Streetwise Professor

January 1, 2024

Agency Problems, or, The Progs Lose Control Of Their Bodily Functions in Fear of How the SCOTUS May Rule

Filed under: Commodities,Derivatives,Economics,Politics,Regulation — cpirrong @ 2:43 pm

In the coming year the Supreme Court will rule in two cases that could result in the imposition of substantial constraints on the administrative state. Since federal administrative agencies are progressive pets, the prospect has the left freaking out. And I do mean freaking out.

The first case is Securities and Exchange Commission v. Jarkesy. Here Jarkesy is challenging the legitimacy of the SEC (and by implication other agencies) relying on internal administrative law judges (“ALJs”) to decide enforcement actions brought by the agency. Jarkesy argues that such cases should be tried in Article III courts (i.e., in federal court).

The Constitutional basis for his argument is compelling. Agencies flout the separation of powers: they combine legislative, executive, and judicial functions. In the case of enforcement actions like that against Jarkesy, the SEC brings the charges against the defendant/respondent, prosecutes the case, and if the agency uses an ALJ, tries the case and renders the judgment and assesses the penalty. The case is brought under regulations adopted by the agency in a quasi-legislative role (supposedly under powers delegated by Congress–an issue that is relevant in the other case I will discuss).

Jarkesy argues that being subordinate to, and accountable to, the agency, ALJs are not independent are subjecting him to their judgment violates his Constitutional rights, and in particular his right to due process.

As an empirical matter, Jarkesy has a compelling case. I recall that in an antitrust case, Justice Potter Stewart opined that the “only consistency” in such cases is “that the government always wins.” (That was in the 60s.). And that was before Article III courts. That is even more true in cases before ALJs in agencies like the SEC and FERC. (When is the last time a FERC ALJ decided against the agency in a big matter?)

Jarkesy therefore wants the trier of fact to be an ostensibly independent Article III federal court. He doesn’t want to have his fate decided by an ALJ who is effectively beholden to the commissioners who run the agency who are bringing the charges and prosecuting them.

Reasonable, no? But not to the progs. They are losing their sh!t over the prospect. Case in point, this article in the Atlantic–which is always a reliable barometer of prog opinion.

According to author Noah Rosenblum, this would represent The End of the World as We Know It.

It would “destroy the government”!!!!!!!! (He says this like it’s a bad thing!–JK).

Rosenblum’s argument veers between the hysterical and the dishonest.

This part in particular cracks me up:

Jarkesy’s second claim—that the internal adjudicator who first heard his case held too much independence—is especially galling. These adjudicators should be independent; the alternative would be to put their regulatory powers at the political whim of whichever administration might be in charge. 

The relevant question is “independent from whom?” The very essence of Jarkesy’s argument is exactly that ALJs are creatures of “whichever administration may be in charge.” “The political whim of whichever administration might be in charge” is precisely the problem, not the “alternative.”

Article III courts are about as independent of the current administration (whether it be the presidential administration, or the commissioners of an agency) as is possible–and that’s by the Founders’ design. ALJs are definitely not.

Rosenblum loses control over his bowels at the thought that allowing those accused by federal agencies be judged by, you know, federal judges will gut the ability of agencies like the SEC to prosecute financial crimes:

The SEC was created as an independent agency in 1934, after the financial crash of 1929, to thwart the sort of market manipulation that preceded the Great Depression; Congress has granted it additional powers over the years to continue protecting financial markets. Responding to catastrophes and guarding against market manipulation is exactly the kind of work that Congress should empower the executive branch to do. Requiring Congress to legislate in response to every new fraud some crook might dream up would not be a good use of its time. And there’s no reason to think that delegating authority to police markets runs afoul of the Constitution.

Requiring those who “police markets” to prove their cases beyond the relevant burden of proof (preponderance of the evidence in a civil case) to a truly independent trier of fact does not permit manipulators and fraudsters to run rampant, any more than requiring your local police and prosecutor to prove charges before a judge allows murderers and rapists to run rampant.

Given the stakes in federal securities cases, which can easily run into the tens or hundreds of millions, if not more, requiring prosecuting agencies to clear such a hurdle is eminently reasonable.

What is Rosenblum so afraid of? These people would be prosecuted before Article III courts under the same laws and regulations that they are currently prosecuted before ALJs. A decision adverse to the SEC in Jarkesy would not eliminate the Securities Act, or the Exchange Act, or the SEC regulations adopted pursuant thereto. It would just require the SEC to prove cases brought under those acts and regulations in an Article III court rather than on the agency’s home court.

Rosenblum’s ultimate argument is that Jarkesy is a scumbag:

George R. Jarkesy Jr., a right-wing activist and conservative-radio talk-show host.

Heaven forfend that such a MAGA man should have rights! Oh! The humanity!

The kind of ad hominem chickenshit to which the left routinely resorts to today, and uses to stamp “QED!!!!” on its argument. By doing so, Rosenblum betrays the substantive weakness of his arguments.

I note that many seminal Supreme Court cases involving fundamental Constitutional rights have involved scumbags. And the Supreme Court ruled–rightly–that scumbags have rights too.

It is interesting to note that the CFTC now brings most of its manipulation cases–you know, “exactly the kind of work that Congress should empower to the executive branch to do”–in Article III courts. Now, as it happens, there is a tangled and unrepresentative story behind this, namely that the CFTC ALJs proved to be particularly dysfunctional and inveterately opposed to the agency’s enforcement staff. (I have intimate knowledge and experience regarding this history.). But the why is no matter. The reality is that an agency can bring manipulation cases (and fraud cases, for that matter) in federal court. Requiring the SEC (and other agencies) to do so will not “destroy the government” or allow wrongdoers to run rampant.

Indeed, the CFTC’s experience in federal court–most notably, its loss in the DRW/Wilson case–demonstrates the virtue of forcing agencies to play in the big leagues. It reduces the probability of Type II errors, i.e., false convictions.

I also note that there are rights of private action for certain federal securities, antitrust, and commodities law violations. Here private plaintiffs can bring cases in federal court against alleged malfeasors. I believe that such private rights of action are more reliable deterrents of bad conduct than agency actions, for a variety of reasons. (Again, this observation is based on considerable experience and observation.)

The other case that has the progs’ undies in a bunch is FDA v. Alliance for Hippocratic Medicine. This case threatens to demolish so-called “Chevron deference,” a reference to the case Chevron v. Natural Resources Defense Council in which Justice Scalia (!) on behalf of the court opined that courts should defer to agency judgements in cases in which Congress did not unambiguously delegate authority. That is, when there are “gaps” in a statute pertaining to a regulatory agency, Article III courts should defer to agency decisions regarding on how to fill those gaps.

Alan Blinder (among others) fears the abrogation of Chevron deference. Blinder is less hysterical than Rosenblum in his criticism (a low bar to clear!) but substantively he is no more persuasive.

The gravamen of Blinder’s argument is that agencies are experts, and we should defer to their expertise: we are not worthy to challenge them, nor are federal judges!

This has been the mantra of progressives since, well, the Progressive Era. Blinder is channeling his inner Woodrow Wilson. (Scary thought, that.)

There are two major problems with this. The first–and arguably less important–is that their “expertise” is vastly exaggerated. I mean vastly. Again based on extensive personal experience, I conclude that this is definitely the case when it comes to complicated markets (e.g., electricity, commodity derivatives). And yes, I realize that these complexities challenge federal judges, but the relevant question is who is better to resolve these issues: on that, I come down firmly on the side of the judges.

The second is what economists call “agency problems”–which in the present context can be called Agency problems. That is, the progressive view endorsed by Blinder (and Woodrow Wilson et al) is that agency decision makers are acting in the public interest.

This view has been laughable since the 1960s when Stigler posited “capture theory,” and then others like Sam Peltzman and Gary Becker looked at how the regulatory sausage is really made. The Public Choice literature has also utterly discredited the public interest view.

In a nutshell: regulatory agencies have their own agendas and own incentives that are not aligned with the public interest, for myriad reasons.

As valuable and insightful as they are, even the Peltzman-Becker-type analyses are inadequate. They are best suited to model the regulatory laws legislatures pass. They posit a decision maker looking to maximize political support (“votes”). That makes some sense when modeling legislatures that are somewhat accountable to an electorate. But the problem raised by Chevron deference is that regulatory agencies are incredibly insulated from such electoral feedback. If you view Congress as an agent of the public, agencies are agents of agents of the public. As a result, their incentives are extremely attenuated, and they have considerable scope to implement their own agendas regardless of whether they comport with the public interest or not.

John Cochrane laments that a new theory of regulation is required, because the Stigler-Peltzman-Becker theories, and public interest theory, are inadequate. I agree that these theories are inadequate, but do not believe that there is a vacuum. Certain strands of public choice that treat bureaucracies as independent agents in their own right have much to teach here. I recommend the works of Gordon Tullock and James Q. Wilson in this regard. (Tullock was an amazing scholar whose work deserves close attention–even his work from nearly 60 years ago.)

Here’s my Cliffs Notes theory of regulation: a large unaccountable bureaucracy combined with Hayek’s “why the worst get on top.” Ideologues with agendas are attracted to agencies with power over their agendas. Ensconced in power, they are largely immune from external check. So ensconced, they wreak havoc, the public be damned.

People, I give you–the EPA.

That’s why deferring to these agencies is disastrous. Their “expertise”–really their specialization in subjects of particular interest to the ideologues who infest them–is positively dangerous when given free rein.

I hope that the Supreme Court decides in Jarkesy’s favor, and also hacks away at Chevron deference. That said, I realize that the Supreme Court usually splits the baby, and that ringing decisions that drastically curtail the scope of agencies’ powers are unlikely. Meaning that the war against the agencies–or more accurately, the war of the agencies against us–will continue.

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3 Comments »

  1. In the UK there are 957 “semi autonomous public bodies” (agencies to you, quangos to me) spending 80 billion pounds of tax payers’ money per year.
    Pari passu, is that better or worse than the USA?

    Comment by philip — January 2, 2024 @ 2:51 pm

  2. I’m a card carrying prog I suppose but I don’t see any mention here of regulatory capture. Here the SEC’s prosecution looks a lot like a criminal case so is a good one for the Court to rule article III attaches & I suspect that is what they will do. However the adjudicative powers of agencies often protect regulated entities from suffering more than a wrist slap for egregious conduct. For instance Enron & others who manipulated Western energy markets in the California energy crisis of 2000-01 invoked very piously the purported expertise of the FERC to avoid antitrust liability in the courts. It worked on the electric side & those of us on the natural gas side barely beat those motions. Also agencies like the FERC often function as safe spaces for industry factions to engage in kabuki style battles but avoiding the pain of truly final court judgments. I have been an interested observer of FERC over many years & my view is that nothing is ever truly settled & next year’s cases may modify or end the sting of last year’s losses. It is an insiders’ game where the consumer is left in the cold. As I said, this looks like a good case for an Article III holding but I can’t ignore the larger effect which will likely be to reduce liability risk for industry insiders to end users of industry products or services, here investors rather than consumers. In this way it will advance what this prog sees as the broad policy of the GOP dominated federal courts to protect the wealthy by reducing avenues for the have-nots to obtain redress for illegal or fraudulent business activities. Just my opinion.

    Comment by Ty Kelly — January 4, 2024 @ 5:14 pm

  3. I look forward to the outcome.

    Direct experience of these issues in the UK dealing with the PRA. Our external counsel was really clear. If the PRA say “the standard is X” then the standard is X. And that goes even if the standard has never been written down, codified or communicated. So the regulators use the tribunal process as a big stick to hold over you whilst you negotiate and sign a contract you can’t fail to deliver on, as if you do now you’ve breached a written promise to the regulator so they have direct access to their toolkit against individuals.

    Needless to say this wasn’t a totally happy process. The regulator was more right than wrong, but not everywhere..Even my friend there admits they made up the metric and the benchmark for this.

    Comment by Anonymous — January 5, 2024 @ 3:58 pm

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