|Table of Contents|
Front Cover 1
Front Cover 2
Table of Contents
Minority and dissenting views of Hon. James M. Collins and Hon. Robert Krueger
Additional views of Hon. John E. Moss
Back Cover 1
Back Cover 2
F EDERA REGULA AN
SUBCMMI ?EEON OVERSIGHT AND
COMMITTEE ON INTERSTATE AND
HOSEOF RERSENTAIVES ETR -FUH CONGRESS
FEDERAL REGULATION AND
SUBCOMMITTEE ON OVERSIGHT AND
INVESTIGATIONS OF TI
COMMITTEE ON INTERSTATE AND
HOUSE OF REPRESENTATIVES
U.S. GOVERNMENT PRINTING OFFICE
75-1 WASHINGTON : 1976
For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington. D.C. 20402 Price $6.10
Stock Number 052-070-03736-9
COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE
HARLEY 0. STAGGERS, West Virginia, Chairman
JOHN E. MOSS, California SAMUEL L. DEVINE, Ohio
JOHN D. DINGELL, Michigan JAMES T. BROYHILL, North Carolina
PAUL G. ROGERS, Florida TIM LEE CARTER, Kentucky
LIONEL VAN DEERLIN, California CLARENCE J. BROWN, Ohio
FRED B. ROONEY, Pennsylvania JOE SKUBITZ, Kansas
JOHN M. MURPHY, New York JAMES M. COLLINS, Texas
DAVID E. SATTERFIELD III, Virginia LOUIS FREY, JR., Florida
BROCK ADAMS, Washington JOHN Y. McCOLLISTER, Nebraska
W. S. (BILL) STUCKEY, JR., Georgia NORMAN F. LENT, New York
BOB ECKHARDT, Texas H. JOHN HEINZ III, Pennsylvania
RICHARDSON PREYER, North Carolina EDWARD R. MADIGAN, Illinois
JAMES W. SYMINGTON, Missouri CARLOS J. MOORHEAD, California
CHARLES J. CARNEY, Ohio MATTHEW J. RINALDO, New Jersey
RALPH H. METCALFE, Illinois W. HENSON MOORE, Louisiana
GOODLOE E. BYRON, Maryland JAMES H. SCHEUER, New York RICHARD L. OTTINGER, New York HENRY A. WAXMAN, California ROBERT (BOB) KRUEGER, Texas TIMOTHY E. WIRTH, Colorado PHILIP R. SHARP, Indiana WILLIAM M. BRODHEAD, Michigan JAMES J. FLORIO, New Jersey ANTHONY TOBY MOFFETT, Connecticut JIM SANTINI, Nevada ANDREW MAGUIRE, New Jersey MARTIN A. RUSSO, Illinois
W. E. WILLIAMSON, Clerk KENNETH J. PAINTER, Assistant Clerk
SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS JOHN E. MOSS, California, Chairman RICHARD L. OTTINGER, New York JAMES M. COLLINS, Texas
ROBERT (BOB) KRUEGER, Texas NORMAN F. LENT, New York
ANTHONY TOBY MOFFETT, Connecticut MATTHEW J. RINALDO, New Jersey
JIM SANTINI, Nevada W. HENSON MOORE, Louisiana
W. S. (BILL) STUCKEY, JR., Georgia SAMUEL L. DEVINE, Ohio (Ex Officio)
JAMES H. SCHEUER, New York HENRY A. WAXMAN, California PHILIP R. SHARP, Indiana ANDREW MAGUIRE, New Jersey HARLEY 0. STAGGERS, West Virginia
MICHAEL R. LEMOV, Chief Counsel JAMES L. NELLIGAN, Operations Director FRANCES WHITE, Deputy Chief Counsel LOWELL DODGE, Special Counsel Regulatory Reform Task Force Director WILLIAM BRAUN, Counsel LESTER 0. BROWN, Special Assistant ROBERT CLARKE BROWN, Counsel CAROLYN EmIGH, Special Assistant RICHARD A. HELLER, Counsel PATRICK MCLAIN, Counsel MARK L. ROSENBERG, Counsel ELLIOT SEGAL, Special Assistant KIRK C. SMITH, Special Assistant THOMAS GREENE, Counsel to the Chairman BERNARD WONDER, Minority Counsel
Ronald Cormier,' Erline Jones,' James Reiger I
1 On detail from the General Accounting Office.
The ri;s of ,dm;,,1Xtr/1Ce bod;,r probably has been thle most
ignificant legal trend of the last century and perhaps more values today are affected by their decisions than by those of all the courts, rerniew of administrative decisions apart. They also have begun to have important consequences on personal rights. .. They have become a veritable fourth branch of the Government, which has deranged our three-branch legal theories as mNuch as. the concept of a fourth dimefnsionu unsettles
our three-dimensional thinking.
-.Justice Robert H. Jackson, 1952.
Yo man is a warmer advocate for proper restraints and
wholesome cheeks in every department of government than I am; but I have never yet been able to discover the propriety of placing it absolutely out of the power of men to render essential Services, because a possibility remains of their doing ill.
-President George Washington, 1787.
This report: "Federal Regulation and Regulatory Reform" is, we believe, one of the most comprehensive studies ever made on this subject. It is the product of nearly two years of investigation that included 28 days of public hearings, some 220 witnesses from both government and the private sector. a hearing record in excess of 3.500 pages and extensive written submissions from individuals and agencies. It represents our commitment to more effective government on behalf of the American public.
A government truly of and for the people must be accountable to them. An important part of this accountability is oversight by the Congress which, in turn, is answerable to the citizens its Members collectively serve.
Federal regulation of commerce for the public convenience and necessity goes back to 1789, the first year of government under the United States Constitution, when Congress passed measures signed into law by President Washington for the regulation of ocean-going ships and the coasting trade and for the administration of customs laws. The growth of Federal regulation over the past two centuries stems not from the whims of politicians or from some conspiratorial scheme to build big government. As this report demonstrates, regulatory laws were created to cope with problems experienced by people. As long as people desire the protection of their government, the important concern is not merely the scope of federal regulation, but its quality and efliciency. The Subcommittee's recommendations for improving the independence and integrity of regulatory agencies are directed toward these goals.
Iii offering this st udy, it is our hope that the Subconunittee's report will serve both as a reaffirmation of our faith in representative government and as a catalyst for needed reorganization and reform.
Jonx E. Moss,
Chairman, Subcommittee on Oversight and Investigations. \TVASHINGTON, D.C., October. 10976
The Subcommittee gratefully acknowledges the assistance of the U.S. General Accouitin~ Office: the Amnerican Law, Economics, and (Government Divisions of the Library of Congress; and the Congressional Budget Office in the preparation of portions of this report. The Subcommittee also acknowledges the able editorial assistance of Mr. Marcus Rosenbloom.
Part I: Page
Chapter 1-Introduction ----------------------------------------- x
Chapter '-'-Securities and Exchange Commission ------------------- 15
Chapter 3-Federal Trade Commission ----------------------------Chapter 4-Environmental Protection Agency ----------------------- 11i
C hapter 5-National Highway Traffic Safety Administration-__ 155
Chapter 6-Consunier Product Safety Commission ------------ 193
Chapter 7-Federal Communications Commission ---------------- 24
Chapter 8-Food and Drug Administration ..----------------------- 279
Chapter 9-Interstate Commerce Commission ----------------------327
Chapter 10--Federal Power Commission ---------------------------377
Chapter 11-Congress and the regulatory agencies ------------------- 423
Chapter 12-Quality of regulators --------------------------------441
Chapter 13-Increasing public participation ------------------------467
Chapter 14-Overlapping and duplicative programs ---------------- 45
Chapter 15-Use and misuse of benefit/cost analysis ----------------503
Chapter 16-Regulatory reform alternatives ----------------------- 517
Chapter 17-Conclusions and recommendations --------------------- 537
Minority and dissenting views of Hon. James M. Collins and lion. Robert Krueger --------------------------------------------------------629
Additional views of lion. John E. Moss --------------------------------717
Digitized by the Internet Archive
FEDERAL REGULATION AND REGULATORY REFORM PART I
SECURITIES AND EXCHANGE COMMhISSION
FEDERAL TRADE COMMISSION
ENVIRONMENTAL PROTECTION AGENCY
FEI) ER TAL RE('LATIUN ANI) RI,'GULATOI1Y RIF'Il() I
TAB'L' (F CONTENTS
Regulation and its critics pag
Summary of conclusions and recommendations The subcommittee's study --------------------------------------------- 4
The subcommittee's report ------------------------------------------4
Important distinctions ------------------------------------------ 7
Previous regulatory reform studies------------------------------- 8
Ranking the regulatory agencies ---------------------------------------11
The top group ------------------------------------------------------ 11
In the middle ------------------------------------------------------12
At the bottom ------------------------------------------------------ 13
FEDERAL REGULATION AND REGULATORY REFORM
I NTRODUCTIO N
Forty-four years aco. ta great Anierican President described 1the Federal regulatl ory ager ac n "tribune of the peoplee" To somre, looking back across the years. thl)se words may seem a hollow promise. To this Subonumnittee, they represent a goal of this government and at staldard of aIchievenent; sometimes c(qualed, sometimes ignored. always i)etillOlt.
That standard, we believe, makes clear both the promise and the failure of FIederal regulation today. To the extent regulatory agencies have based their decisions on the broad public interest, they have often fulfilled their purposes. affording Americans better health, more competitive markets. essential information, and public protection against fraud and deceit. To the extent they have seen their role as representatives of special interests. promoters of narrow economic purposes, or servants of entrenched bureaucracy, they have not been tribunes of the people.
We have studied regulation and regulatory reform for many months. Our reasons for engaging in this extended inquiry are varied. As Members of Congress we are aware that our public service depends, in the final analysis, solely on the consent of the people we serve. Do our delegate agencies understand this as well?
As Members of Congress we or our predecessors have struggled to enact laws to improve the quality of life and redress some of the inequities in our system. How well have we succeeded ?
A M,,libers of Congress we believe we have a continuing obligation, throu1i legislative oversight, to measure against a permanent standard the performance of the agencies we have created.
In the several hundred pages of this report-and the thousands of pa jes of hearing anrl documents sul)pporting its con+1usion s ai(1 recomnendatio is- thle re..erl will find h'9 rsh words for Some Federal regulatory agencies and S-ome regulators. There are examples of agencies which have. we believe. intentionally failed to carry out the law. There are also examples of agencies, and individual Federal lmIiploYvees. who have been effective and have carried out their responsii liti aN more. There are tales of courage in these pages and in4to) 2ces of pure cowardice.
What we found most clearly is that regulation cannot be summed up in catch words, simple phrases. or rhetoric. It is a many-faceted process which has sometimes succeeded and sometimes failed. More important. regulation) is a dynamic process. like our government itself and like our ~oeiety. We find that regulation has changed over the years :mnd
continues to change even as we study it. If the Federal regulatory agencies do not meet the standard of achievement we have set-and many do not-they offer, at least, hope of improvement and a means for moving toward a just society. It is toward that goal that we have directed this study.
REGULATION AND ITS CRITICS
Attacks on Federal regulation have driven its image to an historic low. Though often self-serving, the criticism is useful. Reform of Federal regulation has become accepted almost universally as a critical need, reflecting intense concerns that cross party lines, that run deeply in both I-louses of the Congress, and that are shared by Congressional leaders with those in the Executive agencies.
Criticism of regulation nonetheless is characterized by contradictory arguments. Some urge a simplistic repeal of law, on the grounds that we are plagued with too much government and too much Federal regulation. Others look not to the quantity of regulation, but to its quality, asserting that the basic defect of regulation is that it reflects the interests in the industries regulated to the near exclusion of other legitimate interests. Still others cite failures of policy or structural deficiencies leading to cumbersome procedures and excessive delay.
Common to many of these critics is the assumption that government has lost touch with the governed and that bureaucracy is inflexible. Some, but not all, add that the regulatory agencies are responding, not to the. people, or even to special interests, but to their own need to survive.
To determine the true problems of regulation, their nature and extent, and possible remedies, the Subcommittee on Oversight and Investigations began its own study of the operations of Federal regulatory agencies in April 1975. It was appropriate for the Subcommittee to undertake this study because of its jurisdiction over a number of these. This report refers mainly to 9, including 6 independent regulatory commissions and 3 executive branch regulatory agencies: Independent commissions
Consumer Product Safety Commission
Federal Communications Commission
Federal Power Commission Federal Trade Commission
Interstate Commerce Commission
Securities and Exchange Commission LExecutive branch agencies
Environmental Protection Agency
Food and Drug Administration
National Hig'hway Traffic Safety Administration
Our policy, detailed below, was to look in depth at their performance, to assess the validity of congressional mandates and the quality of execution and especially to question whether regulation seemed to be serving a useful purpose justly and efficiently.
SU3IfARY OF CONCLUSIONS AND RECOMMENDATIONS
The Subcommittee finds that the primary goal in the reform of Federal regulations houh e to 0 iake regulatorY programs funct i more effectively on behalf of the consuming pu)blic. We also have coIneluded that regullatory refrn can be acoml ished only if approanIbi I ,agenCy-y-agency and progran-bv-)rograi:1 and not with anv swee)mng, aeross-the-boar(d olution. It is irriatioilal to sutlbject conol regulation and other types of regulations. in Aluding health safctv. anl c1nvironI1,ntial, to the same criteria an to the same so 1t iols. The process of reform is thus laborious, requiring full recognition of the complexity of the Federal regulatory processes.
Although we firmly believe that reform must proceed agenc-y-yagency, we have nonetheless identified certain common failings in the agencies studied.
All suffer from a critical defect, an insufficient response to the public they were created to serve. Our studies confirm earlier observations that the actions of regulatory agencies reflect more than anything else their primary attention to the special interests of regulated industry and lack of sufficient concern for underrepresented interests. Given the frequent communication between regulated industry and regulatory agencies, and given the cohesive structure of regulated industry, this finding should not be surprising.
The Subcommittee has concluded that, if durable change is to be accomplished, there will have to be fundamental adjustments in the political environment of regulation and new structures for increasing the accountability of agency actions to broad public interests. Regulation relating to health and safety, in particular, must not be biased by extraneous interference on behalf of special interests.
Our first set of recommendations is therefore directed at creating new structures and a political environment which supports rather than impedes regulation in the public interest by1. establishing new mechanisms of effective public participation, to offset the dominance of regulated industry in agency proceedings;
2. strengthening Congressional oversight to increase the accountability of the agencies to elected representatives of the public;
3. merging three important health and safety regulatory functions: vehicle safety, food and drugs, and product safety into a single commission to reduce duplication of functions, to insulate two regulatory programs from political interference associated with their location in the executive branch. and to strengthen accountability to the Congress;
4. reorganizing Federal energy regulation and information gathering in a single independent agency; (These regulatory functions should remain insulated from programs designed to promote the development of energy resources and research, public education, or advocacy associated with such promotion. These promotional functions should remain within the Executive Branch. Coordinated energy policy and planning functions would remain a necessary part of both an independent energy agency and an Executive Branch agency.)
5. increasing the openness of agency proceedings to facilitate public participation; and,
6. increasing the independence of regulatory agencies from executive dominance.
The second set of general recommendations is intended to increase the effectiveness and fairness of regulation by reforming existing agency practices. We propose that the Federal government1. eliminate weaknesses in the enforcement efforts of regulatory agencies by introducing improved and evenly applied sanctions;
2. improve the process for selecting regulators of high quality, and si iengthien conflict- of-i nterest laws and regulations governing their perfoimace on the job;
0. eliminate unnecessary delay and cumbersome procedures;
4. eliminate the misapplication of benefit/cost. analysis in rulemaking procedures; and
5. separate promotional and regulatory f unctions by removing promotional programs from independent regulatory agencies.
The Subcommittee recommends reduction of regulation by1. consolidating Federal programs in energy regulation and in safety and health regulation;
2. eliminating duplication and overlap in and between regulatory programs;
3. eliminating anti -competitive regulation unnecessary to the continued protection of the public; and
4. terminatingr individual regulations or regulatory programs determined, upon review, to be ineffective.
Finally, the Subcommittee recommends continued study and development of mechanisms to enable citizens to protect their interests more effectively both in and outside agency proceedings by1. restructuring Federal citizen class suit provisions or, in the alternative, establishing the right of a State attorney general to bring class
2. reforming the doctrine of standing to sue, to widen access of consumers to the Federal courts; and
3. increasing the role of small claims courts as a means of consumer redress.
These recommendations are described in f urther detail in chapter 17. Tn addition, recommendations addressed to individual agencies are set forth at the end of each of the chapters which immediately follow.
THE 51JBC03MMJT'1E IS STUDY
On April 20, 1975, Subcommittee Chairmnan John E. Moss anno-anced the commencement of a "comprehensive study" of Federal regulatory agencies. The study was to include an assessment of the independence, performance, and economic effects of the activities of regulatory agencies under the Subcommnittee's jurisdiction.
In June 1975, the Subcommittee sent to each of the nine regulatory agencies a detailed questionnaire covering such topics as history and goals ; staffing, procedures, and operations; planning and evaluation; 1Operations andl workload; outside sources of advice; public interaction; Office of Management and Budget (0MB) reviews; freedom of information activity; litigation capability; rulemaking; and, in the case of commissions, commission meetings, periods of service of
con Imi IiQ '111d !-rio}* andl slub'(jl1lelt eI1l)y~vncrit of cminiIL"
sionrs. s agMlcyFc~jOHSQ wer recivedin Jly,1975). t he tl coniiiwncell'(1d to alylze the dat a for tOlV e ficti y ir I h isue
and ostace30t ejieCtive regullation.
In Supteniber 191'., tbe )Subconn,, :1%evWi~ a p-int, enit Ifld "Ani
Economic Ev-aluatio n of the 0M'1B Ijw on 'lie C."ost, of 1',eg(ulation
and Restrictiv-e Prtactic S',* prepared 1)'v tI'la Office of Lcollonluc Analysis, U.S. General Accounting Tltc.- p ae~r vv-'a il res1)onse
to the P~resident's charge that llw coinibiikcd c(ust to coilstlhiirs of groverinent regulation and restricted pi)fltc~1es inl the piv ate s ector amounted to "soinetinig inl the order of $2,UO()00 per famiily." Th'le rei dent based this estimate on an 0MB paperr1 The General Accounting Office concluded:
In our opinion, OMB's summary of the cost of government regulation at $2,000 ier year for the average American faily has substantial shortcomings. The W![' compeundiumn does not provide a methodical structure for carefulfly alnalyzing- and tabulating the cost of government regulation....
The OMB does not make a clear distinction between the gross cost and tho net cost4 associated with government regulation. The gross cost of any undertaking is the total economic cost assoc iated with the project. Tbe ne(t cost.,:ee, are the residual that remains when an undertaking's benefits ar~e sub tr-aetif( from its gross costs....
The 0MB approach in this effort is akin to the hypothetical corporation. issuing an annual report which lists the corporate expense.; in its slimmary statement but neglects to report the corporate revenues.
In November 1975, the Subcommittee conducted hea-rin '-(v; jointlN with the Senate Committee on Com~merce and the CommitteeC On! Government Operations, addressing the issue of improving the (qualit y of ap)pointnis to regulatory agenTcies. These he7 earings togrethier wi,-th lwi'r effortsfQ Provide the basis for findi1*- in Chapter 1'2. Inl 1ecemiber 1975, thie Subcommitittee held a series of ineetinir v, wi :,,genIC-V ofjle-lals to review responses to thie qunestionnaire. to (i o~s 13i(5identifiedl~ in the questionnaire return akntd from other sou rce,to de~tif aeasof -urher information, needed by the Subcoininittee.
;~s cof i I S liearii :)2s on re, tu.]atory ref on, x piorl tr h i io.4
imotatisisof performnarce with a~rcl;cv' heIads. FYc'AoxV'mg1 the a'gency- hea,,L.riiios, the Subcommittee for 2 day's hoard testmon-v from public witnesses on agrency performance and on thie need for 1'ef(,rlm.
As the following chart Indicates, the budgets of the agencies studied Wz(exludng nonreg-ulatory functions) amount to less than one-third of one percent of the nul 'Flierail budget and have not grown significantly as a per.,-entage (if the total1 Federal buldget.
COMPARISON OF BUDGET AUTHORITY OF 9 REGULATORY AGENCIES TO TOTAL U.S. BUDGE-T
Comparison of budget authority 1971 1972 1973 1974 1975
9 regulatory agencies to total United States budget 1----- .I 052 1. 1111 2. S14 2. 125 2. 240
9 regulatory agencies, excluding nonregrulatory functions, to
tota-l United States budget ---------------------------- .221 .297 .3138 32 .322
Inflation during this period has averaged 7.5 percent annually.
The hearings covered a total of 28 days, receiving testimony from approximately 220 witnesses and compiling a record in excess of 3,500 printed pages. A number of issues left unresolved in the hearings were pursued subsequently with agency officials through letters, interviews, and, in two cases, extended investigation. The record of these hearings has been published with additional materials in six volumes which should be viewed as supplementary to this Report.
In August of 1976, the Subcommittee issued a print entitled: "The Number of Federal Employees Engaged in Regulatory Activities," a staff paper prepared for the Subcommittee by the Congressional Budget Office. The paper reports that the Federal government devoted 92,172 man-years of effort during fiscal year 1976 to activities defined by CBO as "regulatory." Under a refined definition, excluding positions not directly related to regulation such as public information, consumer education, legislative liaison, and research, the total is 84,773. Either total falls significantly short of recent claims that there are more than 100,000 regulators employed by the Federal government. In a letter of transmittal accompanying the report, Subcommittee Chairman John E. Moss noted:
The 84,773 figure is small compared to the total number of Federal workers. 4,561,400 persons are employed by the Federal government according to the President's proposed 1977 budget. Thus, about 2 percent of all Federal employees are directly, but not exclusively, involved in regulation. Approximately 45 percent of all Federal workers are in military uniform. The 84,773 figure is also small compared to persons employed by one of America's leading manufacturers, General Motors, which now has 756,000 persons on its payroll.
Ijn addition to the questionnaires, meetings, hearings, and studies, several papers have been prepared for the Subcommittee by Congressional Research Service and by the General Accounting Office.2 Moreover, Members of the Subcommittee and its staff have spent hours at the agencies themselves, interviewing, attending meetings, and studying information and materials made available by the agencies.
THE SUBCO.MITITTEE S REPORT
From the several possible approaches to writing a regulatory reform report, the Subcommittee chose to study directly the performance of the regulatory agencies. This performance is measured principally
2 The Subcommittee utilized the following Congressional Research Service, Library of Congress, reports:
(a) "Issue Paper on Economic Impacts of Commission Regulation," Douglas N.
Jones, Economics Division, June 1975.
(b) "Regulatory Agencies: Their Organizational Status and Political Accountability," Ronald C. Moe, Government and General Research Division, September 1975.
(c) "Executive-Appointments in Independent Regulatory Commissions," Ronald C.
Moe, Government and General Research Division, October 1975.
(d) "Major Consumer/Public Interest Issues Facing the Nine Regulatory
Agencies," various authors in Economics Division, December 1975.
(e) "Independence of Federal Regulatory Agencies," by Stuart Glass, American
Law Division, August 1976.
(f) "The Authority to Conduct Litigation on Behalf of Federal Agencies: The
Relationship of the Justice Department to Independent Regulatory Agencies," Robert
D. Poling, American Law Division, June 1976.
The subcommittee utilized. in particular, the following General Accounting Office reports:
(a) "Financial I)isclosure System for Employees of the Food and Drug Administration Needs Tightenin-." FPCD-76-21, Jnnuary 19, 1976.
(b) "Use of Cancer-Causing Drugs in Food-Producing Animals May Pose Public
Health I-Tanrd: The Case of Nitrofurans." MWID-76-85, Feb.-uary 25, 1976.
(c) "Review of EPA Monitoring of Auto-Exhaust Emission Controls of Vehicles
Actually on the Road," to be published in October, 1976. Presented as testimony on April 7. 197f, printed in Regulatory Reform Hearings before the Subcommittee on
Oversight and investigaltions, .4th Cong., 2d sess., vol. V, p. 3 et seq. (1976).
A complete list of all GAO Reports on the regulatory agencies is contained in Appendix B.
against the mandate assigned to each agency by the Congre s. The next nine chapters each begin with a description of an agency 's current statutory responsibilities. In setting forth each agency's responsibilities, the Subcommittee has emphasized the components of its authority which are intended to protect the public or serve the public's interest.
The analyses and case studies which follow the description of each agency's responsibilities serve several purposes:
-to determine on the basis of the agency's experience the appropriateness of the law and the need for amendment or repeal;
-to identify achievements and failures as signals for possible
recommendations of exemplary performance or reform; and
-to explore systemic weaknesses, such as structural defects in
public representation or enforcement procedures, the process of recruiting and selecting qualified personnel, or the provisions for
planning and evaluation.
Chapter 11 analyzes the relationship between the agencies and the Congress.
Four systemic problems affecting all regulatory agencies are explored in chapters 12, 13, 14, and 15:
-weaknesses in the current system for selecting and appointing
commissioners, administrators, and other high level regulatory
-methods of assuring consumer participation in agency proceedings;
-overlapping, conflicting, and duplicative regulation; and
-use and misuse of benefit/cost analysis.
Chapter 16 explores some alternative approaches to improving regulations.
The Subcommittee's general findings and recommendations are offered in chapter 17. It is followed by a set of appendices, including summary data from agency responses to the Subcommittee's questionnaire of June 1975 and to further inquiries.
The Subcommittee's study rests heavily on a distinction between
(a) economic regulation and (b) regulation designed to protect the public from health and safety hazards. Although some economic regulation must be retained in sectors of the economy where competitive forces do not function (as in the production and sale of oil and natural gas), the Subcommittee looked for opportunities to reduce economic regulation. We found several to recommend, as reported in the final chapter, but some agencies ripe for reducing regulations, such as Civil Aeronautics Board and the Federal Maritime Commission, are outside the jurisdiction of the Subcommittee.
In contrast, the Subcommittee concluded it is necessary to strengthen health and safety regulation, particularly to guard against undetectible or unavoidable hazards, such as the alarming buildup of cancer-causing agents in drinking water, food, and air.
The study also draws a distinction between the 6 independent regulatory commissions and the 3 executive branch agencies. The distinction proved important in assessing White House personnel
policies, the role of the Office of Management and Budget, and the (llestion of the relationship between the agencies and the Congress.
Finally, the study took into account differences between agency decisions resulting from a process of rulemaking and decisions using cumbersome adjudicatory proceedings. This distinction is important in assessing, for example, the activities of the Federal Trade Commission. Within rulemaking, a further distinction is necessary, between formal (on-the-record hearings, providing cross-examination, etc.) and informal (notice and comment) proceedings. This latter distinction applies particularly to health and safety regulation, as reflected in the Subommittee's general conclusions.
PREvIOUS REGULATORY REFORM STUDIES 3
Concern for reforming Federal regulation is not new. Efforts to reorganize Federal regulation have arisen in every Administration over the past four decades.
A pattern has been established: a major study is undertaken, a report is published, and reform proposals are offered. The first report was issued in 1937 by President Roosevelt's Committee on Administrative Management, known as the Brownlow Committee. The report charged that the independent regulatory commissions were a "headless fourth branch" of government.
The independent commissions present a serious immediate problem. No administrative reorganization worthy of the name can leave hanging in the air more than a dozen powerful, irresponsible agencies free to determine policy and administer law. Any program to restore our constitutional ideal of a fully coordinated Executive Branch responsible to the President must bring within the reach of that responsible control all work done by these independent commissions which is not judicial in nature. That challenge cannot be ignored.
The Committee recommended that the commissions be abolished and their functions be distributed among the departments. Once relocated, the functions would be divided between an administrative section directed by a single administrator and a judicial section that would remain independent in the making of regulatory decisions. Few results can be traced to the recommendations emanating from the Brownlow report.
The first Hoover Commission (1947-1949) conceded that the regula tory (01 fli~sjioPs had a rightful place in the ,oliital :ystei but d & nei'al "aled to liv- ill) to original expectations. Its' reconimendations tended to be colteerned with structure rather than subs'tance and were modest in scope.
The Hoover Commission argued that the regulatory commissions would be more effective and efficient if the administrative responsibilities were vested in the chairmen. The Commission noted also that there was little coordination between the commissions and the agencies in the executive branch with similar regulatory responsibilities. The Commission therefore recommended that there be established an Administrative Management Director in the Bureau of the Budget to "suggest ways and means to improve and thereby reduce the cost of disposing of business before administrative agencies."
3 "1 1 qcti.on is b:wved in J)art on a section entitled "Government Studies" in Moe, "The of!ernl Regulptory Agencies: Congress Studies Their Future," Government Division. Con. gressional Research Service, Library of Congress (Issue Brief Number 1B75042, Updated 1iine 9, 1976).
The report of the second Hoover Commission (19,-1,,,) suported the concept of an integrated legal staff within agencies under a General Counsel. improving internal procedures and separating where possible the judicial and executive functions of administ rative agencies and increasing the independence of hearin examiners. The Commission also recommended an administrative court to try cases then handled by administrative agencies, and not a speciahlized court to review actions of administrative agencies. No significant changes in the organization and functions of independent regulatory comissions resulted from this Commission and its report.
Both the Kennedy and Johnson Admini.-trations eSehewedl large public studies of governmental organization comparable to the earlier Hoover Commission. In 1960, President-elect John Kennedy requested James M. Landis to write a report on regulatory commissions and to suggest methods to improve the operations of these agencies. Landis proposed that the administrative powers of the chairman of the respective commissions be enhanced and that staff positions be made more attractive by delegating authority. He further suggested that regulatory policy formulation come under Presidential guidance to insure uniformity, such guidance to be provided by the establishment of several otices in the Executive Office of the President.
During this period, studies of regulation wo -,e pursued also by several committees of the Congress. Noteworthy among these efforts was the 1959-1960 investigation of the independent regulatory commissions by the Special Subcommittee on Legislative Oversight, a predecessor of this Subcommittee, under the Chairmanship of Oren Harris. During the 86th Congress. the Subcommittee held 52 days of hearings. "to examine the execution of the laws by the administrative agencies administering laws within the legislative jurisdiction of the parent committee, to see whether or not the law as the Congress intended in its enactment has been and is being carried out or whether it has been and is being repealed or revamped by those who administer it."
Included were hearings on television quiz shows and ex parte contacts in proceed(lingrs of the Federal Power Conmmission. The Subcommittee report, issued on January 3, 1961, included a compilation of the Subcommittee's recommended actions. It urged. for exa mlle. that all commissions:
(a) Review their investigatory procedures to insure that there shall be less reliance upon Information derived from the regulated industry or other interested participants in proceedings before the commission and more reliance upon the independent investigatory results of the commissions themselves. This is particularly important In the field of granting licenses, renewals, and exemptions from regulations; and
(b) Establish and publish procedures setting forth the manner in which complaints by the public against practices of companies regulated by the commission will be handled...
It also recommended to Congress that:
Provision should be made for administrative and civil sanctions and procedures whereby a commission can effectively enforce the statute and its own rules and regulations. Violators presently know that they can keep the fruits of their violation and go scot free because the drastic nature of existing sanctions prevents their effective application or because the cumbersome procedure for enforcing existing sanctions or penalties make them of no practical effect. . .
The custom of writing reports on wholesale governmental ormanization was resumed during the Nixon Administration. In 1971. three
reports were issued by the President's Advisory Council on Executive Organization, the Ash Council. Two concerned executive departments and one dealt exclusively with independent regulatory commissions.
The underlying theme of the report on the independent commissions were not sufficiently accountable to either the President or the Congress.
Insofar as these commissions could be brought under Presidential guidance for purposes of policymaking, the President's Advisory Council argued, Congress would also be a beneficiary since such an arrangement would enhance the oversight function.
Trhe regulatory commissions were viewed by the Ash Council as being essentially ineffective and unable to respond well and in a timely fashion to economic, technological, and social changes. This apparent inability to adapt to changing conditions was attributed by the Council to three factors: "collegial organization, the judicial cast of agency activities, and the misalignment of certain function responsibilities."
The Council recommended a major restructuring of the independent regulatory commission system.
To assure coordination of regulatory matters with national policy goals, to improve the management efficiency of regulatory functions, to improve accountability to the Congress and the executive branch, and to Increase the probability of superior leadership for regulatory activities the transportation, power, securities, and consumer protection regulatory functions should be administered by a single administrator, appointed by the President. These functions should be performed by agencies respectively designated: Transportation Regulatory Agency, Federal Power Agency, Securities and Exchange Agency, and Trade Practices Agency.
In short, the Interstate Commerce Commission, Civil Aeronautics Board, and the Federal Maritime Commission would be combined within a new Transportation Regulatory Agency. The promotional subsidy-granting activities of the Civil Aeronautics Board would be transferred to the Department of Transportation. The Federal Trade Commission's consumer protection responsibilities would be vested in the Federal Trade Practices Agency while its antitrust enforcement responsibilities would be vested in a new Federal Antitrust Board, the latter to consist of a chairman and two economists, each appointed by the President with the consent of the Senate. Finally, the responsibilities of the Securities and Exchange Commission under the Public Utilities Holding Company Act would be transferred to the Federal Power Agency.
The Federal Communications Commission was specifically omitted from this list of plural-member commissions which were slated to 1 come single administrator executive agencies. The changes and reforms directly attributable to the Ash Council report were negligible.
Tbe Landis and Ash reports were written primarily from the perspect ire of the Execitive Branch. What distinguishes this Subcommittee's study is that it is based on a detailed review of the operations of nine agencies. In addition, its focus is on the accountability of regulatory agencies to the Congress which created them and the need to create structures for increasing the responsiveness of agency decisions to the public interest and to consumer interests. A concurrent regu-
Iatory Ieform stdlly, conducted ( tle ;la0t ( 01o1ilit tee oil ( 1oil1meOce a11d GOvenOilent Operatilns ullndr the 0 101oitv of Seinte Resolution 71, is scheduled for completion in eaIly 1977.
RANKING THE REGULATORY AGENCIES
The Subcommittee has ranked the nine regulatory agencies under its juris(lictio 8 11 lea s pall V I le (i f ltbee y (Ill0 of
these 11mWSe aS Viwwed II I the lii1t(1of thiis i'io iti. 010 S Ilwoii imilttee's- hteariiigs, anid theC resjponses' to the 411hconlrnlt tee wS 111 te 1197questionnaire. The nine agency chapters of this report are arranged according to this ranking, with the Securities and Exchange Commission placed first and the Federal Power Coniniission 1ist. Criteria used in this ranking include the following aspects of agency performance: fidelity to public protection mandate defined hy Congres: quantity and quality of agency activity; effectiveness of agency enforcement programs: and quality of public particip1t ion.
Judged by these criteria, the nine agencies fall into three di-tinct groups. In the top group are thc, Securities and Exchange Commission. the Federal Trade Commission, and the Environmental Protection Agency. Four agencies occupy positions in the middle: the National Highway Traffic Safety Administration, the Consumer Product Safety Commission, the Federal Communications Conmuission, and the Food and Drug Administration. At bottom, some distance from the others, are the Interstate Commerce Commission and the Federal Power Commission. The Subcommittee attaches less significance to ranking within each group than to placement in one group or another.
THE TOP GROUP
In the first group. the Securities and Exchange Commission and the Federal Trade Commnission have both benefitted froT recent congressional efforts at reform. Reform efforts at the Federal Trade Commission which pre-date the Magnusn-Moss Warrainty-Federal Trade CommiQ'ion Improvement Act of 1974 have accelerated Over the past several years. as demonstrated by use of the authority now rooted in statute to issue substantive "trade regulation rules." The Commission has begun also to consider major antitrust and consumer protection problem areas including investigations and complaints directed at anti-competitive conditions in the petroleum cereal, and automobile industries. Since the FTC reorganization during the euIv 1970's, the agency has been able to attract well qualified profesSionals and has become much more effective in its work.
The Securities and Exchange Commission has m:aintained consistently vigorous enforcement efforts over the past several <1ee:i1e=. It has attracted qualified leaders to the commi sion an<1 to its staff. Its courageous handling of the ongoing investiat ion of illegal corporate payments is commendable. Its resistance to White House efforts to install politically favored employees should be a model for all agencies.
The SEC's response to the Subcommittee's 1975 questionnaires. consistinlI1 of extensive essTays corposed specifically in response to the
questions, proved more helpful to the Subcommittee than the responses of any other agency. Althouigh s r" room exists for improvement in the Comuission's response to the 1975 Securities Act Amendments, the agency's ability to change its orientation and develop new programs is encoiiraging. Sucggrestions for further improvement are outlined in the SEC chapter.
The Environmental Protection Agency, like the Federal Trade Cornmission, has been able to attract a large number of well-qualified individuals. Operating frequently under tight statutory deadlines, the agency has made a good start at establishing programs for protecting the environment. When the agency has fallen behind schedule, environmental advocates have not hesitated to sue. As a result, the agency is now working under court order in shaping a number of its new programs. Despite significant failures, two of which are detailed in the EPA chapter, the agency is establishing itself as a formidable force in improving the environment. On occasion, EPA has displayed political courage in standing up to efforts by the Office of Management and Budget to undermine its programs. The agency also proved itself to be remarkably open to the numerous inquiries of this Sibommittee.
IN THE MIDDLE
In the second group of agencies, The National Highway Traffic Safety Administration, whose motor vehicle safety standards program began aggressively in 1966, has fallen into a period of minimal productivity in the past 5 years, as measured by its output of new vehicle standards. It has been unable to overcome continued intervention by other executive branch offices and the Congress, some clearly at the behest of reguiflated industry. NHTSA has needlessly tied itself in knots, partly in response to pressure from the Council on Wage and Price Stability and the White House, by performing benefit/cost studies which prove little and are not required by law. To its credit, the agency has held fast to its truck brake and bumper standards and has continued to support passive restraint systems, despite intense pressure to drop the idea. NHT A is also able to claim part of the credit for the dramatic drop in the annual rate of fatalities on the Nation's highways.
The Consumer Product Safety Commission, newest among the regulatory agencies, was provided in 1972 with a mandate reflecting several of the reform measures now being urged for other agencies. The CPSC commenced operation in 1973 amidst expectations that it would soon develop into an aggressive cost-effective regulatory agency. Its performance to date has been disappointing. The agency has fumbled over arranging its priorities, run into complex problems in seeking to maximize public participation, and delayed launching an effective enforcement program. A definitive judgment on the Consumer Product Safety Commission will be possible only after its basic programs, including the prompt issuance of product safety standards, have had more time to operate.
Both the Federal Communications Commission and the Food and Drug Administration have been struggling to revise deeply rooted patterns of over-reliance on the industries they regulate. The Federal Communications Commission has shown signs only recently of loosen-
ing its close relationship with broadcasting and telephone iiadut ries. It has begum to encourage competition in the sale of telephone equipment and has opened mIore of the television market to cable television.
The Food and Drug Administration saddled with a panoply of advisory groups heavily weighted toward the regulated indust ry, and adroit at using the device of non-decision to "resolve" impI)ortant policy questions, seems to be awakening somewhat to its public protection mandate, but at an extremely slow pace. Its response e to oversight has been good, but lasting improvement, by such means as effect ive use of its imminent hazard suspension power (for hazardous foods. drugs, and devices) remains to be seen.
AT THE BOTTOM
A quantum jump downwards separates thle Interstate Commerce Commission and the Federal Power Commission from all others. The infusion of talent that has lifted the performance of some agencies. such as the Federal Trade Commission and the Environmental Protection Agency, has seemingly passed the ICC and the FPC by. The oldest of the independent regulatory agencies, the Interstate Commerce Commission, was studied primarily regarding its railroad regulating functions and its enforcement program. The Subconmmnittee does not have jurisdicition over motor carriers. IIhile the Commission did ultimately respond to Subcommittee hearings regarding its enforce:nent program, the response was slow.
The ICC remains mired in confusion over its appropriate regulatory function. It persists in enforcement actions directed at relatively trivial violations to the exclusion of violations with broader public import. We see reason to hope for a brighter future in the Commission's Office of Rail Public Counsel. potentially a prototype for an effective form of public participation in proceedings of all regulatory agencies.
The Federal Power Commission takes the cellar position because of its overt disregard of its congressional mandate. Specifically it has refused to maintain a program of "just and reasonable" natural gas prices consistent with its governing statutes and applicable court decisions. It has acted without sound evidence. It has not enforced the delivery of natural gas supplies to consumers. The Federal Power Commission has displayed a conscious indifference to the public beyond comparison with any other regulatory agency. The Subcommittee believes that this agency is in line for a major overhaul by the Congress.
rEI)ERAI liTG 1 ULATIION ANI) REGULATORY RFIF'OIt\1
SECURITIES AND EXCHIANGE(,(omssw
TABLE OF CONTENTS
I. Summary 17
II. Mandate 18
A. Introduction -------------------------------------------- 18
B. The Securities and Exchange Commission and its public protection responsibilities ---------------------------------- 21
III. Case studies ---------------------------------------------------24
A. SEC review of off-board trading rules -----------------------2
B. The SEC and corporate accountability ----------------------29
C. White House personnel practices at the SEC -----------------42
IV. Securities and Exchange Commission resources -------------------- 48
A. Increasing magnitude of SEC responsibilities ---------------- 48
B. SEC budget: 1973-77 -------------------------------------49
V. Conclusions and recommendations ------------------------------- 51
A. Off-board trading ----------------------------------------51
B. Corporate accountability -----------------------------------51
C. White House personnel practices ---------------------------- 53
SECURITIES AND EXCHANGE (m O3IzissioN
I. Summary *
The Securities and Exchange Commission (SEC) has responsibility for implementing and enforcing the Federal securities laws. The statutes are the Securities Act of 1933 and the Securities Exchange Act of 1934. These provide for financial disclosure by companies whose securities are traded publicly and for regulation of the Nation's securities markets. The Securities Acts Amendments of 1975 confer on the Commission additional major responsibilities requiring it to play a much more active role in economic analysis and policymaking in the securities markets and facilitate establishment of a national market system and various related market mechanisms. The Commission is to use its authority to assure that present markets are eompetitive and that they permit development of a national market system. The purposes of the 1933 and 1934 Acts remain unchanged: to protect the public interest and public investors and to maintain fair and orderly trading. The 1975 Amendments. designed to achieve significant reforms, add: to foster fair competition by removing unnecessary regulatory restrictions and removing obstacles to competition.
Under the 1975 Amendments, the SEC has a mandate to reexamine exchange rules restricting the ability of member firms to effect trades otherwise than on exchanges. The Commission has been slow to perform that duty. It abrogated portions of these anticompetitive rules effective one year after the issuance of its order, and it has made no commitment to do anything about the remainder of the rules.
Underlying the episodes of illegal and questionable corporate payments, disclosed largely through the SEC's enforcement and voluntary compliance programs, is a significant failure of corporate accountability. In pursuing innumerable instances of such improper corporate payments and accounting practices, the Subcommittee believes the Commission and its staff have functioned admirably and in a highly professional manner. Nonetheless, the Commission bea rs some measure of responsibility for not having exercised its standard-setting and enforcement authority earlier regarding accounting practices.
The Commission has shown commendable resistance to political hiring pressures despite the practice of the White House Personnel Office of making politically motivated referrals to the SEC and insisting upon clearance of candidates appointed to SEC positions which are not In the competitive -ivil srvi O syvte1.
Depite important new responsibilities, the White House Office of Management and Budget (OMNIB) imposed severe restrictions on the Commission's budget. For fiscal year 1976, the Congress authorized $51 million, based on the SEC's best estimate of what would be needed
Much of the information contained in the background statement about the SEC idrawn from material supplied by the Commission in response to the Subcommittee's June 1975 questionnaire. The Commission's responses to selected Subcommittee questions arsummarized, along with those from other agencies. In Appendix A to this Report.
to iniplemient the new law. Only.$49.3' million was appropriated. The OMB disallowed all requests by the SEC for supplemental staff positions needled for implementation n of its new securities laws responsibilities. For fiscal year 1977, the Congress authorized $55 million which the 0M.NB cut to $53.1 million. The practical effect of these cuts is even greater than appears. At a time when securities registration statemnents, tender offers, and other financial reports have increased, the SEC found it necessary to transfer 35- employees from the Division of Corporation Finance, which reviews such financial reports. 'Moreover, despitee the budget cuts, both the Divisions of Corporation Finance and Enforcement have been required to engage in unanticipated enforcemnent actions due to illegal and questionable corporate payment cases. MN. ore than 200 corporations have disclosed such information voluntardly to the SEC and 20 formal enforcement actions have been brought.
The Subcommittee recommnends': (1) that the SEC promptly implement the law with respect to anticompetitive off-board trading rules, or request (with appropriate justification) that Congress amend the law.
(2) To restore confidence in the system of corporate accou 1nt ability and to protect the public interest and public investors, the SEC should require to the maximum extent practicable uniform accounting principles and auditing standards, assure that certified public accountants are effectively independent of the corporation being audited, and enforce the corporate disclosure requirements of the Federal securities laws stringently.
(3) To neutralize the effect of politically motivated referral of candidates for SEC employment, whatever the source, it is recommiended that the SEC place all referral documents in a file available for public inspection. Also, no staff positions should require a partisan political commitment within the SEC (or any other independent regrulatory commission). Staff positions outside the competitive service should be only those legitimately involving a, confidential or senior advisory position relationship with the cominission; even in those cases, there should be no political clearance.
The Securities and Exchange Com-mission, perhaps the most prestigious of the independent regulatory agencies, has come to a crossroads. The agency and several of the fundamental statutes which it administers were direct products of the speculative boom of the iRoaring, Twenties and the ensuing Great Depression. As bankruptcies exposed abusive corporate financing and trading practices and aplpallincr losses to individual investors and the American public, Presiident Franklin Roosevelt and the Congress responded with the Securities Act of 1933.' With its strong emphasis on disclosure, the Act can be viewed as a corporate Freedom of Information Act for nwestors. Its sponsors believed that by requiring appropriate disclosure, purchasers of new corporate issues, could protect themselves from the abuses which had proved so costly in the recent past. Since
1 15 U. S.C. I 77a et seq.
the craion, f thIe I onI __j(l )O t -d&I pa;1g Iftb tle
Federal Trd oiunso a u utdwth t1, li aI 1111: ratlfl (R41
of 19,'-1 crete ek 1 ls Act l Ixtend 1d t lie I C I' I' Ih eoprt,
disclosure, prinicilIde. 1\Wh ere thI e Secul Ir*1ties Ac-t hI ize o ni
and updated diselosiu'e through ,_(h I'eport. to be filed wif h thew SEC. Itak
holel .III general. everyv-), >1 l~do iaeho l01 P()ot 1,1 11 il-l (s QI eeywas aIssured ac~sto ieev:1iit iiitoi'iiiat iol t L()protect 11iiiiielf to tOe -aIlel extent I,-wa thle firs-t purch,,Iaser of thle -(ecu!ritv.
The original Coinmis-sion was fortun1ate to hjave, hadl aijpiit( (I
exceptilonalIly able mneibers who11 engagWed a staff both dedic1(ated a,,d able. Former conmissiofler- iiiclude formeri Supremef C ourt Ju1-Iti(Io Williami 0. D~ougrlas, Judge)(, Jeromei N. Frank, Jawies LaniIs, and~ Judge Ferdinan-d Pecorra. liv1w immediately set about enfor-ing- dhe
niew Federal securities laws strictly, and they devied mneaisures to make thle adin~istrati ve process effective. Opinion is virtually uniaiuimnous that they- were largely succes-sful in both respects.
The Comins ~sionl's responsibilities were enlarged by the Pubhlic
Utility Holding- Company Act of a9,, the Investment Company Act of 194O,4 and th e Investment Adv-isers' Act of 1940.5 These added new responsibilities to the SEC's l'iniay efforts. During World War IT, its work became less visible. In addition to the much more immediate worldwvide problems en ga ginar public attention, the SEC's work ge somewhat more specialized ,6 and the offices of the Commission were moved from Washingoton, D.C. to Philadelphia.
After the war, the Commission returned to Washington. During thep 19,50s. the SEC broadened its protection mission to include sellers ats well as buyers, 7 but no fundamental changes occurred in its duties and operations.
.There were, however, significant shifts in the securities business during the 1960s. The markets experienced unprecedented gains in both volume of equities traded daily and their turnover rate (liquidity). The delay by brokerage firms and the.New York and American Stock Exchanges in innovating and introducing modern financial and operating practices appropriate to this avalanche of orders led
'1 US.. 7a t eq
2 15 17.S. C. I 79a et seq.
4 1.5 U.S. C. I 80Oa-1 et seq.
515 U. -. C. I 80b -l et seq.
Is The Commission describes, In part, its activities during this period as follows:
"The reorganization of the electric and gas industries was a Herculean task In which the Commission facedl and solved with a great measure of success:
1. Many complicated problems of Industrial structure akin to those that confront theourts; in antitrust cases, for the Holding- Company Act Is In large measure a specia!!ized antitrust statute;: and
2. Tutricate ,ind novel riuestionq of eniiitv andl crpmriton law eenrd ytlhe need to determine who was entitled to what In these holding cornp any breakups4."
R~- Tion--: of The1 cou ri t ie ( and:, 1( E X P1lan P C, 'MmT1i <,4ion to Quest ion 1 [,to th- Subco-1 mittee's Jne 197r5 Que.,tlonnairel, p. 43 unly 25, 1975).
* when wvartime proszperity and the reviviIng pros-pects; of once;-depressed, compainies created a new tyroe of investor--victim. ri:., the (lefraudedI Rriler overreached by ncr I)icr wo ?Ik I 1neT -w ,illI aho11t ther-i r com P iInie newly-fou-ndIrr rihe and! fm1 T 11- T Tc I prospecl-z. T'1in~ Itsz bro;ad adiitaiepwor.s to define frxiud under Othtsat. the Commiissqon late In 1942 promulgated its now famous Mule 10h-5 which bne fraudulent. deoeptive, andl manipuilativ.e acts that victirnh'ed sellers ais well as tho-e T'-" victimized huyr< idat 47 .
directly to "...the most prolonged and severe crisis in the securities industry in forty years." 8By the time computers were in place, an extended bear market had set in. Brokerage firms, including some major New York Stock Exchange firms, went bankrupt; others were so shaky that the NYSE "suspended" net capital and other rules.
One of the most serious aspects was the so-called Paperwork Crunch, involving daily handling, clearing and delivery of millions of pieces of paper. It was exacerbated by ar~ehaic practices in clearing securities transactions, transferring record ownership, and safeguarding securities and funds. ITncler the increasing pressure of ballooning' trading volume, it was inevitable that these serious flaws would become plainly visible.
In addition to the failure to use advanced technologthmaks
experiencedl a major shift in public investment patterns as institutional investors (e.g., pension funds, bank trust departments, insurance companies, and mutual funds) trading huge blocks of shares became dominant. Various sweetheart, give-ups, and other highly questionable reciprocal commission rate deals offered by brokers to institutions focused attention on brokers' fixed commission rates. These and other problems prompt ted intensive reviews of the SEC and the securities industry by both Houses of the Congress and the SEC. Four years of legislative study and hearings by the Subcommittee on Commerce and Finance of the House Interstate and Foreign Commerce Committee and by the Subcommittee on Securities of the Senate Banking, Housing, and Urban Affairs Committee culminated in the Securities Acts Amendments of 1975,9 a searching and detailed series of amendments to several of the acts administered by the Securities and Exchange Commission but primarily to the Securities Exchange Act of 1934.
One of the primary thrusts of these amendments was to promote more effective competition in the securities markets. The SEC was directed to eliminate anticompetitive rules of the exchanges and the National Association of Securities Dealers (NASD), designated as self-regulatory organizations. The SEC also was directed: ". having due regard for the public interest, the protection of investors, and the maintenance of fair and orderly markets, to use its authority under this title to facilitate the establishment of a national market system for securities. .." "
Whereas the SEC saw its basic function prior to 1975 as securities market regulation, disclosure of corporate financial information, and suppression of fraud, the SEC now mnust actively assess the economic consequences of the securities market structure and practices, including the use of current technology and the degree of competition;" after ha-ving appraised alternative solutions, it must take a nmuch more affirmative, role in implementing remedial action. Ini addition to its charge to "facilitate the establishment of a national market system," it must review and approve all rules of exchanges (rather than, as
13 IS.E.C.. Letter of Transmittal, Study' of Unsafe and Unsound Practices (December 28, 1971).
9 P.L. 94-29, approved June 4, 1975.
10 Section 1.A (a) (2) of the Securities Exchange Act of 1934 (as added by section 7 of P.L. 94-29), 15 U.S.C. 78k-i.
n115 U. S.C. 78k-1 (a).
previously was the case, merely failing to disapprove new i les) ,2 Thus, the SEC is to provide leadership ill fashioning new trading mechanisms. Whether it can carry out its new responsibilities ill tle economic sphere as well as it has done in the past with respect to miore limited legal regulation remains to be determined.
B. THE SECURITIES AND EXCHANGE COMMISSION AND ITS PUBLIC PROTECTION RESPONSIBILITIES
The Securities Act of 1933 is based on the premise that if the public investor is assured of receiving relevant information about corporations, the securities of which were being publicly offered, he can protect himself and make appropriate investment decisions. The statute requires a corporation to file a registration statement for approval before its securities are offered for public sale. To carry out the Act, Congress granted authority to prescribe accounting standards, principles and practices as well as the form and content of registration statements and other public filings. The Securities Act also makes unlawful, in connection with the offer or sale of any security, fraudulent or deceptive statements or practices, regardless of whether the security is otherwise exempt from the provisions of the Act. Enforcement is supported by civil and criminal peli&s for violation of these antifraud provisions, and the SEC is authorized to seek injunctive relief.
Even before enactment of the Securities Act of 1933, however, it was recognized that additional legislation would be needed. Protection of the purchaser through disclosure of information in connection with subsequent sales and resales, i.e., ongoing trading in the securities could not be achieved under the first statute. Congress thus passed the second of the major securities laws, the Securities Exchange Act of 1934.14
The Exchange Act, in section 4, created the Securities and Exchange Commission, composed of 5 commissioners, appointed by the President and confirmed by the Senate. Section 4 specifies that no more than 3 may be of the same political party, and ". . in making appointments members of different political parties shall be appointed alternately as nearly as may be practicable." Additionally, the Commission was authorized to "appoint and fix the compensation of" officers, attorneys, accountants and other experts as may be necessary. At the same time, the Exchange Act transferred all functions of the Federal Trade Commission under the Securities Act of 1933 to the SEC.
The Exchange Act also extended the scope of corporate disclosure initiated by the Securities Act. Accordingly, the SEC imposed requirements of continuing disclosure and, as authorized, required periodic reports and disclosure of material events, such as trading by insiders. These provisions, always important, provided the statutory underpinnings for the SEC's voluntary compliance program and enIs Section 19(b) of the Securities Exchange Act of 1934 (as amended by section 16 of P.L. 94-29). 15 U.S.C. 78s(b).
z 15 U.S.C. I 77a et seq.
14 15 U.S.C. I 78a et seq.
forcement actions pertaining to illegal and questionable corporate payments. However, these disclosure provisions do not apply to all publicly owned corporations.15
The Exchange Act provided clear and direct authority for the Commission to regulate the functions and mechanisms for trading securities. It required registration of brokers, dealers, and exchanges directed the SEC to oversee many of their practices; and imposed sanctions for improper conduct. There was also additional antifraud and manipulation strictures applicable to the various securities markets and additional civil and criminal penalties for violations of the statute or rules issued under it.
In 1935. the Commission's responsibilities were broadened by the Public Utility ITolding Company Act,"' a reaction to the concentration of control by pyramidal holding company structures which had subjected a very substantial portion of the country's publicly owned utiititcs to a small nuala er of strategically placed operators. The Commission was given broad authority to regulate these holding com,,ies and simplify their structure. The SEC was given no authority with respect to the operations of the utilities, their rates, or the availability of service, responsibilities which at the Federal level fall to the Federvl Power Commission. The SEC merely scrutinizes the corporate andJ financial structure of the holding company, a task outside the jurisdict ion of the Federal Power Commission.
The statutory responsibilities of the SEC have been augmented since those early years. For example. under Chapter X of the National Bankruptcy Act of 1938,1 it advises the court in certain bankruptcy matters, althoulrh it hlis ro direct administrative responsibilities. The TIrust Indenture Act of 1939 directs the Commission to require disclosure with respect to debt securities. This requirement is analogous to the Securities Act requirement for common stocks and other equities.
The Investment Company Act of 1940 s may be viewed as a generalization of the congressional concern evidenced in the Holding Company Act. An SEC study of the investment trust industry found that pooled-resource investment companies were being operated in a way which subjected shareholders to enormous risks, while providing large benefits to their managers.9 Abuses ranged from larceny and embezzlement to misusing investors' funds and self-dealing with (loans to and purchases from, etc.) insiders. It was against this background that the Investment Company Act was passed, requiring registration with the Commission and disclosure to the Commission and stockholders. It made various management practices criminal violations under Federal law and strictly regulated actions by insiders with respect to the activities of investment trusts. Companion legislation, the Investment Advisers Act of 1940,20 provides for registration of professional securities advisors.
a Indeed, it is the fact that these disclosure provisions do not reach all corporations doing business abroad which has been cited by the Administration as a reason for additional legislation and another agency to administer the reporting program which would be aptlicable to companies doing business in foreign countries. 31 15 U.S.C. 79a et sea.
I 11 U.S.C. 572. 608, 665.
I 15 U.S.C. 80a-1 et seq.
1 Securities and Exchange Commission, Report on Investment Trusts and Investment Comnarif., (19T14 2OH.
SI.% 1'. ..(I. S 0 1 et s q.
An additional piece of legislation wich adds to tihe ('olnission's statutory base indirectly is t ie Securities Investor Protect ion Act of 1970.21 TI'h failure of several large and prestigious Wall Street brokerage firms as well as many smaller firms late in tlhe 1960s heightened congressional con cern for the safety of cnstomers' funds in the custody of brokers. Spurred by the most prolonged and severe crisis in the securities business in 40 years, the Congress created tihe Securities Investor Protection C(orporation (SIPC) to adinitister tlhe Act and provide a Federal Deposit Insurance Corporation-lilke systemil of underwriting protection for customers against losses of their assets in brokers' hands. The SEC was given responsibility for taking action to protect investors should SIPC. in a particular case, decline to extend its reserves to cover investors' credit with a brokerage firm.
Most recently the panopl y of Federal security u laws has been strengthened by the Securities Acts Amendments of 1975 (hereafter rrrferred to as the 1975 Amendments) which significantly amended
the Exchange Act by augmenting the Coninission's authority and specifically directing it to facilitate the establishment of a national market system and remove anticompetitive exclane rules and other unnecessary regulatory restrictions. The Comnmission, was give:i authority over many new classes of persons in the securities trading business. The 1975 Amendments strengthened the SEC's regulatory authority over various exchange practices, including statutory support for an administrative decision to d(leregulate brokers' conunission rates and( authority to increase the number of seats on an excl1ane.
The opportunity and the mandate to shape a new national market system is perhaps the most far reaching or the amendments. The present structure of the Nation's securities markets was lar2elv d(irected by two factors: first, the historical fact of the New York Stock!: Exchange's early appearance (1792) and (owing to the economics of securities trading) its enormous headstart guaranteed a continuing position of market dominance: second, the fact that the SE('' has in general maintained a hands-off approach with respect to the internal organization of exchange functions and the economic structure of the securities marketplaces. Now, however, the Securities A.ets Amendments of 1975 direct the Commission to play a much more at ive role in the restructuring operation from which will e(rLCe the national market system. As barriers to competition are remiove(d. the other, major force in the restructuring operation is to be the interplay of competitive forces. The situation demands what properly may )e
called creative regulation: its exercise can no longer be limited to policing an exchange or other self-regulatory organization. The SEC must participate and indeed lead in the building of a new trading system, national in scope, free and open, and protective of the public interest and public investors.
The Nation's securities markets are primarily capital-allocating mechanisms but also are important in raising capital. The function is essential to our economic system, and thus the economic implications of every option warrant thorough economic analysis by the
1 15 U.S.C. ( 78aaa et seq.
2 Walter Werner. "Adventure in Social Control of Finance: The Natfonal Mairket Syster for 'nni tie 75 (f *'oliurn. I. Pe '. l 1,0O 1 97' 1.
Commission. This is the sort of planning which has been limited in the past at the SEC.2.
III. Case StudiM
A. SEC REVIEW OF OFF-BOARD TRADING RULES
The Securities Acts Amendments of 1975 were enacted after exbaustive congressional review of the goals and methods of regulating the securities industry. One of the major thrusts of this legislation, in harmony with a recognized goal of regulatory reform, was to develop markets which are freely competitive while at the same time orderly, open, and protective of the interests of public investors.24
Congress amended the Exchange Act by adding a new section 11A. Subsection (a) iets forth Congress' findincrs, including that: 2n C.
(C) It is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure(i) economically efficient execution of securities transactions;
(ii) fair competition among brokers and dealers, among exchange markets,
and between exchange markets and markets other than exchange markets;
(iii) the availability to brokers, dealers, and investors of information
with respect to quotations for and transactions in securities;
(iv) the practicability of brokers executing investors' orders in the best
(v) an opportunity, consistent with the provisions of clauses (i) and (1v)
of this subparagraph, for investors' orders to be executed without the participation of a dealer.
One means towards this end, endorsed by the 1975 Amendments, is the removal of restrictions which are anticompetitive or which might prevent a national market system from evolving competitively in response to changing market conditions.
This theme appears again and again in the 19 75 Amendments. Con25
gress amended section 6 of the Exchange Act, for example, which prescribed standards for registration of an exchange as a national securities exchange to require that the Commission, as a prerequisite to registration, affirmatively find that
(5) The rules of the exchange are designed to promote just and equitable principles of trade, . to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest.
(8) The rules of the exchange do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of this title.
In addition, Congress focused on one class of exchange rules for immediate action. The SEC was charged specifically with the responsibility, under subsection (c) (4) of section 11A,
to review any and all rules of national securities exchanges which limit or condition the ability of members to effect transactions in securities otherwise than
23 Id. at 1254-55.
24 Section 11A (a) (1) (C) of the Securities Exchange Act of 1934, 15 U.S.C. 78k-(a) (1)
(C). See the legislative history for a general discussion of this objective: H. Rep No. 94-123. 94th Con-., 1st Sess. (1975). ("The Committee feels, that the provisions of & bill eliminating barriers to competition should well serve the Investing public who, after all, are consumers of financial services." Id. at 48) ; S. Rep. No. 94-75. 94th Cong., 1st Sess. (1975) ("The bill approaches the problem of encouraging the development and Implementation of a national market system from the point of view of preserving the competing markets for securities that have developed, breaking down all barriers to competition that do not serve a valid regulatory purpose, and encouraging maximum reliance on communication and data processing equipment consistent with justifiable costs." Id. at 8.)
25 15 U.S.C. 78y, as amended by section 4 of the Securities Acts Amendments of 1975, Public Law 94-29.
on such exchanges. On or before the ninetieth day following the day of enactnient of the Securities Acts Amendments of 1.-5 [Jutie 4, 1975], the ('(,remision shall (i) report to the Congress the results of its review, including the effects on competition of such rules, and (ii) commnence a proceeding . to amend any such rule imposing a burden on competition which does not appear to the Comnmission to be necessary or appropriate in furtherance of the purposes of this title. The Coinmmission shall conclude any sucih proce(dif within ninety days of the date of publication of notice of its commencement.'
Thus the Commission was expressly directed to report its conclusions to the Congress within 90 days of enactment of that provision and to commence a proceeding (under section 19(c) of the Exchange Act) to "amend" any such ru e ". . imposing a burden on competition which does not appear to the Commission to be necessary or appropriate in furtherance of the purposes of this title."
The rule which was expected to be of primary concern to the Comnision in this review was rule 394 of the New York Stock Exchange (NYSE) 27 The purpose of the rule is to require NYSE member firms to channel all of their own (principal) orders and their customers' (agency) orders through the NYSE for execution on its floor. Thus, rule 394 serves as a boycott of other non-exchange markets by NYSE members with respect to both principal and agency transactions.28
Under that rule, members of the NYSE could not, except under very limited conditions, execute orders for stocks listed on the NYSE otherwise than on the floor of the NYSE or on a regional exchange.29 Non-exchange transactions in stocks listed on the NYSE could be consulmmated only after the member wishing to do so had gone through cumbersome ani time-consuming procedures. These include bringing back to the floor of the NYSE the quotation from a dealer market maker who is not an exchange member. Dealer market makers who are not exchange members but who trade exchange-listed securities comprise, as a class, the "third market." The member then must afford the specialist (the only individual who can execute transactions in that particular stock on the floor of the NYSE) the opportunity to equal or better the third market maker's quotation. If the latter quotation is still better, then, upon securing permission of a floor governor, the NYSE member could execute the transaction off-board, assuming the previously quoted price is still available.
The legislative history of the 1975 Amendments is replete with specific references to thigh particular rule and to the fact that each of the congressional committees which studied the securities industry and developed the legislation found that this rule significantly re"15 U.S.C. 78k-1(c)(4) as added by section 7 of the Securities Acts Amendments of 1975, PL 94-29.
277T. Rep. No. 94-12-1. 94th Conz., 1st Seqs. 47 (1975). "When a member of the NYSE executes a trade on behalf of a customer, he Is acting as a broker and the transaction is referred to as an agency transaction. On the other hand. If he trades (either as the buyer or seller) for his own account, he is acting as a dealer and effecting a principal transaction. In an agency transaction, the NYSE member effecting the trade is paid a commission by both the buyer and the seller, for merely matching the two orders; if he acts as principal, he only receives one commission but of cotirse has the opportunity to make a profit on the purchase or sale itself. The NYSE reports that, Over 6 years beginning 1970. approximately 390 "peci-lst" maemers who evocuto trades on its floor earned from aencv (book) trades about $26A.4 million in co1mizzi, (ns. In addition to dealer profits earned from trading for their own accounts. In 1975, dealer profits were $41.8 million. New York Stock Exchange, "Report of the Committee to Study the Stock Allocation System" (Jan. 27, 1976), p. 190. NYSE, Department of Economics (Augnst 1976).
20 The New York Stock Exchange had attempted to extend the boycott to regional stock exchanges, but the SEC blocked the extension through administrative action in what Is known as the Multiple Trading Case (In re New York Stock Exchange, 10 SEC 270 (1941).
stricted brokers from searching out the best price for their customers and impeded competitive market making activities. Since market makers compete by narrowing the spread between the buying and selling price, the advantages which would accrue to the securities markets generally and to public investors individually was a major reason why both Houses of Congress found rule 39-I to be inconsistent with the development of the national market system. The I-louse subcommittee concluded that:
[t]he Subcommittee finds that New York Stock Exchange rule 394 is not necessary to make the Exchange Act work. Accordingly, the New York Stock Exchange should immediately rescind the rule. If this is not done, the Subcommittee will introduce legislation which will have the effect of abrogating the rule.
Similarly, the Securities Industry Study Report 31 conducted by the Senate Subcommittee on Securities, discussed rule 394 specifically and recommended substantial modification (although not outright abrogation) to facilitate trades between NYSE members and te third market while, still protecting public limit orders (public orders to buy or sell a certain number of shares at a particular price).
The Committee on Jrtrtate and Foreign Commerce in its report on H.R. 4111 characterized its action to eliminate rule 394 as giving
".. life to the proposals contained in the [House] Securities Industry Study Report." 32 Although the Senate version did not take the full step of total abrogation, the conferees indicated that they did
* charge the SEC with an explicit and pervasive obligation to eliminate all present and future competitive restraints that could not be justified by the purposes of the Exchange Act." 33 The conference committee generally accepted the Senate provisions but added a requirement for prompt review and amendatory action, if appropriate, of those exchange rules '. . which limit or condition the ability of members to effect transactions in securities otherwise than on such exchanges." 34 Therefore, for at least the past 5 years off-board trading rules have been viewed as a class of particularly anticompetitive rules, appropriate for special treatment.
In the first report required by the statute, the SEC found unequivocally that the effect of rule 394, and of similar rules which other exclan',es have adopted, is anticompetitive. In that report (dated September 2, 1975 and referred to herea Fter as the Sept ember Report), which was addressed to the Speaker of the House and the President of the Senate, the SEC stated:
[t]he Commission has concluded that off-board trading rules of exchanges impose burdens on competition, and the Commission is not now prepared to conclude that these burdens are necessary or appropriate in furtherance of the purposes of the Act.
The Commission added that rather than commence a proceeding for the limited purpose of amending those anticompetitive rules as required by the statute, it had initiated a proceedings to determine: (i) the extent of the aiiticompetitive efYect, (ii) whether there are countervailing considerat-ions which argue against abrogation of these off3 TT. Rep. No. 92-1519, 92d Cong., 2d Sess., XIII (1972).
31 S. Doe. No. 93-13, 93d Cong., 1st Sess. 104-5 (1973).
"- ]I. Rep. No. 94-123, 94th Cong., 1st Sess. 48 (1975).
33 I. Rep. No. 94-229, 94th Coig., 1st Sess. 94 (1975).
34 Id. at 94.
board trading rules, and (iii) whether such rules could be appropriately modified so as to further the purposes of the Act.
According to the statutory timetable, the (Conunission should have concluded its proceeding to amend those rules within 90 days. By December 1975, those anticompetitive rules which the CMonMnission could not find necessary or appropriate in September were to be amended; also, as the legislative history demonstrates, Congress expected them to be abrogated.
Instead, the Commission, in its December Report issued at the
close of the proceedings, decided with respect to rule 394 to draw a distinction between restrictions imposed on trading for customers (agency transactions) and those for a member's own account (principal transactions). Specifically, all transactions which a member conducts in the capacity of a broker may not be subject to any offboard trading restrictions after January 2, 1977 This provides a year's grace period to allow the self-re, ulatory organizations and their member firms to make appropriate changes in their manner of doing business. With respect to restrictions on oilff-board dealer transactions by members, the SEC did not amend the rules, notwithstanding the Commission's conclusion in the September Report,36 and its findings in December,37 that the anticompetitive effects of principal restrictions are not necessary or appropriate to the working of the Exchange Act. The Commission merely undertook to re-examine the issues with respect to principal restrictions no later than March 1, 1977. There was no commitment to take amendatory action on that date.
The primary concern asserted by the Commission in connection with abrogation of rule 394 as it applies to agency transactions is the protection of public limit orders---orders to buy or sell when trades reach a stipulated price.
Of all the arguments advanced in favor of retaining some form of off-board trading rule, . the most persuasive concerned the desirability of continuing protections for public limit orders . .
As a result. the Commission sanctioned a one-year delay in the abrogation of the restrictions applicable to agency transactions because: [ilt is clear, therefore, that the only fair, realistic, and practicable way of mandating satisfaction of public limit orders . is through the creation and development of a composite book and the imposition of a requirement that all transactions, whenever and by whomever effected, must clear that book.? This delay was permitted despite the Commission's conclusion that public limit orders are not protected now in any absolute sense. The Commission can perceive little reason why satisfaction of public limit orders should be mandated when an exchange member wishes to effect a transaction
a Securities Exchange Act of 1934 Release No. 11942, 5-7 (December 19, 1975) (hereinafter cited as December Report).
3 .Sentember Report at 16.
S"Thus, exchange markets and exchange specialists enjoy. in large part as a consequence of off-board trading rules, important competitive advantages over the third market and over-the-counter market makers, respectively." December Report, at 6. The report also details, at pages 5-7, many ways in which brokers and dealers are precluded from taking trading actions which they might wish to take because of these restrictive exchange rules.
9 December Renort at 43.
9 Id. at 44. "Composite book" refers to a mechanism of the national market system na envisioned by the SEC which would aggregate public limit orders, regardless of the market of origin, in one national repository. When the price in any market reached the pri-c specified in the limit order, the public or'er would be encuted automatically, thereby protecting all public limit orders in stocks traded in the national market system.
directly with an over-the-counter market maker. but not mandated when the same member effects the same transaction with the same over-the-counter market maker on a regional exchange. Moreover, even if public limit orders on the "primary" exchange were required to be filled prior to a transaction by a dual member on a regional exchange opportunities for avoidance would still
During the one-year delay, the Commission permits exchanges to require that the specialist's public limit order book be cleared either right before or right after an off-board trade.
The Commission concluded that market making would be, improved byabrogating restrictions on off-board principal trading: Weighing the potential disadvantages to the markets against the potential advantages which the Commission anticipates would result from the elimination of exchange rules preventing or impeding the execution of principal transactions off-board, the Commission presently is of the view that, under appropriate circumstances, increased ability to engage in over-the-counter market making in listed securities by a larger segment of the broker-dealer community (whether by existing exchange members or others), with exposure to orderflow, is mor4, likely to improve the securities markets than injure them. In addition, the Commission is convinced that the risks inherent in abrogating exchange restrictions at the present time could be minimized by the prompt achievement of additional elements of a national market system."'
Instead of immediate abrogation or abrogation effective as of some future date to motivate the affected parties to the ". . prompt achievement of additional elements of the national market system', the Commission deferred for more than one year the making of any decision with respect to principal restrictions. Thus, at the end of the 180-day starting period, the Commission had accomplished little toward what the statute designated as a high procompetitive priority.
The primary legal question raised by the Commission's handling of this issue is whether it had the statutory authority to delay the effective date of its amendment of exchange rules. Section 11A(c)
(4) (A) specifically requires that the Commission conclude its "amending". proceeding within 90 days. One can only infer from the statute's specification of a time limit that Congress e: pected results in that period; that it did not mean that the Commission could conclude the hearing and defer its decision. The congressional desire for prompt effectuation of the Commission's findings is clearly expressed in section 11A(c) (4) (B), which directs expedited judicial review, should a Commission decision pursuant to subparagraph (A) of that subsection be challeii zed in the courts. Any interpretation which permits more than minor-' delays seems inconsistent with the congressional purpose to reform exchange rules. Nothing in the statute or legislative history suggests that a 1-, 2-, or 3-year delay is authorized.
Furthermore, the SEC's judgment in deferring the decision-making process with respect to restrictions on off -board principal trade s is questionable. The Commission justified that delay as permitting time for the development of a national limit order book. However, the incentives seem perverse. If the reason that the Conunission cannot abrogate the rule now is the absence of the book, then it rould seem to be in the best interests of the respective exchanges to do little or nothing to accelerate that development so that the Com, -mission will
41 Id. at 2T.
continue to tolerate off-board trading restrictions. On the other hand, if a date certain for abrogation had been set, it would be to the interest of all concerned to move expeditiously. If the Conunission fears that abrogation of principal restrictions would result in self-dealing, it simly could prohibit that formi of self-dealinlg
Six months after the issuance of the Decemvber Rep Cirt. Chairman
Hills testified before this Subcommnittee that the SEC haId received and was reviewing 11 different proposals which have been received for establishing a national limit order book.42 Chairman Ilills mad(le clear his faith in the NYSE:
There is, in my judgment, a determination in the New York Stock Exchange, for example, to try to create a truly competing specialist system. We will be interested in seeing what their proposals are and how they propose to do it." Conclueion
The excessive fact-finding efforts in the proceeding reflected in the September and December Reports and thle deferral of the effective dates of the amendment display timidity and reluctance in contrast to the Commission's vigor in other regulatory matters.
The reports set the stage for outright abrogation of rule 394. The Commission finds the anticompetitive effect described in the statute; it does not find, at least in the 'September Report, that such anticompetitive restrictions are otherwise necessary for statutory purposes. However, a concern for protecting some public limit orders and the need for some exchange members to adjust to trading without anticompetitive advantages afforded by rules like 394 are offered as explanations for not abrogating the rule."4 The Subcommittee finds them insufficient givenn the statute's procompetitive standards.
The episode, above all else, shows a failure by the Commission to carry out the terms of the statute as written by the Congress. It has moved more slowly than the Congress intended. It seems most reluetant to disturb the status quo. It seems to have substituted its own judgment for the basic legislative conclusion. Finding that all the criteria for abrogation were met, it nonetheless concluded that it was not wise to take the action required by the statute. The Commission may certainly come to Congress and request an amendment to the statute. It may not disregard the law.
B. THE SEC AND CORPORATE ACCOtNTABILITY
1. Public disclosure.-In responding to the widespread use of basically unsound financing and trading practices characterizing the pre-Great Depression era, Congress provided that reform reach behind fair dealing in securities and public disclosure of financial information. The 1933 and 1934 Acts speak to standards for corporate financial reporting and registration and corporate reporting controls. The SEC
SubCommittee on Oversight and Investigations, Regulatory Reform/Orernqight Hearings on the Securities & Exchange Commission, 94th Cong. 2d Sess. at 719 (June 1, 1976) (hereinafter referred to as Subcommittee Hearings). aId. at 721.
'"The Commission is providing a one-year period prior to eliminating exchange restrictions on over-the-counter agency transactions in the interests of providing time to the exchange community, members of exchanges and the securities industry at large tn consider such adjustments in the current ways of doing business and in the existing pattern of regulation as may be deemed appropriate in response to the rule." December Report, at 46.
was granted rulemaking authority to assure that public investors would be furnished information necessary for informed investment decisions.
Congress authorized the SEC to require the disclosure of information which is material and necessary or appropriate for the proper protection of investors and to insure fair dealing in the security.45 The Supreme Court in Afiliated Ute Citizens v. United States speaks of material facts as those which "... a reasonable investor might have considered . important in the making of this decision." 4 Also with respect to the kind of information required to be disclosed, the Congress authorized the SEC to prescribe the form and content of financial reports to be filed with the Commission.47
Congress provided further that reports be certified by "an independent public or certified accountant," 48 thereby addressing the need that the information be verified. Recognizing that the methods of accounting for information may give misleading results, Congress authorized the SEC to prescribe ". . the methods to be followed in the preparation of reports." 49 With respect to the timeliness of reports, the Congress required each issuer of a security registered with the SEC to file ". . such information and documents as the Commission shall require to keep reasonably current the information .. ." set forth in filings.50
The securities markets rely on the continuing generation and updating of relevant, accurate. and timely information as the basis for informed capital-raising and capital-allocating decisions. The SEC's execution of the disclosure mission is essential both for the proper functioning of the capital markets and the economy as a whole. Disclosure starts from the basic operating unit of the economy, the corporation: provides the body of knowledge describing the operation of that and other units, hence the economy; and yields the factual basis for decisions by a number of economic actors: investors, financial analysts, economists, investment and commercial bankers, competitors, labor, consumers, government policy-makers, public administrators, and regulators. Ultimately, such information helps to form perceptions about the total economic environment. The circle is completed when a corporation's management or board responds to decisions made by outsiders who have acted on its own information. Management also is affected indirectly by individual and collective perceptions as to the state of the economy. It is difficult to overstate the need for relevant, accurate, and timely information about the basic unit of our free enterprise system.
2. Adininistra on of pubbi d~sdosure.-Scandalous episodes of corporate illegality, unaccountability, and use of questionable business practices raise questions about the effectiveness of our system of corporate ac countability. Not every corporation has been required to
4 Section 10 (b) and (c), Securities Act of 1933 and Sections 12 and 13, Securities Exchane Aet of 1()34.
41 .106 7. c. 128, 153, 15-1 (1072).
4"Sf,,ti 19('i) nnd Scbedile A, Securities Act of 1933 (15 U.S.C. 77aa), and Section 13, Securities Ex(hance Act of 1934.
4 ehedule A. Sectirit ieq Act of 1933.
41 Section 19(a), Securities Act of 1933, and Section 13(b), Securities Exchange Act of' 1934.
6 Section 13(a), Securities Exchange Act of 1934.
Citizens, iulliillgr th Nation -orj-oI'aj -t itzken< 1111lW-l ~ i~ Nev e rthI eles,4 iore thami 2()( corj)orilltl li ave di-'- viosed ieglor questionable lpaylllentsi or rel atcd act I l\~ lliIlfl t h SI( volunltary Coil) 1)1ian1ce P,rgi'aiii. An "iddit jol 20 have been1 S;lhiJcts of formal SICeXo~I~etatioiai 11( iel1!Ic (dO i~iol
brought by t he S ,JutieIepiuict.adInt-lrnaIl hvi ev
ice conitinlues to 7r'x 1lloih r wcc~sivlea ialprc~a~
of all pulicly oWledl corjpora"tions, they frequen'Itly are11-cg L worlds lag~.Ofaprxmel )(Ofla]Q Vi(1vltilav
disclosed ille-al 01' (lliC-tiimialhle i
(1) internal corporate conduct and financial controls;
() board of, dir-ectors;
(3)indpenentac-ount ants. auditors, and le~ral counsr~el ;
(4) -public disclosure of corporate lpracttices and firnances ; and (5) enforcement by the Secrities and Excliangce Commilission. The following analysis of the SEC's role in the breakdown inl the sZystem of corporat-e accountability and its: rc- ponse to the underlying problems looks firs-t ait accounting' ( and audtig n the-.n ,itdicoue
(a) Pccb lgaccounttngy ,8toddaro"., prilc/)e8an ;ar
Tn exercisingl its statutory authority to pres-cribe the mcllod to be followed in the preparation of ac-ountfs, the SEC his toi'ir-al has relied on the standard-setting bodies created by the accounting profession, especially the Ameri1can Institute of Certified Public Accountants, (AJCPA).
The results of the Commissionfs 19"8 decision,5 by a 3 to 2. ~o to rely primarily on the private accounting profess sion to establish accounting priciles has been disappointing at, best.
In 1940, the Committee on Account*ing Procedure (CAP) -was established by the AICPA, then known as7"the American Institute of Accountants. The CAP dealt almost exclusively with the articulation of existling accounting practices and pragmatic solutions to speci fic accounting problems. Little effort was devoted to the development of -l rational conceptual 1structulre.54 The AICPAv finally real. ted to thle CAP's failures by creating the Accountingr Principles Board (API3) in 1939. The APB folded, in the early 19 70-z, after destroying( its credlibility as an organization ca-pale of resolving financial report ing controversies. Its failure to set, dow n hard and fast rules al)wut mergrer accounting until October 1970, after billions of dollars haid b)(enac counted for by inadequate and often misleading methods, brought
51 Fortune MYaganzino The Fortune DotUbl 500 Directoryl, 1975. SSubcommittee Hearings, May-June. 1i97f, and Suihconinitttee on Oversig!ht tind Investigaitions Stall stud.", -SEC Voluntaryl Com1p I anc Progruam On (o irt icou (Subcorlm ttee Print, June L)76), (hiereinafter rcierrted to ais b Ojco iapziIe -tui St r3 SLC, -Adnhinlstrat.ive P111y on Financi'al Staternents," A'Ccoun1t',[1eiciReea No. 4, April 25. 1938.
64 Seep Thle Whea(-rt Comm?1it tee Re~port: Exta blushing Financiatl cotnqi'ad sept of the Study vn Estabilshament of Acc2unting- Principles, (New York: AIC1PA, 11)7 -).
condemnations from public investors, financial analysts, academicians,
accountants, and the Congress.55
In his analysis of the history of the CAP and the APB, the bodies the SEC depended on for setting accounting principles, Professor Maurice Moonitz, formerly the Director of Research for the APB, wrote:
1. Neither the Committee on Accounting Procedure nor the Accounting Principles Board issued a binding statement of accounting principles In over thirty years of continuous activity in the area.
2. Neither agency adopted a set of terms with related definitions, e.g., "cost," 6"asset," "revenue." This is not surprising, since usable terminology and related
*definitions are part of a basic framework of some sort. Useful definitions cannot
be framed in vacuo.
3. Practice followed APB recommendations closely and quickly with respect to the form of financial reports.
4. APB opinions expressing principles affecting the amount of periodic net income are relatively few. Their quality is spotty. Their impact on practice Is uneven.
5. When opinions expressing principles affecting the amount of periodic net income received acceptance in practice, they were preceded by research studies published and widely distributed for an extended period before APB acted.
6. The buffeting the board took in its attempt to resolve difficult issues led it, in later years, to avoid them, and concentrate instead on compiling a record by issuing opinions on less controversial topics."
In the wake of the APB's disintegration, the AICPA created the Financial Accounting Standards Board (FASB). Instead of reacting
-.to the dismal record of the FASB's predecessor boards by reversing its :1938 decision, the SEC continued to recognize the standards, principles, and practices promulgated by the private sector through the FASB in its Statements and Interpretations ". . as having substantial authoritative support, and those contrary to such FASB promulgations will be considered to have no such support." 57 Dr. Abraham J. Brioff, a CPA, Emanuel Saxe Distinguished Professor of Accountancy at the Baruch College of the City University of New York, and the author of several books on accounting, in his written statement submitted to the Subcommittee, discusses the FASB's performance to date:
f have observed the ways in which it has avoided the critical Issues, vacillated on other controversial matters, and handed out special dispensations in order to obtain a consensus for a particular standard. I expected much, much more from a select body endowed with presumptive independence and supposedly possessed of intellectual might, integrity and intrepidity. In short, we have had a surfeit of compromise, of the vulgar pragmatism, of pussy-footing and Inching along.'8
The FASB has accomplished virtually nothing toward resolving fundamental accounting problems plaguing the profession. These include the plethora of optional "generally accepted" accounting principles (GAAPs), the ambiguities inherent in many of those principles, and the manifestations of private accountants' lack of independence
MR ee: Robert Chatov, Corporate Financial Reporting (Macmillan New York, 1975), at 228-29. A. A. Sommer, Jr., "Survey of Accounting Developments in the 600s: What's Ahead in the '70s," The Business La'wyer 26 (November 1970) at 207-214. I Maurice Moonitz, Obtaining Agreement on Standards in die Accounting Profession, Studies in Accounting Research No. 8 (Orlando: American Accounting Association, 1974), at 28.
5T SEC, "Statement of Policy on the Establishment and Improvement of Accounting Principles and Standards." Accounting Series Release No. 150 (December 20, 1973).
8 Abraham J. Briloff, "The Establishment and Implementation of Accounting Standards," Subcommittee Hearing8, May 21, 1976, at 584 (hereinafter cited as Briloff Statement). See also Op. Cit., Chatov, at 248.
with respect to their corporate clients. Considering the FASB's record, the SEC's continued reliance on the private accounting profession is questionable.
Recent disclosures of illegal and questionable corporate payments show that the protection of investors requires more than uni form accounting principles. Public investors and the public generally need the protections afforded by effective, well-enforced internal orp rate
il 11 :1So *
(b) Internal control.-A systemll of internal contr l rr -of 1, raetions and accounts permit auditors few all(lit ve"rlon t v-ivni..'s other than samplin. D)esicning and enforcing a Sei-h of 11Lt OiS for large. complex covporat a.l is !partiV~,hAiy ,tIic' vet 'i(l (,'ea nizations are most in need of effect ive intirn1al cn to. In for ,er ion disclosed by In wsuits pursuant to the SK( (s oi. i'y compelling e iactequa ofv 1!- rna \"so~cntm)U~ 7lf atl ot
PITY 59 11.. ILN l" a ,(,i :e
program, 'and by the ,Sun7.*oin'i"! t, ty .'t. ,/ *** do. uen 11 .nt
inadequay of internal contro'3 contihaud s diia t1y-c to the incidence of corporate illegait and unaccountability.
(I) L,~~~au~~o~u 0 0,e -P 0t / poit .,/-' C c o' .4 p 'a;
In 36 of the first 89 companies which disclosed to the (' il:il or questionable payments or practices. "top management" had knlowledge of such payments or practices.61 In addition, the Sulcomnmttee staff studied n detail 25 copan, s which had discussed disclosure with SEC staff. In 40 percent of these case histories, corporate officers or senior management knew about the payments. Inadequate internal controls permitted lower echelon employees to engage in illegal or dubious business practices and permitted senior managers or corporate officers to be parties to these practices or related activities. In a number of other cases, for example, Gulf Oil, Lockheed, Northrup, and United Brands, the illicit payments were in fact engineered by executives in the top hierarchy of the corporate organization.
(ii) Ineffective finance d con trols
Apart from noting the absence of suitable codes for employee oonduct, a significant number of corporations disclosed information which indicates that internal financial controls are ineffective. One of the primary purposes of such controls is to prevent practices such as overilling or over-invoicing, kicking back the excess to purchasing agents or suppliers, or laundering through off-the-book bank accounts-practices which crop up repeatedly in payoff disclosures.2 Other payments or practices which escape internal controls are inaccurate accounting entries, off-the-book funds, and falsification of books and records.
Securities and Exchange Commission, Report of the Securitfer and Exchanqe Commission on Questionable and Illegal Corporate Payments and Practicesr, submitto(i to the Senate Banking, Housing and Urban Affairs Committee, May 12, 1976 (hereinafter cited as REC Report).
00 Op. cit., Subcommittee Staff Study, at 5-12.
SEC Report, Exhibit A.
SOp. Cit., Subcommittee Staff tudy and SfC Report.
Of the 25 cases examined in the Subcommittee staff sample, 44 percent of the corporations had recorded payments in accounts which did not reflect the true nature of the payment; 20 percent maintained offthe-book accounts; and 12 percent showed that books and records had been falsified.
The Commission has recommended to the Senate Committee on Banking, Housing and Urban Affairs that legislative remedies embody a prohibition against not only falsifying corporate accounting records but also against corporate officials or agents making false and misleading statements to persons conducting audits of the company's books and records and financial operations.63 In addition, the SEC recommended legislation to require
management to establish and maintain its own system of internal accounting controls designed to provide reasonable assurances that corporate transactions are executed in accordance with management's general or specific authorization; and that such transactions as are authorized are properly reflected on the corporation's books and records in such a manner as to permit the preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements."
The SEC recommendations, however, stop short of assuring necessary corollary protection: a requirement that independent accountants, who already must test management's system of internal controls for purposes of performing a valid independent audit, attest to the quality of the system of internal controls.
(c) Board of directors.-In addition, the SEC has been cognizant of the role of the board of directors in the system of corporate accountability. The board sets corporate policy and oversees management's execution of that policy in administration of the corporation's operations. In some of the illegal and questionable payment cases, significant information necessary for proper oversight had not been submitted to the board. The events disconcerted independent directors who saw nowhere to turn for outside advice and counsel on difficult legal, accounting, and auditing questions. In other cases, directors had knowledge of the payments; in still others, senior corporate officials who had knowledge or approved of the payments were candidates for the board.65
In its report to the Senate Banking Committee, the SEC suggested reforming boards of directors of publicly owned corporations:
actionin to further enhance the creation by public corporations of audit committees composed of independent directors to work with outside auditors would, however, serve as a valuable adjunct. 21 to the Commission's other legislative proposal to improve corporate accountability via internal controls." The SEC adds:
Similarly, corporate accountability can be strengthened by making the role of the board of directors more meaningful and separating the critical aspects of the functions of the board and independent counsel.7
The Commission has implemented those recommendations to some extent in its enforcement actions. The resolution of those enforcement
8 ,9EC Renort, at 58.
ft Id., at 59.
For ,xample, see Cities Service Company. Kraftco Corp., and Gardner-Denver Co. section, ofS ,womn nmittee Stafl Study at 7, 9, and 11. I SEW Report, at 67.
*Id., at 67.
proceedings typically has utilized a temporary committee comprised of independent directors charged with conducting a ful I investigation with the aid of independent legal counsel and outside auditors to perform the necessary detailed inquiries." The Commission's one otlhr action on board reform has been to seek the views of the New York Stock Exchange with respect to amending its listing qualifications in accord with the SEC's recommendations.
Limited though its action has been, the SEC does aim to make boards of directors more effective, to establish permanent in(ependellt audit committees, and to encourage boards to employ independent counsel. The. case histories and the Subcommittee Staff Study, however, yield strong evidence that more specific recommendations are in order, if corporation directors are to exercise effective oversight in the system of corporate accountability.
A director must be willing to devote considerable time to his important and continuing responsibilities. A director elected because of demonstrated expertise should be expected to manifest that expertise in fulfillment of his responsibilities and should be compensated appropriately. The majority of the board should be detached from management and from any other conflict of interest, e.g., association with the company's investment banker or corporate counsel. The board
should provide itself with independent staff. A board's key audit committee should be comprised of a majority of independent directors who adopt rules to govern the committee's proceedings. The audit committee should have available to it independent expert advisors.09 Likewise the nominating committee should be comprised of a majority of independent directors. Assuring the independence of the board and its key auditing and nominating committees as well as holding directors to professional standards of performance are critical to building an effective system of corporate accountability to protect public investors as well as a corporation's customers, suppliers, and competitors.
(d) Independent auditors.-In requiring independent accountants to certify financial reports filed with the SEC, the Federal securities laws underscore the crucial function of independent auditors in protecting public investors. The quality of this work and the public's confidence in the certification is rooted in the auditor's independence in appearance as well as in fact. Conversely, the auditor must perform in a manner that warrants confidence.
When asked why many independent accountants did not uncover illegal or questionable payments, inaccurate accounting entries, or falsification of books and records, defenders of the profession point out that the payments were quite small in relation to a corporation's total operations and that sampling, which will miss small items, is the only cost-effective method in auditing large organizations. Moreover, they explain that outside auditors were deluded in a few instances by well-conceived and well-concealed fraud.
8 Settlements requiring independent investigatory committees Include Gulf Oil Corp., Ashland Oil Corp.. General Tire Corp.. American Shipbuilding Corp., Lockheed Aircraft Corp.. 3M Corp.. Northrup Corp., United Brands. #"The Wall Street Journal reported on April 21. 1976: "Data comiled by andI for the rNew York Stocki exchange in internal and outside studies indicate that most of thO Big Boaird's 1.550 listed companies already have a majority of outside directors and tnc-T' endent audit committees." It may be appropriate to limit these requirements to corporations of significant size to minimize financial burdens on small- and medium-sized corporations.
Deficiencies in accounting practices do not appear to be so limited. Testimony before the Subcommittee documented that the standards and procedures supported by the accounting profession's standardsettingy bodies and tolerated by the SEC assure less than the requisite independence in the auditors. Dr. Briloff testified:
Miss EMIGH. Dr. Briloff, coming back to the discussion of whether this Is a good system of corporate accountability, or are these just unique problems which have arisen because of certain economic conditions or political pressures or something of that nature, I think it is very important that the subcommittee grasp the exact nature of the problem we are facing. Is it a systemic problem, or is it just a unique problem of human frailty that arises from time to time?
Mr. BRILOFF. I would say, Ms. Emigh, that the problem is systemic in the following sense. First of all, it is important for the committee to understand that the present field rules in accounting are that it is not the auditors whose statements -tre being disseminated and which they are certifying; instead these statements are the statements of management. Therefore, when the auditors say: "these statements present fairly in accordance with generally accepted accounting principles," it does not mean that in the auditor's mind these are necessarily fair statements.
Now it almost sounds like Alice in Wonderland for you to hear it, but it is imapoiit for you to recognize this. AUl it essentially means is that management has, fn m the book of GAAP. selected a series of alternatives, and then those alternatives that management have selected are presented fairly-very much like the discussion of Lockheed, let us say. So it is systemic to that extent, and in fact in my concluding remarks in the prepared statement I urge that the SIC, if it does nothing else, should do that which Commissioner Sommer and Dr. Burton [Chief Account~nt] and others of the Commission have said: "Auditors, when You Sign uIT to that particular certificate, we want you in fact to put your credentils on the line as the independent auditors and to say, all things consi( ored, you in your judgment consider this to be the fairest." It is systemic to that extent."0
In 1964, the AJCPA appointed the Special Committee on Opinions Of the Accounting Principles Board to consider, among other things, the issue of the auditor's assertion of "fairness" with respect to a corporation's financial statement. In support of its recommendation that the APB should set forth its views at the earliest possible time as to the purposes and limitations of published financial statements and of the independent auditor's attest function, the Special Committee asked:
What purposes and limitations attach to financial statements and the auditor's opinion? This question is of first importance to the public and the profession. Literature abounds on it, but the answer is cast in many different molds. Until the profession has an official utterance about it, there is no point in beginning. The Committee believes that such an utterance should be the subsoil on which subsequent pronouncements could be grounded and understood.
Nevertheless, it remains true that until the basic coicepts and principles are formulated and promulgated, there is no official bench mark for the premises on which the audit attestation stands. Nor is an enduring base provided by which to judge the reasonableness and consistency of treatment of a particular subject. Instead footing is given to controversy and confusion."
*.in the standard report of the auditor, he generally says that financial statemLents "present fairly" in conformity with generally accepted accounting principles-and so on. What does the auditor mean by the quoted words? Is he
70 Subcommittee Hearings, May 21, 19T6, at,642. 71 AICPA. Report of Special Committee on Opinsion* of the Accounting Prinoiples Board, (Spring 1965), at 12, 13.
saying: (1) that the statements are fair and in accordance with generally accepted accounting principles; or (2) that they are fair because they are in accordance with generally accepted accounting principles; or (3) that they are fair only to the extent that generally accepted accounting principles are fair; or
(4) that whatever the generally accepted accounting principles may be, the presentation of them is fair? (Emphasis in text.)
Not until 10 years later, after many lawsuits and some verdicts against accountant s, did the AICPA's Auditing Standards Executive Committee promulgate "Statement on Auditing Standards No.., The Meaning of 'Present Fairly' in Conformity With Generally Accepted Accounting Principles in The Independent Anllicr> Report. In
paragraph 4, the Committee set forth its interpretation of "fairness:
(a) the accounting principles selected and applied harc ge wnral accepti nc...;
(b) the . principles are appropriate in the circumstances . .:
(c) the financial statements, including the related notes, are informative of matters that may affect their use, understanding, and interretatiol .;
(4) the information presented in the financial statements is classiid and summarized in a rcason(abtle manner, that is, neither too detailed inor too) condensed.. .
(c the financial statements reflect the undmrl1yvin~ eve(1 :(Id t rI sactions . within a range of acceptable limits, that is, limits th't are r, aonable and practicable to attain in financial statements . emphasiss added].
In his statement to the Subcommittee, Dr. Briloir provides a critiue of the Auditing Standards Executtive Commnittee's interpretation of "fairness:
Considering the awesomeness of the problem with which it was wresrig, could any set of standards be more pusillanimous than the foregin.4 Were d we find a mandate to the auditor to determine and apply the fairest o: the alternative GAAPs which may be available in the particular circumstance? Where is the auditor exhorted to ferret out those "events and transactions" which might be contrived, designed by management to produce a particular appearance, and to make abundantly clear that these events and transactions are to be given only limited significance by the users of the statements? What, if anything, in these five standards suggests a new, better doctrine? Will the Committee now constitute a new subcommittee to consider how wide is the "range" sugge-ted by criterion (e)?
Granted paragraph 7 does counsel the auditors that "GAAP recognize(s) the importance of recording transactions in accordance with their subslance." and that the "auditor should consider whether the substance of transactions differs materially from their form." But even on this self-evident assertion the Committee saw fit to introduce an equivocating footnote directing the reader to Statement on Auditing Standards No. 1, section 110.02 which contains this resounding coda: "The statements remain the representations of managementt"
Does the Executive Committee expect that the pronouncement will bridge the gap in credibility, and raise the level of confidence in the auditor's output? If it really is of this view, then, as in so many other instances, those who would beguile are the most deceived.'
In addition to the deficiencies inherent in the AICPA's "fairness" standard, the Subcommittee's hearing examined the deficiency of auditing standards in reconciling accounts among subsidiaries and be* Ibid., pp. 13-14.
7 Now incorporated in AIOPA Profess#ional Standards: Auditing, Section 411.
7 Briloff statement. Subcommittee Hearings, May 21, 1976. at 606. See also United States v. Simon, 425 F. 2d 796 (2d Cir. 1970), cert. denied Mar. 30, 1970.
tween subsidiaries and the parent corporation. Responding to a question concerning such reconciliation as exemplified by the Gulf Oil1 Corporation and Equity Funding cases, Dr. Briloff testified as follows:
I cannot, as a matter of professional conscience, see how Price Waterhouse, for example, as the auditors for Gulf Oil Corp., could have avoided the audit for a period of I believe 15 years or so, of this [off-shore] shell corporation where, had they just gone iu and even done a superficial review, and related and compared the book entries on that shell corporation with those of the home office which was transferring the funds into this shell corporation, a comparison of one set of entries with the other would have demonstrated the fact that things don't match. And this would have blown the whole plot and the conspiracy sky high.
With respect to Equity Funding, there are some parallels I suppose with what it i,; that we are talking about [in the Gulf Oil case]. But yet I (10 believe an invidious distinction must be made. In view of the fact that in Equity Fundin~g the principal ,auditors there, the Wolf and Weiner group of auditors of Equity Funding, were indicted and then convicted for actual complicity in the f rand, as contrasted with what we have here, and that is a case of benign neglect (f what it is that was going on in Gulf Oil, and an invidious distinction must be made.
The conviction of the persons in Equity Funding would indicate that It was certainly far more grievous from the vantage point of the auditors. There is, however, interestingly, one very interesting or significant parallel between the two. As the Trustee's Committee Report in Equity Funding pointed out, if Hlaskins and Sells, which were the auditors of the life insurance subsidiary of Equity Fundling, had taken the effort to compare the entries on the books of that life iuslliance company with the entries that were made on the books of another subsidiary of Equity Funding-namely, that California sales agent- they would have found there, too, a lack of relationship and a lack of symmetry. So to the extent that there is any parallel, it is there, but we have a different kind of conduct at least as far as the auditors are concerned.
Is there an abuse of power in both instances for different reasons? An abuse of power, the answer is yes. Was there a lack of adequate accountability and halvisalflity as to what management was doing in both instances? The answer is categorically yes.""
The SEC has not exercised fully its statutory authority to remedy deficiencies in generally accepted auditing standards.77 In this era of comnplecx corporate structures, conglomerates, and multinational corporations, the SEC's reliance on the private accounting profession alone to assure that corporate records are examined by independent auditors. has been insufficient to protect pubJlic investors and accomplish the objectives of the Federal securities laws.
Dr. Briloff testified that the accounting and auditing flaws revealed by illegal or questionable corporate payments are systemic also with regard to disciplinary actions by the profession and the SEC's enforcement actions:
It is systemic in the respect that there is a dual system of disciplinary proc(bilres that prevails within the leading organization in accountancy, namely in the American Institute of CPAs. To put it very briefly and bluntly, these pro711F Zubwomrniftere Hearinqs, May 21, 1976, at 651-652.
77 sec. 13 of the Securities Exchange Act of 1934 specifies : "(a) Every Issuer of a securIty ref-ritered T)nrmlaflt to section 12 of I hi title shall Wie with the Commiission, in accordance with snch rules and regulations as the Commission may pre~crlbe as necessary or appropriate for the proper protection of Investors and to insure fair dealing In the security . .(2) such annual reports . certified If required by the rules and regulations of the Cominisflon by Independent public accountants ..,.as the Commission may prescribe. (1)) The Commission may prescribe . .the methods to be followed . In the preparation of reports, . and in the preparation, where the Commission deems It necess ,irv or desirable, of sep~arate and/or consolidated balance sheets or Income accounts of :ixw person directly or indirectly controlling or controlled by the Issuer, or any person under direct or Indirect common control with the Issuer ..
cedures are consistent with St. Matthew's observation about the blind guys that strain at gnats while swallowing camels.
This is precisely what it is that the Institute does. They will get someone who has bribed a revenue agent, and they should, but when it comIes to these usess cel~bres that cause this glut in credibility with respect to our private corporate sector to become unstuck the Institute is somewhat oblivious. It is overly sensitive to the feelings on the )part of the oligpoly that controls the Institute.
I am sad to say that with some w'aningful ex(cep)tin I find the same dual system of justice or injustice prevailing inll terms of the disciplinary procedures followed by the SEC. While the smaller accounting firms, when the SEC followed the necessary steps. are expelled from practice before the SE(C, or suspended for an extended period of time, when it comes to the major accounting irms the SEC might somehow or other get them to enter into a consent decree which to all intents and purposes says that we will not commit adultery in the wame place at the same time and the same way with the same consenting party. But change any one of those variables and everything is all right.'
In ad(lition to the absence of suitable standards for private accountants and the inadequacies of the profession's and the SEC's discipinary actions, the accountant's professional responsibilities are particularly confusing because of the decision of the Supreme Court in Ernst &( Ernst v. Hochfelder.9 In its opinion, the Court explained the issue as
. whether an action for civil damages may lie under section 10(b) of the Securities Exchange Act of 1931 . and Securities and Exchange C('ommission Rule 101)-5 .. in the absence of an allegation of intent to deceive, manipulate, or defraud on the part of the defendant."
The Court concluded that ". . the language of section 10(b) ... clearly connotes intentional misconduct...." "8 Dissenting. Mr. Justice Blackmun argued that auditors should be held responsible for negligence, particularly because of their critical role in the issuing and trading of securities. He wrote:
The language of the Rule [10b-51 . seems to me, clearly and succinctly, to prohibit negligent as well as intentional conduct of the kind proscribed, to extend beyond common law fraud, and to apply to negligent omission and commission."- 3
The implications of lHochfelder extend far beyond the accounting profession: "In our complex society the accountant's certificate and the(, lawyer's opinion can be instruments for inflictingr pecuniary loss more potent than the chisel and the crowbar." 8 Reasonable standards of disclosure must be required of those who represent the public in the provision of corporate information. As Dr. Briloff noted in his testimony, the potential impact of Hochk/elder is that ... accounting statements would become more precarious and potentially deleterious than they are now." 85
The Hochfelder decision also will make substantially more difIcult the private enforcement of the Federal securities laws. The Supreme
H hearings, May 21. 1976, at 653. See also Briloff statement, at 612-613 and 620. v 423 U.S. 816, 47 L. Ed. 2d 668 (1976).
SId. at 674.
8 Id. at 681.
2 Id. at 690.
SDr. Briloff also is critical of the majority's decision. In his prepared statement, he concluded :
"Nevertheless. the court has decreed that neglicence by a professional person is not sufficient to hold him liable to those who were victimized by his negligence even thoih the person professes competence, expertise and responsibility (and where he is paid on the basis of such professions).
"For me this very pretentious profession is the perpetration of fraud if it is known that negligence is a hidden factor in the profession's tool box." (Briloff Statement. at 616.) SUnited States v. Benjamin. 325 F.2d 854, 863 (2d Cir. 1964), cer. denied sub nom. Howard v. United Rtates, 377 U.S. 953 (1964). SSubcommitteeff Hearngs, May 21, 1976, at 655.
Court held that, under section 10(b) of the Exchange Act, private plaintiffs must show "scienter," that is, the "intent to deceive, manipulate, or defraud," before liability can be found. Recognizably, a negligence claim is easier to prosecute than one in which scienter is required. By burdening private parties with the scienter requirement, the decision sharply degrades the discipline provided by an injured private citizen who acts to obtain compensation for financial injury. In order to retain the sane level of discipline by proving intent, the enforcement staff of the SEC would have to be grossly enlarged at public expense. Section 10(b) should be amended to establish clear liability for negligence by persons effectgin transactions in securities without regard to intent. Of course, the negligence standard implies a failure to meet a standard of care appropriate for the person in question. Thus, the standard that a professional such as a certified public accountant should meet would be expected to be higher than the standard applicable to a person making ordinary transactions in securities.
(e) Public disclosure of corporate practices and finances-SEC enforcement of Federal disclosure laws in the voluntary cornpiance program.-An essential element of corporate accountability is SEC enforcement of the disclosure requirements of the Federal securities laws. In 1974, the SEC began looking into cases of illegal domestic political contributions which had come under scrutiny by the Office of Watergat e Special Prosecution Force. Shortly thereafter, the Commission became alerted to reports of foreign payoffs. The Commission and its staff are to be commended for their initiative in undertaking these investigations. In view of the apparent magnitude of domestic and foreign payoff cases, the Commission employed and expanded its voluntary compliance program.
The compliance program is intended to encourage publicly owned corporations under the SEC's jurisdiction to conduct their own investigations of illegal or questionable payments, to disclose findings as well as related improper activities, and to terminate such payments and activities, all on a voluntary basis. Each company is free to proceed on its own reading of the Federal reporting requirements. The informal views of the staff and Commission need not be sought as to whether the information should be disclosed on the form of
Directed by Chairman Moss to evaluate the SEC's voluntary compliance program, the Subcommittee staff examined material filed by more than 60 corporations, analyses and recommendations of Commission staff, and the Commission's conclusions. Of the 60 corporation files, 8 are summarized in the Subcomimittee Staff Study because, in the opinion of the staff, they point to serious shortcomings in the voluntary compliance program.
Although the Commission has obtained some significant results from its voluntary compliance program, the potential charges are very serious. The SEC Report notes optimistically that among the 9,000 or so corporations which regularly file documents with the Commission, only about 100 of them have participated in the voluntary compliance program. Since almost all of those companies have voluntarily approached the Commission rather than vice versa, that same observation
SEC Report, p. 12 ff.
could suggest that there may be many other companies which have not come forth. The efficacy of the SEC program, therefore, should be assessed critically at the earliest point.
To this end, the Subcommittee Staff Study questions whether the SEC's action was sufficient in eliciting all relevalt facts. The staff study concludes:
... more effective enforcement is essential, In part because of the Inadequacy of the Commission's enforcement staff to investigate the approximately 100 corporaUons which have thus far made some disclosure of illegal or questionable payments or the maintenance of false books and records."
During the Subcommittee hearings, the need for follow-up inreStigations of involuntary disclosures also was evident. In the following colloquy, Dr. Briloff highlights some of the deficiencies in the McCloy report which is the result of the Gulf Oil Corporation's socalled independent investigatory committee.
Mr. BRLOFF. What I see as serious deficiencies and In turn particularly to the accounting implications, I am concerned that the independent auditors that te McCloy committee took on, namely Leidersdorf & Company, that they did not on their own pursue the various accounting practices and try to unearth and to discern the various patterns of Illegal payments that they could have pursued. Instead, as I recall the report, they relied essentially on disclosures and leads that had been furnished to them and they then went ahead and did describe of course importantly what was going on in this shell corporation, the Bahamas Ex. CGorporation, which was essentially the laundering machinery for these illicit payments.
I am concerned also about the fact that the supposed independent auditors in the McCloy inquiry did not insist upon getting testimony under oath from all those who might have had some knowledge and responsibility for what was going
*n. As a consequence only this week we hear that somehow some new documents have come into some litigation in Pittsburg which points up the fact that more members of the board of directors of the Gulf Oil Corporation knew a great deal more than they were telling Mr. McCloy that they knew about what it is that was happening and going on.
Also, there is a segment in the McCloy report about the fact that somehow or other some special documents were found in the private files of one of the partners of Price W aterhouse and Company but unfortunately that partner was seriously ill and hospitalized and therefore could not be interviewed by the McCloy committee. All of this Indicates the fact that an important effort was made and somehow or other conceivably the pathological review was ostensibly completed but then maybe what we ought to do is according to what the SEC may have felt or the McCloy committee may have felt, maybe if we close it up it will go away and we can go forward.'
Without thorough follow-up investigations by the Commission, the public cannot be confident that disclosure has clarified the full nature and extent of illegal and questionable activities. Likewise, the Colnmiion will not know the degree to which Federal disclosure laws and regulations have been violated. Moreover, absent thorough follow-up investigation, the Commission's success in securing cessation and remedial action is doubtful at best.
The Staff Study is critical also of the failure to require disclosure in some cases or to permit only generic disclosure in others. For example, the Commission did not require disclosure of $22 million in payments by the Celanese Corporation, although senior management
7 Subcommittee Staff Report, at 12.
0 Subcommittee Heatings, May 21, 1976, at $30-631.
knew about the making of a large portion of those payments and although h in-house and independent accountants had known for at least 3 years that Celaneses internal auditing controls had broken down. The SEC staff concluded that the payments vere material and recommended that the Commission require disclosure quantifying and describing the payments, but the Commission ruled them immaterial. In two cases, Kraftco and Cities Service. the Commission did not require disclosure of the names of corporate officers, some of whom were nominees for board director, who knew about illegal or questionable payments and who knew that internal controls had broken down. In another case, Gardner-Denver, the name of another corporate officer. also a nominee for director, was not required to be disclosed even though he knew of facts indicating an illegal transaction and, therefore. a failure of internal controls at least at the levels of senior management and in-house and independent counsel. It is ironic that the Commission recognizes the need for better internal controls and in fact recommends legislative remedies, yet the Commission has ruled that where the system of internal controls has been inoperative and where corporate officers or managers, some of whom were nominees for director, knew that necessary safeguards were not functioning. shareholders should not be so informed before electing the directors or giving proxies.
Despite some shortcomings. the SEC and its staff have taken important. often courageous action in attemptingz to determine the scope of illegal, unethical corporate actions and to devise remedies. Nevertheless, the need to strengthen the SEC's compliance program is imperative considering the pervasive influence exerted by management of publicly owned corporations, the deficiencies evidenced by some elements of the accounting profession, and the importance of public confidence in the economic system and the integrity of the political process.
C. WHITE HOUSE PERSONNEL PRACTICES AT THE SEC
The White House has played a major role in the referral and clearance of applicants for positions at regulatory agenices, positions that are for the most part outside the competitive civil service system. Because the public needs and expects its regi ilatory commissions tn decide difficult social and economic issues, without re-aTrd to partisan politics or selfish privilege, the Subcommittee has examined in depth the recent activities of the White House and the effect of White House personnel policies on the SEC as an independent rezulatorv acencv.
Section 4(a) of the Securities Exchange Act of 1934 authorized thie creation of the Commission with five commissioners and further provided that:
not more than three of such Commissioners shall be members of the same poltica! party, and in making appointments members of different political parties shall be appointed alternately as nearly as may be practicable.* Thus, the Congress established a bipartisan independent regulatory commission rather than an Executive Branch bureau which would bear the traditional and direct relation to the President and his Executive Office.
89 15 U.S.S. 78d.
iNotwithstanding its indeI~edllt nat re, sIaff it t.ii the Securities and Exchange Coiniissioir generally follow t he
same rules and are subject to the samie criteria as are appolintments to comparable positions within the Executive Branch.o
Several classes of these positions within the Federal establ ilinent generally, including the SEC, are niot part of the competitive civil service. For these posts, there need be no competitive examinations. The political affiliations of the candidate for certain of these P i iohns are a required criterion; e.g. the position of Commissioner, as (directed( by section 4 of the Securities Exchange Act. Below that level, several other personnel classifications also are exempt from competitive
The Civil Service Commission has by rule 2 establisLed three schedules or classes of appointments outside the competitive ser ice. In general, these classifications are summarized as follows:
(1) Schedule A-positions for which examination is not practicable (staff attorney positions throughout the government are included under this heading);.
(2) Schedule B-certain additional positions for which competitive examination is not possible (not significant with respect to the SEC); and
(3) Schedule C-"positions of a confidential or policy-determining character . ." 3 at the GS-15 or lower level.
Schedule C positions permit a political appointee to have his own private secretary or personal adviser who is outside of the competitive structure of the civil service laws. These positions are classified as Schedule C only through GS-15. Positions with the potential for salaries above GS-15 are classified within what is called the "executive assignment system" with certain limited and specified exceptions."'
When an agency desires to have a supergrade position filled other than by competition, presumably because the position directly affects policy or politically-sensitive decisions or advice, it must have the position classified as a non-career executive assignment (NEA), for which Civil Service approval is required.
The Civil Service Rules specify the criteria which a position must satisfy in order that CSC will classify it as NEA.5 The Commission must determine that:
there is a need for filling the position by a person who will:
(1) he deeply involved in the advocacy of Administration programs and
support of their controversial aspects;
(2) participate significantly in the determination of major political policies of the Administration; or
9OThe Sihcommitt-e reconlzes that the situation which is fond to obtain in th SEW in regard to White House Personnel Office presence is not necessarily different from that at any of the other regulatory cominmissions.
5 U.S.C. 2102 and 2103 provide that all positions in the Executive ranceh aro within the competitive service unless exempted expressly. The independent regulatory commisslon-, including the SEC, have always been treated as subject to these provisions of the U.S. Cdo.
'Ex-eptions from the Competitive Service (Rule VI), Civil Service Rules. Z C.F.T.
M 5 C.F.R. 6.2 (Schedule C).
k 5 C.F.R. 305.102.
5 C.F.R. 5 9.1 et seq.
(3) serve principally as personal assistant to or adviser of a Presidential
appointee or other key political figure.
(c) The Commission shall not except a position which has as Its principal responsibility the internal management of an agency, or a position involving longstanding recognized professional duties and responsibilities resting on a body of knowledge essentially politically neutral in nature. .. .
Through theluse of positions established in Schedule C and through categorization of a limited number of positions as NEAs within the staff of an independent regulatory commission, there is the potential for a significant presence to develop which is not only politically partisan but also which in order to fill positions appropriately categorized As Schedule C or NEA must have previously. established political loyalties. The Securities and Exchange Commission reports having five positions classified as NEA: the General Counsel, thie Chief Accotintant, the Executive Director, the Director of Economic and Policy Research, and the Executive Assistant to the Chairman.
Given this structure -of positions and the possibility of filling certain of them from outside the competitive civil service system, an incumbent Administration would be attracted by such opportunities to place its spokesmen in controlling positions in agencies which the Congress intended to be independent of the Presidency. The Subcommittee staff, therefore, requested information from the SEC in order to determine what had been the agency's experience with White House preferences and to evaluate how well it had been able to maintain it in ependence f roni White House influence -on personnel.""&
Tfhe White House activity reported by the SEC falls into two broad categories: (1) referrals to the SEC of individuals seeking employmient, and (2) clearance of individuals selected by the SEC for NEA. or Schedule C positions prior to their appointments.
Refecrrals.-T he SEC disclosed an active policy of referral of candidates for employment by the White House. For example, during the calendar years 1969 and 1970, 60 such referrals on record were submitted, usually with a form memorandum of transm ittal. -Of these -60, the SEC reports having hired only three, of whom two were not employed until 4 and 5 years respectively after the date of the White House referral.
Shortly before July 1971, the White H-ouse took steps to formalize its personnel program, including referrals to the Federal departments and agencies.
To this end, in March 1971, it circulated to the many units of the Federal establishment a, handbook 11 marked "Administratively Confidential." The introduction states: "1[t]he purpose of this handbook is to outline the prloced~ures for the Department (sic) and Agencies to cooperate with the White House in the management of non-career personnel." It contained chapters dealing with "recruiting, clearance, personnel, administration, handling unsolicited applications and part-time positions." The new personnel program clearly prescribed procedures
96Similar Information was requested from each agency studied in this report. The other agencies were apparently not as frank as the SE~C or had less complete records, since the eight other agencies together only reported a total of 86 referrals from the White House Personnel Office over the period from 1969 through June 1 976. PT The White House Personnel office handbook dated Mar. 17, 1971, does not appear to have had any formal title. it seems to have been merely a mimeographed set of instructions to the agencies and departments.
for White House referrals to the agencies, including the use of a new form. With that form the White IHouse could indicate whether the candidate was being referred on a "must", "high priority", "courtesy", or "routine" basis." The SEC indicated that a rnStmw of the calldidate's qualifications usually accompanied each referral. The prescribed procedure included a standard method for informing the White louse what action followed the referral.
From July 1971 until I)ecember 1975, the SEC records show 115 referrals under this procedure. The referral foriims, copies of which were furnished to the Subcommittee, frequently included coniinents giving instructions for special handling ("Interview inimuediately re a part time position in Philadelphia") ,99 for supplying additional information about the candidate's credentials ("Please interview for staff attorney, was extremely hard working campaign volunteer who worked for who could certain (sic) speak for
his abilities"),to or for advising the agency about any flexibility which might be available to it in dealing with that particular candidate (" has a must rating from the Inaugural Committee but is not necessarily an SEC must.").1o In other cases, the transmittal was made by memorandum rather than by the routine form. One such 1970 memorandum which found its way into the SEC's files stated: "He [the candidate] is the son of who is a member
of the Onondaga County Legislature in New York. I have
known for a good many years, and if the son is anything like his father, he would make a good addition to the Administration." 102
The record shows a continual flow of such referrals from the White House with indications for the agency's guidance of how seriously it was to take the referral and, in some cases, of the disposition it was expected to make. The SEC reports that of the 115 referrals which were made by the White House Personnel Office over the 41 o year period beginning July 1, 1971, only 6 individuals were employed. In view of the circumstances, the agency displayed remarkable fortitude. The potential for serious abuse of the regulatory process nevertheless remains a threat.
During this same period, as a part of the new White House personnel program, the SEC was required to report periodically to the White House on positions, incumbents, vacancies, and prospective vacancies. For non-career supergrade positions. reports were required weekly. On a monthly basis, the SEC reported
* on the number of non-career positions available, intended for replacement, or in White House clearance.'03 In addition, the form asked for specific informnation, including political affiliation, on persons occupying noncareer positions at GS-16, GS-17, and GS-18 levels.'
A nine page report was required monthly on personnel-related matters, including disposition of White House referrals. Other reports,
"Subcommittee Hearinga at 729.
10Jd. at 731.
IM Id. at 732.
'11 Id. at 739.
w The White House involvement in the clearance process will be discussed separately below.
x~' Revised (combined) response of the SEC to Questions 67, 68, and 609 of the Subcommittee's Questionnaire.
required monthly, provided information on Schedule A attorney positions, including full-time positions and upcoming vacancies.
The White House Personnel Office ,t this time closely monitored the availability of non-competitive positions throughout the Federal government and sent a stream of referrals with appropriate instruetions to departments and independent regulatory commissions alike.
Clearame.-The White House handbook also specified its role in the clearance of non-career appointments, both those in the executive departments and those in independent regulatory agencies such as the SEC. The handbook advised that it
* * has the responsibility for clearance contacts on full-time Presidential and Executive level positions. * For non-career supergrade, Schedule C/GS-15 and below, and Schedule A Attorney/Advisor positions, the Departments should make the formal clearance contacts [presumably political clearance, although the Handbook is not clear on this point] and submit a completed clearance contact sheet (Exhibit 212b)'5 along with a biographic data sheet (Exhibit 212a)"15 to the White House Personnel Office for approval. . Also, submittals for candidates who are not Republicans should be accompanied by a brief written justification for the appointment. * *
White House clearance of non-career positions, including the executive assignments and those covered by Schedule C, appears to be al accepted practice under all administrations. Chairman Moss first corresponded with Chairman Hampton of the Civil Service Commission on this issue three years ago. At that time, Chairman Hampton stated that (1) the Civil Service Commission took no part in the process of appointing individuals to positions classified in Schedule C, as the appointing authority in such cases is with the agency, and (2) the Commission does review, as it is required by statute,' the qualifications of candidates for appointment to NEA positions after being advised that agency and White House officials have found the candidate t1o be suitable. Further, Chairman Hampton stressed that he considered this arrangement to be appropriate, since in its operation it serves the purpose of keeping separate and distinct the competitive and the non-competitive services, thereby strengthening the former. 107
Following the Subcommittee's hearings on June 1, 1976, Chairman Moss wrote again to the Civil Service Commission, particularly to learn the authority for the requirement for White House clearance of NEA appointments and more generally to see whether there had been any change, with the passage of time, in Chairman Hampton's views of the propriety of the White House personnel practices.
The Ci il Service Commission reply OS made clear that the requirement for White House clearance does not come from the Commission. Chairman Hampton further stated:
I remain of the opinion that it is proper for the Administration to determine the supportiveness of appointees to positions that are appropriately NEA. If suchi is not the case, I see no reason for such clearance. I believe, too, that any agency that wants its key positions to not have an NEA type of relationship to the Administration should fill its positions by career appointments.
Im References to Exhibits are to forms Included In the White House issued Handbook. 106 5 U.S.C. ,3324.
101 Letter, Robert E. Hampton, Chairman, Civil Service Commission to John E. Moss, Chairman. Subcommittee on Commerce and Finance, Ilouse Committee on Interstate and Foreign Commerce, dated Aug. 16, 1973 (See Subcommittee IHcarings. at 761.) los letter of Chairman Hampton to Chairman Moss, dated June 25, 1976, Subcommittee Hearings, at 762.
T 11 e d i t i 11 c t i o I Is bet \N (,(,I, I (,., I i n et lo vel (I ),,i r t I I i c T i t :i i i d :i i i i 11
rv (,( )111111 i -Si I 1 .1 re 111 t () I I I t Iliake. 'I'llo 1:1 '1 Ild xecll t 1 vf, ,,,,1 7! d(-r w1i icli we inw t- currentIv ()I,(, m t e m ake ii-) I dist ill(1 Tj I I I I it 0 t I 1 :1 t st, v t, I-:] 1 1) 1 (,(.f f I (-.! I.-;I :i t i on r(we I i t I y I in ve beei I I)r( 1 1 m <( j 1, ;l1TCvtiII- thf, consilliler I I milict Safety (.,OM IDIS.,- 1011 11,1" beell ell'Ictod, wll* -Il (I') 1, v la *k e to tile typ", of ',ppointnents ,iI)prt)I)rii1ke in iiidlejwiid ,vt
The lt, is!ntive aI)jro-.ich seems to ini- to i) the Ic- t an (,r to
therefore. may be vi ,\\-(A :is in a,
rli TOCOSIllir :i 1)ictlirc 4 the relat 'mQ11 hef vef 71 :111 w 11 !111 Tit
A(Imillistration :I Ild an i 11(lelwndelit re'-111 -I! )I, '011111 I i D 1 1. Tlwl-e is
a 1) 1):, re I I I I o uct*oli Ovl(lel)t to t!)- Exck-.11tive 111-:111cli I-wl woeli -11(" 2trClirv Wliich r,-,I)orts directly to the AV11*te Ilollse "111(l the ill
col III,) on. Lea 4 of all dll till. .11011 11j)j)P,1r to
11,11 11,11nrloll lmz(-)f-,-lr -1!:z tl,(, rl:j'Lt,, r nf clo,,ii-, T)ce -IS
In t!w 4,d)k ()T-,i?-n1tfee*s view, the proper question is not w1wIller tile Wlil-te 11,oli-, clear (or de(Iiiie to clear) "T)pointments to jm-i71 I.- 10 Ti.
1--: "N FA within an iii(1q)cn(!e1,,t re(r dilatory comm 11 that tlw ii-1iin1)ont of a 1)osition will be called iij)on to
1 11.11'0 or def( ml policy. then it may be approj )riate
TO 11111-1VO Adwl'iii-41-:ition clearance. The real isz-iie is whether :m v
III 'III ino-1(,j-)e3i(1,cnt re rulatory commission sliould be (,1azc*fi(,(l as
-NEA. The Conlifil Riile-: :11)ove Sze'- out
T11:1 01., '1 In c:,der it may be as
'NEA. However. a 1.(,view of these sties fin(1 3 tliem pe(,,iil;arlv
ail,"' Tlicahle 10 1) (" I' t Aiors in a-i iii ler-no:lont recrlfla oiy commission
t the S11 'rti, l'il);, n membership anJ a, need for ilnr1rt:,11 rillem"'kill'). and adjulic.-tincr. Partisan Politics in the SEC are
11 o'.-I t 0 f 1)'I
0111-r" t-, I)iactice of referrals from t1le, 17"hite Hon 7(, for em,_)w i) 1,,nt I'll the ,- Fc i, :. of couI-,_:e, ,t bv-prodii-f of the Ser -ice
If !ziirh po."tions within the SFC (1;,l not exl -C. tile referr"'1-: of ill who do not inect objective.
ci M h- in hir val.-L to it
X0111d cerliil!1v I)e i:iuch ea._ ,. 101* 'M '1111'eLc Vto 'a I'd o -u I' C
if t',,e rtile z (rovor A-in x wlitran(-e 1-nd to tl,,(,
"'V, e (, )" I (_11 if
C-1,1L 10c, v the sl'irit an.1 of cli f le
%; '-'C mid its can-l.,
1) tl.e 1TO,,< ,
11inf" wit 'Ml
V commls:-,.011. "l I I d to with mis<11011S ST10h. as 4 11 e EC, can hai,('1v 1.)e health-v. uiitwr IATS4111-c, of it Is l)o
practice cotild I hv,-aA 't. in v.-hole or in the conffre : zlolml pur1)ese undel-IN-11I(T itS 111S, cc on a Uthuiced, 1,, COM I_ I
1'.-Jv 11"embers of the seiiinr st.ifT i1pon. whoin relv for
I( All be the product of Wliite House 1)1.i -91
C, t or ani)-roval. it
iz than realistic foi- the ConLrrvs or tl,,e to indel
p c, 1 iU e n t, 1) *, i) a I' tiszan deel- ons on c rit I c.Ll I iv _,:Illa t n ry I -:Silos.
"'ITt shmild be noted that the White House cc)nfld,-iifiaI handhnnk, by Ito, O vn torrl,;, i.TiTv to "'non-career per-sonnel." It iloes n-', to po
IV. Securities and Exchange COMMiOn Resntrce8
A. INCREASING MAGNITUDYE OF SEC RESPONSIBILITIES
In June 1972, the Advisory Committee on Enforcement Policies and Practices issued its report to 0;the Securities and Exchange Commission recommending that "[ti he Commission should establish a goal of' doubling the size of its total staff over the next five years." 110 In suport of a 20 percent annual growth rate over the succeeding 5 years, the Advisory Committee estimated the demands that would be placed on the SEC during the 1973-1977 period. One indication was provided by a comparison of the size of the Commission's staff and its responsibilities in June 1941 with its size and responsibilities in June 197 1. The Committee's findings are summarized in the following table:
SEC staff and re8ponsibilities: 1941-1971 Percent
SEC staff positions----------------------------------------- -18
Shares traded (in billions of shares)-------------------------- -1, 7"~
Dollar volume--------------------------------------------- -2, 490
1933 Act registration statements -------------------------------- +
Reports under 1934 Act:
Reporting companies----------------------------------------- +307
Reports filed ----------------------------------------------- +557'
Registered investment companies --------------------------------- +211
Assets of registered investment companies ------------------------+3, 024
Investment Company Act of 1940:
Reports filed---------------------------------------------- +5.
Applications for exemption ---------------------------------- +150
Source: -Derived from SEC, Report of the Advisory committee on Enforcement Policies and Practices, June 1, 197-'2, at (Aa--64e.
The Advisory Committee also noted:
The expanding workload in recent years in virtually every area of the Commission's activities should have been met by the employment of additional personnel to review and comment on required filings, inspect broker-dealers,. investment companies and investment advisors, develop improved coordination with self-regulatory organizations and process the flow of routine applications.
The burden has not been any less in the area of formal enforcement. . In the Committee's view, these enforcement activities [attacking the proliferationof 'shell' companies, improper use of inside information, improper use of customers' funds and securities by brokers, infiltration of organized crime into the securities industry, unlawful corporate take-overs, misuse of pension fund assets and manipulative securities promotions on a national and international scale] are Indispensable to an effective program of securities industry regulation and should be expanded and made more effective.Lu
In addition to the workload expansion which the Advisory Commnittee projected, the demands on the SEC have been increased dramatically by the major new responsibilities imposed by the Securities Acts Amendments of 1975, the advent of call options exchange markets and sharply accelerating call options trading volume, and the
110 SEC, Report of the Advisor-y Cormittee on Enforcement Policies and Practikes, June 1, I a72, at viii. The Adyvhsory Committee members were: John A. Wells, Chairman, Manuel F. Cohen, and Ralph H. Demniler.
W~ Ibid., at 65-4&.
informal and formal enforcement actions neesitated by such events as the continuing illegal and (questionable payments (lsclosures.
Some of the inew duts set forth in the 1975 Arwnflments are one time only; e.g., the section 31 review of exchange and NASI) rules to assure conformity- with t le Exchage Act as um1ende(. In 2 instances, the Commission dealt with its understafling problems by requesting Congress to postpone the due dale of the reports on the bank and the street name studies 6 months. their r tasks are of a c('t iluingir naturee; e.g.. the section 19 re(uirentHt to apov o i-ulmI),v il 1: projoeI rules o.f the exchanges and the NASI). Many of the new statulltory responsibilities involve processing document.s and data subject to deadlines.
In informal enforcement activities, the Division of Corporation Finance has had to review disclosure filings of more than 200 companies in its voluntary compliance program. The review usually includes several sessions with representatives of the corporation seeking to discuss whet her disclosure of certain payments and practices is necessary and, if so, the extent of disclosure required. The Corporation Finance and Enforcemn)ent lDivisions' staffs in mall V cses draft recommendations to the Commission for resolution of disclosure issues. In formal enforcement proceedings, the Division of Enforcement has brought to date around 20 actions pertaining to unexpected illegal and questionable payment cases, in addition to its familiar workload.
B. SEC BUDGET: 1973-1977
In contrast to the anticipated 100% increase in permanent staff positions for the 5-year period from 1973 to 1977, such positions actually increased only 23% from 1973 to 1975, and they are estimated to increase at a far lesser rate, 7%1. in 1976 and 1977. If FY 1977 budget amounts as reduced and approved by OMB are appropriated, the staff will have increased by only 3'2% in the 5-y ear period, despite a total workload which far exceeds what the Advisory Comminittee in 1972 predicted for the 1973-1977 period.
As might be expected, total budgeted amounts also fell below the Advisory Committee's target growth rate. In constant dollars (adjusted(l for inflation) ,the SEC's budget grew only 22% between 1973 and 1975. On a straight-line basis, that is comparable to a 7.3% per year growth rate, in contrast to the 20% per year goal. Using the 1977 budget estimated. the total budget in current dollars will increase 19% for the 1976-1977 period. Assuming that the rate of increase of inflation stabilizes at the Admniinistration's 6% per year projection through 1977, the annual rate of increase in real terms for each of the two years would be 3.5%. At a 7%7 per year inflation rate, the annual rate of increase would be only 2.5%,.
The annual rates of growth in permanent staff positions and total budget indicate that the SEC did better in the 1973-1975 period than it will in 1976 and 1977. Indeed, with respect to the FY 1975 budget, the Subcommittee Chairman made the following statement at the Subcommittee's hearings:
Mr. Moss. At the time of the chairmanship of former Chairman Bill Casey and ;former Chairman Ray Garrett, Congressman Broyhill, who was at that time the
ranking minority member on the [legislative] Commerce Subcommittee, joined me in appearing before the Appropriations Committees of the House and Senate to urge an increase in the budget and in the staff levels at the SEC."2
The House legislative subcommittee's position has been consistently to increase the SEC's budget. The Congress on several occasions in the past 3 fiscal years has increased the amount of the SEC's budget over what had been requested on its behalf by the OMB.
In light of the Commission's major new responsibilities at the time of writing, what b, ame the 1975 Securities Acts Amendments, the House legislative subcommittee consulted with the SEC to determine the amount needed to be authorized. The Congress' final authorization of .51 million for FY 1976 and $55 million for 1977 was understood to reflect the SEC's best estimate of what would be needed to implement its new responsibilities. Yet for FY 1976, the Commission secured only $49.3 million, 1.7 million less than what it estimated it would need. For FY 1977, the OMB already has cut a little over $3 million.
Of particular concern to the Subcommittee in this regard is the way in which the Commission has secured additional staff for FY 1977. After the OMB rejected a supplemental request for an additional 132 staff positions, the Commission countered with a request for 57 new positions. In a letter to 0MB Director James Lynn, SEC Chairman Hills pointed out that 35 staff were transferred from the Division of Corporation Finance ". . to other programs relating to our new legislation, despite a projected increase in registration statements" "' and despite the continuing voluntary compliance program responsibilities. Chairman IHills ". . offered . a commitment to reduce the 1978 personnel level of the Commission to the level of 1976 or below, in exchange for temporary increases in personnel." 114 In the same letter, Chairman Hills stated that the Division of Enforcement is ".. facing at least a temporary increase in investigation pressures". apparently in reference to illegal corporate payment cases. He also stated that the Commission has
[a]ttempted to fund (with ever-increasing difficulty) certain mandatory increases within our existing appropriation, e.g., postal rates, health benefits, reimbursement of travel costs for members of the National Market Advisory Board, and other such built-in escalating costs."
Despite his recognition of increases in statutory duties, registration burd(lens, and enforcement activities, Chairman Hills reiterated the SEC's commitment, "... subject to authorization of a temporary personnel increase, to a minimum of 10 percent reduction in personnel for support services." 16
During discussion at the Subcommittee hearings of this commitment to reduce 1978 staff levels to those of 1976, Mr. Hills first explained:
[i]t is something no different from any projection. a target we are shooting for. But given the present understanding of what we can do to improve our own internal systems, I think it is a reasonable target to shoot for."
1". Subcommittee Hearings, June 1, 1976, at 711. For further data on OMB's actions with respect to the Commission's budget and manpower requests for the 1971-76 period, see Apwondix A-4. OTMB has consistently ordered significant cuts in the Commission's requests. ? Rodv,-:ck M. HIills, letter to 0MB Director James T. Lynn. Dec. 1. 1975, at 2. 11 ) Ibid., t 2.
tu bi f J1.
:Subcoiniittee Ilcarbz,., Juine 1. V'7', ,t-06
Later, during( the same hearing Chaiiniaial Musaiw Nowv do t.
unduerstanld that thle prebeclit levels of taiiganld bIdcting ae, i your Judgment, Chairnian 11ills, adequate ?" Mr. Hillsb sone Given our piresellt look at the Ithing'_S We can1d to improv'0e our ca W-ii inl terms of mnoderNization, thalt rcordtkeeping" and whthv-oit is,. our lest judgment wve will have 41het stff to) do ill he jb inl tile 1.g11m.
There are a couple of big "ifs" in that. If our bas ic foriti rviion wvork, so thant the hand(lin(ig of information an(l ilings, in (orporat eFr iu't;.I d facilitated whenl wet ha:ve aina large bulge inthe corjpoiate registrationr statements, which wve see co)liing, we Nvill be able to do that jot) with fewe r p cop>1. 1 :1 11 anticipat ing--i ;t va Ie we (c't i ipirove ouri I iet hids tha ut ini ch . . T!e SL budget] is theIt k-inIid I \\-)I IlId like anbu1d,;( v\ork~inii foir me to have, rt c(giii we are cutting_ ve ry close- and iiaiy have to Collie c l: to Cnr~s"
The Coimnssionl is i o be comlipIlimnented( fr Its illri to ice~ t productivity and deficiency. Ncverthless,- theli coni itc i2ol cerned that t.,,( Coi-Iiis,-sioil'5 commit men t t o redllice 1,'h1e 'A"Y I97 -taff4i level to thiat of FY 19,76 will compounds the (liffiC ll 'e arL I PIg fui the backlogr of badlly needled but unfilled pwitions-. Thec faiIhlre to aIeve thetrltdicrae in staff during the 197- -77 pe-riod, ituA, be contrasted with thle dramatic increase in respoiis_1'1ilities whiich are In addition to those anticipated in 19)72. 'Moreover, it isunrate to assume that a 1973 staff reduced to the 1970, level canl keep pace_ with its increl~as-ii t, responsibilities to assure pub)licll invest tors t111the expanding iiiarl OIet 1*re* orderly and operate inl the public interest.
V. C671(7u1.sc';js cai(d Zfl om Ieu tf0oPS
A. OFF-BOARD TRADING
W ithi respect to its statutory mandate to review off-board trading rules and abrograte those which are found to be anticompetitive and otherwise unjustifiable, the SEC should act promp)tly to carry out the clear letter of the law. The subject matter at issue is of particular im-portance to regllatorv reforni since abrogration. of th-.seecag rules would remove anticompetitive regulatory restrict ions. Where, as is the ca,-c here,. ox,-er-rezulation (by thle exch-ininges. with the ac~iuiescence, of the ;SEC) stifles competition and interferes with free rlikarkct forces, it should be, with rawn, Iln the present situation, thIe Ccni-'recm7s has made thait judgmilent, ablsent a findingo by the SE-kC thatf there are countierva i l ustificationas necessary to carry out the objectives of thie SeuiisExchangre Act of 1911. The SE .C should act l)1oli1)lY to enforce the law.z-.
B3. CORPORATE ACCOUNTABILITY
'Withi r.,eet to itRz role inl azssuring anl adequate syvstein of corporate accoun-tability, the SE; C shudtakethe follow ing( steprs:
accountants and auditors Shoudd become neutral corporate financial reporters. Thus, to the maximumiii extent practicable, the SEC should prescribe by rule a framework of uniform aceonitin~ rinils Ti instances where uniformity is not practicable, the SEC' shouldreur thle independent iiuditor to attestz that the aecoiintinc vicp
'~ TiW.at 7t11.
lected by management represent financial data most fairly. He should
also prescribe supplemental data to permit a translation from one set of assumptions to another, thereby permitting comparability among companies in a particular industry.
2. Luiteriwil co'ftol.-lhe SEC should act promptly to promulgate rules necessary to assure that:
(a) Publicly owned corporations adopt and enforce codes of business conduct that conform to the laws of all countries in which a corporation operates andl that are disclosedd publicly to shareholders through filings with the SEC;
(b) Znprocedures which allow corporations to develop off-the-book accounts are eliminated;
(c) uniform financial controls are applied throughout every departmnent and operating division of the consolidated corporation and complementary accounts among subsidiaries and between subsidiaries and the parent are reconciled regularly;
(d) communication is strengthened among in-house accountants and auditors and the appropriate levels of management;
(e) falsification of books and records is penalized;
(f) a certified public accountant who falsifies or contributes to the falsification of books and records will be suspended from practicing before the SEC; and
(q) independent auditors attest to the quality of internal controls and the quality of enforcement of those controls in the annual report.
.3. Board. of drectors.-The SEC should promulgate rules necessary to assure that:
(a) a director of a publicly owned corporation receives compensation and independent staff sufficient to perform responsibly his board duties;
(b) a majority of the board is independent of senior management and operating executives and from any other conflicts of interest.
(c) the board reviews and approves the corporation's code of busi*ness conduct and system of internal controls;
(d) the board's auditing and nominating committees are comprised of a majority of independent directors;
(e) the board's auditing committee has available to it independent expert advisors; and
(f) the board has the authority to hire and fire the independent accountant, legal counsel, the general counsel, and senior operating
4. AuditlInj standards.-(a) The SEC should prescribe by rule auditing standards to be followed by in dependent accountants who certify financial reports filed with the SEC.
(b) The SEC should prescribe by rule standards of conduct for independent accountants and auditors and for accounting firms practicing before the Commission and should take disciplinary action as may be necessary to assure adherence to such standards.
(c) Legislation amending section 10(b) of the Securities andI Exchange Act of 1.934 is needed to protect the public against negligence by accountants and others, regardless of intent to deceive or defraud.
5. SEC enforcement of Fcderal d~sclosnre las-()To assure that SEC action is sufficient to elicit all relevant facts and to ascertain
the frequency and extent of violations of Federal laws the SEC should:
(i) confirm its authority to pursue all such inve(sti!:tions :, l to examine the accuircy of Vol lintary disloS 1re1 t 10r1ugI a8 8s to corporate books and records in a ftiseit judgment file(l in a Federal
court and thereby enforceal e, if necessaIry, y contepipt of court sanctions:
(ii) verify through its Division of enforcement or by other means, the accuracy of all published corporate disclosures and publih tihe results of its follow-up investigations; and
(iii) seek through supI)lementary appropriations funding sufllcient to augment its enforcement staff for the purpose of such follow-up investigations and for new invest igations.
(b) The SEC should refer to the Department of Justice cases where senior management or the corporation's independent accountants or auditors had knowledge of or participated in illegal payments or any substantial payments which were not truthfully disclosed in corporate books or records. Injunctive relief, while important, is not a sufficient deterrent in such circumstances.
(c) To inform the public of the nature and extent of illegal and questionable activities in which corporations may be engaged,
(i) more detailed public disclosure is necessary as to all companies which have maintained false or inaccurate books or records or which have engaged in any illegal payment (under the laws of the United States or any other country), any substantial questionable payments, or any form of domestic or foreign political contribution:
(ii) disclosure must include at a minimum a detailed description of the nature and purpose of the payment, the amount, the basis of its illegality (or the surrounding facts which make it questionable). and the identity of all corporate officials who participated or had knowledge of the payment;
(iii) disclosure must tell how much corporate employees and particularly senior management and directors knew about all illegal or questionable corporate payments; and
(iv) disclosure always should be in appropriate communications to the shareholders and to the media.
C. WHITE HOUSE PERSONNEL PRACTICES
With respect to intervention by the White House in personnel selection at the SEC. the Subcommittee recognizes problems can arise from referrals from any source which might use its influence to hire biased or otherwise unqualified candidates. The Subcommittee also believes that there can be significant benefits to the SEC, in the form of qualified staff, from well-intended referrals. It would be unwarranted to suggest that no referrals could be made by the White House or any other source. The Subcommittee does recommend that all referrals, letters, or memoranda, whether from the Executive Branch, the Congress, or private sources, be placed in a file available for public inspection, in order to reduce or eliminate the effect of referrals that represent improper pressures upon the agency. The Subcommittee commends the SEC for its demonstrated ability to withstand the pressure
of a continual stream of political referrals as evidenced by the data set forth in the third case study.
With respect to the matter of clearance by the White House, the subcommittee recommends that action be taken to terminate political clearance of staff of the SEC and of the other independent regulatory commissions. In light of the important policy-making an~d quasijudicial functions which the SEC and its sister commissions perform, there can be no justification for requiring political qualifications not prescribed by statute. However, the problem may be more fundaxuent al than deteriing whether one office or another should or should not clear candidates for positions. In light of the characteristics of Schedule C and NEA positions which have been assigned by the Civil Service Commission, the Subcommittee concludes that no NEA positions should be assigned to the independent regulatory agencies and that the Schedule C positions should be limited. It may be appropriate to assign Schedule C for confidential secretaries or personal assistants to the Commissioners. Even for these positions, there is no basis for tolerating political clearance, although it would be proper to allow the principal to select personal staff or to allow the Commission to select a limited number of senior officials on a noncompetitive basis.
FEDERAL REGULATION AND REGULAT()RY R141F()"ORM
It E~i)lRAL TRAD)E(OMMIISSI(}N
TABLE OF (ONTENTS
I. Summary -----------------------------------------------------I. Mandate 5 III. Implementation of the mandate -------------------------------61
IV. Case studies --------------------------------------------------A. The petroleum industry litigation ("Exxon case') -------------4
B. Selecting priorities for consumer protection-Th e need for a
better system ---------------------------------------- 7
C. The choice between adjudication and trade regulation rules__ 82 D. Obstacles to information-The line-of-business program----E. Inadequate use of injunctions ----------------------------- 89
F. Natural gas reserves investigation ------------------------ 91
G. Clearance to practice before the Federal Trade Commission-_ 98 H. Public funding and consumer participation -----------------101
V. Con0, luSions and recommendations -------------------------------108
The Federal Trade Conmission, est ablished by the Congress in 1914, has the responsibility for proceeding against "unfair methods of competition" and "unfair or deceptive acts or practices" which harm consumers. The Commission also has responsibilities under various specialized consumer protection statutes as well as informationgathering and reporting functions. In rela:tionShip to its awesome responsibilities, its resources are limited, with a current budget of $52.8 million and less than 1,700 employees.
The Commission has been extensively criticized during its existence for excessive concentration upon matters of small economic consequence. As a result of reorganizations during, the early 1970's. it has begun to attract a high caliber of professionals and has become a much more effective law enforcement agency. Its authority to issue substantive "Trade Regulation Rules" (proscribing certain unfair acts and practices) was affirmed by the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act, enacted on January 4, 1975.
As a result of its improvements, the Commission has begun to consider some major antitrust and consumer protection problems. In the antitrust area, it has issued complaints against the petroleum and cereal industries as well as against the American Medical Association for alleged anti-competitive practices. Recently, the Commission announced a major investigation into the automobile industry. In the area of consumer protection, the Commission has recently issued a final Trade Regulation Rule which limits the use of the common law "holder-in-due-course" rule and may benefit consumers substantially. The Commission is currently considering proposed Rules in areas such as hearing aids, prescription drugs, eye glasses, and the funeral industry, among others.
The Federal Trade Commission (FTC) has improved its operations. It has become one of the more effective regulatory agencies. It has the potential (not yet fully realized) to make major contributions to curb inflation and to increase consumer protection in the marketplace. Nonetheless, the Subcommittee has identified several conditions which handicap its performance. We believe we also have identified actions necessary to correct those conditions and to raise the level of Commission performance to conform to the public's expectations.
First, the Subcommittee has found that the Commission's onforcment of its antitrust responsibilities in yma jor cases is h ampevd Ih tle burdensome nature of its administrative proceedings, as in the current Exxon case. The Subcommittee therefore reco,,n e e tnt of new legislative authority to permit the Commission to I atitrust cases directly in Federal district court.
In the Commission's Bureau of Consumer Protection, the Subcomrtiiittee has found several opportunities to improve the agency's use of its resources. The Commission has failed to develop a clear set of prioities for future commitment of resources for consumer protection vith the result that its resources are not applied as effectively as possible. Its regional offices, which have a large percentage of the staff, tend to pursue consumer protection cases of relatively minor economic import. Further, the Commission has failed to use its rulemaking authority extensively enough to curb trade practices harmful to consumer interests but has tended to bring administrative actions against individual violations which consume a disproportionate share of its resources. The Subcommittee therefore recommends that the Commission develop and apply priorities for future action by the Bureau of Consumer Protection and that it direct its staff to divert its efforts from administrative cases toward rulemaking.
The Subcommittee has found that the Commission's ability to obtain vital information has been hampered by its lack of adequate statutory authority and by the inclination of the sources of that information to delav the Commission's investigation. The Subcommittee therefore recommends the passage of S. 642 (or a similar bill) which strengthens the Commission's compulsory process authority to obtain data from industries.
With respect to newly granted authority, the Subcommittee believes that the Commission has not exercised sufficiently its recently expanded power to seek injunctions, perhaps because some courts have narrowly interpreted this authority inconsistently with Congressional intent. The Commission has not attempted to gain modification of this judicial language by further assertions of its injunction power. The Subcommittee therefore recommends that the Commission attempt to gain such a modification from the courts and, if the courts remain unconvinced, that Congress clarify its intent.
In examining the Commission's Rules of Practice, the Subcommittee has identified two weaknesses: The rules forbidding ex parte communications with a Commissioner do not cover such contracts while a recommended complaint is pending. In the American Gas Association investigation, such comm1mications led, at minimum, to an appearance of impropriety. Also, the Commission's rules on "clearance to practice" for former employees utilize a vague standard which provides little ,.'uidaiice for either the Conimission or the public and may have allowed some former employees to practice before the agency who should not have been so cleared. The Subcommittee therefore recommends that both of these rules be changed so that the ex parte rule would apply to recommended complaints and other enforcement actions and so that the "clearance" rule would prohibit all participation by former high-level employees for at least two years.
The Subcommittee has also examined the Commission's new authority to fund directly persons or groups which can add valuable testimony to its rulemaking proceedings by representing an otherwis(e N ue'eesoDtod il lrest. Tliis participation w, a analyzed in the context of the Commission's current rulemaking on the hearing aid industry. The Subcommittee has fomid that such participation is extremely useful and we commend the Conmission for its decision
to fund such groups. Further, we recommend additional funding of public witnesses by other Federal regulatory agencies.
The Federal Trade Commission has extremely broad responsibilities in antitrust and consumer protection. Its resources, compared with the size and complexity of the industries which it must examine, are small. Despite the limited budget, I FTC has made highlly effective use of its funds. The Subcommittee believes that its effectiveness could be substantially increased by additional resources and therefore recommends that its budget and personnel be significantly increased to reflect its important mandate.
The Federal Trade Commission (FTC) was created by Congress in 1914 1 to protect against "unfair methods of competition."12 The impetus for the creation of the Commission came from dissatisfaction with judicial interpretations of the Sherman Antitrust Act3 which had been enacted in 1890 and which had declared that "[e]very contract, combination . or conspiracy, in restraint of trade or commerce . is hereby declared to be illegal . ."' The Clayton Act, which was passed contemporaneously with the Federal Trade Commission Act, set specific standards for antitrust violations and gave the new Federal Trade Commission the jurisdiction to enforce the Clayton Act.*
In 1938, Congress broadened the Federal Trade Commission's authority by the enactment of the Wheeler-Lea Act, which declared unlawful "unfair or deceptive acts or practices in commerce." The
effect of this amendment was to allow the Commission to investigate practices which adversely affected consumers but did not necessarily ave an impact on competition. Throughout the years, Congress has given the Federal Trade Commission responsibilities in many
specialized consumer protection statutes: the Federal Cigarette Labeling and Advertising Act,9 the Truth in Lending Act,0 the Fair Credit Reporting Act," and others.2
1 38 Stat. 717, as amended; 15 U.S.C. 41 et seq., approved September 26, 1914. actionn 5, Federal Trade Commission Act, 13 U.S.C. 45.
a 26 Stat. 209, as amended ; 15 U.S.C. 1, approved July 2 1890.
Id. Ree gqrnerally G. Henderson, The Federal Trade Commission, 1-48 (1924) [herein. after cited as "Henderson"].
S38 Stat. 7.0, as amended: 13 U.S.C. 12; approved October 15. 1914. as amended by P.L. No. 74-692. 49 Stat. 1526 (Robinson-Patman Act), and as amended by P.L. No. 81$99. 64 Stat. 1125 (Celler-Kefauver Antimerger Act).
Under Sections 3. 7. and S of the Clayton Act, the Commission is charged with the duty of prevention and eliminating unlawful tying contracts, corporate mergers and acouifiltions, and intorlocuking directories. Under the Clayton Act, as amended by the RbthinonPatman Act. the Commission is charged with the prevention of certain specified practices, i.e.. unlawful rice and related discriminations.
52 Stat. 111. approved March 31. 1938.
'Section 5. Federal Trade Commission Act, 15 U.S.C. 45. This wording was amended by the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act. P.L. No. 9637. 15 U.S.O. 2301. so that Section 5(a)(1) of the Federal Trade Commk'ion Act now reads: "Unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce, are hereby declared unlawful." 79 Stat. .... as amended: 13 U.S.C. 1:31 et eq. "I Q2 Stat. 146. as amended: 15 U.S.C. 1601 et Req. u q4 Stat. 112q. 15 U.S.C. 1681 et e.
12 The Export Trade Act (40 Stat. 516. as ameronded: 13 U.S.C. 61-65). theo Packer, and Stockyards Act (42 Stat. 159. a amended : 7 U.S.C 11-2209). the Wool Prodw'
In its most significant recent action, Congress enacted in 1974 the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act.13 This Act clarified the Commission's authority to make substantive Trade Regulation Rules 14 and gave the Commission authority to seek consumer redress and civil penalties for law violations. The Act also mandated that the Commission issue rules concerning the disclosure and grading of warranties for consumer products.
The Federal Trade Commission therefore may be said to have three basic law enforcement mandates:
(1) To preserve competition by acting in instances where an "unfair method of competition" has allegedly occurred;
(2) To protect consumers from "unfair or deceptive acts or practices," and;
(3) To enforce various specialized consumer protection statutes within its jurisdiction.
In addition to its specific law enforcement responsibilities, the
Commission has a fourth mandate; to gather, compile, and publish information relating to corporations and industries and to report its findings to Congress.5
The Federal Trade Commission has been a frequent target of criticism.1 A persistent charge has been that the Commission expends too many resources on relatively trivial matters. In 1924, it was suggested that the Commission "should exercise a greater discretion in selecting those cases which involve questions of public importance." 17 A Commission of the American Bar Association voiced the same complaint 45 years later. It concluded that "[t]he failure of the FTC to establish and adhere to a system of priorities has caused a misallocation of
13 P.L. No. 93-637, 88 Stat. 2183, 15 U.S.C. 2301. approved January 4, 1975.
14 See National Petroleum Refiners Association v. Federal Trade Commission, 340 F. Supp. 1343 (D.D.C. 1972), aff'd., 482 F.2d 672 (D.D.Cir. 1973), cert. denied, 415 U.S. 951 (1974).
16 Section 6 of the Federal Trade Commission Act provides:
That the commission shall also have power(a) To gather and compile information concerning and investigate from time to
time the organization, business, conduct, practices, and management of any corporation engaged in commerce, excepting banks and common carriers subject to the Act to regulate commerce and its relation to other corporations and to individuals, association. and partnerships.
(b) To require, by general or special orders corporations engaged in commerce,
excepting banks, and common carriers subject to the Act to regulate commerce, or any class of them, or any of them, respectively, to file with the commission in such form as the commission may prescribe annual or special, or both annual and special, reports
or answers in writing to specific questions, furnishing to the commission such Information as it may require as to the organization, business, conduct, practices, management, and relations to other corporations, partnerships, and individuals of the respective corporations filing such reports or answers In writing. Such reports and answers shall be made under oath, or otherwise, as the Commission may prescribe, and shall be filed with the Commission within such reasonable period as the Commission may prescribe, unless additional time be granted in any case by the
(f) To make public from time to time such portions of the information obtained
by it hereunder, except trade secrets and names of customers, as it shall deem ex\pedient In the public interest: and to make annual and special reports to the Congress and to submit therewith recommendations for additional legislation; and to provide for the publication of its reports and decisions in such form and manner
as may be best adapted for public information and use.
Sce e.a.. Fnmn, ldmini,1trative Reform. of the Federal Trade Coin mission, 59 Geo. L.T. 777 (1971) : Report of the ABA Commission to Study the Federal Trade Commission (1969) fhere!nafter cited as ABA Rpport] : R. Cox. R. Fellmeth & .T. qchulz. The Consumer and the Federal Trade Commission (1969) Auerbach. The Federal Trade Commiosion Internal Oaanization and Proeedutre, 4S Minn. L. Rov. 390 (1964) : Report on Re ulatori u Agenies. to the Pre.qidN,-t-Flect (19(60) : Comwissiwo on Organization of the Erpr,,t' frrTnrlh of the (oiernrment, Task Force Report on ReglatoryI Commo"."'ROnq (1949) :Horrinrr, Politic.q, PcrsovYlitics and the Federal Trade CommIis.ion T and II, 2q Am. Vol. Sci. 1,v,. 1016( (1934), 29 Am. POl. Sci. Iev. 21, (1935) Henderson. supra note 4.
funds and personnel to trivial matters rather than to matters of pressing public concern." 18
A second persistent problem has been excessive delay.19 Thie ABA Commission noted in 19G9 that "[p]roblems of delay have vexed the FTC ever since it was established, and some of the most notorious examples of protracted adinnistrative proceedings have occurred in that agency." 20
In view of these flaws, the Commission introduced major changes in recent years, rearranging its Bureaus and i)ivisio(ns to I'eIlet its mIandates. Its new Office of Policy Planning and Evaluation is charged with the rIesponsibility of recommending "how and where its resources should be utilized in order to best serve the public interest." 21 Evaluation conunittees have been created in the two major operating bureaus in an attempt to screen potential cases closely.
It appears that the Federal Trade Commission has made progress in allocate in its resources according to degree of importance. The (omimission's antitrust program has increased its emphasis on "industrywide" investigatiollns and complaints, such as those for the p)etroleum,)22 cereal3 and automobile 24 industries. In consumer protection, with its authority to issue substantive "Trade Regulation Rules" (TRR's) allirmed by the Magnuson-M)oss Warranty-Federal Trade Commission Improvemient Act, the Commission has addressed significant consumer problems. It is currently considering proposed rules for funeral services, prescription drugs, eyeglasses, hearing aids, and credit practices, among others. The Commission has issued final Trade Regulation Rule for mailorder merchandise and amplifiers. It recently issued a final TRR which modified the common law by limiting the use of the "holder-in-due-course" rule by banks and other note purchasers to escape responsibilities for defects in merchandise. Consumers may no longer be compelled to pay the note-holder if the merchandise proves defective.25
III. Implemention of the Mandate
To carry out its law enforcement responsibilities the Federal Trade Commission has used four different methods:
(1) Advisory opinions;
(2) Industry guides;
(3) Trade regulation rules; and
(4) Administrative proceedings which may result in cease-anddesist orders.
Advisory opinions are issued upon the request of a person or corporation which seeks the Commission's advice about a proposed course of
11 ABA Report. qupra note 16.
1* Sr. e.a., ElmaInn, upra note 16: ABA Report 28-32. SABA Report 28 (footnote omitted).
SSOec. 13, Manual of Organization of the Federal Trade Commission. Exr.ron Corp. t a., FT' DoToket No. 89.4. SWe Section III (A) of this Chapter. SKellowq Corp. et al., FTC Docket No. 8883.
SThe Commission announced on August 2. 1976 that it had been grantedl clearance by the Department of Justice to open a major antitrust investigation of the structure of the domestic automobile industry.
UEndor the holder-in-due-course" doctrine, a consumer was obliged to continue -ayment to a creditor holding an installment contract even if thero was a defect in th. pro luIt :mrchased. The now rule roiures that cnunmer credit contracts preserve the buyer's riht to) dispute the obligation to pay if the goods are defective.
action.26 The advisory opinion is not binding upon the Commission but the issuance of an advisory opinion will normally indicate what the Commission's continuing view of a practice will be.27
Industry guides are meant to provide guidelines for voluntary action by an industry and relate to a practice or series of practices within an industry.28 Though industry guides do not have the force of law, failureue to comply with the guides may result in corrective action by the Commission 29
A Trade Regulation Rule (TRR) also concerns practices within a given industry but, unlike a guide, has the force of law. It is in essence a determination that certain practices are "unfair or deceptive" and thus violate the Federal Trade Commission Act. A Trade Regulation Rule is prospective in nature. It indicts no one for past conduct but forbids such conduct in the future.30
An admi77straive action may be brought against an alleged violator when the Commission has "reason to believe" 31 that the Federal Trade Commission Act has been violated. The Commission first issues a complaint. If the respondent does not admit the violation and accept an agreement to cease the offensive action, a hearing is held before an Administrative Law Judge. The Judge, after the hearing.
issues an "initial decision" which becomes the Commission's final order if not appealed within 30 days. If appealed to the Commission itself, the Judge's decision may be affirmed, modified, or reversed. If the Commission finds that a violation has been committed, it may order that the offensive act or practice cease.
As an adjunct to an administrative action, the Commission has been given new authority recently to seek a temporary restraining order or a preliminay injunction in Federal court to stop the offending practice while the administrative case is pending.3- In appropriate cases, the Commission may also seek a permanent injunction.
The work of the Federal Trade Commission covers a large variety and number of actions proceeding at one time. In 1922 the Commission
28 See FTC Procedures and Rules of Practice, Part I, Subpart A Section 1.1, 1.4. An advisory opinion will not be issued:
"(a) where the course of action is already being followed by the requesting party; (b) where the same or substantially the same course of action is under investigation or is or has been the subject of a current proceeding, order, or decree initiated or obtained by the Commission or another governmental agency; or (c) where the proposed course of action or its effects may be such that an informed decision thereon cannot be made or could be made only after extensive investigation, clinical study, testing or collateral inquiry." Id., Section 1.1 Policy.
7 Id., Section 1.3 (b) states that:
"Any advice given is without prejudice to the right of the Commission to reconsider the questions involved and, where the public interest requires, to rescind or revoke the advice. Notice of such rescission or revocation will be given to the requesting party so that he may discontinue the course of action taken pursuant to the Commission's advice. The Commission will not proceed against the requesting party with respect to any action taken in good faith reliance upon the Commission's advice under this section. where all relevant facts were fully, completely, and accurately presented to the Commission and where such action was promptly discontinued upon notification of recission or revocation of the Commission's approval."
23 1., Section 1.5-1.6.
20 W., Section 1.5.
8 Trade Remglation Rules have been promulgated only to protect consumers, although there is some support for rulemaking bout "unfair methods of competition." See Birru8 4 ,rtcer. 1ntitrust: Rilemalinq v. 4diudication in the FTC. 54 Geo. L.. T., 1106 (1966). In response to a Subcommittee question In December, 1975, the FTC stated that: "Tho staff of tbh lBureau of (CoTn etition are eonducttnr le-til r search regarding the authority of the Commission to issue Trade Regulation Rules in the competition area. Careful eon ldoration Is being given, in addition, as to whether and under what condition" such proopeding, would be appropriate. No conclusions have been reached o recommendationq r i'do In this regard, however, and no 'study' exists regarding this area." [Subcomnfefteo filesAl.
31 Section 5(b). Federal Trade Commission Act, 15 U.S.C. 45.
hadI :154 Iinvestgra t ionspuii. t ~llr e a e' tl oe
million dollars ;Its s talt littIle mlore than 3I O7 'i'il num1ber, of pending11j
inetiaions reached a hi gh of 3,9 ;8 in V"-fal Year 19;53 By v197,
the nmbe of' penld Ing forl-1 I ives4tngt ions ha"d d ropped IIIatialy; oly10( new formal~l ivivestigat ions1 wereI' inlit'iated that ear7
A similar:11 trend hsbeenl evidentf for :iJ III i1i- I fli ive ('omfplli!1I s:. IT)
19,22, there wvere, 257 compl]a inTts penld inir."1 1))", 1962, tho numbe10r of pending~ -ompla~~its1- (1d r-isen to 1110 ~'Ii u brOf newV comp11IlaintS
issued (lech'ined fro tt in198~ oI n17.2 Tin 1975, new Comnplaiiits issued numbered only 4~2 Th Ilis declinee inl wnmb~ers many r~
both thle shift, to large cases in the Buireaui of Competition andl the-- increased ueof trade regulation rules instead of adiinistrafiv a atio ns
by the Bureau of Consiumer Protetion.
In addition to investiga(,tionis arnd adm miist rat i e complallt~. tlie
stflY -- isfa work on advisory opiniions, inuu m, guidles. new t ra(le rI"u
hd-Iioln rules4 ad1 Conll ] anee act ions. Ini 19 7.5. for example. thec (Commiission provided at least 75 advisory onin ionMs to the bilcines,; coill11n1n1itN-.44A of early 1976l. I7 proposed 1-r d~e, re~rulation rulles; were
Penldin beor the j Co.p (11w (icions resulltedl inl IS
divestIt ure orders d11iIfr fiscal 197.54" anld thle 19S SeSSIM't or 1ria
tion of about $4 million for failure to comply it ani0s ores
UThis was added by the Trans-Alaska Pipeline Aiithorization Act of 1973. P.T,. No. 93-153. which amended 'Section 13(b) of the Federal Trade Commission Act to read:
"(b) WVhenever the Commission has reason to helieve-(1) that anv person. partnershin. or corporation Is violating-, or is about to violate, any provision of law enforced by the Federfil Trade Commission, and (2) that the enjoining thereof pending the Issuance of a complaint by the CommjissIon and until such complaint is dismissed by the Comnrision or set aside by the court on review, or until the order of the Commission made thereon has become final, would be In the Interest of the public-the Commission by any of Its attorneys destIg-nated by It for such purpose may bring suit In a district court of the United Stnrtes to enjoin any such act or practice. Upon a proper showing that, weighing the equtiesF and considering the Commission's likelihood of ultimate success, such action Would be In the publc Interest. and after notice to the defendent, q temnorary restraining order or at prehiniInary Injunction may be granted without bond : Provided, hoirever, That If a complaint isR not filed within such period (not exceeding 20 days) as may be specified by the court after isqiuanep of the temporary restraining order or preliminary Injunction, the order or Injunction shall be dissolved by the court and be of no further force and effect:- Provided further, That In proper cases the Commission may seek, and after proper proof. the court may Issue a permnent Injunction. Any such sit shaill be brought In the district In which such person, partnershin or corporation resides or transacts buisiness."
Is A recent decision Indicates that the showing of evidence necessary for en injunction mfty be difficult. See PTO v. Simeon Manzagement Corp.. 391 F. Supp. 697 (N.D. Cal. 1975). aff'4. 532 F. 2d 708 (9th Qir. 1978). The holding appears contrary to the Congressional Intent (see np. 90-91. infraa.
34 There were 231 "applications for complaints" docketed with the Commission and 1*23 docketed with the "branches" as the field offices were called at that time. Annual Report of the Federal Trade Commission at 17, 38, cited In Henderson, supra note 4, at 337-38.
SATIA Rport 19. Table TTT. This i,. the 'number of "formal investientionqs" or "Qevendigit Investigations" (so-called because the file number contains seven digits) and does Dot Include "preliminary Investigations."
t7 F or ain nnalysis of the activities of the Federal Trade Commission for the v-e'rs 10711974, see The Fedferal Trade Commi*ion-197 $, Staff Report on the Subcommittee~ on Consumer Protection aind F1inance, Committee on Tnterstate and Foreign Comrcne. Uh. House of Renresentatives, 93d Cong., 2(1 Sess. (1974).
u"Td. a t 17.
30 Hendorson ""..
41 ATIA Poot2.T'ile 7VIi.
41 TId. qt 2(), Tabile TV. This ineluides P 5 enniplaints sozttlod hr Consent.
42Th Fede [',ral Tred 17,('omiRon19 sitp)ra note 37. at 114. This inlio~109 on pla9ints seZttled1 byr c'ntl.
4"Pdpi Trade Commission. A nnual Reponrt f ( the (Tnrs. icl'ear 1 O7.-. -~ f,20 F-Or dataf~ OTI f',e a Vcf age of pfldifi., 1".u .(, ib Ur IIUIcI A-0,~ to this P'p )!.
44 Ta 5
45 Testlmony o f Calvin T. Collier. Chnirmnn. Fedvr-il Tradeo Corml-loei ~nTT) vro~
Re form-VolW. IV, Hra-rinq before the _1heonwn. on? O7rrviolb and Jncfqh no the fl'oe nn oni !nfoter t~u andorc~qn Cror!mrree. 1 ril Nof. 1- -1. lith ('nn- 2,1~
4'-ed(I(,ra I T r!d oCommnissi-on, Annuanl Peport to thef Cngre-,, Flszenl Tegr 1)7. -.t ~
In the Bureau of Consumer Protection, compliance activities in the 1975 fiscal year resulted in judgments for $273,000 in 7 cases.48 Another 23 cases were certified to the Department of Justice or filed in court that year.49
The Federal Trade Commission's budget and staff have increased moderately. In fiscal 1971, for example, the Commission had a budget of approximately $22.5 million and employed 1325 people. For fiscal 1977, the Commission has a budget of $52.8 million and a staff of approximately 1700.
The Commission is an improving agency which performs its public mission well in most matters. However, it does need improvement in some areas and seven of the eight case studies which follow were selected because they illustrate weaknesses in the Commission's authority, the Commission's R1ules of Practice or the Commission's method of organizing its work. The petroleum industry litigation ("Exxon case") was analyzed both because it is the largest antitrust action ever undertaken by the Commission and because it demonstrates certain problems with such cases in an administrative agency. Two aspects of resource allocation decisions were examined in the Bureau of Consumer Protection because these decisions determine the future direction of the Commission's consumer protection activities.
The case study on the Commission's authority to gather information was selected because of its importance in terms of the Commission's ability to enforce the law. The Commission's newly broadened injunction authority was examined because of its potential importance as a law enforcement tool. Case studies were on parts of the Commission's Rules of Practice which have weaknesses, the Rules on ex parte contacts and on "clearance to practice" of former employees were selected because of their impact upon the public's confidence in the objectivity of the Commission.
The eighth case study analyzes the new mechanism for direct funding of the public groups to participate in Commission rulemaking. It reveals not a weakness but rather the value of this new procedure for receiving the views of concerned citizens.
IV. Case Studies
A. THE PETROLEUM INDUSTRY LITIGATION ("EXXOXN CASE 1)
The "petroleum industry litigation" or the "Exxon case," 50 which is a current administrative proceeding at the Federal Trade Commission,51 is one of the most complex antitrust cases ever litigated. Review of this proceeding demonstrates the immense difficulties which the Commission has had and will continue to have with cases of this dim ension. We explored the following questions: 52
48 Id. at 23. For further information on compliance activities, see Appendix A-9 to this Report.
40 [d. For information on refusals to Initiate FTC litigation, see Appendix A-6 to this r P01' t.
0 FTC Docket No. 8934.
51 In fiscal year 1976, the Exxon case was budgeted for an expenditure of $2.5 million and 45 man-years.
;-Thp Suwbommitte's nnnay ik was not dire"'ted to the question of whether or not thp rpsnondents have In fNct violated the Federal Tride Commission Act. No statement In this Report Is meant to influence the Federal Trade Commission in its adjudloation of this case, nor should any implication concerning the Subcommittee's opinion on the merits of the ca se he drawn from Its .election of fh issio. The Subcommitte's belief Is that, as the Exxon case raises 1qsues vital both to national owergry policy and to the future of complex liti-a ,iton at the 1TC, these issues should be pr'oniptly resolved by the Commission.
(1) Can an antitrust case of this magnitude and complexity be handled appropriately in an administrative rather than a judicial forum?
(2) Has the Commission managed this adjudication adequately and allocated sullicient resources to its resolution ?
(3) How long will it take for this case to proceed to a hearing before the Administrative Law Judge, then through review by the Coiiiinission, and finally into court review?
(4) Have there been deliberate attempts on the part of the res)ondents to delay this litigation ? If so, how successful have they been (
1. The course of the discovery proceedings
On July 18. 1973, the Federal Trade Commission isued a complaint against Exxon and seven other major producers of petroleum products: Texaco, Gulf, Mobil, Standard Oil (California), Standard Oil (Indiana), Shell, and Atlantic-Richfield. The complaint was the result of a nearly two-year investigation into the restrictive practices of the major integrated oil companies.53 The Preliminary Staff Report on this investigation was transmitted to Senator Henry M. Jackson, Chairman of the Senate Committee on Interior and Insular Affairs on July 6, 1973 (in response to his request of May 31) and made public a few days later.54
A major emphasis of the Preliminary Staff Report was to determine the causes of the then current petroleum shortage. The staff concluded that the shortage "can be traced to six separate, but interrelated factors:
(1) The Oil Import Control Program;
(2) Interdependent and cooperative behavior by the largest
(3) The failure of these firms to construct refinery capacity
sufficient to meet current needs;
(4) Government induced barriers to entry which have inhibited
non-integrated firms from entering into refining:
(5) An insufficient supply of domestic crude for independent
(6) The fact that major station gasoline prices have not been
allowed to reach their natural level during the period of shortage
in certain areas of the country." 65
The staff found further that:
"These major firms, which consistently appear to cooperate
rather than compete in all phases of their operation have behaved in a similar fashion as would a classical monopolist: they have attempted to increase profits by restricting output. With their advanced econometric models and computer simnulations the major oil companies should have been able to predict the current increase in demand for petroleum products. Whatever their forecasts
aThe Commlssion had approved on Septemher 14, 1971. ) reoalution for the no of compulsory p)renes "to investigate the acts and practices of firms onegged in the prod'titon or refining of crude oil or the distribution of petroleum products to determine the effect of vertical Interation and joint ownership andl operating arranJentens on the structure, conduct and performance of the petroleum industry .. M "Invest1ation of the Petroleum Industry." Permanent r mm. on nvot'-tn. Comm. on Government Operations, United States Senate (Committee Print, JOly 2. 1973).
Sf4. at .A
showed, however, they failed to expand refinery capacity sufficiently to -meet this (lemand."51
It was the contention of the Commission staff that a major factor in the conipefitiveness of the petroleum market is the viability of the inIdep enideflt refiners aind independent marketers.
The1 st.affI alleged that :
Ellorts by the majors to squeeze the independents' market
,are~ have kept retail gasoline prices from responding to excessive demand. In a normal competitive market the 'cure' for a shortage would be for prices to increase. Tihe higher prices would cause producers to increase supply and at the same time it would (liscoliragre some amount of consumption. Thus supply and demnand would be brought into equilibrium. But what has happened here is that the majors have used the shortage as an occasion to attempt to debilitate, if not eradicate, the independent marketing sector." 115
The complaint issued by the Commission listed a variety of acts and practices which the respondents had allegedly committed. The effect of these acts and practices has been, according to the complaint, to violate the Federal Trade Commission Act in three ways:
(1) The acts and practices "constitute a combination or agreement to monopolize refining of crude oil into petroleum
products . 51
(2) The companies "have maintained monopoly power over the
refining of crude oil into petroleum products 0 .
(3) The companies "have restrained trade and maintained a
noncompetitive market structure in the refining of crude oil into
petroleum products . .1 60
The complaint was not specific about the type of relief that would be requested. It merely stated that "the Commission may order such relief as is necessary or appropriate in order to correct or remedy the effects of anti-competitive practices engaged in by the respondents and to restore competition in the relevant market or markets." However, subsequent events made it clear that divestiture of pipeline and refinery operations would probably be requested. Speaking at a news conference immediately following the issuance of the complaint, James T. Halverson, then D~irector of the Bureau of Competition, st-id that:
We are also looking at the potential for divestiture relief. We think to pressure [sic] the independent marketer in the United States it may be appropriate to have the creation of an additional independent viable refining capacity in the relevant market we have identified and of course that would require divestiture of refining capacity and connecting pipelines. That does not rule out any other form of divestiture relief or other forms of injunctive relief I have not mentioned"
11 Id. at 29.
58 Complaint of Federal Trade Cornmi8sion v. Exxron Corp., et at., (DK. #8934), July 18, 1973, at 11 ; Trade Reg. Rep., 1973 Trade Cas. 5120, 388. 50 Id.
61 Complaint. 8upra note !58, at 13.
62 Federal Trade commission News conference, reported In Antitrust and Trade Regulation Reporter (Bureau of National Affairs), No. 623 at p. D-1 (July 24, 1973). [Note: Mr. Hlalverson probably meant "protect" rather than "pressure" In the second sentence. We assume -Pressure" was either a slip of the tongue or a reporter's error.]
The major oil companies were thus faced with a coNplaint whi:h alleged a variety of anti-competitive practices and which cnceiv alv could lead to a major restructuring of the industry through divestiture of pipelines and refinery capacity. Theirl response was immediate and vigorous. During the month of August 1973, each of the eight respondents filed a "M option for a More I)efinite Statemnnt." This motion requested the Administrative Law Judge (ALJ) to require the Commission's trial staff to specify more clearly the alleged aoticompetitive ats and practices. After a reply by the Commission attorneys, on November 23, 1973, the Judge denied the respondents' motion for a more definite statement and scheduled a pre-hearing conference for December 18, 1973. The respondents attempted to have this order reversed by the Commission but were unsuccessful.63
It was clear from the outset that the ability of the Commission's complaint counsel (the attorneys prosecuting the administrative
case) to prove any antitrust violations would depend in great measure on their ability to obtain internal oil company documents through the pre-trial discovery process. The first step in that process was to learn enough about the oil companies' record-keeping systems so as to be able to specify the needed documents. This is because subpoena for documents must specify the documents with sufficient particularity to allow the respondents to determine reasonably well what is required."6
On December 7, 1973, complaint counsel filed their first "Application for Oral Depositions." That application requested authorization from the Judge to question the comptroller of each of the eight oil companies regarding the structure of the company and the identification, location, and contents of various corporate records.65
On December 12, 1973, the application was granted, and subpoenas ad testificandum (for testimony) were issued shortly thereafter. During December, all eight of the companies filed with the Administrative Law Judge motions to quash the subpoenas. Illustrative of their arguments was the statement by Gulf Oil Corporation that:
"The Information sought clearly will not "round out," "extend," or "supply further details," but is designed to provide the basic knowledge necessary to investigate this Respondent, in order to make a prima facie case against this and other Respondents. This postcomplaint investigation by the staff is necessitated by the premature filing of the Complaint under extreme political pressure before
At the same time, pressure had come from certain sectors of the Administration for the withdrawal of the FTC complaint. On September 4, 1973, the Treasury Department sent a "Report on the FTC's Petroleum Investigation" to the Commission and made that report public the next day. The Treasury Report challenged all of the major findings of The FTC and concluded that "[many of the facts in the FTC report are inaccurate. Consequently, the resulting conclusions are questionable." (Report at 3). The Treasury Report further alleged that success of the complaint "would cause considerable adverse impact on future domestic energy supplied." (Report at 5).
Responding to the Treasury Report on September 7, 1973. James T. Halverson, then Director of the Bureau of Competition wrote to then Deputy Secretary William E. Simon. Mr. Halverson argued that the Treasury analysis "demonstrated a misunderstanding of both the Commission's complaint and the staff report." Halverson pointed out that the data upon which the Treasury report was based was incomplete and totally supplied by the petroleum industry. At the same time, it was learned that Deputy Treasury Secretary Simon had previously written FTC Chairman Engman on July 30 expressing "a great deal of concern" about the FTC complaint and asked to meet with Enmnan. The letter was intercepted by an Engman aide, who feared that it could be an improper attempt to influence a Commissioner and the meeting was never held.
"See United States v. Morton Salt, 338 U.S. 632 (1950); FTC v. American Tobacco Co., 264 U.S. 298 (1924) ; United States v. R. J. Reynolds Tobacco Co., 268 F. Supp. 769, 777 (D.N.J. 1966).
*Applilcation to Take Oral Deposition submitted by Counsel Supporting the Complaint, Exxon Corp. et al., Docket No. 8934, Federal Trade Commission, December 7, 1I7, at 3.
the Investigation was completed, and while several subpoenas duces tecum served on major oil companies were still pending. The Rules of Practice and Procedure as formulated by and construed by the Federal Trade Commission (1) do not allow postcomplaint discovery until after specification land clarification of the issues of fact and law, and (2) state that postcomplaint investigation of the nature sought by the staff in this proceeding is absolutely prohibited. The state of the record in the subject proceeding mandates quashing the subpoena on either basis.'
During the consideration on the depositions by the Commission in early 1974, the respondents also attempted to persuade the Commission that the complaint should be dismissed because the Commission did not have "reason to believe" that the Federal Trade Commission Act had been violated and the proceeding was not in the "public interest." These issues were certified to the Commission by the Judge on February 1, 1974, and the Commission denied the Motions to Dismiss on February 12, 1974. The Commission's order denying reconsideration 67 on June 4, 1974 held that the complaint bad been properly issued and commented on Congressional interest relative to the complaint:
"Respondent's argument that Congressional interest rather than the public interest prompted the issuance of this complaint is misplaced. None of the communications received by this agency f rom any Member of Congress is even remotely of the character deemed improper by the courts. Pillsbury v. FTC, 354 F.2d 952 (5th Cir. 1966) ; D. C. Federation of Civie Associations v. Volpe, 459 F.2d 1231 (D.C. Cir. 1971). And it has long been settled that the adequacy of the Commission's Reason to believe' a violation of law has occurred and its belief that a proceeding to stop it would be, in the 'public interest' are matters that go to the mental processes of the Commissioners and will not be reviewed by the courts. Once the Commission has resolved these questions and issued a complaint, the issue to be litigated is not the adequacy of the Commission's pre-complaint information or the diligence of its study of the material in question but whether the alleged violation has in fact occurred. This is the posture of the instant matter." 68
A major issue which arose in early 1974 in the Exxon case was the right of the respondents to obtain access to documents in the CommisSion's files which had formed the basis for the complaint recommendation. On February 15, 1974, Exxon, Gulf, Mobil, Shell, and Arco filed a motion for the issuance of a subpoena for documents in the Commission's files. At the same time, respondents attempted to take depositions from Commission employees and other government employees. Mobil Oil Corporation moved on February 19, 1974, for a subpoena to depose Chairman Lewis Engman. Respondents moved on March 29, 1974, for subpoenas to other present and former government officials, including Dr. Paul McCracken (former Chairman of the Council of Economic Advisors), Stephen Wakefield (former Assistant Secretary of the Interior and then at the White House), Professor Phillip Areeda, of Harvard Law School (former Executive Director of the President's Cabinet Task Force on Oil Import Con66 'Memorandum in Support of the Motion to Quash and Motion to Dismi'sq. Afade on Behalf of Gulf Oil Corporation, Exxon Corp., et al., Docket No. 8934, Federal Trade Commission, December 21, 19T3, at 6.
117Both the Respondents and complaint counsel urged reconsideration In order to clarify the Comml-zslon's policy on post-complaint Investigations. 68 Federal Trade Commission, Exxon Corp., et al., Docket No. 8934, Order Denying Reconsideration, June 4, 1974, at 1.
trol) and Governor John A. Love (former Director of the Federal Energy Office). On April 19, 1974, the Judge denied Mobil's motion for a subpoena to Chairman Engnan.
At that point, the Commission's complaint counsel were at tmt ing to proceed with their pretrial discovery. On February 22, 197-4, they filed their "Prediscovery Statement." This document iinclldod a description of the petroleum industry, the principal acts or practices which the complaint was designed to test, an out line of the pi )Icil) ll facts to be proven, a statement of the law, a stateinent o)f ih ea and factual issues, replies to respondents' questions and a stateint of colltemplated relief. Respondents replied to this Ire(l),"'oVer Statenint by moving to strike certain allegations in the complaints and certain principal facts in the Prediscovery Statement.9
Complaint counsel's next step was to apply for further depositions regarding record-keeping systems. As complaint counsel were preparing this motion, the respondents filed two joint briefs on June 17, 1974. The first of these was a lengthy brief on the issues of "res judicata" and "collateral estoppel" in which the respondents argued that previous court decisions regarding the petroleum industry prevented the Commission from raising certain issues. The second Joint Brief related to "governmental action" and "primary jurisdiction." Respondents argued that "Section 5 of the Federal Trade Commission Act cannot be applied to state or Federal governmental action, the consequences of government action, or the conduct of private parties resulting from governmental action." 70 The oil companies further asserted that, because the Commission lacls primary jurisdiction over energy policy, the issues must be referred first to other Federal officials.1
Complaint counsel proceeded to file their application for further oral depositions on June 25, 1974. This application requested depositions from 5 or 6 corporate officials for each of the 8 companies (44 people in total) with respect to corporate structure and the identification, location, and contents of various corporate records.72
It was at this point that complaint counsel received a severe setback, as their application was denied by the Administrative Law Judge on July 9,1974. The Judge reasoned that:
Complaint counsel have fallen far short of showing that the requested depositions are necessary and that the information sought is unobtainable by voluntary methods. Instead, they have done no more than to submit argumentative, unsupported, and unpersuasive statements to the effect that "depositions are the only suitable mechanisms available" to them; that consideration of alternative means of obtaining the information is "unrealistic" that even if alternative methods were "theoretically possible," they would require an "unthinkable" expenditure of time; and that enforcement of the "voluntary methods" requirement of Rule 3.33 would mean, in effect, that their discovery plan "would be sidetracked and delayed indefinitely, if not fundamentally destroyed."
For example, M1obil filed a Motion to Strike on March 6, 1974; Gulf it!i a Co'unterstatement of the Issues and a Motion to Strike on March 25, 1974; and Arco filed a Counterstatement of Issues on March 26, 1974.
-OJoint Brief of All Respondents on issues Relating to Governmental Ac:on and Primary Jurisdiction, Exxon Corp., et al., Docket No. 8934, June 17, 1974, at S. ,Jd., at 51.
"Application for Oral Deposition, Exxon et al., Docket No. 8934, Counsel SupprtLng the Complaint, June 25, 1974, at 2.
Under Commission practice, the taking of depositions, whether for discovery or for the preservation of testimony, is not a routine procedure. The Commission has consistently required justification. Although the Commission has itself questioned the wisdom of the "voluntary methods" provision, Standard Educators, 79 F.T.C. 8589 91-3 (1971), the requirement has persisted. Thus, the wisdom of the Rule is not the issue. In that connection, the administrative law judge rejects complaint counsel's suggestion that their discovery plan, including the instant proposals, has been "endorsed" by the Commission (Showing, p. 6)."
On July 16, 1974, complaint counsel requested leave to appeal the Judge's decision to the Commission. The Judge denied this request on July 22. By this denial, complaint counsel in late summer and fall of 1974 -were forced to show that the information needed could not be obtained by "voluntary" methods.
Complaint counsel concluded that the requirement for such a showing would unduly delay the case. They therefore prepared and submitted to the Judge on October 18, 1974, a "Motion for Major Integrated Procedural Relief" to be certified to the Commission for a decision.
In this motion, the Exxon trial staff requested that the Commission modify its discovery rules to conform with the Federal Rules of Civil Procedure. The complaint counsel argued that:
The Discovery Rules of the Commission's Rules of Practice are inadequate for thorough and expeditious discovery.
The crux of the problem is the discovery provisions of the Rules of Practice and their woeful inadequacy in the context of this extremely broad and complex litigation. Although there are a multitude of deficiencies in the discovery provisions, their primary failings may be categorized as two: provisions in the Rules that require burdensome, unnecessary procedures and that lead in almost every case to time-consuming litigation; and provisions that wrest control over discovery from the adversary seeking it, ceding substantial power over the course and conduct of discovery to the Administrative Law Judge and, Indeed, to the opposing party. These problems and their vast implications in complex and bitterly-contested cases can only defeat meaningful discovery and must be resolved forthwith."
The complaint counsel's motion was certified to the Commission for
a decision, which was reached on March 4, 1975. The Commission declined to adopt the discovery provisions of the Federal Rules of Civil Procedure for the Exxon case but noted that the Judgre -was free to use the Federal Manual for Complex Litigation. The Commission further stated that thouzli it iDreferred not to have special rules for one particular case, new discovery rules for the entire Commission would be promulgated soon. Pro osed new disco ery rules similar to the
Zn P v
Federal Rules of Civil Procedure were in fact issued for comment on April 4, 1975.711
The respondents generally opposed the Motion for Procedural Relief. In one brief submitted by Shell Oil Company and entitled "A Problem Solving Proposal," it was argued that "The surge of events has passed the Exxon case by. 11 77The brief argued that the Exxon
730rder Denying Application of Complaint Counsel for Oral Depositions, July 9, 1974, at 4-5.
TAMotion of Complaint Counsel for Major Integrated Procedural Relief, October 18, 1974, at 3 (emphasis In original) .
73 Order Denying Motion for Major Integrated Procedural Relief.
7640 PR 15239. After extensive comments, those proposed rules were withdrawn on May 28, 1976 (41 Fit 21793) and new proposed rules were Issued. As of September 23, 1976, no now rules had been adopted.
ITA Problem Solving Proposal In Response to Motion for Procedural Relief, submitted by attorneys for Shell Oil Company, November 18, 1974, at 4.
complaint should be withdrawn in favor of a broad tu(dy of future national energy policy:
The Exxon case, precipitously filed in a fevered atmniosphere, is ill-equipped to materially assist the search for solutions to the current and foreseeable challenge to this nation posed by the energy crisis. Its focus and the assumptions upon which it was based are hopelessly outdated. The ever-changing quality of the energy system and needs of the nation have rendered c'mpllaint counsel's objectives nugatory if not dangerous. It represents nothing more than a static approach to a dynamic problem. Thus, the complaint is premised upon dated fact and suppositious ab)outt the petroleum industry, a situation which alone invalidates the fi(ney of the co anilaiint. Moreover, in view of the future energy and economic crises we face, pursuit of the complaint might well irreparably damage our long-term economic and energy goals."7
In the midst of the litigation on the procedural rules, a significant event occurred which created another controversy. The Ad(imiinistrative Law Judge retired at the end of 1974 and the new Judge on January 17, 1975, notified the respondents that hie had participated in seven cases involving oil companies while lihe worked in the Commiission's Oflice of the General Counsel. Texaco moved on March 6, 1975, that the new Judge be disqualified because of his earlier work. The Judge declined to do so but certified the issue to the Commission. The Commission on May 13, 1975, denied the motion, finding that "Ins role as appellate advocate was neither investi(rative nor prosecutorial in nature within the meaning of Section 554 [of the Administrative Procedure Act]." 79
It was clear during the spring of 1975 that the pre-trial discovery phase had only begun. The Judge expressed concern in March that "complaint counsel have made no progress in securing discovery from respondents since the original wave of depositions early in February and March 1974." 80 After the Commission denied their Motion for Procedural Relief on March 4, the complaint counsel had no choice but to renew their earlier "Application to Take Oral Depositions" from the corporate officials regarding recordkeeping systems.
During the late spring and summer of 1975, litigation continued concerning the "res judicata" issue, the "coUllateral estoppel" issue and the Judge's orders regarding preservation of records. It became apparent to complaint counsel that the only way to proceed as quickly as possible to get information about record systems was to reach agreement with respondents as to some "voluntary" method. Therefore, it was agreed that the corporate officials would submit to "voluntary interviews" not under oath or officially on the record, although a transcript would be made. Two of the companies (Gulf and Mobil) preferred formal depositions. A motion clarifying the procedures was filed on May 8, 1975. The interviews began shortly thereafter.
During the summer, respondents renewed their requests to obtain information from Commission employees. On July 29. 1.975. Exxon requested interviews with five Commission staff economists.81 When that request was denied, Exxon moved for a subpoena to the five
-Id. at 19.
Federal Trade Commission, Order Denying Motion to Disqualify Administrative Law Judge. Exxon, et al., Docket No. 8934, May 13. 1975. at 2.
)Order granting, in part, Motion of Certain Respondents for Tssunnee of Subpoena Directed to Federal Trade Commission and Requiring Complaint Counsel to Iesimie Discovery Efforts, March 17. 1975, at 9.
1 Letter to Roger B. Pool, Esq., Federal Trade Commission from William Simon, IIowrey & Simon, attorneys for Exxon Corporation, July 29, 1975.
economists on September 2, 1975. The motion was denied by the Judge on September 17, 1975, holding that "Exxon has failed to establish any basis or rationale for granting the deposition request. .. 11 812
T7he next major action in the Ex~xon case was the filing by all respondents of a Joint Memorandum Relating to Worldwide Changes in the Oil Industry Since the Complaint, which was filed on Septembl1er '10, 19 75.
'The oil companies asserted that the complaint should be reassessed in the light of factors such as the changed foreign petroleum situation, the termination of the mandatory oil import program, the elimination of state proratiomung, the repeal of the oil depletion allowance and the acceleration of "independent" entry and growth throughout the industry. On October 17, 1975, in a move which apparently surprised both complaint counsel and the Commission, the Administrative Law Judge certified to the Commission on his own motion a recomnmendation that the Commission consider the withdrawal of the complaint. Responding to the respondents' brief on changes in the oil industry, the Judge noted that:
Given the changes in facts that have occurred since issuance of the complaint and the much broader crisis facing this nation, It is recommended that the Commission consider whether it is preferable, in the public interest, to have such extensive discovery under the complaint (followed by hearings) or, If warranted, to conduct a broader investigation under Section 6 of the Federal Trade Commission Act which investigation could cover the vital issues facing the nation. To the extent that matters now falling under the complaint might be encomp~assed in any overall investigation, they could, of course, be Included. If, in the course of such an investigation, any evidence of law violation were uncovered, the Commission could then take appropriate action, including issuance of a complaint."
In a one-page opinion on October 23, 1975, the Commission decided not to withdraw the complaint, by a 3-1 vote, Commissioner Stephen Nye dissenting.
During the winter of 1975-76, complaint counsel analyzed the results of the voluntary interviews to determine which internal company documents would be necessary to prove their case. On February 20, 1976, they submitted to the Judge an 1800 page motion for the issuance of a subpoena for documents from the respondents. If granted, this subpoena -would be complaint counsel's first real access to the companies' internal papers. After several extensions, respondents answer was filed on July 6, 1976. They argued that [t]he burden which would be imposed by the proposed subpoena is unconscionable." 814 Theyalleged that "1[in]ucli of complaint counsel's proposed discovery is irrelevant and unreasonable." 85 As of September 1, 1976, no decision had been reached by the Administrative Law Judge on the subpoena motion.
82 Order Denying Motion of Exxon Corporation for Issuance of Subpoenas ad Trlfiftcandurn. September 17. 1975, at 4.
86Cerfification to Commission of Recommendation of Administrative Law Judge that Comission consider Withdrawal of Complaint, October 17. 1975. at 5.
8' Joint Response to Motion by Complaint Counsel for Issuance of Subpoenas Duces Tcu m to Respondents, July 6, 1976, Volume I, at 3.
% Id. at 8.
. Analysis of the problems
(a) The difficulties of complex antitrust litigation in an administrative forum
The Exxon case demonstrates the difficulties of resolving a massive and complex antitrust case in an administrative forum. Two basic problems are prominent. First, the Administrative Law Judge lacks effective power to compel testimony or documents at either the pretrial or trial stages. And second, the Commission, having issued a complaint because it had "reason to believe" that the law has been violated, is then placed in the awkward position of deciding whether or not it has been violated, a situation which may lead to the appearance of impropriety with uncertain effects.
During the pretrial and trial stages of any major antitrust litigation, it is critical that the presiding officer have thie ability to decide initial procedural isses yuicklv so that the iIses may he S h ar )ned and developed. The ditlic1ty with this in an tIn ii strative setting is that the Administrative Law Judge does not have stli cit power to enforce these ruins imminediatolv. Peter A. White. who was fori nearly two years the Commission's chief complaint counsel in the Exxon case, commented in a recent article that:
. The power of contempt, however infrequently used, is the cornerstone of effective judicial control. Yet the administrative law judges before whom conimmission cases are tried initially and the commission itself have no contempt (and therefore no enforcement) authority whatever. Accordingly, any order, whether procedural or substantive, of an administrative law judge or the commission may be flatly disregarded (for valid or spurious reasons) by a respondent in a commission proceeding. This action requires the extremely time-consuming and inefficient procedure of the commission initiating enforcement proceedings (in effect a new lawsuit) in federal court."
The Commission itself has agreed with this analysis and has indicated that this is an inherent problem of administrative agencies which contributes to delay. In a June 16, 1976, letter to the Subcommittee, the Commission stated that:
The Commission does believe that the ability to impose immediate and meaningfiul sanctions for failure to comply with discovery processes would be an aid in expediting hearings. But this is a problem that has long plagued administrative agencies . .
". . By far the most important sanction that Federal judges possess for violation of a discovery order is the contempt power. Although judges seldom have need to resort to use of this power to compel obedience to discovery orders. the fact that punishment for contempt of court is a possibility is undoubtedly a great deterrent against disobedience.
Absent the possession of court-like power to impose imme(ldiate fines or other penalties for contempt of its processes, there is little the Commission and its Law Judges can presently do to expediate compliance with a discovery order if the person to whom it is directed chooses not to cooperate. If that person is a party, or is representative of a party, the sanctions listed in 3.3S(a) [an adverse inference] may be available. However, if such sanctions would not he appropri" White, FTC: Wrong Agency for the Job of Adjudication, 61 A.B.A.J. 1242, at 1243 (1975).
ate and the information sought is deemed critical, court enforcement with its attendant delay is the only alternative."
In a complex matter where economic stakes are high. preliminary issues must be resolved before the case may proceed. Therefore, respondents who have the financial resources to do so can always seek Commission review, as the respondents in Exxon have done, with the result that action stalls until the Commission decides the issue.
Even more delay can occur when a respondent chooses not to comply with a Commission order requiring submission of documents. This may occur as a result of litigation over the subpoena request filed by complaint counsel on February 20, 1976, seeking access to oil company documents. If the Judge decides to issue this subpoena and the Commission concurs, the respondents may simply refuse to comply. The Commission may then seek subpoena enforcement of the subpoena by Federal district court. Even if the district court judge orders compliance, respondents may request a stay of that order pending appeal. Since the documents requested are obviously central to the preparation of the case against the oil companies, the action cannot proceed while this litigation continues. In contrast, a subpoena issued by a judge during a judicial antitrust proceeding ordinarily is not immediately appealable.*8
The second problem as noted concerns the Federal Trade Commission's dual role as both prosecutor and judge. The Commission issues a complaint because it has "reason to believe" that the law has been violated. The Commissioners, the staff. the respondents and the public know that the Commissioners may themselves be called on someday to decide these charges. Under the circumstances, the Commissiorn is clearly open to the argument that it will always have a bias toward finding a violation once a complaint has been issued. The Subcommittee has found absolutely no indication that any such bias exists. But the tension created by such a dual role could lead to a public perception of an inconsistent position, thereby reducing FTC's credibility, status, and effectiveness.
The Commission's awareness of a possibility of bias could in fact incline it to lean the other way. In a close decision, the Commission may decide against its own staff merely to counter the belief that it prejudges its complaints.
Another result of this dual role is the Commission's inability to receive much management information on a case once it has entered ad" Letter to Honorable John E. Moss. Chairman, Subcommittee on Oversight and Investigations from Honorable Calvin J. Collier, Chairman, Federal Trade Commission, June 16, 1976.
88 "Ordinarily a respondent or third-party witness will comply with Commission discovery orders. But when confronted with a balky witness, the Commission must apply to a Federal district court for an order directing the witness to comply if it continues to seek production of the information. If the judge determines that the demand is valid. he will order compliance-although sometimes on terms different from those laid down by the Commission. This does not necessarily end the matter, however. A judicial order enforcing a Commission subpoena (or other Commission compulsory process) is regarded as a final appelahle order. Ellis v. ICC. 237 U.S. 432 (1915) ; T'United States v. frcDonald. 3.113 F.2d 832 (2d Cir. 1961). If the witness persuades the court to stay its order ending appeal, more time is consumed in the process of appeal. In this respect, the witness is in an sdvantaeoniis position compared to a person who has been orlored by a ju're to answ,'r dr-mnds put to him by a grand jury or in the course of judicial trial. No imnwdinte nppmil is ordinarily allowed from an order commanding compliance with grand jury siihjowni lr court subhnoena issued during the course of a trial. Cobblcdr)9f v. T- united States. .09 T'.. ."-2 (1910) ; Borden Co. v. Sylk. 410 F.2d 843 (3d Cir. 1969) : United
Stafe.s v. Fri (l. .16 F.2d 691 (2d Cir. 1967). In such proceedings, a recusant witness may seeok nppoallao review only nfter he has been hold in contempt. Obviously this p)recondiflion tests the sincerity of witnesses resisting discovery orders." Id.
judication. This happens because of its prollhibl)ition against er parte communicatiois. contacts with only one side il a controversy,~" Thus, while the Commissioners approve bu(lget reIuests. they do so without knowledge of the many mid-litigation strategy decisions wih are made. While this may not have pIroved( a l)prolem yet in t he early stages of this case, the time may well come when lack of such information may be important.
(b) Likely timetable for the case
The EAxxon case has raised issues at thle core of the containing debate over national energy policy. The basic quest ion is whet her the petroleum industry is competitive. A corollary question is whether a prohibition upon owning more than one phase of petroleum prd()(luction ("divestiture") would effectively promote competition.
Divestiture has been vigorously debated in the Congress and will probably continue to be. To the extent that the Conunmission's adjudication could produce useful information for the Congress. there is a clear interest in prompt proceedings. The difficult is that the
schedule depends largely upon the response to the oil companies. Owen M. Johnson, Jr., Director of the Bureau of Competition, commented at the Subcommittee's oversight hearings last spring that:
Mr. JonNsoN. I really don't have an answer to the time question. I suppose one could look at the history of major antitrust cases and make some deductions therefrom. The Exxon case will be larger because of its theory, based upon the interaction of eight companies. It will involve a lot of documentation on joint ventures, exchange agreements, and that sort of thing. We have to show how these eight companies relate to each other.
Reference was made here today to the IBM case, where the complaint was issued in 1969 and the case is now at trial in 1976. You can look at these historical parallels and hope they are somewhat comparable, but the administrative law judge will control the progress of discovery in the Exxon case. A lot of the timing is subject to his orders, subject to the respondent's reaction, and subject, quite probably, to court enforcement on certain aspects of our discovery. So we really can't come up with a figure."
Probably the respondents will oppose the Federal Trade Commission's complaint vigorously. From the time the complaint was issued until the present, the oil companies have filed more than 100 motions on various discovery issues and other pre-hearing issues.9 Their response to the Motion for a Documents Subpoena (filed by the Commission staff on February 20, 1976) indicates that they will oppose by all legal means any effort of the Commission to obtain the internal company documents which are needed to prove the validity of
the complaint. Litigation over that subpoena alone could last through*Under Section 4.7 of the Federal Trade Commission Rules: ; 4.7 ERx Parte Communications-(a) In an adjudicative proceeding. no person not employed by the Commission. and no employee or agent of the Commission who performs any invoP
M ~ee letter to Patrick M. McLain and Mafirk L. Rosenhbro. Conul. c.ihconrn on Oversight and Tnvestieatio)ns from David .. Savlr, Assistant Director f,r Tner:! Litigtion. Brean of ampetition. Federal Trade CompTiinion with attached i-t of mt!'*C in Exrxon litigation, Mairch 10, 1976, [Subcommittee fles].
out 1977 and perhaps into 1978. One can hardly estimate with confidence the amount of time that would be necessary to analyze those documents if and when they become available. The "Prehearing Schedule" submitted by the Commission staff in October, 1974, allocated 16 months to such analysis,92 an estimate which assumed that no other activities would be required of the allotted staff.
It is reasonable to assume that the -analysis could continue into 1979, even if the Commission suffers no major reverses in court. After analysis of the documents, the complaint counsel plans to begin a third phase of discovery, the depositions. The October 18, 1974 procedural motion stated that. "Ten months have been allotted for the extensive third wave of discovery. Complaint counsel expect to take from 500 -to 700 (1epositlons of respondent officials and employees, a process that will require great coordination of efforts to accomplish in less than one
That estimate assumed that there would be voluntary compliance with these depositions. In view of the intense opposition to the firstw aile depositions, this assumption may not be sound, although it could be supported by other f actors in the litigation.
The third wave of discovery, given no significant opposition, would likely take place during 1980. If opposed like the first-wave, respondents could probably delay action into 1982 or even 1983. On the basis of the respondent's actions so far, trial might not begin until 1985, even with no significant reversals.
It is impossible to set a time for the length of trial, the Judge's initial decision, the Commission's decision on review, or the expected judicial review. Even a preliminary decision on the issues may be many years, even decades away, despite the gravity of national interest in resolution of the issues. To the extent that the structure of the Federal Trade Commission and its Rules of Procedure account for the laggard pace of events, the structure and procedures must promptly be corrected.
(c) Deliberate delay by respondents
Numerous procedural and other motions submitted by the oil companies have done more than buy time for the respondents. Compared to the legal establishment of the oil companies, the staff resources of the Commission are modest. Therefore, any time spent responding to opposition motions leaves less time for preparing its case. NYot only time but exhaustion f avors the respondents.
It is ext remely difficult, however, to distinguish between a. legitimate procedural motion and a deliberate delaying tactic. We believe, however, that many of the more than 100 pretrial motions filed by respondents in the three years since the complaint was issued were without substantial legal basis and were filed partly for the purpose of delay. respondents have taken full advantage of their ability to raise issues before both the Admninistrative Law Judgre and before the Commission and they were aided in these tactics by the structure of the Commission and its procedures.
92 This schiedifle listed July 1, 1975, for commencement of second-wrive discovery and October 1. 197G. for its conclusion. it is not clear what this was based upon, although It was certainly too early at that time to estimate the number of documents which would have to be reviewed. Motion of Complaint Counsel for Major Integrated Procedural Relief, October 18. 1974, at 64.
93 Id, at 62.
Moreover, certain decisions of the Administrative Law Judges have contributed to the delay. The first Judge's decision in 1974 to force complaint counsel to pursue "voliiuntary methods" before he would issue a subpoena substantially protracted the first wave of discovery. The Subconmittee believes that this decision was inconistent with both the intent of the Commission's discovery rules and with the public interest. Although the present Rules of Practice do require for a subpoena a showing .that such discovery could not be accomplished by voluntary methods . ." it is obvious in the context of this case that the respondents are unlikely to yield sufficient information voluntarily.
The second Judge's submission to the Conmmission on October 17, 1975 (on his own motion) of his recommendation that the Commission consider withdrawing its complaint may also result in delayin this proceeding by encouraging the respondents to oppose the Commnl1ssion. We believe that the Judge's action suggests prejudrgment of the merits in a way which adversely affects the Commission's ability to resolve this case. The Subcommittee further believes that the Judge. in atin on his own motion, followed a course that is not appropriate to his supposedly impartial role.
(1) The Exxon case illustrates the difficulties of deciding a ma sive. complex antitrust case in an administrative forum. Neither the Administrative Law Judge nor the Commission has effective power to obtain necessary information efficiently in the course of such litigation. It is likely that the action would proceed with fewer delays in a Federal district court.
(2) It is doubtful that trial will commence before 1985, particularly if there is no change in the resistance by the oil companies.
(3) The respondents have taken full advantage of their ability to file dilatory pretrial motions. If they continue to do so, they will to that degree delay the eventual decision, possibly for decades.
It is our opinion that the tactics in the Exxon case will emerge in any major antitrust action by the Federal Trade Commission and perhaps in smaller cases. The "cereal case" (against Kellogg, General Mills, General Foods and Quaker Oats) 5 and the American Medical Association I8 are especially likely to encounter tactics like those used by Exxon. We believe that the Commission is entirely correct in bringing cases that cover a whole range of possibly anti-competitive practices within an entire industry. We regret that this policy may be severely hampered by the structure and rules of the Federal Trade Commission.
Therefore we recommend that the Congress consider lerilation which would permit the Federal Trade Commission to file its antitrust cases in Federal district court. Filing in Federal district court would allow procedural and pretrial motions to be dided in one
Federal Trade Commission. Rules of Practice. 3.33. 16 CFR 1.3. The Commission recently proposed new discovery rules which eliminate this "voluntary methods" requirement. 41 F.R. 21793 (May 28. 197r).
9 Docket No. q113. The complaint was issued in 1972 and trial began in April. 1970.
SDocket No. 9004. The complaint was Issued on December 22, 1975.
forum, the district court, rather than by the Administrative Law Judge, thcn the Commission, and, third, a Federal Court of Appeals via judicial review. The Commission's dual role as prosecutor and judge would be eliminated. The difficulty of conducting complex pretrial discovery would be reduced because of the availability of meaninoful sanctions in the district court. The Subcommittee believes that such legislation would substantially improve the ability of the Federal Trade Commission to carry out its Congressional mandate.
Meanwhile, we recommend that the Commission undertake rule changes to resolve the issues in the Exxon case as rapidly as possible. As its Rules of Practice, which were designed for small antitrust cases, may be inadequate for resolving industrywide actions, the Commission should consider other Rules of Procedure for exceptional cases. If the Commission believes that its statutory powers are not sufficient to expedite this litigation, it should so inform the Congress and should recommend corrective legislation.
B. SELECTING PRIORITIES FOR CONSUMER PROTECTION---THE NEED FOR A BETTER SYSTEM
We have noted above that the Federal Trade Commission formerly concentrated its limited resources on cases of modest economic scope.97 Prior to the passage of the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act,98 the major method used by the Bureau of Consumer Protection to enforce the Federal Trade Commission Act was to bring a complaint against the alleged individual violator. Since the passage of the Magnuson-Moss Act, there is an indication that the specifically affirmed power to engage in "rulemaking" will be a more major, if not the dominant, method of enforcing the Federal Trade Commission's mandate to protect consumers. In a statement to the Subcommittee on Oversight and Investigations, Chairman Calvin Collier noted that "the Act has prompted the Commission to shift substantial resources away from case-by-case adjudication and into rulemaking." 11
Undoubtedly, rulemaking will enhance the Commission's effectiveness. First, the Commission may use its resources to make rules for an entire industry or consumer problem in a single rulemaking proceeding rather than bring a number of cases against individual offenders. Second, by making general rules, the Commission may provide better guidance for vendors than when it adjudicates only specific cases.100
An important decision which the Commission must address is the extent of the use of rulemaking. However, the critical question at present. whatever enforeouient method is used, is the choice of target industries and consumer problems. For this choice, the Commission has not yet developed a systematic approach.
ITi storicallv, the Bureau of Consumer Protection's selection of possible cases or areas for invest igation has favored two methods:
(1) The mailbag" approach, that is, reliance upon letters from the public, from industry and from the Congress.
I FTee soi rcpq cited In note 16, supra.
9 Ptib. L. 93-637, 15 U.S.C. 2301. approved January 4, 1975.
9 Testlnony of Calvin T. Collier, Chairman, Federal Trade Commission, Hearings supra note 45, at 519.
ro Sc S tion TIT(C' of 1-111 Chapter. infra. for di euqsson of the rulemaking versus adjudication in the land sales and vocational schools programs.
(2) A self-starting approach, perhaps based on research or the personal knowledge of staff members.
The Commission's procedure for beginning an investigation is relatively simple. The first step is the issuance of a Memorandum Initiating an Investigation (MII) by an Assistant Director of the Bureau of Consumer Protection or by a Regional Director.' An investigation in this stage is known as a "Preliminary Investigation." It is an informal evaluation of the desirability of a full investigation. Often, an MII follows the suggestion of a staff attorney that a particular investigation is warranted.
If the preliminary investigation indicates that a subject deserves investigation, a "formal investigation" (or "seven-digit investigation") may be opened. "Seven-digit" refers to a file number with seven digits assigned to the matter. A seven-digit investigation is launched also at the discretion of an Assistant Director in the Bureau of Consumer Protection or a Regional Director.02 At this point normally an "investigational subpoena" is issued by the Assistant Director or Regional Director 103 for documents or testimony. The Conmmnissioners themselves first become aware of the proposed formal investigation when someone objects. A motion to quash the investigational subpoena must be ruled upon by the Commission itself.04
1. Recent changes in resource allocation
The Commission has introduced certain changes in its planning procedures which seem constructive. The first consists of program budgeting and a requirement that manpower and other operating costs be estimated when a complaint is recommended.05 This process should provide useful information on the deployment of staff resources for review by Commissioners, the Executive Director, the Bureau Directors, and Assistant Directors.
A second change was creation in January, 1976, of an Evaluation Committee in the Bureau of Consumer Protection, under direction of a Division of Evaluation.06 The memorandum which created the Division of Evaluation described its functions as follows:
The purpose of creating a Division of Evaluation was to ensure that. on an individual case basis as well as program-wide, consumer protection matters are generating the greatest possible consumer benefits relative to costs.
The Division's functions will include developing new programs, monitoring existing programs, and analyzing the effectiveness of completed programs. These activities should provide information crucial for the development of long-term planning capabilities and for the strengthening of the Consumer Protection Mission through the institutionalization of cost/benefit and resource-use analysis where appropriate at every major stage of program development and execution."
o101 Pursuant to delegated authority under Section 2.1, Procedures and Rules, Feder1al Tra de Commission.
In Pursuant to the delegation of authority in Section 2.7(a) of the Federal Trade Conmmission Rules, 16 CFR Part 2.
1o section 2.7th) of the Federal Trade Commission Rules, 16 CFR Part 2.
I se'e Federal Trade Commission response to question 49, Subcommittee questionnaire of .Tune, 1975. Sunbhcommitto file.
10 The Bureau of Competition has had an Assistant Director for Evaluation for several years.
1 Memorandum to Staff of tbohe Bureau of Consurnmer Protoection and Reoonal Offois, Federnl Trade Commission. from .Joan Z. Bernstoin. Director. February 24. 1977. 2it. The Evaluation Committee nnqists of ceorn rnmbers: the As'st1nt Dire r T EvnTItion. the Denitv As
2. Use of regional ofie resources in consumer protection
A significant portion of the staff resources of the Bureau of Consumner Protection is located in the 11 Commission Regional Offices '108 and one "Field Station." 109 These offices currently have 390 of the 1,678 employees of the Commission 110 and d1(uring fiscal 1976, they spent approximately 40 percent of the resources of the Buveaui of Consumer Protection."' Therefore any discussion of the proper use of resources in the Bureau of Consumer Protection must recognize the importance of the staff resources in the Regional Offices.
Since the founding of the Federal Trade Commission, Regional Office employees usually have served only as investigators for the Bureaus, primarily the Bureau of Consumer Protection. As a result, the regional staffs did not develop the expertise necessary to prepare cases.
In the early 1970's, the Regional Offices were given authority to originate investigations, to issue investigational subpoenas, and to recommend complaints directly to the Commission. They were further encouraged to expand their activities into Bureau of Competition matters. As the Regional Offices have begun to extend their duties, however, the Commission has not been clear about what they are supposed to do. As most Regional Offices have concentrated on rather local, matters, the economic effects are limited. Some Regional Offices have begun to investigate cases of national scope," to a limited extent.
Coupled to this lack of direction for the Regional Offices is the Comnmission's failure to address the single most-important question concernintr their operation: How large should they be in relation to the total Commission staff ? The Subcommittee, finds that a disproportionate amount of Bureau of Consumer Protection resources may be concentrated in the Regional Offices and these resources are often spent on matters of relatively minor economic consequence.lls
In an attempt to restructure the relationship of the Regional Offices to the Bureaus, Chairman Lewis Engman, on December 31, 1975, abolished the position of Assistant Executive Director for Regional Operations. This official's function had been to coordinate and approve all Regional Office matters for submission to the Commission. As a result of this change, the Regional Offices report to Program. Directors on the Bureau staff and ultimately to the Bureau Directors. Perhaps this new system will help to coordinate Bureau priorities with Regional
1IN Atlanta, Boston, Chicago, Cleveland, Dallas, Denver, Los Angeles, New York, San Francisco. Seattle, and Washington, D.C.
100 Honolulu. A second field station in Kansas City was closed as of JTuly 16. 1976.
110 Staff telephone conversation with Jack Duggan, Assistant to the Executive Director, Federal Trade Commission, Sept. 1. 1976.
M1 Federal Trnde Commission, Program Budget Justification to Congress, Fiscal year 1977, at 5 (1976 Resource estimates).
112 The Seattle Regional Office was critiei7ed for an Investigation of the house plant Industry. Federal Trade Commission Investigation of the Nursery ad Houe Plant Indstr, HearingRi Before the Suhwonnn. on Federal Spendina Practices. pEfficiency and Open Governmnent of the Sen. Comm. on~ Government Opera tions, 9411h Cong., 2d ,Sess., December 4, 1975, nnd M.NTirch 4. 1976.
1The Suibcommittee Intends no criticism of the Regionl Office employees themselves: they operate within the system which the Commission has created.
Office activities. In any event, the Coummission must still (decide what proportion of its resources should be in Regional Olices. It must determine in its judgment where these resources can be deployed most effectively.
Our concern with the effective use of these resources is consonant with the analysis by the Coninission's Office of Policy Planningr and Evaluation, a semi-annual critique of present programs. In its January 1)7( analysis of the Bureau of Consumer Protection, it bore down on Regional Oflice plans and policies: e.g. regarding the Advertising Monitoring and Substantiation Program, the Office
Approximately 30 percent of the resources usage in this program has been used by the regional offices to prosecute cases of dubious public interest.'"
As to Affirmative Disclosure of Material Product Information, the Off0ic noted that:
No Regional Office activities were expressely planned for this program; nonetheless, there is a raft of cases and investigations.'
Overcommitment of resources was a problem in at least one area: Textile, Wool and Fur Labeling. The Office found that:
Resource usage is runing about forty percent over the plan approved by the Commission [for the program]. If the Commission's resource allocation decisions are to have any meaning a serious effort must be made in the regional offices to reduce expenditures here.Y
3. Future planning and priorities
The most serious deficiency in the Bureau of Consumer Protection's resource allocation is its failure to plan where future resources should be placed. The Commission apparently believes that there are no industries or consumer protection problems which are not now under consideration. In response to the Subcommittee's question, the Commission stated that:
The Commission is constantly on the alert for remediable consumer protection problems. As quickly as it is able to identify those problems, it addresses them. Accordingly, there is no backlog or inventory of problems of which the Commission is aware, which it feels can solve, and which are not being addressed1 It is not clear that the Commission has any data upon which to base its conclu-ion. In response to our question. "low does the Federal Trade Coammiion as embl. a data base for (deterniijni what areas
or industries not now being reviewed are most likely to have consumer protection problems ?" the Commission said that it "does not assemble what could be referred to as a data base"."8 Even if the Commission is aware of every con u:mr protection problem, it does not appear to have any systematic mneto(l for both determining the relative importance of these problems and for ensuring that its commitment of staff resources reflects these priorities. It is therefore unable to plan realistically so as to direct available staff to investigate practices which the Commission believes should receive prompt attention.
"A Federal Trade Commission, Program Budget Mid-Year Review, January, 1976, Vol. II, Program 101, at 4.
U Id., Program Ill. at 7.
no Id., Program MO4, at 1.
11 Letter to Honorable John E. Moss, Chairman, Subcommittee on Oversight and Investigations from Calvin J. Collier, Chairman. Federal Trade Commission, June 9, 1976,
reprinted in Hearings, supra note 45, at 644-51.
The result is that individual staff professionals may generate new investigations without knowledge of the Commission's true priorities. These ideas may actually match the priority list. The investigator must show that its possible benefits outweigh the investigation's costs. Such ideas usually are evaluated with respect to other current proposals, but are not measured against project that are possibly more important for f uture, programs because the Coimrission has failed to determine what its f uture, emphasis should be.
Because they are primarily occupied with local situations, the Regional Offices, though they depend on Prognrm Directors in Washingrton to all ocate staff for each program, cannot in actuality, transfer staff from one to another priority without advance preparation.
The Commission should seek to develop a system that will define future priorities, so as to identify projects of which will receive the first call on available resources. It would perhaps be helpful to conduct periodic, surveys of consumers to obtain data for such plans and as a basis for priorities.119
(1) The Commission should determine which specific areas, industries, or problems warrant future emphasis. The Commission should permit no significant commitment of staff to any but planned activities. It should require proposals for new investigations to conform to accepted future priorities.
(2) The Commission should convert the resources of its Regional Offices to operations in major consumer protection areas which warrant the most attention.
(3) The Commission should delineate clearly the future role of the Regional Offices. Their major functions should be liaison and coop~eration with State and local consumer protection agencies and citizens groups as well as initiation of administrative cases when, and only when, those cases are rated significant in the scale of Commission priorities.
C. THE CHOICE BETWEEN ADJUDICATION AND TRADE REGULATION RULES
Section 5 of the Federal Trade Commission Act 120 prohibits "unfair methods of competition" and "unfair and deceptive acts and practices" and describes the manner by which the Commission enforces violations of this section. These adjudicative proceedings are similar to a judicial proceeding: upon issuance of a complaint, the parties have a right to appear at a hearing, and, after weighing evidence and argument, the Commission issues an order. Under Section 5, respondents may challenge a final Commission order in the United States Court of Appeals. In addition to adjudication, the Commission has defined its policy of consumer protection by isuing Tralde Regulation Rules. A Trade Regulation Rule defines industry-wide acts or practices which are unfair or deceptive. It forbids such acts, which affect an entire industry, with the same force as a Commission order or a statute.
119 JJ One such survey was considered In 1973 but was never carried out because of lack of money and concerns about its usefulness. 12015 U.S.C. 45.
In 1963, the Commission issued its first Trade Regulation Rule. It applied to the advertising and labeling of sleeping-bag.1 In 1971.,
the Commission's authority to issue indust rywide rules was challenged. The test case concerned gasoline octane ratings. In 1973, th. United States Court of Appeals for the District of Columbia uphed the Comnmision's authority to issue the octane rule and oflher T s. On January 4, 1975, the Magnuson-Moss Warrantv-ederal I Trade Commission Improvement Act.'2- Title II, affirmed the unt lority of the Commission to act by Trade Regulation lRuitle. The Act azio) sets new procedures for the Conmmission in such proceedings.
The Comimission's decision whether to proceed by ease or with a trade re-gulation rule necessarily depends on many factors, including the incidence of the past violations, the effectiveness of a rule, and prior adjudications. Review of its activities in consulier protection indicates, however, that the Commission has not assigned to rulemaking resources sufficient to ensure that substantive regulation rules are issued as quickly as possible.124 Instead, the Commission has continued to employ administrative action for certain consumer protection cases, an uneconomic use of staff resources.
Its actions on vocational schools and land sales programs demonstrate the flaws in this policy, as the following tables indicate.
m 16 CFR 400.
lu National Petroleum Refiners Association v. FTC, 340 FP. Supp. 1343 (D.D.C. 1972), aff'd. 482 F.2d 762 (D.C. Cir. 1973), cert. denied, 415 U.S. 951 (1974).
SPub. L. 93-637, 15 U.S.C. 2301.
SThe Commission has been criticized for extensive delays in rulemaking. See Hearings on the Federal Trade Commission Before the Subcomm. on Consumer Protection and Finance of the House Comm. on Interstate and Foreign Commerce, March 20, 1976.
LAND SALES 115
[Time period: 1st half fiscal year 19761
Preliminary investigations Formal investigations Part Ill
Pending Opened recommend- Pending Opened recommend- Consent
end of during ing formal end of during ing orders Complaints Orders Matters Projects Rules
Activity summary period period investment period period complaint issued issued issued pending pending pending
Fiscal yearl95------------5 16 -------21 7 2 1 2 -------2-----------1st half fiscal yearl9 ---------3 3 3 23 4 1-------------- 1 3-----------3 -----------------I IFederal Trade Commission, "Program Budget Mid-Year Review," January 1976, vol. 1, program JO.4.
[Time period: 1st. half fiscal year 19761
Preliminary investigations Formal investigations Part Ill
Pending opened recommend- Pending Opened recommend- Consent
end of during ing formal end of during ing orders Cornplaints Orders Matters Projects Rules
Activity summary period period investment period period complaint issued issued issued pending pending pending
Fiscal year 1975----------------------- 8 24 1 19 6 7 3 6 2 2
1st half fiscal year 195---------4 3 2 16 3 4 3 1 1 6 2 2
1 Id., program iO.2.
In the vocational schools program, rule ilak in1g lo( eed NI. have
been pending since August, 1974. Nevrt N iless, tle (ouiio s
continued to open investigations (both preliinary and forl:al) and has continued to issue comIlaints and approve consent ondlers. Undoubtedly, these enforcement activities have (discouraged the offending pn ctices. Nonetheless, such cont inning diversion of stafff
resources retards the rulemaking proceeding.
In its January 1976 review, the Oflice of Policy Planning and Evaluation commented on the vocational schools program that:
actuall accomplishments have fallen far short of plan, which included final promulgation of the TR for this year. Giving the most generous interpretation possible to the staff time reports, only 26 percent of the time spent in this program has gone to ruleinmkiing. Only about 9 percent of recorded time has been spent by the Bureau on rulemaking. The remaining 74 percent has gone to litigation.
As yet, no rulemaking is pending on land sales. But the Office of Policy Planning and Evaluation has recommended that a rule would be much more effective, stating in January 1976 that
unfortunatelyl, Bureau resources are almost exclusively devoted to the selection and litigation of cases appropriate for consumer redress. Litigation has proved a costly method of achieving the wanted objective . .. [a]lthough rulemaking was planned, the Bureau now claims that it has no time for it, due to the tremendous efforts being devoted to litigation. We do not see how the Commission will ever get out of the land sales business if the Bureau continues to use the current strategy. Of course, aside from the terrific costs, that strategy is often hampered by the insolvency of the firm investigated."
The policy planners believe that a rule requiring disclosures in the land sales area would be cost-effective and would prevent many frauds, and reduce consumer complaints. Mark F. Grady, Act ing Director of the Office of Policy Planning and Evaluation testified before the Subcommittee that:
We thought that many of these cases seek to redress harm that could have been prevented if the circumstances were merely disclosed to consumers prior to the time that they entered into the contract. To the extent that here could be a better disclosure which might he required by a rulemaking, then the occasion for litigation would be reduced.
As a consequence, our recommendation was that rulemaking be given priority even if it would require some present reduction in the number of clases.x
The Commission has testified that administrative cases on land sales serve a good purpose. Chairman Collier told the Subcommittee that:
I think some of those cases involve situations where a rule which lhas a prospective effect just simply won't achieve everything Congress may have intended us to achieve with the redress authority, for example, in a situation where the law is neither mysterious nor unclear would it be unfair to invoke it in a particular case. This would occur if we only rely on putting out a new rule. I think that would simply be an instance of the Commission doing exclusively on a prospective basis that which Congress indicated in this legislation should not be restricted to only prospective efforts. And I think that may account for the number of individual matters that happen to be pending in the land sales area in particular. Losses to consumers are not insignificant, the rules of law are not all that complex and individual cases may be the best way to remedy problems in that industry as well as to do individual justice."
17 Id., Program J02, at 1. (Footnotes omitted.) I' Id., Program J04. at 1.
SI earinq. supra note 45, at 641.
I id. at 640-41.
We agree that, in certain circumstances, administrative cases are useful in achieving consumer redress in fraudulent land sales. However, the Commission should give serious consideration to the development of a rule. The Commission should further consider whether continued occupation with adjudicating individual cases will deny staff the time and opportunity to develop a rule.
We agree with Commissioner Paul Rand Dixon, then Acting Chairman, who wrote to Congressman Rosenthal, Chairman of the House Government Operations Subcommittee on Commerce, Consumer and Monetary Affairs on March 10, 1976, that: Rulemaking allows clear enunciation of agency policy and fair warning of the consequences to be imposed on individual conduct on an industrywide basis. In this way, it minimizes the uncertainty fostered by a case-by-case approach. Use of agency rulemaking is also advantageous in that it limits the scope of litigation by more clearly prescribing the behavior of regulatory subjects.13' Recommendations
(1) The Commission should declare a moratorium on new administrative cases or investigations in the vocational schools area until the proposed rules are either issued or withdrawn.
(2) The Commission should direct the Bureau of Consumer Protection to analyze the possible effectiveness of a disclosure rule in the land sales area.
(3) If the Commission issues a proposed rule on land sales, it should direct that new administrative cases and investigations in the field be limited to situations where consumer harm is significant and where the financial status of the alleged violator indicates that consumer redress will be possible.
(4) The Commission should assess other areas where rulemaking has been delayed to determine whether delays have been caused by the continued opening of new cases. It should order a moratorium on new cases where appropriate.
D. OBSTACLES TO INFORMATION-THE LINE-OF-BUSINESS PROGRAM
Section 6(b) of the Federal Trade Commission Act 132 provides investigatory powers for the Federal Trade Commission. It grants to the Commission authority:
To require, by general or special orders, corporations engaged in commerce, . to file with the commission in such form as the commission may prescribe annual or special, or both annual and special, reports or answers in writing to specific questions, furnishing to the commission such information as it may require as to the organization, business. conduct, practices, management, and relation to other corporations, partnerships, and individuals of the respective corporations filing such reports or answers in writing ....
The gathering of information as contemplated by the Congress in enacting Section 6 is essential to the Commission's ability to discharge its duties. Trade data are needed for the Commission to fulfill its antitrust and consumer protection responsibilities and to provide a sound base for ana-lyzing trends and projecting plans. In the past, the Commission has been frustrated in its inforimation-gathering function,
131 Letter to Honorable Benjamin S. Rosenthal. Chairman. Subcomm. on Commerce. Conm mor and Monet'ary Affairs, House Comm. on Government Operations, from Paul Rand Dixon, Acling Chairman, Federal Trade Commission, March 10, 1976.
13215 U.S.C. 46.