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The paradoxes of rules-based regulation

by Robert Teitelman | Published September 28, 2011 at 12:17 PM

The Wall Street Journal Tuesday has a fascinating story about the broad expansion of the federal crime list and the corresponding decline of the concept of mens rea, "the bedrock principle of criminal law," as the paper writes, that "has held that people must know they are doing something wrong before they can be found guilty." The Journal focuses mostly on individuals that have somehow been swept up into frightening criminal cases without knowing they'd violated anything. And while the paper does swerve into a quick discussion of Sarbanes-Oxley -- mostly as an example of how rushed and sloppy the drafting of legislation in Congress has expanded the boundaries of criminality -- the deeper forces driving this have clearly reshaped white-collar and regulatory law in similar ways as well. Over the past decade or so, there has been a steady shift from civil to criminal white-collar litigation and, for all the talk of deregulation, a vast outpouring of new rules.

An important point: This didn't start yesterday with the Obama administration. This began decades ago. And, as the Journal points out, if there's a culprit here it's not the regulatory agencies, it's Congress.

What's fueling this? The Journal doesn't speculate, but we will. Some of this clearly stems from the prevailing notion that the country was going soft on crime that goes back to the '60s and the backlash against sociological explanations for crime -- not to say the breakdown of order in the big cities, the counterculture and disorienting change. In the '70s and '80s, many drug offenses were criminalized, and sentencing was made increasingly harsh. Despite the fact that crime statistics have significantly fallen, crime continues to be a potent issue among conservative voters; that's one explanation for the prison-building binge that's taken place -- a vast establishment now threatened by fiscal pressures. Another factor: The explosion of lobbying, interest group politics and money in Congress. A number of the cases the Journal touches on represent the influence of narrow-interest groups, which tend to see crime where there was once simply poor judgment or error. These groups run across the political spectrum, from environmental to anti-immigration lobbies. If you believe deeply enough, even an inadvertent transgression seems criminal.

On the white-collar and regulatory side, some of this overreaction -- classic case: the post-Enron Arthur Andersen prosecution, which destroyed the accounting firm and was later tossed out on appeal -- stems from a larger breakdown of oversight that in part can be traced to the broad disdain for regulation from the free market crowd. Regulatory failure, from Enron and WorldCom to the financial crisis and subprime disaster, spawns a political reaction, which emphasizes crime and punishment -- a demand for clarity of right and wrong -- and sweeps over Congress. The legislature then reacts to public opinion by rushing through swiftly enacted rules to insure (as President Obama said after the financial crisis) that these transgressions can never happen again: Sarbanes-Oxley, Dodd-Frank, and dozens of laws that we will never hear of until someone trips over them. This dynamic is quite striking -- and it's reflective of an increasingly insecure, increasingly ideological, increasingly amateur Congress confronted by situations of great complexity. And, again, it certainly isn't confined to the law and order crowd. Look at the howls from the progressive left from everyone from economist Joseph Stiglitz to Frank Rich to filmmaker Charles Ferguson that we need to prosecute and jail Wall Street chiefs for the financial crisis. Nobelist Stiglitz went so far as to say if there weren't laws for these "crimes," we should enact them.

The end result of all this, both on the individual and in white-collar litigation, is the same. An excess of rules and laws, particularly with criminal penalties, is difficult to enforce because it is both draconian and cumbersome to prosecute. Such rules and laws hand a great amount of power to prosecutors and regulators; the penalties rob plaintiffs of any desire to fight the charge. But the cases, particularly involving white-collar fraud, are also difficult to win for prosecutors, which explains why Eliot Spitzer mostly stayed out of court. If there are enough rules, violations always exist, particularly since no individual can know all of them -- or even come close. This creates demand for what in finance is known as compliance officers -- usually lawyers -- to keep you out of trouble and protect you against yourself. Lawyers become a cost of doing business, and sometimes a drag on innovation and flexibility.

Psychologically, the expansion of criminality represents a kind of race to the bottom, in which rules beget rules, and more rules, particularly those with criminal penalties attached, only seem to create more violations. The tension over mens rea has its roots in a fundamental theological conflict: grace or works. Are we saved by the fact of God's inexplicable grace, which no man can predict, or by our works, our good deeds? It's the Puritans' dilemma: Can we ever really detect who is saved and who is not? Can we truly see into another's heart? Aren't we all fallen or guilty of something? To those eager, or desperate, for control and order -- clean, bright lines delineating good from bad, right from wrong, without ambiguity or complexity -- then mens rea is a frustrating affront. A violation is a violation. There are no excuses. To go searching for the contents of the plaintiff's state of mind is an open door to relativism and permissiveness, despite the fact that mens rea has a long history in the criminal law.

In regulation, of course, this inflationary rules-making tendency, including increasing criminalization, has its foil, though in these polarized days it often seems beleaguered: regulation by principle. Delaware's Court of Chancery, the top venue for corporate law, may be the most prominent and successful U.S. venue that conducts itself by principle. But Chancery is not a regulator; it's a court, indeed a court of equity. It adjudicates, not oversees. It's by its very nature conservative and precedential. And it always keeps one eye out for the threat that it may be edged out by expanding federalization of the corporate law. Federal regulation exists as a rules-based system, juggling rules written by agencies or laws passed by Congress. The regulatory system we have today is thus riven by paradoxes: expanding volumes of rules in an age that isn't sure it believes in regulation; a demand for control and order that spawns ineffectiveness and disorder. In short, the more you get, the worse it becomes. It's a crime. - Robert Teitelman

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