Will Wall Street prevail?

Corporate-sponsored groups have launched a campaign of litigation in the lower federal courts challenging the legality of the second major piece of President Barack Obama's legislative program, one that received a lot of attention in last week's first presidential debate: the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. When these cases reach the Supreme Court, we could very well see a reprise of the drama surrounding its decision on the Affordable Care Act at the end of this past term.

As was true of the ACA, a Democratic-controlled Congress passed Dodd-Frank over almost universal Republican opposition, including a Senate filibuster. Unlike the ACA, however, Dodd-Frank — while monumental in its regulatory scope — was enacted with relatively little fanfare or controversy among the general public. The statute's essential purpose is to prevent the kind of reckless and wholly unregulated financial shenanigans that led to the 2008 financial meltdown.

While Dodd-Frank may not be as well-known or as controversial as the ACA, the public is certainly aware that highly speculative and undercapitalized betting on the success of subprime mortgages by the "too big to fail" banks caused the crisis, and that when those banks couldn't pay off their bets, the American taxpayer was called on as the lender of last resort, to the tune of trillions of dollars. Those banks survived and prospered, but the U.S. economy as a whole did not.

Even though the second Great Depression was prevented by taxpayer bailouts, the pain to those taxpayers was dire. In the financial meltdown's immediate wake, $19 trillion of household wealth was lost, 8.7 million jobs disappeared, and 6.3 million more Americans sank below the poverty line.

The Dodd-Frank Act has been hailed by most financial market reformers as a way to provide the regulatory weapons to stop these opaque, reckless and undercapitalized casino operations by the big banks. Unfortunately, unlike key provisions of the ACA, Dodd-Frank is not self-executing; almost all of its provisions must be implemented by agency rule-making done in compliance with the rigorous standards dictated by the Administrative Procedure Act.

For example, Dodd-Frank requires the Commodity Futures Trading Commission for the first time to police the previously unregulated and highly toxic derivatives market, which has a notional value of $300 trillion. That includes the now infamous multitrillion-dollar "naked" credit default swaps market, in which the big banks bet on whether the subprime mortgages held by low-income borrowers whose houses were financially underwater would be paid off. The CFTC must implement by year's end well more than 50 rules consistent with both Dodd-Frank and the Administrative Procedure Act to put itself in a position to ┬┐stabilize these "too big to fail" gambling ventures.

Having failed to block the passage of Dodd-Frank, the Republicans, who control the House of Representatives, have aggressively sought to repeal the act or, failing that, to starve the regulators financially so that they cannot enforce the law. Also prominent in this strategy is the flood of lawsuits in federal courts challenging the Dodd-Frank rules by claiming that regulators have used improper cost-benefit analyses.

As interpreted by every administration since President Ronald Reagan's, cost-benefit analysis has entailed a pseudo-scientific algorithmic "test" that foregrounds the costs of business compliance with a given regulation and minimizes its social and economic benefits. Moreover, Wall Street's champions argue that such cost-benefit analyses may be applied only prospectively, meaning that the trillions of dollars in costs that taxpayers have already borne because of a lack of regulation will never be considered.

The Wall Street strategy of using cost-benefit analysis to overturn Dodd-Frank was clearly revealed in a July 2011 decision by a panel of three conservative judges on the Court of Appeals for the D.C. Circuit in Business Roundtable & U.S. Chamber of Commerce v. the Securities and Exchange Commission. Lawyers for the Roundtable and the Chamber argued that an SEC "proxy access" rule mandated by Dodd-Frank failed a cost-benefit test. (The SEC rule requires public companies to provide shareholders with sufficient information to choose among candidates for corporate boards nominated by the shareholders themselves.)

Dodd-Frank has no requirement that a regulatory agency conduct cost-benefit analyses when promulgating a rule, but that did not trouble the appellate panel. It interpreted a very general and highly ambiguous requirement in the SEC's general governing statute — that the commission consider "whether [its] action will promote efficiency, competition, and capital formation" — as mandating that it consider "the economic implications" of its actions and therefore carry out a strict cost-benefit analysis.

Ignoring Justice Antonin Scalia's complaint (quoting Judge Harold Leventhal) that the use of legislative history to interpret a statute is like "entering a crowded cocktail party and looking over the heads of the guests for one's friends," the judges in the Business Roundtable case looked through the "crowded" administrative SEC record to find evidence friendly to Wall Street's cause, while dismissing as "unpersuasive" the economic evidence produced by the SEC to justify the rule. Thus, the judges' reasoning in Business Roundtable trumped that of the SEC, the most expert agency on corporate governance issues.

The judge-made law in Business Roundtable harks back to the Supreme Court's 1905 decision in Lochner v. New York and its progeny, wherein the Court's conservative justices substituted their own laissez-faire economic ideology for that of Progressive-era state legislatures and later for that of the early New Deal Congress. It was only the "switch in time that saved nine" — namely, Justice Owen Roberts' defection from the conservative bloc to the Court liberals — that ended judicial second-guessing of legislative actions and possibly saved the Court from Roosevelt's "court-packing" plan designed to add six New Deal justices.

Encouraged by the ruling in Business Roundtable, Wall Street trade associations have since filed two more major challenges to Dodd-Frank that rely heavily on the argument that financial regulators should be required to conduct these rigged cost-benefit analyses. The crucial question is: How will the Roberts Court respond to future challenges to Dodd-Frank on those grounds?

The Roberts Court's record on the review of financial regulations is mixed. When considering private parties' access to the courts to challenge securities laws, liberal justices have sometimes made it more difficult for these actions to be brought, as in Tellabs, Inc. v. Makor Issues & Rights, Ltd. (2007), whereas conservative justices have at times shown open-mindedness, as in Erica P. John Fund, Inc. v. Halliburton Co. (2011).

Two recent cases dealing with the substance of private rights of action under the securities laws are, however, problematic. In Janus Capital Group Inc. v. First Derivative Traders (2011), Justice Clarence Thomas, writing for himself and the four other conservative justices, defined the word "make" in an SEC rule to mean that an investment company could not be sued for the false statements in a subsidiary's mutual fund prospectus, even if it helped prepare the document, because the parent company did not "make" them; instead, the subsidiary did when it filed the prospectus with the SEC. To reach this conclusion, Justice Thomas relied heavily on his choice of competing dictionary definitions of "make." In dissent, Justice Stephen Breyer noted: "Neither common English nor this Court's earlier cases limit the scope of [the word] to those with 'ultimate authority' over a statement's content." Thus the Roberts Court twisted the word "make" to allow an "untrue statement of material fact" to go unsanctioned, just as the D.C. Circuit Court, in its Business Roundtable decision, twisted the hortatory language of Congress to require regulators to perform a pro-Wall Street cost-benefit analysis.

In Morrison v. National Australian Bank, Ltd. (2010), Justice Scalia, writing for himself and his four conservative colleagues, threw out a private citizen's suit against the Australian bank on the grounds that it was outside the reach of U.S. securities laws, even though the alleged fraud was committed by the bank's wholly owned U.S. subsidiary, a Florida-based mortgage company. Justice Scalia held that the Australian plaintiff couldn't bring suit in a U.S. court because the stocks claimed to be fraudulent had been purchased on the Australian stock exchange, and the governing statute did not "clearly express" Congress' "affirmative intention" to apply the law extraterritorially.

Wall Street has repeatedly read Morrison as broadly suggesting that if the underlying financial transactions are executed by a wholly owned subsidiary of a foreign company, the financial transactions cannot be regulated under Dodd-Frank. Accordingly, Wall Street banks and their U.S. corporate customers have threatened to execute as many of their over-the-counter derivatives transactions as possible through foreign subsidiaries in order to evade Dodd-Frank. Of course, U.S. taxpayers will in the end be asked to bail out the U.S. parent companies, just as they rescued AIG, whose undercapitalized bets were executed by a single British subsidiary in London. Never mind that Congress, in passing Dodd-Frank, responded to Morrison by clearly stating its "affirmative intention" to apply important parts of the Dodd-Frank extraterritorially.

Wall Street's hope of curtailing the investor protections in Dodd-Frank through the courts is predicated on a shift in the Supreme Court toward favoring corporations that dates back decades, to the 1972 appointments of Lewis Powell and William Rehnquist. As a private lawyer, Justice Powell famously prepared an oft-cited memo calling on the U.S. Chamber of Commerce to launch a litigation campaign responding to "the assault on the [free] enterprise system," an invitation the Chamber has since taken up with a vengeance. This pro-corporate stance by the Court — which, it's important to mention, is often not limited to its "conservative" members — can be seen as early as a 1978 decision, Marquette National Bank of Minneapolis v. First of Omaha Service Corp., in which Justice William Brennan interpreted the National Banking Act as allowing a Nebraska bank to charge Minnesota consumers higher interest rates than were permitted under Minnesota law. Two decades later, in Smiley v. Citibank (1996), Justice Scalia led a unanimous Court in extending Marquette, barring California from using consumer protection laws to protect its residents by limiting the credit card late fees imposed by a South Dakota bank. Recently the Court has split on whether national banks are exempt from all state power, with a five-member majority rejecting Michigan's ability to subject mortgage lenders to registration and inspection in Watters v. Wachovia Bank (2007), while a different five-member majority in Cuomo v. Clearing House (2009) carved out a narrow exception allowing New York to investigate — but not prosecute — the lending practices of national banks in the state.

In the context of Dodd-Frank, the stakes before the federal courts are much higher than ever before. Most of the aforementioned Supreme Court cases were decided without the backdrop of a potential worldwide financial Armageddon. If the U.S. economy is not protected from another crisis like that of 2008, the results will hurt every American household through more lost jobs, lost pensions and lost wealth. Moreover, the American public will probably never again stand for another trillion-dollar bailout of the big banks. In the fall of 2008, economists across the spectrum warned that the country would face another Great Depression if the banks were not rescued. The country's political will and financial resources are now fully tapped.

Despite this fact, will the five conservative justices on the Roberts Court unleash yet more reckless banking activity by undercutting Dodd-Frank, again exposing the world economy to the deluge? We can only hope that at least one of the justices will think twice and make a "switch in time."

Michael Greenberger is a professor at the University of Maryland's Francis King Carey School of Law. This article, Copyright 2012 The Nation, is distributed by Agence Global.