Saturday, November 25, 2006

On the Cusp of Great Changes: American Religion Clause Jurisprudence in the First Decade of the 21st Century

The interpretative bases of the Religion Clauses, never very stable to begin with, seems to have up ended over the course of the last half-decade. I might venture to say that (with a few notable exceptions), except perhaps for their holdings, and the general principles the underlie them, cases decided much before 2000 will be of increasingly little value in helping understand what the Supreme Court is doing when it is confronted by a Free Exercise of Establishment Clause Case. The three prong Lemon test (Lemon v. Kurtzman, 403 U.S. 602 (1971))—secular purpose, secular effects and no substantial entanglement, has been substantially modified into a very different standard or superceded. This makes sense as the court shifts away from a jurisprudence (like Lemon) deliberately designed to make it difficult for the state to accommodate religion (a point made by Justice Harlan in Sherbert (Sherbert v. Verner, 374 U.S. 398 (1963))) to one in which accommodation is easier to justify. It is the limits and contours that that more liberal justification that continues to embroil the court in jurisprudential battles.

What follows is a brief suggestion of the way the Supreme Court is rewriting the analytical bases for approaching interpretive issues touching on the Religion Clauses. But understand that, as in previous interpretive eras, the Supreme Court remains deeply divided. At least two principle foundations of Religion Clause jurisprudence continue to dominate the Court. Their advocates are among the ablest jurists of the last several generations.

One, led ever more aggressively by Justice Scalia, is grounded in appeals to tradition—not jurisprudential tradition, but the cultural understandings and practices of the people in the United States around the time of the adoption of the Bill of Rights. This has led Justice Scalia to adopt an aggressively anti-separationist position. Justice Scalia starts from the position that the Religion Clauses were not meant to force a separation of state from Religion, something that would have been at odds with the lived reality of the Republic at its founding. Neutrality is defined from the perspective of the benefits or grants offered by the state. Where the government offers any benefit or privilege, it must make it available to religion on an equal basis. Indeed, the Religion Clauses compel the privileging of religion as against irreligion and may permit the state to accommodate the beliefs of the majority religion over that of all others (as long as there is no formal establishment). For minority religions, there is the solace of an individually applied Free Exercise Clause. However, where majority religious morals or ethics results in enactment of a statute that is otherwise generally applicable and not purposely intended to target a religion, then even the protections of the Free Exercise Clause would not be available. States are otherwise free to accommodate religion, either through direct funding or through the support of religious activities of citizens (Mitchell v. Helms, 530 U.S. 793 (2000) (“So long as the governmental aid is not itself ‘unsuitable for use in the public school because of religious content,’ . . . and eligibility for aid is determined in a constitutionally permissible manner, any use of that aid to indoctrinate cannot be attributed to the government and is thus not of constitutional concern.”)). For Scalia, the way to avoid the problem of the establishment of any one religion is to permit the establishment of them all (or at least of most of them). In effect, Scalia would like to see a return to Reynolds v. United States, 98 U.S. 145 (1878) (“Congress was deprived of all legislative power over mere opinion but was left free to reach actions which were in violation of social duties or subversive of good order”) and especially Davis v. Beason, 133 U.S. 333 (1890) (“It was never intended or supposed that the amendment could be invoked as a protection against legislation for the punishment of acts inimical to the peace, good order and morals of society. . . . Probably never before in this history of this country has t been seriously contended that the whole punitive power of government for acts, recognized by the general consent of the Christian world in modern times as proper matters for prohibitory legislation, must be suspended”). Justice Scalia would apply these ideas as a general principle in both Free Exercise and Establishment Clause jurisprudence, but in a more modern, neutrality and “original understand” guise, and without the underlying anti-Catholic and anti-Mormon element.

In its more benign form, expounded in the opinions of Chief Justice Rehnquist in his final year, there is also an emphasis on neutrality and a willingness to carve a wider ambit for governmental accommodation of religion. But there is also a definitive reluctance to abandon a formal adherence to some measure of separation between organized religion and the state. Thus, for example, Rehnquist is happy enough to find no constitutional infirmity in the provision of governmental vouchers to students to be used to pay the tuition of private religious schools, but only where it is clear that the choice is made by individuals (and not the state) and where it is also clear that (at least as a formal matter) the individual was offered a true and free choice among religious and secular options (Zelman v. Simmons-Harris, 536 U.S. 639 (2002)). This wing is less convinced that the Religion Clauses compel a privileging of religion over irreligion (or secular interests) and find important the keeping of formal separation, based on a sense that the forms of Establishment of importance to the founding generation, rather than official acts of formal establishment, ought to guide the courts in the setting of the limits of accommodation. As a consequence, Rehnquist was happy to permit a school voucher system but was unwilling to require the state to provide aid to be trained in theology (Locke v. Davie). At the same time, this group is much more willing to defer to the state, both in matters of generally applicable laws that appear formally neutral with respect to religion (Smith), and state rules that accommodate religion as long as formal neutrality is observed and direct endorsement is avoided (Lynch v. Donnelly).

The other, led ever more openly by Justice Souter (with Justice Stevens not far in the background) harkens back to the more traditional jurisprudence of the post WWII period, a jurisprudence substantially rejected by the new conservatives. The core of that jurisprudence is both separation (Everson v. Bd. of Education, 330 U.S. 1 (1947)) and neutrality between religion and irreligion. It views tradition (especially in the form of original understanding as much less useful than Scalia, finding altogether too many different and irreconcilable opinions from which to extract any sort of consensus. Souter remains truest to the old Lemon test, but even he concedes that it has been substantially reworked in the cases after the late 1990s. Neutrality is important in this context, but not dispositive. Moreover, the old ‘effects’ prong in modified form becomes the great battleground for Establishment. A mere formal neutrality is rejected in favor of more intensive scrutiny of effects. The greater the resemblance of effects to the forms or indicia of establishment understood in an 18th century sense, the less likely the law would be viewed as neutral (Rosenberger v. Rector and Visitors of the University of Virginia, 515 U.S. 819 (1995)). For this group, the mere fact that the accommodation is indirect—for example religious choices are made by individuals rather than the state—makes no difference in the analysis, any indirect connection between state action and religious benefit is suspect (Zelman v. Simmons-Harris, 536 U.S. 639 (2002), Souter dissent). Ironically, this view (that the character of the state involvement as either direct or indirect should have no effect) is shared by Scalia, but for the purpose of expanding the power of the state to directly aid religion, even in its religious endeavors (Mitchell). Lastly, Souter’s group remains true to the idea that a foundational purpose of the Religion Clauses is to avoid social and political divisiveness by avoiding the injection of Religion into the national political discourse (the Scalia camp’s response is that the only way to avoid religious discord is to permit all religions to freely participate in political life).

All have camps have substantially abandoned the three part Lemon standard (secular purpose, secular effect and little entanglement) or have reconstituted it to a greater or lesser extent in a neutrality standard (conservative majorities essentially turning the ‘effects’ prong of Lemon into a neutrality and endorsement standard over the strong jurisprudentially based objections of the Souter/Stevens camp). But the use of a common language belies the gulf that separates the definition of those terms as used by either camp. Souter starts from a foundation of separation, and the principles (if not even necessarily the holding) of Everson (Everson v. Bd. of Education, 330 U.S. 1 (1947)). He uses ‘original understanding‘ to paint a more complicated picture of the cultural understandings and consensus of the 1790s, than does Scalia and his camp (Lee v. Weisman, 505 U.S. 577 (1992) (Souter concurring)). For Souter, neither the discourse nor the practices of the times can fairly lead one to any sense of consensus about the meaning of the Religion Clauses. For Scalia, while the writings of the times might be conflicting, the practices of the times, in the aggregate, point to a general consensus against separation of government and religion. Neutrality has also acquired one of three meanings, spring from an unresolved conflict over the core animating principle of the Religion Clauses. The most traditional approach (now held by the most liberal camp) posits that neutrality requires neither governmental involvement in, nor support of, religion and is based on the idea that the Religion Clauses requires separation. The middle ground posits a neutrality between religion and irreligion, that is, that state action can neither privilege nor burden religion as against secular interests, and tolerates incidental benefits to religion where the benefit is evenhanded (Everson). Depending on how one interprets burdening or benefiting, this approach can (and has been) useful to both separationists and religionists. The most radical approach (now held by the most religiously conservative justices) posits the idea (derived from the 19th century Mormon cases and Justice Stewart’s dissent in Sherbert) that religion must be privileged over irreligion, and that neutrality requires an evenhandedness among religions (there was a bit of this in the recent ECHR case requiring UK naval vessels to provide a space for worshipping Satan).

So where are we now? The jurisprudence of the Religion Clauses has been changing radically over the last decade. Though it maintains much of its traditional outward forms, the substance of the analysis has been shifting from the framework of the Lemon standard and its inherent suspicion of any Church State contact to a standard based on formal neutrality, a greater willingness to permit governmental accommodation of religion, and an emphasis on a burden/benefit analysis. The new baseline cases include:

Free Exercise:

Church of the Lukumi Babalu Aye v. City of Hialeah, 508 U.S. 520 (1993); provides a basis for limiting the baseline rule of Employment Division v. Smith, 494 U.S. 872 (1990) by emphasizing the “neutrality” and “general applicability” limits of Smith. In effect, while Smith denies free exercise protection against neutral and generally applicable laws, Lukumi Babalu Aye imposes a standard for determining neutrality and general applicability that permits a court to look to the intent, impact and alternatives to achieving the statutory objectives, essentially a Sherbert style analysis. The future of the applicability of this approach may be hinted at in an opinion of Justice Alito writing as a judge of the third Circuit in Fraternal Order of Police v. Newark, 170 F.3d 359 (3rd Cir., 1999) in which the “generally applicable” standard of Smith was broadened to include categorical as well as individual exceptions, and thus broadly defined, applied a revivified compelling interest standard to the rule at issue.

Cutter v. Wilkinson, 544 U.S. 709 (2005); is both a Free Exercise and Establishment Clause case. It answered the question left open by Boerne (City of Boerne v. Flores, 521 U.S. 507 (1997)), that the state can legislate a statutory free exercise standard for federal statutes (Religious Land Use and Institutionalized Persons Act of 2000). More importantly, it set the standard for determining the judicial approach to questions under such statutory provisions. With respect to the power of Congress to accommodate Free Exercise without violating the Establishment Clause limitations, Justice Ginsburg refused to apply the traditional Lemon test (see opinion note 6). She suggested that this might be part of a class of legislation not compelled by the Free Exercise Clause and not prohibited by the Establishment Clause. To reach this result, the Court applied in lieu of the Lemon standard applied the following test: A governmental accommodation is permitted under the Establishment Clause (even if not compelled by the Free Exercise Clause in particular instances) where (1) it alleviates exceptional government created burdens on private religious exercise; (2) it takes adequate account of the burdens a requested accommodation may impose on nonbeneficiaries (ie a balance of burdens standard, that is that the accommodation does not serve to shift the burden from those accommodated to those who now must subsidize the accommodation who do not share the religious beliefs of the accommodated class); and that the accommodation will be administered neutrally among religious faiths (that is, the accommodation does not benefit one religion over or to the detriment of others). The Court affirmed that the Congress could single out religion for a benefit it does not confer on equally significant secular interests without impermissibly advancing religion (contrast the more narrow rule of Everson that focused on the incidental benefit to religion as the touchstone of permissible accommodation). With respect to the statutory Free Exercise elements of the statute, Justice Ginsburg would have read significant limitations in the interpretation of the balancing required under the compelling interest standard statutorily reimposed (all dicta because the case asserted a facial rather than an as applied challenge to the statute). She suggested that accommodations not be read to privilege religion over a state’s generalized interest in maintaining order and safety, and an expectation that the court would defer to the experience and expertise of state officials administering the statute. This case, I think, will be much more important as an Establishment Cause case than as a Free Exercise Case, For the latter, the O Centro case (below) will be more significant.

Gonzales v. O Centro Espirta Beneficente Unaio do Vegetal, 126 S.Ct. 1211 (2006); is important for two reasons. First it provides a definitive interpretive standard for statutory free exercise under the Religious Freedom Restoration Act and similar provisions. Second, it provides a window on the likely shift of standards in constitutional Free Exercise analysis. The statutory standard of Free Exercise requires application of the compelling interest standard to the particular religious claimants alone, so that state claims of general interests in uniformity, protection of the general health and safety, etc., will carry much less weight. The constitutional free exercise standard that underlies RFRA seems to have inclined the Court to narrow the reach of U.S. v. Lee 455 U.S. 182 (1982) in favor of a much broader reading of Sherbert and Yoder. If a Free Exercise analysis now focuses on the individual claimant, and the state’s interests in compelling the individual claimant to obey the law, then the state’s justification must be targeted directly n the claimant rather than a group of similarly situated people and absent a credible argument that an exemption would “seriously compromise” the state’s “ability to administer the program” it is unlikely to prevail. This solicitous approach to Free Exercise claims seems inconsistent with the dicta in Wilkinson but raised no objection among the judges who were in the majority in that case. I suspect that the divergences between Wilkinson and O Centro will be the subject of judicial exploration in the near future. I think that O Centro, combined with the evolving post RFRA “compelling interest” standard portends a significant expansion of the ability of individuals to exempt out of statutes on religious grounds. Note the importance of the case, O Centro essentially permits, on religious grounds, what the Court specifically refused to permit, on Commerce Clause grounds, in connection with the medical use of marijuana, even though the secular (medical) interests might have been characterized as compelling (Gonzalez v. Raich 545 U.S. (2005)).


Cutter v. Wilkinson, 544 U.S. 709 (2005); see description above for the standard. The case suggests that, as a general rule, the three prong standard (relieves burdens on religion, does not require others to subsidize the religious conduct accommodated, and advances interdenominational neutrality) is the basis for permissible accommodation under the Establishment Clause.

Zelman v. Simmons-Harris, 536 U.S. 639 (2002); this case provides the new jurisprudential framework for working through the jurisprudence of providing aid to schools (including parochial schools) specifically, and more generally on the principles of Establishment Clause jurisprudence. The case points to a new jurisprudential basis for Establishment Clause analysis, in which the first (purpose) prong of Lemon is reduced to insignificance (Rehnquist had already striven to narrow the first prong to situations where the statute at issue was entirely motivated by a religious purpose since Lynch v. Donnelly, 465 U.S. 668 (1984), see also Wallace v. Jaffree, 472 U.S. 38 (1985)), the effects prong is modified to serve as a basis for a new formalist approach., and the entanglements prong drops out completely (except in dissent). The new standard is based on a tolerance for incidental aid to religion where the aid is indirectly procured. “[W]here a government aid program is neutral with respect to religion, and provides assistance directly to a broad class of citizens who, in turn, direct governmental aid to religious schools wholly as a result of their own genuine and independent private choice, the program is not readily subject to challenge under the Establishment Clause.” Zelman. In such circumstances, the indirect and incidental benefit to religion is not fatal as long as the benefit can be reasonably attributed to the action of individuals and not the government. To apply this standard, the Court constructs a two-part reinterpretation of the Lemon ‘effects’ test: (1) is participation in the program based on neutral and neutrally applied criteria? and; (2) are the choices among the participants genuine and independent. For purposes of the first part of the test, the court looks at the class of individuals to receive the benefit, and the rules for institutional participation in the program. The court also looks to see if there are any financial incentives that skew the program toward religious schools. With respect to the genuineness and independence of individual choice, the Court looks to the element of coercion inherent in the choice (was there a genuine opportunity for choice among religious and non religious options, evaluated by looking at all options available to children, not just options among private school choices. The effects test no longer has much of a basis in actual effects—the touchstone is formal effects (/a consequence bitterly derided by Justice Souter in dissent). “The constitutionality of a neutral educational aid program simply does not turn on whether and why, in a particular area, at a particular time, most private schools are run by religious organizations, or most recipients choose to use the aid at a religious school.” Zelman. Justice Souter’s dissent provides an excellent application of the old Lemon test and an explanation of the way the majority’s new standard departs form the old Establishment Clause jurisprudence, especially with respect to the reconstitution of neutrality. Justice Breyer’s dissent provides an excellent account of the older jurisprudence that a core principle of the Establishment Clause is to avoid sectarian strife, and the relationship of this core principle with the old third prong.

Mitchell v. Helms, 530 U.S. 793 (2000); a plurality opinion that is useful only for the exposition of what may be the future of Establishment Clause jurisprudence should Scalia/Thomas every get a majority of the Court behind them. There is a nod to Lemon but the standard the plurality applies has hardly anything to do with the old standard. It starts with the modern conservative notion of neutrality in the provision of aid: “if the government, seeking to further some legitimate secular purpose, offers aid on the same terms, without regard to religion, to all who adequately further that purpose, then it is fair to say that any aid going to a religious recipient only has the effect of furthering that secular purpose.” This stands the old effects test on its ear through a neutrality analysis that starts from the presumption that any attempt to keep religion out of participating in governmental programs constitutes a burdening of religion (in contrast to the earlier approach that started form the presumption that the government had no obligation to give anything to religion). Given this starting point, the plurality questioned the need to avoid direct government aid to religion—as long as its object is secular, the use of the benefit for purely religious purposes should be irrelevant. The plurality was countered by strongly negative concurrences and dissents. The concurrence refused to embrace the purpose or object neutrality is enough standard in favor of the rule that would eventually form the majority rule in Zelman. The dissent offered the more traditional substance over form analysis, suggesting that formal neutrality that had the effect of permitting the state to support religion in the manner that was found offensive at the time of the adoption of the Religion Clauses ought to remain offensive; since the direct or indirect support of a religious establishment was at the heart of the Religion Clauses in 1790, then it ought to form the heart of analysis now. Formalist standards based on neutrality effectively eviscerate the core values of the Religion Clauses even as they pretend to further them.

Locke v. Davey, 540 U.S. 712 (2004); illustrates the limits of Establishment Clause neutrality and formalist analysis and provides, for the first time, a window into the fundamental break between the radicals (Scalia/Thomas) and the conservative moderates (Rehnquist here joined by the liberal traditionalists). It presents the inverse of Cutter v. Wilkinson, 544 U.S. 709 (2005) and ought to be read together with that case. The majority rejected the idea that because the Establishment Clause might permit a state to permit individuals to make a private choice to use state money to pursue a degree in devotional theology, it would constitute a violation of the Free Exercise Clause to deny individuals that right. Like Wilkerson the Court confirmed that the Free Exercise and Establishment Clauses do not cover the same ground. The more interesting question, then, was whether an individual could use the Free Exercise Clause to compel the State to permit him to use the funds in a way forbidden by the State. The answer, in this case was no. In arriving at that answer, the Court might have used language that could limit the breadth of the constitutional Free Exercise Clause in ways that might conflict with the implications of O Centro. It rejected the idea, expressed by the plurality in Mitchell, that any benefit program that does not permit religion to participate on the terms as secular groups or individuals must be presumptively unconstitutional because it cannot be neutral with respect to religion. The Court, over a vigorous dissent, held that interpretation to constitute an unwarranted extension of the facts and reasoning of Lukumi and its progeny. Instead, the Court embraced the more traditional baseline for determining neutrality: the fact that the state has chosen not to fund a particular category of instruction (in this case) does not constitute a burdening of the category, as long as there is no other impediment (“It does not deny to ministers the right to participate in the political affairs of the community . . . . And it doers not require students to choose between their religious beliefs and receiving a government benefit”).

McCreary County v. ACLU, 125 S. Ct. 2722 (2005); provides strong evidence of the volatility of Religion Clause jurisprudence and the importance of the lack of consensus on Religion Clause fundamentals for the development of law. McCreary can be read as Souter’s dissent in Zelman now reconstituted as a majority opinion in a case involving not school funding, but the use of the state or its facilities to present religious messages. At best, it suggest that the Establishment Clause will apply different standards depending on the context (funding vs. presentation of messages). At worst, it suggests that the Court has been unable to settle on a stable jurisprudence as it evolves from the Everson/Lemon framework to the Zelman/McCreary County/Wilkerson framework. Justice Souter announced the fundamental principles of Establishment Clause jurisprudence—(1) neutrality between religion and religion, and between religion and nonreligion; and (2) liberty and religious stability demand a religious tolerance that respects the religious views of all citizens—which may be hard to reconcile with other cases. Justice Souter rejected the attempt to narrow the application of the purpose prong of Lemon (purpose prong violated where religion is a primary (and not the sole) motivation of enactment). Justice Souter than announced a more narrow power in government to support religious messages, one grounded in separation and the development of a clear context in which the religious message is essentially overpowered by a secular message. Justice Scalia, in dissent, categorically rejects the Religion Clause principles embraced by the majority, asserting that the only thing required by the Religion Clause is denominational neutrality. Expanding on the hints he made in Mitchell, Justice Scalia here advances his notion that the Establishment Clause permits the state to favor one religion over another, as long as the formal requisites of neutrality are met (assuming that true neutrality is impossible) and offering members of non majority religions the solace of the Free Exercise Clause, to the extent it is available (and of course, for Scalia, the Free Exercise Clause might be more available than under current doctrine, but that requires overturning the conservative moderate’s holding in Locke v. Davey).

Van Orden v. Perry, 125 S. Ct. 2854 (2005); was the companion case to McCreary County (display of the Protestant version of the Ten Commandments by the state), but this time a plurality of the moderate conservatives reached a different result than in McCreary County. Justice Rehnquist’s plurality stressed tradition and the practices permitted at the time of the Founding. He also suggested a theory hinted at since McColloch v. Maryland, a sort of constitutional adverse possession (since the practices have been so long permitted without complaint, it is too late in the day to suggest that they should never have been allowed). And the plurality again expressed its belief that Lynch v. Donnelly’s reading of the purpose prong of the Lemon test, a reading rejected by Justice Souter in McCreary County, is the appropriate basis for Establishment jurisprudence. Justice Breyer, providing the critical fifth vote, appeared to reject the Chief Justice’s attempt to resurrect the Lynch interpretation of the purpose prong and hinged his decision both on the ‘laches’ argument and his sense that any other result would show a hostility to religion that would advance the sectarian strife that Justice Souter declared in McCreary County to be a baseli9ne principle for application of the Establishment Clause. Justice Stevens’s dissent stressed the denominational neutrality principles as the basis for decision. Since the display favored one set of religions over others, then the display constitutes an invalid Establishment.

Good News Club v. Milford Central School, 533 U.S. 98 (2001); is valuable both for the application of the new neutrality principles in cases involving the power of the state to limit religious expression on or in connection with state functions, and the increasing willingness of the Court to focus on a formal standard and avoid any substantive analysis. The case stands in tension with the opinions in which Justice Souter has written for the majority. To that extent, it also illustrates the volatility of Establishment jurisprudence. Justice Thomas’ opinion was formalist and focused on neutrality analysis without regard to the content of the activities to be permitted. Justice Souter’s dissent emphasized a substantive analysis, which he suggested ought to trump the formalism of the majority’s analysis. He found it odd that the disestablishmentarianism of the Establishment Clause ought to produce a jurisprudence that compelled the state to permit the holding of religious services on its property.


This short summary of current case law suggests a number of things:

1. The Supreme Court has essentially abandoned the jurisprudential standards that guided it from Everson through the early 1990s. Those standards, based on a roughly observed consensus about the application of a neutrality between religion and non-religion, and among religion, was based on a notion of separation between religion and the state. But this set of standards was always fragile. It reflected a temporary pause point within a polity that did not know its own mind about the relationship between the state and religion. Even as the Court was crafting doctrines that were meant to make it difficult for states to accommodate religion, exemplified in the Lemon standard, its members were suggesting that this standard was either wrong, unworkable or based on foundational principles that ought to be rejected.

2. The Court has not been able to fashion another consensus. Instead, it has moved its jurisprudential moorings to one that permits the Court to tolerate greater state accommodation of religion, even accommodations that might incidentally favor religion, and that makes it harder for the state to prevent dissenting individuals from excusing themselves form compliance with statutes under the Free Exercise Clause.

3. That movement has been accomplished by a change in the language of analysis—from purpose, effects and entanglement, to neutrality, benefit, burden, and choice. Whatever the (temporary) outcome of any new consensus, it is clear that the Court has adopted a new jurisprudential language for its engagement with the Religion Clauses. And indeed, these new cases, and the new framework for analysis, makes most cases decided before 2000 unlikely to be useful (other than for the value of their holdings). It is clear that one can go back to the older cases and apply the new framework in ways that either reinforces the original holdings or suggests that the cases are now much more vulnerable. As a result I expect to see many of the older cases litigated again under the new framework.

4. The new language has also divided the Court between formalists and functionalists. That divide has been most apparent in the division over the meaning of effects and the character of neutrality. While the obsession with substantive analysis produced its share of perverse results in the 1960s and 1970s, the new formalist framework will produce its own perversities. As we have seen, under a formalist framework, the Court has been willing, by applying an original understanding analysis, permitted those activities which to an 18th century sensibility were at the heart of establishment—the financial support of theological training and the support of religious services and education. The new formalists say this is different because the state will be expected to establish all religions, the liberal traditionalists say this is an absurd result and one that violates the core understanding of the Clauses (and therefore would require a constitutional amendment to sustain).

5. There is a great division between at least two factional blocks on the Court as to the guiding principles of the Religion Clauses. One group believes that religion must be privileged over non-religion, and even that the majority religion may be privileged over all others, as long as the state adheres to formal neutrality and demonstrates no animus to any religion, and that the path to disestablishment lies in the establishment of all religion. They believe that the Religion Clauses requires the state to favor religion, and that separation is essentially a structural burden on religion. On the other side the liberal traditionalists focus on separation as the baseline for analysis. The state has an active obligation to distance itself from all religion and that the starting point for all analysis is neutrality between religion and irreligion. While state may not burden religion, they are under no obligation to provide religion any benefit, including benefits otherwise made available to secular interests.

6. Even if the newest members of the Court will produce consistent majorities for a time, those majorities will, in turn, be unstable. This is an area of constitutional law in which, over the last century, majority opinions have a way of turning into dissents and vice versa with stunning regularity. This is not surprising; the lack of consensus reflects in full measure the divisions within our political culture, divisions that show no evidence of ending soon. It is likely, however, that the Court will increasingly turn to the jurisprudential baseline advanced by Justice Scalia. It is likely that Justice Alito will tend to share Justice Scalia’s views. But Justice Roberts, to the extent he embraces the former Chief Justice’s views, may act as a limiting force.

Wednesday, November 22, 2006

The Problems of Being a Great Power: China and Neo-Colonialism in Africa

The People’s Republic of China has moved to the forefront of important global political powers. The Chinese have reaped some of the benefits of this new found power. China has started projecting its power in more sustained and direct fashion. It has felt freer to influence government action in the states around it—from the Koreas to Japan and the states of Southeast Asia (particularly Vietnam, with which it has a long love-hate relationship).

Africa has proved to be a particularly important place of power projection for China. China’s President Hu Jintao, and Premier Wen Jiabao, made a much publicized state visit to ten African states. During those visits, China made a great point of extending its financial resources to the host states—while aggressively working to lock up access to the vast natural resources of those states for Chinese industry. Deals were made with leaders who have questionable human rights records, but the deals were effected on terms significantly advantageous to China.

Sunday, November 19, 2006

Multinational Corporations and China: On Multinational Corporations as an Instrument of Globalization and the Projection of State Power

In an article published November 11, 2006 (Cheng Siwei On Economic Globalization, People’s Daily Online, Nov. 11, 2006), Cheng Siwei, the Vice Chairman of the National People’s Congress, the Supreme legislative body under China’s 1982 Constitution, provided a window on the thinking of the Chinese political elite about globalization and multinational corporations. Siwei’s understanding is not to be lightly dismissed; it reflects the thinking of the top echelon of Chinese political society and provides an insight on their understanding of not only economic globalization, but, more importantly, on multinational corporations as the agents of that form of globalization.

I want to focus on two points that Cheng Siwei made in that article. The first is that there is a fundamental distinction and incompatibility between economic and financial markets globalization. The second is that economic globalization is driven by multinational corporations, so that if a state means to be a player in economic globalization it must send its multinational corporations out into the world. Together they suggest an understanding of financial markets and of the mechanics of economic globalization that is to some extent substantially different than that held in the West. These differences in conceptualization may have a great effect as China joins the great commercial states and projects its power (as well as understandings of the nature and character of that power) on the world.

Cheng Siwei grounds his understanding of financial markets globalization in traditional Marxist-Leninist terms. He has this to say:

Financial globalization is incompatible with economic globalization. World financial globalization means world currency can only be measured by its purchasing power after breaking away from the gold standard. The exchange rate in various countries has become a policy tool for competition. World capital floats much faster than before. According to data from the Bank for International Settlements, in 2005 the surplus value of the world's financial products reached 325 trillion dollars, about 7 times the world's GDP. The scale of world finance has expanded while the world financial market are so heavily interdependent that no matter where there is a problem, shockwaves are felt everywhere (Cheng Siwei, id.).
We have seen this before. It was perhaps best theorized during the 1990s by Fidel Castro in many of his writings about global capital and financial markets. See, Larry Catá Backer, Ideologies of Globalization and Sovereign Debt: Cuba and the IMF, 24 PENN STATE INT’L. L. REV. 497 (2006). Cheng Siwei’s conception is anachronistic and over narrow, of course. Cheng Siwei (and by implication, Chinese elites) continue to see financial markets in two dimensional terms—as a function of exploiting financial bottlenecks like currency exchange rates and as a means of artificially creating economic advantage. More importantly, it centers financial globalization in the state, and state to state relations. This makes sense from veterans of command economies. But it belies the realities and complexities of financial markets. It ignores the fact that capital, and the markets through which it is deployed, have to some great extent, escaped the bonds of states that had traditionally exerted a tremendous amount of regulatory control. Global financial markets do not serve the state so much as they serve the needs of productive economic activity. Just as labor migrates to meet demand and generate value, so capital now moves, even more freely than labor, to entities that most effectively generate returns, that is, that produce value. Financial markets globalization has created both a substantial amount of integration, and, as a result, a substantial amount of vulnerability to shock. But all human activity can be characterized by risk. Siwei’s statist and antiquarian views do not bode well for China’s recent forays into the global financial markets through a revivified exchange system centered in Shanghai. On the importance of the emerging different framework perspectives on capital movements and the state, see Larry Catá Backer, Economic Globalization Ascendant: Four Perspectives on the Emerging Ideology of the State in the New Global Order, 16 BERKELEY LA RAZA L.J. – (forthcoming 2006); and Larry Catá Backer, Globalização Econômica e Crise do Estado: um estudo em quatro perspectives, SEQUENCIA (forthcoming 2006).

Much more interesting, from my perspective, are Cheng Siwei’s views on multinational corporations. Again, a residue of old command economy, statist orientation tends to color his views. He has this to say:

economic globalization is based on multinational corporations. Multinational companies are the leaders of economic globalization. The behavior of some corporations, such as intervening in countries' internal affairs, influencing the local economy or evading taxes has been criticized, but most try hard to regulate their company at all levels (Cheng Siwei, id.).
For Cheng Siwei, and not unreasonably from his perspective, corporations can be viewed as the means through which states now project power—economic power. Corporations are special emanations of the state, a concession of state power to individuals for the purpose of producing wealth for the benefit of the state. Indeed, like many elites in the developing world, Cheng Siwei shares the view that multinational corporations exercise not only economic but political power as well—able to intervene, directly or indirectly, in the affairs of weaker states. In this sense multinational corporations and some states exist as equals. So conceived, multinational corporations appear to be the most efficient means, not only of engaging in global economic activity, but doing it in a way that returns significant value to the home state. They are dependent on their home state, but substantially independent as well, behaving well or badly as they see fit.

Now it gets interesting. If multinational corporations are the basis of economic globalization, then if China is to become a major active (rather than a passive) player in economic globalization, then it will have to develop and project its won army of multinational corporations, corporations loyal to and working for the benefit of the state. For Cheng Siwei, then, projection of economic power reduces itself to two things: (1) the production of a sufficient number of well endowed and loyal Chinese multinational corporations, and (2) the development of acceptable governance norms for this army of agents of Chinese economic globalization.

On the importance of producing an army of Chinese multinational corporations, Cheng Siwei had this to say:

Cheng Siwei also says that China should develop its own multinational companies. Chinese companies should be able to invest in other countries, but they must learn the local laws, culture and history as well as establish local contacts. There is a lot of work which needs to be done. ‘Our enterprises have not yet been able to find representatives to establish offices and build up factories elsewhere. But there are still fewer truly transnational companies operating,’ claims Cheng. . . . Cheng Siwei stressed that it would be impossible for domestic enterprises to abandon their Chinese characteristics; they cannot avoid the situation in China, its industrial and business culture. Simply copying foreign businesses will not be enough to make Chinese enterprises the best in the world (Siwei, id.).
To take advantage of globalization, China must deploy agents of economic production that share the characteristics of the most successful producers of economic wealth. This is a notion that has been well absorbed by the Chinese elites since the 1990s and the enactment of the Company Law and the securities markets. But it is not enough to reorganize productivity in corporate form. That form must be projected abroad. China, to succeed in the globalized economy, cannot merely produce wealth, it must command capital. “A transnational company must develop a global strategy and establish its profit and operation model at a global level” (Cheng Siwei, id.). And, of course, there is a certain amount of irony here. It is hard to reconcile Siwei’s views on multinational corporations and his views on financial markets globalization. An army of Chinese multinational corporations maximizing their economic wealth must be free to move capital on a global basis as part of a “global strategy.”

There is also a certain tension here as well. Cheng Siwei expects that multinational corporations from China not serve as vehicles for the production of private wealth for their principle stakeholders on a Western model. These multinational corporations cannot “abandon their Chinese characteristics” or “avoid the situation in China.” Instead, these will be agents of wealth production in which the State will take a major stake. China means to reinvent its command economy in corporate form. It is not clear, however, whether China can keep multinational corporations politically parochial and economically transnational. I have written about this mopre extensively elsewhere. See, Larry Catá Backer, Cuban Corporate Governance at the Crossroads: Cuban Marxism, Private Economic Collectives, and Free Market Globalism, 14 (2) JOURNAL OF TRANSNATIONAL LAW & CONTEMPORARY PROBLEMS 337 (2004). And yet, Cheng Siwei has a point. Chinese multinationals will tend to repatriate wealth to some extent, and will tend to project a Chinese perspective onto global economic culture. But the repatriatrion will be limited to the extent that Chinese multinartional corporate wealth can be maximized elsewhere. See Larry Catá Backer, The Autonomous Global Corporation: On the Role of Organizational Law Beyond Asset Partitioning and Legal Personality, 41(4) TULA LAW JOURNAL – (forthcoming 2006). And Chinese corporate perspectives will be bounded by the normative framework not of China, but of the community of multinational actors in which such corporations will tend to fucntipon. That fra,mework is harmoinizing and multi national; as both economics and economic culture, it is extremely difficult for any single political community to control.

To the extent that this corporatized command economy can project its activity abroad, then all the better. This serves China in two ways. First it reverses the power relationships between China and the West. Chinese, not Western, corporations will start to be the agents of productive economic activity. It will also have significant “psychological” effect. To the extent that Chinese corporations go out into the world, China will be able to overcome its 19th century legacy as an exploited and semi-colonized state. This effect cannot be underestimated as a motivating force. Connected to this is the idea that, by holding active rather than passive economic power, it will be able to join, at least in its own mind, the ranks of the developed states.

But this sort of effort requires expertise. And here, again, there lingers a certain sense of inferiority. Siwei explains that:

"Some people think Chinese enterprises don't have much management expertise. I disagree. I think Chinese enterprises have contributed a lot to China's fast development. The problem is that we haven't seriously studied our enterprises to find out how they work. We should send our professors into companies to summarize their experiences so that those experiences can be developed as a theory." (Cheng Siwei, id.).
And how are Chinese corporations to project Chinese economic power abroad? Well, in the usual way, by acquiring ownership of productive assets abroad. Cheng Siwei notes that “Some Chinese companies already want to purchase foreign enterprises ¨this is another development model¨ but they should pay attention to the market and cultural differences.” (Cheng Siwei, id.). Thus, both a recognition of the forms in which economic power is projected, and a caution about its deployment. And why the caution? Perhaps because of a mutuality principle. Were the Chinese elite to begin to advocate Chinese multinationals to act without regard to the local characteristics of the host states in which they operate, they might find themselves treated to the same actions by the large number of multinational corporations that China hosts.

The consequences and character of the free movement of capital, the character and nature of multinational corporations, the possibilities of pseudo-mercantilist policies through the medium of transnational economic entities, the projection of economic power as the new imperialism—all of these ideas are quickly being absorbed by the Chinese elites. The manner of that absorption serves as evidence of the way in which even the harmonization of “big” concepts are sometimes contextually constrained. China understands economic and financial globalization from its own perspectives, grounded in Marxist-Leninist principles, its own history as a semi-colonial state, and its organization as a command economy. This perspective will significantly affect China’s ability to be a successful player of economic globalization where it does not make the rules.

Thursday, November 16, 2006

Law Reform, Administrative Authoritarianism and Power in China

I was rereading Stanley Lubman’s article, “Bird in a Cage: Chinese Law Reform After Twenty Years,” 20 NW. J. INT'L L. & BUS. 383 (2000). For Lubman, a foundational source of China’s difficulties with the creation of law and legal systems, of course, is the fundamental problem of the Communist Party and the place of the CCP within the state apparatus. See, e.g., id., at 405. I do not deal with that here, but have suggested an alternative approach elsewhere. Larry Catá Backer, “The Rule of Law, the Chinese Communist Party, and Ideological Campaigns: Sange Daibiao (the 'Three Represents'), Socialist Rule of Law, and Modern Chinese, Journal of Transnational Law and Contemporary Problems,” Vol. 16, No. 1, 2006 .

Still, Lubman makes a point in that article the consequences of which are worth developing. He reminds us that “To give concrete form to economic reforms, the Chinese state has generated an extraordinary amount of legislation. . . . As a result of this energetic legislative activity, which has been but sketched here, China now has a large body of legal rules.” Id., at 386. But, Lubman suggested, lots of rules do not necessarily make a legal system. Among the several factors contributing to what he calls Chinese legal fragmentation (Id., at 390), one is particularly interesting for my purposes here:

“The language and phrasing of Chinese legislation and rules create wide scope for administrative discretion in interpretation because a major goal of Chinese legislative drafting is "flexibility." As a result, at all levels Chinese legislation is intentionally drafted in "broad, indeterminate language," which will allow administrators to vary the specific meaning of legislative language with circumstances. Standard drafting techniques include the use of general principles, undefined terms, broadly worded discretion, omissions, and general catch-all phrases.” Id., at 391.

There is a small but interesting insight here that is buried but worth extracting. The rapidity of changes to Chinese law (the Company Law, the securities laws, anti-takeover legislation, for example, and related economic regulation) has two effects. The first is the intuitively straight forward, well expressed by Lubman—the attempt to create a system of laws that might propel China closer to conformity with a least minimal Western or global expectations of rule of law systems). The second is intimated by Lubman’s observation of the effect of Chinese legislative “flexibility.” Lubman is right that this flexibility gives bureaucrats a certain degree of power. But the power to which Lubman refers is merely that given in any current statute.

I would posit that the extent of bureaucratic power is actually far greater. Administrative power is not merely a function of the ambiguity in any given statute, it is also a function of the rate at which these rules are themselves amended. Rapid rule amendment tends to shift power to those who create and administer the rules and away from those who must change their behavior to conform with the rules. The more quickly rules change, the more dependent the target population is on administrators for guidance. As well, the less effective the non-governmental sectors are in defending people against administrative determinations. As a result, the population remains more dependant on the state and its apparatus. While a formal rule based system is created, there are lots of rules, the state retains a monopoly of knowledge about the workings of those rules. Without a stable law system, outside lawyers and other elements of the non-state sector cannot build the necessary expertise to adequately defend clients in proceedings, or to effectively use the law for the benefit of their clients.

A moral worth some thought—sometimes rapid legal change can be as destabilizing as no change at all. Sometimes great changes can work to perpetuate an authoritarian political structure more effectively than a stubborn refusal to enact a complex formal system of law. Sometimes, even a formally adequate legal system can, by appropriate control of the rate and nature of changes in its content, can reduce the value of that system to insignificance. Chinese experience suggests the continued value of Aristotle’s insight of the danger of legislative changes, a danger much augmented by a great increase in the rate and extent of change: “For the law derives all its strength from custom, and this requires long time to establish; so that, to make it an easy matter to pass from the established laws to other new ones, is to weaken the power of laws.” Aristitle, Politics, Bk II, ch. VIII (A web translation of Aristotle’s Politics may be found by clicking on this link).

Rapidly changing law loses its substantive effect, becoming a shadow of itself. The production of a swiftly changing set of legal codes may generate no legal system at all. Worse, it may produce a certain instability. On the one hand, the system vests great power in those who control the production of legal rules and the formal sites of their administration—the courts and the bureaucracy. On the other hand, the system risks losing authority as people avoid the arbitrariness of the new and changing patterns of compelled behavior, through the development of alternative private or informal systems. Aristotle decribes this tension as a balancing act of sorts: “for the alternations will not be of so much service as a habit of disobeying the magistrates will be of disservice.” Aristotle, id. Luhman intimates this result. Other commentators have demonstrated this tension and the resulting reality in the decade after Luham wrote. See Symposium: China: Law, Finance, Security, Journal of Transnational Law and Contemporary Problems,” Vol. 16, No. 1, 2006.

Beneath the formal and official system of laws, then, what remains is a very real and powerful system of custom and habit. In China this traditional system, like the formal system weaved in the legislative looms of Beijing, and the system for the enforcement of those norms, remain in the hands of the governmental class with the authority or power to impose it. The consequence is a continuation of what, to Western eyes looks like an authoritarian administrative state in which legal alterations may have little effect. But unbderstand also, that the custom and habit of which I refer is not merely the usual reference to the old Confucian mandarinate system or the socio/legal culture which it sustains. I refer, instead, inthe first instance, to the customs and patterns of institutonal behavior forged over the course of the last half century under the Chinese Communist Party. Those networks of relationships, power diffusion, and habits of decision making cannot easily be overcome by "paper" statutes or "paper" rules. The reality of the socio/legal culture of China, and especially of the continued existence of multiple power apparatus (State and Party), complicates any attempts at Western style positivist legal reform (that is, of legal reform through the expediant of enacting pretty words on clean paper by a formally constituted legislature for the outside world to see and approve). Larry Catá Backer, “The Rule of Law, the Chinese Communist Party, supra. I do not mean to suggest that rule of law is impossible in China. I also do not suggest that harmonization of economic regulatory standards is impossible. I do suggest that pressuring China to conform to Western forms of rule of law society is playing a fool's game--a game that the Chinese will be more than happy to play for its own advantage. Frankly, were I in the Chinese leadership I would do the same. But this strategy poses a great danger for China in the long run. The danger for China is that, while its legislative organs are busy producing framework legislation satisfying to the West (and of dubious internal effect, especially given the penchant for less Western oriented implementing regulatory systems, the point that Lubman is at some pains to correctly stress (“Bird in a Cage: Chinese Law Reform After Twenty Years,” 20 NW. J. INT'L L. & BUS. 383 (2000)), the Chinese leadership will lose sight of the critical necessaity of shaping their own indigenous rule of law socio-political culture. Recent Party ideological campaigns point in the right direction, but it is unclear whether there is the will to follow through. Fifty years of Party insttutionalization provides at least the normative foundation for order beyond individual will. Is there a sustained courage among Party leaders to implement these norms effectively in a way that is sensitive to individuals, the collective, and effective political organization?

Aristotle reminds us that formal legal structures have definitive limits, and may actually further objectives inimical to their forms. Thus, he tells us, authoritarian states “where the supreme power is in the laws, may not be democratic, and yet in consequence of the established manners and customs of the people, may be governed as if it were.” Id., Bk. IV, ch. V (A web translation of Aristotle’s Politics ). But states that appear to adopt a more law based system may instead produce an inclination to what Aristotle describes as oligarchy, “for the people do not easily change, but love their own ancient customs; and it is by small degrees only that one thing takes the place of another; so that the ancient laws will remain, while the power will be in the hands of those who have brought about a revolution in the state.” Id (A web translation of Aristotle’s Politics). Using conformity to Western legal standards as a veil behind which to entrench limitless individual discretion and the will of factions will do more to undermine recent efforts at socialist market ecopnomy and democratic authoritarianism centered in the Party than any concerted efforts by the West to undermine the current system of Chinese governance.

Saturday, November 11, 2006

A Valuable “Cultural Learnings of America”: Borat, College Boys, and Law as Protection Racket

Sacha Baron Cohen, has made brilliant use of the media in a variety of comedy sketches that provide a tremendous amount of mocking socio-cultural commentary to a society, in England and the United States, that had, until recently appeared to lose their sense of humor. The boyakasha website provides a tremendous amount of fan based information.

One of his characters, Ali G, rocketed Cohen to stardom first on England’s Channel Four and then on the U.S.’s HBO. Ali G purports to be a person of indeterminate ethnic extraction whose entire persona is based on his interpretation of British Black street culture. He has interviewed a great number of prominent people from John McCain, to Ralph Nader, to Noam Chomsky to high ranking English clergy.

Cohen developed a number of subsidiary characters to more sharply draw on the possibilities of mocking the foibles of modern Anglo-American culture, society and politics. One of them, Bruno, purports to be a gay Austrian television presenter. The other, one of the most successful was a character named Borat Sagdiyev, a television reporter ostensibly from a send up Republic of Kazakhstan, whose reporting on the goings on in the United States and England brought all of our hypocrisies, cultural pimples and self delusions into stark relief.

All of these characters are at their most effective when they are able to induce the people interviewed, from high profile members of the elite to the most ordinary of people, to drop their guard. Usually it is quite funny, sometimes it is disturbingly revealing. “The British comedian has perfected his act as the apparently naive reporter whose enthusiastic offensiveness either leaves his interviewees in shock or persuades them to reveal a little too much of their own prejudices.” Ian Youngs, “How Borat Hoaxed America," BBC, Oct. 23, 2006.

The elite, and especially the social, political and media elite, does not approve. Media coverage of Cohen’s characters has been stiff at best, and usually disapproving. This approach was especially intense in connection with the release of the first full length treatment of the Borat character, as he interviewed his way across the united States. The movie, “Borat: Cultural Learnings of America for Make Benefit Glorious Nation of Kazakhstan” released Nov. 3, 2006 in the United States. An example is recent coverage in the BBC (cited above) on the way in which Cohen is able to “dupe” the “victims” who participate in his mock interviews in the making of “Borat: Cultural Learnings.”

Most of Borat's victims were ensnared in a similar way. They would be contacted by a woman calling herself Chelsea Barnard from a fictional film company, One America Productions.

They would be told about the foreign correspondent making a film about life in the US, with the pitch tailored to each person's specialist subject.

Then on the day of the interview, they would be presented with a release form at the last minute, be paid in cash and, finally, Borat would amble in, beginning with some serious subjects before starting his provocative routine.

"We're all primed to do an academic dissertation, we did our homework," says yoga teacher Grace Welch, another member of the three-strong feminist panel.

"And as we're talking, out of the blue, he says: 'Do you know Baywatch?'

"I knew something was going on but I didn't know what it was. I'm looking at the cameramen and everyone was stony-faced. And then he would come out with outrageous things."

Ms Stein first tried to throw Borat out when he started talking about women having smaller brains than men.

The producer persuaded her to carry on, apologetically explaining that Borat did not realise he was saying anything wrong.

But the final straw came when Borat asked the women to lift up their shirts at the end of the interview. Id.

The coverage drips with “moral” judgment, barely concealed accusation, and a bit of condescension; and not just the press. The Republic of Kazakhstan has shown both an inclination to suppress and to humor the Borat character. In November 2005, reports began floating of possible legal action against Cohen by the government of Kazakhstan. See “Kazakh Challenge to Ali G,” BBC, November 14, 2005 (“The Kazakh Foreign Ministry said it may move to prevent Cohen presenting the country in a "derogatory way".”). By December 2005 the Kazakh government shut down Cohen’s Ali G web site; see “Kazakhs Shut Ali G Star’s website," BBC, Dec. 14, 2005. Still, by September 2006, the Kazakh government had toned down its rhetoric, though distribution of media products containing the Borat character would likely remain in short supply within Kazakhstan. See “Kazakhs ‘See Funny Side of Borat,’” BBC, September 29, 2006. Yet, in the same month it was announced that the president of Kazakhstan would fly to the United States ahead of a Kazakh publicity campaign to combat the image of Kazakhstan portrayed by Borat; reportedly the President of Kazakhstan intended to raise the issue of Borat with American President Bush. “Bush to Hold Talks on Ali G Creator After Diplomatic Row,” The Daily Mail, Sept. 12, 2006 (“President Nazarbayev will visit the White House and the Bush family compound in Maine when he flies in for talks that will include the fictional character Borat.”). It seems that Cohen no longer has to write his own material; but, then, that is the point.

Life imitates art on other fronts as well. For example, consider the reaction in Germany to the “Borat: Cultural Learnings” movie. It appears that a human rights group has filed a complaint against the movie in Germany. The reported on November 2, 2006 that the European Centre for Antiziganism Research apparently filed a complaint with the Hamburg state prosecutor arguing that the movie slanders gypsies. But not a peep from the Germans about the sequences featuring Jews, including the already notorious song sequence, “In My Country There is Problem (Throw the Jew Down the Well)” sequence. The cultural impact of that number is hinted at by its imitations on You-Tube. Of course, the notoriety (and perhaps even infamy) of this sequence rests not only on the song itself—its lyrics as a condensed thesis of core ideas shaping Jew hatred at its most irrational—but also for the way it has “outed” a stratum of thought that, like that in the lawsuit discussed below is usually nicely concealed).

In a greater twist of life imitating art, the New York Times reported on November 11, 2006 that a lawsuit had been filed in Los Angeles County court by several people who had been interviewed by Borat, and whose interview appeared in the movie “Borat: Cultural Learnings.” Ben Sisario, “Students Sue Over “Borat” Roles,” The New York Times, Nov. 11, 2006 at A18. The plaintiffs, a number of students at an unnamed university in South Carolina, were appear in the movie making racist and misogynistic comments to Borat. The New York Times reported that the plaintiffs allege that they were “plied with liquor by the production crew before their scene and thus ‘engaged in behavior that they otherwise would not have engaged in.’” (Id.). The suit seeks injunctive relief (to prohibit displays of plaintiffs’ likeness in the movie) and for monetary damages (of course). (Id).). At least one web site has posted the complaint, John Doe v. One America Productions, Superior Court of California, Los Angeles County, Case No. SC 091723. The Complaint, filed November 9, 2006, asserts causes of action for (1) fraud, (2) rescission of contract, (3) common law false light, (4) statutory false light, (5) appropriation of likeness, and (6) negligent infliction of emotional distress.

While the Complaint, as a whole, suggests that Borat could be right—life tends to imitate art, even at its most absurd, I will focus a socio-legal comment or two on one aspect of the litigation—the fist cause of action for fraud. Several key allegations are worth noting in that regard. First, the Complaint alleges that the plaintiffs were induced to appear in the movie because they had been told by defendants that the movie would not be shown in the U.S. (and that this was a lie). Complaint paragraph 12. Before the filming began, the plaintiffs (at least one of whom was under 21 years of age (Complaint paragraph 13)) were allegedly induced to drink heavily. Complaint paragraphs 13-14. Now nice and drunk, the plaintiffs were induced to sign a “Standard Consent Agreement. Complaint paragraph 14. The participation of the plaintiffs in the movie, accompanied by more drinking, immediately followed. Complaint paragraph 15. Now here is the key:

“Believing that the film would not be viewed in the United States, and at the encouragement of DEFENDANTS, PLAINTIFFS engaged in behavior that they would otherwise not have engaged in. Then Film was indeed released in the United States and PLAINTIFFS’ said behavior was included as part of the FILM without their consent.” Complaint paragraph 17.

Let us briefly consider this cluster of allegations and their purported legal effects. There are a number of ways of looking at these factual allegations.

1. The facts might suggest that the plaintiffs appeared to be happy to reveal their opinions about women and minorities, but only for foreign audiences. That suggests that they are engaging in serial acts of fraud every time they speak on these matters in the United States and fail to reveal their real opinions. Where the people to whom they speak suffer damage as a consequences, I guess the plaintiffs have now opened themselves up to multiple lawsuits crafted on the framework they themselves use for their own suit. Funny!

2. Let’s try another one: plaintiffs suggest that “demon liquor” made them act involuntarily. Essentially, plaintiffs appear to suggest that the liquor released their inner demons that made them act unlike themselves. It was the liquor talking, not them. I don’t have much to say about this, other than that generations of people have used this line effectively to cover a host of antics, more of less successfully, in the court of inter personal relations. Alcohol and volition have had an interesting relation in law. I am sure that strange relationship will only be amplified in this case (assuming it survives long enough to get to trial).

3. Here is another variation, I suppose: our innocent plaintiffs were tricked into “acting out” by a combination of alcohol and manipulative statements. Effectively, our innocents were, in ways intimately understood by the criminal defense bar, entrapped into committing offense—or better put, into revealing their baser opinions. Entrapment is discouraged in law—though not necessarily in everyday human interaction. These opinions, no less deeply held because they remained unuttered, are effectively protected against disclosure by the law. Trickery can constitute an involuntary disclosure that is somehow actionable.

Plaintiffs appear intent on teaching us a lesson that Sacha Cohen as Borat could only intimate in the film: fraud is a contextual thing, and the law privileges some kinds of fraud over others. In the world as plaintiffs might construct it, it is perfectly acceptable to pass through life perpetrating a fraud on all they deal with respecting their own identities and opinions. In plaintiffs’ world, law protects their freedom to suggest to women and members of minority groups, perhaps like those from whom they seek jobs or other favors, that they hold opinions irreconcilable with those they actually hold, without cost, irrespective of the costs to the persons who hear this stuff. But giving plaintiffs permission to speak their minds (by suggesting to them, for example, that their truthfulness will never be revealed to the groups they want to continue to mislead) itself can constitute a fraud against which the law provides redress.

Alternatively, plaintiffs seem to suggest that law protects socially constructed constraints (sobriety) and actively guards the boundaries of permissible consent. Indeed, one might see in the way the Complaint is constructed both a sensitivity to these principles and a great effort to exploit them. Thus the heavy emphasis on alcohol, the corruption of the under aged, the sweet-tongued lies of older and more powerful people (drawing on the inequities of power disparities with overtones to sexual harassment discourse), and the encouragement to say things that perhaps they did not mean to please the people for whom they were performing. But perversion comes in a variety of flavors and taints in a number of ways. It is possible to use good concepts for bad ends. It is likely that great protections can be turned into useful means of avoiding responsibility. The courts will eventually tell us which is the better way to construct the plaintiffs in this case—innocents tricked into “not being themselves” or ordinary humans indulging an opportunity to be themselves without cost who, when the true cost is revealed try to seek cover in principles that were never meant for them. Whichever way the court leans, there remains the lingering feeling that if the suit is successful legally cognizable fraud will have been used to privilege a socio-cultural fraud. Surely that ought not be right.

It may well be true that “Mr. Cohen and his staff lie really well” (Complaint paragraph 2), but the truths that his characters reveal is a sight to behold. And the attempts to use the law of fraud to permit those who participated to perpetrate their own fraud—the unchecked power to spin comments that they make—is both the greatest irony and the greatest lesson of “Borat: Cultural Learning.” The lawsuit, more than the movie, perhaps, provides us with a window onto the greatest “cultural learning” of our own society, its law, and its pathologies.

Monday, November 06, 2006

On the Conviction of Sadam Hussein

So, Saddam Hussein has been convicted and sentenced to death by hanging. As reported in Yahoo News today

”The nine-month trial had inflamed the nation, and three defense lawyers and a witness were murdered in the course of its 39 sessions.

"Long live the people and death to their enemies. Long live the glorious nation, and death to its enemies!" Saddam cried out after the verdict, before bailiffs took his arms and walked the once all-powerful leader from the courtroom. There was a hint of a smile on Saddam's face.

With justice for Saddam's crimes done, the U.S.-backed Shiite prime minister called for reconciliation and delivered the most eloquent speech of his five months in office.

"The verdict placed on the heads of the former regime does not represent a verdict for any one person. It is a verdict on a whole dark era that was unmatched in Iraq's history," Nouri al-Maliki said.” Steven R. Hurst and Hamza Hendawi, “Saddam Co-Defendants Sentenced to Hang, Yahoo News, Nov. 5, 2006

I don’t write about the trial or the verdict, other than to say that Saddam Hussein has joined a long list of monarchs condemned to death after public proceedings in the form of a trail—Charles I of England, Louis XVI of France, and the defeated leaders of Nazi Germany and militarist Japan, and the political enemies of Marxist Leninist Regimes (especially under Stalin in the 1930s and Mao Zedong in the 1960s). In each case, the trails were meant as theatre. They served to discredit the ancien regime and legitimate the process of regime change. They also served to strip authority from the body of the representative of the prior political order. Then, with that representative reduced to mere man, the man—and not the state—is condemned as mere criminal; he suffers the same penalties as other bandits and outlaws. The state is preserved and punishment for its sins inflicted on the body of its proxy. The state is now reborn. In the case of the Marxist Leninist Regimes they served either counter revolutionary purposes or as an element of "cold" civil war.

All of this is necessary I suppose, as humans indulge in the ceremonials of legitimacy and the passage of power. The Yahoo News report quoted above captures this aspect of the trial and conviction quite well. The new political order sits in judgment on the old. The old order is represented by proxy. Saddam Hussein becomes the old order. But he is also less. He is merely a man, no longer the representative of the state. He sits as a thief, a usurper of state power. Now just a man, his actions, which until his removal were also the actions of the state (and thus that of the people), are now just the criminal acts of an individual. The tension between Saddam’s physical and symbolic bodies is nicely framed by the quotations by Saddam (still the head of state) and that of Nouri al-Maliki, condemning the man as well as the superseded regime.

But it should be clear that the source of these ceremonials, these rituals of passage, have only the most tenuous relation to law. To the extent this might be considered law, it is the law of state passage, of the passage of sovereignty, of revolution—stripped of its violence. We live in an age of managed conflict—there is no reason to treat revolution differently from other forms of political warfare. To legitimate the law of revolution, a template is necessary. The West has, over the past four centuries chosen the criminal law as its template. And why not? The criminal law is at the heart of the legitimate power of the state. It represents the legitimate use of violence. It is through the criminal law that the people assert self discipline. There is no better way to de-legitimate the old regime and its head than by the deployment of the criminal law. The symbolism is powerful and serves the successor regime well.

But more importantly, perhaps, it spares the state from looking too closely into its own complicity in the acts of the old once legitimate state. Saddam serves as a great mediating object. Responsibility is imposed on the leader, who perversely, is now stripped of the legitimacy of leadership. The state and its citizens are free to indulge the idea that they were either stripped of any power of resistance (at least prior to the revolutionary events leading to change) or that they were the innocent victims of the ferocious criminality of the leaders of the prior regime. As a consequence, the state remains intact and can, under its new leadership, pick up where it left off. Power has shifted, and the normative basis of the social order may have changed. A little de-Baathification and the nation is ready to rock and roll again.

But this has little to do with law. We have taken the language of law and now contorted it for another purpose—the management of politics. This is not necessarily a bad thing. But it has its dangers. Conflating the ordinary approaches of the criminal law to the extraordinary circumstances of revolutionary change (including changes in the aftermath of war) reduces the enormity of the actions subject to trial (Saddam Hussein was convicted of multiple murders) and makes every criminal activity potentially political. But in a political community founded on principles of democratic governance might find such a conflation uncomfortable. The United States is already experiencing the difficulty—where it has become increasing common, for example, to charge any threat (between spouses, on a school yard, etc) as making a terroristic threat.

Yet we have institutionalized this approach in domestic legal orders and now in the system of the International Criminal Court of the Rome Statute. With the institutionalization of conflict management, including the management of revolution and war, the world will become a very different place. We have a sense of the new criminal law of politics and war in the trial and conviction of Saddam Hussein. We may see the rise of a new political law of crime as well. Only time will tell whether this new form of conflict management is more successful than the one it seeks to replace.

Thursday, November 02, 2006

Monitor and Manage: MiFID and Power in the Regulation of EU Financial Markets

I presented the following work as part of a panel Panel on Financial Services: Free Movement and Harmonization in the EU. This was one of a number of panels at the recently concluded conference: EU Financial Services Regulation: Completing the Internal Market, held at the Institute of Advanced Legal Studies, London, United Kingdom, October 26, 2006 and excellently organized by the Academy of European Law and the Centre for C Commercial Law Studies, Queen Mary, University of London) (Event 206R08). My thanks to the organizers for putting together an excellent event, and particularly to Professor Takis Tridimas of the University of London Queen Mary, and Dr. María Pilar Núñez Ruiz, Course Director/Responsable de Projet/Projekleiterin European Business Law, Academy of European Law (ERA).

A summary of my presentation, Monitor and Manage, follows:

MiFID, the Market in Financial Instruments Directive (Directive on Markets and Financial Instruments 2004), is due to come into force on 1st November next year. MiFID will exact a greater degree of transparency—echoing American principles of market regulation. It will also require adherence to a "best execution" standard for all clients. Most analyses have focused on the costs and implementation of these requirements. Transparency is viewed as either a burden (or opportunity) because of the need to produce, keep and manage more data. Markets in information will surely grow. The “best execution” standards provide a greater means of standardizing industry practices—with the potential benefit to regulators to which power over market behavior should flow.

MiFID is one of a batch of harmonizing legislation proceeding from the so-called "Lamfalussy process" (EC Commission Staff Document 2004). The process involves the enactment of framework legislation (Level 1) to be followed by more detailed implementary legislation based on the framework adopted (Level 2). This is eventually to be followed by a comitological process among regulators for greater integration in fact (Level 3) (Ferrarini 2006) and strengthening enforcement (Level 4). The framework provisions, constituting the "Level 1" text, came into force on 30 April 2004 (Directive on Markets and Financial Instruments 2004). Level 2 legislation has started coming down the regulatory pike in the form of an implementary regulation (Implementing Regulation 2006) and directive (Implementing Directive 2006). Level 3 will focus on implementation and enforcement of Levels 1 and 2 requirements through “supervisory convergence” among the regulatory authorities of the Member States and has been advanced in two influential reports of the EU’s Financial Services Committee (the Franq Reports of 2005 and 2006) (Financial Services Committee 2006; Financial Services Committee 2005).

I will focus on the potential ramifications of the surveillance and regulatory aspects of MiFID in terms of nature of the character of the regulatory power in the financial products sector. Specifically I will focus on the effects of the creation of the markets for information created or augmented through MiFID in terms of the regulation of financial markets and the entities they serve. Particular attention will be paid to the effects of MiFID on consequences in terms of public and private anti-corruption campaigns, the use of these regulations to influence the behavior of issuers and market middlemen, and the potential utility of these regulations to elements of civil society and the media in their campaigns for corporate and capital social responsibility.

The E.U. has portrayed MiFID as a multi-objective innovation in legislation. In a June 2006 press Release,

“Internal Market Commissioner Charlie McCreevy said: "MiFID is a ground-breaking piece of legislation. It will transform the landscape for the trading of securities and introduce much needed competition and efficiency. It is good news for investors because it will both increase their level of protection and give them greater choice. It should drive down the cost of capital, generate growth and boost our competitiveness. Once the European Parliament has finalized its formal work, we must move quickly and robustly to ensure equivalent and effective implementation by November 2007. All firms in the business should now prepare.

MiFID will remove obstacles to firms' use of the EU-wide investment 'passport', foster competition and a level playing field between Europe's trading venues, and ensure a high level of protection for investors across Europe.

The implementing (or "level 2") measures develop a number of the provisions set out in the framework (or "level 1") Directive adopted in April 2004. Having emerged from a lengthy consultation and negotiation phase, they are balanced, proportionate and sensible. They will protect investors and consumers without imposing unnecessary compliance burdens on firms” (E.C. Commission 2006).

The EC Commission offered seven (7) reasons for pushing MiFID as a necessary replacement to the Investment Services Directive (ISD) (Commission Directive 93/22/EEC). The Commission argued that ISD (1) failed to provide sufficient harmonisation to prevent dual/multiple regulation of firms doing cross-border business; (2) offered little consumer protection with respect to business models and market structures that emerged after adoption of ISD; (3) failed to regulate the full range of investment services; (4) did not provide a satisfactory framework for competition between exchanges and other marketplaces; (5) fragmented liquidity and created barriers to cross border transactions through its failure to adequately harmonize the regulation of exchanges and other marketplaces; (6) failed to provide an adequate level of supervisory co-operation within and between member states; and (7) was generally otherwise out of date and inflexible (H.M. Treasury 2005, 9).

Of special concern was the perceived need to control and harmonize regulation of alternative markets, and in particular (i) multilateral trading facilities (MTF), (ii) other over the counter facilities and particularly systemic internalisers, firms executing orders from their own account (SI). “The MiFID requirements on transaction reporting263aim to ensure that firms report details of transactions in any financial instruments admitted to trading on a regulated market quickly and accurately to the appropriate competent authority.” (Financial Services Authority 2006).

With respect to Multilateral trading facilities (MTF), the Treasury had this to say in its December 2005 Report: “Since the mid-1990s there has been a growth in organised marketplaces which have not sought designation as exchanges. These have been run by investment firms and banks using a wide variety of business models and trading a wide variety of financial instruments. MiFID defines such markets as MTFs and establishes a EU-wide set of regulatory standards for them. The purpose is to help facilitate competition between venues for the execution of orders, at the same time as guaranteeing that all market places are governed by standards which seek to protect market integrity.” (H.M. Treasury 2005, 10).

The Treasury report extracts two objectives that may not be as compatible as one might like. The setting of uniform regulatory standards is not necessarily competition enhancing, especially if regulatory competition has economic and market efficiency effects. If one views the development of off regulatory markets as evidence of the opinion of the markets on the efficacy of the current regulatory framework (and its potential privileging of some forms of market making over others), then the effort may well have perverse effects.

Like MTFs, SIs present a unique regulatory opportunity from which MiFID does not shy. And indeed, the case of Sis is emblematic of the overarching purposes of MiFID, which is to construct a comprehensive regulatory regime over markets as they have metastasized since the good old days of markets as physical spaces in which people (licensed by the state) traded specific instruments (controlled by the state). The Financial Services Agency was blunt in its July 2006 Report about this aspect of the MiFID regulatory scheme, an aspect it sought to embrace. Referring to MiFID, the FSA had this to say:

“It creates a new, comprehensive EU-wide pre- and post-trade transparency regime for trades in any share admitted to trading on an EU RM, whether those trades are executed on an RM, an MTF or by an investment firm operating outside those systems – i.e. Over-the-Counter (OTC).
• The details of the pre-trade requirements differ according to type of trading venue and trading methodology. They will apply to transactions on RMs and MTFs and also to trading undertaken by investment firms – designated as ‘systematic internalisers’ (SIs) – which, on an organised, frequent and systematic basis, deal on own account by executing client orders outside RMs and MTFs. The details of the post-trade transparency requirements are the same across all trading venues.
• MiFID ends the discretion which Member States had under the ISD to require certain transactions to be executed on an RM (the so-called ‘concentration’ rule). The UK had not exercised this discretion.
• There are also changes to the present provisions requiring the reporting to competent authorities of transactions in instruments admitted to trading on an RM. The main purpose of these changes is to help regulators uphold the integrity of markets by enabling them to obtain a more complete picture of their firms’ trading activities than they can at present” (Financial Services Authority 2006).

Yet even this approach already shows the difficulties and contradictions of the regulatory scheme. Comprehensiveness might well be an object—but the universe within which comprehensiveness is sought is quite constructed indeed. Thus for example, this wholly regulated world (at least for the moment) is restricted to instruments admitted for trading on an EU RM (Regulated Market). While those securities may include securities (essentially equities traded on MTFs and Sis (though they might not!) they certainly do not include the growing range of securities not registered on RMs. There appears to remain a large unregulated space still in the securities markets more appropriately conceived.

Lastly, it is clear to all regulators, at least in Britain, that the new transparency obligations can lead to new markets in information provision. With respect to the growth industry in private information services that MiFID creates, the FSA appears intent on a robust global market:

“We are proposing that firms could use their choice of FSA-approved Trade Data Monitor/s (TDM) to meet their MiFID post-trade publication obligations. Firms could choose on a per trade basis which TDM they want to use. However, to avoid double counting, each trade should be reported only once and to only one TDM” (Financial Services Authority 2006, 106).

We do not intend to regulate the number of TDMs. RMs, MTFs, data publishers and new service providers could choose to be TDMs and be admitted to our list of approved entities. This could include non-UK RMs and other non-UK entities. Some TDMs may also act as data publisher/ consolidator. We would publish a list of TDMs on our website so data consolidators would know where to source the trade information (id. 107).
It is possible that some TDMs may choose to outsource some of their services. It is important to note that TDMs would still remain ultimately responsible for meeting their obligations irrespective of whether there are separate outsourcing or other agreements in place. (Id. 107).

MiFID carries over certain ISD exemptions under MiFID Article 3, that permit Member States to exempt firms providing investment advice and/or receiving and transmitting orders. Exemptions are only available where those firms are otherwise regulated at the national level, not be allowed to hold clients’ funds or securities and only transmit orders to a limited list of entities. There is a significant consequence to exemption: Where a member state exercises this exemption the firm inside it cannot provide cross-border services or establish a branch in another member state without applying for separate authorisations in the country or countries concerned.

With the possible exception of the new markets in information, the U.K. Treasury’s response to MiFID has been guarded:

1.5 MiFID requires revisions to UK legislation (mainly to the Financial Services and Markets Act 2000 (FSMA) and its secondary legislation) but also to the Financial Service Authority’s (FSA) Handbook. This consultation document covers the changes to legislation that are required. The FSA will publish consultation documents in the first half of 2006 on proposals for required changes to its Handbook.
1.6 The Treasury and FSA are working together on the implementation of MiFID. This consultation document has been extensively discussed with the FSA. Likewise, the Treasury is involved in the preparation of the FSA’s consultation document. This is to ensure consistency across the implementation of the directive.
1.7 The Treasury and FSA have both committed to only go beyond the minimum necessary in implementing EU financial services directives where this is consistent with better regulation. This means where there is a market failure which requires correcting and the benefits of doing so demonstrably exceeds the costs. This approach will be applied to the implementation of MiFID (H.M. Treasury 2005, 4).
But the FAS has been more enthusiastic, appearing ready to transpose the language of MiFID into its regulation. The FAS might be less concerned because, other than a change in vocabulary, MiFID does little violence to the normative regulatory universe within which FAS has been comfortable. And it offers a bonanza of sorts to the industry facilitators—at least forma cynical perspective. It will take a tremendous amount of effort to learn and incorporate the new vocabulary and make the dozens of small but significant changes to operations that the new MiFID language might require.

So there you have it. From the EU’s perspective, the MiFID solves any number of problems. Even problems at are essentially conflicting in nature—for example consumer protection, efficiency and competitiveness in Europe. From the UK’s perspective, there is little to MiFID that is earth shattering—the vocabulary is different but the changes might be more or less marginal. I suspect that neither position has it right. More over, I am not convinced that MiFID solves as many old problems as new problems (or perhaps better put—new opportunities for making money from regulatory market distortions) it creates or at least facilitates.

Looking at the totality of that extremely complex project that is MiFID, it is possible to discern two very broad issues with which the entire project is effused:

A. The first is the relationship between regulating states and markets.
1. MIFID broadens the definition of markets (this is a key objective of the new framework)
--MTF (multilateral trading facility)
--SI (systemic internalisers)

2. MiFID looks to the creation (or more complete correspondence between) markets and regulators or regulatory units.

3. But at the same time it preserves the EU traditional segmentation approach to markets and securities regulation (one not unknown in the United States). The effect is to reinforce the policy that markets or trading in different forms of securities merit distinct regulatory frameworks. The issue is only in conceptualizing the differences and constructing the categories. But there is controversy with respect to both.
a. In the case of MiFID, that means that MiFID regulation is substantially limited to markets in equity securities;

b. Coupled with a willingness in the statutory framework to consider extension to other forms of securities markets after a trial run in equities regulation.
B. The second is that MiFID imposes a more focused regulatory regime targeting
1. Information generation; and

2. An enhanced power in the state (and its regulators) to intervene in the management of covered markets.
3. The basic objective is to broaden and deepen governmental power to directly intervene in the functioning of capital markets through the medium of “transactions in shares.”
I want to take this opportunity to highlight what I consider to be six most interesting ramifications of MiFID raised within the context of the broader issues with respect to which I have suggested MiFID is largely concerned. There are seven broad but related issues that MiFID raises that will be worth sustained review as this new broad attempt at regulating markets is implemented.

1. The ability of the private sector to organize markets beyond the regulatory powers/purview of the state will always outpace the ability of the regulating entity (the state/EU/etc.) to extend its regulatory matrix.

A. The move over fifteen years or so from the ISD to MiFID provides a template for the future. There is likely to be a MiFID II in the next decade.

B. There are already examples of possible available venues beyond the MiFID regulatory framework:

i. SI markets below current trading thresholds (this one is particularly interesting for the politics it has generated on the eve of the transposition of MiFID. In 2005 there were press reports of the problems to be created when the EC Commission indicated a desire to set the SI threshold at trading 15% of their own shares, with predictions of the addition of 400 new “markets” adding an additional compliance burdens in the tens of billions of Euro (City Compass 2005). By the summer of 2006, the Commission had retreated: “However, the European Commission dropped the 15% rule in early September. As a result, the compliance costs of MiFID for European securities firms have reduced significantly to a total spending of $1 billion, estimates TowerGroup” (FinExtra 2006).

ii. Virtual markets, internet markets (including games and simulations, virtual securities and the like)

iii. float markets

C. The regulatory framework—comprehensiveness within a limited universe of market trading in securities—invites avoidance. MiFID will increase incentives for the creation of new forms of investment vehicles. More importantly, it may adversely affect competitiveness by enhancing incentives for the creation of new (unregulated or differently regulated) fora in which to trade regulated and unregulated (or differently regulated) securities.

D. At the margin, it may create incentives for moving markets abroad. As the Americans learned after the paroxysm of burdensome regulation from Sarbanes-Oxley through the terrorism and surveillance provisions post September 11, 2001, markets are global and securities (and capital generally) easily translatable (Karmel, 2005).

E. The segmentation of regulation (in the case of MiFID through an initial concentration on equities markets) may result in market distortion (or at least have a market effect) by creating incentives to other forms of securities by people seeking to avoid regulatory burdens of MiFID.

i. MiFID thus can change character entirely, from a process-oriented scheme to a scheme with significant substantive value.

ii. There are parallels with similar American efforts in this regard. Compare, for example, the recent American efforts in regulation through Reg. NMS (Securities and Exchange Commission 2005); another attempt to recapture regulatory monopoly over markets by extending traditional forms of market regulation to markets that have evolved to avoid either the inefficiencies of those forms of markets or the burdens of the regulations over them. Like its EU counterparts, American regulators are seeking to recapture regulatory control of markets that have evolved beyond the forms reflected in traditional regulatory regimes.

a. As one market analyst suggested in the American context: “connectivity providers, such as extranet, direct market access, and FIX engine vendors, are the biggest beneficiaries of Reg NMS. Connectivity becomes increasingly important as the markets become more electronic and more formally linked. While the SEC’s intention was for investors to reap the biggest benefits, this unfortunately is not the case. The typical retail investor will likely see no difference in the way he or she participates in the equity markets, and the typical institutional investor’s job just got harder” (Celent Communications 2005).

b. I suspect a similar result in the wake of MiFID.
2. Governmental regulatory systems remain inefficient and incapable of a comprehensive extension of their control/coercion frameworks as long as regulation is limited by the territorial principle—however broadly applied. This is a lesson that Americans have slowly begun to learn even as they were congratulating themselves of the benefits of regulatory extension to the ends of the federal Republic. While the efficiencies of breaking through Member State regulatory barriers are positive, capital is no longer confined, even within the borders of the E.U. This will be a hard lesson for a Brussels newly come into its power.

A. An example of this limitation in MiFID: the connection between regulation and shares admitted to trading on EU regulatory markets.

i. This raises a tangential question: will shares traded only by EU MTFs and Sis now qualify as shares admitted to trading on EU RMs? Or better put, will such shares if not otherwise registered for trading on RMs now be required to so register? The effects on trading may be significant.

ii. But the FSA was clear that the MiFID would apply broadly even if only to a limited universe of financial instruments. They offered as an example the execution of a trade of a share traded on both the London and New York markets. Even if the trade was effected in New York, if the shares were also listed in London, MiFID would apply. However, if the shares are listed only abroad, MiFID might not extend to domestic execution.

B. Consider the perverse incentives:

i. Outsourcing of trading, and the constriction of complex multinational corporate trading enterprises to take advantage of territorially distinct trading environments.

ii. Emigration of “citizenship” of trading vehicles; with a consequential incentive to move capital transactions outside the EU.

iii. Enhancement of movement to a global free movement of capital model. In this effort the Europeans will be aiding efforts already (inadvertently enhanced by American regulatory effects).

a. Firms may seek to lower transaction costs in trading within unregulated (or differently regulated) global markets (or national markets) beyond the reach of EU regulators and MiFID.

b. This effect may be especially useful with respect to multi-listed shares when regulatory transaction costs are lower elsewhere.

c. There is an irony here: to the extent that MiFID does not apply (to certain advisors, certain securities, and certain markets) devolves back to the Member States, MiFID compounds the problems of territorially induced regulatory fracture. This may enhance regulatory competitiveness but works against market transactional efficiencies.
3. Likewise: MiFID perpetuates the foundational regulatory difficulty of the American approach (an approach that made sense perhaps in the 19309s but which increasingly appears more of an impediment than an enhancement to the attainment of policy goals in a global environment); a focus on transactions and not on consumers.

A. This approach substantially weakens the consumer protection effects of MiFID (but not its costs) and facilitates avoidance.

B. This approach provides the appearance of protection but avoids its substantive effects to any appreciable degree.

C. And it raises a related and quite troublesome issue: the resulting complexity of regulation appears to create the sort of markets in avoidance that tends to benefit the middleman classes—principally lawyers and regulators,

i. It is thus possible to characterize MiFID as a regulator’s scheme rather than a consumer or market efficiency program. There is a sense that MiFID, like the earlier MAD (the Market Abuse Directive) is a regulator’s undertaking.

ii. Complexity requires interpretation and usually increases the need for further regulation. The cycle is well known.

iii. There is another beneficiary—the political classes: regulatory complexities in the purported service of the populace increase the modalities of popular dependence on regulators and other professional classes of “protectors.”

a. The dependency model of the relationship of individuals to the state has only increased in the last century.

b. This is not necessarily a policy objective that has been fully aired or resolved. For some there is in MiFID another brick in the construction of a new feudalism
4. The transaction costs o regulation create great incentives to avoidance as capital seeks its most efficient modality on a global basis.

A. The effect is felt in both legitimate and criminal capital markets (cynically speaking, efficient financial crime pays).

B. The “tax effects” of regulation cannot be understated:

i. It is a necessary result of attempted regulatory monopoly (at least within a political territory); though on a global scale segment market monopolies (to the extent that regulatory monopolists compete) disfavors monopolist power.

ii. The generated costs of these effects are inevitably reflected in the market and the pricing of its products. If these costs generate comparative inefficiencies they can (a) reduce profits on an individual or aggregate scale) or at the limit (b) reduce the size and power of the market.

iii. It produces wealth leakages—to middlemen (lawyers, information purveyors, etc.).

a. It is unclear if aggregate welfare is increased. Substantial empirical study is required.
5. The greatest effect of MiFID is the creation (potentially at least) of robust markets in information.

A. Consider for examples the power in this regard of the new Trade Data Monitoring regimes described in the FSA 1006 report.

B. This new regime will produce significant competitive pressure on traditional information sources—especially traditional regulated markets that had enjoyed substantial information monopolies.

i. Are the Exchanges now closer to obsolescence? The recent merger activity among traditional exchanges suggests that they are conscious of this effect.

C. The extent of the effect will be a function of the success of MiFID in disaggregating markets in transactions for securities (the traditional primary activity of markets) from markets for information on transactions in securities (a new product that MiFID enhances). Disaggregation is the key here to industry creation (information) and regulatory segmentation.

D. The emerging markets for information on transactions in securities will generate its own regulatory distortions and interventions.

i. The FSA’s 2006 Report already points in that direction (pp. 105 et seq.).
6. MiFID continues and deepens a global process of privatizing surveillance. In this sense, MiFID may be not only a regulators’ undertaking, but more precisely an undertaking for the benefit of the police authority of the state (Backer 2004).

A. Since the last quarter of the 20th century, the state (at least in the West) has sought to do two things simultaneously:

i. It has sought to gather more and more information on all operations within its territory (and beyond to the extent relevant). The information has a variety of uses:

a. Law enforcement

b. Source of information in ongoing development of policy.

c. Availability for the benefit of various sectors of its stakeholders (the disclosure regimes of the American Securities laws for the benefit of the investor class is a classic example).

d. Development and influence on (in totalitarian regimes control of ) political, social, economic and other aspects of culture (that is information gathering has normative consequences well exploited by the state) (Foucault 1977, 170-177; Foucault 1978, 89-91).

ii. It has sought to privatize information gathering for its own use in the disciplining of social organization. Government has sought to make surveillance a reflex. It is organized as a “multiple, automatic and anonymous power; for although surveillance rests on individuals, its functioning is that of a network of relations from top to bottom, but also to a certain extent from bottom to top and laterally; this network ‘holds’ the whole together and traverses it in its entirety with effects of power that derive from one another: supervisors, perpetually supervised” (Foucault 1978, 176-177>).

B. MiFID represents another step in the implementation of systems of “[h]ierarchized, continuous and functional surveillance” (Foucault 1977, 176) through which “disciplinary power became in ‘integrated’ system, linked from the inside to the economy and to the aims of the mechanism in which it was practiced” (Id.).

C. The population itself embraces systems through which it serves as the very instrument of its discipline, but with a twist—resistance to participation in surveillance itself becomes a transgression. The emphasis is so great because the stakes have become so high—stability and the management of the state and its relations both domestic and international. This leads to the last point.
7. MiFID is a crucial element in another field of regulation. It serves as an important element in the management of conflict and crime. It serves as a nexus point for the regulation of economic activity, crime and political conflict.

A. MiFID’s multiple objectives thus add a layer of additional complexity, the resolution of which is deferred.

B. While the direct objectives of MiFID are to benefit consumers and the market (efficiency, competitiveness, protection); its more potent beneficiaries may be the police, military and secret service sectors of governments. Information, like munitions in an earlier age, appears to have become among the most important components of war. And war, like any other activity, is difficult enough to maintain without capital.

i. Market regulation in this sense can be understood as a method for the management of crime:

a. Anti-corruption campaigns (World Bank and Chinese Communist Parties are at the forefront of these at the moment; there is an irony there that I was pass by with only a nod).

b. Money laundering (gang activity as the leading form of banking for political and military campaigns waged by insurgent and anarchist groups)

c. Financial fraud (there is a growing conflation between banditry and politically motivated violence; consider the reluctance of the House of Lords to approve the extradition treaty with the United States (Nov. 2, 2006) in the wake of the use of anti-terrorism based extradition powers on English bankers and other financial types for violation of U.S. financial fraud or securities laws).

ii. Market regulation is also a weapon in the political and economic aspects of modern warfare:

a. Financing of terrorist or politically violent movements.

b. Attempts at market disruptions as a tactic of war by combatant organizations.

c. Criminal financial activity with politically destabilizing effects.

C. Where these activities are conflated there is a necessary convergence of the need for market surveillance and for the use of markets as a source for data gathering and the needs of the police and military wings of the state apparatus.
Putting all of this together, MiFID can be better understood. Indeed, it is impossible to understand MiFID except in its broader context. MiFID is at once about market regulation, the creation of new industry (information production), the privatization of governmental functions (surveillance and data gathering), and also the management of crime and of political conflict. Ironically, as a means of subsidizing traditional exchanges (by bringing competitors within the regulatory matrix within which they operate, MiFID’s utility is doubtful at best. It will have substantial effect.

Reference List:

Larry Catá Backer. 2004. “Surveillance and Control: Internal, External and Governmental Monitoring of Corporate Insiders After Sarbanes-Oxley.” Michigan State Law Review 2004:327.

Celent Communications. 2005. “Press Release: Regulation. NMS: One Rule to Bind Them All, Report Published by Velent.” New York, April 18, 2005.

City Compass. 2005. “Estimates of 400 new Exchanges from Brussels for MiFID” (July 27, 2005).

E.C. Commission. 2004. “Commission Staff Working Document The Application Of The Lamfalussy Process To EU Securities Markets Legislation A preliminary assessment by the Commission Services” (SEC(2004) 1459; Nov. 15, 2004).

E.C. Commission. 2006. “Markets in Financial Instruments Directive ("MiFID"): implementing measures close to adoption.” Brussels, 26 June 2006 (IP/06/846.).

Ferrarini, Guido. 2006. “The Harmonisation of Capital Markets Law in the EU: Assessments and Prospects.” Paper presented at the Conference: EU Financial Services Regulation: Completing the Internal Market (London, October 27, 2006).

Financial Services Authority. 2006. Implementing MiFID for Firms and Markets (July 2006).

Financial Services Committee (FSC) (2006), Report on Financial Supervision (‘Francq Report II’), February 2006.

Financial Services Committee (FSC) (2005), Report on Financial Supervision (‘Francq Report II’), July 2005.

FinExtra. 2006. “MiFID compliance bill could reach $1 billion” (October 4, 2006.

Foucault, Michel. 1977. Discipline and Punish: The Birth of the Prison. Trans. Alan Sheridan. New York: Vintage Books.

Foucault, Michel. 1978. The History of Sexuality; Vol. I: An Introduction. Trans. Robert Hurley. New York: Random House.

Gabaix, Xavier and David Laibson. 2006. “Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets.” The Quarterly Journal of Economics 121(2):505-540.

H.M. Treasury. 2005. Consultation Document: UK Implementation of the EU Markets in Financial Instruments Directive (Directive 2004/39/EC) (December 2005).

Karmel, Roberta. 2005. "Reform of Public Company Disclosure in Europe," 26 University of Pennsylvania Journal of International Economics Law 26:379.

Kentouris, Chris. 2006. “Regulations Rule: Despite Differences Reg. NMS and MiFID Converge on Best Execution and Require Metrics.” Security Industry News (September 4, 2006).

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