direct payments to assist with the purchase of policies, rather than tax credits, consumers, employers, and the Obama Administration could have avoided the complications discussed above. But when Congress uses the Tax Code, it incorporates all of its machinery, including the annual accounting rule. That rule may jeopardize the availability of credits for federal policies purchased during the current ACA enrollment season and may discourage signups.25

  1. King v. Burwell, 759 F.3d 358 (4th Cir.), cert. granted 135 S. Ct. 475 (2014).
  2. See, e.g., Jonathan Cohn, Here’s What the Supreme Court Could Do to Insurance Premiums in Your State, New Republic (Nov. 11, 2014).
  3. See 42 U.S.C. § 18082(a)(3) (2012) (establishing the advance payment regime). For a discussion of the rules relating to the computation of the advance payment amount, see Lawrence Zelenak, Choosing Between Tax and Nontax Delivery Mechanisms for Health Insurance Subsidies, 65 Tax L. Rev. 723, 726-28 (2012).
  4. See Robert Pear, White House Seeks to Limit Health Law’s Tax Troubles, N.Y. Times (Jan. 31, 2015), (noting that many consumers did not realize that advance payments may need to be paid back).
  5. Regulations provide detailed rules related to the computation of the premium tax credit. See Treas. Reg. §§ 1.36B-1 to -4 (2012).
  6. See Treas. Reg. § 1.36B-4(a)(1)(i) (2012) (“A taxpayer must reconcile the amount of credit allowed under [S]ection 36B with advance credit payments on the taxpayer’s income tax return for a taxable year.”).
  7. Technically speaking, the statute increases the taxpayer’s tax liability for the taxable year on account of the excess credits. See id. When a taxpayer’s household income is below 400% of the poverty line, Section 36B(f) limits this increase. In these circumstances, the increased tax liability will be limited to between $600 to $2,500, depending on income. See 26 U.S.C. § 36B(f)(2)(B)(i) (2012).
  8. See, e.g., Treas. Reg. § 1.36B-4(a)(4) (2012). The Department of Health and Human Services (HHS) has issued guidance under 42 U.S.C. § 18082(b)(1) (2012) regarding income estimates.
  9. See 26 U.S.C. § 36B(b)(2)(B)(ii)-(b)(3)(A) (2012).
  10. See 26 U.S.C. §§ 441(g), 446(a) (2012) (codifying the Tax Code’s annual accounting rule, which provides that taxable income shall be computed on the basis of the taxpayer’s taxable year, which is usually the calendar year for individuals); see also 26 U.S.C. § 36B (2012) (noting that Section 36B and related provisions “apply to taxable years ending after December 31, 2013,” not to coverage months (emphasis added)).
  11. Spring City Foundry v. Comm’r, 292 U.S. 182 (1934) (holding that gains from the sale of goods early in the year accrued as gross income even though later events in the same year established doubts about full collectability).
  12. See Burnet v. Sanford & Brooks Co., 282 U.S. 359, 365 (1931) (“The computation of income annually as the net result of all transactions within the year was a familiar practice, and taxes upon income so arrived at were not unknown, before the Sixteenth Amendment.”).
  13. In full, 26 U.S.C. § 7805(b)(8) provides, “The Secretary may prescribe the extent, if any, to which any ruling (including any judicial decision or any administrative determination other than by regulation) relating to the internal revenue laws shall be applied without retroactive effect.” 26 U.S.C. § 7805(b)(8) (2012).
  14. Absent a rehearing or other unusual development, the Court will issue its decision in King v. Burwell by the end of June 2015.
  15. See 26 U.S.C. § 36B(b)(1) (2012) (calculating the annual healthcare credit by reference to “coverage months”); see also Treas. Reg. § 1.36B-2(a) (2012) (allocating “premium assistant amount[s]” by month).
  16. See Cent. Laborers’ Pension Fund v. Heinz, 541 U.S. 739, 748 n.4 (2004) (holding that the IRS can invoke authority under Section 7805(b)(8) to protect plans that, under the Court’s ruling, failed Section 411(d)(6)’s requirements); see also Rev. Proc. 2005-23, 2005-1 C.B. 991, as modified by Rev. Proc. 2005-76, 2005-2 C.B. 1139 (stating that a plan will not lose tax-exempt status under Heinz where plan terms are retroactively changed to the date of and reflect the holding of that case). The Heinz case dealt with a statutory regime that does not translate well to the Section 36B premium tax credit regime—Section 411(d)(6) contemplates continuous compliance with a restriction, not a computation of an allowable credit based on factors known only at year-end. Still, Heinz provides some support for the Treasury to allow tax credits for a taxpayer’s coverage months preceding any adverse decision in King v. Burwell.
  17. The government has refused to share its planned response to any adverse decision in King v. Burwell and has made no promises regarding Section 7805(b)(8). See Sarah Ferris, Defiant Health Chief Says ObamaCare Will Win Day at Supreme Court, The Hill (Dec. 23, 2014) (noting that HHS Secretary Burwell “declined to say whether the administration had a contingency plan for the potential loss of $64 billion in subsidies, adding: ‘I’m going to stick with where I am’”).
  18. See 26 U.S.C. § 4980H(a)(2)-(b)(1)(B) (2012) (imposing penalties on an employer when a tax credit is allowed with respect to an employee’s purchase of a qualified health plan); King v. Burwell, 759 F.3d 358, 365 (4th Cir. 2014) (explaining how availability of credits partly determines whether an individual can satisfy the unaffordability exception to the individual mandate, such that she can escape penalties for failing to obtain health insurance).
  19. Of course, other statutes could impose limitations on the Treasury’s taxpayer-adverse exercise of authority under Section 7805(b)(8). See, e.g., Administrative Procedure Act, 5 U.S.C. § 706(2)(A) (2012) (providing that courts shall set aside agency action when discretion has been abused).
  20. The Court of Appeals for the Second Circuit has reserved its judgment on whether the Supreme Court’s “retroactivity rule or other legal principles might constrain the IRS’s authority to limit the retroactive effect on the rights of parties of judicial decisions” under Section 7805(b)(8). Swede v. Rochester Carpenters Pension Fund, 467 F.3d 216, 221 n.9 (2d Cir. 2006). The Treasury has applied Section 7805(b)(8) to a judicial decision only once, when the Court itself directed the Treasury to consider exercising its statutory authority. See Rev. Proc. 2005-23, 2005-1 C.B. 991, as modified by Rev. Proc. 2005-76, 2005-2 C.B. 1139 (following the Court’s suggestion in Cent. Laborers’ Pension Fund v. Heinz, 541 U.S. 739, 748 n.4 (2004)).
  21. Landgraf v. USI Film Prods., 511 U.S. 244, 278 n.32 (1994) (citing Harper v. Virginia Dept. of Taxation, 509 U.S. 86 (1993) (Harper)).
  22. See Laurence H. Tribe, American Constitutional Law § 3-3, at 226 (3d ed. 2000) (“[The] Court [in Harper] did not hold that all decisions of federal law must necessarily be applied retroactively. . . . [T]he Court has not renounced the power to make its decisions entirely prospective, so that they do not apply even to the parties before it.” (emphasis removed)); see also Nunez-Reyes v. Holder, 646 F.3d 684, 698 (9th Cir. 2011) (en banc) (concluding that the Court has not expressly overruled Chevron Oil Co. v. Huson, 404 U.S. 97 (1971), and that courts can limit the retroactive effect of their decisions in narrow circumstances).
  23. In a pre-Harper case, the Court stayed its judgment to allow Congress time to amend a statute to cure its constitutional defects. See N. Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982).
  24. See Am. Trucking Ass’ns, Inc. v. Smith, 496 U.S. 167, 201 (1990) (Scalia, J., concurring) (“[P]rospective decisionmaking is incompatible with the judicial role, which is to say what the law is, not to prescribe what it shall be.”). See generally Bradley Scott Shannon, The Retroactive and Prospective Application of Judicial Decisions, 26 Harv. J.L. & Pub. Pol’y 811, 874 (2003) (arguing that prospectivity’s costs outweigh prospectivity’s benefits).
  25. Cf. Lawrence Zelenak, Choosing Between Tax and Nontax Delivery Mechanisms for Health Insurance Subsidies, 65 Tax L. Rev. 723, 731 (2012) (“A person who is eligible for advance payments based on predicted income, and whose actual subsidy-year income is also in the targeted range, may decide not to participate because of the threat [of Section 36B(f)].”).

The Problem with “Coercion Aversion”: Novel Questions and the Avoidance Canon

* Assistant Professor, University of San Diego School of Law. Many thanks to Larry Alexander, Nick Bagley, Will Baude, Chris Egleson, Dick Fallon, Abbe Gluck, Anton Metlitsky, Abby Moncrieff, Hashim Mooppan, Anne Joseph O’Connell, Dave Owen, Mike Ramsey, David Shapiro, and Kate Shaw for helpful comments and conversations. I am grateful to Taylor Holmes and Ben Schwefel for capable research assistance and to the editors of the Yale Journal on Regulation for thoughtful editorial suggestions.

General Verrilli: I think that it would be – certainly be a novel constitutional question, and I think that I’m not prepared to say to the Court today that it is unconstitutional. … But I don’t think there’s any doubt that it’s a novel question … .

Justice Kennedy: Is it a—I was going to say, does novel mean difficult?


Justice Kennedy may be the swing vote in King v. Burwell. Because of that, the post-oral-argument hubbub has focused on Justice Kennedy’s questions to counsel, which suggested that he was considering resolving the case in the government’s favor using the canon of constitutional avoidance. The King challengers assert that an IRS regulation, which permits federal tax credits to subsidize the purchase of health insurance plans on the federal health insurance exchange, contravenes the Affordable Care Act (“ACA”), which authorizes federal tax credits for purchases of health insurance plans on “an Exchange established by a State.”2 If the challengers’ reading of the ACA were correct, Justice Kennedy posited, the statute would amount to a Congressional threat to withdraw tax credits and impose a destructive subset of federal regulations on states that did not establish exchanges. That threat, he hinted, would be a forbidden attempt by Congress to “coerce” the states: “if your argument is accepted, the states are being told either create your own exchange, or we’ll send your insurance market into a death spiral.”3 His evident inclination was to apply the canon to avoid this reading of the statute and sustain the IRS’s rule.

Justice Kennedy’s unexpected embrace of this idea—let us call it the “coercion aversion” argument—was a curveball. Neither party raised it, presumably because neither had any incentive to raise it: the challengers because the argument would cut against them in this case, and the Solicitor General because it would cut against the federal government in future cases. Only one amicus brief devoted significant space to coercion aversion,4 out of the thirty-one amicus briefs filed on the government’s side.5 The challengers didn’t respond to the argument in their reply.6

From the moment Justice Kennedy floated it, however, it was clear that coercion aversion could point the way to five votes for the government. The Solicitor General grasped its import instantly. Though circumspectly noting his office’s continuing obligation to defend the ACA’s constitutionality,7 he nonetheless did not bat away the helping hand that Kennedy was extending. “[C]onstitutional avoidance becomes another very powerful reason to read the statutory text our way,” said General Verrilli.8

But there’s a problem with coercion aversion, and it arises from the novelty of the asserted Tenth Amendment problem here. This is the choice that the challengers’ reading of the ACA poses to states: “Set up an exchange, or else the federal government will deprive your citizens of tax credits and eliminate the mandate in your state and thereby cause the health insurance markets in your state to collapse.9 Whether this choice is an unconstitutionally coercive “regulatory threat” is clearly a question of first impression, and a consequential one.10 The Court has never invalidated an act of Congress as coercive of the states because of the regulatory burdens it placed on state residents, as opposed to the regulatory burdens it placed directly on states themselves. Nor has the Court ever invalidated an act of Congress as coercive of the states because of the conditions it placed on the money it offered to state residents. To date, the Court has only found unconstitutional coercion where Congress placed conditions on the money it offered to states themselves. Adopting the theory of coercion by regulatory threat would add a new arrow to the quiver of constitutional federalism.

So Justice Kennedy’s question was exactly the right one: is this novel question of constitutional law automatically difficult in a way that means that the King Court should read the statute to avoid it?11 The answer is no. Modern avoidance has two justifications:12 honoring Congress’s presumed intent not to legislate unintentionally close to a constitutional line and preventing courts from unnecessarily issuing constitutional opinions. The logic of these justifications disintegrates when the putative constitutional problem is a novel question of first impression that crystallized only after Congress legislated.13 Congress can’t be presumed to have legislated in light of new constitutional problems that were not evident at the time of lawmaking, and the Court can’t claim to be leaving constitutional law undisturbed when its avoidance holding itself manufactures new constitutional doubts. As a result, the Court should apply the canon to avoid truly novel constitutional problems only if it has exhausted other available tools of statutory interpretation, and even then only in preference to actual constitutional invalidation.

For King, this principle boils down to a simple syllogism. Because (1) the constitutional problem of coercion by regulatory threat is novel; and because (2) the justifications for the modern avoidance canon disintegrate where the problem being avoided is novel; therefore (3) the Court should use coercion aversion to resolve King only as a last resort. In King, an alternative avenue for resolving the case is necessarily available to a justice who would otherwise use the avoidance canon to circumvent this novel problem. To avoid the ostensibly coercive reading of the statute, a justice must conclude that an alternative, non-coercive construction of the statute is “fairly possible” or “reasonable.”14 But if there’s a “reasonable” reading of the ACA whereby tax credits are not linked to the creation of state exchanges, then a fortiori the ACA must fail to state unambiguously the conditions on the availability of tax credits—which would run afoul of the federalism clear-statement cases that require Congress to impose such conditions in unmistakable terms.15 Consequently, a justice inclined towards coercion aversion need not and should not rely on it to resolve the case—even if that justice would rule that a clearly worded regulatory threat of this kind was unconstitutional if she were unavoidably confronted with that novel question on the merits.

The essay proceeds as follows. Part I explains the novelty of the constitutional problem that the justices are considering avoiding. Part II describes the serious difficulties with equating “novel” questions with “difficult” ones for purposes of the avoidance canon. Part III applies this analysis to King. A short conclusion follows.

I. A New Version of Coercion

Imagine that the government loses King, and the Court holds that the ACA provides tax credits only on state exchanges. Now imagine the lawsuit in which a state contends that the ACA, so construed, contravenes the Tenth Amendment. That suit would be a successor to King, so let us call it Prince. The Prince lawsuit would claim that it was unconstitutional to force states to make the choice mentioned above: “Set up an exchange, or else the federal government will deprive your citizens of tax credits and eliminate the mandate in your state and thereby cause the health insurance markets in your state to collapse.”

Prince would pose not merely a run-of-the-mill question of first impression, but a truly novel constitutional claim. The Court has never before held that Congress had coerced the states by harming their citizens. As explained below, the offer in Prince is not barred by either the “commandeering” or the “coercive-conditions” lines of precedent. So, to strike down the offer in Prince as unconstitutional, the Court would have to create a meaningfully new rule of constitutional law.

As an initial matter, Prince is not a case of commandeering of the kind that was at issue in Printz v. United States.16 That case involved the Brady Handgun Violence Prevention Act, which directed state and local law enforcement officers to conduct background checks on prospective handgun purchasers.17 This, the Court held, was impermissible: the federal government may not “command the States’ officers” to “administer or enforce a federal regulatory program.”18 The choice in Prince, in contrast, does not contain any direct compulsion of or “command” to state officers. The tax credits at issue in Prince would act “directly upon individuals, without employing the States as intermediaries.19 A statute of this sort “is thus entirely consistent with the Constitution’s design,”20 because the Constitution gives Congress “the power to regulate individuals, not States.”21

Nor does the line of cases forbidding coercion suggest that a state might be unconstitutionally coerced by a federal statute that regulates not the state, but its citizens; the case law points in the opposite direction. Consider the statute at issue in New York v. United States,22 the Low-Level Radioactive Waste Policy Act (“LLRWPA”). This federal law included various “incentives” designed to encourage the states to provide for the disposal of low-level radioactive waste.23 One set of incentives encouraged states to adopt federal standards for radioactive waste disposal.24 If the state did not adopt the federal standards, it risked having its citizens be “den[ied] access to … disposal sites.”25 The Court was untroubled, reasoning that “[t]he affected States are not compelled by Congress to regulate,” because the “burden caused by a State’s refusal to regulate will fall on those who generate waste and find no outlet for its disposal, rather than on the State as a sovereign.”26 The Court did not contemplate that the additional federal regulatory burdens on these residents might force the state to provide offsetting relief out of the state’s own pocket.27

New York did, of course, strike a part of LLRWPA under the Tenth Amendment28—the “take title” provision—but the Prince offer noticeably differs from that portion of the statute. This provision offered states a choice between two direct Congressional commands to state legislators: either states could “tak[e] title to and possession of” all low-level radioactive waste generated in the state, or else states could regulate that waste in the manner Congress directed.29 Because both halves of the choice were beyond Congress’s power under the Tenth Amendment, forcing a state to choose between the two was also unconstitutional.30

Contrast this choice with the choice in Prince. Article I authorizes Congress, and Congress alone, to decide who should bear the costs of federal law and whether those costs will be subsidized by the public fisc.31 Outside the limited context of takings, the Constitution has never been held to require Congress to “pay as it goes” when it enacts federal laws. Thus, Congress can enact a statute that either (1) subjects insurers to federal guaranteed-issue and community-ratings requirements without offsetting federal subsidies to citizens, or (2) subjects insurers to federal guaranteed-issue and community-ratings requirements with offsetting federal subsidies to citizens. Both regimes are within Congress’s power to enact. The only question, then, is whether Congress has the further power to tether its grant of those subsidies to whether the state chooses to establish an exchange.

Of course, a conditional offer of federal money that leaves a state with no genuine choice but to accept is unconstitutionally coercive.32
But despite the ubiquity of federal conditional-spending schemes, the Court never invalidated such a law as coercive until NFIB,33
and the reasoning of NFIB itself stops well short of condemning a Prince-style offer. What so troubled the justices in NFIB was that the Medicaid expansion offer threatened to upend the terms of a long-standing federal-state bargain upon which the states had relied.34 The NFIB plurality was careful to note the manifold ways in which the federal flow of funds to the states had generated serious reliance interests.35 But Congress has made no analogous bargain with the states around the non-regulation of insurance. There are no elaborate state schemes to regulate or administer the federal tax credits supplied by the ACA. States have no cognizable reliance interest in the continued absence of federal regulation of insurance companies36—or even in the absence of “unwise” or dysfunctional federal regulation of insurance companies.37

Prince also differs from NFIB in another key respect: NFIB, like South Dakota v. Dole,38 involved a federal offer of conditional spending made to the state as sovereign; both cases were riddled with references to the fact that the federal offer threatened to pull money directly out of the state’s budget.39 But in Prince, the threatened loss will come not from the state’s purse, but rather from private individuals. The loss of tax credits will harm state residents, but it will only indirectly and probabilistically harm state budgets. Unlike the “gun to the head” of the state that NFIB deplored,40 Prince holds a gun to the head of the state’s citizens—and it’s a gun that (apparently) not all states perceive to be loaded.41

In Steward Machine Company v. Davis42 the Court considered and rejected the contention that an analogous offer to state citizens was coercive of the states. Steward Machine involved a provision of the Social Security Act that offered employers a tax credit for up to 90% of their federal unemployment tax as long as the businesses paid those funds into a state unemployment plan that met federally specified conditions.43 The challengers argued that this scheme forced “state Legislatures under the whip of economic pressure into the enactment of unemployment compensation laws at the bidding of the central government.”44 The Court grudgingly acknowledged that conditioning federal tax credits to state residents on state legislative action might result in “undue influence” on the states—“if we assume that such a concept can ever be applied with fitness to the relations between state and nation”45—but ultimately concluded the federal offer was proper. Why? Because, the Court reasoned, the federal offer furthered the legitimate end of “safeguard[ing]” the federal treasury from spending additional money on unemployment (itself a proper federal goal) and—“as an incident to that protection”—also promoted state autonomy.46

The Prince offer at least arguably satisfies these criteria. It promotes a legitimate federal goal—subsidizing access to health insurance—while also encouraging states to exercise local control over state insurance marketplaces. To receive billions in tax credits for health insurance purchases by their residents, all the states must do is create state exchanges on which citizens can spend those credits. Steward Machine searched in vain for a constitutional proscription of such an arrangement:

“Alabama is seeking and obtaining a credit of many millions in favor of her citizens out of the Treasury of the nation. Nowhere in our scheme of government—in the limitations express or implied of our Federal Constitution—do we find that she is prohibited from assenting to conditions that will assure a fair and just requital for benefits received.”47

In words that might ring in the ears of the judge who could some day decide Prince, the Court concluded “[a]n unreal prohibition directed to an unreal agreement will not vitiate an act of Congress, and cause it to collapse in ruin.”48

To say that a battle is uphill is not to say that it’s futile. The Tenth Amendment cases discussed above don’t preclude the theory of coercion by regulatory threat, and there’s considerable force to the claim that the Prince offer is worse for the states than any offer that the Court has thus far ratified. The Prince challengers may eventually—and deservedly—win the day.

The crucial question here, however, is not whether the Prince challenge will succeed or fail—it is whether the Prince challenge is novel. That it undoubtedly is. Today, even now that NFIB has broken the glass on invalidating conditional spending offers, the case that holds that Congress has unconstitutionally coerced a state by refusing tax credits to its citizens and regulating private corporations would be a blockbuster, one with large repercussions for federal power. Five years ago, when Congress was enacting the ACA—during an era when, it’s worth remembering, the conditional-spending test of Dole was widely regarded as a dead letter49—it could not have anticipated that this extension of the doctrine of constitutional federalism might lurk beyond the horizon.

II. Versions of Aversion

Both General Verrilli50 and the challengers51 seemed to agree on the threshold matter of the novelty of the theory of coercive regulatory threat, and the justices did not indicate that they felt differently. The real issue, then, is whether this new constitutional problem offers an appropriate occasion to apply the avoidance canon—or, as Justice Kennedy put it, “does novel mean difficult?”

At first blush, it may seem that the answer must be yes—which is why Justice Kennedy’s question was received as a bon mot instead of something that merited a serious answer. To a given justice, a novel constitutional theory may have considerable appeal. A justice may hold beliefs about the Constitution that are quixotic, that are out of the mainstream, or that are simply ahead of their time. To that justice, a novel constitutional problem might feel like a serious constitutional problem, or at least a problem that deserves to be taken seriously. From the point of view of that justice, the formal criteria for using avoidance will appear to be met.

The problem with this logic, though, is that using the avoidance canon to avoid novel constitutional doubts unmoors the canon from its justifications. A chief rationale for the modern avoidance canon is an interpretive presumption—an interpretive presumption that Congress does not want to legislate close to a constitutional line.52 Some have called this regime unfair, but at least it is clear: Congress is on notice that it must speak with special lucidity if it wishes to enact a statute in a constitutional danger zone.53 The more out-of-the-mainstream a constitutional theory is, though, the less defensible this rule is. Congress can’t be expected to legislate clearly to override avoidance of the penumbra of a constitutional right where Congress cannot know that right exists by inspecting settled constitutional doctrine. Imputing to Congress the capacity to divine new constitutional rules is just one tick short of imputing to it the intent to avoid a problem precluded by existing doctrine54—a move that the Court has called “unsound.”55

Put another way, modern avoidance carries an inherent qualification on its appropriate use. The constitutional problem that is being avoided must be the sort of problem that was recognizable as such by the Congress that enacted the law at issue. Treating a constitutional issue as a problem that merits avoidance means treating it as something that Congress might plausibly have legislated with knowledge of. But it’s implausible to require Congress to anticipate the existence of truly new questions of first impression. By using the canon to avoid such questions, the Court doesn’t just move the goal posts for Congressional clarity; it carries them off the field.

The second rationale for the modern avoidance canon—avoiding unnecessary constitutional decision-making—also disintegrates where the constitutional problem is novel.56 To see why, think back to the “classical” version of avoidance, under which the Court supplies a saving construction of a statute only upon finding that the alternative reading is unconstitutional.57 If a statute runs afoul of settled constitutional rules, the Court makes no new constitutional law when it recognizes that fact and construes the statute to save it. Conversely, in a classical avoidance holding predicated on a novel constitutional problem, the Court is by definition making novel constitutional law.

The same dynamic applies to modern avoidance, even though the Court is not formally making new constitutional law when it applies modern avoidance. Constitutional avoidance opinions matter; they influence later Courts,58 and they therefore influence lower courts and Congress.59 Modern avoidance gives “penumbras” to constitutional rights—shadows that have “much the same prohibitory effect as . . . the Constitution itself.”60 If the penumbra is not novel, then the Court does not alter constitutional law when it skirts the penumbra. If the penumbra is novel, however—which it will be when the doubt being avoided is a new one—the Court’s recognition of that new penumbra will make new penumbral constitutional law with new prohibitory effects. Applying the canon to novel constitutional questions is, in essence, self-defeating; as a practical matter, the Court creates new constitutional law simply by applying the canon.

These issues with avoiding novel doubts flow from the inherent nature of the modern avoidance canon: regardless of the case or of judicial proclivity, they will inexorably emerge whenever the constitutional issue being avoided is a truly novel one. Apart from these intrinsic problems, two other pitfalls might or might not arise depending on the case and on the various justices involved.

The first pitfall is that avoiding novel questions enhances the canon’s (already considerable) susceptibility to judicial manipulation.61 Limiting the canon to avoiding only known constitutional problems imposes some quantum of external constraint on its usage. Conversely, the latitude afforded by the canon becomes broader as the canon comes to be invoked to avoid novel or out-of-the-mainstream constitutional concerns. One need only imagine the sheer range of statutory cases in which one could assert a novel constitutional claim on one or both sides of the question presented. The Court’s federalism, separation of powers, substantive due process, and equal protection jurisprudence are fecund ground for the constitutional daydreamer—and everyone who has ever been a 1L knows that just about anything can be made out to be a First Amendment violation if you squint hard enough. A conscientious justice need not and might not abuse these additional degrees of freedom; still, there they are.

The second risk is that avoiding novel constitutional questions will exacerbate the unfortunate tendency of avoidance opinions to display “slopp[y]” constitutional decision-making.62 When a novel constitutional theory is first invented, a theory that is interesting and new and not at all straightforwardly required by existing jurisprudence, the theory is unlikely to have been much litigated, precisely because it is one that is out of the mainstream of regular constitutional argument. But that is no obstacle to the theory reaching the justices’ ears. Ours is the age of the Supreme Court “practice group,” 63 and (not coincidentally) the heyday of the Supreme Court amicus brief;64 each Term, an unstinting stream of green booklets urges the Court to avoid constitutional doubts old and new, slight and serious. Consequently, when the justices encounter a new constitutional doubt, they often do so in the environment least conducive to disciplined constitutional decision-making—bereft of adversarial argument, shorn of factual development, and far afield from the useful outposts of lower court opinions. In these circumstances, a diligent justice recognizing a novel constitutional problem might do the hard work of carefully developing and appraising the competing arguments on both sides. But there’s always the risk that won’t occur, and that instead of avoiding genuine constitutional problems, the justice will effectively be avoiding constitutional jitters or hunches.65 The after-effects of such a holding will be felt not just in casebooks, but also in Congress. At best, a poorly reasoned avoidance opinion may force Congress to revisit a statute to clarify its language, a waste of Congress’s time if the avoided problem isn’t substantial; at worst, a poorly reasoned avoidance opinion may deter Congress from exercising lawmaking powers that it can lawfully wield.66

Does all this mean that the Court should never avoid novel constitutional problems? Not quite. But it does mean that avoiding novel constitutional doubts should be a highly disfavored way of resolving a case,67 a method of last resort, to be used only once one has exhausted other techniques of statutory interpretation, and if one is prepared to hold that the novel constitutional problem is an actual barrier to the statute. At that extreme—where the novel constitutional issue poses an obstacle, not just a “doubt”—modern avoidance and its twin justifications become irrelevant; what remains, for good or ill, is classical avoidance’s raw imperative to save as much law as possible from actual nullification, whether by old law or new.68 Adopting this approach to novel doubts will discipline and curb the Court’s use of the avoidance canon by ensuring that when the justices first confront truly new constitutional questions, they will address them with the caution and carefulness of a court creating law, not dictum.

III. Coercion Aversion

The quartet of concerns just discussed applies with full force to King. First, and most salient, is the problem of confounding Congressional expectations. The government has contended, with considerable gusto, that it never occurred to anyone that the ACA was threatening to withdraw tax credits from states that failed to establish exchanges.69 For argument’s sake, stipulate the opposite—that Congress did consciously intend the threat. Even in that scenario, it never occurred to anyone that such a threat would violate the Tenth Amendment. The theory of coercive regulatory threat was fully aired for the first time in 2015,70 and it relies to a significant degree on NFIB, which was only decided in 2012.71 How could Congress have known in March 2010 that it had to legislate with especial clarity if it wished to make such a threat? In Donald Rumsfeld’s famous rubric, the regulatory threat theory was an “unknown unknown” at the time of the ACA’s passage.72 It is true that, to Justice Kennedy at least, the unconstitutionality of regulatory threats seems to have appeared straightforward. But his view only became evident to the world (and Congress) at oral argument. It stretches the interpretive presumption too far to imagine that Congress has the capacity to forecast the privately harbored constitutional commitments of a single justice—no matter how consequential his vote may be.

Second, a coercion aversion opinion will elicit shadow constitutional law that may have not-so-shadowy effects on future challenges to federal statutes. Consider the ACA’s “maintenance of effort” provision,73 which requires states to freeze into place their 2010 Medicaid enrolment and eligibility policies for adults until “the date on which [HHS] determines that an Exchange established by the State … is fully operational.”74 In other words, the ACA says to the states: “Set up your own exchange, or the federal government will subject your Medicaid program to the maintenance-of-effort rule.” As a limitation on state legislative autonomy, that is not such a far cry from the threat ostensibly being made in King. Opinions from “swing votes” on the Court reflecting that key justices regard such conditional offers as impermissible may induce a state that didn’t establish an exchange to bring a Tenth Amendment attack on this provision.75

Environmental law may also become caught up in the wake of a coercion aversion opinion. Peabody Energy Corporation is an intervenor in a pending challenge to the EPA’s forthcoming regulations on coal-fired power plants.76 Peabody’s brief to the D.C. Circuit, which was filed before oral argument in King, devoted a few sentences to asserting that the EPA was “commandeering” (not “coercing” or “threatening”) states into submitting state implementation plans; it made no mention of King.77 After Justice Kennedy’s questions at the King argument, Professor Laurence Tribe, who is counsel for Peabody, shifted gears. A Tenth Amendment argument leveraging the regulatory threat concept spanned a dozen pages of his subsequent Congressional testimony about the regulations at issue in that case78—regulations now portrayed as having coercive effects “strikingly similar” to the IRS rule in King79—and will surely feature prominently in the ongoing litigation over these new regulations.80

This partial snapshot captures the two most obvious examples of areas of the law that might be affected by an avoidance holding in King. If the justices were to endorse broad or loose language indicating that any kind of regulatory bargaining with the states is per se impermissible,81 the legal uncertainty for other cooperative federalism schemes would concomitantly increase. A King opinion that creates shadow constitutional law about coercion by regulatory threat could have important repercussions.

The two other pitfalls with avoiding novel constitutional questions also happen to be present in King. First, the case illustrates how the license to avoid novel constitutional claims may facilitate the judicial manipulation of case outcomes. Although the avoidance argument that caught the justices’ eye was made by an amicus brief in support of the IRS’s rule, state amici who oppose the IRS’s rule also made a rather novel Tenth Amendment argument: that the IRS’s reading of the statute mandates the states to provide health insurance to state employees and impermissibly subjugates the states to federal taxation.82 So the Scylla of regulatory threat is paired with the Charybdis of a direct mandate to and tax on the states. Is this new constitutional problem less worthy of avoidance than the regulatory threat problem? Who knows? If a justice avoids one of these problems and ignores the other, it is safe to assume that the real work of deciding the case has been done elsewhere.

Second, a non-negligible risk exists that the shadow constitutional law produced in King won’t be well-crafted shadow constitutional law. The theory of coercive regulatory threat received its first public airing at Supreme Court amicus briefing.83 Venturing forth to describe the contours of the regulatory threat concept without a single pair of adversarial briefs on the subject, let alone a set of lower-court opinions or a district-court record, would be a highly risky endeavor for a Court that, quite sensibly, tends not to proceed a voce solo when elaborating constitutional rules.

For all these reasons, the Court should not rely on coercion aversion to resolve King. Some might worry (or hope) that the upshot of this argument will be a defeat for the government, and death spirals in 34 states. But this overlooks an odd but important aspect of King. If a justice is convinced that the ACA can be “reasonably” read not to convey a coercive regulatory threat, then that justice believes that the ACA can be “reasonably” read not to condition tax credits on the creation of state exchanges. That, in turn, entails that the ACA fails to unambiguously specify the terms of a conditional spending offer to the states.84 In other words, the ambiguity that a justice would rely on to avoid this novel constitutional problem is necessarily sufficient to sustain the IRS’s rule on Pennhurst clear-statement grounds.85

Rather than writing a coercion aversion opinion, a justice inclined to avoid this novel constitutional problem ought to seize this alternative. This would be the best outcome: better than writing a coercion aversion opinion in the government’s favor, and (to a justice worried about regulatory threats) much better than holding against the government. Whatever such an opinion might lack in complete candor—if indeed it can be said to lack anything at all86—it would make up for in protecting sound constitutional decision-making in the long term.


If one or more of the justices use coercion aversion to decide King, it will be clear that the considerations urged here will have been overlooked or disregarded by those justices. But if no justice does so, the silence will be ambiguous. The opinions would say nothing about coercive death spirals, would eschew any mention of regulatory threats, and would refrain from speculating on possible Tenth Amendment obstacles. That end result, if a bit of an anticlimax, would be the right one. Even if coercion aversion lurks in the backs of their minds, the justices can—and therefore should—resolve King without using the avoidance canon to inaugurate a new branch of federalism jurisprudence.

  1. See Transcript of Oral Argument at 49, King v. Burwell, 135 S. Ct. 475 (argued March 4, 2015) (No. 14-114) [hereinafter “Transcript”] (alteration in original).
  2. See Patient Protection and Affordable Care Act § 1311, 42 U.S.C. § 18031 (2010) [hereinafter “ACA”]; King v. Burwell, 759 F.3d 358, 364-65 (4th Cir. 2014).
  3. See Transcript, supra note 1, at 16, 49.
  4. See Brief for Jewish Alliance for Law & Social Action (JALSA) et al. as Amici Curiae Supporting Respondents, King v. Burwell, 135 S. Ct. 475 (filed Jan. 16, 2015) (No. 14-114), 2015 WL 350366 [hereinafter “JALSA Brief”]. Another amicus brief spent its final four paragraphs on the argument that the challengers’ interpretation would raise “a serious Tenth Amendment question.” See Brief for the Commonwealth of Virginia et al. as Amici Curiae Supporting Respondents at 42-43, King v. Burwell, 135 S. Ct. 475 (filed Jan. 28, 2015) (No. 14-114), 2015 WL 412333 [hereinafter “Virginia Brief”].
  5. Docket, King v. Burwell, 135 S. Ct. 475 (No. 14-114).
  6. See Reply Brief, King v. Burwell, 135 S. Ct. 475 (filed Feb. 18, 2015) (No. 14-114), 2015 WL 737959.
  7. See Transcript, supra note 1, at 49-50.
  8. Id.
  9. See JALSA Brief, supra note 4, at 31 (“Establish an exchange, or the federal government will destroy your individual health insurance market.”).
  10. See id. at 7 (“Never before has this Court confronted a cooperative federalism scheme that threatens states with regulatory, rather than fiscal, harm if they refuse to implement federal policy.”); Virginia Brief, supra note 4, at 44 (“[I]t is a novel kind of pressure to threaten to injure a State’s citizens and to destroy its insurance markets in order to force State-government officials to implement a federal program.”).
  11. Other scholars have discussed the special problems that flow from using the canon to avoid novel constitutional doubts. See Lisa A. Kloppenberg, Avoiding Serious Constitutional Doubts: The Supreme Court’s Construction of Statutes Raising Free Speech Concerns, 30 U.C. Davis L. Rev. 1, 23-24 (1996); Lawrence C. Marshall, Divesting the Courts: Breaking the Judicial Monopoly on Constitutional Interpretation, 66 Chi.-Kent L. Rev. 481, 488-89 (1990); Robert W. Scheef, Temporal Dynamics in Statutory Interpretation: Courts, Congress, and the Canon of Constitutional Avoidance, 64 U. Pitt. L. Rev. 529, 558-60 (2003); Brian G. Slocum, Overlooked Temporal Issues in Statutory Interpretation, 81 Temp. L. Rev. 635, 670 n.175 (2008).
  12. See Adrian Vermeule, Saving Constructions, 85 Geo. L.J. 1945, 1949 (1997) (“The basic difference between classical and modern avoidance is that the former requires the court to determine that one possible interpretation of the statute would be unconstitutional, while the latter requires only a determination that one reading might be unconstitutional.”); Trevor W. Morrison, Constitutional Avoidance in the Executive Branch, 106 Colum. L. Rev. 1189, 1206-07 (2006) (describing justifications for modern avoidance). This essay adopts an “internal” point of view, in the sense that it accepts the canon as a settled feature of constitutional adjudication and takes its justifications at face value. The articles cited throughout will lead the interested reader to the rich debate over the legitimacy of the canon and the soundness of its rationales.
  13. Novelty is a distinct concept from ambiguity. Constitutional issues are often ambiguous or “unsettled,” and the Court may properly use the canon of constitutional avoidance to avoid addressing unsettled issues or resolving ambiguities. More rarely, though, constitutional questions arise that are not merely ambiguous in light of existing doctrine, but also novel, in the sense that they are unanticipated questions of first impression whose resolution will meaningfully change settled doctrine. As I explain in the text, the mischief begins when the Court uses the canon to avoid this distinct class of constitutional doubts.
  14. Almendarez-Torres v. United States, 523 U.S. 224, 270 (1998) (Scalia, J., dissenting) (“[T]he doctrine of constitutional doubt comes into play when the statute is ‘susceptible of’ the problem-avoiding interpretation—when that interpretation is reasonable, though not necessarily the best.”) (citation omitted); Crowell v. Benson, 285 U.S. 22, 62 (1932) (“fairly possible”).
  15. Pennhurst State Sch. & Hosp. v. Halderman, 451 U.S. 1, 12-13 (1981); see Brief for the Respondents at 39-40, King v. Burwell, 135 S. Ct. 475 (filed Jan. 21, 2015) (No. 14-114), 2015 WL 349885 [hereinafter “Gov’t Br.”]; Brief for Professors Thomas W. Merrill et al. as Amici Curiae Supporting Respondents at 7-9, King v. Burwell, 135 S. Ct. 475 (filed Jan. 28, 2015) (No. 14-114), 2015 WL 456257.
  16. United States v. Printz, 521 U.S. 898 (1997).
  17. Id. at 902.
  18. Id. at 935 (“The Federal Government may neither issue directives requiring the States to address particular problems, nor command the States’ officers . . . to administer or enforce a federal regulatory program. . . . [S]uch commands are fundamentally incompatible with our constitutional system . . . .”).
  19. New York v. United States, 505 U.S. 144, 164 (1992).
  20. Nat’l Fed’n of Indep. Bus. v. Sebelius, 132 S. Ct. 2566, 2626-27 (2012) (Ginsburg, J., dissenting) [hereinafter “NFIB“].
  21. Id. (quoting Printz, 521 U.S. at 920) (internal quotation marks omitted).
  22. New York, 505 U.S. 144.
  23. Id. at 152-54.
  24. Id. at 173.
  25. Id. at 174 (“States may either regulate the disposal of radioactive waste according to federal standards by attaining local or regional self-sufficiency, or their residents who produce radioactive waste will be subject to federal regulation authorizing sited States and regions to deny access to their disposal sites.”).
  26. Id.
  27. See id.
  28. Id. at 175.
  29. Id. at 174-75.
  30. Id. at 176.
  31. Helvering v. Davis, 301 U.S. 619, 645 (1937) (“When money is spent to promote the general welfare, the concept of welfare or the opposite is shaped by Congress, not the states.”).
  32. NFIB, 132 S. Ct. at 2603-05.
  33. NFIB, 132 S. Ct. at 2630 (Ginsburg, J., dissenting) (“The Chief Justice therefore—for the first time ever—finds an exercise of Congress’s spending power unconstitutionally coercive.”).
  34. NFIB, 132 S. Ct. at 2605-06 (Roberts, C.J., joined in part by Breyer & Kagan, JJ.) (“The Medicaid expansion . . . accomplishes a shift in kind, not merely degree. . . . A State could hardly anticipate that Congress’s reservation of the right to ‘alter’ or ‘amend’ the Medicaid program included the power to transform it so dramatically.”).
  35. NFIB, 132 S. Ct. at 2604 (Roberts, C.J., joined in part by Breyer & Kagan, JJ.) (“[T]he States have developed intricate statutory and administrative regimes over the course of many decades to implement their objectives under existing Medicaid.”).
  36. See U.S. Const. art. VI, cl. 2.
  37. Cf. Williamson v. Lee Optical of Oklahoma, Inc., 348 U.S. 483, 488 (1955) (applying the rational basis test to economic regulation).
  38. South Dakota v. Dole, 483 U.S. 203 (1987).
  39. See id. at 208-12; NFIB, 132 S. Ct. at 2601-04 (Roberts, C.J.).
  40. NFIB, 132 S. Ct. at 2604 (Roberts, C.J.).
  41. See Brief for Oklahoma et al. as Amici Curiae Supporting Petitioners, King v. Burwell, 135 S. Ct. 475 (filed Sep. 3, 2014) (No. 14-114), 2014 WL 7463546.
  42. Charles C. Steward Mach. v. Davis, 301 U.S. 548 (1937).
  43. Id. at 574.
  44. Id. at 587.
  45. Id. at 590.
  46. Id. at 591.
  47. Id. at 597-98.
  48. Id. at 598; see also Massachusetts v. Mellon, 262 U.S. 447, 482 (1923) (“But what burden is imposed upon the states, unequally or otherwise? Certainly there is none, unless it be the burden of taxation, and that falls upon their inhabitants, who are within the taxing power of Congress as well as that of the states where they reside.”).
  49. Lynn A. Baker & Mitchell N. Berman, Getting Off the Dole: Why the Court Should Abandon Its Spending Doctrine, and How A Too-Clever Congress Could Provoke It to Do So, 78 Ind. L.J. 459, 464-69 (2003) (describing the Dole test as “toothless”).
  50. See Transcript, supra note 1, at 49; see also supra note 10 (noting acknowledgements of the theory’s novelty by its proponents).
  51. See Transcript, supra note 1, at 15-16.
  52. See Morrison, supra note 12, at 1206-1207.
  53. William K. Kelley, Avoiding Constitutional Questions as a Three-Branch Problem, 86 Cornell L. Rev. 831, 865 (2001) (noting argument that “once it is established as the default rule that Congress must be clear to force the Court to decide a serious constitutional question, there is far less basis for objecting when the Court refuses to act on a constitutional question in the absence of legislative clarity”).
  54. Both of these (mis)applications of the canon are distinguishable from (and worse than) cases where the Court avoids a potential (but not novel) constitutional problem that it thereafter holds not to be a problem when confronted with the question on the merits. This latter type of error is an inevitable cost of a canon that applies to constitutional “doubts,” not constitutional “barriers.”
  55. See Harris v. United States, 536 U.S. 545, 556 (2002), abrogated on other grounds by Alleyne v. United States, 133 S. Ct. 2151 (2013) (rejecting as “unsound” the argument that the canon be used to avoid overruling one of this Court’s own precedents because “[t]he statute at issue . . . was passed when McMillan provided the controlling instruction, and Congress would have had no reason to believe that it was approaching the constitutional line by following that instruction”).
  56. See Morrison, supra note 12.
  57. Blodgett v. Holden, 275 U.S. 142, 147 (1927) (Holmes, J., concurring); Vermeule, supra note 12, at 1959.
  58. See Richard L. Hasen, Shelby County and the Illusion of Minimalism, 22 Wm. & Mary Bill Rts J. 713, 722-23 (2014); compare, e.g., Northwest Austin Mun. Utility Dist. No. One v. Holder, 557 U.S. 193, 204-16 (2009) with Shelby County v. Holder, 133 S. Ct. 2612 (2013).
  59. See Ernest A. Young, Constitutional Avoidance, Resistance Norms, and the Preservation of Judicial Review, 78 Tex. L. Rev. 1549, 1581 (2000).
  60. Richard A. Posner, Statutory Interpretation—in the Classroom and in the Courtroom, 50 U. Chi. L. Rev. 800, 816 (1983).
  61. See Morrison, supra note 12, at 1208 (summarizing criticisms of “the courts’ abuse of the avoidance canon” in service of “the courts’ own policy preferences”).
  62. Young, supra note 59, at 1583 (noting that a court engaging in avoidance “can do a much sloppier job of constitutional decision-making than it would do if it faced the constitutional issue directly”); see also Morrison, supra note 12, at 1208 (noting the argument that “courts tend . . . to overuse avoidance (by invoking it in the absence of genuine statutory ambiguity or in the service of an implausible constitutional concern) . . . ”).
  63. See Brandon D. Harper, The Effectiveness of State-Filed Amicus Briefs at the United States Supreme Court, 16 U. Pa. J. Const. L. 1503, 1522 (2014) (noting that state attorneys general have “created their own Supreme Court practice organization” that is “tasked with preparing parties and amicus briefs before the Court”); William E. Nelson et al., The Liberal Tradition of the Supreme Court Clerkship: Its Rise, Fall, and Reincarnation?, 62 Vand. L. Rev. 1749, 1782-89 (2009) (describing the emergence of Supreme Court practice groups in major national firms).
  64. Richard H. Fallon, Jr., Scholars’ Briefs and the Vocation of a Law Professor, 4 J. Legal Analysis 223, 225-26 (2012) (describing the increase in “law professor amici briefs” in recent years and how these briefs are sought after by Supreme Court practitioners); Michael E. Solimine, The Solicitor General Unbound: Amicus Curiae Activism and Deference in the Supreme Court, 45 Ariz. St. L.J. 1183, 1189-90 (2013) (describing reasons for the recent proliferation of Supreme Court amicus briefs).
  65. This risk persists even if you take the (favorable) view of the avoidance canon advanced by Professor Young, supra note 59. He argues that the avoidance canon is a “perfectly legitimate and even advantageous way to enforce the Constitution,” id. at 1614, but this claim obviously hinges on the existence of some prior account of what enforcing the Constitution entails. The more novel the constitutional question, the harder it will be for a justice to correctly formulate that account.
  66. Frederick Schauer, Ashwander Revisited, 1995 Sup. Ct. Rev. 71, 89 (1995) (“[T]he identification of a constitutional problem is sufficiently probative of the nontentative views of the identifiers that the act of identifying a problem will be treated by rational legislative actors as conclusive, and they will act accordingly.”).
  67. What might one lose by disfavoring avoidance of novel problems? As noted above, the main payoff of modern avoidance—braking the creation of new constitutional law—is basically a wash when issuing the avoidance opinion itself results in the identification of new constitutional penumbras. Another foregone benefit may be the loss of the higher-quality constitutional law that (let us suppose) the Justices would ultimately craft, if they used avoidance to grapple with novel constitutional issues in an incremental fashion. But publicly airing nonbinding drafts of constitutional doctrine in the pages of the U.S. Reports is a costly and unattractive way for the Justices to ruminate on constitutional questions. Many alternative and preferable methods exist for the Justices to improve the quality of their constitutional decision-making, e.g., usage of the discretionary certiorari power to select appropriate vehicles for resolving novel questions and permitting lower federal courts and state courts to “percolate” novel questions.
  68. This principle supplies a post hoc rationalization for Chief Justice Roberts’s otherwise “puzzling” “Commerce Clause essay,” NFIB, 132 S. Ct. at 2629 (Ginsburg, J., dissenting), in NFIB. Chief Justice Roberts’s notable failure to use modern avoidance makes sense if one supposes that the novelty of the Commerce Clause problem made it unjustifiable for Roberts to apply the modern avoidance canon. What was left on the table was the tool of classical avoidance, using which he decided the novel question on the merits and then adopted a saving construction of the act. See NFIB, 132 S. Ct. at 2600-01 (Roberts, C.J.).
  69. See Gov’t Br., supra note 15, at 18-19.
  70. See JALSA Brief, supra note 4, at ii.
  71. See id. at v (citing NFIBpassim”).
  72. Donald Rumsfeld, Sec’y, Dep’t of Def., Dep’t of Def. News Briefing (Feb. 12, 2002), (“[A]s we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know.”). Thanks to Dave Owen for this point.
  73. ACA § 2001(b).
  74. 42 U.S.C. § 1396a(gg)(1).
  75. Of course, a government victory in King might make this challenge moot by deeming the establishment of the federal exchange to have satisfied this condition. See Gov’t Br., supra note 15, at 29-30.
  76. See Petition for Extraordinary Writ, In re Murray Energy Corp., No. 14-1112 (D.C. Cir. June 18, 2014).
  77. Brief for Intervenor Peabody Energy Corp. at 12-13, In re Murray Energy Corp., No. 14-1112 (D.C. Cir. June 18, 2014), 2014 WL 7405848; id. at i (reflecting brief was filed December 30, 2014).
  78. See EPA’s Proposed 111(d) Rule for Existing Power Plants: Legal and Cost Issues: Hearing before the Subcomm. On Energy & Power of the H. Comm. on Energy & Commerce, 114th Cong. (2015) 2-4, 16-27 (testimony of Laurence H. Tribe, Professor, Harvard Law School).
  79. Id. at 3-4; id. at 26 (“[T]he gun consists of subjecting non-complying States to a kind of Russian roulette in which they run the risk of being hit with a centrally planned and administered federal scheme, a plan whose details are as yet unknown, but one that threatens significant disadvantage to them and their citizens, both in absolute terms and vis-à-vis other States, if they decline to submit their own plans to EPA.”).
  80. See Mario Loyola, Federal Coercion and the EPA’s Clean Power Plan, The Atlantic, May 17, 2015.
  81. Cf. JALSA Brief, supra note 4, at 29 (“Given the doctrinal difficulties that arise from regulatory incentives—and the constitutional doubts associated with any regulatory differentiation—it might make sense to hold that regulatory threats are unconstitutionally coercive no matter how trivial they might appear.”).
  82. See Brief for State of Indiana et al. as Amici Curiae Supporting Petitioners at 18-30, King v. Burwell, 135 S. Ct. 475 (filed Dec. 19, 2014) (No. 14-114), 2014 WL 7463545.
  83. See sources cited supra note 4.
  84. See Spector v. Norwegian Cruise Line, 545 U.S. 119, 141 (2005) (plurality opinion) (Kennedy, J.) (noting that the avoidance canon is “a canon for choosing among plausible meanings of an ambiguous statute”); Clark v. Martinez, 543 U.S. 371, 385 (2005) (asserting that the avoidance canon “comes into play only when . . . the statute is found to be susceptible of more than one construction . . . .”).
  85. See sources cited supra note 15.
  86. See David L. Shapiro, In Defense of Judicial Candor, 100 Harv. L. Rev. 731, 736 (1987) (“[T]he prevailing view of the judicial function (and one I fully accept) would support the judge who, as an individual, does not go as far as he might be willing to go if the case before him does not require it. The problem of candor, once again, arises only when the individual judge writes or supports a statement he does not believe to be so.”).

Abstinence in the Face of the Mutual Fund Debt Elixir: In Response to Professor John Morley

* A.B., College of the Holy Cross, 1994; J.D., New York University School of Law, 1997; M.B.A., Columbia Business School, 2001. This article is a private publication of the author, expresses only the author’s views and does not represent the views of any firm or any client or former client. The author would like to thank Paul Connell and the editors at the Yale Journal on Regulation for their first-rate assistance.

In recent years, a combination of bruising market losses, increased correlation among asset classes, unexpected illiquidity and high-profile scandals has left the investment management industry reeling.1 In the wake of the Great Recession,2 asset managers find themselves scrambling to respond to significant shifts in investor behavior and an evolving regulatory landscape.3 Two of the most observable trends have been (i) the investing class’s increasing appetite for alternative streams of return and (ii) a noticeable desire for more regulated investment vehicles.4

As an investment professional involved in today’s “liquid alternatives” mutual fund movement,5 I was quite pleased to come across Professor John Morley’s “The Regulation of Mutual Fund Debt” in the Yale Journal on Regulation.6 The article grapples—albeit from an academic point of view—with many of the issues that fund structurers encounter, on a more practical level, as we imagine, structure and develop innovative products for investors. Morley’s article represents a significant contribution to the discussion of mutual fund regulation, providing—in the professor’s own words—“the first general examination of mutual fund capital structure regulation under the Investment Company Act of 1940.”7 More basically, Morley’s article succeeds in establishing a firm foundation for additional examination and discovery and highlights the importance of imagining what might be instead of settling for what already is.

This short Response (the “Response”) attempts to buttress the still nascent discussion surrounding mutual fund capital structure. Moreover, the Response encourages Professor Morley and the broader academic community to advance the examination of investment vehicles and their limitations in light of the evolving needs of today’s investing public. The seriousness and complexity of the subject matter, and its tangible ramifications for investors, necessitate a more thorough examination. And it is hoped that this Response plays some role in promoting that discussion.

This Response proceeds in three parts. Part I represents the heart of the Response, reintroducing the basic framework through which the article’s author analyzes the features unique to the mutual fund capital structure. This Part suggests that the strictures imposed on mutual fund capital structure represent a small part of the patchwork that forms the Investment Company Act of 1940 (“the Act”). The individual sections of the Act are not easily decoupled. Instead, the overall application of the entire Act exceeds the sum of its parts. As importantly, structuring choices and regulatory limitations have tangible effects on investors. Part II challenges the regime proposed by the article, arguing briefly that a regulatory accommodation allowing mutual funds to issue debt would not fulfill enough of an investor need to justify the change and, at the same time, might not be as harmless as the Article suggests. Finally, Part III concludes the Response by cautioning that any change to the regulation of mutual funds requires further consideration and deliberation.

Part I

As we approach the three-quarter century mark since the adoption of the Investment Company Act and the accompanying Investment Advisers Act of 1940, it is important to remember that, whatever its shortcomings, the regulation of mutual funds has served investors quite well.8 As Professor Morley acknowledges, the current regulatory regime deserves credit for an “almost complete absence of bankruptcies among mutual funds in the last 70 years.”9 Against such a backdrop, any changes similar to those suggested in the article face an uphill battle.

Nonetheless, the article makes a significant contribution by (i) examining the possible explanations for the blanket prohibition on the issuance of mutual fund debt securities and (ii) daring to ask whether mutual funds should be freed from the restriction, to “be allowed to issue debt securities to the public.”10

There are, however, shortcomings in the approach offered by Professor Morley. First, by focusing almost exclusively on the provisions of the Investment Company Act that directly address capital structure, the article glosses over some of the other protections mutual fund regulations typically afford investors.11 Second, the article’s proposal—allowing mutual fund debt issuance regulated as to form and amount—is likely to be met with all of the subjectivity of the current “senior security” regime without the benefit of seventy years of industry practice and regulatory interpretation.12

The provisions of the Act directly addressing capital structure cannot be understood in isolation. To the contrary, they represent a single part of a more robust regime. In describing the scope of the Act, a former SEC Commissioner once observed:

It places substantive restrictions on virtually every aspect of the operations of investment companies; their governance and structure, their issuance of debt and other senior securities, their investments, sales and redemptions of their shares, and, perhaps most importantly, their dealings with service providers and other affiliates.13

In addition to the provisions directly addressing capital structure,14 specific portions of the Act protect investors in terms of diversification,15 disclosure,16 liquidity17 and price transparency.18

Also, the unique tax status of mutual funds adds an additional layer of protection by requiring a reasonable amount of diversification. The taxation of mutual funds is governed by subchapter M of the Internal Revenue Code.19 Unlike most corporations, mutual funds are not subject to entity-level taxation on their income or capital gains, provided that they meet certain gross income, asset, and distribution requirements.20 In addition, at the close of each quarter, a fund must hold a mix of assets that qualify it as a “regulated investment company” and provide a reasonable level of diversification.21

After summarizing the capital structures available to mutual funds and examining several possible legislative motives informing the decision to prohibit mutual funds from issuing debt securities, Professor Morley concludes that the regulation of mutual funds’ capital structure is “incoherent.”22 Any such incoherence, however, might be in the eye of the beholder. And, while no structure can insulate an investor from market losses, the mutual fund regulatory framework has been remarkable for the breadth and depth of its regulation and the lack of mutual fund bankruptcies or scandals that have occurred during its time in place.23

Morley’s main proposal is to lift the ban on debt issuance in favor of a regime that manages some allowable level of debt.24 In many ways, this proposal sets out to solve a problem that does not exist. There seems scant evidence of an investing public clamoring for something that the mutual fund debt elixir will cure. In fact, investors have been inundated with innovative new products in recent years.25 Perhaps the current prohibition on senior securities would be more palatable to Professor Morley if it was recharacterized as a very conservative (and easier to administer) version of the regime he desires—with fund borrowings highly regulated as to form, amount and counterparty.26 Besides, in many contexts, abstinence often proves as easy as temperance might be difficult.27

Part II

Professor Morley cites the lack of available fixed rate products in support of allowing mutual funds to issue debt securities.28 Such a justification seems both curious and inexact. The article asserts that the lack of debt issuance by mutual funds has “profound consequences for the retirement portfolios of household investors” because it means that “most Americans’ retirement portfolios consist almost entirely of common stock, rather than debt.”29 The fact that the mutual fund investment itself represents an equity position in an investment company should be of little concern. More importantly, the mutual fund’s underlying portfolio might be comprised of all types of securities, fixed income and otherwise.30 A mutual fund holding a bond portfolio, for example, undoubtedly offers investors a return stream best characterized as fixed-income-like. Moreover, the risk of holding the equity of a mutual fund is mitigated by the fact that the fund’s capital structure is barred from including any debt or additional class of equity. As the residual claimholder, the mutual fund shareholder is only advantaged versus a typical equity investor in a corporation. Accordingly, she should find comfort from the embargo of any claimant who could assert priority in the capital structure.

In fact, the certainty that inures to the shareholder, free from any claim with priority in the capital structure, is at the heart of the current senior securities regulatory regime. Mutual fund investors enjoy the position as owners of a pro rata share of an underlying pool of investments. Such an understanding would be strained if the mutual fund were permitted to issue debt. The introduction of the accompanying leverage would require investors to perform an additional layer of analysis to understand the distortion to their pro rata status resulting from such debt.

The Investment Company Act of 1940 was, in large measure, a response to hearings that “revealed that the capital structures of many investment companies were highly complex, often consisting of many classes of securities with different dividend, liquidation, and voting rights.”31 Read in conjunction with other sections of the Act prohibiting transactions with fund affiliates, the limitations on capital structure were aimed at mollifying investor confusion and minimizing the risky leverage that characterized investment funds prior to the Act’s adoption.32

As one commentator observed shortly after the passage of the Investment Company Act,

Almost all agreed that it was unsound to have outstanding an issue of bonds or preferred stock, where the common stock was subject to redemption at the will of the stockholder, for the equity could thus be taken away completely from behind the senior security.33

Such words still ring true today. And, the legislative intent of the prohibition on debt coupled with (i) an absence of mutual fund failures, (ii) the wide and increasing variety of available investment products and (iii) the tremendous amount invested in today’s existing mutual funds counteract the notion that a pivot to a debt issuance regime is either necessary or worth the risks.

Part III

Professor Morley has done a real service in providing the opening framework for academicians, practitioners, investors, and firms to explore further the capital structure of mutual funds. While somewhat sympathetic to the incoherent nature of the capital structure regulations, I must confess skepticism toward the view that attributes significant investor benefits to any regulatory change allowing mutual funds to issue debt. Instead, it appears that the article largely aims to solve a problem that does not exist. In the process, it might reveal too trusting a view that any such change might be managed smartly and without unintended consequences. At the very least, a more thorough and holistic examination of the likely effects on the mutual fund’s overall regulatory framework is required before such an alteration can be responsibly suggested. Cognizant too that recent innovations in the alternative investment landscape have significantly expanded the products available to investors—perhaps beyond what Professor Morley and his colleagues in the academy might yet fully appreciate—one cannot help but recall Victor Hugo’s observation that sometimes “caution is the eldest child of wisdom.”

  1. See generally Exotic to Mainstream: Growth of Alternative Mutual Funds in the U.S. and Europe 2, SEI Investments Co. (May 4, 2010).
  2. For a discussion of the Great Recession and its causes, see Steven A. Ramirez, Lawless Capitalism: The Subprime Crisis and the Case for an Economic Rule of Law at xi-xvii (2012); Michael C. Macchiarola, Beware of Risk Everywhere: An Important Lesson From the Current Credit Crisis, 5 Hastings Bus. L.J. 267, 269-273 (2009).
  3. See, e.g. Exploring Strategies in Response to a Shifting Landscape, J.P. Morgan Investor Services (2013) (noting that today’s asset managers are confronting “numerous challenges, including capturing new capital from investors, escalating competition, increased regulatory requirements, operational complexity and profit margins that are still below pre-crisis levels.”).
  4. See generally The Rise of Liquid Alternatives & The Changing Dynamics of Alternative Product Manufacturing and Distribution, Citi Prime Services (May 2013) at 4 (observing a “growing need for alternative strategies” and a “flattening of the differences between publicly offered and privately offered funds.”).
  5. According to one study, “[a]ssets in U.S. alternative mutual funds and Exchange Traded Funds (ETFs) have more than doubled since 2008, and now represent 883 portfolios with more than $550 billion in assets.” The Retail Alternatives Phenomenon: What Enterprising Private Fund Managers Need To Know 2, SEC Investments Co. (June 12, 2013).
  6. John Morley, The Regulation of Mutual Fund Debt, 30 Yale J. on Reg. 343 (2013).
  7. Id. at Abstract. All statutory references to the Investment Company Act of 1940 (ICA) are to 15 U.S.C. § 80(a) (2006), and, unless otherwise stated, all references to the rules under the Investment Company Act of 1940 are to 17 C.F.R. 270 (2013).
  8. See, e.g., Paul Roye, Division Director of Div. of Inv. Mgmt., U.S., Sec. & Exch. Comm’n, Keynote Address at the EEESI General Membership Meeting 2000: Regulation of Mutual Funds in the United States: A Successful Regulatory Regime (Sept. 22, 2000) (noting that the Investment Company Act “has proved to be remarkably resilient”).
  9. Morley, supra note 6, at 346.
  10. Id. at 347.
  11. For a summary of some of those protections, see Dianne M. Sulzbach & Philip T. Masterson, Offering Alternative Investment Strategies in a Mutual Fund Structure: Practical Considerations, The Investment Lawyer (Oct. 2008).
  12. For a summary of some of the SEC’s interpretations of the “senior security” provisions of Section 18 of the Investment Company Act, see Registered Investment Company Use of Senior Securities——Select Bibliography, U.S. Sec. & Exch. Comm’n,
  13. Roye, supra note 8.
  14. For example, Section 18(f)(1) prohibits a mutual fund from issuing any class of senior security, or selling any class of senior security of which it is the issuer. Funds are generally permitted to borrow from a bank provided that immediately after any such borrowing there is asset coverage, as defined in section 18(h), of at least 300%. The Commission and the staff have indicated, however, that they will not object to funds engaging in certain types of transactions without complying with the asset coverage and other requirements of section 18(f)(1), provided that the funds segregate assets, or otherwise “cover” their obligations under the instruments, consistent with Commission and staff guidance. See 15 U.S.C. § 80a-18 (2012).
  15. Section 5(b) of the Investment Company Act categorizes a fund as a “diversified company” or “non-diversified company” based on the quality and diversity of its total assets. Absent a shareholder vote, Section 13(a) prohibits a funds from (i) changing from diversified to non-diversified and (ii) deviating from the investment policy or concentration policy stated in its registration statement. See id. §§ 5(b) & 13(a).
  16. In pertinent part, Section 30(b)(1) of the Investment Company Act requires that every registered investment company file with the Commission “such information documents and reports (other than financial statements) as the Commission may require to keep reasonably current the information and documents contained in the registration statement of such company.” ICA § 30(b)(1). A Fund’s quarterly filing of portfolio holdings is accomplished on Form N-CSR or Form N-Q and, depending on circumstances and timing, need not be audited. See generally Final Rule: Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies Securities and Exchange Commission 17 CFR Parts 210, 239, 249, 270, and 274 [Release Nos. 33-8393; 34-49333; IC-26372; File No. S7-51-02],
  17. SEC guidelines require a mutual fund to have at least eighty-five percent of its assets in liquid securities. A security is generally deemed to be liquid if it can be sold or disposed of in the ordinary course of business within seven days at approximately the price at which the mutual fund has valued it. See Revisions of Guidelines to Form N-1A, SEC Release No. IC-18612 (Mar. 12, 1992) (noting that the eighty-five percent standard was “designed to ensure that mutual funds will be ready at all times to meet even remote contingencies”). Although the Commission has rescinded the Guidelines to Form N-1A, most of the positions taken in the Guidance, including those relating to liquidity, continue to represent the SEC staff’s position.
  18. Nearly all funds offer shareholders liquidity and market-based valuation of their investments at least daily. Mutual fund shares are redeemable on a daily basis at a price reflecting the current market value of the fund’s portfolio, calculated according to pricing methodologies established by the fund’s board of directors. See generally ICA § 2(a)(41); 17 C.F.R. 270.22c-1.
  19. See I.R.C. § 851-855.
  20. The “Qualifying Income” test provides that to qualify as a regulated investment company at least ninety percent of a mutual fund’s gross income must be derived from certain sources, including dividends, interest, payments with respect to securities loans, and gains from the sale or other disposition of stock, securities, or foreign currencies. I.R.C. § 851(b)(2).
  21. The “Diversification” test provides that at least fifty percent of the value of the fund’s total assets must consist of cash, cash items, government securities, securities of other regulated investment companies, and investments in other securities which, with respect to any one issuer, represent neither more than five percent of the assets of the fund nor more than ten percent of the voting securities of the issuer. In addition, no more than twenty-five percent of the fund’s assets may be invested in the securities of any one issuer (other than government securities or the securities of other funds). I.R.C. § 851(b)(3).
  22. Morley, supra note 6, at 347.
  23. See, e.g., Inv. Co. Inst., Investment Company Fact Book at App. A (53d ed. 2013) (noting that “[f]unds are subject to more extensive disclosure requirements than any other comparable financial product, such as separately managed accounts, collective investment trusts, and private pools”).
  24. Morley, supra note 6, at 348.
  25. See generally Retail Liquid Alternatives: The Next Frontier 3, Goldman Sachs Global Investment Research (Dec. 6, 2013) (describing the retail liquid alternative market as having nearly 400 products, with 1/3 of those products launched over the past two years).
  26. It should be noted that investors in funds with embedded derivatives facing certain counterparties are also provided an additional protection beyond the scope of this Response. In general, Section 12(d)(3) of the Investment Company Act of 1940 prohibits registered investment companies from purchasing or otherwise acquiring any security issued by a broker, dealer or underwriter. In effect, this prohibition significantly curtails the counterparty risk a mutual fund might incur contra a so-called “securities related issuer.” See 15 U.S.C. § 80a-12(d)(3) (2012). For a general discussion of Section 12(d)(3) and the accompanying Rule 12d3-1, see Lawrence P. Stadulis & Timothy W. Levin, SEC Regulation of Investment Company Investments in Securities Related Business Under the Investment Company Act of 1940, 2 Villanova J. L. & Inv. Mgmt. 9 (2000). For a general discussion of the ramifications of mutual funds employing derivatives, see SEC Concept Release, Use of Derivatives by Investment Companies under the Investment Company Act of 1940, Release No. IC-29776; File No. S7-33-11 (Aug. 31, 2011).
  27. See, e.g., Gretchen Rubin, Happier at Home (2012) at 122 (discussing this philosophy, albeit in a far different context, and attributing it to Samuel Johnson).
  28. Morley, supra note 6, at 354.
  29. Id.
  30. The PIMCO Total Return Fund, for example, with over $230 billion in assets, seeks to achieve its investment objective by investing primarily in a diversified portfolio of fixed income instruments. See Prospectus for PIMCO Total Return Fund, PIMCO (July 31, 2013).
  31. Roye, supra note 8. See also Alfred Jaretzki, Jr., The Investment Company Act of 1940, 26 Wash. U. L. Qrtly. 303, 307 (1941) (asserting that open-end mutual funds first came to prominence after abuses were uncovered in the structure of investment companies, their affiliations and their high pressure sales practices).
  32. See generally Roye, supra note 8 (noting that “[t]he U.S. Congress enacted the Investment Company Act to address these abuses in the investment company industry, assure investor protection, and preserve the important role investment companies’ play in capital formation”).
  33. Jaretzki, supra note 31, at 335.

The Need for New Federal Anti-Spam Legislation

The CAN-SPAM Act of 2003 was passed in an attempt to stop “the extremely rapid growth in the volume of unsolicited commercial electronic mail” and thereby reduce the costs to recipients and internet service providers of transmitting, accessing, and discarding unwanted email.1 The Act obligates the senders of commercial email to utilize accurate header information, to “clear[ly] and conspicuous[ly]” identify their emails as “advertisement or solicitation,” and to notify recipients of the opportunity to opt-out of receiving future emails.2 Once an individual has opted out, that sender is then prohibited from emailing them further.3 Despite high hopes, the Act has largely been considered a failure for four reasons: 1. It eliminates many pre-existing private causes of action against senders,4 2. it does not require senders to receive permission before initiating contact,5 3. it relies upon a system of opt-out links that are both distrusted and frequently abused,6 and 4. it has been under-enforced.7

In the absence of comprehensive federal legislation, alternative solutions to the spam problem have proliferated, including state-by-state statutory regimes, decentralized private regulation, and restraints on the acquisition of email addresses itself. This paper examines some of the shortcomings of these alternative approaches, advocating instead for a new, more complete federal statutory regime.

I. State Solutions: Low Compliance, Low Enforcement

Some states have tried statutory approaches to curtailing spam.8 These regimes vary widely, ranging from completely prohibiting all “unsolicited commercial email,”9 to permitting unsolicited commercial emails but requiring that they contain certain keywords in the subject line,10 to merely requiring truthfulness in the sender and subject lines,11 to seemingly no regulation whatsoever.12 These broad categories have further differentiation—some states’ laws only apply to email sent to more than a certain number of recipients,13 for example—so that the result is a substantially heterogeneous patchwork of regulation across the country.

Since email addresses, unlike physical addresses, offer no indication of the location of the recipient, complying with each state’s particular laws becomes all but impossible for senders of commercial email. The result is low voluntary compliance, with weak enforcement mechanisms—low-incentive private causes of action14 and underfunded state investigators15—unable to pick up the slack. Uniform federal legislation against spam that preempts these state regimes, includes greater incentives for bringing private action, and allocates funding for investigations would increase compliance and improve enforcement across the country.16

II. Decentralized Private Regulation: Anticompetitive Concerns

Private internet service providers (ISPs) have also stepped in, generating lists of websites that they believe “send or support the sending of spam,” and “blocking transmission” between those websites and the addresses in its own system.17 This decentralized process of private regulation may be more flexible and adaptive to changing technology,18 but it creates significant anticompetitive concerns.19

The criteria for blacklisting can be quite elastic—despite dedicating significant resources to fighting spam and policing relay use, MIT ran afoul of one such blacklist for simply having “bad email practices”20—and could easily allow ISPs to engage in selective enforcement, disproportionately blocking the websites and communications of competitors. Since ISPs are already natural monopolies, with customers in a given location typically having few, if any, alternatives, market forces would do little to restrain capricious blocking activity. Furthermore, ISPs that operate as part of much larger corporations have added potential for abuse by leveraging their blocking power in other markets; AT&T, for example, might use its position as an ISP to block the website and commercial messages of a competing cell phone carrier while allowing its own to go through. In this way, allowing ISPs to maintain blacklists enables them to magnify their already significant market power. Federal legislation against spam can obviate the need for private blacklists, stopping spam without generating anticompetitive forces.

III. Restraints on Email Address Acquisition: No Protection in Many Cases

The Computer Fraud and Abuse Act (CFAA)21 as well as the common law of contract and trespass have been used to curtail spam indirectly by policing the illegitimate acquisition of email addresses.22 However, these solutions are incomplete at best. Focusing on the acquisition of email addresses does nothing for individuals whose email addresses are already in the hands of spammers. Additionally, these restraints miss a wide variety of email address acquisition techniques. Lists of email addresses can still be bought, sold, or posted for free by companies that acquired them. Users may unwittingly leave their contact information searchable on social media sites. Many email addresses can even be guessed.23 Federal legislation addressing the act of spamming directly is needed to close these gaps, and provide recourse once an email address has been acquired.

IV. Conclusion: Crafting Better Federal Spam Regulation

A new federal statutory regime regulating spam is needed to replace CAN-SPAM. State regulations are prohibitively difficult to comply with, and lack proper enforcement mechanisms. Private regulation raises too many anticompetitive concerns. Restrictions on email address acquisition, while beneficial, are an inadequate solution on their own. New federal regulation that directly targets spamming activity, requires opting in rather than opting out, provides sufficient incentives for private parties to file complaints or bring suit, and dedicates resources for investigations would go far in reducing spam below its current level.

  1. 15 U.S.C. § 7701(a)(2)-(3), (6) (2012).
  2. Id. § 7704(a)(1)-(2), (5).
  3. Id. § 7704(a)(4)(A).
  4. See Amit Asaravala, With This Law, You Can Spam, Wired (Jan. 23, 2004), (quoting Lawrence Lessig as saying the Act “is an abomination . . . . It’s ineffective and it’s affirmatively harmful because it preempts” other causes of action).
  5. See Statement on CAN SPAM, Coal. Against Unsolicited Commercial Email (Dec. 16, 2004), (noting that by adopting an opt-out system, “[CAN-SPAM] gives each marketer in the United States one free shot at each consumer’s e-mail inbox . . . .”).
  6. See Daniel Solove, What Exactly Is a “Spammer”?, Concurring Opinions (Jan. 7, 2007), (“It is common knowledge that you shouldn’t click the opt out link on an unsolicited email because many spammers use that trick as a way to verify that people have read the spam and will then send people even more spam.”).
  7. See Jonathan K. Stock, A New Weapon in the Fight Against Spam, Mondaq (Oct. 8, 2004), (“The [CAN-SPAM] Act has largely gone unenforced.”).
  8. See, e.g., Washington v. Heckel, 24 P.3d 404 (Wash. 2001) (finding Heckel liable for sending unsolicited commercial email by applying Washington’s Commercial Electronic Mail Act, codified at Wash. Rev. Code § 19.190 (2012)).
  9. Cal. Bus. & Prof. Code § 17529.2(a)-(b) (West 2013).
  10. See, e.g., 815 Ill. Comp. Stat. 511/10(a)(a-15) (2012) (mandating use of “ADV” and “ADV:ADLT” in “unsolicited electronic mail advertisement’s subject line[s]”); Alaska Stat. § 45.50.479 (2012) (mandating the use of subject line keywords only for sexually explicit content); Wis. Stat. § 944.25 (2012) (same).
  11. See, e.g., Nev. Rev. Stat. §§ 205.492, 205.511 (2012); N.D. Cent. Code § 51-27-01 (2012); Wash. Rev. Code §§ 19.190.010 to .110 (2012).
  12. Hawaii, for example, “has no statutes addressed specifically to commercial email and spam.” Legal Information Institute, Hawaii, Cornell L. Sch., (last accessed Nov. 17, 2013).
  13. See, e.g., La. Rev. Stat. Ann. §§ 14:73.1, 14:73.6 (only applying to “electronic message[s] . . . sent in the same or substantially similar form to more than one thousand recipients”).
  14. Many states, for example, only allow plaintiffs to recover actual damages or a predetermined maximum amount; these are likely insufficient to incentivize the costly and time-consuming process of obtaining a lawyer, filing suit, and litigating. See, e.g., ,s>R.I. Gen. Laws § 6-47-2(h) (2012) (capping what plaintiffs may receive at $100, plus legal fees); Pa. Stat. Ann. § 2250.7(a)(1) (West 2013) (same); Me. Rev. Stat. tit. 10 § 224.1497(7)(B) (2012) (allowing for recovery of actual damages or $250, whichever is greater); Mo. Rev. Stat. § 407.1129 (2012) (allowing for recovery of actual damages or $500, whichever is greater).
  15. See Electronic Crime Needs Assessment for State and Local Law Enforcement, Nat’l Inst. of Justice (Mar. 2001),, at iv (voicing “serious concerns about the capability of [state] law enforcement resources to keep pace” with a wide variety of computer crimes).
  16. One might argue that senders of unsolicited commercial email ought to simply identify the strongest state law, obey it, and then they will be safe in every state. The result of this, however—uniform anti-spam law across the country—is more legitimately achieved through federal legislation than a single state’s unilateral action. Some states, for one reason or another, may not want stronger anti-spam laws. The federal legislative process would balance these interests, and take different states’ desires into account.
  17. Media3 Technologies v. Mail Abuse Prevention System, No. 00–CV–12524–MEL., 2001 WL 92389, at *2 (D. Mass. Jan. 2, 2001).
  18. See David G. Post, Of Black Holes and Decentralized Law-Making in Cyberspace, 2 Vand. J. Ent. L. & Prac. 70 (2000).
  19. Decentralized private regulation also raises the same compliance concerns outlined above. There are many different possible definitions of spam, let alone what constitutes “supporting” the sending of spam. Since ISPs may cover residents of multiple states, and states may have multiple ISPs, the result is a patchwork of private policies overlaid onto a patchwork of state regulations, further hampering compliance.
  20. See Lawrence Lessig, The Spam Wars, The Indus. Standard (Dec. 31, 1998).
  21. 18 U.S.C. § 1030 (2012).
  22. See, e.g., v. Verio, 356 F.3d 393 (2d Cir. 2004) (determining that querying Register’s servers to obtain their customers’ email information for spamming purposes constituted a breach of contract on the part of Verio, as well as trespass to chattels); America Online v. LCGM, 46 F. Supp. 2d 444, 450 (E.D. Va. 1998) (determining that by using an AOL membership to harvest the email addresses of AOL users, LCGM was in violation of AOL’s Terms of Service, and as a result both “exceeded authorized access” and “accessed without authorization” for the purposes of the CFAA).
  23. Combinations of common first and last names with popular domains such as or generate numerous positive results as of this writing (search conducted via web applets such as Linksy’s Find-Email ( There are even programs designed to help automate such guessing, such as the Gmail extension Rapportive (

Expanding the Prosecutor’s Purview: Interpreting the Wartime Suspension of Limitations Act


The question of when a war exists has been extensively considered in international law,1 but the subject is greatly important in the regulation of government contracting because of the little-known Wartime Suspension of Limitations Act (WSLA).2 The Act declares that when the nation is “at war,” the statute of limitations on fraud committed against the United States government will not take effect. When the nation is at war, the general five-year statute of limitations on federal crimes can be extended without end for fraud in government contracting.3

The Fifth Circuit’s 2012 ruling in United States v. Pfluger4 has garnered significant attention within the business community because it ruled that the wars in Iraq and Afghanistan have not ended, thus extending the statute of limitations on fraud against the government.5 Despite the implications of the ruling for companies engaged in government contract work, no scholarship has discussed what the court called a “minimally developed area of law.”6 This Comment seeks to fill that gap by tracing how courts have interpreted the “at war” section of the Act. In the three cases where federal courts have considered this question, they have all come out differently on how to interpret this provision of the Act.

The interpretation will have broad ramifications for the regulation of government contracting because the Act applies to all government contracting, done both in and outside of the war zone. Under United States v. Prosperi, courts have interpreted the Act to give the government power to prosecute fraud committed against the government, even where that fraud has no relation to the war.7 In that case, the court upheld the government’s use of the Act to prevent the statute of limitations from taking effect on fraud committed by a contractor who was working on Boston’s “Big Dig” project. Though the fraud had nothing to do with the war, the court reasoned that because the fraud took place during wartime, the government could stop the clock on the statute of limitations.8

Government contracting was a $516.3 billion industry in FY 2012, and the industry is significantly impacted by the statute of limitations on contracting work.9 By extending the statute of limitations, companies can be deterred from fraud that may be too complex to discover quickly. Similarly, increases in the statute of limitations will raise the regulatory exposure of a company in a government contract and will prevent them from closing the books on earlier contract work. Though the law does not involve action from an administrative agency, it is regulation in Barak Orbach’s conceptualization of a regulation as government action that can “directly influence (or ‘adjust’) conduct of individuals and firms” and which “enables, facilitates or adjusts activities, with no restrictions.”10 The law and its interpretation will directly adjust the activity of firms by determining the length of their exposure to costly prosecutions from the government for their contracting work.

This Comment proceeds in two sections. First, the Comment reviews how courts have interpreted the Wartime Suspension of Limitations Act. The Comment argues that Pfluger marked a departure from the functionalist test in Prosperi that, in an era without formal surrender treaties, will extend the “at war” section of the Act without any end point. Second, the Comment argues for a return to the functionalist test in which the courts are held responsible for determining on a factual basis when the nation is at war. This is a more difficult task for the courts but is necessary to properly construe the statute.

I. Defining “At War”

There have only been three cases that have sought to interpret the “at war” section of the Wartime Suspension of Limitations Act.

A. United States v. Shelton

In the first case, United States v. Shelton, the court ruled that the Gulf War never met the definition of “at war” because a formal Declaration of War was requiring to trigger the statute.11 The case involved a local official in Texas who was indicted in June 1992, more than five years after he was alleged to have engaged in fraud against the United States government in conjunction with his position as Deputy Director of the Texas Department of Community Affairs.12 The government responded that because of the 1991 Gulf War, the statute of limitations was halted.13 The court ruled that “the recent conflict with Iraq did not constitute a ‘war’ as that term is used in the Suspension Act” because the statute was designed for “massive and pervasive conflicts [such] as World War II,” which the Gulf War was not.14

The Shelton court took a strongly formalist approach to the definition of “at war.” No Declaration of War had been issued since World War Two, and under the court’s interpretation, the U.S. would not have been “at war” during the Korean and Vietnam Wars. While various military courts had adopted more expansive definitions of war, the court held that “armed conflict to amount to a ‘war’ for military purposes admittedly should be a lower standard than to constitute a war for civilian purposes.”15 According to the court, the only trigger for the “at war” section would be action from Congress that “formally recognized that conflict as a war. The Judicial Branch of the United States has no constitutional power to declare a war.”16 Shelton avoids complications about when the Gulf War may have ended by arguing that it never began for the purposes of the statute. In seeking to divorce the definition of “at war” from any functional interpretation of U.S. military action, the court was distancing its interpretation of the conflict from Dellums v. Bush, in which Judge Harold Greene ruled that “here the forces involved are of such magnitude and significance as to present no serious claim that a war would not ensue if they became engaged in combat,” which they ultimately did.17

B. United States v. Prosperi

In United States v. Prosperi, the government used the “at war” provision to charge a contractor in Boston’s “Big Dig” with fraud that would have otherwise been time-barred.18 Even though the fraud had nothing to do with the conflicts in Afghanistan and Iraq, the court held that “it makes no difference that the fraud in this case involved a construction project unrelated to the Iraqi or Afghani conflicts.”19

In determining the scope of the “at war” provision, Prosperi rejected the formalist approach in Shelton and adopted a functionalist approach. While noting that courts should generally abstain from wading into questions “fraught with gravity,”20 the court ruled that there are “cases, however, that leave no choice to a court but to interpret statutory or contractual language that depends on the determination of the existence of a declared or undeclared state of war.”21 The court criticized the Shelton decision for missing the major conflicts that should meet the “at war” trigger: “[t]he Shelton formulation thus does not capture the Korean War or the Vietnam War, two of the largest, bloodiest, and most expensive military campaigns in our nation’s history (nor does it capture the conflicts in Iraq and in Afghanistan).”22 Prosperi rejected the requirement for a Declaration of War because “there is no compelling logic connecting a formal declaration of war with the state of being at war.”23

In moving away from a formalist definition, the Prosperi decision opened up questions concerning what level of violence would constitute war. The court ceded that “not every shot fired or every armed skirmish is of sufficient magnitude to stop the running of the statute of limitations.”24 In establishing that the conflicts in Iraq and Afghanistan constituted the United States being “at War,” the decision engaged in a thorough examination of the resources used and American lives lost.25

Prosperi returned to a more formalist definition to define the “termination of hostilities.”26 Instead of applying its earlier empirical examination of the existence of hostilities, the court argued that the “end of more recent conflicts have been signaled by Presidential pronouncement or by the diplomatic or de jure recognition of a former belligerent or a newly constituted government.”27

The court ruled that the U.S. recognition of the Afghan government on December 22, 2001 constituted the end of hostilities in Afghanistan and that President George W. Bush’s “Mission Accomplished” speech aboard the USS Abraham Lincoln constituted the end of hostilities in Iraq.28 While Prosperi had criticized the formalism of Shelton in determining whether a war exists, it returned to this formalism in making its assessment of when war ends.

C. United States v. Pfluger

In United States v. Pfluger, the government used the “at war” provision of the statute to extend the statute of limitations in a case involving fraud by a U.S. soldier in Iraq. David Pfluger was a lieutenant colonel in Iraq accused of taking kickbacks in connection with contracts he arranged for fuel for his Forward Operating Base.29 Pfluger challenged his conviction because the statute of limitations had run, and the government responded that because the nation was “at war” the statute of limitations was suspended.30 The court rejected the narrow definition of war from Prosperi and ruled that the Act “mandates formal requirements for the termination clause to be met.”31

In the decision, the court tried to narrow potential applications of the case to future litigation. Noting that the precedent could lead to “absurd” applications, the court said that it was only claiming that the standard worked in this case: the court “need only determine that it is not an absurd result that the hostilities in the armed conflict authorized by either the AUMF or the AUMF-I were ongoing in May 2004,” when the conduct was carried out.32 To justify that position, the court relied on the standards of active combat developed in Hamdi v. Rumsfeld.33 However, the court went beyond this to state that because the President hadn’t engaged in the “formal requirements for terminating the WSLA’s suspension of limitations” up through “this date,” WSLA would still be in effect when the decision was made in June 2012.34

With the Supreme Court denying certiorari in the appeal of Pfluger, the expansive standard from that case is the most recent law on the subject.

II. Towards a Functionalist Interpretation of the WSLA

Interpretations of the WSLA have been marred first by under-inclusive formalism and now by over-inclusive formalism. In Shelton, the court’s formalism led them to rule that only a Declaration of War could trigger the start of “at war” provision. In Pfluger, the court ruled that only a formal surrender could trigger the end of the “at war” provision. As the law stands in Pfluger, the court has already admitted that it is open to “absurd” interpretations because the AUMF will never expire. In an era where the United States is engaged in what a “forever war” that is difficult to end, the WSLA could mean an indefinite cessation of the statute of limitations for fraud against the government.35

Instead of the formalism of Shelton and Pfluger, other jurisdictions should return to the functionalist test developed in Prosperi. While the functionalist test requires a more in-depth engagement with the facts of the conflict, the alternative is to avoid the question and create a definition that is either far too narrow or far too broad. However, courts should seek to depart from the definition of the “termination of hostilities” offered in Prosperi. There the court argued that the recognition of the government in Afghanistan and a speech by the President regarding the war in Iraq could suffice to establish the termination of hostilities. While there is a need to establish firm dates for the termination of hostilities, such a formal test represents a departure from the functionalism that Prosperi offered in determining whether there are hostilities.

The underlying intent of the Senate was to prevent fraud against the government as they hastily assembled large-scale military procurement programs. The Senate Report accompanying the 1942 enactment of the law stated that in “normal times the present 3-year statute of limitations may afford the Department of Justice sufficient time to investigate, discover, and gather evidence to prosecute frauds against the Government. The United States, however, is engaged in a gigantic war program. Huge sums of money are being expended for materials and equipment in order to carry on the war successfully.”36 With that in mind, “it is recognized that in the varied dealings opportunities will no doubt be presented for unscrupulous persons to defraud the Government or some agency.”37 The Senate was seeking to curtail fraud against the government in the abnormal circumstance in which the country was engaged in large-scale military operations. Increasingly, the “normal times” are wartime, not peacetime, which has allowed for an expansion of the law beyond the limited intent of the Act’s drafters.38

The ruling in Pfluger has stretched the law to a limitless standard wherein the statute of limitations on these crimes will never run out. While courts should not return to the standard in Shelton of never recognizing a war, courts should use the functionalism from Prosperi, which is consistent with the Senate’s objectives, in determining whether a conflict was a war. In determining the termination of hostilities, the court will need to engage in a fact-specific analysis to determine whether or not the “at war” clause was in effect on the date in question. Though this represents a far greater task for courts than any have taken, this is the only way to determine properly when the hostilities have ceased.

Rather, the courts should seek to narrowly tailor their decisions on the dates of termination for the WSLA. When the question cannot be avoided, the court should focus on an individual date in question and then see whether or not the nation was at war. From there, the court can apply the fact-based functionalist test from Prosperi. This approach may be more intensive for the courts, but it is remarkably better than the alternative of the baseless date for the end of hostilities in Prosperi and the indefinite definition offered in Pfluger.

As a regulatory matter, the Executive could play a greater role in helping to ensure transparency and predictability in this process. The Department of Defense should issue guidance that informs companies and courts when it considers the United States to be “at war” for the purposes of the WSLA. This would remove the onus from the courts to interpret activity in far-flung battlefields and would afford firms a clearer understanding of the statute of limitations on their government contracting work. The confusion in this area, and the divergent holdings in different jurisdictions make this a ripe area for greater regulatory oversight from the Executive.

  1. See generally Mary Dudziak, War Time: An Idea, Its History, Its Consequences (2012).
  2. Wartime Suspension of Limitations Act, 18 U.S.C. § 3287 (2012). (“When the United States is at war or Congress has enacted a specific authorization for the use of the Armed Forces, as described in section 5(b) of the War Powers Resolution (. . . the running of any statute of limitations applicable to any offense (1) involving fraud or attempted fraud against the United States or any agency thereof in any manner, whether by conspiracy or not, or (2) committed in connection with the acquisition, care, handling, custody, control or disposition of any real property or personal property of the United States, or (3) . . ., shall be suspended until three years after the termination of hostilities as proclaimed by the President or by a concurrent resolution of Congress.”).
  3. See 18 U.S.C. § 3282 (2006) (providing for a five-year statute of limitations for non-capital offenses except as otherwise provided).
  4. 685 F.3d 481 (5th Cir. 2012).
  5. Lance Duroni, Justices Won’t Review Ex-Army Officer’s Bribery Indictment, Law360 (Feb. 19, 2013, 8:38 PM),
  6. United States v. Pfluger, 685 F.3d 481, 482 (5th Cir. 2012).
  7. United States v. Prosperi, 573 F. Supp. 2d 436, 442 (D. Mass. 2008) (“[I]t makes no difference that the fraud in this case involved a construction project unrelated to the Iraqi or Afghani conflicts.”).
  8. Prosperi, 573 F. Supp. 2d at 442.
  9. Eric Katz, Most Top Contractors Increased Business with Federal Government in 2012, Government Executive (May 8, 2013).
  10. Barak Orbach, What Is Reglation?, 30 Yale J. Reg. Online 1, 4 (2012).
  11. United States v. Shelton, 816 F. Supp. 1132 (W.D. Tex. 1993).
  12. Shelton, 816 F. Supp. at 1134.
  13. Shelton, 816 F. Supp. at 1134.
  14. Shelton, 816 F. Supp. at 1132.
  15. Shelton, 816 F. Supp. at 1135.
  16. Shelton, 816 F. Supp. at 1135.
  17. Dellums v. Bush, 752 F. Supp. 1141, 1145 (D.D.C. 1990).
  18. Prosperi, 573 F. Supp. 2d at 436.
  19. Prosperi, 573 F. Supp. 2d at 442.
  20. Prosperi, 573 F. Supp. 2d at 442 (quoting Ludecke v. Watkins, 335 U.S. 160, 169 (1948)).
  21. Prosperi, 573 F. Supp. 2d at 442.
  22. Prosperi, 573 F. Supp. 2d at 445.
  23. Prosperi, 573 F. Supp. 2d at 446.
  24. Prosperi, 573 F. Supp. 2d at 449.
  25. Prosperi, 573 F. Supp. 2d at 452 & n.28.
  26. Prosperi, 573 F. Supp. 2d at 454.
  27. Prosperi, 573 F. Supp. 2d at 454.
  28. Prosperi, 573 F. Supp. 2d at 455.
  29. United States v. Pfluger, 685 F.3d 481, 481 (5th Cir. 2012).
  30. Pfluger, 685 F.3d at 481.
  31. Pfluger, 685 F.3d at 485.
  32. Pfluger, 685 F.3d at 485.
  33. Pfluger, 685 F.3d at 485 (citing Hamdi v. Rumsfeld, 542 U.S. 507, 521 (2004)).
  34. Pfluger, 685 F.3d at 485 (citing Hamdi v. Rumsfeld, 542 U.S. 507, 521 (2004)).
  35. Harold Koh, How To End the Forever War, Yale Global Online, (May 14, 2013),
  36. S. Rep. No. 1544, 77th Cong., 2d Sess., at 1.
  37. Id. at 2.
  38. Dudziak, supra note 1, at 8.

Essay Responding to Brian H. Potts, “The President’s Climate Plan for Power Plants Won’t Significantly Lower Emissions”

Critics of the Obama Administration’s recently announced efforts to control climate pollution seek to discredit the idea of existing power plant greenhouse gas emissions limits based on legal arguments that are both shortsighted and unfounded.1 2 These arguments have most recently appeared in an essay posted on the Yale Journal on Regulation Online by attorney Brian Potts,3 but some of the same ideas were put forward late last year by C. Boyden Gray, at a Resources for the Future Forum.4 Their basic premise is that the EPA doesn’t have the authority to regulate existing power plant greenhouse gas emissions at all. Mr. Potts also argues that the Agency is constrained by actions it already has taken under another program.

This might seem like just an interesting legal question, but it has much larger implications. In the absence of Congressional action, using available regulatory authorities in the very near term is the only present option for the U.S. to make the vigorous efforts needed to bring our climate emissions under control.5 Existing fossil-fueled power plants are the largest U.S. industrial source of carbon dioxide.6 Once emitted from a smokestack, some portion of carbon dioxide emissions persists in the atmosphere for over a century, causing enduring climate damage – so the need for near term curtailment of such emissions is extraordinarily compelling.7 Attempts to cut off efforts to reduce carbon dioxide emissions from the power sector before they’ve even begun therefore raise significant concerns. Without quick action on this sector, which is some 40% of the carbon dioxide problem, we simply cannot get a handle on U.S. climate pollution. Fortunately, contrary to the arguments put forward by Attorneys Potts and Gray, the EPA does have authority to regulate power sector greenhouse gas emissions using Clean Air Act section 111(d).

The EPA’s authority under 111(d) includes authority to set standards for existing power plant climate pollutants

At the heart of the matter is language contained in section 111(d) of the Clean Air Act, describing when the EPA must direct the establishment of “standards of performance” – limits on air pollution emissions – for existing sources in listed industries.8 This section of the Act was adjusted in 1990, reflecting significant substantive changes made by Congress to an entirely different section of the Act that deals with air toxics like mercury, arsenic and chromium. As described below, Congress, in making housekeeping amendments to section 111(d), was primarily preserving a framework that avoided double regulation of toxic air pollutants emitted by existing sources.

The relevant part of Clean Air Act section 111(d) as it appears in the U.S. Code requires the EPA to “prescribe regulations” under which states submit plans including “standards of performance” for “any existing source” and “for any air pollutant (i) [which is not regulated under the Act’s national ambient air quality standards rules] or emitted from a source category which is regulated under [the section governing air toxics].”9 Attorneys Potts and Gray read this provision very narrowly as barring the EPA’s ability to limit greenhouse gas emissions from existing fossil-fuel fired power plants, because coal-fired power plants (since 2000) are “a source category which is regulated under” the air toxics provisions.10 They assert that because existing power plants’ air toxics are regulated, their greenhouse gas emissions cannot be regulated as well. This argument, however, does not make sense from either a legal or a policy perspective.

In 1990, Congress completely overhauled the air toxics provisions of the statute, moving from the previous system (under which the EPA was supposed to list and regulate toxic air pollutants individually), to one in which Congress itself listed 188 toxic pollutants in section 112(b) of the statute and required the EPA to list and then regulate specified industries.11 Under the new system, for each listed industry the EPA issues new and existing source standards for each emitted 112(b) toxic pollutant.12

Additionally, prior to 1990, section 111(d) authorized existing source performance standards for “any air pollutant (i) for which air quality criteria have not been issued or which is not included on a list published under section … [108(a) of the Clean Air Act] or … [112 (b)(1)(A) of the Clean Air Act].”13 At that time, section 112(b)(1)(A) required the Administrator to list the hazardous air pollutants for which regulation would be promulgated.14 After 1990, section 112(b)(1) contained the list of air toxics that Congress declared must be regulated when emitted by listed industries.15

It is important to understand that as part of the 1990 overhaul of the air toxics provisions, conforming changes to other parts of the statute were required. Attempting to retain the prior prohibition on double regulation of industrial air toxics, and with the EPA now regulating industry-by-industry, both the House and the Senate made non-substantive cleanup changes accompanying the 1990 overhaul.

The House amendment to section 111(d) shows up in section 108, “Miscellaneous Provisions,”16 while the Senate amendment appears in later section 110, “Conforming Amendments.”17 While the codified statute includes only the language of the first-in-time House amendment, both the House and the (later-in-time) Senate amendments appear in the Statutes at Large, which provide controlling “legal evidence of laws.”18 In the Statutes at Large, the conforming amendments are reflected in parentheses: section 111(d) applies to “any air pollutant…which is not included on a list published under section 7408(a) (or emitted from a source category which is regulated under section 112) [House amendment] (or 112(b) [Senate amendment]).”19 While the codified version contains only the House amendment, an additional longstanding rule of statutory construction in such circumstances is, “the last provision in point of arrangement must control” – that is, the Senate amendment controls here.20

Taken together, this means that an accurate reading of the statute is that section 111(d) is to be used to regulate any air pollutant that is not included on a list published under section 7408(a) or 112(b). In addition to being doctrinally correct, this result also simply makes good policy sense, as it avoids double regulation: section 111(d)’s prohibition on using existing source standards for pollutants for which National Ambient Air Quality Standards have been issued avoids double regulation because existing sources of those pollutants are regulated already under state implementation plans.21 The prohibition on using existing source standards for air toxics avoids double regulation because existing sources of those pollutants are regulated under section 112.22 Attorneys Potts and Gray overlook this. Regardless, their position—that these housekeeping changes could have been intended to effectuate a sweeping change in the meaning of section 111(d)—simply does not hold water.

The EPA is unconstrained by prior Best Available Control Technology (BACT) determinations in directing issuance of existing source performance standards

Mr. Potts additionally takes a position in the alternative, namely that any authority the EPA has under section 111(d) to direct existing source standards for greenhouse gases is constrained by its prior efforts under the greenhouse gas permitting authority for new sources. He erroneously asserts that preconstruction permits issued under the Prevention of Significant Deterioration (“PSD”) program found in section 165 of the Act limit the EPA’s authority to prescribe existing source standards under section 111(d) of the New Source Performance Standards program.23 The PSD provisions do require each new (or modified) source to achieve emissions controls that are more stringent than those provided by the performance standard applicable to all new (or as relevant, existing) sources.24 But nothing in the statute requires the converse, i.e., that limits in any new source PSD permits, bind the EPA in setting later existing source performance standards for that industry.

The statute’s language requires that a standard of performance, whether for a new or existing source, be one reflecting the “best system of emissions reduction which (taking into account the costs and non-air quality health and environmental impact and energy requirements) the Administrator determines has been adequately demonstrated.”25 The D.C. Circuit has interpreted the phrase “adequately demonstrated” in the new source performance standard setting context as technology forcing: “look[ing] toward what may fairly be projected for the regulated future,” not as meaning that all sources must be able to meet the requirement.26 While there is much less experience with existing source standards, the statutory definition of “standard of performance” is the same for both new and existing sources,27 strongly suggesting that advancing control technologies must be a consideration to be weighed in existing source standard-setting as well. And, while the EPA is not prohibited from evaluating past greenhouse gas permits for some evidence of the achievability of emissions reductions levels, just as clearly, nothing in the statute or the case law restricts the EPA to prior permit levels in any way, when directing the appropriate level of existing source standards. In fact, the opposite is true. Given that the same definition of “standard of performance” applies in both new and existing source standard setting, it stands to reason that the Agency also must direct that existing source standards be based on the best system of emissions reduction, reasonably expected to serve the interests of pollution control at existing sources, without becoming exorbitantly costly.28

This is not just a battle of legal niceties. We must acknowledge that the “interests of pollution control” in the context of power plant carbon dioxide emissions includes the interest in taking strong near term steps to avoid a climate catastrophe.29 Reducing carbon dioxide emissions from existing sources in the nation’s power sector is absolutely essential, as the Obama Administration’s recently unveiled Climate Plan recognizes. While this industry surely would like to be immune from climate change regulation, with all due respect to Mr. Potts, I believe we are fortunate that his view that the EPA’s authority in this area is limited or constrained is not grounded in the law.

  1. The author would like to thank Jordan Asch for his assistance in the production of this Essay.
  2. President Obama’s Climate Action Plan is available online. Executive Office of the President, The President’s Climate Action Plan, Executive Office of the President (June 2013),
  3. Brian H. Potts, The President’s Climate Plan for Power Plants Won’t Significantly Lower Emissions, 31 Yale J. on Reg. Online (Aug. 22, 2013).
  4. Climate Change Fight Over Utility GHG Rule Shifts Back To EPA After Court Rejects Lawsuit, Inside EPA Environmental Newsstand, Weekly Analysis (Dec. 14, 2012), Mr. Gray’s argument has also recently surfaced at a forum held in Washington on the substance of EPA’s forthcoming proposal. See Kyle Danish, Section 111(d) and Regulation of CO2 Emissions from Existing Power Plants, at slide 6 (presentation made at the Bipartisan Policy Center meeting on GHG Regulation of Existing Power Plants Under the Clean Air Act: What Is It and How Will It Work?) (September 25, 2013),
  5. See Justin Gillis, By 2047, Coldest Years May Be Warmer Than Hottest in Past, Scientists Say, N.Y. Times, Oct. 10, 2013 at A9 (noting that a recent study by scientists at the University of Hawaii shows that “a vigorous global effort” is needed now in order to delay the onset of unprecedented temperatures and allow for societal adaptation).
  6. Fossil-fuel fired electricity generation is responsible for approximately 40% percent of U.S. man-made carbon dioxide emissions. U.S. EPA, Inventory of U.S. Greenhouse Gas Emissions and Sinks, 1990-2011, Envtl. Prot. Agency (Apr. 12, 2013) (EPA 430-R-13-001, April 12. 2013), Executive Summary at ES-54, Table ES-2 (“Recent Trends in U.S. Greenhouse Gas Emissions and Sinks”),
  7. Endangerment and Cause or Contribute Findings for Greenhouse Gases Under Section 202(a) of the Clean Air Act: Final Rule, 74 Fed. Reg. 66496, 66517 n.18 (Dec. 15, 2009) (discussing the climate forcing lifetimes of various greenhouse gases, including carbon dioxide) (hereinafter “Endangerment Finding”). See also, Intergovernmental Panel on Climate Change, Climate Change 2013: The Physical Science Basis: Summary for Policymakers, Working Group I Contribution to the IPCC Fifth Assessment Report (Sept. 27, 2013) at SPM-20 (summarizing the finding that “[d]epending on the [analyzed] scenario, about 15 to 40% of emitted CO2 will remain in the atmosphere longer than 1,000 years.”).
  8. 42 U.S.C. § 7411(d).
  9. Id. § 7411(d)(1).
  10. Id. § 7411(d)(1)(A)(i); see also Regulatory Finding on the Emissions of Hazardous Air Pollutants From Electric Utility Steam Generating Units, 65 Fed. Reg. 79825, 79830 (Dec. 20, 2000) (discussing this regulatory change in section III, “What is EPA’s Regulatory Finding?”); National Emission Standards for Hazardous Air Pollutants From Coal- and Oil-Fired Electric Utility Steam Generating Units and Standards of Performance for Fossil-Fuel-Fired Electric Utility, Industrial-Commercial-Institutional, and Small Industrial-Commercial-Institutional Steam Generating Units, 77 Fed. Reg. 9304, 9308 (Feb. 16, 2012) (discussing the regulatory scheme in subsection C, “What is the relationship between this final rule and other combustion rules?”).
  11. see Sierra Club v. EPA, 353 F.3d 976, 979-80 (D.C. Cir. 2004) (describing the history of the air toxics provisions from 1970-1990).
  12. See generally 42 U.S.C. §§ 7412(c), (d) (describing the process for listing industries and regulating new and existing sources of 112(b)-listed air toxics).
  13. 42 U.S.C. § 7411(d)(1) (1988) (emphasis added) (current version amended by Pub. L. No. 101-549 and at 42 U.S.C. §7411(d)(1)).
  14. 42 U.S.C. § 7412(b)(1)(A) (1988) current version amended by Pub. L. No. 101-549 and at 42 U.S.C. §7412(b)(1)(A)). Section 108 of the Clean Air Act was and continues to be the section describing the Administrator’s duty to list air pollutants for which National Ambient Air Quality Standards (NAAQS) will be issued. 42 U.S.C. § 7408. Carbon dioxide is not a NAAQS pollutant, and it is not a listed hazardous air pollutant. See Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule; Final Rule, 75 Fed. Reg. 31514, 31520 (noting that EPA has not proposed or finalized a decision setting a NAAQS for any greenhouse gas); and 42 U.S.C. § 7412(b)(1) (presenting the list of hazardous air pollutants).
  15. 42 U.S.C. § 7412(b)(1) (2012).
  16. Clean Air Act Amendments, Pub. L. No. 101-549 § 108, 104 Stat. 2399, 2467 (1990).
  17. Id. § 110, 104 Stat. 2574.
  18. United States Nat’l Bank of Oregon v. Independent Ins. Agents of Am., 508 U.S. 439, 448 (1993) (citing 1 U.S.C. § 112).
  19. Clean Air Act Amendments, Pub. L. No. 101-549 §§ 108, 302, 104 Stat. 2399, 2467, 2574 (1990).
  20. See, e.g. Lodge 1858, Am Fed. of Gov’t Employees v. Webb, 580 F.2d 496, 510 & n.31 (D.C. Cir. 1978) (citing over 80 cases so holding).
  21. 42 U.S.C § 7410(a)(2)(C).
  22. 42 U.S.C. §§ 7412(d)(2)-7412(d)(3).
  23. The Clean Air Act’s PSD preconstruction permitting provisions and relevant definitions are found at 42 U.S.C. §§ 7465-7469.
  24. See 42 U.S.C. § 7479(3) (2012) (“In no event shall application of ‘best available control technology’ result in emissions of any pollutants which will exceed the emissions allowed by any applicable standard established pursuant to section [111] of this title.”).
  25. 42 U.S.C. §7411(a)(1) (2012).
  26. Lignite Energy Council v. EPA, 198 F.3d 930, 934 (D.C. Cir. 1999) (quoting Portland Cement Ass’n v. Ruckelshaus, 486 F.2d 375, 391 (D.C. Cir. 1973)).
  27. See 42 U.S.C. § 7411(a)(1) (2012) (defining “standard of performance”); 42 U.S.C. § 7411(d)(1) (referring to the establishment of “standards of performance” for existing sources).
  28. For reference to exorbitance as the upper bound on the cost factor under the definition of “standard of performance” in 42 U.S.C. § 7411(a)(1), see Lignite Energy Council, 198 F.3d at 933 (noting that EPA’s choice in balancing the statutory factors “will be sustained unless the environmental or economic costs of using the technology are exorbitant” and citing National Asphalt Pavement Ass’n v. Train, 539 F.2d 775, 786 (D.C. Cir. 1976)).
  29. For reference to the “interests of pollution control” as relevant to the selection of the best system of emission reduction, see Essex Chemical v. Ruckelshaus, 486 F.2d 427, 433 (1973), cert. denied, 416 U.S. 969 (1974).

Antitrust Enforcement in Private Equity: Target, Bidder, and Club Sizes Should Matter

This Comment argues that plaintiffs have painted “club deals” with a broad brush as anticompetitive, whereas applying the facts alleged plaintiffs themselves to the antitrust regulators’ measurement of market concentration—the Herfindahl-Hirschman Index—implies a more nuanced conclusion: consortium bidding can be pro-competitive for large targets, small bidders and small clubs.

“We will have to trust [K]inder and the honor among thieves.”

– Goldman Sachs internal e-mail expressing hope that Rich Kinder, CEO of buyout target Kinder Morgan, would honor an exclusivity agreement with Goldman, despite the rejection of the agreement by Kinder Morgan’s special committee1

“It is hard to imagine Henry R. Kravis, co-founder of Kohlberg Kravis, calling up David M. Rubenstein, co-founder of Carlyle, to scheme about how to keep a lid on the bidding for a particular company.”

– Andrew Ross Sorkin2


In October 2006, The Wall Street Journal reported that the Antitrust Division of the Department of Justice was investigating whether the largest private equity (PE) firms had colluded to keep buyout prices down.3 A class action against 13 PE firms, also known as “financial sponsors,” followed in December 2007.4 Although the DOJ has backed off,5 the private plaintiffs are pressing forward. The suit alleges that the defendants’ bid-rigging and market-allocating in 17 leveraged-buyouts (LBOs) from 2003 to 2007 deprived shareholders in the target companies of competitive prices, in violation of Section 1 of the Sherman Act.6 The district court has winnowed the claims7 and defendants,8 but most of the largest names in private equity—including Blackstone, Carlyle, Goldman Sachs, KKR, and TPG—remain in court.

This Comment proceeds in three parts to analyze whether the facts alleged in the plaintiffs’ Fifth Amended Complaint (the “Complaint”) state a claim for relief under the quantitative framework set forth by the DOJ and Federal Trade Commission (FTC). While the Complaint is careless with respect to the underlying financial concepts,9 it nevertheless states a claim that should survive a motion to dismiss under the federal pleading standards established by Twombly10 and Iqbal.11

Part I of this Comment shows how the Horizontal Merger Guidelines (HMGs), which focus on behavior by sellers rather than buyers, nevertheless apply to this suit. Measuring the Herfindahl-Hirschman Index (HHI) of market concentration as instructed by the HMGs, Part II models the competitive effects of “club” formation in each of the deals challenged by the lawsuit, concluding that consortia bidding can reduce market concentration for large targets, small bidders and small clubs. Part III concludes with suggestions for further research.

I. The Horizontal Merger Guidelines Apply Literally and by Analogy

The DOJ and FTC, the federal antitrust regulators, have jointly published guidelines apprising regulated parties of how the agencies model the competitive effects of horizontal mergers.12 These guidelines also inform the agencies’ analysis of non-merger horizontal collusion, such as that alleged in the Complaint.13 The HMGs primarily address competition among sellers, not buyers.14 However, the HMGs state that market power of buyers—monopsony—“has adverse effects comparable to enhancement of market power by sellers.”15 Thus, the agencies use “an analogous framework” to analyze competitive effects of buying power.16 Accordingly, the DOJ is tasked with analyzing whether club deals resulted in buyer market power that reduced head-to-head competition for target companies.17 Taking the facts alleged in the Complaint as true, they sometimes did. TPG Founder David Bonderman admitted that “[consortia] . . . limit[] bidding” so that “[there’s] less competition for the biggest deals.”18

In particular, the HMGs instruct the DOJ to interview sellers19 (here, the target companies) about the impact of the anticompetitive behavior. Here, this may be unnecessary, as the DOJ already has comparable, but even more probative evidence in several of the deals: contemporaneous instructions by managers, directors and advisers of the target companies not to bid in groups. For example, in the auction for Philips / NXP, the target directed Bain Capital, KKR and Silver Lake not to combine into a single consortium, but those bidders allegedly defied the instructions in a secret agreement.20 Contemporaneous records such as these accomplish the same investigatory purpose as ex post interviews.

Further, the HMGs emphasize the importance of the definition of the relevant market. “Market definition focuses solely on demand substitution factors, i.e., on customers’ ability and willingness to substitute away from one product to another in response to a price increase.”21 Antitrust defendants routinely argue that customers can switch to imperfect substitutes—that is, the defendants control only a small fraction of the relevant market. Thus, the defendant PE funds in Dahl might argue that other types of investors—such as mutual, index, and hedge funds—are part of their market. Because those non-control investors22 lack the two key tools of PE buyers—operational control and capital structure replacement23—they cannot and do not pay comparable prices. In particular, the difference between the price paid for stock by non-control investors and that paid by PE buyers on average exceeds 5%, the threshold set by the agencies to trigger competition concerns.24

Thus, under the qualitative guidance set forth by the antitrust agencies and the Supreme Court, the plaintiffs in Dahl have stated a claim for relief sufficient to survive a motion to dismiss. The next part maps the quantitative guidance set forth by the HMGs onto each LBO attacked by the Complaint, revealing that, according to the agencies’ own definition of market concentration, club bidding increases competitiveness of large LBOs when individual bidders are too small to bid alone.

II. HHI Analysis in the Club Deal Context Turns on Target Size, Bidder Size and Club Size

A. Model Specification

The heart of the HMGs is an instruction to the agencies to quantify the impact of mergers via the Herfindahl-Hirschman Index (HHI). A tool created by and for the use of the agencies, the HHI also applies in private antitrust suits.25 It is a measure of market concentration calculated by summing the squares of the market shares (expressed in percentage points) of all firms in the market.26 The agencies define un-concentrated markets as having an HHI below 1,500, moderately concentrated markets as having an HHI between 1,500 and 2,500, and highly concentrated markets as having an HHI above 2,500.27 Mergers that increase concentration concern the antitrust agencies. Both the measured size of the market and the size of its biggest players have powerful effects on the HHI.

I use the HHI rubric to analyze clubbing by modeling club formation as the merger—for purposes of whichever target the particular club is eying—of the club’s members. This is a natural application of HHI both because (like merged funds) cooperating funds cease competitively bidding with one another and because (like merged funds) cooperating funds can pool their capital. Allowing clubs has two effects on HHI, the sign of the net effect of which is ambiguous. First and more obviously, allowing clubs increases the size of the biggest players, thereby increasing HHI. Second and less obviously—and indeed ignored by the plaintiffs in Dahl—allowing clubs may bring new players into the market, increasing its size and decreasing HHI. “For example, in a corporate auction involving numerous well-heeled bidders, less wealthy bidders cannot compete. By joining forces, and thus combining resources, poorer contestants can gain access to the contest, thus increasing competition.”28 The following analysis estimates which effect dominates and provides a framework for modelers using different financial assumptions—for instance, different assumptions about leverage ratio or fund diversification requirements—to do the same.

The model estimates the PE fundraising by every fund named in the Complaint for the five-year period ended on December 31, 200729 (the last year of the “Conspiratorial Era” alleged by the Complaint30). It models 100% of those funds as available for the buyouts attacked in the Complaint.31 It makes 15% of the equity capital32 of a given sponsor available to any given deal.33 From these parameters, it computes the maximum equity check that any given fund could write.

To calculate the required total equity for each target, the model takes the deal size34 from the Complaint and applies 3:1 debt-to-equity leverage.35

For each LBO, the model calculates the ‘pre-club’ HHI—i.e., the HHI of the market for that target36 under a regulatory regime where clubbing does not exist. It defines the market as every fund that (1) was either ultimately part of the purchasing consortium or was identified in the Complaint as “participating” or “interested” in the auction process, and (2) could write the entire equity check itself. The market size is the sum of the maximum equity checks of all funds satisfying both criteria.37

The model then calculates the ‘post-club’ HHI—i.e., the HHI of the market for that target under a regulatory regime where clubbing is permitted. It defines the market to include the winning club and every losing fund that (1) is identified in the Complaint as “participating” or “interested” in the auction process, and (2) could write the entire equity check itself. Intuitively, relative to the pre-club analysis, by relaxing the constraint for winning bidders that the bidder be able to afford the entire equity check on its own, the model captures the expansion of the market facilitated by resource-pooling.38 The market size is the sum of the maximum equity check of the club and that of all losing funds in the market.

Finally, the model checks whether the HHIs trip any of the three red flags raised by the HMGs. Those are, in order of increasing concern: (1) an HHI increase over 100 resulting in moderate concentration (“100+” in Table A); (2) an HHI increase between 100 and 200 resulting in high concentration (“100-200” in Table A); and (3) an HHI increase over 200 resulting in high concentration (“200+” in Table A).39

B. Results and Analysis

Table A: HHI Effects of Club Formation in LBOs Challenged in Dahl [Note: Table A has been omitted from the online version. Please refer to the PDF.]

Table A summarizes the results of the model. Under the HHI framework, and accepting the factual allegations in the Complaint as true, the DOJ would likely find the majority of the challenged LBOs to be concerning. Of the 21 LBOs analyzed, 3 trip the least serious red flag, 0 trip the moderately serious red flag, 15 trip the most serious red flag (sometimes by thousands of points), and only 3 trip no red flags at all. This result is intuitive because the accused clubs were often large—larger than would be needed to bring funds into the market, and the fund sizes peaked around the time of the Conspiratorial Era.40

As Table A shows, however, five of the 14 deals tripping the most serious red flag—HCA, Kinder Morgan, Clear Channel, TXU, and Alltel (the five biggest challenged deals)—had, according to the facts alleged by the plaintiffs, no pre-club market. There was no pre-merger market because no sponsor could afford the equity check on its own. Thus, allowing consortium bidding for these large targets did not increase market concentration and should not be viewed as tripping any HHI red flag.41

The deals that did have pre-club markets but nevertheless triggered no red flag—AMC, Harrah’s, and Sabre—exemplify circumstances where the agencies would be well-advised to stay their hand. In AMC, the winning club represented only 10% of the un-concentrated market (2 of the 10 interested firms42). Harrah’s was a highly concentrated market, but the required check was big enough that allowing consortia brought a player into the market, thereby reducing concentration. In addition, the winning club represented just 38% of the buying power in that market (2 of the 8 interested firms43). Sabre, too, was won by a club of just 2 firms (of the 10 total that were allegedly interested44), representing 18% of the market. In fact, in two of these three deals, the post-club market was less concentrated than the pre-club market. Intuitively, when clubs are small, the net effect of allowing them may be pro-competitive—even for fairly small targets.

III. Conclusion

The model and its results show that antitrust regulators (and courts) ought to consider the size of targets, funds and clubs in analyzing whether consortium bidding is anti-competitive in any given instance. In general, targets that are large relative to the funds bidding on them justify formation of clubs—especially small clubs. One size does not fit all.

Nor does one size fit all in modeling these LBOs. Additional precision could be achieved by applying deal-specific leverage ratios based on empirical data from deal databases. The across-the-board assumption of a maximum equity check size of 15% of any given fund could similarly be improved by sponsor-specific estimates based on empirical data on the accused funds—and other funds run by the same sponsors but outside the Conspiratorial Era. At the theoretical level, one could model the plaintiffs’ and/or defendants’ potential objections—some of which are outlined above45—to the underlying mechanics of the model proposed herein.

Further research should analyze the natural experiment furnished by the inception of the DOJ investigation and cessation of the club era: did post-2007 premiums rise back to pre-2003 levels? The experiment is unfortunately clouded by the collapse of the debt bubble in 2008; the narrow window of roughly spring 2007 to summer 2008 may offer the most probative data.

Also unaddressed by this Comment is the qualitative policy question is what sort of reciprocity amounts to an agreement in restraint of trade. For example, it has been shown that a winning strategy in repeated Prisoner’s Dilemma is tit-for-tat.46 If all players follow tit-for-tat, they will always cooperate, despite never having an agreement to do so. Were the defendants in Dahl just playing tit-for-tat, or were they explicitly colluding? Twombly would suggest that a bare allegation of the former, without more, does not an antitrust claim make. The Complaint seizes upon the quid pro quos exchanged by the defendants,47 but merely offering to include a third party in a project because the third party previously involved you is not necessary anticompetitive, even though it is a tit-for-tat. The better question is whether the quid pro quos entailed not competing—for instance, bidding low, bidding with the intent to withdraw, or not bidding at all.48

  1. Fifth Amended Complaint at 133-34 & n.399, Dahl v. Bain Capital Partners, LLC, No. 1:07-cv-12388-EFH (D. Mass. filed Oct. 10, 2012) [hereinafter Complaint].
  2. Andrew Ross Sorkin, Colluding or Not, Private Equity Firms Are Shaken, N.Y. Times (Oct. 22, 2006).
  3. Dennis K. Berman & Henny Sender, Private-Equity Firms Face Anticompetitive Probe, Wall St. J. (Oct. 10, 2006).
  4. Complaint, Davidson v. Bain Capital Partners, LLC, No. 1:07-cv-12388-EFH (D. Mass. filed Dec. 28, 2007).
  5. White & Case, A Recent Court Decision Revives Concern That Some Club Deals Could Violate the Antitrust Laws 1 (2009).
  6. 15 U.S.C. § 1 (2006) (“Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal.”); see Complaint, supra note 2, at 1, 7-12.
  7. Dahl v. Bain Capital Partners, LLC, No. 1:07-cv-12388-EFH, 2013 WL 950992, at *15 (D. Mass. Mar. 13, 2013) (narrowing the plaintiffs’ theory to a conspiracy among the defendants to refrain from “jumping,” i.e., outbidding, each other’s announced deals).
  8. Dahl v. Bain Capital Partners, LLC, No. 1:07-cv-12388-EFH, 2013 WL 4606512 (D. Mass. Aug. 29, 2013) (dismissing THL); Dahl v. Bain Capital Partners, LLC, No. 1:07-cv-12388-EFH, 2013 WL 3802433, at *10 (D. Mass. July 18, 2013) (dismissing Apollo and Providence).
  9. See, e.g., Complaint, supra note 2, at 52 (alleging, for example, that the gain extracted by a financial sponsor in a dividend recapitalization would, in the absence of the LBO, have flowed to the shareholders, without making any showing of how the shareholders would have extracted such a gain from lenders or alternative sources).
  10. Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007) (when plaintiffs “have not nudged their claims across the line from conceivable to plausible, their complaint must be dismissed.”). While Twombly has come to stand trans-substantively for a heightened pleading standard, it has particular applicability in the antitrust context: the Supreme Court held that the parallel failure by companies to enter each other’s lucrative markets, without more, did not state an antitrust claim sufficient to survive a motion to dismiss. Id. at 548-50.

    Unlike in Twombly, the Complaint in Dahl cites documentary evidence of several alleged agreements, or attempts to form agreements, by the defendants. See, e.g., Complaint, supra note 2, at 23 (e-mail from Blackstone President Tony James to KKR Founder George Roberts stating “[w]e would much rather work with you guys than against you. Together we can be unstoppable but in opposition we can cost each other a lot of money.”); id. at 27 (“KKR has agreed not to jump our deal since no one in private equity ever jumps an announced deal.”); id. at 28 (alleging coordination of bids amongst supposed competitors); id. at 142 (alleging that KKR dropped out of the Freescale auction in exchange for Blackstone’s dropping out of the HCA auction). But see Dahl, 2013 WL 950992, at *14-15 (narrowing the plaintiffs’ theory to jumping and holding that mere quid-pro-quos, without more, do not evidence an antitrust conspiracy); Jessica Jackson, Much Ado About Nothing? The Antitrust Implications of Private Equity Club Deals, 60 Fla. L. Rev. 697, 708-10 (2008) (listing shallow pockets, diversification requirements, debt fundraising, and shared expertise as reasons for consortium bidding).

  11. Ashcroft v. Iqbal, 556 U.S. 662, 679 (2009) (“[W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged—but it has not ‘show[n]’—‘that the pleader is entitled to relief.’” (second alteration in original) (quoting Fed. R. Civ. P. 8(a)(2))).
  12. U.S. Dep’t of Justice & Fed. Trade Comm’n, Horizontal Merger Guidelines (2010) [hereinafter HMGs].
  13. Complaint, supra note 2, at 15-16. See also Fed. Trade Comm’n & U.S. Dep’t of Justice, Antitrust Guidelines for Collaborations Among Competitors 5 (2000) (“The Agencies treat a competitor collaboration as a horizontal merger in a relevant market and analyze the collaboration pursuant to the Horizontal Merger Guidelines if appropriate, which ordinarily is when: (a) the participants are competitors in that relevant market; (b) the formation of the collaboration involves an efficiency-enhancing integration of economic activity in the relevant market; (c) the integration eliminates all competition among the participants in the relevant market; and (d) the collaboration does not terminate within a sufficiently limited period by its own specific and express terms.” (footnote omitted)); Jackson, supra note 11, at 712-14 (arguing for the applicability of the collaboration guidelines to Dahl and predicting that the clubs would be treated as joint ventures).
  14. See HMGs, supra note 13, at 2.
  15. Id.
  16. Id.
  17. Id. at 3.
  18. Complaint, supra note 2, at 3.
  19. HMGs, supra note 13, at 4. The HMGs, however, warn that seller interviews may suffer from defects of honesty and accuracy.
  20. Complaint, supra note 2, at 149.
  21. HMGs, supra note 13, at 7-8.
  22. Mutual funds and hedge funds generally do not own a large enough stake in a firm to control it. The summer of 2013, however, witnessed the rising power of activist hedge funds, winning board elections and concessions from management despite owning less than 20% of the firm. See, e.g., Health Management Associates, Inc., Current Report 2-3 (Form 8-K Aug. 12, 2013) (documenting written consent by sufficient shareholders to remove and replace all members of the HMA board of directors with hedge fund Glenview’s slate); Health Management Associates, Inc., Schedule 13D at 2-4 (Aug. 16, 2013) (documenting Glenview’s mere 15% stake in HMA).
  23. Defendant PE funds would also argue that strategic buyers should be considered part of the market. Strategic buyers can use operational control and capital structure replacement and do pay premiums, so they likely should be included in the market. See Complaint, supra note 2, at 196-98 (showing that strategic buyers paid premiums averaging 22%, compared to 16% for sole-sponsor LBOs and 8% for club deals).
  24. HMGs, supra note 13, at 9.
  25. E.g., Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 792 F.2d 210, 219-20 (D.C. Cir. 1986).
  26. HMGs, supra note 13, at 18 & n.9. For instance, a one-firm market has an HHI of 10,000 (100 squared). A two-firm market split equally by the two firms has an HHI of 5,000 (50 squared plus 50 squared). A 100-firm market split equally by the 100 firms has an HHI of 100. A higher HHI implies greater market concentration. Like an least-squares regression, the HHI is particularly susceptible to large outliers—such as a club consisting of all or most of the biggest firms in the market.
  27. Id. at 19.
  28. Pa. Ave. Funds v. Borey, 569 F. Supp. 2d 1126, 1133 (W.D. Wash. 2008); accord In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d 975, 1009 (Del. Ch. 2005) (“The ‘cooperative’ bid that First Boston permitted the KKR Group to make gave the Company a powerful bidding competitor to the Cerberus consortium . . . .”).
  29. For AlpInvest ($5.4 billion), Apax ($18.9 billion), Apollo ($13.9 billion), Bain ($17.3 billion), Blackstone ($28.4 billion), Carlyle ($32.5 billion), Cerberus ($6.1 billion), Goldman Sachs ($31.0 billion), Hellman & Friedman ($12.0 billion), KKR ($31.1 billion), Lehman Brothers ($8.5 billion), Leonard Green ($7.2 billion), Madison Dearborn ($6.5 billion), Permira ($21.5 billion), Providence ($16.4 billion), T.H. Lee ($7.5 billion), TPG ($23.5 billion), Silver Lake ($11.0 billion), and Warburg Pincus ($13.3 billion), I take the corresponding five-year total directly from Private Equity International, PEI 50 (2007). PEI 50 does not list the other sponsors or strategic buyers involved in the challenged LBOs, so as a rough proxy, their corresponding total is estimated to be equal to that of the lowest (50th) fund on the list: $3.9bn.
  30. Complaint, supra note 2, at 1.
  31. This estimate could be somewhat below or above the true figure. It could be too low because a fund’s life may be greater than five years (a common lifespan is ten years, of which, roughly five is focused on deploying capital and roughly five is focused on returning capital); a fund that closed six years ago would be incorrectly excluded from the estimate. See Steven N. Kaplan & Per Stromberg, Leveraged Buyouts and Private Equity, 23 J. Econ. Perspectives 121, 123 (2009). On the other hand, it could be too high because some sponsors—such as Carlyle—are “supermarkets” offering a variety of funds, each targeting a different geography (some outside of North America, the location of the challenged LBOs). See Gregory Zuckerman & Ryan Dezember, Carlyle’s 3 Founders Share $400 Million-Plus Payday, Wall St. J., Jan. 12, 2012 (“Carlyle has launched many more smaller buyout funds than rivals, sometimes with a narrow focus . . . .”).
  32. Equity capital is cash from the sponsor itself and its limited partners representing ownership in the fund’s portfolio companies. Acquisition financing that is not equity capital is debt: money borrowed from banks, bondholders or non-traditional lenders that generates the “leverage” in “leveraged buyout.”
  33. Buyout funds invest in a handful of companies each, so it would be incorrect to assume that an entire fund’s equity, or even the majority of it, were in the market for a given deal merely because that fund’s sponsor was a bidder. See, e.g., David Snow, Private Equity: A Brief Overview 7, PEI Media (2007) (“For example, a firm that says it specialises in doing deals that require between $25 million and $100 million in equity per deal may target $750 million for a fund to complete roughly 7 to 10 deals before needing to go back to investors for more capital.”).
  34. See Complaint, supra note 2, at 59 (PanAmSat); id. at 63 (AMC); id. at 66 (Loews); id. at 72 (Toys “R” Us); id. at 78 (SunGard); id. at 84 (Neiman Marcus); id. at 93 (Texas Genco); id. at 103 (Education Management); id. at 113 (Univision); id. at 120 (Michaels Stores); id. at 127 (HCA); id. at 134 (Aramark); id. at 142 (Kinder Morgan); id. at 150 (Freescale Semiconductor); id. at 156 (Philips Semiconductor / NXP); id. at 163 (Harrah’s); id. at 170 (Clear Channel); id. at 176 (Sabre); id. at 184 (Biomet); id. at 190 (TXU); id. at 199 (Alltel). Excluded are Nalco (data not provided), Cablecom (data not provided), Warner Music (data not provided), Susquehanna (data not provided), Vivendi (deal not consummated), and Community Health Systems (deal not consummated).
  35. That is, 25% of the purchase price is modeled as equity. While the leverage ratios varied from deal to deal, 75% debt for mega-buyouts during the 2003 – 2007 boom era is a reasonable approximation. See Kaplan & Stromberg, supra note 31, at 124 (“The buyout is typically ?nanced with 60 to 90 percent debt . . . .”). But see Ulf Axelson et al., Borrow Cheap, Buy High?: The Determinants of Leverage and Pricing in Buyouts 44 (Nat’l Bureau of Econ. Research, Working Paper No. 15952, 2010) (calculating the debt-to-enterprise-value ratio of public-to-private LBOs during the era of the transactions challenged in Dahl as averaging between 0.65 and 0.68, i.e., 2:1 debt-to-equity leverage).
  36. A separate criticism of the antitrust accusations, not explored here, is that it may not even make sense to characterize a single target as a market.
  37. For instance, suppose only one fund is interested in the target, and that that fund has $10 billion in committed equity capital. The model estimates 15%, or $1.5 billion, of the equity as available for the target.

    Now suppose the total enterprise value of the target is $8 billion. At the modeled 3:1 debt-to-equity ratio, the equity check for the LBO would be $2 billion. Since that exceeds the would-be bidder’s available equity ($1.5 billion), the fund is out of the market and the market size is $0.

    On the other hand, suppose the total enterprise value of the target is $4 billion. At the modeled 3:1 debt-to-equity ratio, the equity check for the LBO would be $1 billion. Since that does not exceed the would-be bidder’s available equity, the fund is in the market and the market size is $1.5 billion.

    Note that it is irrelevant that the market modeled is the market for equity rather than the market for total enterprise value. Intuitively, because HHI is computed from market shares (percentages) rather than absolute dollar values, it doesn’t matter where in this arithmetic the leverage is introduced.

  38. For instance, suppose a $10 billion fund and a $20 billon fund are interested in the target. The model estimates 15%, or $1.5 billion of the former fund and $3 billion of the latter fund, as available for the target. Suppose the total enterprise value of the target is $8 billion. At the modeled 3:1 debt-to-equity ratio, the equity check for the LBO would be $2 billion.

    Under a regime where clubbing is forbidden, the $10 billion fund is out of the market, so only the $20 billion fund is in. The market size is $3 billion.

    On the other hand, under a regime where clubbing is permitted, both funds are in the market. The market size is $4.5 billion.

  39. HMGs, supra note 13, at 19.
  40. The Dahl defendants would argue that the HHIs are inflated (and red flags exaggerated) by excluding from the market PE funds merely because the Complaint failed to identify those funds as interested in a given target. The defendants might also argue that the post-club HHI should use a market size including funds too small to bid alone but able to bid as clubs, even if they did not happen to be members of the winning consortium. To be sure, the defendants should be permitted to make such showings. At the motion-to-dismiss stage, however, the facts of a well-pleaded complaint are treated as true. Ashcroft v. Iqbal, 556 U.S. 662, 664 (2009).
  41. Arithmetically, this result also flows from the HHI formula itself if the pre-club HHI is interpreted as “undefined” rather than zero.
  42. Complaint, supra note 2, at 63.
  43. Id. at 163-64.
  44. Id. at 176-77.
  45. E.g., supra note 41.
  46. Robert Axelrod, The Evolution of Cooperation (1984) (describing tit-for-tat as a strategy by which you cooperate on turn n if and only if your opponent cooperated on turn n – 1); see also Berman & Sender, supra note 3 (quoting Harvard Business School Professor Josh Lerner as characterizing PE bidding as a repeat game).
  47. E.g., Complaint, supra note 2, at 72-73 (Goldman tells Silver Lake that Goldman has, in exchange for Silver Lake’s letting it into SunGard, a “quid pro quo obligation.” (emphasis added)).
  48. See, e.g., id. at 46 (alleging that Blackstone promised future deals to other bidders in exchange for dropping out).

What Do Subprime Securitization Agreements Say About Mortgage Modification?

This paper presents the results of the only publicly available empirical study of what agreements governing subprime securitized mortgages say about mortgage modification.

The mortgage and foreclosure crisis continues to transfix the nation, even as housing markets across the country show signs of improvement.1 The government has tried to promote mortgage modifications to allow homeowners to stay in their homes.2 One particular focus of these efforts has been subprime loans that are securitized, that is, transferred into pools held by trusts and administered by servicers on behalf of investors who buy certificates. For securitized mortgages, a contract called the pooling and servicing agreement governs what the servicer may do to modify the mortgages in the pool.3

Throughout the crisis, an important factor in policy analysis has been what the pooling and servicing agreements that govern securitized subprime mortgages say about mortgage modification. Do these agreements forbid mortgage modifications, so that the most effective modification programs have to trump these agreements, raising all the issues that attend government modification of private contracts?4 Or do the agreements by and large permit mortgage modifications, so that policymakers designing modification programs should concentrate on other possible rigidities that frustrate modification?

Whether and how pooling and servicing agreements constrain mortgage modification is relevant to current policy debates. It is still an open question whether the federal government should take action to trump anti-modification provisions in private securitization agreements, for example by trying to establish the supremacy of federal servicing standards over these agreements. Another question currently under debate is whether local governments should exercise the power of eminent domain to take securitized mortgages and modify them. Municipalities across the country have considered or are currently considering this idea.5 Proponents of such a strategy argue that securitization agreements limit the modification of securitized mortgages, so local governments must step in.6 Another open question is whether differences in terms across securitization agreements impede an effective policy response to problems in the mortgage market, so that the agreements should be standardized.7 The findings reported here suggest that subprime securitization agreements are in fact heterogeneous, so the results bear on this question as well.

Subprime securitization agreements are worth studying because subprime mortgages are commonly understood as lying at the heart of the mortgage and foreclosure crisis. The Financial Crisis Inquiry Report cites “an explosion in risky subprime lending” as the first factual basis for its lead conclusion that the financial crisis was avoidable.8 The Report contains two dissents. One identifies as the lead cause of the crisis a credit bubble “the most notable manifestation of which was increased investment in high-risk mortgages.”9 The other states that “the losses associated with the delinquency and default” of “27 million subprime and Alt-A mortgages” in themselves “fully account for the weakness and disruption of the financial system that has become known as the financial crisis.”10 Although the majority and dissenters disagreed on many topics, they concurred that risky (i.e. subprime) lending was a key part of the crisis.

Subprime mortgages originated in the mid-2000s continue to be important today even though conditions in the mortgage markets have been improving by many measures. For example, as of 2012, subprime delinquencies in mortgage insurer MGIC’s portfolio were at over 60% of their 2006 level.11 Mortgage insurer Radian’s 2012 exposure to mortgages rated A- or below was more than 55% of its 2006 exposure.12

Moreover, even after every subprime loan in existence today is paid off or foreclosed on, subprime loans will remain an important case study of private-label mortgage securitization. The subprime market apparently has started to revive,13 and it will be important to understand how this market has functioned in the past as we discuss how best to regulate it in the future – including whether documentation should be standardized.

Given the importance of what securitization agreements say, it is surprising that no systematic study of the contents of these agreements appears to exist in the academic literature. This paper is a first step toward filling that gap. It presents the results of a review of transaction documents from the sixty-five largest subprime securitization programs from 2006, the last full year of the subprime securit- ization boom. These programs accounted for approximately 75% of the dollar volume of subprime mortgage-backed securities issued in 2006 about which the Bloomberg Financial Information Service has information.14 Although this paper certainly is not intended to be the last word on the contents of securitization agreements, it is the most comprehensive review of subprime securitization contract terms undertaken to date.

One notable finding is that only about 8% of the agreements by dollar volume contain outright bans on mortgage modification. Most agreements (60% by dollar volume) permit material modification subject to conditions. Among the most common conditions are that default must be reasonably foreseeable or imminent, that the servicer must follow “normal and usual” servicing practices, and that the servicer must act in the interests of certificate-holders, the securitization trust, and/or the trustee. Another relatively common condition requires insurer approval for modification of more than 5% of loans in a securitization pool.

Review Process

The Bloomberg Financial Information service lists 614 deals from 2006 in the “Res B/C” category.15 Bloomberg has further in- formation on 482 of the 614 deals. These 482 deals cover $435 billion of volume, which is similar to the $449 billion volume for 2006 subprime securitization reported by Inside Mortgage Finance.16 Deals are grouped by “program.” A program is defined as a series of related deals with the same “motive force.”17 The 482 deals fall into 152 “programs” identified with different names in the database.

The results reported here are based on a review of transaction documents from deals in the sixty-five largest subprime securitization programs. The sixty-five largest programs include securities with $323 billion in aggregate principal at issuance, or about 75% of the dollar volume for subprime securitizations in 2006 about which Bloomberg has some information.

The review covered transaction documents from one randomly selected deal in each program. The numerical results reported be- low are based on aggregating the results of these reviews of sixty-five deals.

A key assumption of the approach is that deals within pro- grams are likely to be similar. This assumption is based in part on guidance from a major New York law firm with extensive experience in securitization and in part on input from the American Securitization Forum. To check the assumption that modification provisions are likely to be the same across programs, the author reviewed half the deals in the two largest programs, a Countrywide program and a First Franklin program. This supplemental review turned up no significant differences in the material-modification provisions among deals in either program.


1. Subprime securitization contracts may expressly bar, expressly authorize, or remain silent on material modification. Express authorization is the most common arrangement (60% of contract volume), followed by silence (32% of volume), and express bar (8%).

The chart below shows the relative prevalence of the three types of contract term. (The chart is omitted. Please refer to the original pdf document.)

Outright bans on material modification are relatively rare, but the situation where there is no express authorization to make material modifications is fairly common. “Material” modifications are defined here to include long extensions of loan maturity (more than a year or so) and reductions of principal or interest. Material modifications, as defined here, do not include short extensions of time to pay or waivers of late fees or penalty interest. Many contracts provide for such minor modifications without authorizing more significant ones.

The paper now turns to a discussion of the two largest categories: the one in which material modification is expressly authorized and the one in which material modification is neither expressly authorized nor expressly barred, in turn.

2. When material modification is expressly authorized, it is subject to conditions.

The review did not identify any contracts that simply authorized the servicer to modify contracts without conditions on the exercise of this authority.18 The chart below illustrates the proportion of the dollar volume of 2006 subprime mortgage-backed securities subject to various conditions. The percentages are relative to the total volume of securities that have express modification provisions (that is, relative to the green 60% slice in the chart above). Totals add up to much more than 100% because more than one constraint applies to the typical loan.

Certain general standards are extremely common: Servicers typically must follow normal and usual servicing practices, act in the interests of investors, and service loans in the same manner as they service their own loans. It is also common for securitization documents to require the servicer to service the loans that are the subject of the transaction in the same manner as other loans that it services for third parties, although this type of provision is less prevalent (29.3% of principal volume). Clearer standards could promote modification by reducing litigation risk.

Provisions that require reasonably foreseeable or imminent default before material modifications are allowed are also extremely common (83.4% of principal volume is subject to such provisions), and provisions requiring actual default as a prerequisite for material modification exist, though they are not common. Presumably, standards based on loan-to-value and debt-to-income ratios could supply an objective means of meeting a “reasonably foreseeable or imminent default” test.

It is also common to require permission from third parties involved with the transaction for material modifications. Such parties include the rating agency, the credit insurer, or the trustee. More than half the total principal volume covered by this study is subject to such a requirement. (The figures reported here include provisions that re- quire permission only when 5% or more of the total volume or number of loans is modified).

3. Even when material modification is expressly authorized, not all types of material modification are necessarily permitted.

The most common form of express authorization to make material modifications takes the form of allowing the servicer to modify “any” term of the mortgage loan as long as specified conditions are met. However, not all authorizations take this form; some authorize only a subset of material modifications. Among 2006 subprime securitizations for which some material modification is permitted, 23% of the dollar volume of principal is governed by provisions that do not expressly authorize material term extensions, that do not expressly authorize principal reductions, or that expressly limit or do not expressly authorize interest rate reductions. Examples of the latter class of provision include those that prohibit loan modification to reduce interest below 5% or below half the rate otherwise applicable under the contract.

4. When material modification is not expressly authorized, the contract typically contains a broad provision empowering the servicer “to do any and all things that may be necessary or desirable in servicing the loan,” or words to that effect. Even when such language is absent, the grant of power to service is a basis for arguing that the servicer may modify the loans.

Turning to the smaller group of securitized subprime mortgage loans for which modification is not expressly authorized (the burgundy slice of the pie graph above), approximately two thirds of the dollar volume of principal in this class is covered by the broad, catch-all grant of power above, which appears to provide a contractual basis for making modifications that satisfy the other standards in the contract.

5. In cases where material modification is not expressly authorized, there are contractual constraints on the power to modify, frequently arising from the agreements’ general provisions.

Where power to make material modifications is not express, if it is assumed that the power to make material modifications may be inferred from the general grant of power to the servicer to service the loans (and possibly to “do all things necessary or desirable” to do so), this implied power will be limited by the general servicing standards in the agreement and, frequently, by specific modification constraints as well.19 The chart below (omitted, please refer to the original pdf document) illustrates the relative importance of various constraints on any implied power to modify. The percentages are expressed relative to the aggregate principal volume of securities that contain neither express authorization nor express prohibition of material loan modifications.

Areas for Further Research

As noted, this paper is a first step toward understanding contractual restrictions on mortgage modification. Although a review of deals within the two largest subprime securitization programs supports the proposition that modification provisions are consistent across deals in a single program, further testing of this hypothesis may be desirable.

Assuming the technique of sampling by program is justified, it would be ideal to extend the research to years before 2006 and to non-subprime deals. Additional aspects of these contracts may also be relevant to mortgage modification. For example, prepayment penalty waivers are typically subject to standards that are different from those governing other loan modifications, and it appears based on casual observation that these standards are quite heterogeneous and often stringent. Another area for further research is contractual limits on servicer liability. A casual review suggests that these limits are both widespread and heterogeneous, suggesting that different servicers face widely varying levels of liability risk if they modify mortgage loans in a manner inconsistent with the contract documents.


Perhaps the most striking finding of the study reported here is just how heterogeneous subprime securitization agreements’ mortgage modification provisions actually are. Many different provisions appear in many – but not most – subprime mortgage agreements. It is very difficult to form a simple picture of what the typical agreement says and to make policy based on that picture, because it appears that for the most part there is no typical agreement. It is easy to imagine that policymakers will demand some kind of standardization as part of any effort to revive the moribund private mortgage securitization market.

Another noteworthy finding is that outright contractual bans on mortgage modification seem rare, appearing in only 8% of the sample. That is not to say that pooling and servicing agreements pose no significant obstacles to mortgage modifications: the restriction on modifying more than 5% of loans in a mortgage securitization pool without insurer approval, which appeared in nearly a third of agreements that impliedly authorize modification, certainly seems important.20

Informed discussion of the contents of existing pooling and servicing agreements will help advance the debate over a number of issues currently under debate, including the use of eminent domain to take mortgages, the use of federal powers to override the agreements, and whether pooling and servicing agreements should be standardized. This paper has taken a first step toward promoting such informed discussion.

  1. Two articles about the foreclosure crisis ran in the New York Times on July 25, 2013. See Shaila Dewan, New Defaults Trouble a Mortgage Program, N.Y. Times,, July 25, 2013, at B2 (describing level of defaults among homeowners who received mortgage modifications under TARP program and quoting Treasury source as saying “the housing market and the economy are improving”); Trip Gabriel, Welcome Mat for Crime as Neighborhoods Crumble, N.Y. Times, July 25, 2013 (explaining that in Cleveland, Ohio the foreclosure crisis’s “legacy of abandoned homes has frayed neighborhoods, leaving behind those who cannot afford to get out, while providing shelter to people on the social margins” and suggesting that this situation contributes to crime in the city).
  2. See, e.g., Lisa Prevost, Loan Modifications, Proactively, N.Y. Times, June 28, 2013 (describing FHFA’s creation of new Streamlined Loan Initiative to promote modifications and differences between the new program and the preexist- ing Home Affordable Modification Program).
  3. See generally Adam Levitin & Tara Twomey, Mortgage Servicing, 28 Yale J. On Reg. 1 (2011) (describing servicing of securitized mortgages).
  4. See, e.g., Anna Gelpern & Adam Levitin, Rewriting Frankenstein Con- tracts: Workout Prohibitions in Mortgage-Backed Securities, 82 S. Cal. L. Rev. 1075, 1149 (2009) (“[I]t would be relatively simple to legislate away both the contractual and TIA barriers to amending RMBS PSAs”).
  5. See Jody Shenn, Eminent Domain Plan Decried by DoubleLine Sees New Life, Bloomberg News, July 17, 2013 (reporting that Chicago and San Bernardino County rejected a plan to seize mortgages using eminent domain last year but that cities in California and Nevada, including North Las Vegas, El Monte, and Richmond, are proceeding with such plans).
  6. See, e.g., Robert C. Hockett, It Takes a Village: Municipal Condemnation Proceedings and Public/Private Partnerships for Mortgage Loan Modification, Value Preservation, and Local Economic Recovery, 18 Stan. J. L. Bus. & Fin. 121, 138-43 (2012) (arguing that structural and contractual impediments to modifications are part of the justification for use of local eminent-domain powers to take mortgages).
  7. See, e.g., Patricia A. McCoy, The Home Mortgage Foreclosure Crisis: Lessons Learned 37 (May 7, 2013) (unpublished manuscript),
  8. National Commission On The Causes Of The Financial And Economic Crisis In The United States, The Financial Crisis Inquiry Report xvii (2011).
  9. Id. at 417-18 (dissenting statement of Commissioners Hennessey, Holtz-Eakin, and Thomas).
  10. Id. at 451 (dissenting statement of Commissioner Wallison).
  11. MGIC Investment Corp. Annual Report (Form 10-K) March 1, 2013, at 25 (2012 data); MGIC Investment Corp. Annual Report (Form 10-K) (March 1, 2011), at 22 (2006 data).
  12. Radian Group Inc. Annual Report (Form 10-K) (February 22, 2013) at 99 (primary insurance in force data for 2012); Radian Group Inc. Annual Report (Form 10-K) (March 10, 2009) at 119 (primary insurance in force data for 2006). Moreover, Lender Processing Services reports that 35% of delinquent mortgages in July 2013 were Alt-A and subprime. Lender Processing Services, LPS Mortgage Monitor: August 2013 Mortgage Performance Observations (2013). LPS’ involvement in the robosigning scandal impairs its credibility. See David McLaughlin, LPS Reaches $120 Million Deal in “Robosigning” Probe, Bloomberg, Jan. 31, 2013; Dustin A. Zacks, Robo-Litigation, 60 Clev. St. L. Rev. 867, 902 (2013) (describing allegations against LPS and employees). However, there is no obvious motive to falsify this figure and it is broadly consistent with our other observations.
  13. See Katherine Rushton, Fresh Fear over U.S. Subprime Lending, Telegraph, June 1, 2013 (discussing resurgence of the U.S. subprime mortgage market); Center for Public Integrity, Subprime Lending Execs Back in Business Five Years After Crash, Sept. 14, 2013, that many former executives of subprime lenders are developing “new loans that target borrowers with low credit scores and small down payments, pushing the limits of the tighter lending standards that have prevailed since the crisis.”).
  14. Bloomberg has some information on 482 subprime issues from 2006. These 482 deals cover $435 billion of volume, which is similar to the $449 billion volume for 2006 subprime securitization reported by Inside Mortgage Finance. The sixty-five programs reviewed here cover 80% of this volume, but not all documents were available for review for some programs, so the actual coverage is approximately 75%.
  15. This list was accessed by using the “DQRP” function. The definition of “subprime” is drawn from classifications made by the Bloomberg Financial In- formation Service. The “Res B/C” loans are categorized as “subprime” in this paper. Based on interactions with Bloomberg representatives, it appears that Bloom- berg put each deal in the “Res B/C” category if the following three categories made up more than 50% of the dollar volume of principal in the deal at the time of classification: (1) “B- or C-rated loans.” Bloomberg made this determination based on the loans’ description in the prospectus; most frequently the prospectus described the loans as “subprime,” “scratch-and-dent,” “blemished-credit” or the like. (2) Home equity loans. Here the governing criterion was whether the loans’ purpose was to take equity out of the home rather than for purchase, although apparently deals might also be put in this category if the arrangers described the deal as a home-equity deal. (3) Loans that were thirty days or more delinquent at the time of classification.
  16. Adam B. Ashcraft & Til Schuermann, Understanding the Securitization of Subprime Mortgage Credit, Fed. Res. Bank Of N.Y. Staff Reports No. 318, at 4 (citing Inside Mortgage Finance data). Because there is no single definition of “subprime,” complete agreement on dollar volumes would not be expected.
  17. The motive force might be the mortgage originator, the underwriter, or another party. This definition of “program” was turned into a working definition by assuming that deals in the same numerical sequence are part of the same pro- gram. For example, we located 26 deals in Bloomberg with names “CWL 2006-1” through “CWL 2006-26.” We were able to locate information about the sponsor, depositor, master servicer, and underwriter for 21 of these deals, and all 21 shared a sponsor, depositor, master servicer, and underwriter. We assumed that these 26 deals were part of the same program. This pattern holds in most cases: deals in the same numerical sequence typically have the same originator or underwriter, suggesting that the same motive force is involved in each deal.
  18. One program, covering approximately 2% of the dollar volume, authorized modification if, in the servicer’s reasonable and prudent judgment, the modification “could be in the best interest” of investors. This appears to be the most flexible standard encountered in the documents.
  19. Agreements that do not expressly authorize material modifications often expressly authorize minor modifications, such as short extensions of time to pay or waivers of late fees or penalty interest.
  20. This restriction is less important if rating agencies or other stakeholders do not count successful modifications against the 5% cap, as has been reported. See Diane E. Thompson, Foreclosing Modifications: How Servicer Incentives Discourage Loan Modifications, 86 Wash. L. Rev. 755, 784 (2011) (citing Monica Perelmuter & Waqas I. Shaikh, Standard & Poor’s Criteria Revised Guidelines For U.S. RMBS Loan Modification And Capitalization Reimbursement Amounts 3 (Oct. 11, 2007).

The President’s Climate Plan for Power Plants Won’t Significantly Lower Emissions

* Brian H. Potts is a partner at the law firm of Foley & Lardner LLP and has authored numerous articles on the Clean Air Act. He holds an LL.M in Energy Law from the University of California, Berkeley School of Law, a J.D. from Vermont Law School, and a B.S. from Centre College. Parts of this Essay appeared in an op-ed originally published by Mr. Potts in The Hill on August 5, 2013.

President Obama released his Climate Action Plan to much fanfare on June 25, 2013 in an attempt to reduce the country’s greenhouse gas emissions “in the range of 17 percent below 2005 levels by 2020.”1 The centerpiece of the plan is to have the Environmental Protection Agency (EPA) issue carbon dioxide (CO2) standards for new and existing power plants, which account for roughly one-third of this country’s emissions.2

Obama’s announcement sent the news media and politicians into a frenzy, with vast proclamations on both sides about these regulations shutting down a large number of power plants, increasing electric costs, and killing the coal industry.3 But as this Essay will illustrate, these proclamations are exaggerated. The new regulations are unlikely to cause any significant retirements of existing coal-fired power plants (the largest emitters by far4), and at best will lead to no more than about a five percent reduction in power plant emissions once fully implemented around 2020. The reason for this lackluster result is not President Obama’s fault. The Clean Air Act – which governs the EPA’s ability to issue these standards – and more than forty years of federal court and EPA decisions interpreting the Act leave the EPA’s hands tied.

This Essay will explain why.

I. The Clean Air Act’s Limitations

The Clean Air Act allows the EPA to set emission standards for new and existing power plants based on the best emissions control technology available. In making this determination, the EPA must consider what emission reductions are achievable from the available technologies, but it must also take into account cost and prove that the chosen technology has been adequately demonstrated.

Unfortunately, the carbon control technology options for coal-fired power plants are limited. The only options are to improve the efficiency of the plant, to switch to lower emitting fuels like natural gas, or to sequester the carbon underground (which involves separating the carbon from the exhaust stream and piping it to underground storage reservoirs, sometimes hundreds of miles away).5 There are no add-on scrubbers that remove carbon dioxide during the process like there are with other pollutants.

The Clean Air Act allows the EPA to set two different types of technology standards. First, EPA can set blanket emission standards, called new source performance standards (NSPS), which uniformly apply to all sources covered by them.6 EPA has set more than eighty of these uniform technology standards for various categories of sources since the Act was adopted in 1970 – covering everything from landfills and petroleum refineries to dry cleaners.7 It set the first NSPS for power plants in 1971, and has revised those standards various times. But the current NSPS for power plants only regulates conventional pollutants, such as particulate matter, nitrogen oxides (NOx) and sulfur dioxide (SO2).8 CO2 is not regulated.

The second general type of technology standard that the EPA can impose is done on a case-by-case (or power plant by power plant) basis. These case-by-case technology standards, called best available control technology (BACT) determinations, are conducted when a company obtains a construction permit to build a new plant or to significantly modify an existing one.9 BACT determinations are set for each pollutant “subject to regulation” under the Clean Air Act, which includes all of the conventional pollutants regulated by the NSPS and others.10 In 2011, the EPA began requiring new and significantly modified power plants to conduct BACT determinations for CO2.11 Every new or modified plant subject to BACT has a slightly different limit to meet, based on the specific layout of the plant and what control technologies are available for that plant.

Now here’s the rub: according to the Clean Air Act, the case-by-case BACT standards must be more stringent than the blanket, uniform NSPS ones. The definition of “best available control technology” in the Act specifically states that “[i]n no event shall application of ‘best available control technology’ result in emissions of any pollutants which will exceed the emissions allowed by any applicable standard established pursuant to [the NSPS] section of this title.”12 In other words, as the D.C. Circuit Court of Appeals has said, “[a]t a minimum, . . . BACT [is] as restrictive as NSPS.”13

This requirement is important because President Obama’s plan calls for the EPA to issue the NSPS standards for new and existing power plants. Yet the EPA has already approved the more stringent case-by-case BACT standards for a number of existing and planned coal-fired power plants, and they have not amounted to much, generally requiring modest efficiency improvements that are relatively inexpensive and achieve at most about a five percent reduction in emissions.14

For example, a case-by-case BACT standard for CO2 was set for the Wolverine Power Supply Cooperative, Inc.’s proposed 600 MW coal fired plant located in Rogers City, Michigan in 2011 and led to only a 4.7% CO2 emissions reduction. A BACT standard for CO2 was also set in 2011 for the existing coal-fired George Neal South Power Plant in Salix, Iowa, and it resulted in only about a 1.2% reduction in emissions.15 These BACT determinations are representative of the various determinations set to date, and the plants are typical of coal-fired power plants in the industry.

These past BACT determinations have put the agency in a difficult legal position. The President’s planned NSPS regulations will almost certainly need to be less stringent than these BACT determinations, or the EPA risks violating the Act. In other words, if the EPA tries to adopt uniform NSPS limits for new or existing power plants that require more than about a five percent reduction in emissions, it will almost certainly run afoul of the Act.

While the statutory language unequivocally provides that BACT limits must be more stringent than the NSPS, the EPA might argue that the converse is not also true, and that the agency can set NSPS standards that are more stringent than previous BACT determinations. But this argument seems tenuous. The technology tests under the Act are the same in all material respects for the NSPS and BACT. So, even if the courts agree that the Act does not bar the EPA from adopting NSPS that are more stringent than previous BACT determinations, they would almost certainly find that the EPA was arbitrary and capricious if the agency set an NSPS at a significantly more stringent level than past BACT determinations that were recently set for the exact same types of sources.16

With this background, let’s turn to Obama’s specific plan for regulating new and existing sources under the NSPS program.

II. The Standards for New Power Plants Will Not Have Any Effect on Emissions

The President’s plan directs the EPA to issue CO2 standards for existing power plants by 2015 and for new plants as expeditiously as possible.17 In April of 2012, well before the release of the President’s climate plan, the EPA issued its first proposal to regulate CO2 from new power plants using the NSPS program.18 That proposal determined, rather counter-intuitively, that the best control technology available for new coal-fired power plants was to be a natural gas-fired power plant, and set the standard based on a typical natural gas-fired plant’s emissions.19 In other words, the proposal – if finalized – would essentially ban the future construction of all coal-fired power plants in this country because no conventional coal-fired plants can meet the standard. Not surprisingly, the utility industry and coal companies went ballistic with public comments (the EPA received more than 2.6 million comments) – many arguing that the EPA’s approach was unlawful.20

The primary legal problems with the EPA’s approach are fairly obvious. A natural gas plant is not a carbon control technology; it’s a different kind of power plant. And courts (and even the EPA) have said for years that technology-based limits should not “redefine the source,” which is exactly what the EPA’s proposal would do.21 Moreover, the EPA’s proposal would impose an NSPS limit for new power plants that is vastly more stringent than any of the existing BACT standards for coal-fired power plants.

The overwhelming industry response and these legal issues led the EPA to recently announce plans to re-issue the proposal in late September of this year, and separate the control technology determination for plants that burn coal as compared to those burning natural gas.22 But even if the EPA does separate coal plants from gas plants in the new proposal, the control technology options for coal-fired power plants are still limited, and the EPA is hampered by past precedent. Technology-based limits cannot require a plant to switch from coal to natural gas,23 and the EPA in its April 2012 proposal has already basically admitted that separating and sequestering the carbon is too costly, noting that it “would add around 80 percent to the cost of electricity” for a new plant.24 All of the previously mentioned BACT decisions considered and eliminated both fuel switching and sequestration as the technological choice. That just leaves the EPA with efficiency improvements in new plant design, which would at best lead to minor emissions reductions – if new plants are built that replace older, higher emitting ones.

Yet even the EPA does not expect new coal-fired power plants to be built any time soon. The EPA admitted in its original NSPS proposal that current market conditions make it highly unlikely that anyone will build a new coal plant between now and 2020, regardless of what the EPA does with the CO2 NSPS.25 Natural gas prices are too low and are forecasted by the EPA to stay that way, while other EPA regulations aimed at mercury and SO2 emissions are pushing the cost of new coal-fired power plants up compared to gas plants. In fact, even though the EPA’s proposal would basically ban the construction of new coal-fired power plants, the agency admitted in its proposal that it “believes that this proposed rule is not likely to produce changes in emissions of greenhouse gases or other pollutants” because of market conditions.26

Given these current market conditions and the looming legal battles, some in the industry believe the EPA will back down from its proposal and allow the construction of new coal plants, as long as they include the most efficient design (a “supercritical” advanced coal plant).27 This would allow the EPA to avoid setting bad legal precedent on the new NSPS, which could impact the viability of its plans for the existing power plant NSPS.

Either way, the EPA’s new power plant NSPS is not likely to have any impact on CO2 emissions between now and 2020.

III. The Standards for Existing Sources Might Reduce Emissions Slightly, or Not at All

The prospect for existing power plant standards, which Obama’s plan calls for the EPA to finalize by June of 2015, is equally ho-hum. As discussed, these existing plant standards should be less stringent than the case-by-case BACT ones, so even if Obama follows through with his promise, the most we are likely to see are standards for existing coal-fired power plants based on modest efficiency improvements.

The EPA’s own statements in the past also pose an obstacle to proposing more stringent standards for existing power plants. The agency has already publicly taken a narrow view of the technological alternatives available to it in imposing CO2 standards for existing sources. In 2008, the agency admitted that these standards would likely focus on incremental improvements in the heat rates of existing units through options that “are well known in the industry” (aka energy efficiency improvements).28 Plus in its already released proposal for new plants, the EPA made the same admission, saying that “[t]he most likely candidates for control actions [for modified existing sources] would be efficiency measures.”29

Existing BACT standards and the EPA’s past statements are not even the EPA’s most significant legal problem associated with setting standards for existing plants. Most of the EPA’s current NSPS regulations only apply to new or significantly modified sources. They do not generally apply to existing plants, as the Act grandfathered existing sources out of many of its most stringent requirements. The President’s plan, however, is to have the EPA issue NSPS for existing sources using Section 111(d) of the Clean Air Act, a rarely used section that the EPA generally has only used to regulate smaller sources that are not otherwise regulated under the Act.

Section 111(d) states that the EPA can force the states to adopt standards for “any existing source for any air pollutant: . . . which is not . . . emitted from a source category which is regulated under section [112] of the Act . . .”30 Based on a plain reading, this section seems to only allow the EPA to issue existing source NSPS for categories of sources that are not subject to hazardous air pollutant standards under Section 112 of the Act. Power plants are a category of sources, however, that are subject to hazardous air pollutant standards for mercury under Section 112.31 As such, it is highly questionable whether the EPA can even regulate existing power plants at all using Section 111(d).32

IV. Conclusion

The EPA’s regulation of CO2 from new and existing power plants under the NSPS program faces significant legal hurdles. The EPA’s best hope for the regulations to make it through the courts is if the agency takes a conservative approach and sets the NSPS for new and existing sources based on something less than the existing BACT standards. This means – at best – reductions in the range of 1-5% by 2020 for existing sources, with no emission reductions from new sources (since none are likely to be built).

The President’s climate plan calls for a 17% reduction in total nationwide emissions by 2020. Given no emission reductions are expected from the new power plant NSPS – and assuming minimal reductions from the existing power plant NSPS – the Administration will need to obtain significantly more reductions from the sources comprising the other two-thirds of national emissions, or the President’s 17% total reduction goal by 2020 will not be met.

  1. Executive Office of The President, The President’s Climate Action Plan 6 (June 2013) [hereinafter Obama’s Climate Plan],
  2. Id. at 6.
  3. See, e.g., Brenda Buttner, How Will Obama’s Fight on Global Warming Change the Economy?, Fox News (June 29, 2012); Jim Malewitz, In Obama Climate Plan, States Seek Flexibility, USA Today (July 12, 2013); Mark Drajem, Republicans Propose Limiting Obama Climate Plan in Budget, Bloomberg (July 22, 2013).
  4. Obama’s Climate Plan at 6.
  5. Interdisciplinary MIT Study, The Future of Coal: Options for a Carbon Constrained World 5, 17-42 (2007),
  6. 42 U.S.C. § 7411.
  7. See 40 C.F.R. pt. 60 (containing all of the EPA’s final NSPS regulations).
  8. 40 C.F.R. §§ 60.40-52da.
  9. 42 U.S.C. § 7475(a)(4). BACT is the case-by-case technology standard that applies in areas currently meeting EPA’s national ambient air quality standards. In those areas that are not currently meeting air quality standards (called nonattainment areas), there is a separate and more stringent control technology standard called the lowest achievable emission rate (LAER) standard. Because there are no national air quality standards for CO2, LAER is not applicable to the analysis in this Essay.
  10. 42 U.S.C. § 7475(4).
  11. Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule, 75 Fed. Reg. 31514, 31516 (final rule June 3, 2010).
  12. 42 U.S.C. § 7479(3).
  13. State of New York v. EPA, 413 F.3d 3, 13 (D.C. Cir. 2005).
  14. See, e.g., BACT Analysis and Correspondence for MidAmerican Energy Company George Neal South Power Plant Construction Permit (Jan. – Mar. 2011) (on file with author); US EPA Comments on MidAmerican Energy Company George Neal South Power Plant Construction Permit (May 06, 2011) (on file with author); Construction Permit for MidAmerican Energy Company George Neal South Power Plant (May 16, 2011) [hereinafter “Neil South Materials”] (on file with author). See also EPA Comments on Wolverine Power Supply Cooperative, Inc. Construction Permit (May 19, 2011) (on file with author); Response to EPA Comments on Wolverine Power Supply Cooperative, Inc. (June 29, 2011) [hereinafter “Wolverine Materials”] (on file with author).
  15. Neil South Materials, supra note 14; Wolverine Materials, id.
  16. Unless, of course, a new technology popped up between the time of the BACT determinations and EPA setting the NSPS (which seems unlikely in this case).
  17. Environmental Protection Agency, Presidential Memorandum – Power Sector Carbon Pollution Standards (June 25, 2013).
  18. Standards of Performance for Greenhouse Gas Emissions for New Stationary Sources: Electric Utility Generating Units, 77 Fed. Reg. 22392 (proposed Apr. 13, 2013).
  19. Id. at 22398 (“We propose that a [natural gas combined cycle] facility is the best system of emission reduction”).
  20. eRulemaking Program Management Office, U.S. Environmental Protection Agency (search for docket number “EPA-HQ-OAR-2011-0660;” then click on “open docket folder” for Greenhouse Gas New Source Performance Standard for Electrical Generating Units; comment letter count will be on the right side of the screen) (last visited Aug. 2013).
  21. See, e.g., Sierra Club v. U.S. E.P.A., 499 F.3d 653, 655 (2007) (“The EPA’s position is that “best available control technology” does not include redesigning the plant proposed by the permit applicant.”); Longleaf Energy Associates, LLC v. Friends of the Chattahoochee, Inc., 681 S.E.2d 203 (Ga. App. 2009) (“The BACT analysis did not, however, require the EPD to consider any alternative control technology that, if applied to the proposed power plant, would constitute a redesign of the plant.”); In re Old Dominion Electric Cooperative, 3 E.A.D. 779, 793 n. 38 (EPA Adm’r 1992) (“[T]raditionally, EPA does not require a . . . [permit] applicant to change the fundamental scope of its project.”).
  22. Zach Coleman, EPA Sends White House Revised Rule for Power Plants, The Hill (July 1, 2013).
  23. See Sierra Club v. EPA, 499 F.3d 653; see also Larry Parker & James E. Mccarthy, EPA’S BACT Guidance For Greenhouse Gases From Stationary Sources, Congressional Research Service 16 (November 22, 2010) (“Natural gas substitution for coal in a facility is generally considered by EPA to be an option that redefines the source”).
  24. 77 Fed. Reg. 22392, 22415 (“The DOE/National Energy Technology Laboratory . . . estimates that using today’s commercially available [carbon capture and sequestration] technologies would add around 80 percent to the cost of electricity for a new pulverized coal (PC) plant”).
  25. Id. at 22398 (“[O]ur Integrated Planning Model [IPM] model projects that for economic reasons, natural gas-fired EGUs will be the facilities of choice until at least 2020”).
  26. Id. at 22430.
  27. Dawn Reeves, EPA’s Stationary Source GHG Rules Face New Legal, Policy Uncertainty, Inside EPA 1 (March 22, 2013).
  28. Parker & Mccarthy, supra note 23, at 16.
  29. 77 Fed. Reg. 22392, 22421.
  30. 42 U.S.C. § 7411(d).
  31. National Emissions Standards for Hazardous Air Pollutants From Coal- and Oil-Fired Electric Utility Steam Generating Units and Standards of Performance for Fossil-Fuel-Fired Electric Utility, Industrial-Commercial-Institutional, and Small Industrial-Commercial-Institutional Steam Generating Units; Final Rule, 77 Fed. Reg. 9304 (February 16, 2012).
  32. See American Electric Power Co. v. Connecticut, 131 S. Ct. 2527, 2537, n. 7 (2010) (“EPA may not employ §7411(d) if existing stationary sources of the pollutant in question are regulated under . . . the ‘hazardous air pollutants’ program, §7412.”).