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March 07, 2014

Guilty Until Proven Innocent?

Many moons ago after years as a stay at home wife and mother, the Editorial Staff went back to school to earn a college degree. Not wanting to go into debt, we kept our grades up and applied for scholarships and worked on campus tutoring math and conducting a series of student-led programs designed to cut the failure/withdrawal rates in challenging courses.

One of these courses was Business Law. For 3 or 4 semesters (memory fails us), we attended class and then planned and conducted 3 study sessions a week for students who were struggling to understand the material. Because this was an undergrad class designed for Business majors, it concentrated on common law definitions of various torts and one or two crimes. We also covered how civil and criminal trials and burdens of proof differ (and perhaps more importantly, why they differ).

Students typically had a hard time understanding how the same offense can be both a crime (violation of a criminal statute punishable by the state) and a tort (a violation of a civil duty typically remedied by ordering the offending party to "make the plaintiff whole" - a fancy way of saying, "The plaintiff suffered a loss because of your actions and you need to compensate him or her for that loss.")

"Isn't that double jeopardy?", they asked every semester. It's not, because the same act constitutes two separate offenses with different "victims". In the criminal action, the plaintiff is the State and the remedy is designed to protect society's interests. Because the potential punishments are more severe and the State has more power than most individuals, the burden of proof is higher. In the civil action, the plaintiff is the party claiming injury, and the remedy is designed to protect the victim's interests. Because (at least theoretically) individuals are on a more even footing and the remedies are usually monetary, the burden of proof is lower.

But there are similarities between civil and criminal actions, too. For example, in most cases the burden of proof is on the accuser. If the accuser can't establish facts proving all elements of the offense by the appropriate standard (preponderance or reasonable doubt), the accused party generally doesn't even have to present their case. Once the accuser does meet the burden of proof, the burden shifts to the accused to establish facts proving a recognized defense. So, for example, if an accuser successfully proves defamation, the accused can avoid punishment by proving the supposedly defamatory statement was in fact, true (truth is a defense to defamation).

This all makes sense, but lately we've noticed several instances of burden-shifting that occurs before an accuser has actually proved the traditional elements of the offense. The first example involves allegations of securities fraud. The Editorial Staff make no claim to know what formal definition of fraud is being used here, but she still remembers the common law elements:

1. An intentional misrepresentation
2. Of a material fact
3. Relied upon by the plaintiff
4. To his detriminent.

In Lay Princess terms, the accuser needs to prove that the accused deliberately misled the accuser, that the deception involved a fact centrally related or relevant to the proposed harm, that the accuser knew about/actually believed the deception, and that as a result of believing this deception, the accuser suffered a loss. That doesn't seem to describe this scenario at all:

The lawsuit is possible thanks to the Supreme Court's 1988 ruling in Basic v. Levinson, which embraced the "fraud on the market" theory. The theory assumes that markets are efficient and the price of a stock incorporates all publicly available information about the company. The Court thus assumed that when an investor buys a stock he relied on that information for his decision.

In other words, judges are directed to accept for class certification that investors were potentially defrauded whenever a company statement turns out to be wrong. Whether an investor bought a stock because Uncle Bob recommended it, or because his wife likes the product became irrelevant.

We respect the efficient-markets argument, but it certainly isn't the only theory of stock-price movements. There is, for example, the madness of crowds. Investors buy shares for any number of reasons, and often the company misstatement alleged as fraud has no discernible impact on the stock price. Yet under the logic in Basic, lawyers don't even have to prove price impact to form a class.

Here's another troubling example:

Uniquely among nations, the U.S. gives mortgage borrowers a trifecta of benefits: extensive tax advantages, no recourse against the borrowers' nonresidential assets if they walk away, and typically no protection for the lender if the borrower prepays the loan to get a lower rate.

These policies long seemed like a great deal for borrowers, but they wreaked havoc on the financial system. People with marginal credit were encouraged to finance more than 90% of the purchase price with 30-year mortgages. If interest rates later fell, they could refinance. If rates rose, they could congratulate themselves for locking in a low rate. If prices rose, they enjoyed all the upside and could tap the equity. If prices fell and they faced foreclosure, their other assets were protected because the loans were usually non-recourse.

The Consumer Financial Protection Bureau now wants to tip the scale even more against lenders by asserting the legal theory of "disparate impact." Consumers can sue if the volume of loans to any racial group or aggrieved class differs substantially from loans to other groups. No intent to discriminate is required, and it's illegal for a mortgage application to ask the borrower's race. Financial institutions trying to avoid making bad loans by implementing prudent underwriting practices can inadvertently get in trouble. A bank forced to pay a fine one year because it irresponsibly made "predatory" loans to people with bad credit can be fined the next year for not making similar loans.

This type of argument strikes us as particularly pernicious, in that the rules of conduct are applied arbitrarily to protect some people from the consequences of their decisions while assuming others are guilty before the accuser has even proven his or her case.

Kind of reminds us of Taranto's excellent point the other day.

Exactly how granting special favors to classes of people viewed as "disadvantaged" while holding others to an unreasonably high standard of conduct helps society become more tolerant and diverse is beyond us. Seems like a tactic designed to destroy civic engagement and make people fearful of dealing with women, minorities, and the poor. All this is particularly ironic coming from an administration that keeps lecturing us about how we all need to play by the same rules.

Posted by Cassandra at March 7, 2014 06:53 AM

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The standard of "mens rea" or "scienter" for white-collar crime is a messy area that's getting messier. See http://scholarship.law.ufl.edu/cgi/viewcontent.cgi?article=1022&context=flr&sei-redir=1&referer=http%3A%2F%2Fwww.google.com%2Furl%3Fsa%3Dt%26rct%3Dj%26q%3Dstatutory%2520fraud%2520mens%2520rea%26source%3Dweb%26cd%3D6%26ved%3D0CE4QFjAF%26url%3Dhttp%253A%252F%252Fscholarship.law.ufl.edu%252Fcgi%252Fviewcontent.cgi%253Farticle%253D1022%2526context%253Dflr%26ei%3DFjkaU4uUIInz2QXdt4CQDw%26usg%3DAFQjCNGzvpumL8kdFbEAe7cqQbVFPE9L4w%26sig2%3DQ2MLVY1gkU5-ryPIsTo9_Q%26bvm%3Dbv.62578216%2Cd.b2I%26cad%3Drja#search=%22statutory%20fraud%20mens%20rea%22 and http://engagedscholarship.csuohio.edu/jlh/vol14/iss2/6/.

There's a trend toward something called "willful neglect" that strikes me as a contradiction in terms--the kind of standard a court might do anything with. It boils down to not quite liking the cut of the defendant's jib.

Posted by: Texan99 at March 7, 2014 04:38 PM

Thanks for the link! It looks interesting.

Posted by: Cassandra at March 7, 2014 04:52 PM

.... individuals convicted of health care fraud can face steep sentences in accordance with the guidelines because health care offenses “often stem from an improper billing procedure that has
been repeated for multiple patients,”
and therefore, providers can be charged with multiple counts of the same offense.90


Posted by: Cassandra at March 7, 2014 05:03 PM

- the relaxations for mortgages by Fannie & Freddie, expressly promoted by Congress, wound up even worse than 10% down. They *did* 'no doc' [umented earnings] *and* 0% down!
- I read Taranto's 'Best of the Web' blog most days, and while he's informative and often entertaining, he's also often a major league jerk.
- 'disparate impact' is a legal theory in search of a problem.

Best Regards,

Posted by: CAPT Mike at March 7, 2014 10:45 PM

"...he's also often a major league jerk."

He's gotten better. BotW used to include periodic jokes about tragic stories which, as they were in the news, likely to be encountered by families still mourning them. It was the kind of gallows humor you expect to encounter with doctors (and, I suppose, journalists), but I was always surprised the editors let it out into the daylight.

Posted by: Grim at March 8, 2014 12:10 AM

Being a real fan of gallows humor (years in the Marines will do that to a formerly sensitive fellow), I never even noticed that Taranto's jokes were sometimes anything but. A large segment of human humor is pratfall humor, which obviously comes at someone else's expense. I don't see a big difference between laughing at someone's fall versus laughing at someone's death. Probably a hangover from Vietnam war stories.

Posted by: Rex at March 8, 2014 06:26 AM

I don't read Mr. Taranto regularly, but then there are few pundits I read regularly so I'm not sure that means anything. I subscribe to his column via email, but don't often click on the daily notifications. Usually I'll run across references to his columns elsewhere and click through.

He's a talented writer who produces incisive and witty commentary. Occasionally his reasoning is tortured, but I've only found that to be true when he's too personally invested in making a point. That's probably true of most writers, though :p

IMO, his best columns are written when he's dispassionate and evenhanded - then, he has a real knack for bringing clarity to murky subjects and his reasoning is a delight to follow. I loved the column I linked to at the end of this post, for instance. Classic Taranto.

I don't think he's a jerk, but he's not what I'd call empathetic. And he definitely delights in getting people upset, which is hard for me to understand because I'm pretty much the opposite.

That said, the gallows humor doesn't particularly offend me. In some people it comes from being insensitive or tone deaf. In others, it's an attempt to distance oneself from something that's very painful. I don't presume to know which one applies here. Sometimes to female ears, men have a very flat affect about things that upset them that makes them seem very callous, but I usually discount that as cultural influence rather than some indicator of heartlessness. Maybe I'm naive, but I've found most men to be quite sympathetic and kind.

It's just not as acceptable for them to show that side in public.

Posted by: Cassandra at March 8, 2014 08:41 AM

Capt. Mike:

My youngest son is in the mortgage business. I wonder how they are going to stay in business with all the shenanigans going on. In this regulatory environment, pricing loans is pretty much a crap shoot.

The law is a moving target, you can't price risk into the products, and the government is actively looking for opportunities to sue the big mortgage banks but not doing anything to fix the regulatory mess they've created.

Posted by: Cassandra at March 8, 2014 08:48 AM

Hi Rex,o,
Heh. I served on a Ballistic Missile Submarine, and we frequently resorted to epic gallows humor. When you're carrying enough ordnance to wipe out *all* of Siberia it's a little weird.

Hi Cass,
Mortgage business, and to some extent all of residential Real Estate is experiencing the 'joy' of Moral Hazard. It's entirely rotten that the mortgage origination business became dominated by gov't sponsored entities that deliberately strayed from good underwriting principles. We will suffer a long economic hangover until Feds retreat away from direct intervention (the 'Fed') and excessive regulation (Obamacare & EPA in particular, buts lots of 'minor' players like new OFA).

Very Best Regards,

Posted by: CAPT Mike at March 9, 2014 11:53 PM

My opinion is that Dodd-Frank will kill off everything but top shelf prime credit.

Mortgage lending will pretty much look like it did prior to congress' "affordable housing" schemes only more expensive. Of course, congress will then wonder why poor people can't buy homes.

Posted by: Yu-Ain Gonnano at March 10, 2014 10:54 AM