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Georgetown’s Chris Brummer, Vanderbilt’s Yesha Yadav and Wharton’s David Zaring ask: Is Regulation by Enforcement Legal?

A critical debate has been making the rounds recently, raising questions regarding the powers vested in regulatory authorities in the United States. Agencies across the United States, from the U.S. Securities and Exchange Commission to the Federal Trade Commission to the Commodity Futures Trade Commission have become vocal proponents of forwarding new legal theories in enforcement actions—and pursuing enforcement in new areas of innovation and experimentation where few explicit rules apply directly. In the process, regulators have attracted incoming fire from industry participants as using enforcement as a means of forwarding policy.  The outcome has been a debate as to not whether enforcement is legal—but more importantly, whether “regulation by enforcement” is permissible.

The basis for the argument forwarded by critics is that, rather than going through the extensive processes of notice and comment rulemaking required by administrative laws, regulators are pursuing enforcement instead as a way around these laws. Regulators, by contrast, are arguing that there’s nothing new in what they are doing, but are instead merely pursuing bad actors under the authority available to them under their Congressional mandates.

In an effort to provide a more nuanced understanding of the issue at hand, Chris Brummer, the Agnes Williams Sesquicentennial Professor of Financial Technology at Georgetown University Law Center and faculty director at the Institute of International Economic Law, has written a paper aptly entitled “Regulation by Enforcement” (to be published in the Southern California Law Review) with Yesha Yadav, Milton R. Underwood Chair, Associate Dean and Professor of Law at Vanderbilt Law School, and David Zaring, the Elizabeth F. Putzel Professor of Legal Studies at the Wharton School, University of Pennsylvania.  The article attempts to provide clarity on several matters, including what is meant by the nebulous term “regulation by enforcement,” whether it’s legal or not, why agencies resort to adjudication instead of rulemaking, and what best practices agencies should follow when pursuing regulation by enforcement.

Regulation by Enforcement

The authors argue that there are two formal ways the modern regulatory agency creates policy. One is enacting rules through the process of “notice and comment” or informal rulemaking. Alternatively, it can enforce rules through “adjudications pursued either through administrative adjudicatory proceedings or by filing suit in federal court — or through informal settlement negotiations with entities charged with illegal conduct.”  Between the two are a range of informal processes—no action letters, staff guidance and other kinds of documents that have limited legal force, but can steer industry behavior.

But agencies are not the only actors or vehicles of lawmaking.  According to the paper, court decisions too can be the means through which policy is advanced.  Decisions by courts have the force of law, and even decisions laying out facts can steer understanding of issues that can have legal significance.

For this reason, regulatory actions pursued in courts can create policy in ways that are similar to the formal rulemaking process required by agencies when they seek to release formal rules and regulations by industry.  And the paper notes that doing so is not illegal.  Dating back to the New Deal, courts have identified several reasons why it can be necessary for agencies to create policy on a case-by-case basis rather than through general rulemaking.

“The idea is that administrative agencies should be able to engage in discrete, incremental lawmaking via litigation if this happens to be their preferred choice,” Professors Brummer, Yadav and Zaring wrote, citing the 1947 Supreme Court case SEC vs. Chenery. “Like common law, where judges are tasked with making rules on a case-by-case basis, adjudication allows courts and agencies to engage in problem-by-problem or issue-by-issue analysis, building on precedent to create a well-established body of law.”

However, the writ of authority is not without limits.  They observe that the Supreme Court has largely assumed that regulation by enforcement would be a gap-filling exercise.  To the extent to which it is perceived to be more than that—what they describe as “void filling”—could invite any number of legal challenges that could ultimately undermine the power of administrative agencies.  “[T]he question as to whether regulation by enforcement is legal under the APA is not entirely settled, even as most of the foundational principles are.” Brummer, Yadav and Zaring add that “An agency that seeks to introduce new regulatory frameworks solely through [regulation by enforcement] could expose itself to significant rebuke in courts with serious risks for the administrative state.”

There are also any number of consequences that also need to be considered, the authors observe.  Enforcing principles or norms in the absence of explicit rules could create the impression that regulatory actions, even if valid, are political motivated or unfair.  Enforcement also is a blunt instrument.  It does not entail cost-benefit analysis, or contributions from outsiders in the form of comment letters.  It thus risks being less informed.

As for why regulatory agencies are showing a preference for adjudication over rulemaking, Brummer argues that: “We think that when regulators turn to adjudication, their incentives to do so can thus plausibly be characterized as lying along a continuum ranging from an interest in cautious case-by-case refinement and regulatory modulation to attempts to bypass administrative controls intended to enhance public participation and review.”  Along this continuum can include pressures to respond quickly to crises or fast-moving challenges.  There might also be less savory motives at play including avoiding the kind of public scrutiny and involvement entailed in administrative procedure. “During notice-and-comment, new proposals are exposed to review by industry and civil society, and agencies are often required to, at a minimum, respond to the concerns raised in the review.  As a result, rulemaking can create political obstacles that draw early media attention, private sector pushback, and can end up diluting or strengthening proposals in ways agency leadership might not wish.  Adjudications, by contrast, channel primary responsibility of dissent to the defendant, and limit the required responsiveness of agencies to criticism,” the professors note.

Best Practices for Regulation by Enforcement

As parting words of advice, Professors Brummer, Yadav and Zaring left a few nuggets of wisdom for regulators looking to learn from the lack of confidence and current atmosphere of mistrust they are faced with. For the trio, “Enforcement by regulation should be undertaken with a clear understanding by regulators as to its risks and exercised in ways that optimize the long-term interests of agencies, their stakeholders, and regulated entities.”

That said, when the need arises, agencies should act swiftly in case a delay in action is mistaken as consent. Delayed action may lead to misunderstandings and raise suspicions of self-motivated reasoning behind enforcement actions. Market actors could also interpret non-action as acquiescence, thus drawing more private participants unwittingly into behavior for which they may later may be punished.

The authors believe it’s also more likely for regulation by enforcement to be palatable when it is a venue of last resort rather than a first resort. The Administrative Procedure Act, which lays out the hoops through which agencies must jump to issue rules, is designed to ensure that authorities govern through proper, transparent, well-evidenced and objective processes. And through publicity, notice-and-comment and mandatory agency engagement, those that may be bound by new legislation – as well as anyone else – is invited to provide input and contribution. Judicial review of rulemaking offers the ultimate check on the implementation of the process. These benchmarks, while onerous, enable agencies to add more moral and legal standing to their rules, and carry stronger claims to legitimacy.  Chronic avoidance of them can create risks of not only rulings against the agency, but also skepticism by courts as to the amount of discretion they should be afforded.

Finally, and as a result, the authors note that it would serve regulatory agencies well to incorporate certain administrative processes into their existing efforts. “Where possible, agencies should respond to amicus briefs and other interventions by industry and civil society, even in the context of legal proceedings,” the professors suggest.