Judicial Oversight of the Bureaucracy: Probably Good

Two years ago, Judge Ned Rakoff rejected a settlement between the SEC and Citigroup.  The SEC had been prosecuting Citigroup over fraud in some securities offerings it put together, similar to many cases in the bubble-era financial world.  As was standard in this situation, finally Citigroup had enough and agreed to settle the case in the standard manner – a fine of $285 million and not having to admit it did anything wrong.  Sick of seeing Wall Street getting simple slaps on the wrist, Rakoff put his foot down:

Judge Rakoff said it was impossible for him to say whether it was “fair and reasonable,” let alone in the public interest, after the bank “neither admitted nor denied” the S.E.C.’s accusations nor otherwise revealed any of the facts in a complex mortgage fraud case.

Rakoff’s ruling was a feel-good moment for people tired of Wall Street’s excesses, and two years later it is being reined in by the powers-that-be.  The New York Court of Appeals for the Second Circuit found that Rakoff had exceeded the bounds of his discretion.  Regardless of the merits of this specific decision, the logic is troubling.  One of the perennial issues facing regulators and the bureaucracy in general is the question of “regulatory capture”, when bureaucracies turn from impartial regulators of an industry to its defenders or advocate.  The SEC as a whole is certainly not captured, or else it never would have brought such a case in the first place.  However, there were no doubt certain elements within the SEC which were very happy to see the case disappear with the minimum of fuss and muss lest it impede the revolving door to Wall Street.  The decision by the appeals court threatens to set general precedent for judicial review of settlement, sharply decreasing the power of the courts in overseeing regulatory disputes.

The courts are not perfect, but the political economy of the situation suggests there are benefits to a supervisory role for the courts in this area.  The professional incentives for judges are much better than for the SEC, since judges aren’t gunning for Wall Street jobs.  Most are aiming to advance in their judicial career, generally doing so by making good law.  Courts can be capricious and produce poor policy, and there are structural incentives encouraging that – little accountability and a partisan nomination process.  However, these structural factors might lead to systematically poor policy. but there are no reasons to believe they systematically create biased policy, unlike the structural incentives facing the regulatory bureaucracy.  It actually does make sense to hand off a fair amount of regulatory oversight to the courts, if we’re interested in a more even playing field for public interests.  The Court of Appeals’ decision is troubling in that regard.


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3 responses to “Judicial Oversight of the Bureaucracy: Probably Good”

  1. Paul Rogerson says :

    Interesting post. Do you think it is clear that the terms of the consent decree were too lenient? I read the opinions, and I found it hard to tell. There are several different elements – the fine, the injunction, the compliance measures, maybe others – and I wasn’t sure what I would compare the SEC’s choices to or how I would predict the likely effects of each term. One concern is that judges, who are not experts, will also have a hard time figuring out what is reasonable. If so, they will not be able to detect biased or excessively lenient terms very well, and their usefulness as a check on agency capture may be limited, even if they are well-intentioned.

    I am also not sure that more judicial scrutiny of SEC actions would, on the whole, lead to stricter oversight of financial institutions. For example, some of the most important recent cases have been D.C. Circuit decisions striking down SEC regulations for failing cost-benefit tests. http://www.nytimes.com/2012/09/21/business/circuit-court-needs-to-let-the-sec-do-its-job.html?pagewanted=all

    • Alex Copulsky says :

      I am not sure that it would necessarily lead to stricter oversight of financial institutions as well – at any given time period it might lead to looser or stricter oversight depending on who’s in the judiciary as well as who is in the White House (who appoints regulatory management). However, I think that moving regulatory oversight to the courts aligns structural incentives better than giving untrammeled discretion to agencies. Depending on the specific agency, the administration in power, and the judge in question, judicial review might lead to more strictness or more laxity in different situations.

      It’s also straightforwardly true that judges aren’t experts and many times will have difficulty parsing the facts of the case. But I think this isn’t a super-strong objection, if only because we’ve already outsourced so much regulatory discretion and oversight to the legal system. If we trust judges to oversee highly technical patent disputes hinging on abstruse software code, I think we ought to be able to trust them to review settlements. To the extent this objection is accurate (probably!), it suggests we should be better funding the court system with technical staffers, not necessarily that we should completely overhaul our legal system to take responsibility out of their hands.

      • Paul Rogerson says :

        It’s true that courts are charged with making decisions in all kinds of cases with complicated empirical components, like patent litigation. That isn’t to say they always do a particularly good job. http://www.vox.com/2014/5/27/5753866/the-real-problem-with-the-federal-circuit The saga of the Federal Circuit raises another point – courts, as well as agencies, may be vulnerable to capture by the interests that appear before them.

        I’ve just remembered that I recently read an interesting paper on this topic. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2407067 I thought it was interesting because it is an empirical paper, and the findings were definitely at odds with my priors about which institutions have which kinds of problems.

        Thinking about it also makes me realize – I’m familiar with the general theory of agency capture, but I have no idea what evidence supports the view that particular regulatory agencies, like the SEC, have been captured. What, in your opinion, is the best evidence on that? I know that some people would want to claim that political checks can help mitigate agency capture.

        In any event, I don’t think the implication of any of these arguments is that we would be better off without judicial review of agency actions. The Second Circuit said the right standard for reviewing SEC settlement agreements is whether there is a “substantial basis” in the record for concluding the agreement is not “fair, reasonable, and in the public interest.” That seems perfectly sensible – the court should check to see if there is an obvious problem. My skepticism is about whether it would be helpful to have judges try to do more. A stricter standard might not make much difference, or just add noise.

        I do agree completely that beefing up the technical capacity of the courts would be a good idea. Getting more people with science backgrounds to attend law school and providing more training for judges already on the bench would both be helpful. Hiring a technical staff could also be good, although maybe you would want different kinds of people from case to case, depending on the subject matter, so having a permanent staff could be inefficient. Richard Posner likes the idea of allowing judges to appoint their own experts in each case and do their own internet research, and sometimes offline research as well. http://www.martindale.com/appellate-practice-law/article_HeplerBroom-LLC_2124534.htm Not everyone is enthusiastic about this, but I’m a fan.

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