Notes Archives – Page 3 of 31 – Southern California Law Review

Slouching Towards San Francisco: Opioid Addiction as Public Nuisance

July 2024July 2024Andrew B. Workman*

INTRODUCTION

The opioid epidemic has afflicted Americans for twenty years, from California to the New York island. What began as an idealistic effort to alleviate chronic pain turned into a national nightmare: powerful, FDA-approved painkillers, liberally prescribed in the late 1990s and early 2000s, unleashed a Pandora’s box of dependance and demand that south-of-the-border cartels have answered with heroin and fentanyl.¹ In 2021, more than 107,000 Americans died of drug overdoses, and an astounding 71,000 of these deaths involved fentanyl and other synthetic opioids.² The economic costs have been staggering: in 2020 alone, the opioid epidemic cost the United States an estimated $1.5 trillion.³

To help redress this catastrophe, every state in the Union, along with countless localities and tribes, has sued opioid manufacturers, distributors, and dispensers.⁴ These public plaintiffs have pursued multiple claims, but public nuisance is “a central feature of the litigation and a key to its momentum.”⁵ To establish a public nuisance, plaintiffs must demonstrate an unreasonable interference with a right common to the public.⁶ A typical interference in the early days of public nuisance consisted of blocking a highway or waterway,⁷ but in the twentieth and twenty-first centuries, plaintiffs have argued that mass harms from products such as tobacco, lead paint, and handguns also interfere with public rights.⁸ In these actions, the alleged interference with public rights enables states or localities to sue on behalf of the public.⁹

But while these suits have generated billions of dollars in settlements,¹⁰ some courts have rejected these claims on the basis that any harms caused by a legal product interfere with private rights rather than public rights.¹¹ These courts cite previous attempts to characterize handguns and lead paint as public nuisances to conclude that the misuse of a product rarely interferes with the public rights traditionally protected by the doctrine, such as the right to use a public highway without interference.¹² Moreover, these courts portend a flood of lawsuits concerning legal products should public nuisance provide a valid basis of recovery against product manufacturers for harms that should instead be redressed under product liability law.¹³

However, a successful public nuisance action brought by the City Attorney of San Francisco against Walgreens in federal district court counters the claim that legal products can cause only private harms. In August 2022, Judge Charles Breyer entered judgment in a bench trial against Walgreens for substantially contributing to a public nuisance in San Francisco by failing to comply with federal regulation in filling opioid prescriptions.¹⁴ While California has a broader view of public nuisance than other states, the evidence at trial presented in compelling detail the social havoc that opioid addiction has inflicted on the city.¹⁵

To my knowledge, this Note is the first to examine this trial in detail, and I do so to demonstrate how opioid addiction interferes with public rights traditionally protected by common law public nuisance. Specifically, I examine how opioid addiction interferes with public space and public morals, forcing local governments to incur abatement costs and exposing residents to offensive activity in broad daylight. Because of this interference, courts should not categorically dismiss public nuisance claims against product manufacturers in the name of tradition.

This Note complements the scholarship of Professors Leslie Kendrick and David Dana, who have both argued that the opioid epidemic has interfered with public rights,¹⁶ by examining this interference with public rights in greater detail. In making this argument, this Note urges skeptical courts to adopt a middle-road doctrinal approach between the broad, inclusive understanding of public nuisance in California and the narrow, traditionalist understanding in states such as Oklahoma. This middle-road approach should be more amenable to states in the traditionalist camp because it retains public nuisance’s common law contours but maintains its flexibility to protect public rights from novel interferences caused by harmful products that bypass regulatory oversight.

Part I will provide a brief history of public nuisance in England, the United States, and California. Part II will discuss the opioid epidemic and the litigation it has spawned. Part III will review the evidence submitted at the successful bench trial in California to highlight how opioid addiction has affected San Francisco. Lastly, Part IV will argue that opioid addiction interferes with public rights traditionally protected by common law public nuisance and address various counterarguments.

I. PUBLIC NUISANCE: A BRIEF HISTORY

A. Common Law Origins in England

Nuisance developed in the English common law as a non-trespassory tort against the land, or more specifically, an interference with the use or enjoyment of land, or with a right of easement or servitude over the land.¹⁷ This remedy allowed private parties to seek relief from non-trespassory interferences with the use and enjoyment of their land and is the origin of the law of private nuisance today.¹⁸ An interference with the property of the King also constituted a nuisance, and hence public nuisance was born.¹⁹ The earliest cases concerned obstructing the King’s road—a criminal infringement on the rights of the Crown and redressable by a suit brought by the King’s justices—thereby interfering with a public right of way.²⁰ By the same reasoning, blocking a waterway constituted a public nuisance.²¹ By the mid-1300s, public nuisance extended more broadly to other infringements on public rights, such as “interference with a market, smoke from a lime-pit, and diversion of water from a mill.”²²

While obstructing a public road or waterway remains the canonical example of public nuisance, the doctrine eventually encompassed “a large, miscellaneous and diversified group of minor criminal offenses, all of which involved some interference with the interests of the community at large.”²³ For example, a description of “common nuisances” (later referred to as public nuisances) by William Sheppard in the 1660s included “pollution from noxious trades,” “victuallers who [sell] unwholesome food,” and “lewd ale-houses.”²⁴ Similarly, William Blackstone’s 1769 catalogue of common nuisances included “the keeping of hogs in any city or market town,” “[c]ottages . . . erected singly on the waste, being harbours for thieves and other idle and dissolute persons,” the “making and selling of fireworks,” and “[a]ll disorderly inns or ale-houses, bawdy-houses, gaming-houses, stage-plays unlicensed, booths and stages for rope-dancers, mountebanks, and the like.”²⁵

Another significant feature of public nuisance in the English common law was the relator action. Public nuisances had traditionally been prosecuted in the courts of leet, local criminal courts that handled “public welfare offences.”²⁶ But by the late eighteenth and early nineteenth centuries, people began seeking injunctions on behalf of the Attorney General in civil court.²⁷ Plaintiffs sought this civil remedy because “irreparable damage” might occur by the time lengthier criminal proceedings concluded and also because of the difficulty in prosecuting corporations responsible for pollution.²⁸ Accordingly, by the end of the nineteenth century, civil actions replaced criminal prosecutions in standard public nuisance cases concerning “general health hazards” and highway obstructions.²⁹ Separately, private citizens could also sue for damages if they received a “special injury” from a public nuisance.³⁰

B. Public Nuisance in the United States

American courts inherited public nuisance from their English forebears, and the doctrine continued to evolve to address changing social conditions. The early American cases largely fell into two groups: obstruction of public highways and navigable waterways, and a “loose amalgamation of minor offenses involving public morals or the public welfare,” including gambling, “keeping a disorderly house or tavern,” and “enabling prostitution.”³¹ But as the economy industrialized, courts applied public nuisance to new conditions such as air and water pollution.³² In the late nineteenth and early twentieth centuries, state legislatures responded to this changing landscape by adopting statutes that defined public nuisance in broad language or enumerated activities constituting a public nuisance.³³ These statutes enabled public authorities to use public nuisance as a “stopgap measure” and abate unforeseen activities that “might injure or annoy the general public.”³⁴ However, beginning in the Progressive Era, state governments adopted comprehensive statutes and regulations that diminished their reliance on public nuisance as a stopgap measure, thus resulting in fewer public nuisance actions.³⁵

By the early twentieth century, individual states as parens patriae—“parent of the country”—sued parties in federal court to enjoin or abate public nuisances.³⁶ Parens patriae standing rests on a state’s “interest in the abatement of public nuisances, instances in which the injury to the public health and comfort [is] graphic and direct.”³⁷ Parens patriae standing later provided the “architecture” of the tobacco litigation in the 1990s and the opioid litigation in the twenty-first century, with “an official (such as a state’s attorney general or a locality’s district attorney) suing on behalf of the public.”³⁸

In 1979, the American Law Institute published the influential Restatement (Second) of Torts (“Second Restatement”), which included a comprehensive overview of public nuisance.³⁹ Section 821B states:

(1) A public nuisance is an unreasonable interference with a right common to the general public.

(2) Circumstances that may sustain a holding that an interference with a public right is unreasonable include the following:

(a) Whether the conduct involves a significant interference with the public health, the public safety, the public peace, the public comfort or the public convenience, or

(b) whether the conduct is proscribed by a statute, ordinance or administrative regulation, or

(c) whether the conduct is of a continuing nature or has produced a permanent or long-lasting effect, and, as the actor knows or has reason to know, has a significant effect upon the public right.⁴⁰

The Second Restatement further defines a “public right” as a right “common to all members of the general public. It is collective in nature and not like the individual right that everyone has not to be assaulted or defamed or defrauded or negligently injured.”⁴¹ Scholars have criticized the Second Restatement’s definition of public nuisance as overly broad, vague, and partially responsible for the subsequent increase in public nuisance lawsuits involving novel harms, such as those caused by products.⁴²

In the decades that followed the Second Restatement and in the backdrop of a burgeoning environmental movement,⁴³ some states successfully sued defendants under a public nuisance theory for creating an injurious and ongoing condition even though the defendants no longer contributed to the condition or, because they had sold the land, could no longer abate it.⁴⁴ In one prominent case, United States v. Hooker Chemicals & Plastics Corp., a federal district court ruled that a chemical company’s formerly owned toxic-waste dump, from which hazardous chemicals later seeped into surrounding surface and groundwater, was a public nuisance and that the company was liable to the State of New York for abatement costs.⁴⁵ The court rejected the chemical company’s argument that upon its sale of the property to the City of Niagara Falls Board of Education—which included notice of the waste in the deed—its liability ended.⁴⁶ The court instead adopted a rule that the creator of a harmful condition cannot evade restitution liability for abatement costs simply by selling the land.⁴⁷ Hooker II and its progeny gave states a framework to recover public health expenditures, incurred to abate an alleged public nuisance, as damages.⁴⁸

Hooker II also exemplifies how damages, as opposed to an injunction, emerged as a viable remedy in public nuisance actions brought by states. At the common law, only plaintiffs who suffered “harm [from a public nuisance] of a kind different from that suffered by other members of the public” could recover damages.⁴⁹ In the nineteenth and twentieth centuries, some courts did allow government entities to recover damages by demonstrating “peculiar and special damage” from a public nuisance.⁵⁰ Kendrick has argued that these earlier cases seem “analogous to contemporary courts allowing governmental entities to pursue damages for the extensive funds that they have spent on treating and seeking to remediate harms such as opioid addiction and tobacco-related illnesses.”⁵¹

Public nuisance famously provided a breakthrough in twentieth-century tobacco litigation. After four decades of unsuccessful personal injury suits brought by individual plaintiffs,⁵² the tide turned when state attorneys general sued tobacco companies on a variety of claims, including public nuisance, to recoup public health costs.⁵³ These suits survived early dismissal and got to discovery, unearthing incriminating evidence of Big Tobacco’s dishonest marketing practices.⁵⁴ As a result, the tobacco companies first settled individually with four states, and then in 1998, collectively settled with the remaining forty-six states—known as the Master Settlement Agreement—for $206 billion.⁵⁵ While the public nuisance claims were not tried on the merits in these suits, their success incentivized states to pursue similar claims against companies that make and sell handguns, lead paint, carbon-emitting energy, and opioids.⁵⁶

C. Public Nuisance in California

California’s expansive view of public nuisance can be traced to the broad definition of “nuisance” in its 1872 statute:

Anything which is injurious to health, including, but not limited to, the illegal sale of controlled substances, or is indecent or offensive to the senses, or an obstruction to the free use of property, so as to interfere with the comfortable enjoyment of life or property, or unlawfully obstructs the free passage or use, in the customary manner, of any navigable lake, or river, bay, stream, canal, or basin, or any public park, square, street, or highway . . . .⁵⁷

Section 3480 further defines a “public” nuisance as one that “affects at the same time an entire community or neighborhood, or any considerable number of persons, although the extent of the annoyance or damage inflicted upon individuals may be unequal.”⁵⁸ To establish a public nuisance in California, a plaintiff must prove that a defendant knowingly created or assisted in the creation of a substantial and unreasonable interference with a public right.⁵⁹

In 1997, the California Supreme Court clarified the meaning of a “public right” by quoting the Second Restatement’s five categories that are protected from interference: “[T]he public health, the public safety, the public peace, the public comfort or the public convenience.”⁶⁰ In upholding an injunction against disruptive gang activity in a San Jose neighborhood, the court articulated the purpose of public nuisance: “[T]o protect the quality of organized social life.”⁶¹ The gang activity at issue included open drug use and dealing, loud music, appropriation of public space, vandalism, and violence.⁶²

This understanding of public rights underpins the enduring use of public nuisance in California to abate problem properties. In 2015, the Second District Court of Appeals affirmed the classification of a restaurant as a public nuisance because of ongoing loitering, drinking, drug dealing, prostitution, and violence that occurred on the property.⁶³ The court dismissed the owner’s argument that he should not be held responsible for the crimes of third parties in a high-crime area because the owner failed to make reasonable operational changes to discourage such activity.⁶⁴ In other words, the owner was liable for the blighted condition of his property since it attracted morally offensive and dangerous behavior that degraded the quality of life of the surrounding community.

California’s broadly worded nuisance statute and expansive understanding of public rights set the stage for successful public nuisance suits involving products. In People v. ConAgra Grocery Products Co., the Sixth Court of Appeals held that three companies created a public nuisance by promoting lead-based paint in the past and remanded the case to the trial court to recalculate abatement damages.⁶⁵ Looking exclusively to California’s public nuisance statute and prior precedent, the court was not persuaded by the defendants’ argument that lead-paint poisoning causes “private harm” that, even in the aggregate, does not interfere with public rights.⁶⁶ Rather, the court held that lead paint interferes with the “community’s ‘public right’ to housing that does not poison children,” and that “[r]esidential housing, like water, electricity, natural gas, and sewer services, is an essential community resource.”⁶⁷ The defendants ultimately settled for $305 million.⁶⁸

Other states have refused to follow California in holding that lead paint poisoning is a public nuisance. In 2008, the Rhode Island Supreme Court reversed a trial court judgment against lead paint manufacturers and a trade association, holding that, among other reasons, the Attorney General had failed to prove that lead poisoning interferes with a public right.⁶⁹ In the court’s view, lead poisoning harms a private right rather than public right, which it defined as a right to “indivisible resources shared by the public at large, such as air, water, or public rights of way.”⁷⁰ The court reasoned that to conclude otherwise would be antithetical to the common law, extend liability to any legal product that interferes with a private right, and blur the boundaries between public nuisance and product liability law.⁷¹

Commentators also share this traditionalist stance and find support in the Second Restatement’s description of a public right as “collective in nature and not like the individual right that everyone has not to be . . . negligently injured.”⁷² Thus, some scholars contend that a product might violate a person’s right to not be negligently injured, but this harm cannot, in aggregate, violate a public right.⁷³ More fundamentally, they view these public nuisance claims involving products as democratically illegitimate attempts to bypass state product liability law, which state legislatures have set forth in statutes.⁷⁴ The Restatement (Third) of Torts similarly states that mass harms caused by dangerous products should be redressed through the law of product liability.⁷⁵

II. THE OPIOID EPIDEMIC

A. A Brief History

The origin of America’s opioid epidemic can be traced to 1995 when the FDA approved OxyContin, a powerful prescription painkiller made by Purdue Pharma L.P. (“Purdue”).⁷⁶ In the late 1980s, Purdue began developing a replacement for its successful painkiller MS Contin, a morphine pill with a patented controlled-release mechanism that was soon to expire.⁷⁷ Purdue’s chemists applied this controlled-release mechanism to oxycodone, an opioid twice as powerful as morphine, and named the resulting pill OxyContin.⁷⁸ The delayed-release feature enabled Purdue to sell the pill in high dosages and convince the FDA to allow a package insert suggesting OxyContin was less prone to abuse.⁷⁹ Following FDA approval, Purdue launched an unprecedented marketing campaign that successfully persuaded doctors to prescribe OxyContin as a general treatment for chronic pain.⁸⁰ Colossal returns followed: annual sales of OxyContin reached $1 billion within five years and ultimately generated $35 billion for the company.⁸¹

But Purdue’s bonanza birthed a national catastrophe. OxyContin initiated an epidemic of addiction from the hollers of West Virginia to the hills of San Francisco. Patients prescribed OxyContin soon learned that its advertised twelve-hour relief lasted eight hours, causing them to experience withdrawal symptoms and seek more pills at higher doses.⁸² The pills could also be crushed into powder, removing their delayed-release coating, that could then be ingested or, when mixed with water, intravenously injected for an immediate, euphoric high.⁸³ As a result, OxyContin made many unsuspecting patients addicted and was widely abused.⁸⁴

In response, Purdue ultimately reformulated the drug in 2010 to make it nearly impossible to crush, and doctors reversed their liberal prescribing habits, but this did little to ameliorate the damage done: users turned to illicit alternatives such as heroin and fentanyl for their fix. Even though opioid prescriptions from retail pharmacies fell from a peak of 255 million in 2012 to about 143 million in 2020,⁸⁵ overall opioid overdoses increased, first with heroin,⁸⁶ and then to a much greater degree with fentanyl.⁸⁷ In total, from 1999 to 2021, nearly 645,000 people died from overdoses involving prescription and illicit opioids.⁸⁸

B. The Opioid Litigation

Opioid litigation has followed a similar trajectory to tobacco litigation. Individual plaintiffs pursued the first claims against Purdue, alleging the company breached its duty of care in deceptively promoting a drug with inadequate warnings and defective design, but these suits rarely survived summary judgment.⁸⁹ In contrast, public nuisance claims fared much better. West Virginia’s Attorney General brought the first public suit alleging multiple claims, including public nuisance, that induced Purdue to settle for $10 million in 2004.⁹⁰ Purdue settled similar suits in 2007, paying $19.5 million to twenty-six states and the District of Columbia, and $24 million to Kentucky.⁹¹

Starting in 2014, a new wave of litigation ensued against a wider group of defendants—other opioid manufacturers, distributers, and retail pharmacies—and filed by a more diverse group of public plaintiffs—cities, counties, states, and tribes.⁹² This litigation has occurred in both federal and state courts and features a range of claims, including public nuisance and violations of the Controlled Substances Act (“CSA”).⁹³ In federal court, three thousand federal lawsuits were consolidated into a multidistrict litigation (“MDL”) in Ohio.⁹⁴ The magnitude of potential liability facing these defendants has encouraged many to settle. Drugmaker Johnson & Johnson and distributors AmerisourceBergen, Cardinal Health, and McKesson finalized a nationwide settlement in February 2022.⁹⁵ Purdue, which has since declared bankruptcy, and its owners, the Sackler family, reached a nationwide settlement in March 2022.⁹⁶ And lastly, Walgreens, Walmart, and CVS agreed to a nationwide settlement in November 2022.⁹⁷

For the few cases that have gone to trial, courts have disagreed on whether the opioid epidemic constitutes a public nuisance. For example, following a bench trial in Oklahoma that resulted in a $465 million judgment against Johnson & Johnson, the Supreme Court of Oklahoma reversed, holding that the district court erred in extending Oklahoma’s public nuisance statute to harms from prescription opioids.⁹⁸ Likening opioids to lead paint and handguns (the subjects of previous public nuisance litigation), the court explained that the harm from a legal product does not interfere with a public right, which it defined as a “right to a public good, such as ‘an indivisible resource shared by the public at large, like air, water, or public rights-of-way.’ ”⁹⁹ Rather, the court viewed the essence of the state’s claim as “a private tort action for individual injuries sustained from use of a lawful product and in providing medical treatment or preventative treatment to certain, though numerous, individuals.”¹⁰⁰ The court also expressed concerns that if it affirmed the trial court, then the misuse of any prescription medicine or legal product could give rise to a public nuisance claim.¹⁰¹

Following the decision in Oklahoma, two bench trials also held defendants not liable for public nuisance. In a bellwether bench trial in the Ohio MDL,¹⁰² a federal district court in West Virginia followed the traditionalist reasoning of the Oklahoma Supreme Court in finding that the distribution of prescription opioids does not interfere with a public right.¹⁰³ Similarly, a state court in California entered judgment in favor of various opioid manufacturers but did so because the People did not present evidence that the manufacturer’s allegedly false marketing caused medically inappropriate prescriptions.¹⁰⁴ But unlike the district court in West Virginia, the court made clear that the opioid epidemic was a substantial interference with “collective social interests” and that a showing of unreasonable conduct could constitute a public nuisance.¹⁰⁵

However, two other bellwether MDL cases succeeded on the merits: City & County of San Francisco v. Purdue Pharma L.P., discussed in Part III, and County of Lake, Ohio v. Purdue Pharma L.P.¹⁰⁶ In the former, Walgreens was found to have substantially contributed to an opioid epidemic in San Francisco,¹⁰⁷ and in the latter, CVS, Walmart, and Walgreens were found liable for contributing to an opioid epidemic in Ohio.¹⁰⁸

III. THE OPIOID EPIDEMIC IN SAN FRANCISCO

The San Francisco City Attorney filed claims in the U.S. District Court for the Northern District of California against dozens of opioid manufacturers, distributors, and dispensers, and by the trial’s close in July 2022, only Walgreens remained.¹⁰⁹ The city pursued a single public nuisance claim at trial.¹¹⁰ Judge Charles Breyer held that the city proved by a preponderance of the evidence that Walgreens knowingly engaged in unreasonable conduct that was a substantial factor in creating an opioid epidemic in San Francisco.¹¹¹ A subsequent remedies trial was scheduled to begin on November 7, 2022, but Judge Breyer vacated this date after Walgreens announced a tentative nationwide opioid settlement for nearly $5 billion.¹¹² Separately, Walgreens settled with the city for $230 million to be paid across fifteen years.¹¹³

Judge Breyer’s lengthy opinion described a city under siege from opioid addiction. The epidemic in San Francisco unfolded in three waves.¹¹⁴ The first wave, from 2000 to 2010, consisted of an increase in opioid addiction and overdose deaths following a rise in opioid prescriptions.¹¹⁵ By 2010, San Francisco’s rate of opioid overdoses was 2.23 times the national average despite the city’s “significant investment in public health programs designed to combat opioid abuse.”¹¹⁶ In the second wave, beginning in the early 2010s, prescriptions declined while heroin use and overdose deaths increased.¹¹⁷ The city had faced a heroin problem in the late 1990s, but in this second wave, the problem became “significantly worse.”¹¹⁸ Evidence suggests heroin returned to the city because of prescription-opioid addiction. The Chief of Emergency Medicine at Zuckerberg San Francisco General Hospital testified that “approximately two-thirds of the patients who present[ed] to the [emergency department] with an opioid-related medical condition report[ed] that their addiction started with pills.”¹¹⁹ The third wave began in 2015 with the arrival of fentanyl, a dangerous synthetic opioid fifty times more potent than heroin.¹²⁰ All in all, the demand for prescription opioids, heroin, and fentanyl caused deaths to skyrocket: from 2015 to 2020, opioid-related emergency room visits tripled, and overdoses increased 478%, from 101 in 2015 to 584 in 2020.¹²¹

The evidence at trial revealed the epidemic’s tremendous toll on city workers and resources. The Fire Department’s Emergency Medical Services (“EMS”) team received so many overdose calls that it created a special response team to answer them.¹²² Encountering unconscious individuals on the streets, many of whom were “frequent callers who rotate from the street to the emergency room and back to the street,” became the “new normal” for EMS.¹²³ Similarly, Public Works faced a “significantly more challenging” job cleaning streets and sidewalks because of the large number of opioid users who “often vomit, have diarrhea, and leave used needles in public right of ways.”¹²⁴ These crews collected 95,000 used syringes annually in recent years, often encountered people experiencing overdoses, and sometimes came across deceased opioid users on their rounds.¹²⁵

The epidemic especially impacted San Francisco’s public parks. The Recreation and Parks Department (“RPD”) created special teams to respond to the harms caused by opioid use in the city’s parks.¹²⁶ Its outreach team engaged with homeless individuals living in parks, and according to Sergeant Maja Follin, a Head Park Ranger in RPD, the “vast majority” of these individuals suffer from substance abuse.¹²⁷ Meanwhile, RPD’s environmental services team removed biohazards such as used syringes and human feces.¹²⁸ In 2019, the team recovered 10,360 syringes from Golden Gate Park.¹²⁹ Their work could be high-stakes and laborious: at Dolores Park, needles were thrown into a children’s play area, requiring RPD to “sift through the sand” and recover them.¹³⁰ Because of these biohazards, RPD regularly closed off sections of parks.¹³¹ And at Jose Coronado Park, so many people “obstruct[ed] the sidewalk using drugs and spending the day . . . lying across the sidewalk and making it impossible for people to . . . access the park or . . . walk down the sidewalk” that the city had to install barricades to create safe passage for park goers.¹³²

The San Francisco Public Library (“SFPL”) system also faced “serious health and safety risks for library visitors and staff” due to the opioid epidemic.¹³³ Library staff routinely discovered patrons using and overdosing on opioids outside the building, in the stacks, and in the bathrooms.¹³⁴ Similarly, staff found needles in the stacks, in bathrooms, on shelves, inside of books, and in children’s reading areas.¹³⁵ On occasion, staff were even stuck with used syringes.¹³⁶ Damage to plumbing from flushed syringes caused multiple library closures and cost tens of thousands of dollars to fix.¹³⁷ Because of the epidemic, SFPL incurred additional expenses, such as hiring a full-time social worker to connect those suffering from opioid addiction with support services.¹³⁸ SFPL also contracted with the San Francisco Police Department to provide officers to patrol the libraries and help respond to the proliferation of drug use and overdoses.¹³⁹

At the trial, the aforementioned evidence demonstrated that the opioid epidemic, defined as “high rates of opioid abuse, addiction, and overdoses,” constitutes a public nuisance that interferes with all five categories of public rights recognized by the California Supreme Court: the public health, the public safety, the public peace, the public comfort, and public convenience.¹⁴⁰ The city also successfully proved that Walgreens had knowledge that its unreasonable conduct caused the nuisance.¹⁴¹ As the “last line of defense” against the diversion of controlled substances,¹⁴² the pharmacy failed to perform due diligence on over 1.2 million red flag prescriptions in a fifteen-year period.¹⁴³ Large volumes of these prescriptions came from “rogue pain clinics and rogue doctors”: from 2006 to 2020, Walgreens pharmacies in the Bay Area filed 161,696 prescriptions from prescribers who later “faced discipline for their prescribing practices and several of whom lost their medical licenses.”¹⁴⁴ This failure to perform due diligence violated CSA regulation, so the court concluded this failure was unreasonable.¹⁴⁵ Moreover, the CSA’s regulatory scheme was sufficient to demonstrate that Walgreens “must have known” about the harms of opioid diversion, notwithstanding external Drug Enforcement Agency (“DEA”) investigations and internal correspondence among executives that revealed Walgreens executives had actual notice of harms from prescription-drug abuse.¹⁴⁶

The court also held that the evidence proved factual and proximate causation. “[C]ircumstantial evidence of sufficient substantiality”—namely that Walgreens, the largest dispenser of opioids in San Francisco, had failed to perform due diligence on thousands of suspicious prescriptions from 2006 to 2020 as the city experienced an opioid epidemic—satisfied causation in fact.¹⁴⁷ And the “cycle of addiction,” and its downstream burden on the city and the public, was foreseeable.¹⁴⁸ As a part of its proximate cause analysis, the court concluded that extending liability to Walgreens would not open the “floodgates” of litigation against any seller of a product with a known risk of harm because Walgreens’s liability stemmed from its unique fifteen-year failure to comply with federal regulation.¹⁴⁹

IV. OPIOID ADDICTION INTERFERES WITH PUBLIC RIGHTS

The decision in City & County of San Francisco v. Purdue Pharma L.P. rebukes the traditionalist, categorical stance that public nuisance should not be extended to products. As demonstrated in San Francisco, opioid addiction interferes with public rights because addiction drives behavior that obstructs public space, forcing local government to incur substantial abatement costs. Moreover, this behavior can essentially turn entire neighborhoods into dangerous public drug dens featuring behavior that is offensive to witness.

Because California broadly defines public nuisance and public rights, the court did not base its judgment on a finding that Walgreens’s conduct interfered with public rights as traditionally understood in the common law.¹⁵⁰ This Note seeks to do so in order to demonstrate how products such as opioids can interfere with traditionally protected public rights in the hopes that states that have rejected public nuisance suits against product-caused harms in the name of tradition might be persuaded otherwise.

A. Opioid Addiction Interferes with Public Space

Courts have refused to extend public nuisance liability in the opioid epidemic because opioids, like lead paint, do not interfere with public rights. For example, the Supreme Court of Oklahoma viewed the state’s public nuisance claim as a “private tort action for individual injuries sustained from use of a lawful product.”¹⁵¹ This rationale largely stems from the Second Restatement’s definition of a public right as “collective in nature and not like the individual right that everyone has not to be assaulted or . . . negligently injured.”¹⁵²

But the opioid epidemic cannot be reduced to individual cases of private injury. It is frequently observed that a public nuisance is a condition rather than conduct,¹⁵³ so it should be emphasized that, here, the condition is opioid addiction. Addiction inflicts private harm, especially in instances of overdose and death, but as demonstrated in San Francisco, it also inflicts substantial civic harm.

An aspect of opioid addiction’s civic harm resembles a classic common law public nuisance. The archetypal public nuisance is obstruction of a highway,¹⁵⁴ and this is often referred to as an interference with the “public convenience” because the highway’s purpose is to improve travel for the public.¹⁵⁵ Similarly, municipalities set aside space for the public convenience: sidewalks make it easier to walk around town safe from motor vehicles; parks provide a place of respite and leisure from concrete city blocks; and libraries facilitate free access to information in a quiet environment.

Opioid addiction interferes with the public’s right to use these spaces as intended. In San Francisco, residents must navigate sidewalks strewn with health hazards, such as feces and needles, and obstructed with the bodies of individuals who are unconscious, and sometimes deceased, from opioid use.¹⁵⁶ Similarly, the prevalence of biohazards in parks impacts the safety of residents, especially infants.¹⁵⁷ This is not an abstract danger: in November 2022, a ten-month-old toddler was hospitalized after being exposed to fentanyl in a San Francisco park.¹⁵⁸ Moreover, these biohazards cause closures until they can be removed.¹⁵⁹ People addicted to opioids can also obstruct access while in an opiated stupor, as shown in one park where the city built a barricade to provide safe access for parkgoers because of the number of opioid users lying about.¹⁶⁰ And in libraries, visitors who seek quiet access to books and computers must contend with people overdosing outside the building, in the stacks, and in the bathrooms; needles left everywhere from bookshelves to children’s reading areas; and closures due to plumbing damage from flushed syringes.¹⁶¹

1. Opioid Addiction and Homelessness

Opioid addiction’s interference with public space stems from, at least in part, its significant relationship with homelessness. In making this connection, I do not intend to dehumanize homeless individuals; I simply point out the obvious impact a substantial, concentrated homeless population can have on a city’s public space and resources. While homelessness has many causes, the evidence at trial made clear that many of San Francisco’s homeless residents suffer from addiction. RPD’s outreach teams submitted that the vast majority of the homeless people living in San Francisco’s parks struggle with substance abuse.¹⁶² Similarly, the Fire Department’s EMS team described “frequent callers who rotate from the street to the emergency room and back to the street,” also suggesting that many of those suffering from opioid addiction are homeless.¹⁶³ The EMS team further noted that a majority of individuals who die of overdose deaths in the city had prior contact with EMS.¹⁶⁴ This underlines the terrifying power that opioids hold over the addicted when one considers that repeated overdose emergencies failed to stop these individuals from abusing opioids.

Unsurprisingly, the opioid epidemic in San Francisco corresponded with an increase in its homeless population. Between 2005 and 2020—the same period of time in which Walgreens’s conduct was examined at trial—the estimated homeless population in San Francisco rose from 5,404 to 8,124, and the unsheltered homeless population rose from 2,655 to 5,180.¹⁶⁵ And between 2010—the year of OxyContin’s reformulation, which contributed to an increase in heroin use¹⁶⁶—and 2020, the number of calls to the city’s 311 line complaining about used hypodermic needles rose from 224 to 6,275.¹⁶⁷ Assuming that housed opioid users would not be discarding needles in public spaces, this increase in 311 complaints may indicate greater opioid use among the homeless population. Similarly, from 2013 to 2016, complaints about homeless encampments also increased from two per day to sixty-three per day.¹⁶⁸ While correlation does not equal causation and many persuasively argue that the primary driver of homelessness in California is a lack of affordable housing,¹⁶⁹ it cannot be disputed that a relationship exists between the city’s visible increase in homelessness and drug use, as addiction can cause a person to spurn employment, housing, and family assistance.

Moreover, homelessness has become one of California’s top issues among voters, reflecting, at least in part, a public exasperated with ubiquitous encampments that feature harrowing spectacles of suffering and depravity. In a 2021 poll conducted by Los Angeles County—before the pandemic and then inflation became top concerns—94% of respondents said homelessness was “a serious or very serious problem.”¹⁷⁰ And in a 2022 survey asking California voters to rank the top issue in California, 13% selected homelessness, just below the 15%—the largest cohort in the study—who selected “inflation or the rising cost of living.”¹⁷¹ The fact that voters expect the government to take greater action on homelessness highlights the issue’s public impact, much like a traditional public nuisance.¹⁷²

2. Opioid Addiction and Methamphetamine Use

One might counter that the increase in homelessness in cities such as San Francisco owes more to the concurrent rise in street use of the psychostimulant methamphetamine. Beginning in the mid-2000s, DEA chemists noticed a new form of street methamphetamine, one made with phenyl-2-propanone (“P2P”), which can be created in a lab using variety of legal, cheap chemicals that have various industrial uses.¹⁷³ An unlimited supply of P2P spurred industrial-scale production by Mexican cartels, making this new form of methamphetamine plentiful and cheap across America.¹⁷⁴

Alarmingly, this new methamphetamine is far more debilitating to the mental health of its users: professionals who work with recovering addicts and homeless people have noticed a startling spike of severe, methamphetamine-induced psychosis, even in those with no prior history of mental illness.¹⁷⁵ Methamphetamine also causes paranoia and antisocial behavior that might explain the visible increase in tent encampments in San Francisco and Los Angeles, since tents provide privacy.¹⁷⁶ As a result, this new methamphetamine has presented difficulties for homeless-service workers and has thus complicated city efforts to abate the obstruction of public space caused by encampments.

However, “the increases in methamphetamine availability and harms are intertwined with the ongoing opioid overdose crisis.”¹⁷⁷ Opioid involvement in psychostimulant overdoses increased from 34.5% of overdose deaths in 2010 to 53.5% in 2019.¹⁷⁸ Surveys of recovering addicts reveal that methamphetamine, a stimulant, is often used with opioids, a depressant, to achieve a synergistic high and counteract the negative effects that arise once the opioid high subsides.¹⁷⁹ Thus, the rise in methamphetamine use and its severe mental health effects, at the least, cannot be understood independent of the opioid epidemic and, at the most, can be understood as a direct outgrowth of the epidemic. In either interpretation, opioid addiction has played a significant role in the recent increase of homelessness and the related rise in methamphetamine use that has made government efforts to convince people to accept services and leave encampments a Sisyphean challenge.

3. Opioid Addiction and the High Cost of Abatement

Because of the opioid epidemic and the related interference with public space and rise in homelessness, San Francisco has incurred significant abatement costs. In 2019, the city spent nearly $100 million on street cleaning—an amount four times more than Chicago, which has 3.5 times as many people and a surface area 4.5 times as large.¹⁸⁰ Opioid related conditions “overwhelm the city’s hospitals” and “tax[] the city’s emergency service teams.”¹⁸¹ San Francisco’s Fire Department, Public Works, Recreation and Parks, and Public Library all have created special teams and allocated resources to respond to the unique challenges presented by the epidemic.¹⁸² Additionally, the city has made a “significant investment in public health programs designed to combat opioid abuse.”¹⁸³ Moreover, because of the link between opioid addiction and homelessness in San Francisco, the staggering $367.7-million budget for the city’s Department of Homelessness and Supportive Housing for 2019–2020 also reflects some of the costs of the opioid epidemic.¹⁸⁴

Because of this significant investment, the opioid epidemic also underlines the enduring, important role of public nuisance as a stopgap measure when regulation fails to protect the public. Scholars have argued that public nuisance no longer serves an important stopgap measure in an era of comprehensive regulation.¹⁸⁵ But, as Dana has noted, “[t]he administrative state has never been perfect at protecting the public from harm, but we do appear to be living in a time when notable regulatory failure and inaction is becoming more, not less, common.”¹⁸⁶

The opioid epidemic thus reveals the important role of public nuisance in the event of such regulatory failure:

[I]n opioids, an alphabet soup of federal governmental agencies (including the FDA, DEA, and Department of Justice) had significant authority to address the burgeoning opioid problem. In creating a comprehensive regulatory scheme, the legislative branch seemingly did its work. But numerous agencies nevertheless stood by, even as pill mills proliferated, the death toll spiked, and millions of painkillers were pumped into, and decimated, certain communities.¹⁸⁷

Even though Walgreens paid $80 million to settle investigations brought by the DEA and Department of Justice for CSA violations at a distribution center and six retail pharmacies in Florida,¹⁸⁸ the company failed to adequately reform its operations and prevent opioid diversion.¹⁸⁹ In other words, despite extensive regulation, Walgreens’s San Francisco pharmacies, more likely than not, failed to conduct due diligence on red flag prescriptions from 2006 to 2020, an oversight that forced San Francisco to foot the bill.¹⁹⁰

B. Opioid Addiction Interferes with Public Morals

Opioid addiction also interferes with community interests in a manner that resembles problem properties, which were traditionally treated as public nuisances in England and America. William Sheppard identified “lewd-ale houses” as a common nuisance in the 1660s,¹⁹¹ and William Blackstone in 1769 listed as public nuisances “all disorderly inns or ale-houses, bawdy-houses, gaming-houses” and “cottages . . . erected singly on the waste, being harbors for thieves and other idle and dissolute persons.”¹⁹² Similarly, early public nuisance cases in America addressed not only obstructions of highways and waterways but also a “loose amalgamation of minor offenses involving public morals or the public welfare.”¹⁹³ William Prosser, who served as reporter of the Second Restatement, categorized problem properties—“houses of prostitution, illegal liquor establishments, [and] gaming houses”—as interfering with public morals.¹⁹⁴ Thus, the common law in England and America treated properties that attracted illicit, immoral behavior as public nuisances because they were offensive and disruptive to the surrounding community.

California courts have long abated the type of immoral, illicit activity associated with problem properties in public nuisance claims. In 1997, the California Supreme Court upheld an injunction against a San Jose gang for open drug use and dealing, loud music, appropriation of public space, vandalism, and violence.¹⁹⁵ Despite widespread criticism of the case among academics,¹⁹⁶ the court persuasively articulated that the purpose of public nuisance is to “protect the quality of organized social life.”¹⁹⁷ This principle justified the abatement of problem properties in the days of Sheppard and Blackstone and thus marks a common law continuance, not a departure. And in 2015, the Second District Court of Appeals in Benetatos v. City of Los Angeles affirmed the classification of a restaurant as a public nuisance because its operation created a condition of lawless blight that attracted loitering, drinking, drug dealing, prostitution, and violence on the property.¹⁹⁸

Opioid addiction has similarly ravaged the quality of organized social life in cities by turning parks and neighborhoods into lawless dens of drug use, petty crime, and antisocial behavior. In San Francisco, open-air drug markets have taken over the Tenderloin neighborhood and United Nations Plaza, exposing local residents and visitors to blatant drug deals and drug use in streets strewn with garbage, feces, and needles.¹⁹⁹ Judge Breyer even noted that “outside this courthouse, people suffering from severe opioid addiction buy, sell, and use opioids in plain sight.”²⁰⁰ At United Nations Plaza, street vendors sell allegedly stolen goods on the sidewalk,²⁰¹ and some commentators have attributed San Francisco’s increase in property crimes such as larceny, beginning in 2012, to people seeking money to purchase drugs.²⁰²

Opioid conditions thus interfere with the public morals by facilitating the type of petty criminality and vice that justifies the abatement of problem properties. One might criticize a common law conception of “public morals” as antiquated in the twenty-first century; certainly, public sentiment is far more understanding and lenient towards drug use and prostitution and far more critical of moralistic judgment. But even so, people still seem to respond negatively to illicit behavior in public. To provide just one example, in Benetatos v. City of Los Angeles, the record included a citizen’s declaration from nearby residents and business owners lamenting the violence and prostitution outside the restaurant.²⁰³ In fact, the Los Angeles Police Department launched its nuisance investigation in response to “recent complaints,”²⁰⁴ presumably from neighbors. And in San Francisco, the successful recall in June 2022 of progressive San Francisco District Attorney Chesa Boudin, who was criticized as being soft on crime, suggests an increasing frustration among residents with quality of life and lawless behavior that the government has failed to address.²⁰⁵

C. Distinguishing Opioids with Other Products

The courts and critics that categorically refuse to apply public nuisance to products might be right to note that California’s recognition of a public right “to housing that does not poison children”²⁰⁶ is essentially the same as a right to not be negligently injured, which the Second Restatement explicitly characterizes as a private, rather than public, right.²⁰⁷ This reasoning adheres to a traditionalist understanding of public nuisance and distinguishes it from legislatively authorized product liability law.

Other critics have argued the history of public nuisance paints a more complicated picture. Kendrick has looked to the “common nuisances” William Sheppard listed in the 1660s—“victuallers, butchers, bakers, cooks, brewers, maltsters and apothecaries who sell products unfit for human consumption”—and questioned whether “there [is] some fine distinction between the activity of selling products and products themselves.”²⁰⁸ And Dana has argued that while product liability law has been legislatively authorized, it is also a “common law creation of the courts,” so courts should have the authority to “interpret it to leave space for products-based public nuisance claims.”²⁰⁹

But this Note primarily argues that opioid addiction has obstructed public space much like the canonical highway blockage and offended public morals much like the canonical problem property. Opioids can therefore be readily distinguished from other products such as lead paint. The former causes tangible harm to the public square, while the latter causes harm within the privacy of the home. The condition of opioid addiction, not unlike the toxic waste in Hooker II, has spilled over onto public sidewalks, parks, and libraries, requiring expensive clean up, emergency response, and social services to abate. And as in Hooker II, in which the chemical company was still liable after selling the toxic dump site, those responsible for the opioid epidemic should not escape liability on the basis that they no longer control the condition that gave rise to the nuisance. Accordingly, the categorical stance against products fails to protect long-recognized public rights from interference.

Thus, the California court of appeal holding in ConAgra Grocery Products, that lead paint interferes with a public right “to housing that does not poison children,”²¹⁰ is incongruous with the common law understanding of public nuisance. But California’s flexible treatment of public rights should not encourage other states to dismiss public nuisance claims concerning products if those products interfere with traditionally recognized public rights, as opioids do.

D. Addressing Counter Arguments

This Section will address three counterarguments²¹¹: (1) opioid defendants are not the proximate cause of the interference with public rights, (2) misguided city policy, rather than opioid addiction, is responsible for the public nuisance in San Francisco, and (3) a flood of litigation will ensue if public nuisance is extended to harms caused by legal products.

1. Proximate Cause Objection

This Note argues that opioid addiction interferes with public rights; nonetheless, even accepting that such an interference has taken place, one might counter that defendants such as Walgreens are not the proximate cause of the interference. In California, proximate causation is an element of a prima facie public nuisance claim,²¹² and in a typical action, the causal chain is quite clear: a defendant’s unreasonable conduct creates a harmful condition, and that condition interferes with public rights. For example, a man who digs a ditch in a road has created a condition that interferes with public convenience. However, a defendant’s conduct in opioid cases—whether that be misleading advertising by manufacturers or negligent supervision of red-flag prescriptions by pharmacies—results in an interference with public rights only because of the intervening action of opioid users. The principle of novus actus interveniens would suggest that opioid manufacturers and pharmacies could not be held liable for the behavior of opioid users because their independent wrongdoing marks a break in the causal chain.

However, the stranglehold of opioid addiction can cause a person to spurn employment, family, shelter, and ultimately life itself, distinguishing opioids from other products such as guns that bear no influence over the free will of their user. As Judge Breyer noted, opioids can ensnare even unsuspecting patients into helpless addiction, making downstream consequences such as “crime, homelessness, and destruction of city property” foreseeable.²¹³ Moreover, just as the crimes of intervening third parties did not absolve the restaurant owner in Benetatos v. City of Los Angeles of public nuisance liability because the owner failed to ameliorate the blighted condition of his property, here, the intervening behavior of opioid addicts should not absolve manufacturers, dispensers, and pharmacies from contributing to the underlying condition that perpetuates this behavior.

2. The Role of Public Policy

One could also argue that progressive policies, rather than manufacturers and pharmacies, are the cause of the interference with public rights in San Francisco. At least since the Summer of Love in 1967, San Francisco has earned a worldwide reputation for being tolerant towards drug use and homelessness.²¹⁴ But following the punitive and, in retrospect, controversial state response to the 1980s crack-cocaine epidemic and the violence it generated, California voters embraced policies more lenient towards drug possession and use. In 2000, voters passed Proposition 36, which required that “people convicted of the possession, use, or transportation of controlled substances and similar parole violations, except sale or manufacture of drugs, receive probation and drug treatment, rather than incarceration.”²¹⁵ Similarly, in 2014, voters passed Proposition 47, which recategorized a variety of nonviolent crimes, including personal use of most illegal drugs and shoplifting of property less than $950, as misdemeanors.²¹⁶ And beginning in 2009, cities such as Los Angeles and San Francisco implemented a “Housing First” approach to homelessness that offers housing with no condition on sobriety.²¹⁷ Critics of these policies argue that it has prevented law enforcement from compelling drug treatment for offenders and from policing crimes such as shoplifting and petty theft that provide those suffering from addiction with the cash to fund their drug use.²¹⁸

While these policies have likely exacerbated the opioid epidemic’s impact on civic order, evidence suggests that opioid addiction has inflicted similar community harm in other states. For example, in the red state of Kentucky, a “county-level survey commissioned by Purdue . . . revealed that ‘[9] out of 10 [people surveyed] agreed that OxyContin had a ‘devastating effect’ on the community.’ ”²¹⁹ Thus, it would be inaccurate to categorically claim that opioid addiction does not interfere with public rights.

3. Concerns About a Flood of Litigation

Many critics contend that if courts extend public nuisance to opioids, then courts would be flooded with product liability suits disguised as public nuisance suits for potentially any legal product that, when misused, causes harm. The middle-road understanding of public nuisance that this Note champions recognizes two primary constraints that should assuage this concern.

First, a product must interfere with a public right to create a public nuisance. As Dana has noted, this requirement distinguishes public nuisance from product liability law because the latter is “focused on the harms specifically borne by discrete individuals, such as individual loss of earning power, medical expenses, and pain and suffering.”²²⁰ By categorically refusing to apply public nuisance to harms from products, courts may hamper government ability to counteract actual infringements on public rights.

Opposing this categorical view, some critics argue that a dogmatic, traditionalist understanding of public nuisance inhibits the doctrine’s potential as a stopgap measure when regulation fails to protect the public. Kendrick has stated that courts and scholars should “interpret the concept of ‘public rights’ more loosely” and believes that an aggregation of a large number of private harms from products should support a public nuisance claim.²²¹ Citing early common law cases and broadly worded public nuisance statutes in America, she argues “contemporary formalist tendencies have gone too far.”²²² California’s statute supports her view.²²³

Kendrick’s approach, while persuasive, would likely not convince skeptical courts concerned about a flood of litigation. Such concerns are warranted: in the decades following the successful Master Settlement Agreement with tobacco companies, public nuisance claims have proliferated against companies for harms the doctrine has not traditionally redressed.²²⁴ Take opioids: the consolidated MDL litigation in federal court consists of 3,000 lawsuits brought by tribes, municipalities, counties, and states as of October 2022 while separate actions have been brought in state court.²²⁵ Unlike the tobacco litigation, in which the attorneys general of all fifty states sued tobacco companies and coordinated an all-encompassing settlement, the opioid litigation features a far greater number of plaintiffs and defendants, complicating an efficient pathway to settle all future claims. Understandably, this litigation presents a “genuinely terrifying” prospect for defendants.²²⁶

The public nuisance litigation against Juul Labs Inc., which allegedly marketed its e-cigarette and fruit-flavored vapor to youth and downplayed the vapor’s high nicotine content, is another example. Even though these lawsuits have garnered over $1 billion in settlements with forty-seven states and territories and more than five thousand individuals, school districts, and local governments, once Juul withdrew many of its popular flavors in response to regulatory and public pressure, competitors swarmed the market with fruit-flavored alternatives, presenting “an enforcement dilemma” for the FDA, which has only authorized “fewer than two dozen vaping products.”²²⁷ Unlike the centralized state-led tobacco litigation, plaintiff lawyers representing school districts joined the fray and shared in the settlements under a tenuous public nuisance theory, and now these plaintiff lawyers and school districts are bringing similar actions against social media companies.²²⁸

Thus, critics hold legitimate concerns that public nuisance gives plaintiff lawyers “the ability to intimidate market participants and reshape the economy without ever scoring a conclusive win in a courtroom (never mind a legislature).”²²⁹ Indeed, the uncoordinated nature of the opioid and Juul litigation and the substitution of prescription opioids and Juul e-cigarettes with alternatives that evade a similar state crackdown raise important questions about whether these suits are more about abatement or more about sharing in the spoils of a company’s downfall, like some communal feast on the savanna after a large lion is outnumbered and slain. Because a public nuisance doctrine in which a large number of private injuries could satisfy the public rights element might result in even more litigation, public nuisance should only redress harms that interfere with traditional public rights.

Second, the other elements in a prima facie public nuisance claim should prevent a flood of litigation against makers of legal products. For example, in California, public nuisance claims require a showing that a party has “knowledge that its unreasonable conduct caused a substantial interference with a right common to the public.”²³⁰ Even if a state can prove a defendant interfered with a public right, the state still must demonstrate the defendant’s conduct was unreasonable and the cause of the interference. For example, a California state court held that opioid manufacturers were not liable for creating a public nuisance because the state’s evidence of a statistical increase in statewide prescriptions did not prove that false marketing caused medically inappropriate prescriptions.²³¹ With no evidence of inappropriate prescriptions, the court found that the marketing was reasonable because the social utility of medically appropriate prescriptions outweighs any harm they might cause.²³² The Second Restatement and many states also require, at a minimum, knowledge of unreasonable risk for a defendant to be liable for public nuisance, so this same burden of proof applies elsewhere.²³³ Therefore, if a product has social utility and is sold legally, then a plaintiff must satisfy a high burden of proof to show a defendant acted unreasonably.

CONCLUSION

A daunting drug epidemic confronts the United States and its institutions. Drug overdose deaths are at historic highs, and more than four out of five Americans who need treatment for illicit drug use do not receive it.²³⁴ Voracious demand for drugs has poured billions into coffers of drug traffickers, who internationally “threaten[] global stability” and domestically “contribute to public health challenges and violence.”²³⁵ City & County of San Francisco v. Purdue Pharma L.P. provides an indelible account of the impact of addiction on civic order. Those who argue that legal products cannot interfere with public rights need only visit San Francisco’s sidewalks, parks, and libraries. There, opioid addiction interferes with public rights by obstructing public space and exposing residents to illicit behavior that, at the least, is offensive to witness in broad daylight and, at the most, poses a legitimate threat to safety and health.

While the opioid litigation appears to be in its final phase,²³⁶ public nuisance should have the flexibility to address infringements on traditional public rights—even if caused by a legal product. Future products may pose novel threats to public rights and, like opioids, may require action from all branches of government. The middle-ground approach to public nuisance outlined in this Note would achieve this end.

97 S. Cal. L. Rev. 767

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Andrew B. Workman*

* University of Southern California Gould School of Law, Class of 2024. I am grateful to Professor Gregory C. Keating for his excellent seminar on public nuisance and for his personal guidance and feedback on this Note. I am also grateful to my fellow members of the Southern California Law Review, especially Jack Frisbie, Class of 2023, who provided helpful feedback on early drafts, and the editors on Volume 97 who helped edit and refine this Note for publication.

“Bob Jones University” in the 21st Century: An Examination of Charitable Tax-Exempt Status and Religious Exemption from Title IX for Religious Colleges That Discriminate Against LGBTQ+ Students

July 2024July 2024Sydney Smith*

INTRODUCTION

On March 30, 2021, the Religious Exemption Accountability Project (“REAP”) filed a historic class action lawsuit with the goal of challenging the abusive conditions that many private religious colleges and universities have created for LGBTQ+ students. These unsafe conditions have been permitted for decades by the U.S. Department of Education’s policies surrounding religious freedom.¹ In the complaint, plaintiffs criticize the privileges—tax-exempt status and government funding—that are bestowed upon these institutions despite their discriminatory practices, denouncing the special treatment they receive simply for shrouding their behavior in religious justifications for protection. The complaint went on to criticize the religious exemption to Title IX, alleging that it “permits the Department to breach its duty as to the more than 100,000 sexual and gender minority students attending religious colleges and universities where discrimination on the basis of sexual orientation and gender identity is codified in campus policies and openly practiced.”²

There are many documented cases in which private religious institutions have engaged in discrimination against LGBTQ+ students without legal repercussions—often involving the enforcement of an “honor code” that prohibits certain types of gender and sexuality expression. For example, one student was expelled from Southwestern Christian University—a semester shy of graduation—when school officials discovered that she was married to a same-sex partner; the school pointed to a “lifestyle covenant” that prohibited “Lesbian, Gay, Bi-sexual and Transgender (LGBT) behavior or acts” to justify its decision.³ Another student, who is transgender, was expelled from California Baptist University after the school alleged that she committed fraud on her school application by listing her gender as “female.”⁴ Another student, after it was revealed that she was in a same-sex relationship, was barred from enrolling in her final semester at Grace University; she was told that she could re-enroll only “if she went through a restoration program involving mandatory church attendance, meetings with counselors and mentors, and regular communication with a school dean.” She was eventually expelled for continuing to date women, and the school demanded that she return thousands of dollars in federal financial aid money.⁵ The complaint filed by REAP alleged dozens of additional acts of discrimination against LGBTQ+ students. The named plaintiff on the lawsuit, Elizabeth Hunter, was subject to discipline from Bob Jones University after posting online about LGBTQ+ issues, including “her posts about reading a book with a lesbian main character, and about writing a book including a lesbian relationship.”⁶ Another plaintiff, Victoria Joy Bacon, alleged that school officials at Lipscomb University directed homophobic and transphobic statements against them, including slurs, and that resident advisors witnessed them being called slurs and refused to intervene.⁷ Nathan Brittsan only attended Fuller Theological Seminary for a few days before being expelled for being homosexual and married to a same-sex partner.⁸ Scott McSwain was told by Union University that he was “going to hell” and that he would be expelled if he did not attend sexual conversion therapy.⁹ These examples represent only a fraction of the reported discrimination that LGBTQ+ students have been subjected to by private religious institutions.

In the REAP lawsuit, plaintiffs argued that it is constitutionally impermissible for government funding to be distributed to private educational institutions that engage in discrimination against students, either through official policies and honor codes or unofficially through other channels. However, I argue that a bright line rule consistent with this position would be difficult to implement in any practical sense—not only because it is virtually impossible for schools to operate without any government funding at all, but also because taking any legislative action to restrict funding to these schools would be extremely unpopular in the current political environment. Under current IRS tax policies, it is unlikely that private religious institutions could have their tax-exempt status revoked for engaging in discrimination on the basis of gender identity or sexual orientation. The most promising route for holding schools responsible for such behavior by revoking tax-exempt status is the IRS promulgating a new regulation forbidding organizations that discriminate on the basis of gender identity or sexual orientation from being categorized as “charitable” for the purpose of tax exemption. The Court should then uphold this new policy by extending the holding of Bob Jones University v. United States beyond just racial discrimination. This order of operations is crucial, as it seems unlikely that a potential extension of Bob Jones University would be effective if not preceded by a new IRS policy. Congress, as the ultimate source of authority for the IRS, has the power to modify those policies which it considers improper. However, it seems likely that independent agency action coupled with judicial review would be more successful than getting the legislative branch to make the politically-unpopular decision to threaten the tax-exempt status of a large number of private religious colleges and universities. Even when Bob Jones University was engaging in blatant racial discrimination to such an extent that the majority of the public did not approve, it was the IRS and Supreme Court that took action, not Congress.

All of the schools mentioned above claim to be exempt from Title IX for religious reasons, and none has ever been subjected to substantive investigations or discipline from the federal government for civil rights violations against LGBTQ+ students. In the REAP lawsuit, plaintiffs argue that the religious exemption to Title IX, to the extent that it allows institutions to discriminate against students on the basis of gender identity and sexual orientation, is a violation of the Equal Protection Clause of the Fourteenth Amendment. However, I am highly skeptical that the Court would issue a holding consistent with this position any time in the foreseeable future. Thus, some practical stop-gap solutions are necessary. First, there needs to be a dramatic reconfiguration of the religious exemption to Title IX. At the very least, the current process of automatically granting religious exemption to any religious educational institution leaves a lot of ambiguity about what protections exist for students and what remedies are available; moreover, it gives implicit permission to such institutions to engage in more and more discriminatory behavior because they were given no conditions on which their exemption would be granted and they have no fear of losing the exemption. Beyond this, the enforcement mechanisms behind Title IX need to be bolstered so that schools operate with a more legitimate fear of negative consequences if they break the law. Currently, the Office for Civil Rights’ (“OCR’s”) only real enforcement mechanism is the threat of cutting off federal funding, but since this has never been done, it is a hollow threat.

There is an infinite number of questions that could be explored in relation to private religious colleges and universities and their religious free exercise rights. In this Note, I seek to limit my focus to just the issue of discrimination against members of the LGBTQ+ community—those who are gender-identity or sexuality minorities. For example, although Title IX governs the way that school administrations respond to sexual assault and sexual harassment allegations made by members of the campus community, this Note does not seek to address this facet of the Act’s effects other than to the extent that such actions (or lack of action) constitute sex-based discrimination (for example, failure to respond to sexual assault allegations made by LGBTQ+ students). I am aware of recent high-profile scandals at certain private religious institutions involving sexual assault and failure to follow proper reporting and investigation procedures laid out by Title IX; although important, addressing these systematic failures would distract from the religious exemption to Title IX and the disparate treatment that LGBTQ+ minority students are subjected to. Furthermore, this Note does not directly address discrimination perpetrated by primary or secondary schools; rather, the focus is placed on post-secondary educational institutions. Despite this narrow focus, the information and analysis provided in this Note will hopefully prove useful to other scholars who seek to apply my argument to a broader array of educational settings.

Scholarly literature has already examined the tax-exempt status question to a certain extent regarding the history and potential application of the Bob Jones University case. Some articles, like The Story of Bob Jones University v. United States: Race, Religion, and Congress’ Extraordinary Acquiescence, take the position that the case only came out the way it did because race is treated much differently than other protected categories.¹⁰ This is somewhat contrary to the argument of this Note: the holding in Bob Jones University should be extended to protect students against discrimination beyond that which is solely on the basis of race. Other articles criticize the Court’s holding in Bob Jones University as overly broad and failing to take into consideration the school’s viable religious liberty claims. One such article, Bob Jones University v. United States: A Political Analysis, highlights what it refers to as the “hazards” of the Supreme Court getting involved in such questions, holding out free exercise of religion as an important principle. Despite this article’s fundamental disagreement with my proposal that the holding in Bob Jones University be extended, the article contributes a great amount of political analysis of the history of tax-exempt status for religious institutions and the cases that have developed the Court’s jurisprudence on the issue.¹¹ This information allowed me to more fully understand how policy and jurisprudence might most effectively evolve in the future. Some articles, such as The Sexual Integrity of Religious Schools and Tax Exemption, touch on the Obergefell v. Hodges decision and how the recognition of same-sex couples’ fundamental right to marry may impact the civil rights owed to them in educational contexts. The aforementioned article notably takes the position that the Court’s decision in Obergefell is explicitly inconsistent with “applying Bob Jones to the disadvantage of religious schools that maintain sexual conduct policies”—which is at odds with the central position of this Note.¹² Other articles, such as Discrimination in the Name of the Lord and Discriminatory Religious Schools and Tax-Exempt Status, offer relevant analysis of the interaction between free exercise by religious universities and the civil rights protections afforded to students; however, their decades-old perspectives require updating in light of relevant legal and political developments.

Scholarly literature has also explored the issue of religious exemption from Title IX. One article, Should Religious Groups Be Exempt from Civil Rights Laws?, delves deeply into the issue, examining civil rights protections for race, sex, and sexual orientation.¹³ However, there is a gap in this article, written in 2007, which does not account for new developments in the law surrounding the definition of discrimination “on the basis of sex,” especially in the context of civil rights laws like Title IX and Title VII. This has important implications for what is thus categorized as discrimination on the basis of sex. In the U.S. Supreme Court’s October 2019 term, the Court released an opinion in Bostock v. Clayton County that held, “[a]n employer who fires an individual merely for being gay or transgender violates Title VII.”¹⁴ This opinion relies on a new (to the Supreme Court’s jurisprudence) definition of discrimination on the basis of sex. If this definition is applied to Title IX as well, there may be implications for how colleges and universities must act in order to remain in compliance with Title IX.

One work of scholarship stands out in particular for its similarity to this Note’s contribution to the debate. In 2022, the Brigham Young University Prelaw Review published an article entitled The Constitutionality of the Title IX Religious Exemption. This article responds to the Hunter v. Department of Education lawsuit, but its author, Madelyn Jacobsen, makes the opposite argument from mine by arguing that the religious exemption to Title IX is “crucial for maintaining [religious] diversity in higher education” and that restricting or eliminating the religious exemption to Title IX would necessarily constitute a restriction on free exercise of religion.¹⁵ Jacobsen mimics the language often used in legal disputes surrounding free exercise of religious “closely held beliefs.” This Note contributes a much-needed alternative perspective on the debate where the Jacobsen article left a clear gap. Another work of scholarship stands out in particular for the similarities that the author brings in personal background that contribute to the article’s perspective. The author of Loving the Sinner: Evangelical Colleges and Their LGB Students notes that she attended Wheaton College, a private Christian college that is one of the many targets of the Hunter v. Department of Education lawsuit, and reflects on this experience as being “encased in a protective coating of ignorance and denial” about her homosexuality.¹⁶ Because of this background, the author homes in on the personal experiences of LGBTQ+ students at private religious colleges and carefully considers the stakes of all major actors: the religious institution’s interest in maintaining the pure religious character of its student body and minority students’ interest in expressing themselves fully while still attending the college in question. The author conducts analysis through a framework of “institutional religious freedom,” focusing mainly on sexual codes of conduct, voluntary association, and third-party burdens. This Note adopts a similar perspective, due to my similar personal upbringing, but shifts the analytical angle from the religious freedom owed to institutional actors to the civil rights owed to minority students.

I. BACKGROUND

A. Government Funding and Tax-Exempt Status for Private Religious Colleges

Public institutions have historically provided the setting for legal challenges to laws that involve education; colleges like the University of Michigan and University of Texas have famously been involved in litigation over segregation and affirmative action because of their receipt of significant funds from state and federal sources. There is a bit more uncertainty surrounding the applicability of such laws to private institutions. Although private religious colleges may not be fully state sponsored like public institutions, almost none of them operate entirely independently from the government. Federal funds are given to private religious colleges through a variety of means, including loans and grants for construction and renovation of campus facilities;¹⁷ noncategorical state “capitation grants”¹⁸; Medicare reimbursements for campus medical centers; National Institute of Health (“NIH”) grants for science departments; and Health Resources and Services Administration grants to medical, dental, or nursing programs.¹⁹ Federal student loans, tuition tax credits, and federal Pell Grants allow colleges to be able to raise tuition rates without lowering enrollment.²⁰ Beyond direct grants and loans, private religious colleges also receive a tremendous amount of assistance from the savings received through tax-exempt status.²¹ Furthermore, gifts to religious colleges are treated as charitable deductions for income-tax purposes, which incentivizes giving.²² Thus, the perception that private educational institutions are independent from the public sphere is a myth.

An oft-repeated argument about the private sector (including privately-owned businesses and private colleges and universities) is that it should be subject to fewer government restrictions and regulations because of its independence from the public sector. However, since the vast majority of private religious colleges accept millions of dollars of public funds each year, plaintiffs in the Hunter lawsuit argued that there are constitutional restrictions on how those funds may be used. Plaintiffs acknowledge that the receipt of public funds is permissible; “[h]owever, when the government provides public funds to private actors . . . the Constitution restrains the government from allowing such private actors to use those funds to harm disadvantaged people.”²³ In light of this, it would be inconsistent to allow institutions that receive public funds or that benefit from tax-exempt status to discriminate against sexual and gender minority students.

This stance represents a logical extension of the U.S. Supreme Court’s 1983 opinion in Bob Jones University v. United States, in which the Court held that Bob Jones University (“BJU”), a private religious college, did not qualify as a tax-exempt organization under §501(c)(3) of the Internal Revenue Code because of its racially discriminatory policies.²⁴ In 1980, the IRS had issued a ruling providing that a private school with a racially discriminatory policy does not qualify as “charitable” within the common law concepts reflected in the Internal Revenue Code. The Court held that “an institution seeking tax-exempt status must serve a public purpose and not be contrary to established public policy.”²⁵ BJU continued to enforce its policy of denying admission to applicants who engaged in interracial marriage or applicants who were known to advocate for interracial marriage. In light of this discriminatory policy, the IRS revoked BJU’s tax-exempt status. The university was asked to pay a portion of federal unemployment taxes for a year, and then filed a refund action in federal District Court; the IRS filed a countersuit claiming millions of dollars in unpaid taxes.²⁶

The Court analyzed Internal Revenue Code (“IRC”) §501(c)(3)—the portion of the Internal Revenue Code that sets forth regulations that apply to charitable organizations—against the backdrop of the congressional purpose, which was to give preferential treatment to charities in exchange for the benefit that they provide to society, and their relationship with the public interest.²⁷ The Court invoked the history of charitable tax-exempt status; the status was originally conceived as similar to charitable trusts, which could not “be illegal or violate established public policy.”²⁸ In light of this purpose, the majority held that in order to qualify for tax-exempt status, an institution must “demonstrably serve and be in harmony with the public interest,” and that “[t]he institution’s purpose must not be so at odds with the common community conscience as to undermine any public benefit that might otherwise be conferred.”²⁹ Indeed, any institution that engaged in racial discrimination was excluded from the category of those that confer a public benefit and could thus be excluded from the charitable category and stripped of the accompanying tax-exempt status. Therefore, the IRS’s action stripping BJU of its charitable tax-exempt status was a valid exercise of its congressionally-granted authority.

One portion of the Bob Jones University decision that is potentially relevant to the question before us is which level of scrutiny the court should apply. It is worth noting that this analysis should not be interpreted to mean which level of scrutiny should be applied when sex is involved—a question that would involve its own analysis of what is included in the definition of “sex discrimination.” Indeed, the Court did not craft its ruling in Bob Jones University based on whether race is a suspect classification that triggers the application of strict scrutiny. Rather, the question is how closely the Court should scrutinize government policies that implicate religious freedom. In Bob Jones University, the Court applied strict scrutiny to the potential burden that the IRS rule placed on religious freedom for the university. Thus, this means that the relevant balancing test that the Court would have to consider in judicial review of a new IRS rule would be whether there is an overriding interest in protecting the LGBTQ+ community from discrimination that outweighs the religious freedom of private religious universities. In engaging in this examination, the Court should come to the same conclusion as the similar question, from Bob Jones University, regarding racial discrimination.³⁰

The First Amendment provides a baseline level of protection for religious freedom, providing that the government “shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof.”³¹ The Court’s jurisprudence regarding the Free Exercise Clause has evolved over time, beginning with a compelling interest test and eventually departing from it in Employment Division v. Smith.³² In Smith, the majority delivered a scathing criticism of the compelling interest test, claiming that its application would produce a “constitutional anomaly” and “a private right to ignore generally applicable laws.”³³ Smith explicitly rejected the compelling interest test’s expansion of the First Amendment’s protection of religious liberty and asserted that the Free Exercise Clause

does not relieve an individual of the obligation to comply with a law that incidentally forbids (or requires) the performance of an act that his religious belief requires (or forbids) if the law is not specifically directed to religious practice and is otherwise constitutional as applied to those who engage in the specified act for nonreligious reasons.³⁴

It may surprise a modern audience to learn that Justice Antonin Scalia wrote the majority opinion in Smith, which places limits on religious freedom when it clashes with a compelling governmental interest.³⁵

Congress reacted explosively to this inflammatory Supreme Court decision, fearful that it may lead to infringement on the free exercise of the religious beliefs of Christians. Shortly after Smith was decided, Congress passed the Religious Freedom Restoration Act (“RFRA”), which expanded the religious freedom protection granted by the First Amendment by legislatively establishing a compelling interest test (a test that had been explicitly rejected by the judicial branch). Under this new law, whenever the government imposes a burden on religious liberty, the courts are required to apply strict scrutiny in their analysis of the government’s justification.³⁶ RFRA prohibits the government from substantially burdening the free exercise of religion, “even if the burden results from a rule of general applicability,” unless the government is able to demonstrate that application of the burden (1) furthers a compelling governmental interest; and (2) does so by the least restrictive means.³⁷ Because of RFRA’s new permissive standard, the Court would be required to analyze any potential burden on the free exercise of religion by private religious institutions under strict scrutiny, using a compelling interest test. This law makes it more difficult to hold religious institutions responsible for engaging in discrimination against LGBTQ+ individuals because it provides such strong protections for religious groups against government intervention.

Government funding and tax-exempt status are one important piece of the puzzle when it comes to protecting LGBTQ+ individuals from experiencing discrimination at the hands of their private religious institutions. The other piece is Title IX, a historic legislative act drafted in the Civil Rights era to prevent discrimination in the realm of education, which applies certain standards to all educational institutions that are the recipients of government funding, including private religious schools. However, the efficacy of the Act is undermined by the blanket exemptions granted to religious organizations. The process for granting religious exemptions to Title IX should either be vastly reworked, or the exemptions should be done away with entirely. I will analyze these options and consider the legality and practicality of each option.

B. Title IX and the Religious Exemption

Title IX provides that “[n]o person in the United States shall, on the basis of sex, be excluded from participation in, be denied the benefits of, or be subjected to discrimination under any education program or activity receiving Federal financial assistance.”³⁸ In Cohen v. Brown University, the Court recognized Congress’s dual objectives in passing Title IX: (1) “to avoid the use of federal resources to support discriminatory practices;” and (2) “to provide individual citizens effective protection against those practices.”³⁹ Specifically, Title IX, also known as the Education Amendments of 1972, was intended to update Title VII of the Civil Rights Act, which had been passed in 1964. Title VII prohibits employment discrimination based on race, color, religion, sex, and national origin, but Title IX was intended to expand that prohibition against discrimination to the education system as well.⁴⁰ Without Title IX, the only aspect of the education system in which discrimination on the basis of sex would be prohibited is discrimination against employees of the school; Title VII left students largely unprotected.

Regulations that govern the implementation of Title IX are set forth in the Code of Federal Regulations (“CFR”), and the Office for Civil Rights (“OCR”)—a department within the U.S. Department of Education—has the legal authority to enforce Title IX.⁴¹ The OCR performs invaluable work: investigating complaints, ensuring that institutions are complying with necessary regulations, and even providing technical assistance.⁴² One of the most important tools that the OCR wields is the right to conduct compliance reviews. This provides a significant incentive for schools to comply with its legal obligations because if it is found to violate Title IX, there can be harsh consequences—at least on paper. First, an institution is given the option to voluntarily remedy the violation. If it refuses to do so, OCR may: (1) initiate a termination of the institution’s federal funding, or (2) refer the case to the U.S. Department of Justice to pursue a case in court.⁴³ However, these threats have proven hollow, as no university has yet had its federal funding revoked—a bold move that would send shockwaves through the higher education community in the United States. Separately from federal agency enforcement of Title IX through administrative channels, individuals have the authority to initiate proceedings against allegedly discriminatory institutions. An individual has the right to file a lawsuit in court alleging Title IX violations and to file a complaint with the OCR, but the former is not required to have standing for the latter.⁴⁴ Courts may order specific remedies or may award monetary damages to victims of sex discrimination who file lawsuits. Given that the OCR’s threat of revocation of federal funding is a largely hollow threat, the “implied private right of action” of Title IX has “given Title IX its teeth” and serves as a crucial enforcement mechanism.⁴⁵

Title VII contains a religious exemption section which restricts the protections afforded by the new piece of legislation. Section 2000e-1 states, “[t]his subchapter shall not apply to an employer with respect to the employment of aliens outside any State, or to a religious corporation, association, educational institution, or society with respect to the employment of individuals of a particular religion to perform work connected with the carrying on by such . . . .”⁴⁶ Thus, when Congress recognized that the protections of Title VII were exclusively restricted to the employment sector and set out to expand it to the education sector, Congress inserted a similar section exempting religious organizations from Title IX as well. Despite Title IX’s illusion of broad protection against discrimination, § 106.12 goes on to exempt educational institutions that are controlled by religious organizations, declaring that the act “does not apply to an educational institution which is controlled by a religious organization to the extent application of this part would not be consistent with the religious tenets of such organization.”⁴⁷ In the cases of both Title VII and Title IX, the religious exemption sections were crafted as a part of a political compromise with the religious right to pass the legislation.⁴⁸

For most of the history of Title IX, very few institutions sought religious-based exemptions. However, in 2013, there was a sudden increase in the number of official claims of religious exemption. In fact, between 2013–2021, more than 120 religious institutions claimed exemption from Title IX.⁴⁹ This development can largely be traced back to evangelical fears about the Obama administration—anticipation of a crackdown on religious freedom. Though it was not to the extent that the American evangelical community expected, the Obama administration did seek to expand the protections of Title IX. On October 26, 2010, the executive branch issued guidance to schools to include LGBTQ+ individuals under Title IX protections. The letter defined gender-based harassment under Title IX in a new way, labeling it sex discrimination “if students are harassed . . . for failing to conform to stereotypical notions of masculinity and femininity.”⁵⁰ The letter goes on to explicitly state that “Title IX does protect all students, including lesbian, gay, bisexual, and transgender (LGBT) students, from sex discrimination.”⁵¹

The Code of Federal Regulations lays out a very basic framework for how exemptions are to be granted. C.F.R. § 106.12, governing Educational Institutions Controlled by Religious Organization, suggests that no formal process must be followed in order to secure a religious exemption to Title IX..”⁵² The further relevant procedures provided by the Code do not serve to confer exemption on the institutions, but only to reassure the institutions that they are eligible for those exemptions. Indeed, even without such advance assurance of religious exemption, if the Department of Education notifies an institution that it is under investigation for non-compliance with Title IX, the institution may choose to raise its exemption at that time. To do so, the institution shall submit a letter to the Department of Education’s Assistant Secretary, “identifying the provisions of this part which conflict with a specific tenet of the religious organization”—regardless of whether or not the institution already sought assurance before the fact.⁵³ An institution may write to the Department of Education’s Assistant Secretary to seek assurance of their religious exemption. However, “[a]n institution is not required to seek assurance from the Assistant Secretary in order to assert such an exemption.”⁵⁴ Consistent with this interpretation of the automatic triggering of this exemption, in 1976, President Oaks of Brigham Young University wrote a letter to the Department of Education that he clarified was notifying the Department of BYU’s exemption from Title IX (rather than requesting exemption). President Oaks specifically noted that BYU “did not concede that the Department of Health, Education and Welfare has the power to review our claim of exemption on the ground of religion.”⁵⁵ Thus, there is a long history—stretching back almost as far as the origin of the exemption itself—of the automatic triggering mechanism of the religious exemption to Title IX.

Once exemptions started being requested, the Department of Education started approving requests—seemingly indiscriminately: “In the nearly 50 years since the enactment of Title IX, the Office for Civil Rights has never denied a claim to religious exemption. As a result, religious educational institutions decide for themselves whether and to what degree they are exempt from Title IX.”⁵⁶ In 2014, the Department of Education—under the Obama administration—issued guidelines making it clear that transgender students are also protected under Title IX. This guidance, paired with the growing contemporary evangelical panic surrounding transgender people, seems to have drastically increased the number of schools seeking exemptions from Title IX. In response to this avalanche of requested (or declared) exemptions, a number of Democratic Senators asked the Department of Education to publish a list, for the first time, of the colleges that specifically request waivers. In the letter, the Senators cited taxpayers’ “right to know when institutions of higher education—as recipients of tax dollars—seek and receive exemptions under Title IX.”⁵⁷ The Department of Education released the requested list, revealing that at the time 248 schools had been granted exemption to Title IX. Under the Trump administration, new regulations reversed the policy of transparency. However, under the Biden administration, the policy was again reversed; today, an official list is once again maintained by the Department of Education’s Officer for Civil Rights, along with a copy of the office’s response to each request.⁵⁸

Title IX’s private enforcement mechanism was put to use on March 9, 2020, when an individual filed a complaint with the OCR, alleging that Brigham Young University (“BYU”) discriminates against students on the basis of sex. BYU is a private university with enrollment of almost 35,000 students, and is affiliated with the Church of Jesus Christ of Latter-day Saints.⁵⁹ The university is known for its strict honor code, which until recently included a section explicitly titled “Homosexual Behavior” that banned students from “all forms of physical intimacy” with a member of the same sex.⁶⁰ That section was removed in early 2020, inspiring a number of members of the campus community to publicly come out as LGBTQ-identifying. However, the elation sparked by this move was short-lived; shortly after, the Church of Jesus Christ of Latter-day Saints clarified that same-sex romantic behavior remains incompatible with official school rules. In a public letter, Church Educational System Commissioner Elder Paul V. Johnson clarified that “[t]he moral standards of the Church did not change with the recent release of the General Handbook or the updated Honor Code. . . . Same-sex romantic behavior cannot lead to eternal marriage and is therefore not compatible with the principles included in the Honor Code.”⁶¹ This announcement was met with protest, as many students felt like they were experiencing whiplash with regard to the Honor Code—and even felt trapped if they came out while believing themselves to be in a newly-safe environment.⁶² It was in the wake of this policy reversal that an unnamed individual filed a complaint with the OCR, alleging that BYU was engaging in discriminatory behavior.

In response to the complaint, the OCR launched a rare investigation into the private religious university. The complaint specifically alleged that BYU “engages in the different treatment of students who are involved in same-sex romantic relationships by stating that such relationships are not compatible with the principles of the University’s Honor Code.”⁶³ In a letter dated October 21, 2021, the OCR notified BYU that it was opening an investigation into the individual’s complaint. BYU responded on November 19, 2021 by requesting assurance from the U.S. Department of Education that the university is exempt from Title IX and its accompanying implementing regulations.⁶⁴ On January 3, 2022, the Department responded by assuring BYU of its exemption from a number of specific regulations under Title IX “to the extent that application of those provisions would conflict with the religious tenets of the University’s controlling religious organization”—including regulations involving admission, recruitment, housing, counseling, financial assistance, athletics, and comparable facilities.⁶⁵ Thus, in a letter dated February 8, 2022, the OCR concluded that it lacked jurisdiction to address the individual complainant’s allegations. Although it was rare for the OCR to go through the motions of initiating a Title IX investigation into any private religious college for alleged discrimination against LGBTQ+ students, the investigation was ultimately halted prematurely because the religious exemption to Title IX blocked the OCR from exercising jurisdiction over the complaint. If the complaint had been filed against any other educational institution—a public university, or even a private one without a religious affiliation—the OCR would have initiated a fact-finding mission and published the results. This exposes the university to significant liability and serves as a deterrent to the implementation of discriminatory policies that violate Title IX.

Again, the text of the religious exemption to Title IX reads as follows: “[Title IX] does not apply to an educational institution which is controlled by a religious organization to the extent application of this part would not be consistent with the religious tenets of such organization.”⁶⁶ Thus, there are two parts to the religious exemption to Title IX that should be examined separately: (1) Title IX does not apply to an institution “controlled by a religious organization” (with “control” defined very broadly), and (2) institutions are exempt only to the degree that their “religious tenets” conflict with Title IX. Below, I will elaborate on both elements.

1. “Controlled by a Religious Organization”

Title IX does not apply to an educational institution “controlled by a religious organization.” There are six different ways that an educational institution may establish that it is controlled by a religious institution: (1) it is a school or department of divinity; (2) it requires faculty, students, or employees to be members of or espouse personal belief in the religion of the controlling organization; (3) it contains an explicit statement that it is controlled be a religious organization in its charter, the members of its governing body are appointed by the controlling organization, and it receives a significant amount of financial support from the controlling organization; (4) it has a doctrinal statement along with a statement that members of the institutional community must engage in the religious practices of or espouse a personal belief in the statement; (5) it has a published institutional mission that is approved by the governing body of the controlling organization and is predicated on religious tenets; or (6) other sufficient evidence as laid out in 20 U.S.C. § 1681(a)(3).⁶⁷ This inclusive qualifying language is problematic; with “control” defined so broadly, potentially up to 1,000 colleges are encompassed by the words “controlled by a religious organization.”

2. Conflict Between “Religious Tenets” and Title IX

There is an age-old debate in American legal jurisprudence about how to determine whether an action—or inaction—is actually motivated by “religious belief.” This question is especially difficult in the context of an organization, not just an individual. If construed too broadly, there is a risk that a religious organization might simply do anything or discriminate against anyone on any basis and then fall back on a loose claim that the action was based on religious belief. Therefore, it is important to know where the line is drawn. The A.S. Singleton memo, written by the Assistant Secretary for Civil Rights at the U.S. Department of Education in 1985, instructs that religious exemption claims be consistent with the requirements of the First Amendment and the Religious Freedom Restoration Act.⁶⁸ The Office for Civil Rights purports to follow a special procedure to determine whether a provision of Title IX conflicts with religious tenets, requiring that schools submit a statement reflecting either their religious tenets or religious practices.⁶⁹ “A school claiming an exemption may refer to scripture, doctrinal statements, catalogs, statements of faith, or other documents.”⁷⁰

When administration officials from educational institutions write to the Department of Education to formally request a religious exemption from Title IX, the Civil Rights Office writes—and publicly publishes—a response letter. In each letter, they note that the requested exemptions must be based on actual religious tenets, and if the “governing organization” does not agree that those are actual religious tenets, the exemptions may not be valid.⁷¹ This creates the impression that religious exemptions to Title IX must be claimed on the basis of legitimate religious beliefs; however, the reality is that the Court is unwilling to scrutinize such organizational claims. Generally, the Court has thus far shied away from articulating a bright line test for what constitutes a religious belief, seemingly out of fear of being under-inclusive and resulting in the legal condemnation of “religiously-motivated” activities that the Court wishes to protect. This hesitation has had an unfortunate impact on the amount of scrutiny applied to explanations for why religious educational institutions seek to be exempt from Title IX.

II. ARGUMENT AND ANALYSIS

In the following section, I will consider two main aspects of the issue of the constitutionality of discrimination by private religious institutions against LGBTQ+ students: the question of the tax-exempt status of those institutions and the question of those institutions’ religious exemptions to Title IX.

Race permeated the Bob Jones University case so thoroughly that scholars have struggled to extract any universal principles from it that are separate from race.⁷² For one thing, the details of the circumstances surrounding the case involve overt racial discrimination: BJU maintained a policy forbidding interracial dating, a regulation that succeeded an outright ban on African-American students enrolling in the university as a seeming-concession to changing cultural attitudes toward racism.⁷³ The language of the majority opinion makes it hard to ignore the racial elements that motivated the Court’s decision—especially with an eye to the historical effects of the systematic exclusion of African Americans from the educational system in the United States. However, I propose that the Court’s holding in this case is consistent with an extension to include other protected groups of people (specifically, members of the LGBTQ+ community). The most effective way to implement such an extension of legal protection is through the Court granting certiorari for a new case that presents a ripe opportunity and then issuing a holding that clarifies the extent of the application of Bob Jones University. An appropriate case should follow an IRS action, much like the IRS action taken against BJU; absent those circumstances, a lawsuit like the one REAP filed in 2021 is unlikely to be effective. In Bob Jones University, the Court held that as an official extension of Congress’s authority, “the IRS has the responsibility, in the first instance, to determine whether a particular entity is ‘charitable’ for purposes of § 170 and § 501(c)(3). This in turn may necessitate later determinations of whether given activities so violate public policy that the entities involved cannot be deemed to provide a public benefit worthy of ‘charitable’ status.”⁷⁴ It is the duty of the IRS in this instance to recognize the injustice of discriminatory anti-LGBTQ+ policies at educational institutions. The Court noted that these determinations should be made “only where there is no doubt that the organization’s activities violate fundamental public policy.”⁷⁵ Here, this is obviously the case, exemplified by Executive Orders and legislation forbidding discrimination against LGBTQ+ individuals and U.S. Supreme Court decisions like Obergefell and Bostock.⁷⁶

Even assuming that such protections are put into place, might these institutions be allowed to side-step any attempted regulation by opting out of receiving federal funds entirely and agreeing to pay federal taxes? A small number of private Christian colleges in the United States have attempted to opt out of federal funds entirely. Hillsdale College, a private Christian college in Michigan, refuses to accept any federal funds, remaining independent on principle.⁷⁷ Would Hillsdale College or another similar institution thus be allowed to discriminate against their LGBTQ+ students? One of the main arguments of this Note has been that acceptance of federal funding and tax-exempt status creates a legal responsibility for educational institutions to abide by generally-applicable laws, including civil rights laws. But is the inverse true? Does independence from taxpayer dollars immunize an institution from punishment for refusing to follow federal rules? This question forces us to turn to the second major issue of this Note: Title IX.

The complaint filed by REAP in Hunter v. Department of Education suggests that religious exemptions to Title IX are blanketly unconstitutional. However, this stance is unlikely to be adopted in the current political climate, in which religious freedom is highly prized and anti-LGBTQ+ discrimination is not at the forefront of most Americans’ minds. I predict that the Court will be unwilling to find that religious exemptions to Title IX are blanketly unconstitutional and the next step is to challenge the legality of the process by which such exemptions are granted. Automatic exemptions should be presumptively suspect. A better process would be for colleges to be required to request exemptions and have them formally approved. This would place the right to consider the reasoning behind the exemption requests and their validity in the hands of the executive branch—the Department of Justice. Though it is important to consider the applicability of Title IX to institutions that opt out of the public sphere, we must keep in mind the likelihood of many colleges adopting this approach. Even though a small handful of institutions have been able to stay afloat without federal funds—albeit for a short period of time—federal funds still constitute the lifeblood of most educational institutions in the United States. I find it unlikely that this “independence” movement will catch on past the small ranks that it claims today.

As I briefly mentioned above, before any legal action may be taken to protect the vulnerable LGBTQ+ population at educational institutions that are abusing the tax-exempt status they enjoy as charitable organizations, the source that holds the authority to take action must be identified. The Court considered this question in Bob Jones University. Given that Congress is the source of IRS authority, it has the discretion to modify IRS rulings. However, in the “first instance,” the IRS is responsible for construing the IRC, which courts then exercise review over. “Since Congress cannot be expected to anticipate every conceivable problem that can arise or to carry out day-to-day oversight, it relies on the administrators and on the courts to implement the legislative will.”⁷⁸ This proper order of operations is demonstrated in the successful alteration of rules that govern tax-exempt status in the Bob Jones University case. It was the IRS that first acted, modifying the IRC to exclude organizations that discriminate on the basis of race from the definition of “charitable.” This is why I argue that it would be most practical and effective for legal action to start with the IRS and proceed from there with an inevitable challenge before the judicial branch.

The current iteration of the U.S. Supreme Court, the Roberts Court, has skewed dramatically toward religious organizations and the free exercise of religious beliefs. According to a 2022 New York Times article, the Roberts Court “has ruled in favor of religious organizations in orally argued cases 83 percent of the time”—which is far more than any other recent Court.⁷⁹ This trend is especially pronounced when the religious organization in question is Christian, as there is a substantial Christian majority currently sitting on the Court, both Catholic and Protestant. Beyond the Court’s favoring of religion, the U.S. Congress is also very reluctant to take any steps to limit religious freedom or take away power from religious organizations (like powerful private religious educational institutions). Thus, even if the Court were willing to uphold a law seeking to hold private religious educational institutions accountable for discrimination, such a law would likely not even make it through both chambers of Congress in the first place. With regard to religious exemptions to Title IX, the same political forces are likely relevant here, creating another practical roadblock. One potential way that this roadblock may be overcome is a change in the social and political climate in the United States. This was crucial to how the Bob Jones University case ended up with the outcome that it did—the Court was motivated by the confidence that a majority of the American public despised racial discrimination and would support eradicating it from the educational system to whatever extent possible. Though BJU maintained its racially discriminatory policies, it was very much in the minority among its peer institutions. The legality of anti-miscegenation laws was put to the test in 1967, when the Court struck down a Virginia state law that banned interracial marriage.⁸⁰ BJU maintained policies forbidding interracial marriage almost two decades later. The public opinion had reached a tipping point such that religious freedom was not accepted as an excuse for overt racial discrimination and a ban on interracial marriage was much less widely accepted by that time. However, I believe that today, the United States has yet to reach this tipping point regarding religious freedom and LGBTQ+ discrimination.

This unwillingness to protect vulnerable LGBTQ+ individuals from religiously-motivated discrimination is exemplified by some of the Court’s decisions over the past five years. In 2017, the U.S. Supreme Court heard a case called Masterpiece Cakeshop v. Colorado Civil Rights Commission, in which the owner of a cake shop refused to make a wedding cake for a same-sex couple. The Court invalidated a ruling by the Colorado Civil Rights Commission that the cake shop had violated the civil rights of the same-sex couple; here, the Court clearly stood on the side of religious liberty and free exercise over the protection of civil rights.⁸¹ In 2021, the Court heard a case called Kennedy v. Bremerton School District, holding that a public school football coach was not prevented by the First Amendment from praying on the field with his players in what the court called “a personal religious observance.”⁸² Here, the Court continued to plow forward in carving out new rights to the free exercise of religious belief, which it had previously not recognized. In 2022, the Court heard 303 Creative v. Elenis, in which an individual Christian business owner challenged a Colorado law that banned businesses from discriminating against LGBTQ+ customers. During oral arguments, Justice Alito drew a distinction between discrimination on the basis of race and on the basis of sexual orientation, which would be consistent with a position that seeks to distinguish the Bob Jones University precedent from the Hunter v. Department of Education case.⁸³ These recent cases are among a series of examples of the Court demonstrating a strong preference for religion over other concerns—civil rights laws, anti-discrimination laws, etc.⁸⁴

One of the reasons that I advocate for either the revocation of tax-exempt status from private religious institutions that discriminate against LGBTQ+ students or the enforcement of Title IX (over claimed “religious exemptions” by those institutions) is that tax-exempt status and government funding should be considered a privilege, not an automatic and irrevocable guarantee. Clearly, charitable tax-exempt status was originally intended to protect the money collected by charities from being reduced through government taxation, thereby increasing the amount of good that a not-for-profit organization may do with it. However, in the modern era, tax-exempt 501(c)(3) status organizations have grown to incredible sizes, with private religious institutions reporting endowments topping $1 billion.⁸⁵ These institutions are able to avoid enormous tax bills through the privilege of tax-exempt status, which is now practically automatic—especially when you combine the status as an educational institution with the almost-untouchable status as a religious institution. Free exercise absolutists in the United States have begun to argue that religious organizations should be completely free from any scrutiny by the government, lest the government be considered to be interfering in religious affairs that it ought not be involving itself in. However, there is a difference between restricting free exercise (through banning a practice or criminally punishing those who engage in a practice) and simply withholding a privilege from those who have proven themselves unworthy of receiving American citizens’ hard-earned tax dollars. The Court made this clear in its holding in the Bob Jones University case, in which a religious institution was stripped of the privilege of tax-exempt status because of its refusal to obey universally applicable civil rights anti-discrimination laws. The Court did not force BJU to integrate or to change its policies on interracial marriage, actions which would be more constitutionally suspect as infringing on the university’s religious freedom. Indeed, the Court did not approve the use of a “stick” as a punishment; rather the Court approved the use of a “carrot” as an incentive. The solution advocated for in this Note is of the same fundamental nature, and thus should pass constitutional muster for the same reasons. Any view that would characterize the Court’s holding as infringing on BJU’s freedom to exercise its religious beliefs is unnecessarily absolutist in nature and sets a far different trajectory for First Amendment jurisprudence than I believe was intended or is practical. The First Amendment to the Constitution is deservedly revered for its guarantee that the free exercise of religion may be protected from government interference, harassment, or persecution; however, it should be correctly interpreted as conferring a negative right (the right to be free from persecution) rather than a positive right (the right to guaranteed access to tax dollars and exemption from taxation).

I have mentioned more than once the practical difficulties of enforcing Title IX over claimed religious exemptions, even of conducting any investigation at all into allegations of misconduct. There are also practical difficulties involved in the revocation of the tax-exempt status of private religious universities that are often wealthy, powerful, and politically well-connected.⁸⁶ Thus, I will briefly address a few solutions beyond what I have proposed as the ideal. For one thing, the recent decision in Bostock may have implications on how sex discrimination is interpreted by both the executive and judicial branches. If the executive branch adopts a definition of sex discrimination that is consistent with the Court’s definition in Bostock—especially if this is paired with public opinion that tilts the scales in favor of civil rights protections for LGBTQ+ people over absolute unchecked rights for religious organizations—this may pave the way for expanded protections. In March 2021, the Civil Rights Division of the U.S. Department of Justice issued a memo explaining the application of the decision in Bostock v. Clayton County to Title IX.⁸⁷ The memo references an executive order issued by the Biden administration—Executive Order 13988—that pairs well with the holding in Bostock, holding that “[a]ll persons should receive equal treatment under the law, no matter their gender identity or sexual orientation.”⁸⁸ The memo indicates that the Civil Rights Division has determined that “the best reading of Title IX’s prohibition on discrimination ‘on the basis of sex’ is that it includes discrimination on the basis of gender identity and sexual orientation.”⁸⁹ On its face, this seems to be a significant civil rights victory for the LGBTQ+ community, ensuring that Title IX includes robust protections for individuals in that community. However, one blatant roadblock stands in the way from this having made much of a measurable impact yet: the religious exemption to Title IX. This is a welcome policy interpretation overall—protecting students at a great number of colleges throughout the United States that are not religiously affiliated; however, given that the religious exemption is so robust and the process so lacking in oversight, even the aforementioned change in how Title IX is interpreted does not protect minority students at private religious institutions, where students are most likely to encounter discriminatory treatment.

Another potential respite for LGBTQ+ students at private religious institutions may be the Equality Act, which “prohibits discrimination based on sex, sexual orientation, and gender identity in areas including public accommodations and facilities [and] education.”⁹⁰ It does so by expanding the definition of “public accommodations,” authorizing the Department of Justice to intervene in equal protection matters in federal court that relate to sexual orientation or gender identity, and amending the Civil Rights Act to include “sex, sexual orientation, and gender identity” in the prohibited categories of discrimination.⁹¹ Notably, the Act explicitly states that it trumps the Religious Freedom Restoration Act (“RFRA”), meaning that an individual or institution sued for discrimination under the Equality Act would be unable to rely on RFRA as a defense. As the bill currently stands, it may provide a cause of action for students; the Religious Education Accountability Project endorses it, stating that it “ensures strong protections for LGBTQ students attending religious colleges—ensuring that no institution is permitted to claim religious exemptions in order to discriminate against its LGBTQ students while still receiving taxpayer money.”⁹² The measure passed in the House of Representatives in February 2021, but has yet to be taken up in the Senate. It faces strong opposition from absolutist proponents of religious liberty, who have even proposed language be inserted into the Act that would explicitly carve out another religious exemption for religious colleges and universities.

Another possibility is private enforcement by large associations or organizations that these private religious institutions are members of and rely on. For example, the National Collegiate Athletic Association (“NCAA”) wields extensive power among colleges that want to participate in competitive athletics—as do the individual conferences that the schools belong to. The Pac-10, a major athletic conference that includes several universities on the west coast, has overlooked Brigham Young University, a private university affiliated with the Church of Jesus Christ of Latter-day Saints, in a number of league expansions over the past few decades. Reportedly, this is because BYU is seen as “not a good cultural fit” for the conference.⁹³ Effective in 2023, BYU will be admitted to the Big 12 conference, a move that attracted harsh criticism from groups like Athlete Ally, which released a statement saying that “acceptance to an athletic conference is an honor and privilege, and . . . there should be standards of equality and inclusion that schools must meet to be included.”⁹⁴ Pressure from the NCAA or athletic conferences to adopt non-discriminatory policies may be an attractive option, given that there would be much less possibility of a religious freedom claim when the action is taken by a private association rather than the government. The First Amendment provides protection from government intervention, not absolute protection for religious groups against any hardship.

Finally, I would like to consider the likelihood of success for the aforementioned potential avenues of protection for LGBTQ+ students at private religious institutions. It has been a somewhat encouraging development that the Department of Justice has demonstrated a recent willingness to initiate investigations into claims of civil rights violations against LGBTQ+ students. As I mentioned above, in 2021, the DOJ announced a somewhat unprecedented investigation into BYU. However, this enforcement mechanism may not have any teeth after all because the investigation was subsequently dropped when BYU asserted its religious exemption based on relevant religious tenets consistent with its affiliation with the Church of Jesus Christ of Latter-day Saints.⁹⁵ It would surely be notable if the DOJ thoroughly investigated colleges for allegedly “over-extending” their exemptions, actually engaging in sufficient fact-finding and being willing to flex their enforcement muscles. It would be quite a development if these investigations were able to turn up anything substantial—and even more so if the Biden administration’s justice department categorically revoked the exemptions.

CONCLUSION

In this Note, I have considered the practicality and effectiveness of the argument that it is constitutionally impermissible to grant tax-exempt status and distribute any government funding to private educational institutions that engage in discrimination against LGBTQ+ students. I have concluded that the approach taken by the plaintiffs in Hunter v. Department of Education is unlikely to be successful. It is important to remain practical: a bright line rule consistent with this position would likely be impossible to implement, especially in the current political environment. The Hunter v. Department of Education lawsuit is still in the early stages of litigation; though it represents the best opportunity thus far presented in federal court, it is not a guaranteed win. Recently, a very unwelcome development spells trouble for the plaintiffs and the LGBTQ+ students they represent: the court ordered that the Department of Justice, over its objections and assurances that it would be able to effectively defend the suit itself, will be joined by intervening parties in the defense of the religious exemption to Title IX. Three Christian universities—Western Baptist University, William Jessup University, and Phoenix Seminary—along with the Council for Christian Colleges & Universities (“CCCU”) sought to intervene in the lawsuit. In the filing, CCCU adopts sweeping and broad language that the DOJ may be unlikely to adopt itself—that “the Title IX exemption is constitutionally required.”⁹⁶ On October 8, 2021, the court issued an order allowing this intervention and therefore opening up the suit to the much more hard-lined and sweeping rhetoric of the intervenors. There is some chance of victory—albeit small—for the plaintiffs at the lower court level. However, the chances of victory would wane even more if the case were to be elevated to the Supreme Court; I do not see a path to victory for the plaintiffs in front of the current conservative-supermajority Court.

It is noteworthy that the first time the scope of the religious exemption to Title IX was adjudicated, the court ruled against the civil rights of LGBTQ+ students—in favor of the free exercise rights of religious institutions. In Maxon v. Fuller Theological Seminary, plaintiffs brought a Title IX case against Fuller Theological Seminary because they were expelled for violating “school policies against same-sex marriage and extramarital sexual activity.”⁹⁷ In November 2019, a motion to dismiss was granted in federal district court, as the court held that the religious exemption to Title IX was valid and applied in the case. Although this is a discouraging step, this was only a district court, and the Supreme Court has yet to issue a final authoritative word on the issue.

97 S. Cal. L. Rev. 737

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Sydney Smith*

* J.D., University of Southern California Gould School of Law, 2024. B.A., Bowdoin College, 2019.

Miss-Stake by IRS: Proof-of-Stake’s Underinclusive Regulatory Guidance

June 2024June 2024Jack H. Duncan*

Death and taxes are the two certainties of life, and for some, the former may be more conceptually pleasant than the latter. To allay some of that unpleasantness, this Note uses the IRS’s guidance (or lack thereof) on the taxation of new types of digital currencies to provide a basic conceptual understanding of how tax law is formed. “Staking rewards,” which is income derived from new types of digital currencies, have sparked debate over when it should be taxed. However, such ambiguity has failed to elicit a clear response from the IRS.

It is understandable why this area of law feels convoluted to many. Unlike other disciplines, tax law is not judge-made law. Therefore, tax law often lacks clear natural-language holdings from case law. Instead, it is applied either statutorily (under the Internal Revenue Code) or administratively (through regulations, notices, and letters from the IRS). This Note illustrates that in many instances, our tax system is not as convoluted or ambiguous as it is appears.

This Note looks at the IRS’s non-response up until the Revenue Ruling on July 31, 2023, to argue that such silence regarding income from staking rewards was not only deliberate but also necessary, at least during that time. This argument analyzes the taxation of staking rewards in three parts. Part I explains the background and mechanics of staking rewards and how those traits factor into questions of how it should be taxed. Scholarship on taxing staking rewards is growing yet scarce, and typically published either by advocates or adversaries of digital currencies. Accordingly, Part I of this Note also provides a consolidation of arguments and analyses from both sides of the debate. Part II outlines what is left unclear by the Internal Revenue Code, the IRS, and case law. Part III explains what the IRS had ruled up until the recent Revenue Ruling, and what guidance may be expected to follow. Here, in Part III, is this Note’s novel contribution. Part III uses the debate on staking rewards as a lens to justify non-guidance by the IRS to balance the risk of stifling innovation in new technology sectors and avoid commitment to “unfair” tax guidance. These considerations draw on tort law to illustrate the need to allow for development of a sufficient “background of experience” before regulating developing technology into the ground.

INTRODUCTION

Digital assets, cryptocurrency, and blockchain are areas of rapid growth in the legal field and are consequently raising new questions about their legal and tax implications and treatments. The Internal Revenue Service (“IRS”) has provided some guidance on the taxation of a few mechanisms, such as proof-of-work (“PoW”), Mining, Hard Forks, and transfers to investors and service providers.¹

plus.lexis.com/document/openwebdocview/Tax-and-Accounting-Aspects-of-Virtual-Currency/?pddoc
fullpath=%2Fshared%2Fdocument%2Fanalytical-materials%2Furn%3AcontentItem%3A62PH-S571-JB7K-23MY-00000-00&pdcomponentid=500749&pdmfid=1530671&crid=eac337b2-6033-4b53-ad74-f9b9a36ae1f0 [https://perma.cc/46NG-ESGP] (last updated Nov. 30, 2023). However, newer applications to blockchain systems, namely proof-of-stake (“PoS”) consensus mechanisms, have highlighted the ambiguities in the existing guidelines. This Note will address two main questions: first, what are the different ways a statutory analysis may qualify the timing and character of staking rewards as assets or income, and second, whether and how the IRS may choose to provide guidance for interpreting and applying the Internal Revenue Code (the “Code”). This Note will only provide a high-level, normative assessment of what “should” be the approach to taxation of staking rewards. It will serve as a roadmap by compiling and interpreting the (limited) guiding authority that has been obscured for a variety of reasons, including writing on the topic, which is primarily the conjecture of staking advocates and cryptocurrency skeptics. This roadmap will explain why Congress and the IRS had, for so long, declined to clarify their intentions to regulate and interpret the reporting requirements of staking rewards, with a focus on why such ambiguity was and is justified for the developing nature of digital currencies under our tax system. More broadly, this Note should be used to understand how and why the IRS finally issued Revenue Ruling 2023-14 on July 31, 2023 stating its opinion that staking rewards should be taxed at receipt.² While there are some arguments that the recent ruling does not necessarily impose tax on all staking rewards, it is premature to explore such edge cases before the IRS’s opinion (which is not binding on courts) is interpreted by a court.³

I. BACKGROUND

A. What Is a Blockchain?

Another more descriptive name for blockchains is “distributed ledgers.” Information is shared among participants on the blockchain (“purveyors”), and transactions are constantly appended to the ledger, and then redistributed to users. Once a majority of those users agree that the new ledger is valid, it becomes the standard for all future transactions. The utility of the blockchain is that every user is incentivized to republish only validated ledgers because to publish an invalid ledger would conflict with the “distributed” version propagated by all the other users and cause the party publishing the invalid ledger to lose credibility and consequently, lose the ability to record its own transactions on the ledger.

If the utility of organizing data like this is not immediately clear, consider a typical property law topic: recording acts. Different jurisdictions have different ramifications for failure to properly record, or check the recording of, a real estate transaction in indices that are maintained by a county clerk. So, prompt recording and diligent record checking are important (but sometimes insufficient) to prevent title disputes in land transactions. For example, imagine purchasers A and B are both interested in purchasing Blackacre from seller X, in a state with a “notice” recording act. Here, A purchases Blackacre from X in year 1, and B “purchases” Blackacre from X in year 2 and records the deed of sale on the same day (before A had recorded her deed). So long as B is a bona fide purchaser, and she did not have notice of A’s transaction, her claim to the property would prevail. Blockchain systems are designed to solve exactly this type of problem. Through use of a “consensus mechanism,” each subsequent transaction is validated before it is added to the ledger, which maintains the integrity of frequently updated data sets. Had Blackacre’s state used such a consensus mechanism, the automatic validation of A’s transaction would generate notice to other buyers like B, not only cementing A’s deed, but also saving B from accidentally buying Blackacre from an unscrupulous seller. This illustrates how seamlessly this kind of technology can promote fair function of law without any change needed to our laws or regulations. While some people are still skeptical of “new blockchain applications,” in 2018, Burlington, Vermont, contracted with a blockchain startup, “Propy,” to provide exactly this kind of blockchain-supported recordkeeping for the County’s recording of land transactions.⁴

B. What Are Consensus Mechanisms and Staking Rewards?

A consensus mechanism is the way in which a blockchain validates transactions of cryptocurrency; the validation itself is carried out through cryptography (encryption or decryption).⁵

//perma.cc/F4DK-V9EK]. Consensus mechanisms used are either PoW or PoS. PoW is the older mechanism (launched by technologies like Bitcoin), which is why it is more familiar to the IRS. PoS mechanisms are newer, and accordingly, enjoy much less tax guidance from the IRS, specifically with respect to “staking rewards” (discussed below). A PoS consensus mechanism expands its ledger and confirms transactions by selecting users to “verify that a transaction is legitimate and add it to the blockchain,” rather than have every user assess the accuracy of each newly published ledger.⁶ Those who verify transactions are called “validators,” which is a desirable role because validators who successfully confirm a transaction receive a reward in the blockchain’s native cryptocurrency—a staking reward.⁷ Prospective validators must “stake” some of their own native cryptocurrency (or cryptocurrency that has been “delegated” to them by “stakers”) as a form of collateral to ensure that they will not verify fraudulent transactions. However, should they “improperly validate bad or fraudulent data, they may lose some or all of their stake as a penalty.”⁸ Validators receive a fee in the native currency, called “gas,” which they will use to pay staking rewards to the participants who delegated/staked tokens to them.⁹ Network participants also hope to be selected as validators because they desire to support the good function of the blockchain.¹⁰ This type of “skin in the game” means that the larger a stake, the more likely the network is to deem the person as a provider of trustworthy consensus votes, increasing the chance that the person will be selected as a validator.¹¹ This mechanism causes the participants holding only a small amount of native currency to pool their coins or delegate them to a validator (rather than trying to be a validator themselves) and receive staking rewards in return on a pro rata basis, similar in some respects to a partnership.¹² Tokens received as staking rewards are not distributed from a preexisting fund. Instead, they are actually created through the validation.¹³ This may lead to novel and unique tax treatment based on ambiguities of asset character or uncertainties in the timing of their receipt or credit.¹⁴ After an explanation of income, this Note will outline some difficulties in applying traditional timing rules for inclusion of income to staking rewards.

C. How to Measure Income

Defining what is income is a chronic question in the world of tax law, and for purposes of this Note, it is necessary to understand how to measure and identify income before we can decide if/when such income is “taxable income.” The Haig-Simons definition of income is widely accepted and illustrative of a non-statutory measurement of income: “Personal income may be defined as the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and end of the period in question.”¹⁵ This broad definition of income is constructed to measure a person’s change in wealth (∆W) by comparing the inflow and outflow of their assets. For example, Consumer B has $10 of wages per week, $100 in savings (S), and every week his only consumption (C) is purchasing groceries. To illustrate, assume two scenarios: in scenario 1, he consumes $5 this week (increasing his savings by $5) and in scenario 2, he consumes $15 (decreasing his savings by $5). In both scenarios his income will be the same because he still received $10 of wages. To maintain equivalency of income, the Haig-Simon algebraic sum compensates for the different consumptions by factoring in B’s change in savings (∆S). In scenario 1, B was underbudget, so his change in savings (∆S) was +$5, but in scenario 2, B went overbudget, which required spending $5 of his savings, generating a negative change in savings of -$5. The variables for this income definition are change in wealth (∆W), consumption (C), and change in savings (∆S), which are related as the following equation dictates.

Going forward, the relevant variable for questions of income from staking rewards is the change in savings (∆S) because it is a broader model for income, representing a taxpayer’s purchasing power, rather than just net receipts.¹⁶

D. Unique Tax Nature of Staking Rewards

Two fundamental aspects of measuring income are tax-free recovery of capital and determining when income is sufficiently concrete such that it should be taxed.¹⁷ Here, “capital” is the amount invested in an asset, the “recovery” of which is not taxed at the asset’s “disposition.”¹⁸ The amount invested in an asset (“basis”) is typically determined to be the amount paid for the asset (“cost basis”).¹⁹ For example, if Investor X buys Z stock for $100 in year 1, and in year 2 it has a fair market value (“FMV”) of $200, X has then realized $100 in gain (the $200 FMV less the $100 cost basis); however, because Investor X did not sell the asset, that gain is not seen as sufficiently concrete, and she does not recognize any taxable income. If instead our tax system treated X as recognizing her amount realized (that is, even though she had not sold the Z stock), she would owe taxes on the full $100. Additionally, there would be another problem if the system taxed the full FMV of $200. X bought stock Z with “post-tax dollars,” money that had already been taxed when it was first received. Now she is being taxed on that same $100 again, despite such value not reflecting any real gain. Commissioner v. Glenshaw Glass defined the test for recognition of real gain under I.R.C. § 61 as “accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”²⁰ The previous focus on measurements of ∆S or purchasing power flows from the emphasis that the Glenshaw Glass test puts on accessions to wealth.

1. New Property

The fundamental reason that the taxation of staking rewards is unclear is because of the meaning of “recognition.” If X had sold the Z stock for dollars, it would be clear (1) that she had realized gain and (2) how to measure amount of gain. However, because she continues to hold Z stock, it is harder to determine if she has experienced an accretion to wealth and how much that accretion is.

Application of our tax system is not always limited to strict statutory interpretation. In such gaps of explicit authority, the spirit of the law assumes that what an unrelated buyer is willing to pay X for an asset is an adequate estimated valuation from which the appropriate tax effect may be calculated. However, applying this question to staking rewards is not as simple as merely determining the market value of the reward because the tokens received are “newly minted”; therefore, there is no purchase or sale, and no third-party source has given up any tokens—even though the number of tokens held by a given person has increased.²¹ That said, determining gain when a taxpayer receives assets without any purchase or sale (and therefore no cost basis) is not wholly uncharted waters in tax law. For example, § 1221(a)(3) of the Code specifically excludes certain “self-created” assets from the definition of capital assets.²² Further, analysis of the relevance of staking rewards being “new property” is explored later as part of the review of staking rewards as capital assets.

2. Dilutionary Effect

The “dilutionary” characteristic of staking rewards is a result of their status as “created property” and is one of the main factors current cryptocurrency tax guidance fails to address. Recall that staking rewards are distributed because PoS consensus mechanisms provide participants with the opportunity to maintain the network.²³ Additionally, because validators increase their frequency of opportunities to maintain the network by pledging more tokens, they are willing to pay staking rewards to participants who pledge tokens roughly proportionate to the size of each pledge.²⁴ This is where issues of dilution can arise.

Abraham Sutherland, a professor at the University of Virginia School of Law and legal advisor to the Proof of Stake Alliance, explains that the amount of “true gains and losses” for stakers depends on two variables: the “staking rate” and the “token creation rate.”²⁵ The staking rate represents what percent of a network’s total tokens are actively staked, and the token creation rate represents the rate that tokens are created on the network through other means.²⁶ Describing or creating useful models that account for the token creation rate is beyond the scope of this Note, so the following analyses will assume there is no alternative method of token production, setting the token production rate equal to zero. Sutherland goes on to illustrate that as the staking rate increases, the amount of true economic gain decreases.²⁷ So, when enough participants on the network receive staking rewards in proportion to their initial holdings, they may hold more tokens, but that will not be indicative of a relative increase to their purchasing power (which is another measurement of “income”). Imagine if tomorrow every person in the world had their net worth doubled; the inevitable parallel result would be that the price of goods and services would also double. That is a simplistic illustration of Sutherland’s models of true economic gain on PoS networks and how applying IRS guidance intended for PoW mining income will result in the overstatement of income.²⁸

Understanding dilution’s effect on income is easier through analogy to inflation. For such an analogy, it is helpful to apply a non-statutory definition (such as section 61 of the Code). Recall the Haig-Simons definition of income modeled by equation (1) below.²⁹

As explained above, tracking ∆S is necessary to ensure income correlates with purchasing power.³⁰ For example, consider Investor X, who purchases $100 of stock B when the constant, annual rate of inflation is 10%. Inflation in this case, is “a rise in prices, which can be translated as the decline of purchasing power over time.”³¹ This means that for B’s stock to maintain its same purchasing power it must appreciate at a rate equal to the inflation rate, which would require stock B’s value rise to $110 by year’s end.³² Assume that B’s value does go up by $10. That change in savings would result in $10 of income despite X having no “real” income (“true income” in dilution explanation above) because inflation raised the prices of everything by 10%.³³ This illustrates how effects of dilution and inflation can be similar. Despite reductions in purchasing power caused by inflationary effects, there is no exception to the requirement that all of a taxpayer’s nominal gains must be included in the year of receipt.³⁴ Dilution in the cryptocurrency context is similarly insufficient (by itself) to justify an exception from inclusion at receipt. It does, however, indicate a need for a better method of valuing the true economic income of taxpayers.³⁵

Another real-world analogue is the taxability of stock dividends. A stock dividend is simply a payment from a corporation to its shareholders in the form of additional shares.³⁶ Receipt of stock qualifies as an “accession to wealth” under the Glenshaw Glass rule and would typically be includable as section 61 income.³⁷ But that was not the case in Eisner v. Macomber, in which a stock dividend was issued to all shareholders in proportion to the number of shares owned.³⁸ The Supreme Court justified the lack of income because of the non-change in positions of the corporation and the shareholders, based on the fact that the corporation’s “property [was] not diminished, and . . . . [t]he proportional interest of each shareholder remain[ed] the same.”³⁹

This stock dividend is similar to dilution, which is why it is cited by some staking advocates. There are, however, two differences between the dilution effects and the stock dividends in Macomber. First, the distribution was pro rata, exactly proportional to the recipients’ holdings, and second, the distributed shares had a definite “source”: the corporation.⁴⁰

First, staking rewards were only distributed exactly pro rata in the above hypothetical where the staking rate was 100% and every participant either received rewards for maintaining the network as a validator or delegated their tokens to a validator and received a pro rata share of that validator’s income. The Court in Macomber leaned heavily on the fact that the distribution was pro rata to show that the shareholder’s “interests [were] not increased.”⁴¹ The Court doubled down on the pro rata requirement for a stock dividend to be excluded from income in Koshland v. Helvering, in which the Court determined a stock dividend that “gives the stockholder an interest different from that which his former stock holding represented” is includable as income.⁴²

For the second issue, tax law generally does not always know what to do with an ambiguity, such as a lack of source, because it makes it harder to confirm that the tax consequences adequately follow the economic reality of a transaction.⁴³ Here, without a source like a donor or seller, there is nobody whose situation can be compared with the recipient. By confirming that the corporation’s “property [was] not diminished,” the Court illustrated that the corporation did not give up anything and reinforced the reasoning that a taxable event did not occur.⁴⁴

Proponents of preferential tax treatment for staking rewards point to the lack of source to support arguments varying from categorizing staking rewards as found property, created property, or even property entirely outside the scope of our tax system.⁴⁵ Conversely, opponents to preferential treatment for staking rewards point to the lack of source as an example of an ambiguity beyond the scope of reasonable speculation; the New York State Bar Association (“NYSBA”) even drafted a report requesting clear guidance to determine the source of the staking rewards.⁴⁶

Regarding staking income, the fact that the holder received additional tokens may not be determinative. In Macomber, the shareholder received additional stock from a “distribution,” which the Court qualified as essentially a stock split (a stock split is done by “splitting” outstanding shares that are in the hands of shareholders, which increases the stock issued while lowering the stock price in proportion to the number of shares into which each share was split).⁴⁷ Stock splits are analogous to staking rewards because neither have a source. Additionally, per I.R.C. § 305 (which partially codified Macomber), stock splits are not includable as income.⁴⁸ But for the difference that a stock split is virtually always exactly pro rata, Macomber and I.R.C. § 305 support the argument that staking rewards should not be included in taxable income at receipt.

3. Lack of Explicit Guidance

In 2014, the IRS issued IRB Notice 2014-21 (the “2014 Notice”), and, despite such Notices not being law or even binding authority,⁴⁹ it remains one of the most informative pieces of guidance on taxing cryptocurrency, due in part to the scarcity of any guidance at all.⁵⁰ The 2014 Notice determined that income from cryptocurrency “mining” was taxable; its applicability to the newer PoS and staking consensus mechanisms, however, is disputed.⁵¹ While some tax professionals believe that the differences between mining and staking are insignificant and assume the reasoning applied by the IRS to mining should also apply to staking, the IRS itself showed that it was not prepared to make that assumption in/after Jarrett v. United States, after successfully having the case dismissed as moot (such dismissal was affirmed on appeal this past July).⁵²

In Jarrett, taxpayers sued the IRS seeking a refund for taxes paid on staking rewards.⁵³ Not willing to offer a decisive ruling, the IRS decided to simply refund the taxes paid, and when the Jarretts declined the refund seeking a legal determination by forcing a case in federal court, the IRS (successfully) moved for dismissal for lack of subject-matter jurisdiction.⁵⁴ There are many possible reasons for the IRS’s refusal to provide clear guidance here; perhaps the IRS thought that an informed ruling was not yet possible because staking is too new, or the IRS could see material differences between mining and staking (mining requires computational “work” to receive mined tokens, which could liken it more to traditional income producing activities, while staking rewards are paid to holders who passively delegate their tokens to validators). This indeterminacy has split members of the tax and crypto community into two groups who disagree on the appropriate method of taxing staking rewards. The first group’s position, supported by the NYSBA, is that staking rewards should be immediately included as income.⁵⁵ The second group’s position, supported by groups like the Proof of Stake Alliance, is that taxes on staking rewards should be deferred until the disposition of the tokens.⁵⁶ The arguments of each of these groups are analyzed in Sections II.B and II.C.

II. WHAT HAS NOT YET BEEN DETERMINED

For PoS mechanisms, the two main questions regarding staking rewards are: (1) Character: What kind of income is it? and (2) Timing: When should it be taxed? The character analysis in this Note is only concerned with the effect capital asset status would have on the timing of inclusion in income.

A. Character: What Makes it Capital?

One of the main factors in determining the taxes one owes is determined by the “character” of the underlying asset/transaction that resulted in gain or loss of income. Generally, the character of gains and losses is either “ordinary” or “capital.” Capital gains/losses result from transactions in assets that were or are held for investment, with most other income being ordinary.⁵⁷ While asset character can be nuanced, the factors used to determine whether an asset is capital should be the same for digital assets and traditional assets.

Courts and the IRS have been resolving character determinations of digital currencies since well before the inception of blockchains and cryptocurrencies. The main example is litigation on the taxability of “miles” provided by airlines. In Charley v. Commissioner, the Ninth Circuit approved a tax deficiency assessed against a taxpayer due to his failure to report his receipt of airline miles as income. ⁵⁸ In this case, the court declined to comment on whether, “in the abstract” the receipt of airline credits was income, but the court did hold that here there was taxable income (that is, not capital gain) upon their redemption because the taxpayer (1) received the credits from his employer through his job, and (2) converted them to cash.⁵⁹ However, six years later, the IRS provided an announcement that taxpayers who fail to report frequent flyer miles received through their business would not be pursued for a deficiency.⁶⁰ This case and announcement illustrate the IRS’s familiarity with digital assets and its acknowledgment that determining the tax treatment of receiving digital assets is complicated. Unfortunately, it does not provide much guidance for staking rewards.

Whether an asset is capital or ordinary depends on multiple factors, like its intrinsic qualities, the nature of its use, and how it was acquired, among other factors.⁶¹ In the case of staking rewards, tax experts are unable to agree on a statutory determination under those factors for the character of staking rewards. Therefore, this Note first will look through a policy lens to assess whether staking rewards align with the justifications for preferential tax treatment of capital assets in the first place.

1. Policy Supporting Preferential Treatment Applied to Staking Rewards

When determining the character of new classes of assets, people seem to jump straight to the statutory analysis despite the lack of precedent for how courts and the IRS will apply the Code to that new class of assets. Here, the IRS is in fact likely waiting to assess the character of these assets to determine where the Code may be applicable and where it may require an update to accommodate the crypto sphere. Before analyzing the statutory application or inferring how new statutory language may mimic existing code, a step back to the policy level should be taken. This is important because in the past, the IRS has denied valid textual applications of the Code in favor of interpretations that it believed better carried out the intent of Congress.⁶² Generally, arguments in favor of preferential treatment of capital assets are grouped under “lock-in effect,” liquidity, bunching, inflation, double taxation, and investment incentives.⁶³

Crypto investments are subject to the lock-in effect, which is where a holder avoids selling an asset that has appreciated in value because the holder will recognize taxes on the realized gain at the time of disposition, sale, or exchange. This externality is a transaction cost, which may cause the asset to be held when it otherwise would have been disposed of, absent the imposed taxation. Taxing cryptocurrencies such that transactions that otherwise would have occurred are prevented reduces market efficiency by slowing the flow of assets to the holder who most values that asset. The lock-in effect is especially prevalent for assets (such as crypto) which taxpayers may hold longer than they would have absent tax incentives (such as stepped-up-basis, which allows the elimination of gains in appreciated property inherited from a decedent).⁶⁴

A justification for preferential treatment related to lock-in is the liquidity problem. A reduction in liquidity impairs the mobility of capital.⁶⁵ Liquidity is reduced when taxpayers realize gains on assets in excess of their income from other sources. For example, X has an income of $10,000 per year, and her most valuable asset is her house and the land it sits on, which are capital assets valued at $10,000. Absent preferential treatment for capital gains, if tomorrow some market force causes the fair market value of her home to jump to $100,000, she would owe taxes on $90,000 of appreciation. This would be consistent with the goal of tax law to track “accessions to wealth;” however, forcing taxpayers like X to satisfy her tax obligation by selling her home runs against the “efficiency” goals our tax system.⁶⁶ This treatment applies to assets like stock and securities too, and those same reasons also apply to crypto holdings.

“Bunching” is the recognition of lump sum gains all at once, which is the analogue to the lock-in effect. It results from the fact that we generally do not measure taxable gain “mark-to-market” (as value accrues), but rather only when the asset is sold. This means that gains accrued over many years may end up being recognized in a single year. In our progressive tax system, lower tax rates are applied to a taxpayer’s income up to a certain “bracket” threshold, after which a higher rate is applicable to each subsequent dollar earned. If instead, the gain was spread over a taxpayer’s holding period, they would normally enjoy the benefits of “running through the brackets” by having their first dollars earned each year enjoy the lower tax rates of the lower brackets. However, for a one time “lump” gain, the brackets are only “run through” once, and the excess gain is all taxed at the taxpayer’s marginal rate. The typical critique of this policy rationale is that bunching may not matter for most taxpayers, who already “run through the brackets” each year from other income. However, there is insufficient data on the average wealth of crypto investors, and accordingly, it is unclear if there is a need to counteract the bunching effect. Data is lacking because a feature of blockchains is the protection of anonymity. This illustrates potential support for delaying determinations about asset character until the IRS and Congress have sufficient information to inform their legislation.

Inflation (which this Note acknowledges above in Section I.D.2, does not warrant other tax benefits such as deferred reporting) is a concern for investment income across the board (regardless of whether measured in crypto or government legal tender—“fiat”). Taxes are supposed to correlate with “accessions to wealth” experienced by taxpayers. During times of inflation, an investor may see the nominal value of her assets rise, but not any faster than the costs of other goods did. This lack of “real economic gain” is why our tax system attempts to (partially) correct for taxing income that does not represent an accession to wealth. The two main ways our tax system addresses these issues are (1) by correlating (“indexing”) tax brackets to inflation⁶⁷ and (2) by allowing preferential treatment on gains prone to reflect inflation. Crypto investments can face inflation just like fiat investments, and it is a particularly tricky question to answer for staking income. As mentioned above in Section I.B, PoS consensus mechanisms impose “gas” fees (paid in additional native coins) to process the validation. Depending on the cost of the gas relative to the staking reward, some exchanges may be more inflationary, and others may even be deflationary. If staking rewards cause inflation in their markets, that may further suggest that their nature warrants preferential tax treatment because they are prone to growth without an accession to wealth.⁶⁸

One of the most established reasons given in support of preferential treatment for capital assets is that it incentivizes investment, which in turn promotes economic development. While there is still some skepticism on the merit of cryptocurrencies, taxes should not control investment in this sphere. An “efficient” tax system is not supposed to excessively alter the behavior of taxpayers or harm the good function of our free market.⁶⁹ Accordingly, tax incentives to invest in cryptocurrencies may be justifiable if there are substantial benefits derived from the development of cryptocurrencies, blockchain technologies like “web3,”⁷⁰ or other future applications. It is in that way that investment in this sector is akin to traditional investing. Evidence of Congress’s concern that the potential benefits of capital asset treatment for cryptocurrencies could be lost by improper regulation is shown in a letter from members of Congress to Treasury Secretary Janet Yellen.

Digital assets could be impactful technological developments in certain sectors, and clear guidelines on tax reporting requirements will be important to those in this ecosystem. It will be important that we continue to work to provide further clarity, and to help ensure that the United States remains a global leader in financial innovation and development, while ensuring that this technology does not become a vector for illicit finance, tax evasion, or other criminal activity.⁷¹

Ultimately, taxes are imposed to sustain the federal government’s budget. The Treasury would obviously like to have as large a fund as it needs; however, increasing the government’s tax revenue is not as simple as raising taxes on taxpayers. At a certain point, excessive taxes will result in reasonable taxpayers opting to engage in different activities because the tax burden of the activity will have exceeded the benefit of that activity. To illustrate this kind of “tax elasticity,” imagine two taxpayers, A and B. A lives in State Y and B lives in State Z, but otherwise, they are identical, working the same job, and paying 30% of their income in taxes. If tomorrow, State Z decides to raise the tax rate for B’s profession by 60%, a likely result would be that B would decide to move to State Y, where she may enjoy the better tax treatment that A has.

In this (exceptionally oversimplified) hypothetical, State Z raised taxes to pad its budget, but instead, it lost a source of taxable income by causing B to move to Y (think Cayman Islands). This concept is illustrated by economist Dr. Arthur Laffer’s “revenue maximizing rate,” which is the theoretical ideal rate of taxation to apply that will be as large as possible, without being so excessive that whatever action the tax is targeting begins to be avoided by taxpayers.⁷² Economists and tax professionals argue over what rate for capital gains would maximize revenue. However, there is a consensus that at some point, a marginal increase in tax rates will not raise the tax revenue to the Treasury. The key for taxing cryptocurrency, then, is to find that point.

Cryptocurrency investment has seen expansive growth and adoption, with many sources, including Coinbase, creating expectations among purveyors, without clear factual support, that growth to their assets will qualify as capital gains.⁷³ Perhaps a factor in causing this: 75% of Americans who invested in cryptocurrency indicated that they invested in cryptocurrency because they think “it is a good way to make money.”⁷⁴ If so, many people are choosing to invest based on expectations on their return, and such purveyors may be very sensitive to tax burdens reducing their returns on investment. So, explicit removal of preferential treatment, even only in part, may result in an outsized withdrawal from the crypto sphere.

While typically an argument in favor of giving preferential treatment to certain capital gains, “double taxation” does not support such treatment for staking rewards. Double taxation occurs in the corporate setting. Companies are taxed on their profits, and then may distribute a portion of those profits to shareholders as “capital outlays” (like stock or dividends). These capital outlays are then included as taxable income for the shareholders. Because the “same” income is taxed twice, here, some argue that shareholders/corporations should enjoy a lower tax rate on their receipts. Staking rewards are not taxed prior to the receipt of the validator, however, because they are not derived from a corporation’s profits. In short, one of the reasons relied on to justify preferential treatment for capital gains on financial instruments, such as stock, is not applicable to staking rewards. However, as is the case for other capital gains (such as dispositions of real property), double taxation is not a requirement to receive capital gain preferential treatment.

2. Statutory Determination of Capital Assets: Quality, Use, and Receipt

The following high-level statutory analysis is only intended to provide context for the inclusion of income analysis. The fundamental statutory authority on the matter is I.R.C. § 1221, with most character determinations starting or ending in § 1221(a), which lists assets that would otherwise be capital assets (“§ 1221 exceptions”).⁷⁵ The main § 1221 exception that might apply to staking income is § 1221(a)(3), which covers self-created property (generally, self-created property is not taxed until it is sold, but at that point, it is taxed as ordinary income—with certain exceptions).⁷⁶ Despite validators “making” rewards, some staking advocates argue that like the comparison to “new property,” this analogy is not applicable to the Code, which excludes from capital asset status any “patent, invention, model or design (whether or not patented), a secret formula or process, a copyright, . . . or similar property” held by “a taxpayer whose personal efforts created such property.”⁷⁷ The argument that the § 1221(a)(3) exception does not apply relies on the conclusion that staking rewards do not qualify as any of the explicitly listed property, nor would it qualify as “similar.”⁷⁸ The self-created property argument often analogizes a farmer’s crop or a mineral miner’s ore.⁷⁹ While these arguments can be pursued under a capital asset determination, this Note will not try to resolve disputes that tax experts have so far failed to resolve. Instead, this Note will revisit these arguments⁸⁰ to illustrate the different methods for tax accounting as that question is more aligned with the timing of inclusion for staking rewards.

B. Timing: When Is it Income?

Tax planning is a timing game of “pulling” benefits (like accelerating loss recognition) and “pushing” burdens (conversely, deferring gain recognition).⁸¹ This shifting of tax benefits and burdens can yield great value to a taxpayer, which is why taxpayers and the Treasury are so keen to determine when taxable gain/loss is recognized. Due to the time value of money, taxpayers derive benefit from pushing/deferring tax burdens, essentially getting the equivalent of an interest-free loan from the government.⁸² Reciprocally, deferrals taken by taxpayers reduce the government’s tax revenue, and such “tax expenditures” by the Treasury can sum to substantial burdens in funding the government.⁸³ The Treasury seeks timely and consistent payment of taxes to maintain its budget, which is why the Treasury may not want to grant tax-timing benefits like permitting stakers to defer inclusion of their income (that is, until they sell the newly received tokens).⁸⁴ This is further developed below in the context of tax accounting methods. Notwithstanding the time value of tax deferral, timing considerations (when a receipt should be taxed) are also important to ensure that taxes owed correlate to the taxpayer’s “ability to pay,” which is one of the main characteristics of a just tax.⁸⁵

Tax accounting is the method used by taxpayers to determine when receipts should be included for the purpose of “clearly reflect[ing] income.”⁸⁶ The two main methods of accounting for income are the “cash method,” which includes income at receipt, and the “accrual method,” which includes income at the time it was earned.⁸⁷ Deference is given to taxpayers to select their method of tax accounting.⁸⁸ Accordingly, most analyses of staking income apply the cash method, rather than the accrual method, because stakers have an easier time arguing the doctrine of constructive receipt than arguing that they never even nominally received the actual reward when new tokens were actually credited to their wallet.⁸⁹

The constructive receipt doctrine is used by stakers to argue that the amount received is an overstatement of their true economic income. Additionally, there may be grounds for a reduction in the amount of includable income based on the “cash equivalence doctrine,” which was added as a factor for determining constructive receipt. Constructive receipt is relevant because it requires an actual receipt of property or the right to receive property in the future.⁹⁰ When receipts, like staking rewards, lack sufficient determinacy as to what the “cash equivalent” is, an additional test may be applied to assess the kind of “economic benefit” received.⁹¹ Economic benefit can be a source of debate because “[a]lthough the courts are uniform in holding that a ‘cash equivalent’ is taxable on receipt, there is disagreement as to what types of property interests are cash equivalents.”⁹² So, a takeaway from this source of debate is that even though there may not be satisfactory legislation to inform stakers on when to include income, there are policy arguments that staking income should not be taxed on receipt. On the other hand, the failure of these accounting doctrines to produce a clear answer of when staking income must be included has supported arguments that immediate taxation is appropriate (such as the NYSBA’s suggestion that we should apply imperfect guidance like the 2014 Notice to staking income, even though staking income was not considered by the Notice at its time of announcement).⁹³

An investment vehicle similarly subject to a timing of receipt analysis is the taxation of Simple Agreements for Future Equity (“SAFEs”).⁹⁴ SAFEs are relevant because they are investment mechanisms promising to return some amount of stock to be determined at a future triggering event.⁹⁵ The IRS has ruled that SAFEs, which do not specify a “substantially fixed amount of property” are not “forward contract[s]” and therefore do not satisfy the requirements of a constructive sale, nor is their conversion into preferred stock a taxable event.⁹⁶ Simply put, SAFEs are an example of how the IRS and the Code have previously distinguished actual receipt of rights to property from constructive receipt of value.

C. Taxable at Time of Receipt

The IRS could resolve this issue by ruling that staking rewards will be treated the same way as mining rewards, taxing the rewards as gain at the time of receipt. This resolution would be easy to manage for the government and is justifiable because staking rewards appear to be income because the taxpayer actually received additional tokens. This is the position of the NYSBA, which argued in a 2022 report that there is not a significant difference between staking rewards and mining rewards (which the IRS has said is includable as gross income at receipt).⁹⁷ However, the NYSBA did acknowledge that this is an area lacking regulation and that “[t]he government should provide specific guidance clarifying that staking rewards should be includable as gross income when received at their fair market value at such time.”⁹⁸

1. Support for Taxation at Receipt

Taxation upon receipt would simplify the issue by bifurcating the timing and character determinations. Taxing the rewards at receipt may further simplify the determination of tax liability because without satisfaction of the § 1222 one-year holding period requirement, the gain would be taxed at ordinary rates whether or not the asset is a capital asset.⁹⁹ There may be a future need to determine the character for a later disposition, but having already been taxed at receipt, the issue of basis determination will presumably have been resolved—allowing the established rules of capital asset character determination to apply.¹⁰⁰ Lastly, this may be a palatable answer if legislators or the IRS are worried about tax evasion. The realization requirement is one of the greatest tax planning tools and by ruling that realization of income from staking rewards occurs immediately, the staker/validator would have no ability to manipulate the timing of tax liabilities to her benefit.¹⁰¹ This plan also helps the Treasury by providing tax revenues earlier, which is the preference of the government because of the time value of money.

D. Taxable at Time of Disposition

A key difference between crypto exchanges and fiat exchanges is that the market never “closes” for crypto currencies. Knowing the prices of stocks at the moment of receipt can be important for determining a purchaser’s cost basis, and that is possible because they are listed on nationally regulated exchanges.¹⁰² This may seem unimportant because cost basis (in the most basic case) is set at the amount an investor paid for the asset. However, while that is the most familiar scenario for assets on a secondary market like the New York Stock Exchange or NASDAQ, staking rewards (like stock dividends) are different because they are comprised of freshly “minted” coins, which were actually created by the staking process.¹⁰³ Lacking a bona fide sale or purchase, our tax system must apply some other way to assess the reward’s fair market value, potentially even by deferring taxation until there is a disposition that makes the value clear. This raises logistical questions like whether an asset’s value should be some average of each crypto exchange’s sale price measured at the precise instant of sale. Assuming stakers would even be able to determine and track such information across hundreds of transactions, what kind of administrative practicality could the IRS hope to enforce in an audit? The speculative nature of a solution like exchange price averaging shows the lack of clear solutions without a better understanding of the scope of the problem at hand.

1. Support for Taxation at Disposition

Immediate taxation of staking rewards generally benefits the government at the expense of taxpayers and the crypto industry. There are three main issues with this approach: (1) liquidity of taxpayers, (2) difficulty in valuation resulting in overstatement of income, and (3) the magnitude of the burden imposed by guidance.

First, the liquidity issue (defined above in Section II.A.1) is particularly problematic. Even if the IRS rules that staking rewards are recognized immediately, the taxpayer will not be able to use that income to satisfy her tax liability (because she cannot pay taxes with the cryptocurrency received). So, absent alternative income, she will not have the liquidity to pay her tax liability without selling her staked rewards immediately upon receipt.¹⁰⁴ The illustrative example of this problem is a farmer’s crop harvest.¹⁰⁵ In Schniers v. Commissioner, a cash basis farmer was found to have neither actually, nor constructively, received income until the sale of his raised cotton crop.¹⁰⁶ The tax court stated, in relevant part:

The point is that income is not realized by a cash basis farmer from merely harvesting his crops. He realizes income only when he actually or constructively receives income from the sale of those crops. He is not required to sell the crops in the year in which he harvests them. He may decide not to sell them until the following year.¹⁰⁷

However, proponents of immediate taxation compare staking rewards to Cesarini v. United States, in which the plaintiffs were deemed to have recognized income of cash found in a piano after they purchased it.¹⁰⁸ The flaw in this comparison is that the property creating income was actual cash, and while the court in Cesarini properly applied Regulation § 1.61-14, subsection (a) of that regulation stipulates that income from found property is includable “to the extent of its value in United States currency.”¹⁰⁹ And while staking rewards are not really “found property” to begin with, the importance of being able to determine an equivalent value in U.S. dollars creates a second problem with respect to immediate taxation of staking rewards: valuation difficulties.

The second issue, valuation, is driven by three factors. First, crypto exchanges are volatile and do not have closing prices. Second, there are dilutionary effects of the distribution of staking rewards (discussed above in Section I.D.2); and third, there is an excessive burden for taxpayers to document their rewards. Such difficulties illustrate a shortcoming of the NYSBA’s position that “staking rewards should be includable as gross income when received at their fair market value at such time.”¹¹⁰ Here, their suggestion takes for granted that the IRS can overcome the difficulty of determining fair market value in the first place. Additionally, there is no account for which of the multiple crypto exchanges (which often have different prices, unlike regulated stock markets) should be consulted for value determination, nor have they proposed a way to measure FMV factoring in dilution.¹¹¹

Finally, the third factor is one that should be carefully considered before presenting guidance on staking rewards. In assessing burdens, the IRS will want to consider the magnitude of that guidance’s impact, which is directly related to the number of taxpayers or size of industry that will be affected. For example, the IRS should be cautious of yielding to groups like the NYSBA, which argue that processes like mining and staking are so similar that mining guidance (like the 2014 Notice) also covers new forms of crypto income like staking rewards.¹¹² The NYSBA’s argument fails to account for the difference in magnitude of effect that would result from regulating mining and staking identically—the 2014 Notice affects so few taxpayers because miners make up a small percentage of PoW network participants.¹¹³ By contrast, the effect of applying this guidance to PoS networks, such as Tezos (the underlying asset in Jarrett), would have a much higher magnitude because around 70% of network participants actively stake, and would therefore be affected.¹¹⁴ This would compound the harm done by potentially imperfect legislation because it would be unjust to more taxpayers, possibly to the extent that the imposed compliance burden pushes people away from PoS networks.¹¹⁵ This raises three issues: compliance by stakers, administration by the IRS, and efficiency of the tax altogether.¹¹⁶ Sutherland uses the Jarrett case to illustrate the excessive burdens of compliance and administration if stakers were required to follow the 2014 Notice.¹¹⁷ Sutherland asserts that due to the frequency that staking rewards are distributed, even small stakers could have around 125 annual taxable events, each of which would need to be recorded for basis reporting purposes.¹¹⁸ He goes on to point out that administration would be practically infeasible too, as the IRS would need to pull excessive amounts of data to audit a staker.¹¹⁹

III. IRS RESPONSE

Tax law is typically seen as a discipline of well-defined and mechanical rules,¹²⁰ which is why the uncertainties of the application of the Code and the IRS’s legislative intent has generated confusion. Jarrett has become the (non)landmark case for exactly this type of uncertainty with respect to staking income.¹²¹

A. Governance So Far

The guidance provided prior to the recent Revenue Ruling was limited to the 2014 Notice,¹²² Revenue Ruling 2019-24 (with an accompanying FAQ) (“Rev. Rul. 2019”),¹²³ and expansion of I.R.C. § 6045.¹²⁴ These three pieces of guidance (hereinafter, the “Big Three”) do not make any mention of staking rewards or PoS networks, and only Revenue Ruling 2019-24 and § 6045 have the force of law.¹²⁵

com/terms/r/revenue-ruling.asp [https://perma.cc/SBM7-4FY9]. The review of gaps in guidance below is not exhaustive and is intended to illustrate the types of issues caused by inadequate guidance.

1. Ambiguities and Gaps in Guidance

In addition to not accounting for the implications of newer technology like PoS and staking rewards, much of the Big Three contains gaps and ambiguities resulting in variable interpretations. Section 6045 is particularly illustrative of this issue. This section’s recent updates (effective as of the start of 2024) primarily relate to the regulation of “digital assets” as securities and focus on transactions conducted by “brokers.”¹²⁶ The characterization of cryptocurrencies as securities is beyond the scope of this Note (and regardless, determination of a crypto currency as a security by the IRS is mostly independent from similar determinations by the SEC). However, § 6045 is still referenced by tax analyses.¹²⁷ Section 6045(g)(3)(D) defines a digital asset as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.”¹²⁸ Without any distinction of the consensus mechanism, token type, or validation method, it is likely that this definition of “digital asset” was drafted with the intent of bringing cryptocurrencies under the applicable securities regulations, not to inform appropriate methods of taxation in general. Section 6045(c)(1)(D) was also expanded to include as “brokers,” those responsible for “effectuating transfers of digital assets on behalf of another person.”¹²⁹ This section defines brokers in order to require them to report cost basis of exchanged digital assets.¹³⁰ Some tax professionals are concerned with this requirement because the textual definition of a broker may now include miners and stakers if their activities were considered as “effectuating transfers of digital assets.”¹³¹ In response to these concerns, Congress attempted to pass two poorly-formed and conflicting amendments to clarify that § 6045 should not be read to have that effect. Failing to pass either of them resulted in the drafters of the legislation writing a letter to Secretary Janet Yellen (quoted above in Section II.A.1).¹³² Review of such previous attempts to provide guidance can be incredibly informative, especially when viewed with a consideration of why they failed.¹³³

The interpretations of the 2014 Notice and Rev. Rul. 2019 that followed demonstrate the problems with attempting to interpret legislative intent with respect to an application that essentially did not exist at the time of drafting.¹³⁴ For example, the NYSBA points out in their report, the 2014 notice did not address whether virtual currencies fall under an existing asset class or are a new class of assets, which is necessary to apply the Code, further illustrative of the gaps of the 2014 Notice.¹³⁵

Lastly, Rev. Rul. 2019 does not cover staking rewards either; it covers income from “airdrop[s],” another type of token distribution, which follows something called a “hard fork.”¹³⁶ However, Rev. Rul. 2019 is still referenced in the staking argument because it applies a rigid requirement to include income at the time of receipt even if “the airdropped cryptocurrency is not immediately credited to the taxpayer’s account.”¹³⁷ Recall the analysis of the constructive receipt doctrine in Section II.B to see how this is a divergence from the general rule of including income “in the taxable year during which it is credited to his account.”¹³⁸

The IRS’s relative silence is understandable because any determination, announcement, or notice would fill the vacuum of existing authority and possibly assume greater weight than the IRS is prepared to put forth at this time. The motion to dismiss the Jarrett case, and avoidance of providing a ruling, illustrates the IRS’s reluctance to be “pinned down” in the future, and its desire to have taxpayers carry some of the uncertainty.¹³⁹ The question is what the intended purpose of this kind of uncertainty is, and whether it is effective in accomplishing that purpose.

B. The Importance of IRS Action or Inaction

At a certain point, absent guidance from the IRS, the development of blockchain and cryptocurrency industries may be shaped by a reliance on continued non-regulation, or at least an expectation that potential future regulation will not be overly burdensome (or will be prospective). Cryptocurrency has a checkered reputation among many skeptics, and stories like the collapse of the world’s second largest crypto-exchange, FTX, do not help with that image.¹⁴⁰ And while the collapse of FTX is an issue of securities regulation, rather than tax-specific regulation, its effects were still hugely impactful to the market for cryptocurrencies as a whole, which indicates the possibility that more legislators will be calling for new swaths of legislation soon.

1. Appropriate and Unavoidable Uncertainty in Tax

In practice, the IRS wants to let taxpayers carry some uncertainty, particularly when it comes to new legal ground.¹⁴¹ The IRS has good reason to avoid the creation of bright-line rules, especially in the case of emerging technologies. Taxpayers carrying uncertainty caused by a lack of regulation must act with a certain degree of reasonableness for fear of pushing the bounds of what is permissible too far. Once taxpayers know exactly when they trigger tax effects, they will often allow that limit to dictate their behavior, in some cases engaging in activities which they would not have done but for those tax effects. Take for example the annual gift tax exclusion. Each year, the IRS sets a limit on the size of a gift that one may make without paying taxes (for 2022 that amount was $16,000).¹⁴² A common practice among the wealthy is to gift their children this maximum amount each year.¹⁴³ Naturally, this tax benefit is disproportionately enjoyed by the wealthy, and is an example of how our system fosters generational wealth among the rich. This shows how even if the IRS determines a “limit” which it is okay with, such bright-line rules can cause taxpayers to let tax effects change their behavior, which may be an efficiency cost if that behavior is bad.¹⁴⁴

While clear guidance from Congress and the IRS may help address concerns that cryptocurrency transactions are underreported, such clear limits in tax law may cause taxpayers to try and game the system. This “gaming” can be particularly pernicious in the face of illogical or poorly planned rules. For example, consider the Cohan rule, which was intended to reduce the compliance burden of recording certain deductible expenditures by allowing taxpayers to approximate their total deductions.¹⁴⁵ Taxpayers realized that the lowered burden of compliance made it nearly impossible to audit the accuracy of their “approximations,” resulting in increased abuse of the rule; this resulted in the amendment of § 274(d), which closed this loophole by imposing substantiation rules (requiring taxpayers to maintain adequate records).¹⁴⁶ So, if Congress or the IRS present illogical rules, they risk opening opportunities for tax arbitrage.

Congress and the IRS must therefore weigh the need for regulation now against the risk of providing regulation without enough information to do so as thoughtfully as is necessary.

2. Risk of Stifling Innovation

Regardless of the public’s perception of cryptocurrency, it is a large part of web3, the next generation of the internet.¹⁴⁷ As the letter from members of Congress to Secretary Yellen shows, there is real reason/motivation to avoid inhibiting this development with poor regulation.¹⁴⁸ It is helpful to look outside of tax law to an area of law rich in considerations of how to balance regulation of new technology: tort law. For example, in Pokora v. Wabash Railway Co., Judge Cardozo limited another case, which required drivers to fully exit their vehicles to look down each side of a railroad before crossing, or else the drivers risked being found contributorily negligent if hit by a train.¹⁴⁹ In his ruling, Judge Cardozo explained the risk of arbitrary and uninformed rule making:

Illustrations such as these bear witness to the need for caution in framing standards of behavior that amount to rules of law. The need is the more urgent when there is no background of experience out of which the standards have emerged. They are then, not the natural flowerings of behavior in its customary forms, but rules artificially developed, and imposed from without.¹⁵⁰

While Judge Cardozo ruled with respect to railway accident tort law, his reasoning was truly premised on the fact that (at the time) railroads were new and disruptive technology in some respects. Requiring drivers to fully exit their vehicle was a burdensome and often ineffectual (as was the case for John Pokora, who followed the regulation and was still hit by a train.)¹⁵¹ Judge Cardozo’s reasoning was particularly sound, considering that trains were so fast that a perfectly compliant person, such as John Pokora, could still end up injured because a train could appear in the time it took a driver to turn around and reenter their car. Today, the clear answer is to retrofit crossings with gate arms that indicate when a driver may cross safely. At the time, such technology was not available. The point, however, is that prematurely creating rules that may have led to the public resenting the adoption of railways could have chilled the development of infrastructure that would inevitably become crucial to the economy of the United States. Regulations on cryptocurrencies and blockchains may have the same effect if those rules are not informed by a “background of experience,” which is still expanding.¹⁵² Previously advanced amendments have been conflicting, and sometimes, practically ineffective.¹⁵³ This implies that we may still be waiting for the “crossing-gate arm” that the crypto space needs. Now, if you are convinced that the utility of railroads seems greater than that of blockchain technology, refer to the legislators in Boston (now a hub of the tech industry) who decided that computer sales was too risky of a business and therefore barred the purchase of Apple stock by individuals in Massachusetts when the company went public in 1980.

In Boston, state regulators said the offering is too risky and barred sale of the shares in the Bay State.

The decision affects individual investors, but doesn’t extend to financial institutions, which are presumed to be sophisticated. . . .

Under the Massachusetts ruling, the Apple stock falls short of several provisions aimed at weeding out highfliers that don’t have solid earnings foundations.¹⁵⁴

Limiting regulation like Boston’s is especially frustrating when the opportunity was only withheld from individuals but not large entities, which is another illustration of the harm that may result from poorly informed regulation.

3. Other Concerns the Treasury and IRS Must Consider

In general, the IRS wants to be careful when outlining rules. Putting aside the obvious concerns of allowing tax planning avenues conducive of tax evasion, whenever a bright-line rule is put forth, tax planners will now have a hard limit on what is permissible, and therefore may act in ways that take their tax saving right up to the edge of what may be permitted by the IRS (recall Section III.B.1 detailing the abuse of the Cohan rule).¹⁵⁵ This is exactly why the IRS tends to prefer taxpayers carry some of the uncertainty, which requires taxpayers to plan more carefully, and often, more reasonably. A sequential point for the IRS and Treasury to consider is related to the potential for stifling invention discussed above. Taxing PoS participants like PoW miners could have a large negative impact on the viability of PoS networks. By overburdening PoS networks with taxes that may push more people to PoW networks, and because PoW networks consume much more energy than PoS networks, there may even be a negative environmental impact based on applied taxes, which had not been considered.¹⁵⁶

C. Possible Points of Reference for Predicting Future IRS Action

There have been a multitude of other possible interpretations not explored by this Note, which may form the basis for future action by the IRS. For instance, Sutherland examined the argument that tokens on a PoS network should be treated as interests in a partnership, where the tokens are just used as a way of “voting” how the network should be maintained.¹⁵⁷ If the IRS took that position, it would then be at least partially constrained by subsection K, the Code’s rules of partnership tax. It is also possible that the IRS will determine staking rewards are “new property,” warranting actual amendment of the Code. The “new property” argument is popular among staking advocates, and legal experts have already pointed out that the recent Revenue Ruling 2023-14 made no determination of whether or not staking rewards are “new property,” implying that the ruling may not cover every mode of receipt regarding staking rewards.¹⁵⁸ In any scenario, it is important to recognize that the IRS does not promulgate the Code; rather, it is “organized to carry out the responsibilities of the secretary of the Treasury under section 7801 of the Internal Revenue Code.”¹⁵⁹ Accordingly, before attempting to use past actions of the IRS to predict the trajectory of tax legislation over cryptocurrencies, one should remember that the IRS is not the legislating body (it only seems that way in the context of staking rewards due to the lack of actual legislation). As an arm of the government, it acts more like a computer, applying information to the Code and returning answers of “compliant” or “noncompliant.”

1. Determinations Based on All Facts and Circumstances

Deferral of explicit guidance on staking income is not to say that the IRS may not adopt flexible regulation as we wait for a sufficient background of experience to develop. There are plenty of instances in the Code of overbroad rules intended to apply where individualized review is needed, but providing such review would be too difficult administratively. One such code section, possibly informative of additional future action by the IRS (albeit substantively unrelated to staking rewards), is the “loose” rule of § 302 relating to stock redemptions when corporations repurchase stock from its shareholders.¹⁶⁰ Section 302 is “loose” in two ways: first, it sets an apparently arbitrary threshold of 80% on what constitutes “substantially disproportionate” with respect to reduction in voting control by a shareholder following a redemption.¹⁶¹ Second, the accompanying regulation § 1.302–3 requires that a “facts and circumstances” assessment should be used to smoke out any intent that indicates a “substantially disproportionate redemption.”¹⁶² The 80% threshold in § 302 seems “loose” for the lack of explanation of what materiality 80% holds. This implies that at one point the Treasury may have decided that precise measurements of control were too difficult to apply, so using a high precision test would not have resulted in a significantly more efficient application of the rule. Accordingly, it is not unreasonable to assume that the IRS could administer guidance similarly vague for staking rewards, which are incredibly burdensome to track as they stand. The second “looseness”—stemming from the facts and circumstances test in § 1.302-3—illustrates the Treasury’s willingness to apply flexible guidance that accounts for the unique aspects of different applications. In the face of calls for guidance, the Treasury may adopt similarly flexible approaches to staking rewards in an attempt to balance the importance of express rulings with its desire to avoid premature regulation.

CONCLUSION

Pressure on the IRS to provide guidance has waned after Revenue Ruling 2023-14, but there is still lingering uncertainty on the need for additional guidance,¹⁶³ and many possible solutions risk replacing current uncertainties with new ones. Therefore, the IRS should consider Judge Cardozo’s concerns on premature regulation by observing whether the effects of this Revenue Ruling indicate that this guidance waited for PoS networks to develop a sufficient “background of experience” with which the IRS was equipped to provide informed guidance.¹⁶⁴ Such retrospection by the IRS will be important for any further guidance down the track, else we risk “shutting down the railroad” just because we have yet to invent the crossing-gate arm.¹⁶⁵

97 S. Cal. L. Rev. 537

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Jack H. Duncan*

* Senior Submissions Editor, Southern California Law Review, Volume 97; J.D. Candidate 2024, University of Southern California Gould School of Law; B.S. Mechanical Engineering 2019, Tufts University. Thank you to my dad, John B. Duncan, and my academic success fellow, Tia Kerkhof, for each of their support. I would also like to thank Professor Edward McCaffery for his guidance. Finally, many thanks to all the Southern California Law Review members for their invaluable work on this Note.

Auditor Independence: Moving Toward Harmonization or Simplification?

June 2024June 2024Nikita Patel*

INTRODUCTION

Auditor independence has been a priority for the Securities and Exchange Commission (“SEC”) under the leadership of both the Trump Administration and the Biden Administration. In 2020, former SEC Chair, Jay Clayton, pointed out that in the United States “auditor independence rules are far-reaching and restrictive,” which could have “unintended, negative consequences.”¹ Shortly thereafter, the SEC issued new regulation that lowered auditor independence requirements and brought the SEC’s independence rules closer to the rules set forth by the Public Company Accounting Oversight Board (“PCAOB”) and American Institute of Certified Public Accountants (“AICPA”), the other two regulatory entities responsible for auditor independence.² Meanwhile, the current chair, Gary Gensler, has signaled that auditor independence remains a “perennial problem area,” indicating that a tightening of the auditor independence requirements is soon to be seen.³

While the future of auditor independence regulations remains up in the air, the problems associated with a lack of auditor independence continue. In 2019, the SEC alleged that PricewaterhouseCoopers LLP, one of the “Big Four” accounting firms, had violated auditor independence rules in connection with nineteen service engagements for fifteen publicly traded companies by providing prohibited non-audit services that could have impaired the firm’s objectivity.⁴ Non-audit services are ancillary services, such as reviews of accounting software or tax advice, that do not assist in the goal of auditing, which is reviewing the financial statements for fraud or error. The SEC also alleged that another Big Four accounting firm, Ernst & Young LLP, had violated auditor independence standards, along with one of its partners and two of its former partners.⁵ The Chief Accounting Officer for Ernst & Young’s client on this engagement was also allegedly involved with this misconduct, indicating how far-reaching auditor independence violations can be.⁶

Auditor independence is governed by a self-regulatory model, in which the SEC, in partnership with the PCAOB, the specialized non-profit corporation created by the Sarbanes-Oxley Act of 2002,⁷ provides oversight over the AICPA, which is a private industry professional organization charged with setting substantive auditor regulation. Despite the importance of auditor independence regulation in investor protection and the existence of this self-regulatory model, the regulatory framework in this area remains entangled.

While the SEC and PCAOB provide oversight over the AICPA, they also issue their own auditor independence regulation and have enforcement practices associated with auditors.⁸ Among the SEC, PCAOB, and AICPA, each standard-setter has rules that overlap with the others in the same subject-matter and some rules that defer to the rules set by the other organizations.⁹ This leads to a waterfall effect, in which all three entities have to change their regulations any time one of the other two does, in order to ensure that the rules are not in conflict.¹⁰ This effort has been called “harmonization,” and has the goal of ensuring that all regulatory frameworks in this area are made consistent with each other, to provide more certainty to the accounting firms and other stakeholders involved in audits, including public company boards of directors.¹¹ However, an alternative solution to harmonization may be “simplification,” in which instead of expending effort to harmonize the regulation of the three entities each time one of them makes a change, the existing self-regulatory model could be streamlined so that the AICPA is the primary or sole standard setter, with the SEC and PCAOB providing government oversight.

To explore whether simplification is a compelling alternative to harmonization, this paper turns to federal judicial decisions by conducting a novel case study of all auditor independence cases decided after the passage of the Sarbanes-Oxley Act of 2002. These decisions indicate that the courts largely use AICPA standards and case law requirements in assessing auditor independence, rather than SEC or PCAOB standards. This new finding suggests that simplification of the regulatory framework by relying solely on AICPA rulemaking is a viable solution, given that the federal courts already rely on AICPA rules.¹²

This paper will proceed as follows. First, Part I provides a brief summary of the business of public company audits to preview how the structure of the audit industry gives rise to unique incentivizes and pressures that may impact auditor independence. Next, Part II includes an overview of the impact of the Sarbanes-Oxley Act of 2002 on the audit industry and highlights the debate over auditor independence, including the ways that various stakeholders have argued whether auditor independence is a worthy goal, or if auditors’ role as gatekeepers is unnecessary. Thereafter, Part III provides an overview of the self-regulatory model that governs auditor regulation, as well as regulations promulgated by the SEC, PCAOB, and AICPA in the area of auditor independence, including a summary of recent efforts to harmonize the standards set by each entity. The core of the paper’s contribution to the literature on auditor independence regulation is in Part IV, which a presents a novel case study that examines which body of regulation, between the SEC, PCAOB, and AICPA, is preferred by the federal courts when determining whether there have been auditor independence violations. This leads to the key finding that, in determining whether auditor independence violations have occurred, the federal courts rely almost exclusively on AICPA standards and case law requirements developed by the courts, rather than SEC or PCAOB standards. Accordingly, the paper then briefly examines in Part V whether this finding indicates that rule-making authority should be consolidated by giving the AICPA authority to set substantive auditor independence regulation, with the SEC and PCAOB providing oversight, given that there is already a self-regulatory model in place. Put differently, the paper concludes by considering whether the three regulatory frameworks should be simplified into that of the AICPA, the standard setter that is the most comprehensive, and the one that has been most acknowledged by the courts.

I. THE BUSINESS OF PUBLIC COMPANY AUDITS

The role of auditors in public company financial reporting is to provide third-party reasonable assurance to investors that the financial statements of their client companies “are free of material misstatement, whether caused by error or fraud,” in the form of a formally issued audit opinion, which is appended to the clients’ public company SEC filings.¹³ Audit opinions state whether the auditor believes that the financial statements included in the filings are free, in all material respects, from error or fraud.

Generally, auditors are viewed as “gatekeepers,” meaning individuals who are “reputational intermediaries who provide verification and certification services to investors.”¹⁴ As gatekeepers, auditors have incentives to signal to outsiders that they are credible because their reputation of trustworthiness is what allows them to attract future clients and remain in business by giving credibility to their audit opinions.¹⁵ The reputation of auditors is also partially what enables them to provide verification services because investors recognize that auditors have fewer incentives than their clients’ management teams to mislead investors because the management teams are corporate insiders whereas auditors are objective third parties.¹⁶ A traditional understanding of the audit profession puts forth the proposition that auditors are trustworthy because they are not incentivized to risk their reputation by assisting one client with fraud, which could lose them many additional clients and destroy their reputational capital.¹⁷

Additionally, auditors have built up years of expertise that demonstrates to third parties that their services and opinions can be trusted.¹⁸ The utility of auditors extends from the fact that they have specialized technical expertise in the area of accounting. Members of accounting firms that conduct audits are generally expected to hold state licenses as Certified Public Accountants, which give them both reputational capital and technical expertise.¹⁹ Additionally, these accounting firms are typically well staffed with local and global teams to address the audit needs of multinational companies that are listed on exchanges in the United States, despite the complexity and geographical scope of the audit procedures that may be required.²⁰

It is widely known that auditing is part of an oligopoly, in which the “Big Four” accounting firms—PricewaterhouseCoopers LLP (“PwC”), Ernst & Young Global Limited (“Ernst & Young”), Deloitte Touche Tohmatsu Limited (“Deloitte”), and KPMG International Limited (“KPMG”)—dominate the market. The Big Four were responsible for the audits of 88% of SEC large accelerated filers—which are companies with a public float of larger than $700 million that are required by the SEC to submit securities filings on a shorter timeline than other filers—and 44.7% of all public companies in 2022.²¹ There are several smaller players in the market as well, including RSM US LLP, BDO USA LLP, and Grant Thornton LLP; however, the largest of these entities produces less than a third of the revenue produced by the smallest Big Four accounting firm, leaving the market substantially dominated by the Big Four accounting firms, which have offices globally.²²

Auditors for public companies are required to examine their clients’ financial statements and notes to the financial statements, which provide supplemental information. Auditors use a variety of mechanisms, including inspecting records, confirming balances with third parties, checking compliance with internal policies, and completing detailed tests of transactions to ensure the financial statements are free from material error or fraud.²³ Auditors also often test the robustness of management’s internal controls over financial reporting. Internal controls over financial reporting are policies and procedures surrounding accounting and reporting that are designed to limit the risk of fraud and error in the financial statements. All of this testing is done with an expectation of independence—that the auditors are not personally invested in the entity they are auditing, do not have conflicts of interests, and are reviewing the information with an air of “professional skepticism.”²⁴

II. THE DEBATE OVER AUDITOR INDEPENDENCE

When discussing auditor independence, much emphasis has been placed on the fact that each of the large public accounting firms have three lines of business: audit, tax, and consulting services. In the wake of the Enron scandal, debate over whether these three lines of business lead to inherent conflicts within public accounting firms that obstruct independence. Enron was a publicly traded energy company based in Texas that went bankrupt in 2001, partially as a result of a major decline in stock price after accounting irregularities were discovered at the company.²⁵ At the time, Enron was the seventh-largest company in the United States based on market capitalization, and its bankruptcy was the largest in United States history.²⁶ The accounting irregularities alleged were largely technical in nature, involving the use of (1) mark-to-market accounting, a practice that can lead to the overstatement of the value of assets by recording them at their current market value rather than their historical cost; (2) improper recognition of liabilities within “special purpose entities” that were owned by the company, which reduced the liabilities that were attributed to Enron; as well as (3) alleged improper payments to company officers, all of which were not in accordance with Generally Accepted Accounting Principles (“GAAP”) that are set by the AICPA and required to be followed by public companies.²⁷ Arthur Andersen LLP (“Arthur Andersen”), the public accounting firm responsible for Enron’s audit, did not, however, note any of these issues with GAAP in the audit opinions it issued about the accuracy of Enron’s financial statements, which led to surprise when the company collapsed.²⁸

In the wake of the Enron scandal, many stakeholders argued that one of the main contributing factors to Enron’s collapse was that the company’s auditor, Arthur Andersen, was receiving more revenue from its consulting engagement with Enron than it was from its audit engagement, to a factor of 1.08 times.²⁹ Arthur Andersen received approximately $27 million in annual non-audit fees and $25 million in annual audit fees from Enron in 2000 and expected to grow the overall fees to approximately $100 million annually, which some alleged was why Arthur Andersen did not disclose Enron’s lack of compliance with GAAP.³⁰ Arthur Andersen was exonerated of any liability; however, the court did not reach the issue of whether the firm was conflicted and what effect that may have had on the audit.³¹

Enron was used as an example of how pressure on accounting firms to maximize revenue from consulting engagements prevents accounting firms from robustly auditing financial statements. Primarily, stakeholders worried that accounting firms would fail to report material misstatements or fraud in financial statements in order to preserve relationships with management of the companies they were auditing or to sell them consulting services; in extreme cases such as Enron’s, the concern was that this failure to report could collapse the company entirely and thus completely eliminate a revenue-generating client.³²

The furor and fallout over Enron and implications on the weaknesses of accounting firms was used as a major justification for Congress’s passage of the Sarbanes-Oxley Act of 2002, given that investors lost billions upon Enron’s collapse.³³ Specifically, the social costs of the Enron collapse were high because pension funds that supported teachers, firefighters, and government employees were endangered from the losses, leading to outcries for reform.³⁴ William Donaldson, the SEC Chair during the time of the passage of Sarbanes-Oxley, testified before Congress that Enron was a major event leading to the reforms that were implemented in Sarbanes-Oxley.³⁵

Sarbanes-Oxley included sweeping regulatory changes designed, in part, to “restor[e] public confidence” in the accounting profession, emphasizing for the first time in Congressional legislation the importance of auditor independence.³⁶ The Act created the PCAOB to inspect accounting firms and set auditing regulations, departing from the prior regulatory structure in which the accounting profession was almost entirely self-regulated by the AICPA.³⁷ Sarbanes-Oxley also created a slew of additional auditor independence rules, such as requiring audit committees to pre-approve all audit and non-audit services provided by an auditor, reducing the consulting services that could be provided by an auditor, requiring that certain auditors rotate off an audit engagement on a regular schedule, requiring that independence concerns be raised to the audit committee when auditors identified them, and requiring disclosure to investors of non-audit and audit services provided by accounting firms.³⁸ The stated purpose of these reforms was not only to “restor[e] public confidence in the independence and performance of auditors of public companies’ financial statements,” but also to “enhance the integrity of the audit process and the reliability of audit reports.”³⁹

While Sarbanes-Oxley seemed to significantly reduce the opportunity for accounting firms to provide both audit services and consulting services to their clients, there exists a gray area in which accounting firms are able to provide certain “non-audit services” to their audit clients.⁴⁰ Accounting firms have found that these non-audit services can be a profitable substitute for revenue lost from consulting services, and according to a study that reviewed audit revenue as compared to non-audit revenue disclosures in annual proxy statements—which require public companies to disclose certain matters prior to their annual shareholder meetings—non-audit revenue represented 18% of the fees paid to auditors by public companies in 2021.⁴¹ These non-audit services allow public company auditors to provide a number of ancillary services to their audit clients, such as, (1) audits over accounting and information systems, including payroll software and human resources software, (2) “carve-out” audits that evaluate portions of the business that are set to be divested, (3) tax services, (4) statutory audits, which are audits that comply with local governmental audit requirements, especially in foreign countries, and (5) employee benefit plan audits, typically meaning audits over pension plans. All of these services can be provided without impairing independence under the SEC, PCAOB or AICPA rules, and several of them are repeat, annual services, making them especially lucrative and enticing to accounting firms.⁴²

The oligopoly presented by the Big Four accounting firms also puts significant cost pressure on accounting firms to lower audit costs to attract and retain clients, while still maximizing revenue and market share.⁴³ This balance is primarily struck by the accounting firms in two ways.

First, the accounting firms can look to drive efficiencies in the audit process to lower the cost of annual audits to clients.⁴⁴ This is often accomplished by retaining clients and using institutional knowledge gained over years of repeat audits to streamline audit processes and thus reduce hours and audit costs.⁴⁵ However, this has the added effect of lowering auditor independence as auditors become entrenched in relationships with their clients over a number of years.⁴⁶ For this reason, mandatory rotation of audit firms has been adopted in a number of foreign jurisdictions, including in Europe.⁴⁷ Some have also argued that mandatory audit firm rotations should be adopted in the United States, in addition to the existing United States requirement of rotation of the individuals who lead each audit project, known as audit engagement partners and who are usually equity partners in the accounting firms.⁴⁸

Alternatively, accounting firms can look to increase revenue from ancillary, non-audit services.⁴⁹ This method of increasing revenue by cross-selling non-audit services along with public company audits is seen as a positive to many because efficiencies are driven by the institutional knowledge that auditors already have as a result of their financial statement testing, lowering the costs for both the audit and the non-audit services. For example, an accounting firm that is performing both a public-company financial statement audit and a report on internal controls for the same client can use some of the testing done for the financial statement audit to satisfy testing requirements for internal controls, thus lowering the costs for the combined services.⁵⁰

Many argue that this bundling is a positive development, and given that audit services are fungible, lower transaction costs for companies in the form of reduced fees to accounting firms increase shareholder value.⁵¹ Additionally, tracking independence over each and every ancillary service would increase transaction costs without providing shareholder value, given that some of these non-audit services can be provided without impairing auditor independence, and especially because some argue that accounting firms are already conflicted by virtue of the fact that they are paid for audit services provided.⁵² Further, proponents of bundling argue that auditors are still incentivized to provide quality audits because despite the pressure to increase non-audit service revenue, auditors would not want to risk their reputational capital, which allows them to stay in business and attract other clients.⁵³

However, others argue that fee dependence on non-audit services poses the same problems as those that existed prior to Sarbanes-Oxley, in which instead of sacrificing audit quality to retain consulting revenue, firms are now sacrificing audit quality to retain other non-audit service revenue.⁵⁴ This leads to concerns that auditor independence will be impaired in a way that increases costs to investors because material misstatements are less likely to be caught, and this outweighs the costs saved from efficiencies by the same accounting firm providing both audit and non-audit services.⁵⁵

While this paper reserves judgment on these questions of how non-audit services effect auditor independence, the primary view of auditor regulation since the accountings scandals of the early-2000s and Sarbanes-Oxley has been that auditor independence is of paramount importance to the audit industry in order to protect investors from fraud or inadvertent material errors from management.⁵⁶ In the following Part, this paper will explore the existing regulation surrounding auditor independence, including identifying the many agencies and self-regulatory organizations that promulgate such regulations, and untangle the many requirements for independence as they have appeared over time.

III. SELF-REGULATION AND THE TANGLED REGULATORY FRAMEWORK OF AUDITOR INDEPENDENCE

Modern third party audits have existed since approximately the 1920s and have varied widely in their form and requirements.⁵⁷ However, it was not until the Securities Act of 1933 that companies were required to have their financial statements certified by an independent accountant before they could register on the public markets.⁵⁸ This requirement was expanded with the passage of the Securities Exchange Act of 1934, which mandated annual and quarterly financial reporting for public companies, as well as reporting on material events, all of which were required to be certified by “independent public accountants.”⁵⁹ The Federal Trade Commission and SEC subsequently passed rulemaking that defined “independent public accountants” as those who had neither served as officers or directors of the company to be audited, nor had a “substantial financial interest” in the company, which was defined as more than one percent of the auditor’s net worth.⁶⁰

While the SEC retained statutory authority over auditor independence regulations, eventually the AICPA formed its own auditor independence requirements and in 1977 created the Public Oversight Board (“POB”) to serve as a self-regulatory organization over the accounting profession.⁶¹ The AICPA is independently funded by membership dues from members, which include individual accountants who are certified public accountants.⁶² The AICPA is governed by a council consisting of AICPA members elected by their fellow members in each state, representatives of state CPAs, and members-at-large of the AICPA, among others.⁶³ However, in the wake of the accounting scandals of the early 2000s, the SEC issued additional independence rules to move away from complete industry self-regulation by the AICPA and POB without public oversight, and these rules were then amended to coincide with the sweeping reforms passed by Congress in the Sarbanes-Oxley Act.⁶⁴ Sarbanes-Oxley required the formation of the PCAOB—a nonprofit corporation under the oversight of the SEC—but still allowed the AICPA to issue auditor independence standards.⁶⁵ The membership of the PCAOB, which consists of a five person Board, is determined by appointment from the Chair of SEC and a vote of the five SEC commissioners.⁶⁶ The PCAOB is funded by mandatory fees from public companies who are subject to audit requirements under the Exchange Act as well as fees from brokers and dealers subject to SEC regulation.⁶⁷ As a result, since 2003, when Sarbanes-Oxley took effect, the accounting profession has been governed by three primary sets of auditor independence standards, those set by the SEC, PCAOB, and the AICPA.⁶⁸ A summary of the interaction of the regulations set by the AICPA, SEC, and PCAOB is provided below and will be discussed further in the following sections:

Figure 1.

A. Self-Regulatory Models in United States Financial Regulation

The diffuse structure that contains SEC, PCAOB, and AICPA involvement in auditor independence regulation is not unheard of within United States financial services regulation. The SEC is involved in several self-regulatory models in which the SEC provides oversight to an industry organization that sets standards, and, in some cases, enforces those standards. For example, the Financial Industry Regulatory Authority (“FINRA”) sets regulation for registered broker-dealer firms and registered brokers⁶⁹ and enforces those rules.⁷⁰ The Exchange Act gives the SEC the authority to approve any rule changes made by FINRA⁷¹ as well as revoke the authority of FINRA or issue sanctions against FINRA.⁷²

The SEC is also part of self-regulatory frameworks with national securities exchanges.⁷³ The self-regulatory framework between the national securities exchanges and the SEC works much in the same way as SEC’s oversight of FINRA, in which the SEC provides oversight over and approval of the rulemaking of each securities exchange and issues sanctions for violations of the Securities Act of 1933, the Investment Advisers Act of 1940, and the Investment Company Act of 1940.⁷⁴

The SEC also has a self-regulatory model with respect to credit rating agencies.⁷⁵ Pursuant to Section 15E of the Securities and Exchange Act of 1934, each credit rating agency was required to set internal controls and policies to ensure accurate credit ratings,⁷⁶ and the SEC was required to review such policies to ensure they were robust.⁷⁷ Additionally, prior to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), the SEC relied on credit agencies to provide a measure of credit-worthiness in SEC rules.⁷⁸ However, Section 939A of the Dodd-Frank Act required that the SEC remove such references to the credit agencies within its rules and instead create its own independent standards.⁷⁹

Although the examples above illustrate that the self-regulatory model has been widely used, the model has also been subject to debate over its merits.⁸⁰ Supporters of the model argue it is beneficial because the knowledge of industry participants enhances the usefulness of rulemaking,⁸¹ places the costs of enforcement on industry,⁸² and is more adaptive than the state-driven model because industry entities have the experience and ability to focus on specialized regulations in a way that public entities with vast oversight responsibilities may not.⁸³ However, others believe that the self-regulatory model is not as beneficial as the European state-driven model, in which public entities are the singular or primary regulators with little or no input from industry organizations, because the self-regulatory model can result in conflicts of interest in terms of funding and regulatory capture, given that individual standard setters may be members of the group facing regulation and may seek to avoid restrictions.⁸⁴ In response, proponents of self-regulation may argue that the oversight of the public entities is sufficient to mitigate these conflicts and harness the benefits of a specialized industry standard-setter working hand-in-hand with a public oversight agency, especially when safeguards such as individual term limits for regulators, or limitations on the ability of individual regulators to participate in a “revolving door” in which they rotate between industry and regulatory entity, are put in place.⁸⁵

While the self-regulatory model is not unique to auditor regulation, what is somewhat distinctive about the auditor regulation self-regulatory model is that the SEC and PCAOB not only provide oversight over the AICPA, which is the industry organization run by accountants, but the SEC and PCAOB also have concurrent jurisdiction to set independence standards and have set their own standards for auditor independence in addition to those of the AICPA.⁸⁶ While there are additional organizations that set auditor independence standards, including state boards of accountancy, state CPA societies, federal and state agencies, and the International Ethics Standards Board, the standards set by these entities are heterogeneous and are generally superseded by the SEC, PCAOB, and AICPA rules.⁸⁷ Therefore, the regulation promulgated by these entities will not be examined in this paper. In order to assess the current landscape of auditor regulation, this paper will examine the regulations passed by the SEC, PCAOB, and AICPA in Sections III.B–D.

B. SEC Independence Rules

Under the current SEC independence rules:

The [SEC] will not recognize an accountant as independent . . . if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant’s engagement. In determining whether an accountant is independent, the [SEC] will consider all relevant circumstances, including all relationships between the accountant and the audit client.⁸⁸

The SEC independence rules then set forth a non-exhaustive list of instances in which an auditor would not be independent, primarily consisting of eight categories: (1) lack of financial independence, (2) client investment in the accounting firm, (3) employment by client, (4) non-audit services, (5) contingent fees,⁸⁹ (6) improper partner rotation, (7) lack of audit committee approval,⁹⁰ and (8) improper compensation.⁹¹ Perhaps the most important of these rules are those defining financial independence because without financial independence, an auditor may have conflicts of interest that prevent them from conducting a robust audit.⁹² Accordingly, a summary of these rules is given below, along with a brief summary of the independence restrictions posed by the remainder of the SEC independence rules.

1. Financial Interests

SEC Independence Rule 2-01 states that independence is impaired when (1) the accountant has a direct financial interest or material indirect financial interest in their client;⁹³ (2) the accounting firm, a covered person in the firm, or any of the covered person’s immediate family members have a direct investment in the client, in which “covered person” includes individual accountants within a firm that provide services to a client;⁹⁴ (3) any partner or employee in the firm, including their close family, has more than 5% beneficial ownership of the client’s securities or controls the client;⁹⁵ or (4) the accounting firm, a covered person in the firm, or any of the covered person’s immediate family members have loans, savings accounts, checking accounts, broker-dealer accounts, insurance products, futures commission merchant accounts, consumer loans, or financial interests in investment companies that own the client.⁹⁶

In addition to the requirements of financial independence listed above, the SEC independence rules also prohibit the audit client from investing in the accounting firm or underwriting an accounting firm’s securities.⁹⁷ Moreover, the SEC independence rules place limits on accounting firm employees from being employed at the client both during and after the audit engagement.⁹⁸

2. Audit Conduct

The SEC independence rules also mandate certain conduct during the audit. For example, auditors are not allowed to provide non-audit services that could impair their independence, such as bookkeeping services, financial information systems design and implementation, appraisal or valuation services, actuarial services, management functions, human resources, investment advising, legal services, or expert services unrelated to the audit.⁹⁹ Much of the intent behind this regulation is to reduce the types of conflicts discussed in Part II, in which auditors are incentivized to ignore errors in the audit in order to receive revenue for these non-audit services.¹⁰⁰ Additionally, audit partners are required to rotate every five years if they are the lead partner on the engagement or every seven years otherwise, to avoid forming ties with clients that may impair independence.¹⁰¹ Auditors are also not allowed to receive contingent fees or have partners compensated for any services other than audit services.¹⁰² The audit engagement, typically including fees and non-audit services, must also be approved by the client’s audit committee to ensure independence.¹⁰³

3. Enforcement and Entanglement

The SEC’s enforcement mechanism for auditor independence violations is relatively straightforward. Under the SEC independence rules, the SEC can “censure a person or deny, temporarily or permanently, the privilege of appearing or practicing before [the SEC] in any way to any person who is found by the Commission after notice and opportunity for hearing”¹⁰⁴ to have “engaged in unethical or improper professional conduct.”¹⁰⁵ What is interesting about this mechanism is that it defers to “applicable professional standards” in determining whether there has been “unethical or improper professional conduct.”¹⁰⁶ As a result, the SEC defers the determination of the standard for violations of independence standards to the body that sets the professional standards, which has often been interpreted, both by the SEC’s Administrative Law Judges and the federal courts, to be the AICPA.¹⁰⁷ This is one instance in which the auditor independence regulations are entangled between two different standard setters—the SEC and the AICPA.

One other instance in which the auditor independence rules are entangled between regulators is that although the SEC has delegated the authority to the PCAOB to set auditor independence standards, the SEC independence rules passed in the wake of Sarbanes-Oxley in 2003 are still effective.¹⁰⁸ Aside from some minor updates to debtor-creditor relationships passed in 2019, the SEC independence rules remained largely untouched until 2020,¹⁰⁹ at which point the SEC, along with making minor updates to the independence rules, brought the PCAOB rules into harmony with the SEC rules where they conflicted, acknowledging that for several years there had been a period in which the SEC and PCAOB rules surrounding auditor independence were not consistent.¹¹⁰ This inconsistency is explored further in the sections below, including analyzing the frequency with which the courts used the SEC and PCAOB standards during this time, or the AICPA standards, which are defined in Part III.D.

C. PCAOB Standards

The PCAOB sets forth “Ethics and Independence” standards for accounting firms and their associated persons.¹¹¹

standards/ethics-independence-rules [https://perma.cc/WP6J-2LLD]. While several of these rules set forth additional requirements when compared to the SEC rules, several are similar or aligned with the SEC independence rules and AICPA standards.¹¹² First, accounting firms and their employees are required to “comply with all applicable auditing and related professional practice standards,” which implies that SEC and AICPA standards are binding.¹¹³ However, in 2003, the PCAOB released a note to PCAOB Rule 3500T, which states that the “[PCAOB’s] Interim Independence Standards do not supersede the [SEC’s] auditor independence rules” and that in situations when the SEC Rules are more or less restrictive than the PCAOB rules, the more restrictive rule is to be followed.¹¹⁴ Additionally, the PCAOB explicitly requires that accounting firms and their employees comply with AICPA Code of Professional Conduct Rules 101 and 102, including any interpretations and rulings under these rules.¹¹⁵ Further analysis of the AICPA rules will be provided in Section III.C.

The PCAOB independence rules extend beyond the SEC independence rules in three areas: (1) limiting auditors’ ability to provide audit clients with tax services,¹¹⁶ (2) requiring auditors to communicate with the client Board’s audit committee about certain independence-related matters,¹¹⁷ and (3) requiring auditors to submit a form to the PCAOB that summarizes audit hours by partner (“Form AP”).¹¹⁸

1. Tax Services

Generally, the PCAOB rules extend beyond the SEC rules by maintaining that an accounting firm is not independent of its audit client if the firm provides “marketing, planning, or opining in favor of the tax treatment of” confidential transactions or aggressive tax position transactions, or if the firm provides “tax service to a person in a financial reporting oversight role” at the client, which generally prohibits providing tax advice or preparation services to management and finance employees of the audit client.¹¹⁹

2. Audit Committee Communication

Further, the PCAOB goes beyond the SEC rules and requires accounting firms to seek audit committee pre-approval before the firms perform any permissible tax service or non-audit service related to internal controls.¹²⁰ Part of the intent of these rules is to present to the audit committee the ways that it might impair the accounting firm’s independence to provide both tax and non-audit services to the client.¹²¹ In line with this requirement, accounting firms are required to describe to the audit committees of their clients “all relationships between the registered public accounting firm . . . and the audit client or persons in financial reporting oversight roles at the potential audit client that . . . may reasonably be thought to bear on independence” both prior to beginning the audit and annually thereafter, including an annual affirmation of independence to the audit committee, which essentially requires accounting firms to disclose personal relationships that may impair independence.¹²²

3. Form AP Filing Requirements

Finally, the PCAOB requires that accounting firms file a “Form AP” with the PCAOB for each audit report it issues for a client.¹²³ The Form AP lists the lead engagement partner for the audit and notes the hours they have completed on the audit engagement, with the goal of providing users of financial statements information about the “independence of the specific individuals and firms that participate in the audit.”¹²⁴

004.pdf [https://perma.cc/U3D4-2X49] .

D. AICPA Standards

The AICPA promulgates what is the most rigorous standard of independence requirements for auditors, when compared to the SEC and PCOAB. The AICPA Code of Professional Conduct begins by setting forth a single independence rule: “A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by [the AICPA Governing] Council.”¹²⁵ Stemming from this rule, the AICPA has then set forth hundreds of interpretations,¹²⁶ which are binding on accounting firms and accountants performing “attest engagements,” which are any services to a client requiring independence from the client, including audits.¹²⁷

Given the complexity of the interpretations to the independence rule and the many scenarios effecting independence that they address, it would be impractical to describe all interpretations within this paper. However, to summarize, the interpretations to the independence rule cover a variety of situations regarding the independence of individual accountants, such as how to handle the employment of a family member at an audit client¹²⁸ and how to address whether an individual accountant’s financial investments in a client’s securities impair their independence.¹²⁹ The interpretations also cover more complex situations regarding the independence of accounting firms as a whole, such as how to maintain independence in situations in which a nonclient acquires a current client¹³⁰ or how “network firms” with multiple offices should each remain independent of each other’s clients.¹³¹

In the absence of any relevant interpretation, accounting firms and accountants are expected to apply the AICPA’s “Conceptual Framework for Independence.”¹³² The Conceptual Framework for Independence requires that accountants evaluate whether a particular “relationship or circumstance” would lead a reasonable person “to conclude that there is a threat to . . . independence . . . that is not at an acceptable level.”¹³³ The Conceptual Framework then lists potential “threats” to independence, such as holding an adverse interest from the client, advocating for the client, familiarity with the client, auditor participation in management of the client, self-interest, self-review, and undue influence by the client or a third party.¹³⁴ Following the potential threats, the Conceptual Framework identifies “safeguards” which can reduce threats to an acceptable level that will ensure independence, such as external review, competency requirements for professional licensing, analysis of an accounting firm’s revenue dependence on one client, and accounting firm policies for engagement quality control, such as external review.¹³⁵ By ensuring threats are low or nonexistent or by balancing them with safeguards, accounting firms and accountants can ensure compliance with independence standards under the Conceptual Framework in situations in which there is no authoritative interpretation set forth by the AICPA.¹³⁶

The AICPA also has a senior committee, the Auditing Standards Board, that sets forth Generally Accepted Auditing Standards (“GAAS”).¹³⁷ GAAS sets forth specific testing requirements and procedures for auditors as they undertake audit engagements for clients.¹³⁸ In addition to these audit testing requirements—which are largely technical in nature and outside of the scope of this paper—GAAS also sets for ethical requirements relating to audits of financial statements, stating that an “auditor must be independent of [a client] when performing an engagement in accordance with GAAS.”¹³⁹ GAAS then defers to the Code of Professional Conduct’s Conceptual Framework, which was discussed previously.¹⁴⁰ GAAS is often referenced more frequently than the Code of Professional Conduct, as will be discussed in Part IV, because GAAS includes not only ethical requirements for auditors, but substantive guidance for how audits are to be conducted in practice.¹⁴¹

Overall, there is significant overlap between the regulations set forth by the AICPA and the SEC and PCAOB.¹⁴² The AICPA standards set forth detailed guidance for accounting firms to ensure they comply with the broader standards set forth by the SEC and PCAOB. For example, while the SEC and PCAOB rules prevent auditors from receiving contingent fees from their clients, the AICPA rules state that same proposition and provide guidance that states contingent fees include finder’s fees, fees based on cost-savings achieved by the client, and exclude fees based on the results of judicial proceedings in tax matters.¹⁴³ This level of detailed guidance means that practitioners often consult the AICPA standards, as they set forth a more restrictive set of guidelines and also a more informative set of interpretations that can be applied to specific circumstances. This delegation of substantive regulation to the private industry organization—AICPA—is also consistent with other self-regulatory models.

E. Harmonization Efforts

In October 2020, the SEC issued updates to the auditor independence rules set forth in SEC Independence Rule 2-01.¹⁴⁴ These updates covered a variety of miscellaneous matters in the SEC independence rules, including refining the definition of affiliates of audit clients, amending the definition of an “audit and professional engagement period,” excluding some student loans from causing independence violations, and addressing inadvertent violations of the independence rules due to mergers and acquisitions, among other matters.¹⁴⁵

As a result, stakeholders raised concerns that the PCAOB rules, particularly those related to affiliates of audit clients, such as subsidiaries, were no longer consistent with the SEC independence rules.¹⁴⁶ In response, and to “provide greater regulatory certainty,” the PCAOB amended its rules to align with the SEC independence rule changes.¹⁴⁷ Additionally, several of the PCAOB rules that needed realignment with the new SEC rules were those that the PCAOB adopted directly from the AICPA or had interpreted based on the AICPA rules.¹⁴⁸ As a result, the AICPA issued a temporary policy statement as a stop-gap measure that stated to accounting firms and accountants that they would be considered in compliance with the AICPA Code of Professional Conduct if they complied with the updated SEC independence rules.¹⁴⁹ Soon thereafter, the AICPA put forth a proposal to change its rules and definitions to align with the SEC and PCAOB changes.¹⁵⁰ This proposal has not been adopted as of the time of this paper, but it seems likely that the AICPA will bring its standards into alignment with the current SEC and PCAOB independence rules.

Overall, this amendment waterfall that began with the SEC proposing changes in October 2020 that were then adopted by the PCAOB, and which still have not been adopted by the AICPA two years later, shows that the regulatory framework for auditor independence remains entangled. This entanglement may be occurring because the Sarbanes-Oxley Act created the PCAOB, which is allowed to pass audit regulations subject to the oversight of the SEC; and the Sarbanes-Oxley Act also allowed the SEC to become more involved in rule-setting for auditors, which had previously been handled entirely by the AICPA.¹⁵¹ While some argue that harmonization between these three entities is a worthy goal to disentangle regulations that are not consistent between the three entities,¹⁵² one might also consider whether harmonization is the answer, or rather whether simplification is a better goal, to avoid having to involve three regulatory agencies in rule changes, in order to ensure clear standards for accounting firms, clients, and stakeholders in the market. The following section of the paper will explore whether one regulatory entity is dominant over the others, and whether this agency should be favored for simplification that centers around focusing auditor independence on this agency and its rules exclusively, rather than the standards set across all three entities.

IV. CASE STUDY

As discussed, the following case study will assess published federal court opinions in which auditor independence was at issue in a civil litigation to determine whether SEC, PCAOB, or AICPA standards were used in the courts’ reasoning.¹⁵³ While a study of administrative law decisions from the SEC was considered, federal court decisions were deemed to be a more relevant indicator of which body of regulation is used in deciding civil matters because SEC administrative law decisions rely almost exclusively on a single, broad rule, SEC Rule 102(e)(1)(ii), which “censure[s] a person . . . after finding that a person engaged in improper professional conduct.”¹⁵⁴

There were fifteen cases decided by federal courts in which auditor independence was at issue in civil litigation, and which were used to comprise the population for this case study.¹⁵⁵ The population of cases includes only cases in which auditors were performing financial statement audits, and therefore excludes government and internal audit services, as these non-financial statement audits are typically not part of the debate over auditor independence because they involve different monetary incentives, risks for auditors and investors, and different auditing standards. Additionally, cases were only observed after May 6, 2003, which was the effective date of the Sarbanes-Oxley legislation, given that Sarbanes Oxley completely changed the landscape of auditor independence, giving the SEC broad authority to issue rulemaking in this area and effectively creating the PCAOB.¹⁵⁶ Finally, cases that relied on state regulations over auditor licensing and independence were excluded, as they do not address the relevant issue of federal regulatory structure.¹⁵⁷

This case study aims to examine which body of regulatory law federal courts rely on in making determinations over whether auditors have breached their independence obligations. Each of the AICPA, SEC, and PCAOB have their own enforcement mechanisms to sanction auditors who do not adhere to independence requirements, and each enforcement division uses their own regulation as well as occasionally relies on the regulation of the other entities to sanction auditors.¹⁵⁸ However, the civil courts do not have a requirement to adhere to the regulations of any particular standard-setter under the requirements of Sarbanes-Oxley or the Securities and Exchange Act of 1934. Given this lack of constraints, the standard used by the federal courts in determining independence violations has not been examined and is ripe for analysis to determine whether one set of standards (that is, those of the AICPA, SEC, or PCAOB) is preferred over the others. Therefore, this study will examine all fifteen federal court decisions to determine what standards have been used by the courts in the area of auditor independence as well as whether the result was in favor of the auditor or against the auditor in each scenario.

There are three major areas in which auditor independence has been examined by the federal courts. First, individuals who have been sanctioned by the SEC for violations of auditor independence standards can appeal to the federal courts for a review of the SEC’s decisions under a broad “abuse of discretion” standard to argue that the agency acted arbitrarily and capriciously in a way that requires the SEC’s decision to be overturned under 5 U.S.C. 706(2)(A).¹⁵⁹

Next, auditor independence is frequently at issue in Securities and Exchange Act Section 10(b) and SEC Rule 10b-5 claims, which are often brought as class-actions.¹⁶⁰ To prevail on these claims, plaintiffs must prove scienter, meaning that the defendant employed a “device, scheme, or artifice to defraud,” in addition to proving the elements of a material misstatement or omission, on which the plaintiff relied, and was the proximate cause of the plaintiff’s loss.¹⁶¹ Plaintiffs often allege that auditors’ violations of independence rules are evidence of scienter for purposes of satisfying this element to bring a successful 10(b) or 10b-5 claim.¹⁶² However, this practice has been complicated by the heightened pleading requirements for Section 10(b) and Rule 10b-5 claims established in the Private Securities Litigation Reform Act of 1995 (“PSLRA”), which was passed in part to reduce the number of non-meritorious securities class action claims raised by plaintiffs and requires that plaintiffs “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”¹⁶³ The PSLRA has resulted in different pleading standards for scienter among and within circuits, however, many courts find “scienter [is] plead with particularity by facts supporting a ‘motive or opportunity’ to commit fraud.” ¹⁶⁴ As will be discussed in Section IV.B, this heightened pleading standard has reduced the circumstances in which courts have viewed violations of auditor independence rules to be sufficient to show scienter.

Finally, plaintiffs also bring state law claims—including negligent misrepresentation, professional negligence, and fraud suits—against auditors who have violated auditor independence standards, using the alleged violations of these standards as de facto evidence of a breach of duty.¹⁶⁵ In one instance, a plaintiff also attempted to bring a state law breach of fiduciary duty claim against an auditor who allegedly did not comply with auditor independence standards.¹⁶⁶

Given the heterogeneity of the claims within these cases, this paper examines the cases within these three groups—reviews of SEC administrative decisions, federal securities law claims, and state law tort claims—to identify developments in the case law regarding auditor independence and to examine when courts apply SEC, PCAOB, or AICPA standards in determining whether there has been an independence violation sufficient to warrant a judgment against auditors.

A. Appeals of SEC Administrative Decisions

In Ponce v. SEC, the Ninth Circuit reviewed an appeal from a decision that the SEC made to bar a plaintiff accountant from practice, and the court acknowledged that as part of the SEC’s decision, the accountant had been held in violation of SEC Independence Rule 102(e)(1)(ii), which means he engaged in “improper professional conduct.”¹⁶⁷ In order to determine whether there was truly “improper professional conduct,” the court turned to AICPA standards and ruled that the auditor failed to maintain his independence because he allowed his clients to run up a substantial balance of unpaid fees, which under AICPA guidance, resulted in a presumed lack of independence because the AICPA standards set forth that “independence is considered to be impaired if fees for all professional services rendered for prior years are not collected before the issuance of the member’s report for the current year.”¹⁶⁸

Similarly, in Dearlove v. SEC, the Court of Appeals for the District of Columbia Circuit used the same approach as Ponce, albeit six years after the decision¹⁶⁹ and six years after the implementation of Sarbanes-Oxley, including its resulting reform of SEC independence rules and the formation of the PCAOB. In Dearlove, the court concluded that “the appropriate standard of care . . . is supplied by . . . GAAS” when reviewing whether the SEC had abused its discretion in determining that an accountant violated SEC Independence Rule 102(e)(1)(ii) by failing to maintain independence from their audit client.¹⁷⁰

Ponce and Dearlove are indicators of how the federal courts have given credibility to the AICPA standards, including GAAS, in determining whether there has been a violation of auditor independence. The court’s opinion in Dearlove references SEC Independence Rule 102(e)(1)(ii), but it does so only to note that the SEC rule states “improper professional conduct” will warrant sanctions, before deferring to the AICPA GAAS standards to assess what improper conduct is.¹⁷¹ The court also stated that “the SEC need not establish a standard of care separate from the GAAS in order to give meaning to” what SEC Independence Rule 102(e)(1)(iv)(B)(2) describes as “unreasonable conduct,” showing further deference to AICPA standards.¹⁷² The fact that this decision came more than six years after the implementation of Sarbanes-Oxley, when the court had the ability to reference the updated SEC independence rules or PCAOB rules, but chose not to, shows even more significant reliance on the standards set by the AICPA.

B. Determinations of Scienter in Securities Claims

Similarly, in In re WorldCom, Inc. Securities Litigation, defendants moved for summary judgment on the matter of whether Arthur Andersen, the auditors at the helm of both the Enron, and in this case, WorldCom accounting scandals, had the requisite scienter to be in violation of Section 10(b) of the Securities and Exchange Act and SEC Rule 10b-5 because they allegedly recklessly issued false audit opinions.¹⁷³ The plaintiff alleged that violations of the AICPA’s GAAS were sufficient to prove scienter, even under the heightened pleading standards required by the PSLRA, which required the plaintiffs to plead recklessness in order to avoid their claim being dismissed.¹⁷⁴ The court recognized the importance of violations of GAAS in proving scienter, but ultimately denied summary judgment due to conflicting expert reports on whether GAAS was violated.¹⁷⁵ Although the claim survived the motion for summary judgment due to unresolved questions of fact, this case was another high profile example of the federal courts giving credence to AICPA standards in determining whether there was auditor wrongdoing.¹⁷⁶

In re WorldCom, Inc. Securities Litigation also included a Securities Act claim, in which the plaintiffs alleged that Arthur Andersen was in violation of Section 11 of the Securities Act, which states that a “preparing or certifying accountant . . . may be liable ‘if any part of the registration statement . . . contained an untrue statement of a material fact.’ ”¹⁷⁷ Arthur Andersen attempted to assert a due diligence defense, in which it claimed that it “had, after reasonable investigation, reasonable ground to believe and did believe, at the time . . . the registration statement became effective, that the statements therein were true,” and then moved for summary judgment.¹⁷⁸ In deciding whether summary judgment was appropriate on this issue, the court issued an even stronger affirmance of the relevance of AICPA standards, concluding that a “reasonable investigation” that would support a due diligence defense, like that raised by Arthur Andersen, must be a “GAAS-compliant audit.”¹⁷⁹ Because the plaintiff presented sufficient evidence to rebut the argument that the audit was “GAAS-compliant,” Arthur Andersen’s motion for summary judgment was denied. While this second issue is not directly related to auditor independence rules, it shows the courts’ general deference to the AICPA’s GAAS.

However, not all courts have agreed with the Southern District of New York’s decision in WorldCom, which may be in part due to differing interpretations of the heightened pleading requirements of the PSLRA. In In re Cardinal Health, Inc. Securities Litigations, the Southern District Court of Ohio ruled that Ernst & Young’s failure to adhere to the AICPA’s GAAS requirements for auditor independence did not establish the requisite scienter for a plaintiff’s claim to survive Ernst & Young’s motion to dismiss on a Rule 10b-5 claim.¹⁸⁰ The Court reasoned that while recklessness is generally sufficient to meet the pleading standard under the PSLRA, claims brought against auditors were subject to the even more heightened pleading standard of “a mental state ‘so culpable that it approximate[s] an actual intent to aid in the fraud being perpetrated by the audited company,’ ” which was not met in this case based merely on the alleged failure of Ernst & Young to adhere to AICPA GAAS requirements.¹⁸¹

Further, the court opined that an auditor’s past sanctions in SEC administrative proceedings were insufficient to prove scienter.¹⁸² In this case, the court also noted that SEC administrative decisions were not dispositive in determining scienter for Rule 10b-5 claims, perhaps suggesting that judicial interpretation of independence violations supersedes determinations by regulatory bodies.¹⁸³ This is in line with existing administrative law doctrines that do not require federal courts to defer to the SEC’s interpretations of the Exchange Act.¹⁸⁴

Similarly, in In re Royal Ahold N.V. Securities and ERISA Litigation, the United States District Court for the District of Maryland ruled that alleged violations of AICPA’s GAAS standards on independence—in which the only allegations from the plaintiff were that auditor independence was impaired due to the auditor providing audit and non-audit services—were not sufficient to establish scienter for a Rule 10b-5 claim against an auditor.¹⁸⁵ However, the court did note that violations of AICPA’s GAAS can be sufficient to plead scienter when they are coupled with allegations that show that “the nature of the violations of those violations was such that scienter is properly inferred.”¹⁸⁶ Likewise, in New Jersey v. Sprint Corp., a group of class action plaintiffs brought Rule 10b-5 claims against Sprint Corporation and Ernst & Young for filing false and misleading registration statements, prospectus supplements, and proxy statements that did not disclose that the company had considered dismissing their auditor, Ernst & Young, and that there were conflicts between executives at the company and the auditor, which resulted in auditor independence violations under AICPA’s GAAS.¹⁸⁷ The court relied on the AICPA’s GAAS to assess independence, noting that the plaintiffs did not plead sufficient facts to show that Ernst & Young lacked the independence in “mental attitude” required by GAAS, and even if sufficient facts were pled to show that Ernst & Young violated GAAS, this would not be sufficient under the PSLRA to establish scienter because the standard for scienter is recklessness, that is “so obvious that the defendant must have been aware of it” which goes beyond a mere violation of GAAS. ¹⁸⁸ Therefore, the motion to dismiss was granted in favor of Ernst & Young.¹⁸⁹

While the varied interpretations in different jurisdictions over whether violations of the AICPA’s GAAS standards is sufficient to plead scienter persists, some courts have ruled that merely “articulating violations of GAAS and GAAP alone is insufficient” to satisfy the element of scienter under the PSLRA’s heightened pleading requirements and instead imposed additional requirements to plead scienter through case law.¹⁹⁰ For example, the court in Grand Lodge of Pennsylvania v. Peters determined that in order to prove scienter, violations of GAAS must be accompanied by “red flags” that would put a reasonable auditor on notice that their client was committing fraud.¹⁹¹ Therefore, the plaintiff’s allegations in this case that the auditor was conflicted by providing consulting services to the client in violation of GAAS were insufficient to establish scienter for a Rule 10b-5 claim.¹⁹² Additionally, the court in In re Williams Securities Litigation ruled that “GAAS violations must be coupled with evidence that the violations were the result of the auditor’s fraudulent intent to mislead investors,” in order to have a sufficient pleading of scienter.¹⁹³ This supports the idea that some courts grant credibility to the AICPA standards, however, they impose additional burdens on plaintiffs that are developed through case law.

This case law has developed in the years since the passage of the PSLRA. The Ninth Circuit Court of Appeals summarized the development of the additional requirements to prove scienter, other than GAAS violations, in New Mexico State Investment Council v. Ernst & Young LLP.¹⁹⁴ The court ruled that failing to “maintain independence in mental attitude during an audit,” in violation of GAAS and PCAOB standards, is not sufficient to prove scienter.¹⁹⁵ Rather, there should be “red flags” that a reasonable auditor would have investigated as well as a showing that there were violations that amount to more than “alleging a poor audit.”¹⁹⁶ New Mexico State Investment Council indicates how the courts’ reliance solely on AICPA standards has lessened slightly over the years, as the burden to meet additional case law requirements for scienter has increased due to the passage of the PSLRA and its heighted pleading requirements, which require that plaintiffs “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”¹⁹⁷

While the discussion above indicates that courts have largely relied on violations of AICPA’s GAAS and case law requirements in determining whether auditor independence violations are sufficient to show scienter, other courts have discussed Sarbanes-Oxley in determining whether an auditor independence violation is sufficient to show scienter as an element of a Rule 10b-5 violation.¹⁹⁸ In Brody v. Stone Webster, Inc., the First Circuit Court of Appeals examined whether scienter could be presumed on the part of PwC in connection with a 10b-5 claim because PwC allegedly turned a blind eye toward accounting irregularities to protect its accounting and consulting revenue from a client.¹⁹⁹ The court determined that “turn[ing] a bind [sic] eye” to misleading accounting for a “profit motive” may have been a rationale for the passage of Sarbanes Oxley, but it is not enough in itself to prove scienter sufficient for a valid Rule 10b-5 claim under the PSLRA without specific allegations that the auditor ignored “red-flags” that were signs of fraud.²⁰⁰

Courts have also been reluctant to find that scienter has been sufficiently pled in accordance with the PSLRA when plaintiffs allege auditor independence violations on the basis of general policy arguments against auditors depending on fees from clients.²⁰¹ In In re ArthoCare Corporation Securities Litigation, plaintiffs alleged that PwC was not independent in its audit because the firm had a longstanding relationship with its client and was dependent on the client’s audit fees.²⁰² The United States District Court for the Western District of Texas found that general allegations based on a perceived lack of independence or violations of GAAS due to fee dependence or long-standing relationships, which are allegedly against public policy, are not sufficient to establish scienter on the part of auditors under the PSLRA.²⁰³ Similarly, in Ley v. Visteon Corporation, the Sixth Circuit determined that an allegation that Ernst & Young was not independent during an audit because it sought to preserve revenue from a client by not pointing out the client’s alleged accounting irregularities was not sufficient to plead scienter on the part of the auditors under the PSLRA’s requirements because it was merely an allegation of a “motive.”²⁰⁴

On the whole, these cases show a broad trend of the courts giving credibility to the AICPA’s standards, as compared to SEC or PCAOB standards. As the case law has developed, violation of AICPA standards has been shown as one of the avenues plaintiffs can use to establish scienter for Securities and Exchange Act Section 10(b) and SEC Rule 10b-5 claims, when additional case law requirements are met. Notably, neither violations of the PCAOB independence rules nor the SEC independence rules have been used by the federal courts to assess whether there has been scienter for the purposes of a Section 10(b) or Rule 10b-5 claim that has been sufficiently pled in accordance with the PSLRA. Instead, the courts have relied on the AICPA rules as one factor for establishing scienter, and then have developed additional case law standards, such as finding “red flags” and alleging more than a poor audit, in order for plaintiffs to prevail on Section 10(b) and Rule 10b-5 claims against auditors. This focus on the AICPA rules is aligned with the deference given by the courts to AICPA standards in appeals of SEC enforcement decisions, discussed in Section IV.A.

C. Fraud, Negligence, and Other State Law Causes of Action

In state law actions for fraud, courts have required a heightened standard for liability that extends beyond a violation of the AICPA’s GAAS independence standards in order to hold auditors liable. For example, in In re Parmalat Securities Litigation, plaintiffs pled that Deloitte aided an audit client with common law fraud.²⁰⁵ Given that this was a state law cause of action, the court applied the New York common law requirements for fraud, requiring the plaintiff to prove “that the defendant (1) made a material, false statement; (2) knowing that the representation was false; (3) acting with intent to defraud; and that plaintiff (4) reasonably relied on the false representation; and (5) suffered damage proximately caused by the defendant’s actions.”²⁰⁶ The court focused primarily on the intent to defraud and ruled that an auditor’s violation of GAAS does not by itself show intent, however “an auditor’s decision to take on non-audit work that threatens to compromise its duty of independence gives rise to a strong inference of . . . [fraudulent] intent . . . when . . . the auditor has a ‘direct stake’ in the alleged fraud.”²⁰⁷ This heightened standard to show the intent element for common law fraud in New York, which includes not only a GAAS violation but also an auditor’s direct stake in the fraud, is in some ways analogous to the heightened standard to prove scienter on the part of auditors, as discussed in Section IV.B, because in both instances the courts have recognized a violation of the AICPA’s GAAS standards as helpful in showing intent, in addition to adding case law requirements to plead a valid claim.

However, some courts have not found it necessary to analyze auditor independence regulation when determining whether auditors were negligent in their review of their clients’ financial statements. In a consolidated action, insurance companies brought state law claims against Enron, Enron management, and Enron’s auditors, Arthur Andersen, in the wake of the Enron accounting scandal and resulting collapse.²⁰⁸ The plaintiffs specifically alleged that Arthur Andersen made negligent misrepresentations to investors and committed common law fraud in violation of Texas law.²⁰⁹ In connection with the negligent misrepresentation claim, the plaintiffs were required to show (1) the defendant provided information (2) that was false, (3) the defendant did not exercise reasonable care or competence in obtaining or communicating the information, (4) the plaintiff justifiably relied on the information, and (5) the plaintiff suffered loss by justifiably relying on the information.²¹⁰ In connection with the common law fraud claim under Texas law, the plaintiffs were required to show “(1) a material representation was made; (2) the representation was false; (3) when the representation was made, the speaker knew it was false or made it recklessly . . . (4) the representation was made with the intention that it be acted upon by the other party; (5) the party actually and justifiably acted in reliance upon the representation; and (6) the party suffered injury.”²¹¹ While the plaintiffs alleged that Arthur Andersen’s violations of AICPA’s GAAS standards showed the firm lacked independence, which they claimed was sufficient to show that Arthur Andersen did not meet the standard of care and competence as required by the negligent misrepresentation claim,²¹² and that the violation of GAAS showed that Arthur Andersen made false representations about its independence sufficient for a common law fraud claim,²¹³ the court did not reach these issues, instead dismissing both claims because the plaintiffs could not show they relied on Arthur Andersen’s representations.²¹⁴

Another area in which courts have assessed whether auditor independence gives rise to liability is in the area of state law claims for breach of fiduciary duties. In In re SmarTalk Teleservices, Inc. Securities Litigation, a trustee argued that PwC exceeded its normal role as an independent auditor, as defined by the AICPA’s GAAS, and therefore PwC owed a trustee fiduciary duties that the firm then breached by providing inadequate accounting and audit services.²¹⁵ While the court did not reach the issue of whether there was a valid cause of action for breach of fiduciary duty, the court determined that whether PwC violated GAAS standards for independence was a genuine issue of material fact and denied the auditor’s motion for summary judgment on the breach of fiduciary duty claim, providing yet another example of the federal courts giving credence to the AICPA standards in determining auditor liability.²¹⁶

V. IMPLICATIONS OF STUDY ON HARMONIZATION OR SIMPLIFICATION OBJECTIVES

In all three areas of the law covered by the case study, including appeals of SEC enforcement decisions, federal securities claims, and state law claims, the federal courts have preferred to use the AICPA standards, including GAAS, in their decision-making over auditor independence. In many instances when AICPA standards were used in federal securities actions, case law requirements were also supplied to determine whether there was sufficient evidence presented to plead scienter. But, notably, there were no cases found that apply PCAOB or SEC auditor independence rules.

On the whole, this paper does not aim to provide a normative proposal for auditor independence regulation. However, the case study presented in Part IV can shed light on the process of harmonization, which, as discussed in Section III.E, involves the SEC, PCAOB, and AICPA each having to change their rules regarding auditor independence each time one of the other entities changes their independence rules, in order to ensure that the rules are not in conflict. Given that the case study indicates that AICPA standards are preferred by the federal courts, along with case law, in determining whether auditor independence has been violated, there is an argument to be made that the power to regulate auditor independence should be simplified into one regulatory framework run by a single entity—the AICPA. Under this proposal of “simplification,” the regulations set by each entity would not need to be harmonized each time one entity makes a change in auditor independence rules. Rather, given that the federal courts rely on AICPA standards, the substantive rule-making authority would be given to the AICPA alone. This is because the current framework has two entities, the SEC and PCAOB, whose frameworks are rarely applied in the federal courts or outside of internal enforcement actions and investigations.

As discussed in Part III, the AICPA, PCAOB, and SEC are involved in a self-regulatory model, in which the SEC provides oversight over the PCAOB, and the SEC and PCAOB have concurrent jurisdiction to set auditor independence standards as a federal regulatory agency and as a non-profit corporation subject to the oversight of the SEC, respectively. In this self-regulatory model, the SEC also provides oversight over the AICPA, which is a private industry organization run by accountants and which sets substantive auditor independence regulation. This self-regulatory model could be simplified to reflect other self-regulatory structures in United States financial services regulation so that rule-making authority is deferred entirely to the AICPA, with oversight by the SEC, in order to simplify the regulatory framework and reduce conflicts between the independence rules set by the AICPA, SEC, and PCAOB. This would be similar to the model between the SEC and FINRA, in which the SEC allows FINRA to set rules for national securities exchanges and provides oversight over that rulemaking, rather than having the SEC set its own detailed regulation over exchanges. Given that the AICPA sets forth the most comprehensive rulemaking and interpretations of auditor independence standards, and the federal courts rely on these standards, simplifying the regulatory framework for auditor independence by deferring to the AICPA seems like a possible solution.

Overall, the relative costs and benefits of self-regulation and the outsourcing of rulemaking to private industry are beyond the scope of this paper; however, the following arguments are meant to provide a brief summary of why simplification of rule-making authority regarding auditor independence regulations by giving authority to the AICPA and oversight to the SEC may or may not be beneficial.

There are valid reasons to argue against simplification that comes in the form of allowing the AICPA to be the only standard-setter in the area of auditor independence. Several critics have pointed out that self-regulation was one of the issues at the forefront of the Enron collapse and resulting scandal, and that the accounting profession needs an external regulator.²¹⁷ However, others have argued that it was not self-regulation, but market failures and misaligned incentives over reputational costs that caused the accounting scandals during the early 2000s.²¹⁸ Further, self-regulatory organizations, such as FINRA, have successfully provided guidance to their respective stakeholders, with some oversight from the SEC, indicating that self-regulatory organizations with some administrative oversight can be successful.²¹⁹

Additionally, critics may argue that the AICPA relies on the SEC and PCAOB enforcement practices in addition to running its own enforcement program,²²⁰ and to split up the enforcement and regulation practices could pose problems. However, given that the current system splits the enforcement burden between the SEC, PCAOB, and AICPA, and each uses violations of the other’s regulations to bring sanctions, consolidating the regulations into one body would not have to change this framework.

CONCLUSION

This paper reserves judgment on the relative merits of self-regulation and instead notes that the current regulatory harmonization effort is not the only solution to disentangle the regulatory framework for auditor independence. Instead, this paper poses a new potential solution—simplification—to the problem of unwinding the tangled regulatory framework of auditor independence to promote efficiency in rulemaking and clarity for stakeholder accounting firms, regulators, and clients.

Given that the courts frequently defer to AICPA auditor independence standards—along with case law requirements for pleading federal securities law violations—rather than SEC and PCAOB standards, and having three regulatory frameworks that need to be continuously updated to align with each other is complex and costly, simplification is a worthy goal. However, it is just one solution of many. As the SEC, PCAOB, and AICPA continue to pursue harmonization,²²¹ it is worth considering whether other alternative approaches to auditor independence regulation, such as simplification, exist.

APPENDIX

Appendix
	Case Name and Citation	Procedural Posture	Body of Law Applied	Result in Favor of Auditor?
1	Ponce v. SEC, 345 F.3d 722 (9th Cir. 2003).	Appeal of Administrative Decision	AICPA and SEC	No
2	Dearlove v. SEC, 573 F.3d 801 (D.C. Cir. 2009).	Appeal of Administrative Decision	AICPA and SEC	No
3	New Jersey v. Sprint Corp., 314 F. Supp. 2d 1119 (D. Kan. 2004).	Motion to Dismiss	AICPA	Yes
4	Newby v. Enron Corp. (In re Enron Corp. Secs., Derivative & ERISA Litig.), 762 F. Supp. 2d 942 (S.D. Tex. 2010).	Motion to Dismiss	AICPA^a	Yes
5	In re WorldCom, Inc. Sec. Litig., 352 F. Supp. 2d 472 (S.D.N.Y. 2005).	Motion for Summary Judgment	AICPA and SEC	No, on Securities Act Claim. Yes, on SEC Rule 10b-5 claim.
6	In re Cardinal Health, Inc. Sec. Litigs., 426 F. Supp. 2d 688 (S.D. Ohio 2006).	Motion to Dismiss	AICPA	Yes
7	In re Royal Ahold N.V. Sec. & ERISA Litig., 351 F. Supp. 2d 334 (D. Md. 2004).	Motion to Dismiss	AICPA	Yes
8	Brody v. Stone & Webster, Inc. (In re Stone & Webster, Inc., Sec. Litig.), 414 F.3d 187 (1st Cir. 2005).	Motion to Dismiss	Sarbanes-Oxley	Yes
9	Ley v. Visteon Corp., 543 F.3d 801 (6th Cir. 2008).	Motion to Dismiss	AICPA	Yes
10	Grand Lodge of PA v. Peters, 550 F. Supp. 2d 1363 (M.D. Fla. 2008).	Motion to Dismiss	AICPA	Yes
11	In re Williams Sec. Litig., 496 F. Supp. 2d 1195 (N.D. Okla. 2007).	Motion for Summary Judgment	AICPA	Yes
12	N.M. State Inv. Council v. Ernst & Young LLP, 641 F.3d 1089 (9th Cir. 2011).	Motion for Summary Judgment	AICPA	Yes
13	In re Parmalat Sec. Litig., 501 F. Supp. 2d 560 (S.D.N.Y. 2007).	Motion to Dismiss	AICPA	Yes
14	In re ArthroCare Corp. Secs. Litig., 726 F. Supp. 2d 696 (W.D. Tex. 2010).	Motion to Dismiss	AICPA	Yes
15	In re SmarTalk Teleservices, Inc. Secs. Litig., 487 F. Supp. 2d 928 (S.D. Ohio 2007).	Motion for Summary Judgment	AICPA	No
Note: The plaintiffs pled a violation of AICPA standards, but the court did not reach the issue in this case before making its final determination.

97 S. Cal. L. Rev. 495

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Nikita Patel*

* Executive Articles Editor, Southern California Law Review, Volume 97; J.D. Candidate, University of Southern California Gould School of Law, 2024; B.S., B.A., Boston College, 2017. Many thanks to Professor Jonathan Barnett for his feedback and guidance, as well as to the editors of the Southern California Law Review for their thoughtful suggestions. All mistakes are my own.

Perfecting the Judicial Peremptory Challenge: A New Approach Using Preliminary Data on California Judges in 2021

May 2024July 2024Sarah Park*

Even the most carefully planned and genius strategies are pointless without an assumption of fairness: chess depends on a fair arbiter, soccer depends on a fair referee, and litigation depends on a fair judge. Just as arbiters and referees are frequently criticized for questionable decisions, judges also deal with accusations that bias has impermissibly clouded their judgment. To protect litigants, the California Legislature presented a solution—the California Code of Civil Procedure section 170.6, a statute arming litigants with the option to replace their assigned judge if they declare that judge biased. This judicial peremptory challenge asks for no evidence of bias, further frustrating the disagreement between proponents who claim that this right will trigger a chain reaction to increased public confidence and decreased discrimination against litigants, and opponents who conversely warn that it will open a Pandora’s box of abuse, intimidation, and discrimination against innocent judges. The difficulty of constraining various harmful human tendencies is the problem of judicial peremptory challenges writ large.

It appears that much of this policy debate about judicial peremptory disqualification is informed by theory rather than empirical data. The study conducted by this Note reveals that, at least in 2021, (1) peremptory challenges do not occur often but abuse still occurs among the few times they are asserted, and (2) timing and form rules are weak procedural obstacles. My proposal acknowledges that judges are sometimes not the epitome of neutrality but takes issue with litigants who may inflict damage on undeserving judges and the adjudication generally. Instead of the current “no-questions-asked” regime, the recommended procedure is the following: after litigants receive judicial analytics, they can file the disqualification motion with an independent judge who will review both the motion and the challenged judge’s evidentiary explanation for factual and legal sufficiency. Admittedly, like its federal counterpart, this is not peremptory per se, but it is preferrable as it will perfect the peremptory challenge and diminish the risk of abuse even more than the current model.

INTRODUCTION

There is in each of us a stream of tendency, whether you choose to call it philosophy or not, which gives coherence and direction to thought and action. Judges cannot escape that current any more than other mortals.

—Justice Cardozo¹

The Lady Justice sculptures that adorn the United States Supreme Court building serve as a reminder of the high standards to which we hold judges: her blindfold and scales represent unwavering impartiality.² But juxtaposing Lady Justice, a godlike figure from ancient mythology,³ with judges, human beings vulnerable to inevitable fallibility,⁴ begs the question of whether these standards are unattainable ideals. What happens when judges cannot wear the blindfold and hold the scales yet still wield the sword symbolizing power?⁵ The California Legislature responded to this reality by enacting California Code of Civil Procedure section 170.6 (“Section 170.6”) which grants judicial peremptory⁶ challenges, or the power to automatically disqualify a judge for bias even without any evidence of such bias, to litigants.⁷ Given that plaintiffs and defendants in the United States bear the burden of proof to succeed in their claims and defenses respectively, the significance of this exceptional legal right is apparent. But the California Legislature was not blind to the potential for this statute to act as a double-edged sword:⁸ litigants and their attorneys are naturally inclined to exploit this power to “shop” for a judge that is likely to favor their cause.⁹ This cost-benefit analysis (“judge shopping,” which seems contradictory to the very essence of judging, weighed against public confidence in the judiciary) still plagues practitioners, legal academics, and judges today, decades after Section 170.6 was added to the California Code of Civil Procedure.

Although peremptory challenges are more commonly associated with jurors rather than judges,¹⁰ the ability to change the assigned judge cannot be understated. The jury has indisputable influence over a case’s outcome by “mak[ing] findings of fact and render[ing] a verdict for [] trial.”¹¹ Indeed, the foundational right to a judgment by one’s peers in the community dates back to the Magna Carta.¹² Nonetheless, the judge still decides questions of law¹³ and thus arguably holds equal, if not more, influence than the jury.¹⁴ This is especially so given all cases have a judge but not all of them have a jury.¹⁵ Moreover, a majority of cases do not proceed to trial: a judge’s ruling on a summary judgment motion has a conclusory effect akin to the end of trial.¹⁶ Even if a case reaches trial, a successful motion for judgment as a matter of law¹⁷ or a motion for new trial¹⁸ can subvert the jury’s verdict.

Considering judges’ unparalleled authority over litigants’ fate, notwithstanding the jury’s role, it is no surprise that judges must not “manifest bias . . . including but not limited to bias . . . based upon race, sex, gender, religion, national origin, ethnicity, disability, age, sexual orientation, marital status, socioeconomic status, or political affiliation . . . .”¹⁹ Judicial independence not only has a rich history predating Enlightenment philosophy,²⁰ but is also at the core of national identity in the United States: former President Adams, one of the Founding Fathers, wrote about the right to trial by “judges as free, impartial, and independent as the lot of humanity will admit” in the original Massachusetts Constitution.²¹ Judges are supposed to represent the best of human nature, maintaining superior morals and ethics. This image erodes when judges rule with regard to “which side is popular” and “who is ‘favored.’ ”²² Impartiality in the courts is not a mere exercise in political correctness but a vital component of a fair, just, and democratic society rid of corruption. Once the public no longer trusts judges to treat them equally with their adversary, a domino effect to anarchy may ensue whereby people will stop respecting and therefore complying with orders from the judiciary and government at large. However, judicial discretion is as crucial to the proper functioning of the legal system as judicial impartiality because indeterminate laws require judges to “consider practical consequences and the overall context of a matter.”²³ Alexander Hamilton, one of the Framers of the U.S. Constitution, distinguished between the “guided exercise of discretion” and the “imposition of personal will and preference” by highlighting the “importance of courageous judges to the preservation of individual liberty and to the amelioration of oppressive legislation.”²⁴

Ideally, litigants would always use Section 170.6 in good faith to defend themselves from judicial bias. Unfortunately, courts confront the ironic truth that some litigants abuse this ability as an offensive maneuver instead. Litigants may take advantage of peremptory challenges to substitute their judge with one that has aligned interests—that is, a biased judge. Section 170.6 can accordingly exacerbate the very problem it was designed to minimize. Bias is a two-way street in which litigants can also discriminate against judges of a particular gender, race, or ethnicity, among other demographics. There was increased legislative movement toward eliminating peremptory juror challenges for this reason in 2021²⁵ and publicity on race-based discrimination in jury selection in 2022.²⁶ If attorneys can discriminate against potential jury members, they can discriminate against judges as well, and the legal field should brace for any future spillover on peremptory challenges to judges. In 2022, 60.1% of judges in California were male, and 61.4% of them were white.²⁷ Imagine the harm that would result if most of the disqualified judges were members of groups that have historically endured discrimination. The judiciary would subsequently lose the diversity of thought and experiences necessary to adequately understand and evaluate heterogeneous litigants from the United States, a country often referred to as a melting pot.

This Note illustrates the need to abandon the judicial peremptory challenge as it exists today and instead opt for a blend of other variations—specifically, the challenge should be less peremptory and more stringent. Preliminary empirical data in 2021 reveals that (1) peremptory challenges do not occur frequently but abuse still occurs among the few times they are asserted, and (2) timing and form rules are weak procedural obstacles. Although the challenge is not widely abused, a different model will decrease the incidences of abuse even further. In lieu of a conclusory allegation of bias that is instantaneously granted, the proposed disqualification approach allows the challenged judge to refute the allegation with evidentiary explanations. This will hopefully pull the reins on the litigants, however few, who make an unwarranted, illusory charge of bias against their judge in order to gain a tactical advantage.

This Note begins by providing a high-level overview of how peremptory challenges to judges are treated by federal courts and other state courts besides California. It also explores Section 170.6 in detail, particularly the statute’s legislative history and interplay with judicial rules and peremptory juror challenges. Next, it summarizes the current policy arguments both in favor and against peremptory disqualification of judges: points of contention include discrimination against judges and confidence in the judiciary, among others. It continues with an analysis of data collected from every order in 2021 in which a California superior court judge decided on a Section 170.6 motion, tracking for the number of filed motions, number of denied motions and why they were rejected, number of disqualified judges, and the disqualified judges’ political party. It then synthesizes the findings with judicial disciplinary actions due to bias in 2021, which informs the policy debate by revealing the concerns that actually come to fruition in practice, rather than in theory only, at least in the context of California for this time frame. It additionally explores the reasons behind challenging a judge using The Robing Room, a public forum. Afterwards, it discusses alternative disqualification procedures offered by some legal scholars before advocating a new approach. Finally, the Note ends with recommendations for future research.

I. MODERN LAW OF JUDICIAL PEREMPTORY DISQUALIFICATION

Section 170.6 is a relatively recent addition to judicial disqualification law²⁸—the decades since its enactment pale in comparison to the more than one thousand years people have spent developing legal justifications for disqualifying judges.²⁹ In the mid-eighteenth century, the thirteen American colonies adopted English jurisprudence that,³⁰ unlike civil law countries, narrowed the scope of judicial disqualification so that a judge could only face disqualification if they had a direct pecuniary interest in the case.³¹ Thus, lacking basis in common law,³² disqualification for bias did not enter the stage until 1903, well after the founding of the United States, when Montana’s legislature answered the cries of a losing litigant.³³ This win for victims of judicial bias was part of a growing focus on ensuring that judges apply the law in an evenhanded manner,³⁴ eventually escalating into the federal law’s official acknowledgment.³⁵ The evolution of judicial disqualification finds itself at a fork in the road: some states in the West and Midwest, including California, allow disqualification with an allegation of bias alone—known as a peremptory challenge—while other states in the East and South join the federal courts in imposing stricter standards by requiring support for the allegation as well.³⁶

A. Federal Law

In 1911, 28 U.S.C. § 144 introduced judicial peremptory challenges into the federal realm.³⁷ This federal statute closely mirrors Section 170.6 as it permits the disqualification of a district court judge upon a timely affidavit claiming bias. However, it departs from Section 170.6 in a significant way: it requires the affidavit to “state the facts and the reasons for the belief that bias or prejudice exists” and accordingly affords less leeway to litigants.³⁸ On its face, its wording and legislative history hint at the intent for peremptory disqualification;³⁹ judicial interpretation steered it on the opposite trajectory.⁴⁰ After the Supreme Court in Berger v. United States opined that the challenged judge may conduct a hearing to scrutinize the alleged facts for legal sufficiency,⁴¹ the Court clarified in Liteky v. United States that “expressions of impatience, dissatisfaction, annoyance, and even anger, that are within the bounds of what imperfect men and women, even after having been confirmed as federal judges, sometimes display” fall short of bias.⁴² The latter case defined the extrajudicial source doctrine: critical, disapproving, or hostile opinions based on facts or events during the proceedings do not warrant disqualification unless “they reveal such a high degree of favoritism or antagonism as to make fair judgment impossible.”⁴³ Congress largely acquiesced to this rejection of peremptory intent lest they infringe upon the separation of powers by attempting to regulate the judiciary.⁴⁴ As a result, “disqualification under [28 U.S.C. § 144] has been rare.”⁴⁵ Naturally, the statute could no longer be classified as fully peremptory, distinguishing it from its state counterparts that order automatic disqualification, like Section 170.6.

B. California Law

1. California Code of Civil Procedure Section 170.6

In 1957, the California legislature debated whether to accept or deny the legacy of judicial peremptory challenges and ultimately concluded with the birth of Section 170.6 through an “overwhelming vote of both houses of the Legislature” and approval by the Governor.⁴⁶ The legislation was more radical⁴⁷ than California Code of Civil Procedure section 170.1 which concerns challenges for cause⁴⁸ and California Code of Civil Procedure section 170.5 (added as section 170.4 in 1897), which addresses bias as a ground for disqualification.⁴⁹ This was not the first time the Legislature dealt with judicial peremptory challenges: four previous measures failed to receive executive approval despite passage by the Legislature.⁵⁰ Therefore, Johnson v. Superior Court, the first case to apply Section 170.6, acknowledged how the “[s]tate [b]ar and the Legislature have long felt that there is a need for such a measure.”⁵¹

Unlike federal judges under 28 U.S.C. § 144, California judges generally fortified Section 170.6 by “liberally constru[ing it] with a view to effect its objects and to promote justice,”⁵² starting with its constitutionality. Since the constitutionality of peremptorily disqualifying a judge has been debated since the early twentieth century,⁵³ it comes as no surprise that Section 170.6 came under attack almost immediately after its enactment. Even before the Legislature took action, the courts in the state ruled in several cases that a similar disqualification statute enacted in 1937 was unconstitutional.⁵⁴ Johnson represented a turning point as the Supreme Court of California deemed Section 170.6 constitutional and overruled the lower court’s decision that “the statute makes an unconstitutional delegation of legislative and judicial powers to litigants and their attorneys and is an unwarranted interference with the powers of the courts.”⁵⁵ Section 170.6 is materially different from its unconstitutional predecessor because it calls for litigants to submit a sworn statement instead of a “judicial determination of the existence of the fact.”⁵⁶ According to the court, Section 170.6 complies with the Constitution and deserves protection because “[p]rejudice, being a state of mind, is very difficult to prove, and, when a judge asserts that he is unbiased, courts are naturally reluctant to determine that he is prejudiced.”⁵⁷ About twenty years later, Section 170.6’s constitutionality returned to the forefront in Solberg v. Superior Court—this court found no separation of powers violation under California Constitution Article III, Section 3.⁵⁸ In a post-Johnson and Solberg world, the conversation between Section 170.6’s proponents and opponents has shifted away from constitutionality, but policy concerns persist. As this Note will later discuss, the thousand-year-old debate has still not found its rest.

Section 170.6 was amended to widen its scope: beginning in 1959, the statute extended to criminal, not just civil, cases,⁵⁹ and beginning in 1961, oral statements under oath, not just written documents.⁶⁰ This trend halted in 1965, when the Legislature forbade litigants from receiving a judicial reassignment if their original judge already presided over a proceeding prior to trial that involved a “determination of contested fact issues relating to the merits.”⁶¹ For the next ten or so years, the statute was only amended twice—in 1967⁶² and 1976⁶³—to subject court commissioners and referees to potential peremptory disqualification as well.⁶⁴ The Legislature obviously did not shy away from its peremptory intent, given that the affidavit form was amended in 1981 to add “peremptory challenge.”⁶⁵ After another amendment in 1982 that clarified the timeliness requirement for single-judge systems,⁶⁶ the statute was expanded yet again in 1985. Now, litigants who file an appeal that results in the reversal of the trial court’s judgment qualify for protection if the “trial judge in the prior proceeding is assigned to conduct a new trial on the matter.”⁶⁷ Timeliness was then defined as ten days for criminal cases with an all-purpose assignment in 1989.⁶⁸ The following two amendments in 1998⁶⁹ and 2002⁷⁰ responded to modifications of the California Constitution—the elimination of the justice court⁷¹ and unification of the municipal and superior courts, respectively⁷²—which were products of the Legislature’s “stead[y] move[ment] towards completion of the courts’ restructuring.”⁷³ In 2003, the Legislature merely maintained the codes⁷⁴ and did not make any substantive changes.⁷⁵ The last amendment, in 2010, made similar corrections, but also extended the filing deadline for civil cases with an all-purpose assignment to fifteen days after receiving notice of the assignment⁷⁶ and “codif[ied] existing court practices by requiring the party making the challenge to notify all other parties within five days after making the motion [to peremptorily disqualify the judge].”⁷⁷

In general, Section 170.6 guarantees litigants the extraordinary right to have an alternate superior court judge hear their matter once they accuse their judge⁷⁸ of bias, even without any factual basis for actual bias.⁷⁹ Litigants can raise a challenge under Section 170.6 at any trial, special proceeding, or hearing involving a “contested issue of law or fact,”⁸⁰ including trial, law and motion proceedings, injunction hearings, and contested probate or family law proceedings, but excluding settlement or case management conferences.⁸¹ Each side in a case, defined by whether the co-plaintiffs or co-defendants have substantially adverse interests,⁸² is given one challenge—the norm.⁸³ “[I]f the trial judge in the prior proceeding is assigned to conduct a new trial⁸⁴ on the matter” after “reversal on appeal of a trial court’s final judgment,” the movant can still use Section 170.6 regardless of whether they have already availed themselves of this procedure.⁸⁵ They, however, cannot make the motion “for the first time in post-trial matters which are essentially a ‘continuation’ of the main proceeding,”⁸⁶ meaning “action[s] . . . involv[ing] ‘substantially the same issues’ and ‘matters necessarily relevant and material to the issues involved in the original action.’ ”⁸⁷ Absent good cause, there is no continuance of the trial or hearing because of the motion; if a continuance is granted for other reasons, the matter must be continued for limited periods to be reassigned as soon as possible.⁸⁸ In the aftermath of the 2010 amendment, civil litigants must serve notice on all parties within five days of making the motion.⁸⁹

Either an affidavit accompanied with a declaration that a “fair and impartial hearing or trial cannot take place” under penalty of perjury⁹⁰ or an oral motion under oath will suffice as long as it is made before the hearing or trial commences.⁹¹ Litigants should submit the written or oral motion “as soon as possible after [they] know[] with some reasonable certainty who the actual trial judge will be”⁹² and must take care to abide by the timing rules governing master calendar, all-purpose, and single-judge systems. Table 1 below describes each of these various case-management systems and their nuances:

Table 1.
Case-Management System	Definition	Rules
Master Calendar	The case is assigned to different departments for specific types of matters.^a	The litigant should make the motion to the judge supervising the master calendar. When the case is set for immediate trial, litigants are instructed to make their challenge at the time of assignment, but when the case is set for a later trial date, they should comply with the 10-day/5-day rule.^bThe 10-day/5-day rule dictates that a litigant must make their challenge at least five days before the trial or hearing date if the judge’s identity is known at least ten days before the trial or hearing date.^c If they wait until they appear before the judge, they will have essentially waived their right to challenge that judge.^d However, a late-appearing or late-named party will not be penalized as long as they make the motion within ten days after their appearance.^e
All-Purpose/ Direct-Calendar	The randomly assigned judge “maintain[s] [their] own calendar, set[s] and handl[es] all motions and other proceedings, and conduct[s] trial.”^f At the time of the assignment, the judge must be expected to process all substantial matters in addition to trial.^g	Once a civil litigant receives notice^h of an all-purpose assignment, they have fifteen days to make their challenge.ⁱ If the litigant receives service by mail, they are entitled to a five-day extension.^j However, if the litigant has not yet appeared, they have fifteen days after their appearance.^k For a criminal litigant, they have ten days instead of fifteen days.^l
Single-Judge	There is only one judge in the courts.^m	A litigant must make their challenge within thirty days after they first appear in the action.ⁿ
Sources: ^aO’Connor’s California Practice Civil Pretrial, supra note 48, at Ch. 3-E § 3.3(2)(a). ^bSee, e.g., People v. Roerman, 10 Cal. Rptr. 870, 878–79 (Ct. App. 1961) (rejecting the motion because it was not made until the day trial was scheduled to begin even though the case was calendared to the judge for more than a month). ^cE.g., Eagle Maint. & Supply Co. v. Superior Ct., 16 Cal. Rptr. 745, 747 (Ct. App. 1961). ^dSee, e.g., Michaels v. Superior Ct., 7 Cal. Rptr. 858, 860–61 (Ct. App. 1960); Peremptory Challenges to a Judge in California, L. Off. of Stimmel, Stimmel & Roeser, https://stimmel-law.com/en/articles/peremptory-challenges-judge-california [https://perma.cc.6NLU-5PLS]. ^eSch. Dist. of Okaloosa Cnty v. Superior Ct., 68 Cal. Rptr. 2d 612, 612 (Ct. App. 1997). ^fO’Connor’s California Practice Civil Pretrial, supra note 48, at Ch. 3-E § 3.3(2)(b). ^gSee, e.g., People v. Superior Ct. (Lavi), 847 P.2d 1031, 1043 (Cal. 1993). ^hAccording to the opinion of Cybermedia, Inc. v. Superior Ct., 82 Cal. Rptr. 2d 126, 127 (Ct. App. 1999), notice should reference the case name and full case number and be addressed to the attorney if the party is represented; otherwise, it is insufficient. ⁱCal. Civ. Proc. Code § 170.6(a)(2) (Deering 2023). ^jMotion Picture & Television Fund Hosp. v. Superior Ct., 105 Cal. Rptr. 2d 872, 876 (Ct. App. 2001). ^kCiv. Proc. § 170.6(a)(2). ^lId. ^mO’Connor’s California Practice Civil Pretrial, supra note 48, at Ch. 3-E § 3.3(2)(b). ⁿSee, e.g., People v. Superior Ct. (Smith), 235 Cal. Rptr. 482, 484 (Ct. App. 1987) (refusing the movant’s argument that their motion was timely because it was made within thirty days after their attorney’s first appearance).

If litigants who successfully appeal the trial court’s judgment end up with the same trial judge, they must make the motion “within [sixty] days after the party or the party’s attorney has been notified of the assignment,”⁹³ or else it will be time-barred. The motion must be directed to the very judge under attack (the particular department will not suffice) who will then determine if it has been duly presented.⁹⁴

There are compelling policy reasons for these rules, namely that both litigants who “wish[] to postpone [the] motion until [they are] fully informed” and the court that needs “time to make adjustments after a disqualification” are satisfied.⁹⁵ Also, criminal litigants have less time to submit their motions than civil litigants because, like the Legislature probably thought, there are heightened concerns of abuse in criminal cases⁹⁶ in which “the sides . . . are not in symmetrical positions,” as the prosecution possesses more power.⁹⁷ Criminal cases usually involve juries that dilute the judge’s influence, whereas civil cases are usually wholly decided by the judge.⁹⁸ Even so, criminal defendants are insulated from the “depriv[ation] of life, liberty, or property, without due process of law” by the Bill of Rights in the Fifth Amendment of the U.S. Constitution.⁹⁹ Given what they have to lose as compared to civil litigants, it is critical to avoid infringement on their right to a fair trial.

If the motion is timely filed with acceptable form,¹⁰⁰ it will be granted, and the transition process is automatic in the sense that the affidavit is not contestable. The “judge immediately loses jurisdiction over the case,” and “any action that [they] make[] in the case [is] considered ‘void,’ ” save to transfer the case to another judge.¹⁰¹ A challenge is “exercised when the challenged judge transfers the case for reassignment,”¹⁰² and it cannot be rescinded, no matter what—the dismissal of the movant makes no difference.¹⁰³ If no other judge is available, the disqualified judge should contact the Chairman of the Judicial Council to solicit the assignment of an outside judge.¹⁰⁴ In order to prevent the appearance of judicial impropriety, if the judge is assigned to more than one case concerning the same movant, they are disqualified from all such cases.¹⁰⁵ A writ of mandate petition is the “exclusive means of appellate review” for the motion, irrespective of its success.¹⁰⁶ Upon a failed motion, the litigant has two avenues of redress before appeal: review by a different judge, like the district’s chief judge, and mandamus review.¹⁰⁷ On the other hand, litigants who never assert a challenge will have “forfeited the right to complain about [how the trial court’s alleged bias affected subsequent rulings] on appeal.”¹⁰⁸

2. Judicial Rules

Section 170.6 intersects with other bodies of judicial rules, complicating the tapestry of California peremptory disqualification law. Upholding impartiality in the courts permeates all the guidelines that judges should follow, regardless of origin—Standard 10.20(b)(3) of the California Rules of Court instructs judges to “ensure that all orders, rulings, and decisions are based on the sound exercise of judicial discretion and the balancing of competing rights and interests and are not influenced by stereotypes or biases.”¹⁰⁹ In light of this goal, the California Rules of Court encourage outreach to the community¹¹⁰ and collaboration with local committees and bar associations that endorse programs designed to educate about unconscious biases.¹¹¹ When litigants encounter judges who ignore Standard 10.20 of the California Rules of Court, they can submit complaints of bias either directly to the court or to the Commission on Judicial Performance without losing their statutory remedy through Section 170.6.¹¹² California Code of Judicial Ethics Canon 3D(4), Government Code section 68725, and Rule 104 of the Rules of the Commission on Judicial Performance obligates judges to cooperate with the Commission on Judicial Performance.¹¹³ In one instance, the Commission on Judicial Performance ordered the removal of a judge who communicated with the potential movant to stop their challenge.¹¹⁴

California Code of Judicial Ethics Canon 3B(5), Canon 3C(1), and Canon 3E(5)(f)(iii), among others, comport with the Model Code of Judicial Conduct rule 2.3¹¹⁵ because they advise that judges should be free of bias.¹¹⁶ Similar to the California Standards of Judicial Administration, California Code of Judicial Ethics Canon 3B(6) directs judges to “require lawyers in proceedings before [them] to refrain from . . . bias.”¹¹⁷ They consequently may feel cognitive dissonance (psychological discomfort from simultaneously complying with incongruous beliefs¹¹⁸) from essentially allowing litigants to discriminate against them using Section 170.6. Granted, these “standards, insofar as they may conflict with [S]ection 170.6, would be ‘invalid’ since the Judicial Council may only make rules which are not inconsistent with statute,”¹¹⁹ but this paradox may still trouble them. Furthermore, California Code of Judicial Ethics Canon 3D(1) instructs judges with reliable information on the violations of other judges to report those violations to the appropriate authority and take any other corrective actions.¹²⁰ Considering these numerous regulations that either officially or informally punish judges who harbor biases, whether explicit or not, are peremptory disqualifications truly necessary?¹²¹

3. Comparison to Peremptory Juror Challenges

In California, judicial peremptory challenges enjoy less resistance than in some other jurisdictions¹²² but are nonetheless more controversial than peremptory juror challenges. The California legislature passed AB 3070 in 2020—a proposal to require “the party exercising the peremptory challenge [to] show by clear and convincing evidence that an objectively reasonable person would view the rationale as unrelated to a prospective juror’s race, ethnicity, gender, gender identity, sexual orientation, national origin, or religious affiliation.”¹²³ The Legislature deliberately replaced the need to show purposeful discrimination under an objective standard in order to better target unconscious bias.¹²⁴ Unlike judicial peremptory disqualification, in which there is confusion regarding who holds the cause of action for discriminatory exclusion,¹²⁵ the bill clearly gives the right to both the party and the trial court. California Governor Gavin Newsom signed the legislation into law (California Code of Civil Procedure § 231.7), which went into effect for criminal trials on January 1, 2022 and will take effect for civil trials starting January 1, 2026.¹²⁶ The statute joined reforms in other states:¹²⁷ Washington enacted a similar procedure in 2018 that was praised as a solution to Batson v. Kentucky,¹²⁸ a landmark case prohibiting unconstitutional discrimination during jury selection.¹²⁹ After observing Batson’s shortcomings in actually resolving racial bias and discrimination,¹³⁰ supporters argue that the spirit and letter of this legislative decision carries the promise of giving life to the federal precedent.¹³¹

But this law is not without dissenters. The Alliance of California Judges rebukes it for creating “confusion and delay” since “lawyers could challenge every peremptory challenge made by the other side.”¹³² Ultimately, it falls short of putting an end to peremptory juror challenges altogether, making others think that the change is not enough: Senate Bill 212 was introduced in 2021, which would have abolished peremptory challenges in criminal cases.¹³³ One wonders at the end of the day if it is still accurate to classify this challenge as peremptory as “[a] challenge subject to questioning and explanation is, by definition, not peremptory.”¹³⁴ Whether judicial peremptory challenges can inherit this reform such that it is workable to judges poses an interesting question.

C. Comparison Between California Law and Other States’ Law

Section 170.6 is one of the two forms of judicial peremptory challenges practiced by twenty states. Judicial officers in thirteen states, like jurors, can be substituted upon request without any accusation of improper personal interest, while those in the remaining seven states can only be substituted upon an affidavit of bias.¹³⁵ Table 2 below describes some differences between Section 170.6 and peremptory challenge statutes in other states:

Table 2.
Parameters	Section 170.6	Statutes in Other States
Is there a fee for reassignment to a new judge?	No	Yes^a
How many challenges to a party per case?	One	Two^b
Does alignment of interest or lack thereof define a party (or side)?	Yes	No^c
Must litigants informally ask the judge to voluntarily recuse from the case before filing an affidavit?	No	Yes^d
Can criminal litigants transfer their case to a different judge?	Yes	No^e
Sources: ^aSee, e.g., Mont. Code Ann. § 3-1-804 (West 2023); Nev. Rev. Stat. Ann. § 1.230 (West 2023). ^bE.g., Or. Rev. Stat. § 14-250-70 (West 2023). ^cMo. R. Civ. Pro. § 51.05 “divides the parties into classes (e.g. plaintiffs, defendants, third party plaintiffs, third party defendants, interveners) and affords one change of judge per class” and Nev. Rev. Stat. Ann. § 1.230 treats “[e]ach action, whether single or consolidated . . . as having only two sides. Clingman, supra note 135, at 337–38. ^dS.D. Codified Laws § 15-12-22 (2023); see Clingman, supra note 135, at 338. ^eInd. Code Ann. § 35-36-5-1, Nev. Rev. Stat. Ann. § 1.230, Tex. Gov’t Code Ann. § 74.053, and Wyo. R. Civ. P. 40.1(b)(1) are some statutes that recognize this right in civil cases only. Clingman, supra note 135, at 338.

Although these states are not uniform in protocol, they all place weight on a movant’s good faith and decline to investigate whether the movant’s reasons, if even stated, are true, differentiating state law from federal law, which demands supporting facts.

II. THE POLICY TRADE-OFFS

A. Public Confidence in the Judiciary

Those who applaud the judicial peremptory challenge, a device that makes it easier to disqualify judges, emphasize its utility in maintaining and increasing public confidence that the judiciary will deliver equal justice under the law. Although “the law, not any individual or group, is a judge’s only legitimate constituent,” judges have free speech protections in judicial election campaigns.¹³⁶ If their views on controversial legal and political issues are broadcast through various media outlets, the public will naturally lose hope that due process¹³⁷ still exists in the courtroom. Since judges will likely reveal their biases, there are practitioners who advocate for appellate courts to adopt the peremptory strike system, as in California trial courts through Section 170.6, so the public can trust that their matters will be heard by a neutral arbitrator.¹³⁸ They echo Justice Kennedy’s advice for states to “adopt[] recusal standards more rigorous than due process requires” in an effort to protect judicial integrity.¹³⁹ Meanwhile, worried about the increasing caseload burdening the federal judiciary, some academics urge Congress to set up a commission responsible for establishing a judiciary reform act that would go into effect in 2030.¹⁴⁰ As the judiciary becomes more congested with inefficient case management and reduced dockets, judicial competence suffers, especially considering the “10% problem,” which is a “rough estimate of the percentage of district court judges who are considered unfit or limited in their capacity to dispense justice fairly.”¹⁴¹ These academics provide the 2030 Commission with a solution: peremptory challenges.¹⁴²

Curiously, the reason cited for condemning the challenge sounds familiar—increasing public confidence in the administration of justice. One legal scholar believes peremptory disqualification injures the judiciary’s reputation because “automatic transfer does not permit a judge to refute the allegations of bias, and so may create the public impression that more judges are biased, or have conflicts of interests, than is actually the case.”¹⁴³ Regrettably, judicial discretion, in which “the law gives the judge a range of options and choices, or relies on the judge’s assessment of the circumstances in drawing further conclusions,” exposes judges to criticism without crisis managers to guide them through this era of social media.¹⁴⁴ As committees and organizations dedicated to judicial independence face extinction, many stress the need for the legal profession to rally in defense of judges, perhaps by devoting resources to educating the public on what judges actually do.¹⁴⁵

B. Abuse of the Challenge

Peremptory challenges to judges can disrupt the harmony between not just a litigant and their judge, but also the litigant’s attorney and the judge, as well as the litigant and their attorney, essentially poisoning the most material relationships in the courtroom. First, the litigant must present the motion to the very judge they want disqualified.¹⁴⁶ Since the judge knows the movant’s identity, they may feel “frustrated at being required to grant relief to a party who had made what [they] consider to be an unwarranted slight to their integrity.”¹⁴⁷ If the motion is rejected, the litigant is stuck with the allegedly biased (and now insulted) judge until appeal because it is difficult to prevail on other review proceedings.¹⁴⁸ Second, although the attorney might wish to evade a particular judge for their entire legal career, a successful motion in one case does not insulate them from the judge’s hostility in future cases.¹⁴⁹ Third, caught in a web of ethical obligations, the attorney deals with an uncomfortable dilemma: Are they loyal to the judge or their client? No matter their self-interest to stay on good terms with the judge, they must reconcile their duty of vigorous advocacy on behalf of their client with their duty of honesty and respect to the court. They are probably tempted to use their affidavit power (that is, to capitalize on the boilerplate affidavit requesting only a conclusory accusation of bias) to win their client’s case, for they are given the benefit of the doubt.¹⁵⁰ However, their capability as “true advocates” is impeded by ethical rules that impose professional discipline should they lie about judges.¹⁵¹ They also cannot claim the full extent of free speech rights under the First Amendment, presumably fueling their apprehension at the growing number of sanctions in 2022.¹⁵²

Since the genesis of peremptory disqualification statutes, the risk of “judge shopping” has haunted legal scholars and practitioners alike. They argue that marginal improvements to judicial accountability do not warrant sacrificing judicial independence and integrity. When litigants judge shop under the guise of eliminating bias, they perpetuate the narrative that judges are simply “politicians in black robes” even though the Model Code of Judicial Conduct, court rules, judicial discipline sanctions,¹⁵³ and public opinion motivate judges to act properly. Admittedly, this illegitimate purpose is not allowed; the challenge, however, is an absolute right without regard for pretenses. For instance, according to one columnist, “[Section 170.6] could be warranted against the judge who tends to let all of [their] cases go to trial” if the attorney is “hoping to escape [the case] via summary judgment.”¹⁵⁴

To rebut these complaints of abuse, the challenge’s supporters point to the stringent rules governing the motion: specifically, its timing (framed as rushing litigants to “move[] as expeditiously as . . . is possible . . . after theretofore agreed on matter becomes litigated”¹⁵⁵) and form. These restrictions should discourage litigants from not only judge shopping, but also “from waiting to see how the judge views the case and rules on motions before making the peremptory challenge decision.”¹⁵⁶ Section 170.6, for example, is a “limited right and is not a vehicle for disqualifying judges in all situations in which there is a potential for bias.”¹⁵⁷ One law professor advances a limited conception of misuse such that litigants (1) can avoid extremist judges who are not necessarily biased but (2) cannot technically judge shop since a randomly assigned judge will preside over the previously assigned judge’s disqualification.¹⁵⁸ Peremptory disqualification increases the chance of the new judge sharing the same beliefs as most judges, which promotes a representative judiciary that reflects the citizenry because “an average judge may be more representative than a random one.”¹⁵⁹ This kind of judge shopping, as defined by the challenge’s opponents, is akin to “forum shopping,”¹⁶⁰ but the former is attacked as a radical threat to American ideals, while the latter enjoys more forgiveness from critics. The same can be said of “filing several cases simultaneously and dismissing all but the case before one’s preferred judge.”¹⁶¹ Besides statutory safeguards, like the very short window of opportunity to exercise a challenge, litigants might eschew the challenges—if their motion succeeds, they risk an even more unfavorable judicial draw, but if their motion fails, they risk a resentful judge.

C. Intimidation of Judges

There is also a strong assertion that judges will encounter intimidation, further cementing the deadlock between the two stances. A judge is more likely to be influenced by pressure from the litigant and their attorney when the defendant’s life, liberty, and property are hanging in the balance—in other words, criminal cases. Does the judicial peremptory challenge enable prosecutors to shop for “law and order” judges who are “tough on crime”?¹⁶² If a judge is peremptorily disqualified from every criminal matter to which they are assigned (colloquially known as “papering” or “blanket challenges”),¹⁶³ they risk not only a non-criminal reassignment that poses a “very serious problem for a judge whose entire legal career has been spent in the criminal justice system,”¹⁶⁴ but also transfer to a court that is, in their opinion, more inconvenient or less prestigious.¹⁶⁵ As judges try to appease prosecutors to avoid repeated disqualification, the pool of judges actually deciding criminal cases becomes undersaturated with lenient and liberal judges.¹⁶⁶ Prosecutorial control over judges (along with other challenges due to unusual judicial philosophies) results in a much smaller spectrum of worldviews among judges, hampering the development of legal interpretations and encumbering healthy debate.¹⁶⁷ Erwin Chemerinsky responds to the “unlimited use of peremptory challenges against a single judge, albeit in different cases,” by prescribing even greater procedural protections.¹⁶⁸ However, even if litigants manipulate this mechanism to pressure judges,¹⁶⁹ it is hard to imagine judges succumbing to partiality after only one or even a few cases. Perhaps district attorneys or public defenders who frequently appear in the same court can effectively intimidate judges,¹⁷⁰ but in the big picture, criminal cases make up a small subset of total filings.¹⁷¹

D. Discrimination Against Judges

Two law professors illustrate how judicial peremptory challenges can act as a vehicle for discrimination: one uses a hypothetical,¹⁷² while the other uses two cases in which attorneys were accused of discriminating against their judges.¹⁷³ There is a 1985 study suggesting that race-based abuse of the challenge was rare,¹⁷⁴ but the latter professor dismisses its applicability because there is now greater awareness about the unconstitutionality of racially charged decisions,¹⁷⁵ especially after Batson and J.E.B. v. Alabama ex rel. T.B.¹⁷⁶ With more judges who identify with marginalized groups, there are consequently more opportunities for challenges based on protected characteristics (leading to disproportionate disqualifications along racial lines, for example).¹⁷⁷ In California, where 63.1% of judges are white, a white judge will probably substitute a disqualified judge of color.¹⁷⁸ These removals are contrary to a socioeconomically representative judiciary—judicial officers from historically oppressed groups are more likely to have public-interest experience and less likely to have a upper-class background than their colleagues.¹⁷⁹ Additionally, empirical studies implying that age and gender are outcome determinative may tempt litigants into issuing ageist or sexist challenges.¹⁸⁰ Other studies have confirmed the discriminatory effects of peremptory juror challenges,¹⁸¹ substantiating arguments that the challenge is inherently flawed and does more discriminatory harm than any good.¹⁸² This could ring true for judicial peremptory challenges as well: What is stopping attorneys who discriminate against jurors from also discriminating against judges?

Then again, litigants are forbidden from exercising the challenges solely based on group affiliation like race and ethnicity, gender, sexual orientation, religion, and so forth.¹⁸³ They may not even want to rely on such factors—a judge’s “prior decisions made while on the bench, statements made in public forums, [and] professional and political reputations years deep”¹⁸⁴ better predict judicial propensity, after all. According to a member of the Alaska Judicial Council, the challenges in that state did not, in fact, depend on race or gender.¹⁸⁵ The problem, however, is not simply solved. Take California Code of Civil Procedure section 170.2, Section 170.6’s sister judicial disqualification statute, for example. It prohibits discrimination against judges, yet it does not seem to apply to Section 170.6.¹⁸⁶ Despite precedent that judges deserve shelter under the Equal Protection Clause of the Fourteenth Amendment,¹⁸⁷ “any party charging that [their] adversary has used a [S]ection 170.6 challenge in a manner violating equal protection bears the burden of proving purposeful discrimination,”¹⁸⁸ which is a high, if not unattainable, standard. Historical patterns of a movant’s discrimination could replace direct evidence of discriminatory intent, but there is a caveat: Is it possible to discern a pattern from a relatively small sample size?¹⁸⁹ Moreover, in the event the judge, as the right holder, declines to pursue their cause of action for discriminatory challenges, there is much uncertainty about whether litigants then have standing to object.¹⁹⁰

III. EMPIRICAL FINDINGS IN CALIFORNIA

A. Research Methodology

It appears that much of the policy debate about judicial peremptory disqualification is informed by theory rather than empirical data. Where are the surveys asking the public in states that allow the challenge about their confidence in the judiciary and perception of judicial bias? There is some research investigating how the challenges can intimidate judges (especially if initiated by prosecutors¹⁹¹) and discriminate against judges of a certain race or gender.¹⁹² Nonetheless, there remains a dearth of statistical findings regarding the frequency and type of abuses resulting from peremptory challenges in actual operation.¹⁹³ “[W]ithout [the collection of empirical data], predictions about what attorneys will do [or cause] with peremptory challenges are guesswork,” leaving the aforementioned hypotheses with no answers.¹⁹⁴ Therefore, this Note aims to paint a more complete picture by tackling two questions: (1) do strict procedural rules really act as a barrier to slow the number of disqualifications, so the number of disqualified judges is roughly equal to the number of judges disciplined for bias, and (2) are there discriminatory effects based on judges’ political parties that prevent a representative judiciary? It will do so by adhering to the recommendations to examine orders on peremptory challenges in cases.¹⁹⁵

Due to limited time and resources, only the available orders on LexisNexis (specifically, the 240 citing decisions of Section 170.6 after filtering for a timeline of January 1, 2021 to December 31, 2021) are analyzed. LexisNexis is a trustworthy source,¹⁹⁶ but checking other databases, such as Westlaw, would have ensured that this methodology did not overlook orders. This truncated sample is largely not generalizable to the years before or after 2021. California is also not a microcosm for the entire nation: when interpreting the number of disqualified judges who were registered Democrats versus the number of disqualified judges who were registered Republicans, one should remember that California is a “blue” state that is considered a Democratic stronghold. Further, this Note interprets suggestive trends, not causal relationships, from the data as no formal statistical methods are used. Lastly, given that the cases’ dockets, including other related orders, opinions, and filings are not reviewed, there is missing information for some orders (for instance, the disqualified judge’s identity, the order’s date, whether the order was accepted or denied, and the reason behind the decision), which could misrepresent the results. For decisions that anonymously mention both the disqualified judge and the supervising or presiding judge, and hence create confusion about the role of the decision’s author, the analysis below errs on the side of caution and excludes these orders when tracking disqualified judges. Ideally, the study would only include orders from 2021; for consistency, it includes orders both without a date and from before 2021 if the decision that discusses the order is from 2021.

B. Preliminary Empirical Data

There were 134 cases from January 8, 2021 to December 30, 2021 that revealed 158 ascertainable orders either accepting, denying, or discussing previously accepted or denied judicial peremptory challenges. For reference, there were 4,464,380 total filings in California superior courts in 2021.¹⁹⁷ Curiously, out of the 58 counties in California, only 11 (19%) had reported orders: Los Angeles (76 filed motions), Orange (41 filed motions), Sacramento (24 filed motions), San Diego (5 filed motions), Alameda (3 filed motions), Riverside (3 filed motions), Contra Costa (2 filed motions), Butte (1 filed motion), Madera (1 filed motion), San Francisco (1 filed motion), and Santa Clara (1 filed motion). Given that the study found 158 motions from just 134 cases and movants in only 11 out of 58 counties, this low occurrence of the challenges suggests that (1) litigants are generally not taking advantage of this litigation tool for improper purposes and (2) a majority of judges are perceived to be impartial. Since succeeding judges are randomly selected, there is a chance that litigants who detected bias in their judge would have issued a challenge if not for the fear that they might have to litigate under an even more biased judge. But, excluding pessimistic litigants who have little faith in judicial officers as a whole, it is unlikely that they will choose not to file a motion and endure a laborious litigation under a biased judge.

Among the 158 motions under Section 170.6, only 54 (34%) denied the challenge—Figure 1 displays the number of denials per specific reason:

Figure 1.

Section 170.6 is replete with rigorous procedural rules to make it harder for litigants to recklessly eliminate a qualified judge assigned to their matter. First, a little more than half of the denied motions (52%) failed to comply with Section 170.6(a)(2)’s timing standards.¹⁹⁸ Second, 4 challenges (7%) were defeated because they were addressed to an appellate judge and thus did not survive Section 170.6(a)(1).¹⁹⁹ Third, there was a three-way tie for reasons that blocked 3 motions (5.5%) each: submitting more than one challenge, in violation of Section 170.6(a)(4), whether it was from one party or one determined side;²⁰⁰ the continuation rule, codified by Section 170.6(a)(5); and the form standards, mandated by Section 170.6(a)(5) for written affidavits and Section 170.6(a)(6) for oral statements.²⁰¹ Fourth, 2 others (4%) were unsuccessful because the court had no authority.²⁰² Fifth, 1 (2%) was denied as the movant had not yet appeared in the action.²⁰³ There was also a strange motion that was declared a “sham” since the litigant who filed the challenge was not a real person—as a result, the judge denied the challenge as it was not “duly presented” in accordance with Section 170.6(a)(4).²⁰⁴ Regrettably, the reasons for 9 denials (17%) could not be gleaned from the publicly available case material.²⁰⁵

In line with the empirical finding that 66% of challenges were granted, attorneys, at least competent ones, are not only aware of the timing and form rules, but also successfully follow them. This comes as no surprise considering they are used to meeting the many deadlines that make up litigation. The odds of submitting a faulty challenge and consequently suffering under an offended judge are negligible—presumably, counsel would not carelessly file a motion that they know or should know is bound to fail. There are several safeguards that litigants must navigate, but untimeliness, the most frequent reason for rejected motions, was a weak barrier, stopping just 18% of the challenges. The statute counts on the time limit for filing the motion to prevent litigants from peremptorily disqualifying their judge based on how the judge has been ruling on the case. However, litigants or their attorneys may already know how the judge will view their case as soon as they receive the judicial assignment (or at least within the designated time frame) due to “random internet searches, anecdotal opinions from colleagues, or perhaps printed biographical material about the judge.”²⁰⁶ Hence, it looks like the limit on the number of challenges per case is the only statutory design that might effectively stall abuse, as litigants are reluctant to gamble that their new judge will not be worse.

The remaining 104 successful challenges (66%) disqualified at least 37 judges from 1 or more cases. Figure 2 below illustrates this proportion:

Figure 2.

Given there were 1,755 superior court judges in 2021,²⁰⁷ 2% of those judges (notwithstanding both the unnamed judges and judges who ruled prior to 2021) were peremptorily disqualified. According to the California Commission on Judicial Performance’s 2021 Annual Report, a judge was disciplined for bias on 8 occasions: 5 times for “bias or appearance of bias not directed toward a particular class (includes embroilment, prejudgment, favoritism)” and 3 times for “bias or appearance of bias toward a particular class.”²⁰⁸ For context, there were “1,868 judgeships within the commission’s jurisdiction” including the judicial positions at the supreme court, courts of appeal, and superior courts.²⁰⁹ Even if all 8 instances of bias were from different superior court judges, less than 1% (0.5%) of all superior court judges would have faced discipline.

According to this data, there were more disqualified judges (2%) than judges disciplined for bias (0.5%). Judicial accountability was promoted when the 0.5% of judges who deviated from ethical guidelines were disqualified; what about the remaining 1.5% of judges? Of course, these judges might have just luckily evaded discipline for their bias. Discipline, unlike peremptory challenges, requires an investigation, not solely a mere allegation.²¹⁰ That being said, if the litigants and their attorneys truly thought their judge was biased, they could have complained to the Commission on Judicial Performance (at least anonymously) in order to avoid facing the same judge again.²¹¹

A disqualified judge’s age, race, and gender, among other characteristics, were not easily identifiable. However, the judge’s political leanings (determined by which political party they were registered for) were discoverable for 21 out of the 37 disqualified judges. Thirteen judges (62%) were Democrats, 7 judges (33%) were Republicans, and 1 judge (5%) was a Libertarian. This Note is committed to preserving these judges’ anonymity as they may understandably want to keep their politics confidential. Unfortunately, the distribution of party affiliation in the state judiciary was not readily ascertainable, but the total voter registration by political party provided some context—in 2021, 46.5% of voters were Democrats, and 24% of voters were Republican.²¹² The comparison is illustrated by Figure 3 below:

Figure 3.

The law does not and cannot cover every kind of situation, so judicial discretion in the interpretation of the law maintains the legal system. Accordingly, judicial disqualification must take into account the diversity of experiences and legal philosophies that make up the bench. Each judge should have opportunities to arbitrate cases; otherwise, caselaw will cease to think outside the box. Yet, the data reveals that 62% of the disqualified judges were registered Democrats, and 33% of those judges were registered Republicans. Granted, without knowing how many California judges in sum have a Democratic-party affiliation, this is weak evidence for party-affiliation bias. But it is at least some insight that may suggest at best discriminatory effects and at worst purposeful discrimination against Democrat judges—for not only criminal, but also civil cases.²¹³ If judges from a particular political party are systematically taken off matters through peremptory challenges, the judiciary becomes less representative. Consider how there are “persuasive correlations between the political party of the appointing authority and the judge’s decisions on certain issues,” according to an academic study of judicial decision-making.²¹⁴ Other group affiliations are also implicated: Black, Hispanic, and Asian voters are typically more liberal than conservative.²¹⁵

Of 37 disqualified judges, 33 of them had reviews on The Robing Room—a forum “by attorneys for attorneys” in which “judges are judged.”²¹⁶ Fifteen judicial profiles had at least 1 comment from or before 2021 that mentioned a Section 170.6 motion—all but 1 recommended a peremptory challenge. Out of the 32 comments urging others to use Section 170.6 (many of which listed more than one reason), only 15 comments (47%) complained of the judge’s bias. While 3 comments (9%) gave no reason at all, the remaining 17 comments cited explanations that did not concern bias: 17 (53%) for incompetence, 9 (28%) for unpleasant temperament, 4 (12.5%) for unnecessary delay, and 4 (12.5%) for disliked persons working in the judge’s chambers. Out of respect for these judges, their identities will remain anonymous, especially since the information is not necessary to this Note’s analytical aims. Figure 4 below demonstrates this distribution of motives:

Figure 4.

Section 170.6 blatantly spells out the one acceptable rationale for challenging the judge—bias. When litigants abuse their affidavit power against unbiased judges (that is, “judge shopping,” although the term does not quite capture the concept), they are admitting their search for a judge who will favor their side. The sample of comments from The Robing Room implies that Section 170.6 is not an obscure and hidden procedure. Rather, attorneys understand that they can peremptorily disqualify their judge through Section 170.6. Fifty-three percent of these comments recommending a challenge did not complain that the judge was biased. Admittedly, it is uncertain whether the litigants who challenged their judge in this study held the same beliefs as these reviewers or were influenced by these reviews in making their challenge. Though the data does not definitively prove that reasons outside of bias motivated these challenges, it still exposes what some practitioners think these challenges should be used for. Incompetence, unpleasant temperament, unnecessary delay, and disliked persons working in the judge’s chambers are undoubtedly serious problems, but they are problems that nevertheless affect both the plaintiff and defendant—there is no favoritism and therefore no bias. The duty of vigorous advocacy on behalf of the client is not a free pass for attorneys to bend the law to their will.

Besides The Robing Room, there were other published sources documenting criticism of the disqualified judges: circulating petitions for removal, judicial corruption activism pages, and news articles about their behavior in their private or public lives. One news outlet asked a disqualified judge about her alleged bias toward women to which she responded that there is probably an equally strong sentiment that she is biased toward men. Notably, the Commission on Judicial Performance publicly admonished one of the disqualified judges for improper conduct extraneous to bias.

There is arguably universal consensus that public confidence in the judiciary is of the utmost importance—the public needs assurance that they can rely on the courts for remedies to their legal grievances. The uproar against judges on the Internet (that is, the petitions, activism pages, news reports, and so forth) feeds the public impression that judicial independence is forgotten and left behind on the courthouse’s steps. Even if a judge’s attitudes on contentious issues in the legal and political community escape the public eye, the seemingly innocuous knowledge of the judge’s political-party registration can speak volumes given modern political polarization.²¹⁷ Republican litigants confronting Democrat judges may believe the “politicians in black robes” will unequivocally rule left, and vice versa for Democrat litigants. The perception of bias in the courts is disconnected from whether bias is actually rampant among judges.

IV. ALTERNATIVES TO CALIFORNIA’S JUDICIAL PEREMPTORY CHALLENGE

A. Existing Alternative Procedures

Despite an overall low risk of abuse, since judicial peremptory challenges are seemingly infrequent, there is little need for the challenge at all, at least in its current form. The empirical findings cast alternative approaches in a new light. This Note focuses on three ideas for compromise: the panel-exclusion approach, the interlocutory appeal approach, and the independent judge approach.

1. The Panel-Exclusion Approach

The panel-exclusion approach advocates the adoption of a procedure similar to that used in arbitration.²¹⁸ Litigants would anonymously exclude judges who are randomly placed on the case’s panel.²¹⁹ Unlike the challenge as it currently stands, court administrators would provide litigants with a “compilation of numerous exclusion decisions,” including rates, prior to any challenge, so litigants can make informed decisions without relying solely on “mistakes in individual cases.”²²⁰ This is an especially fruitful modification considering the overwhelming amount of unsolicited opinions and false stories online. Judicial analytics not only puts judges on notice about their inappropriate behavior and thus provides opportunities to cure such behavior, but also wins trust from the public by prioritizing transparency and honesty.

2. The Interlocutory Appeal Approach

A retired Associate Justice of the Arkansas Supreme Court admires Tennessee’s civil procedure in which “[t]he judge refusing to recuse, following a motion to do so accompanied by an affidavit, must enter an order stating his or her reasons for not recusing and any other pertinent information from the record for an immediate, interlocutory appeal to the Tennessee Court of Appeals, where that court will expedite and conduct a de novo review.”²²¹ Through the appeal, parties who failed to disqualify their judge would not have to endure a lengthy trial with an offended judge. Therefore, the challenge’s opponents might appreciate this third type of recourse before appeal of the entire case (joining review by a different judge, like the district’s chief judge, and mandamus review). The retired Associate Justice praises its efficacy in guarding judicial integrity and due process and urges Arkansas, a state where judges have discretion to deny disqualification motions without stating reasons, to follow suit.²²² His argument has merit in other jurisdictions with automatic disqualification, such as California, because appellate review will presumably lead to fewer judicial removals and prevent the public from falsely believing that there are more biased judges than is actually the case. The remedy provides no relief to litigants and attorneys who fear the insulted judge’s retaliation, but it should curtail judge shopping, especially on discriminatory grounds like race or gender, and minimize the odds of judicial intimidation. There is instinctive apprehension about crowding the appellate dockets, including the Supreme Court, but the Tennessee Administrative Office of the Courts—finding only ten or less appeals per year in a span of three years—and a Tennessee Court of Appeals judge—a “self-described ‘fan of the rule’ ”—calm these concerns.²²³ However, litigants lacking sufficient resources may not appeal even if their judge’s personal views have irreparably infected the proceeding.²²⁴

3. The Independent Judge Approach

Although his analysis revolves around a federal recusal statute’s reform, one legal scholar contributes a slightly different antidote to this dialogue. Another disinterested trial judge (that is, not the affected judge with a personal stake in the challenge) should rule on the disqualification motion because even the best-intentioned judge might be oblivious to their own faults. He further diverges from the affidavit procedure by suggesting that “the challenged judge be encouraged to file evidence refuting facts asserted in the recusal motion, and perhaps also an explanation of why disqualification is not justified,” so there is an “adversarial presentation of the issue.”²²⁵ Judges may worry about offending their colleagues,²²⁶ but given dissenting opinions and reversals of lower courts’ judgments, they are likely already accustomed to internal disagreement and can consequently stomach any potential discomfort.²²⁷ Additionally, he contends that “the appearance of justice will be better served, even if the actual rate of recusal remains unchanged.”²²⁸

B. The Proposed Alternative Procedure

A more promising solution is a hybrid model between the panel-exclusion approach (specifically, the dissemination of judicial analytics) and the independent judge approach. After litigants receive the exclusion decisions and rates, they can file the motion with a different trial judge who will review both the motion and the challenged judge’s evidentiary explanation for factual and legal sufficiency. An interlocutory appeal is rendered unnecessary if an independent judge can accurately filter for allegations that actually deserve a judicial peremptory challenge. Admittedly, like federal law, this is not peremptory per se, but it will hopefully further reduce the number of “uninformed, misinformed, [and] delusional”²²⁹ litigants who exercise the challenge.

As judges lack crisis managers, it is imperative that resources are invested into educating the public on judicial duties and verified statistics on judicial bias. Unlike news outlets, petitions, social media posts, and activism pages probably do not check the accuracy of the information they release. With the help of Big Data²³⁰ and artificial intelligence, judicial analytics will become more accurate over time, which will better alert litigants about the judges who are actually biased than other unverified sources. By making such information accessible, perhaps litigants will place less weight on factors like the judge’s race and gender, for example. The Robing Room states that slanderous comments posted in bad faith are subject to removal;²³¹ realistically, it can hardly stop all “sour grapes” who harbor disdain toward their judge for merely siding with the opposing party after fairly applying the law to the facts. Consider how one of the disqualified judges in the study asserted that there are an equal number of people who think she is biased toward either women or men. There is a possibility that the other sources noted in the study, besides the public admonishment, are campaigns by losing litigants to unjustifiably vilify their judge.

It seems problematic to allow judges to entertain motions petitioning their own disqualification, and the public agrees.²³² An independent adjudicator should handle the challenge, so the challenged judge does not have to awkwardly decide their own neutrality. It is a win-win situation—if the reviewing judge finds the challenged judge corrupted with partiality, then the public will trust that the judiciary is void of collusion, but if the reviewing judge deems the challenged judge unbiased, then the public will have faith in the judiciary’s independence, and the judge will be guarded from discrimination. Some argue that the challenged judge is ideal because they are closest to the alleged facts;²³³ this is precisely the issue. That said, the reviewing judge may have a connection to the challenged judge—for example, a friendship—that skews their decision in favor of a denial. Perhaps the reviewing judge should show that there is no personal relationship to the challenged judge, but at some point, judges have to be trusted to rule fairly.

In lieu of an automatic transfer, judges can defend their fitness to serve and expose the litigants who use bias as a pretense for prohibited reasons, like discrimination based on party affiliation. It is easy for Section 170.6 to act as a Trojan horse carrying ulterior motives because automatic reassignment is swiftly delivered following a quick evaluation of procedural adequacy. If judges have no chance to prove the allegations of bias wrong, these litigants unwittingly trigger an endless feedback loop in which their baseless challenges inflate the number of “biased” judges which, in turn, instigates more challenges. The expectation is that fewer than 1.5% of judges will encounter peremptory disqualification, closing the disparity between the number of disqualified judges and the number of judges disciplined for bias. This will then demonstrate to the public that judges are not always predisposed to bias. To play devil’s advocate, the public may feel disheartened upon witnessing too many judges found guilty of bias, but the judiciary should commit to their integrity and weed out the “10% problem,”²³⁴ the estimate of incompetent judges. Judges inevitably do not command from Olympian heights; rather, they are subject to their beliefs and attitudes. It is difficult to procure solid evidence of judges’ unconscious biases,²³⁵ but litigants should still explain what manifestations, whether inside or outside the courtroom, caused them to suspect such biases.²³⁶ They should not have free reign to judge shop due to a random feeling, especially in the U.S. legal system that is rooted in proof. Judicial economy is indeed lost if an inquiry is made into the merits as well,²³⁷ but it is a wiser alternative than the current framework that passively allows litigants to chase unequal justice.

V. RECOMMENDATIONS FOR FUTURE RESEARCH

Regrettably, without formal statistical methods to control for irrelevant factors, this Note is unable to confirm a causal relationship between a judge’s peremptory disqualification and any complaints of bias on their Robing Room profile. For the same reason, it is unknown if failed judicial peremptory challenges affected case outcomes (comparing the case in which the challenge was initiated to any future cases with the disqualified judge—this would have informed the policy debate on whether disqualified judges are truly hostile). Therefore, the first recommendation for future research is setting up a more sophisticated study in order to discover results beyond mere correlations. Another recommendation is conducting surveys directed to (1) the public asking about their impression of judicial bias,²³⁸ (2) judges asking about their various group affiliations (especially characteristics that are not available through public materials such as race and ethnicity, gender, and age), and (3) attorneys asking what resources they have at their disposal when deciding whether they should use Section 170.6. Since judicial disciplinary proceedings for bias may miss judges with more subtle manifestations of bias, one suggestion is to conduct an experiment²³⁹ testing how widespread conscious and unconscious biases are among superior court judges in California. Ideally, this Note would analyze the relationship between the type of case (for example, personal injury) and judge shopping; unfortunately, there were not enough free and accessible documents online. For this pursuit, as a judge’s area of professional expertise is easy to find, future researchers should investigate whether movants of a specific type of case are strategically challenging judges with or without experience in that practice area. Lastly, the challenge’s prevalence is a regional phenomenon in the United States, so studies conducted in other states are recommended as well.

CONCLUSION

Notwithstanding limitations, the empirical data reported in this Note has value—it discovered that judicial peremptory challenges were quite rare and therefore abuse from these challenges was not out of hand. Among the few filed motions, most were automatically granted, indicating that the procedural protections were a flimsier shield than the statute had planned. Juxtaposing the higher percentage of disqualified judges with the lower percentage of judges reprimanded for bias implies that litigants are alleging bias as a mere formality. This is further corroborated by the finding that more than half of the comments on The Robing Room recommending others to challenge a certain judge did not mention bias.²⁴⁰ In regard to discrimination, it found significantly more Democrat judges disqualified than Republican judges. Without additional research, this Note can only surmise about possible fixes to prevent discrimination, like the standard for employment law in which the judge’s ability to perform their duties must relate to the reasons for exclusion.²⁴¹ Whether the challenge can inherit AB 3070 (the 2020 law that “requir[es] an attorney exercising peremptory strikes to show clear and convincing evidence [under an objective standard] that [their] action is unrelated to that juror’s membership in a protected group or class”²⁴²) such that it is workable to judges poses an interesting question. Altogether, this Note concludes that there is not a serious risk of abuse from the challenge but Section 170.6 is still not a satisfactory remedy by legislation—there is no need to settle for less when there is a better solution. As Justice Kennedy wrote, judicial disqualification standards should extend beyond the minimum requirement of due process; however, they should not stretch so thin when judicial integrity is not completely broken. The proposed alternative will heal the issues produced when the challenge is granted as a matter of right by implementing an audit into the accusation’s truth. In other words, as a middle ground in the policy dichotomy, it will perfect the peremptory challenge and diminish the risk of abuse even more than the current model.

97 S. Cal. L. Rev. 253

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Sarah Park*

* Executive Senior Editor, Southern California Law Review, Volume 97; J.D. Candidate 2024, University of Southern California Gould School of Law; B.A. Communication 2019, University of California, Santa Barbara. Thank you to Professor Jonathan Barnett and Professor Robin Craig for serving as my advisors. To my family and friends—law school, much less this Note, would not be possible without your continuous support. I would also like to express my gratitude to the dedicated members of the Southern California Law Review for their hard work.

Restraining the Second Amendment in the Era of the Individual Right: Adopting a Modified South African Gun Control Model

May 2024July 2024Lukas T. Huldi*

In New York State Rifle & Pistol Association v. Bruen, the Supreme Court announced a novel historical test for judging the constitutionality of firearm laws. In combination with its earlier decisions in District of Columbia v. Heller and McDonald v. City of Chicago, the Court has created an onerous burden on federal and state legislatures attempting to regulate civilian firearm ownership. Given Heller’s individual right ruling, McDonald’s incorporation, and Bruen’s historical precedent requirement, it is clear that designing a restrictive firearm ownership system based on models that have proven successful in other Western countries is not possible, as most, if not all, of these would run afoul of these precedents. South Africa’s firearm licensing system, on the other hand, can provide a useful starting point for creating a framework that states can adopt. South Africa has significant private firearm ownership, its licensing system is not unduly restrictive, and it has proven successful in reducing gun violence. This Note therefore proposes adopting a version of South Africa’s firearm licensing system modified to survive judicial review in the United States. This Model Act likely represents close to the most restrictive licensing system that can pass judicial review following Bruen and might prove similarly effective in reducing gun violence in the United States.

There is almost no political question in the United States that is not resolved sooner or later into a judicial question.

—Alexis de Tocqueville¹

INTRODUCTION

The United States is in many ways an odd country, and there are few things more quintessentially American than the sheer quantity of firearms and relative frequency of mass shootings in this country. Presently, the United States has about 120 guns for every 100 citizens,² and a higher rate of gun violence than any other wealthy, developed country.³ The tragic reality is that the gun control debate in the United States is never untimely. In light of the level of gun violence and ready availability of firearms in the United States, one solution seems simple: restrict access to firearms. After all, there is evidence that this approach can be successful.⁴ However, since the Second Amendment⁵ has been interpreted to protect a broad, individual right to keep and bear arms,⁶ and any realistic prediction of the foreseeable future provides little reason to expect that the Second Amendment will be repealed, designing a perfect gun control statute from scratch is simply not an option. Moreover, our federal governmental structure further restricts our options. Promulgating a comprehensive, federal regulatory scheme that does not run afoul of the individual rights in, or the structural aspects of, the Constitution is infeasible.

Apart from the legal constraints on gun control, political, cultural, and economic roadblocks abound. Firearms are a prominent aspect of modern American culture,⁷ and many Americans enjoy firearm ownership for safe, legitimate purposes like self-defense, hunting, and sport shooting.⁸ Additionally, the United States firearms market is a $28 billion industry with significant lobbying strength.⁹ Suffice it to say, there are significant constraints within which any regulatory structure must fit. Fortunately, however, it is not necessary to start from scratch. Foreign practices that have proven effective can be tailored to our constitutional constraints to develop a model gun control act for the several states to adopt. In particular, this Note proposes a distinctive approach: start with South Africa’s Firearms Control Act of 2000¹⁰ and modify it to create an act that satisfies the U.S. Constitution and serves the policy goals of reducing access to firearms by those who would misuse them while keeping them available to responsible citizens. The purpose of this act is to provide a framework for the states to create a comprehensive firearm licensing system that can survive judicial review under current Second Amendment doctrine.¹¹ This Model Act serves as a starting point for responsible firearm regulation in the era of the individual right and does not purport to be the final word on the Second Amendment question.

South Africa’s gun control system may be a surprising basis for a new federal gun control law in the United States; its intentional homicide rate far surpasses ours.¹² However, South Africa has seen a steady decrease in gunshot-related deaths since it adopted the Firearms Control Act of 2000.¹³ The United States could see a reduction in its gunshot-related deaths by adopting a similar model. In any case, the large-scale empirical questions over the efficacy of various gun control systems are beyond the scope of this Note. The Note instead focuses on how we might adapt a comprehensive, firearms licensing scheme to our constitutional framework. South Africa’s model is an excellent starting point because it restricts access to especially dangerous firearms while providing individuals the opportunity to own firearms for self-defense, which the U.S. Supreme Court has said is the core right of the Second Amendment.¹⁴ The Firearms Control Act of 2000 also does not completely prohibit ownership of AR-15’s and other similar firearms. This is important because a law completely banning AR-15’s and similar rifles could be in danger of being declared unconstitutional and setting an even more cumbersome precedent.¹⁵ Additionally, other potential solutions devised to completely side-step the Supreme Court’s latest precedents are not only unlikely to succeed beyond perhaps the short term, but, if successful, could also create a worrying trend whereby state governments could close off its courts to citizens seeking to vindicate their constitutional rights. California, for instance, has created a one-way fee-shifting penalty that allows government defendants to recover costs from a plaintiff who loses on any claim in a case challenging a state or local firearm regulation, but never allows a plaintiff to recover attorneys’ fees from the government, even if the plaintiff wins on every claim.¹⁶ If held constitutional,¹⁷ this fee-shifting statute would chill future lawsuits by citizens seeking enforcement of their right to bear arms and would, at the very least, force them into a federal forum, unduly burdening the district courts.¹⁸ This has implications far beyond the gun control debate and could threaten other enumerated constitutional rights.¹⁹ Such jerry-rigging of procedural laws bearing on a constitutional right is bad policy that could encourage other states to similarly attempt to sabotage any constitutional right it wishes to infringe.²⁰ Rather than venturing down this destructive path, it is more effective to work within governing caselaw to achieve legitimate policy goals like gun safety and gun violence prevention.²¹ Even if many or all of the Supreme Court’s recent Second Amendment cases were incorrectly decided, they remain binding precedent.²² Thus, a detailed look at the Court’s recent Second Amendment precedents is necessary to develop a statutory scheme that will survive judicial review.

Part I begins with a breakdown of the Supreme Court’s recent Second Amendment jurisprudence from Heller through Bruen, analyzing the various doctrines articulated in these cases. Part I ends with a summary of the constitutional limitations that the model gun control statute must satisfy. Part II summarizes the salient points of South Africa’s Firearms Control Act of 2000. Part III provides the full text of the Model Firearms Control Act. Part IV argues that this Model Act is likely to be upheld by the Court.

I. CONSTITUTIONAL LIMITATIONS OF GUN CONTROL

Second Amendment jurisprudence has been rather scant from its ratification in 1791 until the Heller decision in 2008, when the Amendment took on its modern meaning.²³ Before the swell in revisionist legal scholarship that began in the 1960s, “[t]here was no more settled view in constitutional law than that the Second Amendment did not protect an individual right to own a gun.”²⁴ Yet, the Second Amendment is now interpreted to protect a broad, individual right to own a firearm for self-defense.²⁵ Because of this recent, dramatic shift in case law, an investigation into the Court’s modern Second Amendment jurisprudence is required to create a model gun control act that is likely to survive judicial review.

A. The Trilogy of Modern Second Amendment Jurisprudence

In a trilogy of cases—District of Columbia v. Heller,²⁶ McDonald v. City of Chicago,²⁷ and New York State Rifle & Pistol Association v. Bruen²⁸—the Supreme Court established a broad, individual right to keep and bear arms, irrespective of any militia service, effective against both the federal and state governments. This broad protection of firearm ownership is built on four main principles: (1) the individual right approach, (2) the pre-existing right doctrine, (3) the common use doctrine, and (4) incorporation. To shape a gun control scheme to fit within controlling Supreme Court precedent, these four doctrines flowing from this trilogy of cases must be mapped out and understood.

1. The Necessity of an Individual Right

Before the Court would have an opportunity to incorporate the Second Amendment to the states, it had to lay some precedential groundwork to convert the Second Amendment into a right that could be incorporated. To a large extent, finding an individual right to keep and bear arms for the purpose of self-defense without any militia service requirement was a prerequisite to incorporating the right. Prior to Heller, scholars and jurists had proposed three main approaches to interpreting the Second Amendment.²⁹ First, the “collective right” approach argued that the right to keep and bear arms protected the right of the states to arm and organize militias.³⁰ Second, the “limited individual right” or “sophisticated individual right” approach suggested that the right to keep and bear arms does protect an individual right, but only to the extent that individuals participate in a well-regulated militia.³¹ Third, the unmodified “individual right” approach embraced the idea that the Second Amendment protects an individual’s right to keep and bear arms irrespective of any participation in a well-regulated militia, essentially reading the prefatory clause out of the amendment.³²

Throughout pre-Heller Second Amendment case law and scholarship, the individual right approach was overwhelmingly disfavored.³³ From ratification until 2001, no federal appellate court had ever endorsed the individual right approach to the Second Amendment,³⁴ and the first case to adopt this approach, United States v. Emerson,³⁵ did so only in dictum.³⁶ Shortly following Emerson, then Attorney General John Ashcroft issued a memorandum to all United States Attorneys stating that the individual right approach reflects the correct understanding of the Second Amendment, reversing the Department of Justice’s longstanding policy regarding Second Amendment interpretation.³⁷ Had the Court endorsed the collective right approach in Heller, as it had 132 years earlier,³⁸ the right to bear arms would essentially be a right belonging to the states, making incorporation nonsensical as a state could not meaningfully infringe its own right.³⁹ Alternatively, had the Court endorsed the limited individual right in Heller, a subsequent decision incorporating that right would only prevent states from disarming individuals serving in its own militias, which would provide no protection to anyone outside the National Guard.⁴⁰ Thus, it was necessary for the Court to find an individual right to keep and bear arms in the Second Amendment, independent of any militia service, to meaningfully incorporate that amendment against the states.

2. The Pre-Existence Doctrine: Finding the Individual Right in Text and History

In finding a free-standing, individual right to bear arms in the Second Amendment, the Court relied on the notion of some constitutional rights having pre-existed the ratification of the clauses protecting them.⁴¹ According to the Court, the Second Amendment did not create a new right but constitutionalized a pre-existing right.⁴² This pre-existence argument relies on the proposition that the framers of the Second Amendment intended to codify a right to bear arms that already existed in English law⁴³ and simply wished to create a stronger protection for it. The Court purported to find a textual basis for this conclusion, stating that “[t]he very text of the Second Amendment implicitly recognizes the pre-existence of the right and declares only that it ‘shall not be infringed.’ ”⁴⁴

The Heller Court began its historical analysis by stating that “[t]he Second Amendment is naturally divided into two parts: its prefatory clause and its operative clause.”⁴⁵ The prefatory clause states “[a] well regulated Militia, being necessary to the security of a free State . . . .” The operative clause states that “the right of the people to keep and bear arms shall not be infringed.”⁴⁶ The Court asserted that the prefatory clause announces only the amendment’s justification, and does not limit the scope of the operative clause.⁴⁷ After its explication, the Court concluded that the prefatory clause “fits perfectly” with an operative clause understood to grant an individual right to keep and bear arms because the pre-constitutional history showed that tyrants had eliminated militias not by banning them but by disarming them.⁴⁸

The Court supported its individual right approach through a sort of reverse incorporation argument limited to “analogous arms-bearing rights in state constitutions that preceded and immediately followed adoption of the Second Amendment.”⁴⁹ Although many of the state constitutions had more individualistic wording,⁵⁰ the Court did not take this to conclude that the Second Amendment was materially different from its state analogues. To the contrary, the Court used the more individual rights-focused arms-bearing provisions of state constitutions—and state supreme court decisions interpreting those provisions—to read the Second Amendment as conferring a broad individual right.⁵¹ Pennsylvania’s Declaration of Rights of 1776 read “the people have a right to bear arms for the defence of themselves and the state . . . .”⁵² and Vermont’s 1777 Declaration of Rights contained a nearly identical provision.⁵³ The Court further supported its argument by describing roughly contemporaneous state analogues.

Between 1789 and 1820, nine States adopted Second Amendment analogues. Four of them—Kentucky, Ohio, Indiana, and Missouri—referred to the right of the people to “bear arms in defence of themselves and the State.” Another three States—Mississippi, Connecticut, and Alabama—used the even more individualistic phrasing that each citizen has the “right to bear arms in defence of himself and the State.” Finally, two States—Tennessee and Maine—used the “common defence” language of Massachusetts.⁵⁴

The Court noted that the decision of at least seven of these nine states to unequivocally protect an individual right to bear arms is strong evidence that the framers of the Second Amendment conceived of the right to bear arms as an individual right.⁵⁵

The Court next sought precedential support for its individual right interpretation.⁵⁶ The Court first cited Nunn v. State, an 1846 case in which the Georgia Supreme Court struck down a ban on carrying pistols openly, stating that the Second Amendment protects “the natural right of self-defense.”⁵⁷ The Heller Court noted that the Georgia Supreme Court “perfectly captured the way in which the operative clause of the Second Amendment furthers the purpose announced in the prefatory clause, in continuity with the English right.”⁵⁸ In further support of its position, the Court cited State v. Chandler, an 1850 case in which the Louisiana Supreme Court held that United States constitution guaranteed citizens the right to carry arms openly.⁵⁹ In response to the dissent’s reliance on Aymette v. State, an 1840 decision in which the Tennessee Supreme Court adopted a limited individual right approach for its own state constitutional right to bear arms,⁶⁰ the Court reasoned that more important than this decision was the Tennessee Supreme Court’s later decision in Andrews v. State.⁶¹ In Andrews, the Tennessee Supreme Court concluded that its state constitutional right to bear arms protected the right to bear arms for personal self-defense, overruling Aymette.⁶²

Turning to its own precedents, the Court asked whether any of its prior decisions foreclosed its ultimate conclusion in Heller. The Court began with its decision in United States v. Cruikshank,⁶³ in which the Court vacated a white mob’s convictions for depriving black militia men of their right to bear arms, holding that the Second Amendment “means no more than that it shall not be infringed by Congress.”⁶⁴ The Heller Court reasoned that there was no claim in Cruikshank that the defendants had violated the victims’ right to carry arms in a militia, and that the Cruikshank Court’s discussion made little sense if it was speaking of a collective rather than an individual right.⁶⁵ The Court rests this argument on the Cruikshank Court’s conclusion that “ ‘the people [must] look for their protection against any violation by their fellow-citizens of the rights it recognizes’ to the States’ police power.”⁶⁶

The Heller Court next turned to United States v. Miller,⁶⁷ reasoning that it not only failed to foreclose the possibility of an individual right, but also “positively suggests” it.⁶⁸ Miller considered whether a law prohibiting the unregistered possession of a short-barreled shotgun ran afoul of the Second Amendment.⁶⁹ In concluding that it did not, the Miller Court announced its interpretation of the Second Amendment’s purpose.

In the absence of any evidence tending to show that possession or use of a ‘shotgun having a barrel of less than eighteen inches in length’ at this time has some reasonable relationship to the preservation or efficiency of a well regulated militia, we cannot say that the Second Amendment guarantees the right to keep and bear such an instrument.⁷⁰

The Court reasoned that the Miller Court’s basis for concluding that the Second Amendment did not apply was not that the Second Amendment failed to protect non-military use, but that it did not protect the type of firearm at issue.⁷¹ Before announcing its “common use” doctrine, however, the Court acknowledged some limitations on the individual right to bear arms, such as the historical precedence for prohibiting the public carry of “dangerous and unusual weapons.”⁷²

3. Market Share as Constitutionality: The Common Use Doctrine

With the individual right in hand, the Heller Court turned to the law at issue, which totally banned handgun possession in the home and required any lawfully owned firearm to be disassembled and bound by a trigger lock.⁷³ In determining that the law was unconstitutional, the Court began by concluding that “the inherent right to self-defense has been central to the Second Amendment right.”⁷⁴ True enough, there is no serious doubt that the right to self-defense predates the constitution as part of the common law⁷⁵ and continues to exist in the United States today.⁷⁶ The right to bear arms to effectuate this defense of life and limb also existed in England prior to the ratification of the U.S. Constitution, at least by statute, as a “public allowance, under due restrictions, of the natural right of resistance and self-preservation . . . .”⁷⁷ Although the statutory right to bear arms for self-defense in England was considered less fundamental than the right to self-defense in general,⁷⁸ and was a concession by the Crown that presupposed an omnipotent legislature—a feature clearly absent from our constitutional scheme—the Court has insisted on the centrality of individual self-defense to the right to bear arms.⁷⁹

The purported centrality of self-defense to the Second Amendment, combined with the individual right approach, allowed the Court to announce a new, sweeping doctrine in Heller. The Court reasoned that “[u]nder any of the standards of scrutiny that we have applied to enumerated constitutional rights, banning from the home ‘the most preferred firearm in the nation to “keep” and use for protection of one’s home and family,’ would fail constitutional muster.”⁸⁰ It noted that few laws in our nation’s history have come close to the restriction the District of Columbia has imposed and several of those laws have been struck down.⁸¹ Because handguns have been overwhelmingly chosen by the American people as their preferred arm for self-defense, a complete prohibition of its use runs afoul of the individual right to bear arms for the very purpose of self-defense.⁸² This common use doctrine begs the question: If it is unconstitutional to outright ban firearms in common use for self-defense, how would the Court approach bans on classes of arms which are not in common use because they were banned before they could get into common use?⁸³ The Court did not address this question,⁸⁴ noting that it did not undertake an analysis of the full scope of the Second Amendment.⁸⁵ However, the Court stated that nothing in its opinion “should be taken to cast doubt on longstanding prohibitions on the possession of firearms by felons and the mentally ill, or laws forbidding the carrying of firearms in sensitive places such as schools and government buildings, or laws imposing conditions and qualifications on the commercial sale of arms.”⁸⁶ In fact, the Court noted that the measures it listed are presumptively lawful and that its list was inexhaustive.⁸⁷ This is an important concession by the Court because by noting that its list of presumptively lawful measures was inexhaustive, the Court indicated that it might be open to other presumptively lawful restrictions to the right to bear arms, so long as there is a historical precedent that is satisfactory in the Court’s view.

4. Incorporation

The Supreme Court would of course go on to conclude in McDonald v. City of Chicago that the right to bear arms is “deeply rooted in this Nation’s history and tradition”⁸⁸ and incorporate the Second Amendment in full.⁸⁹ In so doing, it relied heavily on Heller’s individual right approach and common use doctrine, arguing that history and precedent pointed “unmistakably” to the conclusion that the Second Amendment is “deeply rooted” in our “history and tradition.”⁹⁰ Just as in Heller, the Court argued that the right to bear arms for self-defense was as fundamental as the broader right self-defense.⁹¹ In incorporating the individual right to the states, the Court had another perfect occasion to utilize the doctrine of reverse incorporation⁹² to adopt a standard of review based on how state supreme courts have analyzed their own constitutions’ arms-bearing provisions that the Court saw as analogous to the Second Amendment. Most states recognize an individual right to keep and bear arms but allow “reasonable regulations” restricting that right.⁹³ Despite the states’ far greater experience in drafting and reviewing gun laws, the Supreme Court left the decision over what standard applied to Second Amendment cases to another day, eventually settling on Bruen’s historical test.⁹⁴

The confluence of the individual right approach, the common use doctrine, and incorporation has opened many long-standing state firearms laws to constitutional scrutiny, even before Bruen was decided. California, for instance, has prohibited the purchase, sale, and manufacture of high-capacity magazines⁹⁵ since 2000,⁹⁶ and by popular initiative in 2016 expanded the prohibition to make possession of high-capacity magazines a felony offense, regardless of the date the magazine was acquired.⁹⁷ This new law gave rise to protracted but groundbreaking litigation. In Duncan v. Becerra,⁹⁸ the outright ban on possession of high-capacity magazines was ruled unconstitutional as a Fifth Amendment taking without just compensation and as violative of the Second Amendment because it imposed a substantial burden on the right to self-defense and the right to keep and bear arms.⁹⁹ The district court enjoined the statute, and its decision was affirmed on appeal by the Ninth Circuit,¹⁰⁰ but was later reversed on rehearing en banc.¹⁰¹ The Supreme Court then vacated the judgement and remanded the case to the Ninth Circuit for further consideration in light of its decision in Bruen.¹⁰² On remand from the Ninth Circuit, the District Court once again held California’s high-capacity magazine ban unconstitutional, but stayed its order enjoining enforcement while the California Attorney General appealed the decision.¹⁰³ It therefore remains to be seen how the latest Supreme Court precedent will affect this high-capacity magazine ban, but it suffices to say that the law in this area remains very much in flux.

5. The Third Act: Applying Heller to Public Carry Licensing

Building on the bedrock of the individual right principle, the common use doctrine, and the Second Amendment’s incorporation, the Court recently expanded the Amendment’s protections with its historical precedence doctrine. At issue in Bruen was a New York law that made it a crime to possess a firearm without a license.¹⁰⁴ New York’s provision for licenses to carry firearms outside the home for self-defense was particularly stringent. An applicant could not obtain that license without a showing of “proper cause.”¹⁰⁵ New York courts have defined “proper cause” as requiring an applicant to “demonstrate a special need for self-protection distinguishable from that of the general community”¹⁰⁶ such as evidence “of particular threats, attacks or other extraordinary danger to personal safety.” Living or working in a high-crime area was considered insufficient to demonstrate proper cause.¹⁰⁷

To evaluate the constitutionality of the New York law, the Bruen Court began by clarifying the test for Second Amendment challenges. The Court noted that the circuit courts had coalesced around a two-part test that combined a historical inquiry with means-end scrutiny, but it rejected this approach.¹⁰⁸ The Court instead leaned on its historical approach from Heller and specifically rejected any interest balancing test,¹⁰⁹ settling on the following standard:

When the Second Amendment’s plain text covers an individual’s conduct, the Constitution presumptively protects that conduct. The government must then justify its regulation by demonstrating that it is consistent with the Nation’s historical tradition of firearm regulation. Only then may a court conclude that the individual’s conduct falls outside the Second Amendment’s “unqualified command.”¹¹⁰

In applying this test, the Court stated that it would consider whether historical precedent from before, during, and relatively shortly after the founding demonstrates a “comparable tradition of regulation.”¹¹¹ When comparing modern firearm laws and regulations to historical precedents, it is of course necessary to reason by analogy to determine whether the two are relatively similar.¹¹² Although the Bruen Court did not provide an exhaustive list of features that would render historical precedents relatively similar to modern laws, it provided two metrics: “how and why the regulations burden a law-abiding citizen’s right to armed self-defense.”¹¹³ Thus, for a historical precedent to support the constitutionality of a modern regulation, there must be (1) a comparable burden and (2) that burden must be comparably justified.¹¹⁴ For instance, there have long been prohibitions on carrying arms in sensitive places such as legislative assemblies, schools, and courthouses, so laws prohibiting carrying arms in such places, or even in newly defined sensitive places, are presumptively constitutional, so long as the sensitive place is analogous to those historically designated as such.¹¹⁵ New York’s licensing scheme, by contrast, could not be justified as analogous to these historical “sensitive places” laws because it generally banned citizens from carrying arms in any place “where people typically congregate,”¹¹⁶ meaning that entire cities would essentially be exempted from Second Amendment protection.¹¹⁷

Turing to New York’s proper-cause requirement, the Court stated that the plain text of the amendment protects ordinary citizens’ general right to carry handguns publicly for self-defense, emphasizing that confining the right to bear arms to the home would nullify half of the Second Amendment’s explicit protections—to not only “keep” but also “bear” arms.¹¹⁸ The central right of the Second Amendment has been held to be the right to bear arms for self-defense in case of confrontation, which often will take place outside the home.¹¹⁹ In assessing New York’s requirement that applicants for a license to carry a firearm in public show “proper cause”—as defined by the New York courts—the Court assessed a variety of sources that the respondents appealed to, dating from the 1200s to the early 1900s.¹²⁰ The Court explained that, “when it comes to interpreting the Constitution, not all history is created equal.”¹²¹ Therefore, even in light of the pre-existing right doctrine, historical evidence long-predating the enactment of the Second and Fourteenth Amendments will carry less weight than historical precedents closer in time to these enactments if legal conventions have changed in the intervening years.¹²² Thus, English practices traceable from the Middle Ages to the ratification of the Constitution will carry more weight than ancient practices that became obsolete before ratification.¹²³ Likewise, post-enactment history can be elucidating when “a regular course of practice” can settle the meaning of disputed terms and phrases.¹²⁴ However, when post-enactment precedents take effect long after ratification, they will be accorded less weight.¹²⁵ With the parameters of its historical inquiry set, the Court proceeded to determine that the historical record the respondents compiled failed to demonstrate a historical analogue for New York’s firearm licensing scheme.¹²⁶ That is, there was no historical tradition of limiting the public carry of firearms to citizens who could demonstrate a special need for self-defense, nor was there a historical tradition of broadly prohibiting the carry of commonly used firearms for self-defense.¹²⁷

A few key takeaways from the Court’s evaluation of this compendium of historical precedents will inform how a model gun control statute can be structured. First, the manner of public carry was historically subject to reasonable regulation—individuals could be restricted from carrying deadly weapons in a way that would be likely to terrorize others.¹²⁸ Second, states with surety laws¹²⁹ provided financial incentives for responsible arms carrying, rather than directly restricting public carry.¹³⁰ Third, states have historically been able to restrict or eliminate one kind of public carry—usually concealed carry—so long as they allowed the other type of carry—usually open carry.¹³¹ Fourth, the more widely enacted a type of statute is, the more likely the court is to uphold it. Thus, the relatively few historical examples prohibiting the carry of pistols—and in some cases all firearms—in towns, cities, and villages could not “overcome the overwhelming evidence of an otherwise enduring American tradition permitting public carry.”¹³² Finally, as Kavanaugh’s concurrence underscores, the Court’s opinion does not jeopardize the existing “shall-issue” licensing regimes employed in forty-three states, only the “may-issue” regimes employed by six states and the District of Columbia.¹³³ The difference between these two is that when an applicant meets the statutory criteria in a shall-issue regime, they must be issued a license. Under a “may-issue” regime, however, even if an applicant meets the statutory criteria, a licensing officer has the discretion to refuse to issue a license, based on the difficult to meet “special need” requirement.¹³⁴ Although the Court did not explicitly say that “shall-issue” regimes and “proper cause” requirements for licenses to carry firearms for self-defense are per se unconstitutional, it is difficult to see how either of these could be upheld.¹³⁵

B. Summary of Second Amendment Precedent

Before moving on to the model statute, a brief summary of the major limitations imposed by the foregoing trilogy of modern Second Amendment jurisprudence will prove helpful. First, the core right protected by the Second Amendment is an individual right to keep and bear arms for self-defense. Second, this right is effective against both the state and federal governments. Third, if the Second Amendment’s plain text—as interpreted by the Supreme Court—covers an individual’s conduct, it is presumptively protected, and the government must demonstrate that the law in question is analogous—though not necessarily identical—to a historical practice of firearms regulation. Fourth, when seeking a historical analogue to justify a modern regulation, not all history is created equal. Examples of post-ratification regulation that settle disputed terms and are relatively close in time to the adoption of the Bill of Rights can be particularly informative, as can evidence of English and Colonial practices that stayed in effect at least until ratification. Fifth, the more widespread a particular firearm regulation is, the more likely it is constitutional. Sixth, a legislature might well be able to ban or severely restrict either concealed carry or open, so long as they allow one of the two methods to remain legal. Finally, some types of firearm regulations are presumptively lawful—prohibitions on possession by felons and the mentally ill, laws against brandishing a firearm—while some are presumptively unlawful—shall-issue regimes, proper cause requirements.

As onerous as these requirements might appear to be, there is still a way for legislatures to assert meaningful control over the exercise of the Second Amendment, albeit with less free reign than they had previously been allowed. A systemic approach to gun ownership composed of rules that have historical analogues in the American legal tradition can be modeled on South Africa’s firearm licensing system. South Africa’s Firearms Control Act could provide a method to limit possession of high-capacity magazines while still allowing them to be owned for self-defense.

II. SOUTH AFRICA’S GUN CONTROL SYSTEM

South Africa is fairly unique in its approach to firearms ownership in that a central focus of its firearm licensing system is to allow people the means to defend themselves.¹³⁶ Its licensing system is nevertheless comprehensive in spelling out the requirements for owning different categories of firearms and is fairly stringent in its requirements for firearm ownership in the first place—at least when compared with current law in the United States. Because the South African Model allows for a right to own a firearm for self-defense,¹³⁷ yet provides a comprehensive licensing scheme, it provides an ideal starting point for drafting a model statute for the United States.

The main feature of South Africa’s Firearms Control Act of 2000¹³⁸—which states could benefit from replicating—is a licensing system requiring citizens who wish to own a firearm to first obtain a competency certificate¹³⁹ and then obtain a license specific to each firearm that they wish to own.¹⁴⁰ The type of firearm a citizen can own will depend on the type of license that they receive, which, in turn, depends on their purpose for owning the firearm. For instance, a citizen cannot obtain a semi-automatic rifle for occasional hunting or sports shooting because such a weapon is not necessary for that purpose.¹⁴¹ This an important feature that could lawfully be replicated in the United States¹⁴² to strike a balance between the states’ interest in public safety and the private interest in self-defense. Take high-capacity magazines, for instance. Some states have tried to outright ban them,¹⁴³ but it is not clear that this is constitutional under Heller, McDonald, and Bruen.¹⁴⁴ South Africa’s Firearms Control Act could provide a method to limit possession of high-capacity magazines while still allowing them to be owned for self-defense uses.

Although South Africa’s system provides a good starting point for a model act, some areas will need modification to comport with U.S. constitutional standards. The main modifications are in the types of firearms that can be owned and the permit issuance requirements. Heller instructs that firearms in common use receive Second Amendment protection¹⁴⁵ and Bruen indicates that “may issue” regimes are very likely per se unconstitutional.¹⁴⁶ The primary modifications this Note proposes for its Model Act appear in Sections 2(b), 3, 5, and 6 in Part III below.

III. THE MODEL FIREARMS CONTROL ACT

The following is the full text of the Model Firearms Control Act that this Note proposes the states adopt. This act is intended to supplement existing state firearms regulations by creating an individual licensing requirement.

A. Chapter 1: Definitions, License Requirement, Eligibility Certificate

§ 1 Definitions
- (a) Designated Firearms Officer. A “Designated Firearms Officer” means a law enforcement official designated as such by state law.
- (b) Accredited Hunting Association. An “Accredited Hunting Association” means an association meeting the criteria designated by state law.
- (c) Accredited Sports Shooting Association. An “Accredited Sports Shooting Association” means an association meeting the criteria designated by state law.
§ 2 License Requirement
- (a) No person may possess a firearm without holding a license issued by the state for that firearm. A separate license is required for each firearm.
- (b) No person may receive a license to possess a firearm without first having been issued an eligibility certificate.
- (c) A Designated Firearms Officer may not issue an applicant a license to possess a firearm that is not legal to possess in the state within which the applicant resides.
- (d) Familial transfer. Ownership of a firearm cannot be transferred from one person to another unless the transferee has a license to possess that firearm, even if the transferor and transferee are family members.
- (e) Issuance. Upon meeting the criteria for any firearms license, the Designated Firearms Officer to whom the application has been delivered must issue the applicant the appropriate firearms license. Neither the Designated Firearms Officer, nor any other state or federal government employee or agent may prevent an applicant from delivering a valid application to the Designated Firearms Officer.
§ 3 Eligibility Certificate
- (a) Requirements. To receive an eligibility certificate, the applicant must:
  - (1) Complete an application delivered to a Designated Firearms Officer responsible for the area in which applicant resides;
  - (2) Provide a full set of the applicant’s fingerprints;
  - (3) Be eighteen years old or older;
  - (4) Be lawfully present in the United States;
  - (5) Not suffer from a mental illness that renders the applicant a danger to himself or others;
  - (6) Never have been convicted of a crime punishable by a year or more of imprisonment;
  - (7) Never have been convicted of a crime involving:
    - (A) Fraud in relation to—or supplying false information for the purpose of—obtaining an eligibility certificate, license, permit, or authorization to possess a firearm in terms of this Act or a previous law; or
    - (B) Domestic violence.
  - (8) Not be addicted to any substance that has an intoxicating effect; and
  - (9) Pass a firearms safety course as prescribed by state law.
- (b) Issuance. Upon the applicant’s completion of the above requirements, the Designated Firearms Officer to whom an application has been delivered must issue a qualified applicant an eligibility certificate within thirty days of delivery.
- (c) Denial pending investigation. If the Designated Firearms Officer has a well-founded doubt that an applicant has not met one or more of the eligibility requirements, the Designated Firearms Officer can deny an applicant an eligibility certificate for up to thirty days, during which time he or she may conduct a further investigation to determine whether the applicant has met the requirements to receive an eligibility certificate. After thirty days, the Designated Firearms Officer must either:
  - (1) Issue the eligibility certificate if the applicant meets the necessary criteria; or
  - (2) Provide the applicant with the reason for denying the certificate.
  If the Designated Firearms Officer has a well-founded doubt as to the mental stability of an applicant, the Designated Firearms Officer has the discretion to require an applicant to undergo a screening by a licensed psychologist or licensed psychiatrist before issuing an eligibility certificate contingent on the psychologist or psychiatrist’s determination that the applicant is of stable mental condition.

B. Chapter 2: Types of Licenses and Use of Firearms

§ 4 License to Possess a Firearm for Self-Defense
- (a) Firearms that may be possessed for self-defense. A person can receive a license to possess the following firearms for self-defense:
  - (1) A handgun that is not fully automatic; or
  - (2) A rifle or shotgun that is not semi-automatic or fully automatic.
- (b) Issuance. A license to possess such a firearm for self-defense must be issued to any natural person who
  - (1) Holds a valid eligibility certificate; and
  - (2) Applies for a license to possess a firearm for self-defense.
- (c) Limits. No person may possess more than two licenses under this section.
§ 5 License to Possess a Restricted Firearm for Self-Defense
- (a) Restricted firearms defined. The following are considered “restricted firearms” for the purpose of this section:
  - (1) A rifle or shotgun that accepts detachable magazines and is semi-automatic but not fully automatic.
- (b) Requirements to issue a license to possess a restricted firearm for self-defense. A license to possess a firearm for self-defense must be issued to any natural person who
  - (1) Holds a valid eligibility certificate;
  - (2) Applies for a license to possess a restricted firearm for self-defense; and
  - (3) Shows cause why the particular restricted firearm for which a license is sought serves a self-defense need that a non-restricted firearm cannot serve.
- (c) Basis for denial. The Designated Firearms Officer reviewing the application to possess a restricted firearm for self-defense must provide an objectively reasonable basis, based on clear and convincing evidence, to deny an application for lack of cause under section 5(b)(3).
§ 6 License to Carry a Concealed Firearm for Self-Defense
- (a) Concealed carry defined. “Concealed carry” means carrying a firearm on the person of the license holder in a way that is not visible to others.
- (b) Requirements to issue a license to carry a concealed firearm for self-defense. A license to possess a firearm for self-defense must be issued to any natural person who
  - (1) Is twenty-one years old or older;
  - (2) Holds a valid eligibility certificate; and
  - (3) Completes an application delivered to a Designated Firearms Officer responsible for the area in which the applicant resides.
- (c) Arms that may be possessed for concealed carry. A person who holds a license to carry a concealed firearm can carry any handgun that is concealable on the person, is not fully automatic, and that the person has a license to possess.
§ 7 License to Openly Carry a Firearm for Self-Defense¹⁴⁷Either this section or section 5 can be deleted at the determination of the state legislature, but one type of public carry—either open or concealed—must be permitted. See Bruen, 142 S. Ct. at 2150.
- (a) Openly carry defined. “Openly carry” means carrying a firearm on the person of the license holder that is not concealed.
- (b) Requirements to issue a license to openly carry a firearm for self-defense. A license to openly carry a firearm for self-defense must be issued to any natural person who
  - (1) Is twenty-one years old or older;
  - (2) Holds a valid eligibility certificate; and
  - (3) Completes an application delivered to a Designated Firearms Officer responsible for the area in which applicant resides.
- (c) Arms that may be possessed for open carry. A person who holds a license to openly carry a firearm can openly carry any handgun that is not fully automatic and that the person has a license to possess.
§ 8 License to Possess a Firearm for Occasional Hunting or Occasional Sports Shooting
- (a) Purpose. The purpose of this section is to provide responsible, law-abiding citizens access to ordinary firearms for such lawful activities as hunting, target practice, and sports shooting.¹⁴⁸
- (b) Persons eligible under this section. Any person who holds a valid eligibility certificate can receive a license to possess a firearm for occasional hunting or sports shooting.
- (c) Arms that may be possessed for occasional hunting or sports shooting. A person may receive a license to possess the following firearms for occasional hunting or occasional sports shooting:
  - (1) A rifle or shotgun that is not semi-automatic or fully automatic; and
  - (2) A handgun that is not fully automatic.
§ 9 License to Possess a Firearm for Dedicated Hunting or Dedicated Sports Shooting
- (a) Dedicated hunter defined. A “dedicated hunter” means a person who regularly participates in hunting activities and who is a member of an Accredited Hunting Association.
- (b) Dedicated sports shooter defined. A “dedicated sports shooter” means any person who regularly participates in sports shooting and who is a member of an Accredited Sports Shooting Association.
- (c) A person who is a dedicated hunter or a dedicated sports shooter can receive a license to possess the following firearms for dedicated hunting or dedicated sports shooting:
  - (1) A rifle or shotgun that is not fully automatic; and
  - (2) A handgun that is not fully automatic.
C. Chapter 3: Use and Transportation of Firearms
- § 10 Use of Firearms. A person may use a firearm for which the person holds a valid license where it is safe and lawful to do so.
- § 11 Transportation of Firearms. A person lawfully possessing a firearm can transport that firearm in any manner that is consistent with state law.
IV. CONSTITUTIONALITY
The Model Act that this Note proposes is designed to survive judicial review by United States courts, rather than to be considered constitutional in an abstract sense. The object of the application of Second Amendment jurisprudence here is “the prediction of the incidence of the public force through the instrumentality of the courts.”¹⁴⁹ As such, this Section argues that the confluence of Second Amendment doctrine and practical considerations will allow the Model Act to remain “lawful” in the realist sense.¹⁵⁰
A. “Longstanding Prohibitions”
The Heller Court enumerated in dictum certain restrictions on the right to bear arms that its common use doctrine did not place in jeopardy.
[N]othing in our opinion should be taken to cast doubt on longstanding prohibitions on the possession of firearms by felons and the mentally ill, or laws forbidding the carrying of firearms in sensitive places such as schools and government buildings, or laws imposing conditions and qualifications on the commercial sale of arms.¹⁵¹
Although somewhat reassuring at the time the Heller decision was handed down, Bruen and McDonald have not given this assertion clear majority support. First, in McDonald, only Chief Justice Roberts and Justices Scalia and Kennedy joined Justice Alito’s endorsement of this list of presumptively lawful restrictions.¹⁵² Next, in Bruen, this passage was omitted entirely from the majority opinion, appearing only in Justice Kavanaugh’s concurrence.¹⁵³ Perhaps, then, this ipse dixit of “longstanding prohibitions” will not carry any special favor with the Court in the future and sections 3(a)(1–7) of the Model Act will have to be justified under Bruen’s historical test.
1. Prohibition on Firearm Possession by Felons
When applying Bruen’s historical test to section 3(a)(7) of the Model Act—which denies eligibility certificates to felons—the first question is whether the Second Amendment’s plain text covers an individual’s conduct.¹⁵⁴ To conclude that the Second Amendment does not cover this conduct requires reliance more on dicta from Heller, McDonald, and Bruen, as well as the majority’s focus on the rights of law-abiding citizens in these cases,¹⁵⁵ rather than a formally applied Bruen analysis. In United States v. Minter, for instance, a district court was faced with a challenge to the constitutionality of a federal law that makes possession of firearms and ammunition by convicted felons illegal.¹⁵⁶ The district court reasoned that “the Supreme Court in Bruen ha[d] already signaled the answer to this question,” and concluded that “the Bruen Court’s decision did not undermine Heller’s statement,” emphasizing that the Second Amendment protects the “right of law-abiding, responsible citizens to use arms for self-defense.”¹⁵⁷ Several other district courts have considered the constitutionality of a felon-in-possession laws post-Bruen, many of which have concluded that the Second Amendment’s plain text does not cover this conduct.¹⁵⁸ However, this reliance on dicta might not be enough to avoid the historical inquiry that Bruen demands.¹⁵⁹
If the Second Amendment’s plain text is interpreted to include convicted felons in its reference to “the people,”¹⁶⁰ Bruen’s historical test would require the government to determine whether section 3(a)(7) is “consistent with this Nation’s historical tradition of firearm regulation.”¹⁶¹ Because the earliest felon-disarmament laws date from the twilight of the nineteenth century and the early part of the twentieth century,¹⁶² an earlier historical analogue must be identified. One possible analogue is some American Colonies’ practice of attainder, which was utilized to disarm “disaffected” or “delinquent” individuals.¹⁶³ Although a bill of attainder would surely constitute a due process violation today, the colonial practice of attainder is still sufficiently analogical to felon-in-possession laws because it is an example of state legislatures disarming individuals considered dangerous.¹⁶⁴ Additionally, a colonial New York law prohibited convicted felons from owning property or chattels, implicitly prohibiting them from owning firearms.¹⁶⁵ Finally, a few historical examples of proposals made during the ratification process show that the founders did not intend to confer the right to bear arms on convicted felons.¹⁶⁶ Proposals from Anti-Federalists in Pennsylvania,¹⁶⁷ Samuel Adams in Massachusetts,¹⁶⁸ and delegates from New Hampshire¹⁶⁹ all show that the framers thought of the Second Amendment as recognizing the right of law-abiding citizens to bear arms. One of these proposals, for instance, provided that “no law shall be passed for disarming the people or any of them unless for crimes committed, or real danger of public injury from individuals.”¹⁷⁰ Although these were only proposals, they are still helpful because they illustrate how Americans at the time understood the government’s authority to limit firearm possession. These proposals’ rejection does not necessarily show that early Americans objected to such limitations on the right to bear arms and could simply be a result of a lack of Federalist support.
Although the historical precedents identified here are not overly persuasive, they have thus far been sufficient for many federal courts that have heard challenges to the federal felon-in-possession law and entertained the question of whether it is consistent with this Nation’s historical tradition of firearm regulation.¹⁷¹ Taking a realist view, this could simply be because the judiciary is staffed by those “who know too much to sacrifice good sense to a syllogism”¹⁷² and are unwilling to invalidate a law that is so sensible on its face. Even the Supreme Court, staffed as it is today, might not invalidate such laws. Assuming Justice Kavanaugh’s concurring opinion in Bruen to be an honest representation of how he (and Chief Justice Roberts, who joined his concurrence) will vote in the future, the Heller Court’s enumeration of presumptively lawful regulations will not be stripped of all persuasive effect.¹⁷³ After all, it is hard to imagine that Justices Sotomayor, Kagan, or Jackson would not endorse the “longstanding prohibitions” passage from Heller. Thus, we can expect laws that prohibit felons from possessing firearms—and section 3(a)(6) of the Model Act—will not be invalidated by the Supreme Court, even if on practical rather than doctrinal considerations.
2. Prohibiting Firearm Possession for Certain Non-Felonies
Possibly more challenging, however, is section 3(a)(7), which denies eligibility certificates to individuals convicted of fraud for the purpose of obtaining a firearm; unlawful use or handling of a firearm; or domestic violence. After deciding Bruen, the Supreme Court vacated and remanded for further consideration a circuit court decision rejecting a challenge to a Massachusetts law similar to section 3(a)(7) of the Model Act.¹⁷⁴ The law in question prohibited the plaintiff from receiving a license to carry a firearm in public because he had been convicted of attempting to carry a pistol without a license and of possession of an unregistered firearm in the District of Columbia.¹⁷⁵ Although these convictions were misdemeanors, Massachusetts law denied public carry licenses to “persons who had, ‘in any state or federal jurisdiction, been convicted’ of ‘a violation of any law regulating the use, possession, ownership, transfer, purchase, sale, lease, rental, receipt or transportation of weapons or ammunition for which a term of imprisonment may be imposed.’ ”¹⁷⁶ In upholding the Massachusetts law, the circuit court applied intermediate scrutiny, which the Supreme Court has since rejected as inappropriate for Second Amendment analysis.¹⁷⁷ However, in a similar post-Bruen case, the Fifth Circuit upheld a law prohibiting possession of a firearm by persons under indictment,¹⁷⁸ and several district courts have upheld laws prohibiting possession of firearms by felons,¹⁷⁹ domestic violence misdemeanants,¹⁸⁰ and unlawful users of controlled substances.¹⁸¹ Although some district courts have held similar laws unconstitutional,¹⁸² there is, as of yet, no circuit precedent invalidating these laws.
In addition to the weight of circuit precedent, the plain text of Heller supports the conclusion that “prohibitions on the possession of firearms by felons and the mentally ill”¹⁸³ and similar measures are “presumptively lawful.”¹⁸⁴ However, if the Court determines that Bruen abrogates the “longstanding prohibitions” dictum from Heller, a historical analogue will have to be found.¹⁸⁵ Bruen provides two metrics to be considered in determining whether a regulation is relevantly similar to a historical analogue: (1) how they burden a “law-abiding citizen’s right to armed self-defense,” and (2) why they burden that right.¹⁸⁶
Under these metrics, section 3(a)(7) of the Model Act could escape invalidation on the same basis as felon-in-possession laws¹⁸⁷: because it burdens a law-abiding citizen’s right of lawful self-defense in a way similar to, and for a reason practically identical to, the colonial practice of disarming “disaffected” or “delinquent individuals” through attainder,¹⁸⁸ and the colonial practice of prohibiting convicted felons from owning chattels, including firearms.¹⁸⁹
First, the burden is similar because a regulation prohibiting possession of firearms to certain classes of misdemeanants does not actually burden the right any more than a law prohibiting a felon’s possession of firearms. The right described in Bruen is one belonging to law-abiding citizens, not citizens convicted of felonies.¹⁹⁰ Individuals convicted of a felony or misdemeanor domestic violence; unlawful use or handling of a firearm; or fraud for the purpose of unlawfully obtaining a firearm are by definition not law-abiding.¹⁹¹ To the contrary, those individuals would be showing that they are willing to commit serious violent crimes—domestic violence—or crimes showing that they are not safe users of firearms. Second, the reason for the restrictions in section 3(a)(7) of the Model Act are identical to the reasons for the colonial practice of prohibiting dangerous individuals from owning firearms: to ensure those bearing arms are responsible, safe, and law-abiding. In discussing the regulations in shall-issue licensing regimes, Bruen acknowledges that regulations designed “to ensure only that those bearing arms in the jurisdiction are, in fact, ‘law-abiding, responsible citizens’ ” are constitutional.¹⁹² Because section 3(a)(7) is closely analogous to the presumptively lawful measures expounded in Heller,¹⁹³ it is likely to be held constitutional.
Another potentially problematic provision is section 3(a)(8), which does not allow individuals addicted to narcotics to obtain an eligibility certificate that is a prerequisite to possession of any firearm. In 2023, a federal court in Oklahoma ruled that the federal statute prohibiting possession of firearms by users of substances made illegal by the federal Controlled Substances Act¹⁹⁴ was unconstitutional.¹⁹⁵ However, this ruling is far from sounding the death knell for laws prohibiting possession of firearms by drug addicts. Even if this position was adopted by the circuit courts or the Supreme Court, it would not invalidate section 3(a)(8) because that section only prohibits individuals who are addicted to, rather than mere users of, intoxicating substances from obtaining eligibility certificates. This is intended to prevent individuals whose mental stability would be regularly impaired by the abuse of drugs or alcohol from possessing firearms and would not apply to an occasional marijuana user. Section 3(a)(8) is therefore very similar to a law prohibiting possession by those with mental illnesses, as described in Heller as presumptively lawful.¹⁹⁶
One final challenge section 3(a)(8) might face is that it is unconstitutional under Robinson v. California.¹⁹⁷ In Robinson, the Court held that a law criminalizing being addicted to the use of narcotics was cruel and unusual punishment under the Eight Amendment.¹⁹⁸ This comparison is, however, inapposite. Section 3(a)(8) does not criminalize drug addiction; it only prevents drug addicts from arming themselves—for their own safety and the safety of the general public. It is fundamentally no different from making it illegal for blind persons to drive. Moreover, the Model Act does not prevent persons who were once addicted to drugs but are no longer addicted from obtaining an eligibility certificate. Thus, section 3(a)(8) falls far short of being a punishment at all, much less a cruel and unusual one.
B. Regulation of Different Classes of Arms
1. Purpose-Based Licensing
The defining characteristic of the Model Act, in accordance with South Africa’s licensing system, is how it ties the ownership of a firearm to its use by only allowing ownership of firearms that are suited to the purpose for which the license is sought. Although access to certain firearms, such as semi-automatic rifles, is restricted under the Model Act, they are not entirely banned. This is done in an attempt to limit access to especially dangerous firearms while acknowledging the reality that a blanket ban on assault weapons might not be held constitutional by the current Supreme Court because of the inherent difficulty in finding a historical precedent regulating distinctly modern arms.¹⁹⁹ Moreover, given the Supreme Court’s current 6-3 conservative supermajority, a blanket ban would create a risk of creating a dangerous precedent. If the Supreme Court invalidated an assault weapons ban, future Justices who might not consider such a ban unconstitutional per se might nevertheless feel duty-bound to apply Supreme Court precedent faithfully.
The requirements for a license to possess a firearm for self-defense described in section 4(b) of the Model act would likely be found constitutional under Bruen because it is very closely analogous to the “shall-issue” carry licensing system in place in the vast majority of states.²⁰⁰ Bruen held only that the discretion afforded to licensing officials in the states with “may-issue” regimes is unconstitutional,²⁰¹ and did not jeopardize the licensing requirements that are employed in forty-three states.²⁰² The Court explained that “nothing in our analysis should be interpreted to suggest the unconstitutionality of the 43 States’ ‘shall-issue’ licensing regimes, under which ‘a general desire for self-defense is sufficient to obtain a [permit].’ ”²⁰³ Moreover, the Court used the fact that “shall-issue” licensing regimes are in place in the vast majority of states to bolster its argument that New York’s “may-issue” regime was unconstitutional.²⁰⁴ The Court further explained that states are free to “require applicants to undergo a background check or pass a firearms safety course,” and that these measures “are designed to ensure only that those bearing arms in the jurisdiction are, in fact, ‘law-abiding, responsible citizens.’ ”²⁰⁵ Section 4(b) of the Model Act follows the convention of a “shall-issue” licensing regime, but applies to firearm ownership for self-defense in general, not just to public carry. Regulations such as section 4(b) of the Model Act, just like regulations that the court mentioned,²⁰⁶ serve only to ensure that firearm owners are law-abiding, responsible citizens.²⁰⁷ Thus, section 4(b) burdens the right of law-abiding citizens to keep and bear arms for self-defense to a similar extent, and for the very same purpose, as the public carry licensing requirements in effect in forty-three states.²⁰⁸ Although the modern prevalence of the licensing requirement might not be doctrinally relevant, practically speaking, 4(b) would be unlikely to be invalidated unless a court were either willing to invalidate the widespread practice of public carry licensing or unwilling to accept licensing for firearm ownership in general.
2. High-Capacity Magazines and Semi-Automatic Rifles
Perhaps the most difficult constitutional question in this area is whether states can ban specific types of arms. The Supreme Court has not given clear guidance on these issues in any of its decisions, resulting in discordant lower court rulings on the issues of high-capacity magazine bans²⁰⁹ and assault weapon bans.²¹⁰ Heller states that the Second Amendment protects individual ownership of the types of firearms in common use, and that this protection means states cannot outright ban handgun ownership, but it is not clear how expansively “common use” (or for that matter, the “type” of a firearm) will be interpreted. Several states have attempted to prohibit possession of high-capacity magazines and assault weapons such as the AR-15;²¹¹ however, until the issue is squarely addressed by the Court, states will have to operate based on discordant lower federal court decisions.
Adding to this opacity is the term “assault weapon” itself. “Assault weapon” is a legal term that is not uniformly defined by legislatures.²¹² Some states define these weapons by its semi-automatic²¹³ functioning in combination with features like flash hiders,²¹⁴ pistol grips,²¹⁵ and adjustable stocks.²¹⁶ Regardless of how they are defined, however, the most functionally important aspects of assault weapons are that they are semi-automatic rifles and accept detachable magazines.²¹⁷ Assault weapons typically fire an intermediate rifle cartridge—a cartridge that is less powerful than a full-power rifle cartridge but more powerful than a pistol cartridge—making for a light and easy-to-use weapon with low recoil.²¹⁸ Perhaps the most common cartridge used in assault weapons in the United States is the 5.56 x 45mm NATO round.²¹⁹ Although the projectile weighs only one tenth of an ounce, it is capable of traveling at up to 3,200 feet per second—almost triple the speed of sound—making for a rather destructive weapon.²²⁰ Because the functionally important aspect of an assault weapon is that it is a semi-automatic rifle that accepts detachable magazines, the Model Act addresses these features specifically rather than fussing over the minute details of weapons that make little functional difference.
In acknowledgement of the constitutional invalidation risk that an outright ban on high-capacity magazines or assault weapons poses,²²¹ the Model Act takes an intermediate approach limiting, but not prohibiting, access to assault weapons and does not attempt to regulate magazine capacity. Under sections 4 and 5 of the Model Act, citizens cannot be granted a license to possess a semi-automatic rifle or shotgun—classified as restricted firearms under section 5(a)—for self-defense unless they show the particular restricted firearm for which they are seeking a license serves an important purpose for which a non-restricted firearm is insufficient. For instance, if a person lives on a property with large open fields, a handgun might not be sufficient for self-defense because it is difficult to shoot accurately over a long distance and a manually operated rifle²²² would be too slow to operate and use for self-defense. In this instance a semi-automatic rifle could be necessary to defend against an attacker who is armed with a semi-automatic long gun, thus serving an important need under section 5(b). Moreover, unlike the unfettered discretion that the “may-issue” regimes discussed in Bruen allowed for,²²³ section 5(c) severely limits the discretion of the designated firearms officer by requiring “an objectively reasonable basis based on clear and convincing evidence” to support a denial.²²⁴
Individuals could also obtain a license to possess a restricted firearm for dedicated hunting or sports shooting under section 9 of the Model Act. This is intended for individuals who regularly engage in hunting or sports shooting activities such as competitive shooting. This provision serves the purpose of limiting access to such particularly dangerous firearms as semi-automatic rifles while still allowing individuals to continue to engage in hunting, target practice, and shooting competitions using other kinds of firearms. The requirements that a person be regularly engaged in hunting or sports shooting and belong to an accredited hunting or sports shooting association is meant to keep semi-automatic rifles from being available to any adult for any purpose.
At first blush, this restriction on semi-automatic rifles seems to violate the historical test created in Bruen,²²⁵ unless a historical analogue can be found. However, a close reading of Bruen’s test shows that, in reviewing section 9 of the Model Act, the burden to find a historical analogue would never shift to the government. The Bruen test states that the Second Amendment presumptively protects an individual’s conduct only when its “plain text covers an individual’s conduct.”²²⁶ The Court has held that the plain text of the Amendment covers “ ‘the individual right to possess and carry weapons in case of confrontation’ that does not depend on service in the militia.”²²⁷ Section 9 of the Model Act, however, does not burden the “individual right to possess and carry weapons in case of confrontation”²²⁸ in the slightest. It restricts only the sporting use of certain weapons, not their self-defense use.²²⁹
The restriction on the sporting use of certain especially dangerous arms notwithstanding, individuals who wish to own a restricted firearm for self-defense have that option, subject only to a showing that the restricted firearm they wish to possess serves an important purpose that a non-restricted firearm cannot. This provision requiring an applicant to show that a restricted firearm serves an important purpose is also likely to be found constitutional under Bruen. Because section 5(a) concerns a restriction on firearms ownership for self-defense—unlike the sporting use contemplated in section 9—the “plain text” of the Second Amendment presumptively covers the conduct in question. Therefore, the burden would shift to the government to prove that section 5 burdens the right to bear arms for self-defense in a similar way and for a similar reason as a historical analogue to that regulation.²³⁰ The clear historical analogue for section 5 is the English prohibition on going armed with dangerous or unusual weapons.
The offense of riding or going armed with dangerous or unusual weapons is a crime against the public peace, by terrifying the good people of the land, and is particularly prohibited by the statute of Northampton, 2 Edward III, c. 3 (Wearing Arms, 1328), upon pain of forfeiture of the arms, and imprisonment during the king’s pleasure . . . .²³¹
Laws prohibiting going armed with dangerous or unusual weapons form a “long, unbroken line of common-law precedent”²³² that was recognized in the United States following the adoption of the Second Amendment.²³³ Although the Court stated in Bruen that the English and colonial laws prohibiting affrays were not sufficiently analogous to New York’s proper cause requirement,²³⁴ it did not foreclose reliance on these laws to justify other firearms regulations.²³⁵ The Court went so far as to state that “colonial legislatures sometimes prohibited the carrying of ‘dangerous and unusual weapons’—a fact we already acknowledged in Heller.”²³⁶ Crucially, sections 4 and 5 of the Model Act concern dangerous and unusual weapons, not a restrictive carry licensing scheme like the one the respondents sought to justify in Bruen.
In comparing sections 4 and 5 of the Model Act with the historical analogue, it is first necessary to establish whether the arms described in section 5(a) can fairly be described as “dangerous and unusual.” Clearly, compared with the types of arms the English law prohibited at the time of Blackstone’s Commentaries, the arms described in section 5(a) are extraordinarily dangerous and unusual. Even compared with other modern firearms, however, semi-automatic rifles that can be reloaded quickly are uniquely destructive.²³⁷ They are capable of inflicting an incredible amount of damage in a short period of time, making them especially dangerous and unusual by any standard.²³⁸ Comparing the relative burdens of the historical prohibition and the Model Act, the latter clearly burdens the right to bear arms to a lesser degree than the historical analogue. The historical offense outright prohibits going armed with dangerous or unusual weapons while sections 4 and 5 only limit it to certain uses. Within the terms of the Model Act, these uses include the “law-abiding citizen’s right to armed self-defense.”²³⁹ Moreover, the historical analogue and the Model Act burden the right for a similar purpose—to prevent especially dangerous and frightening arms from being widespread and to prevent individuals from terrorizing others with these arms.²⁴⁰
C. Public Carry
The portion of the Model Act regulating public carry of firearms for self-defense—sections 6 and 7—is perhaps as restrictive as courts will allow under Bruen. Of course, sections 6(b) and 7(b) make clear that the Model Act establishes a shall-issue public carry licensing regime, as required by Bruen.²⁴¹ Sections 6 and 7 also require an applicant to have a valid eligibility certificate, which is where most of the requirements that help ensure safe use of a firearm are listed. The eligibility certificate requirements would not be likely to face much resistance from the courts because they do not burden the right per se;²⁴² rather, they are “designed to ensure only that those bearing arms in the jurisdiction are, in fact, ‘law-abiding, responsible citizens.’ ”²⁴³ The Model Act leaves to the states the decision of whether one type of carry—open or concealed—should be banned.²⁴⁴
CONCLUSION
The governing case law concerning the Second Amendment greatly limits how states can restrict firearm ownership. The Supreme Court’s historical approach to Second Amendment challenges places many regulations many people find desirable outside the realm of constitutionality. This does not mean, however, that all reasonable regulations are impossible to implement. The Model Firearms Control Act presented in this Note is an initial step toward a comprehensive firearms licensing system that can serve to keep Americans safer while respecting their right to armed self-defense. The relatively limited nature of the regulations advocated in this Note is simply an acknowledgement of the reality that the Supreme Court has adopted a sweeping interpretation of the Second Amendment irrespective of its true meaning, which may best be left to historians. Given its current membership, the Supreme Court will not, for the foreseeable future, overturn its trilogy of Second Amendment precedents, so all states can do is implement the safest gun control solutions that governing case law will allow. On a later day, perhaps, a differently constituted Supreme Court will reconsider Bruen and replace its untenable historical inquiry with some form of means-end scrutiny. If and when that happens, the Model Act proposed in this Note can be expanded to be more restrictive while still respecting the individual right to armed self-defense. This Note offers an initial large step in implementing such solutions.

97 S. Cal. L. Rev. 211

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Lukas T. Huldi*

* Senior Editor, Southern California Law Review, Volume 97; J.D. Candidate 2024, University of Southern California Gould School of Law; B.S. Criminology & Criminal Justice 2020, California State University, Long Beach. Thank you to Professor David B. Cruz for his invaluable feedback and to the Southern California Law Review for their meticulous editing. A very special thank you to Alyssa Polito whose unwavering support during my time in law school has made this Note possible.

“Shelby County” to Clean Air Act: Evaluating the Constitutionality of California’s Clean Air Act Waiver Under the Equal Sovereignty Principle

May 2024July 2024Justine Huang*

In August 2022, California promulgated the Advanced Clean Cars II regulation, banning all sales of new gasoline-powered cars in the state by 2035. Transportation is the largest source of air pollution in California, responsible for nearly 40% of greenhouse gas (“GHG”) emissions; thus, the regulation is a crucial step towards meeting the state’s carbon neutrality and climate goals. California has the unique authority to regulate motor vehicle emissions due to a waiver exemption in the Clean Air Act. Congress recognized California’s expertise and unique air pollution challenges early on by authorizing just two standards: the national and California standards. Over the last five decades, California has received over one hundred waivers for its motor vehicle emission standards. However, in May 2022, seventeen states challenged the constitutionality of the waiver provision in Ohio v. EPA (pending in the D.C. Circuit Court of Appeals as of the publication of this Note), alleging, inter alia, that it violates the equal sovereignty principle—the idea that states must have equal political authority—by allowing only California to set new vehicle emission standards. These states further argue that California cannot regulate GHGs because climate change is a global problem not unique to California. To date, no court has addressed the constitutionality of the Clean Air Act under the equal sovereignty principle. Thus, this Note takes the principle seriously and analyzes how courts historically have applied it. In 2013, the Supreme Court developed the equal sovereignty principle as a meaningful concept for the first (and last) time in Shelby County v. Holder to invalidate section 4 of the Voting Rights Act. This Note applies the test established in Shelby County to the Clean Air Act waiver at issue, arguing that the equal sovereignty principle does not apply to the Clean Air Act, and even if it were to apply, the Clean Air Act waiver provision remains constitutional because Congress’s reasons for granting California an exemption remain relevant. California’s pioneering role in early air pollution control, its large economy, and its characteristic geographic and climate conditions put the state in a unique position to protect public health by regulating automobile emissions, while the state faces increasingly formidable threats from climate change that have exacerbated the local air pollution problems that initially compelled its motor vehicle regulations. Thus, even as California’s motor vehicle regulations have shifted from reducing local smog to reducing GHG emissions, California’s current needs continue to justify its differential treatment—maintaining, and perhaps even strengthening, the Clean Air Act waiver’s relevance in the twenty-first century.

INTRODUCTION

In August 2022, the California Air Resources Board (“CARB”), California’s chief air pollution regulator, promulgated the Advanced Clean Cars II regulation, which bans the sale of new gasoline-powered cars in California by 2035.¹ Transportation is the largest source of air pollution in the state, responsible for nearly 40% of greenhouse gas (“GHG”) emissions, 80% of nitrogen oxide pollution, and 90% of diesel particulate matter pollution.² CARB estimates that the new rule will result in significant climate, economic, and public health benefits. By 2040, the regulation is projected to result in a 50% reduction in GHG emissions from cars, pickup trucks, and SUVs.³ Taking gas cars off the road would eliminate the equivalent of 395 million metric tons of carbon dioxide emissions, which is analogous to avoiding the combustion of 915 million barrels of petroleum or shutting down more than one hundred coal plants for a year.⁴ From 2026 to 2040, the decrease in pollution should lead to 1,290 fewer cardiopulmonary deaths, 460 fewer hospital admissions for cardiovascular or respiratory illness, and 650 fewer emergency room visits for asthma.⁵ Thus, the regulation is a crucial step towards meeting the state’s carbon neutrality and climate goals.⁶

The regulations that California enacts are hugely influential; thus, the implications of California’s ability to implement motor vehicle regulations are extensive. If California were a country, it would be the tenth largest auto market in the world.⁷ As of May 13, 2022, seventeen states and the District of Columbia have adopted California’s Low-Emission Vehicle (“LEV”) and Zero-Emission Vehicle (“ZEV”) regulations under section 177 of the Clean Air Act, which allows other states to adopt California’s approved standards instead of the federal standards.⁸ California alone makes up 11% of U.S. new light-duty vehicle sales, or 40.1% when combined with the states that have already adopted its rules.⁹ New York was the second state to ban sales of gas-powered cars by 2035 as part of its plan to increase EV adoption.¹⁰ In February 2021, New York passed a law requiring all new passenger cars and trucks sold in the state to produce zero emissions by 2035,¹¹ and in September 2022, after California finalized its own ban, New York followed California in requiring all new vehicles sold by 2035 to be zero-emissions, setting in motion the regulatory process to implement the law.¹² In August 2022, Massachusetts Governor Charlie Baker also signed climate change legislation to end new sales of gas-powered cars in the state by 2035.¹³

California has the unique ability to implement motor vehicle emissions regulations because of an exception in the Clean Air Act.¹⁴ While the Clean Air Act generally prohibits states from setting vehicle emission standards,¹⁵ it provides a waiver exemption under section 209(b)(1) that allows California to set more stringent vehicle emission standards than the federal government.¹⁶ Given California’s pioneering role in motor vehicle regulations and unique air pollution problems, Congress recognized California’s expertise early on in the history of federal air pollution regulation.¹⁷ However, in May 2022, seventeen Republican-led states filed a lawsuit, Ohio v. EPA, challenging California’s ability to set its own pollution rules and demanding that the U.S. Environmental Protection Agency (“EPA”) revoke the waiver.¹⁸ The petitioner states claimed that the waiver provision is unconstitutional because it violates the so-called equal sovereignty principle—the idea that states must have equal political authority—by only empowering California to set new vehicle emission standards.¹⁹ The petitioners additionally argued that Congress cannot allow California alone to regulate climate change, which is a global problem not unique to California.²⁰ Because California has shifted from regulations to reduce smog and local air pollution to GHG regulations to address global climate change, the petitioners essentially argued that circumstances have changed enough since Congress enacted the waiver provision in 1967 that California’s special treatment is no longer justified.²¹

This Note takes the equal sovereignty claim seriously and argues that the Clean Air Act waiver provision remains constitutional under the equal sovereignty principle. Part I provides relevant background on the waiver provision and history of California’s waiver requests. It then summarizes the equal sovereignty principle arguments made in the pending Ohio v. EPA lawsuit and provides relevant history on how courts have applied the principle leading up to Shelby County v. Holder,²² the first time the Supreme Court held a statute unconstitutional based on the equal sovereignty principle. Part II argues that the equal sovereignty principle does not apply to the Clean Air Act, but even if it were to apply, the test from Shelby County does not invalidate the Clean Air Act waiver provision. This Note concludes by offering final thoughts on the equal sovereignty claim and underscoring the implications of Ohio v. EPA in California’s ability to continue to lead the nation in addressing GHG emissions.

I. BACKGROUND

A. The Clean Air Act and EPA Waiver Provision

California’s ability to implement its own motor vehicle standards stems from the Clean Air Act. Congress passed the Clean Air Act in response to air pollution crises in the mid-20th century resulting from industrialization.²³ “Killer fog” events, where a deadly mix of pollution and fog covered cities in the United States and around the world, spurred federal regulation of air pollution.²⁴ In 1955, Congress enacted the Air Pollution Control Act, the first national air pollution legislation.²⁵ Continuing “killer fog” incidents in the United States then prompted Congress to pass the 1963 Clean Air Act, which established grant and research programs to support states in their air pollution control efforts but left air pollution regulation primarily to the states.²⁶

California was the first state to regulate emissions from cars.²⁷ The first recognized episodes of smog occurred in Los Angeles in 1943, and in the 1950s, a California researcher determined that the automobile was the main cause of the smog.²⁸ In 1966, California established the first tailpipe emissions standards in the nation.²⁹

Congress continued to enact new statutes in response to California’s regulations.³⁰ The 1967 Air Quality Act amended the 1963 Clean Air Act, moving towards a uniform federal policy by requiring national air quality criteria, which states would then implement.³¹ It was also the first statute to give preemptive power to the federal government to adopt and enforce standards relating to the control of emissions from new motor vehicles.³² However, Congress added a waiver provision exempting California from the preemption provision when California could demonstrate a need for more stringent standards than those the EPA established.³³ While the waiver does not reference California by name, it was clearly intended for California because California was the only state that met the requirement of adopting motor vehicle emission standards prior to March 30, 1966.³⁴ Thus, Congress acknowledged California’s expertise early on in the history of federal air pollution regulation.

In fact, the Clean Air Act is a paradigmatic example of cooperative federalism, under which “States and the Federal Government [are] partners in the struggle against air pollution.”³⁵ The federal preemption provision reflects Congress’s interest in allowing automobile manufacturers to produce uniform automobiles for a national market and benefit from the economies of large-scale production without having to accommodate multiple state standards.³⁶ Congress acknowledged the complex nature of automobile manufacturing and noted the importance of ensuring that automobile manufacturers obtain “clear and consistent answers” concerning emission standards.³⁷ Courts have also interpreted that Congress preempted the field of vehicle emission regulation “to ensure uniformity throughout the nation, and to avoid the undue burden on motor vehicle manufacturers which would result from different state standards.”³⁸ However, given California’s lead in early motor vehicle regulations and Congress’s additional interest in having California as a “laboratory for innovation,”³⁹ Congress intentionally struck a balance between having one national standard and fifty different state standards by authorizing just two standards, the national and California standards.⁴⁰ This balance allowed California to continue to innovate and improve its air quality without creating a practical nightmare for automakers and interstate commerce.⁴¹

The 1970 Clean Air Act Amendments, which form the basis of the contemporary federal Clean Air Act, authorized the development of federal and state regulations to limit emissions from stationary (industrial) and mobile sources (including automobiles).⁴² Section 109 requires the EPA Administrator to establish basic requirements for ambient air quality, known as National Ambient Air Quality Standards (“NAAQS”), for particular criteria pollutants, which the states would be required to meet.⁴³ The current list of criteria pollutants includes sulfur dioxide, particulate matter, nitrogen oxide, carbon monoxide, ozone, and lead, but does not include carbon dioxide.⁴⁴

In 1977, Congress revised the provision to read as it does today. Section 202(a)(1) requires the EPA Administrator to establish motor vehicle emissions standards for pollutants “which, in his judgment, cause or contribute to air pollution which may reasonably be anticipated to endanger public health or welfare.”⁴⁵ The 1977 Clean Air Act Amendments strengthened the deference given to California under the waiver provision in two significant ways. First, the 1977 Amendments revised section 209(b)(1) by requiring the EPA Administrator to grant a preemption waiver for California “if the State determines that the State standards will be, in the aggregate, at least as protective of public health and welfare as applicable Federal standards.”⁴⁶ This amendment allows California, rather than the EPA, to make its own determination as to whether the regulations are sufficiently protective of public health and welfare. It also allows California to make this determination by looking at the entire program as a whole, rather than evaluating each regulation individually. Thus, as long as the entire set of regulations is more protective than the federal system, the EPA must allow California to implement these measures. The EPA Administrator can deny the waiver only if the state’s determination is “arbitrary and capricious” or the state does not need its standards to meet “compelling and extraordinary conditions.”⁴⁷ Second, the 1977 Amendments added section 177, which enhanced the strength of California’s motor vehicle emissions regulations by allowing other states to adopt California’s approved standards in lieu of the federal standards.⁴⁸ According to the House Report, the Committee on Interstate and Foreign Commerce makes clear that it sought to “ratify and strengthen the California waiver provision . . . to afford California the broadest possible discretion in selecting the best means to protect the health of its citizens and the public welfare.”⁴⁹ The legislative and statutory history thus suggests that Congress intended to give California broad discretion to regulate air pollutants in the way it deems most appropriate to protect public health and welfare.

B. History of California’s Motor Vehicle Regulations and Waiver Requests

The Clean Air Act section 209(b)(1) waiver reflects a five-decade history of allowing California to implement motor vehicle emissions standards that are more stringent than federal government standards.⁵⁰ California was granted its first waiver in 1968 and has since received over one hundred waivers for a range of new or amended motor vehicle and motor vehicle engine standards.⁵¹ Smog in Los Angeles initially spurred California to adopt statewide standards to regulate criteria pollutants,⁵² and CARB has consistently developed the first emission standards in the nation.⁵³

As California transitioned from regulating criteria pollutants to promulgating regulations that address GHG emissions, certain EPA administrations began to challenge its waiver requests, leading to the ping-ponging back and forth between administrations. In 2002, recognizing that global warming would impose “compelling and extraordinary impacts” on California, the state enacted Assembly Bill (AB) 1493, Chapter 200.⁵⁴ The bill acknowledged that motor vehicle emissions are a major source of the state’s GHG emissions and that reducing GHG emissions is critical to slowing down the effects of global warming and protecting public health and the environment.⁵⁵ The bill directed CARB to adopt regulations that achieve the “maximum feasible . . . reduction of greenhouse gas emissions” from passenger vehicles, beginning with the 2009 model year.⁵⁶ Thus, in 2004, CARB approved the first regulations in the nation that control GHG emissions from motor vehicles (Pavley regulations), which applied to new vehicles for the 2009–2016 model years.⁵⁷

In December 2005, CARB requested a waiver to allow California to enforce its new GHG emission standards.⁵⁸ The EPA delayed action pending the outcome of litigation regarding whether the EPA had authority to regulate GHG emissions under the Clean Air Act, as the Clean Air Act did not explicitly regulate GHG emissions at the time.⁵⁹ The Supreme Court addressed GHG emissions for the first time in Massachusetts v. EPA, holding in a 5-4 decision that carbon dioxide is considered an “air pollutant” that the EPA may regulate under section 202(a)(1) of the Clean Air Act.⁶⁰ Thus, the Court held that the EPA has the statutory authority to regulate GHG emissions from new motor vehicles and that Congress provided the EPA with the flexibility to address new air pollutant threats that the EPA determines endanger the public welfare.⁶¹

Despite the Supreme Court ruling, in March 2008, the Bush administration’s EPA denied the waiver for the Pavley regulations, which was the first time the EPA denied a waiver for California.⁶² In its decision, the EPA deviated from the traditional interpretation of the “compelling and extraordinary” waiver criteria⁶³ to narrowly interpret that Congress authorized the EPA to grant a waiver only when “California standards were necessary to address peculiar local air quality problems,” as opposed to global climate change problems.⁶⁴ Unlike California’s previous motor vehicle programs, which addressed local smog problems, the GHG emission standards aimed to address climate change. Thus, the EPA determined that California did not need its new motor vehicle standards to meet “compelling and extraordinary” conditions related to GHG emissions because emissions from California cars “become one part of the global pool of GHG emissions”⁶⁵ and do not directly cause elevated concentrations of GHGs in the region.⁶⁶ Alternatively, the EPA determined that because climate change is a global issue, the impacts of climate change in California were not sufficiently unique and different.⁶⁷

In July 2009, the Obama administration’s EPA reversed the 2008 denial and granted California’s waiver request to enforce its GHG emission standards for model year 2009 and later new motor vehicles.⁶⁸ As the EPA stated, CARB has repeatedly demonstrated the need for its motor vehicle program to address “compelling and extraordinary” conditions in California, and Congress did not intend to allow California to address only local or regional air pollution problems.⁶⁹ Rather, Congress intended California to have broad discretion and autonomy, acting as a pioneer and a “laboratory for innovation.”⁷⁰ Thus, narrowing the waiver’s scope would hinder California from implementing motor vehicle programs “as it deems appropriate to protect the health and welfare of its citizens.”⁷¹ In contrast to the 2008 EPA’s reasoning, the 2009 EPA determined that the impacts of global climate change can exacerbate the local air pollution problem.⁷² It found compelling California’s assessment that its GHG standards are linked to improving California’s smog problems and that higher temperatures from global warming will exacerbate California’s high ozone levels and the “climate, topography, and population factors conducive to smog formation in California, which were the driving forces behind Congress’s inclusion of the waiver provision in the Clean Air Act.”⁷³ The EPA noted that California’s GHG regulations will reduce greenhouse gas concentrations, even if only slightly, and “every small reduction is helpful . . . .”⁷⁴ Given California’s unique geographical and climatic conditions that foster extreme air quality issues, its ongoing need for dramatic emissions reductions, and growth in its vehicle population and use, the EPA determined that California’s need met “compelling and extraordinary” conditions.⁷⁵ Still, the EPA acknowledged that “conditions in California may one day improve such that it no longer has the need for a separate motor vehicle program.”⁷⁶

In 2012, CARB adopted the Advanced Clean Cars I (“ACC I”) regulations to increase the stringency of criteria pollutant and GHG emission standards for new passenger vehicles for the 2015–2025 model years.⁷⁷ In 2013, the Obama administration’s EPA granted California a waiver for its ACC I regulations.⁷⁸ The EPA largely followed the 2009 waiver decision in determining that the new standards continued to meet “compelling and extraordinary” conditions.⁷⁹ The EPA found a rational connection between CARB’s emission standards and long-term air quality goals,⁸⁰ as well as compelling and extraordinary conditions within the state pertaining to the effects of pollution.⁸¹

In September 2019, in an unprecedented move, the Trump administration’s EPA revoked the 2013 waiver, marking the first time the EPA retroactively withdrew a previously granted waiver.⁸² The EPA went a step further than its 2008 waiver decision, narrowly interpreting that “Congress did not intend the waiver provision . . . to be applied to California measures that address pollution problems of a national or global nature,” but only conditions “extraordinary” with respect to California; that is, “with a particularized nexus to emissions in California and to topographical or other features peculiar to California.”⁸³ The EPA argued that climate change caused by carbon dioxide emissions is not a local air pollution problem and that California’s new motor vehicle standards deviated too far from what Congress intended in granting California a waiver.⁸⁴ The EPA concluded that California’s GHG standards were missing a specific connection to local features, and thus excluded GHG regulation from the scope of the waiver.⁸⁵

In March 2022, the Biden administration’s EPA rescinded the 2019 waiver withdrawal, restoring the 2013 waiver and California’s authority to enforce its GHG emission standards and ZEV sales mandate.⁸⁶ In determining that California has a compelling need for its GHG standards and ZEV sales mandate, the EPA essentially reverted back to its 2013 analysis, maintaining that pollution continues to pose a distinct problem in California.⁸⁷ The EPA saw no reason to distinguish between local and global air pollutants, reasoning that all pollutants play a role in California’s local air quality problems and that the EPA should provide deference to California in its comprehensive policy choices for addressing them.⁸⁸ The 2022 EPA refuted the 2019 EPA’s premise that GHG emissions from motor vehicles in California do not pose a local air quality issue,⁸⁹ noting that criteria pollution and GHGs have interrelated and interconnected impacts on local air quality.⁹⁰

Congress recently expanded the Clean Air Act to include GHGs, clarifying that GHGs are pollutants under the Clean Air Act. On August 16, 2022, President Biden signed the Inflation Reduction Act into law, the single largest climate package in U.S. history, which will invest almost $370 billion in clean energy and other climate-related measures over the next ten years, and is expected to reduce U.S. carbon emissions by 40% by 2030 compared to 2005 levels.⁹¹ The Act reinforces the EPA’s authority to regulate GHGs under the Clean Air Act, amending sections of the Clean Air Act to define “greenhouse gas” to include “the air pollutants carbon dioxide, hydrofluorocarbons, methane, nitrous oxide, perfluorocarbons, and sulfur hexafluoride.”⁹² It also grants money under the Clean Air Act for any project that “reduces or avoids greenhouse gas emissions and other forms of air pollution.”⁹³ This language supports that Congress fully intends to include GHGs in the Clean Air Act and that California is acting within the scope of the Clean Air Act in implementing its forward-looking motor vehicle emissions regulations.

C. Pending Lawsuit—Ohio v. EPA

Similar to its prior motor vehicle regulations, California will need to request a preemption waiver from the EPA under section 209(b)(1) of the Clean Air Act to regulate post-2025 vehicles. In the meantime, the Biden administration’s EPA’s latest March 2022 waiver decision prompted Republican-led states and private petitioners to challenge the constitutionality of the Clean Air Act waiver provision, making the case highly relevant for California’s ability to regulate motor vehicle emissions in the future.⁹⁴ In May 2022, seventeen states filed a lawsuit in the U.S. Court of Appeals for the D.C. Circuit (Ohio v. EPA), claiming, inter alia, that the section 209(b)(1) waiver provision violates the equal sovereignty principle because it limits state political authority unequally by allowing only California to set new car emission standards and “exercise sovereign authority that section 209(a) takes from every other State.”⁹⁵ Under this principle, the petitioners alleged, Congress cannot give only some states favorable treatment of sovereignty authority, as it has done with California.⁹⁶ Even if section 209(b)(1) allowed California to regulate unique state-specific issues, the petitioners argued that the waiver would still be unconstitutional because it allows California to regulate GHGs to address climate change, which is not a problem unique to California.⁹⁷ The petitioners disagreed with the Biden administration’s EPA’s statement that “California is particularly impacted by climate change,”⁹⁸ arguing that other states will be impacted just as much, if not more, from climate change.⁹⁹

The petitioner states also took issue with the idea of giving one state power to regulate a major national industry.¹⁰⁰ The states argued that California’s “special treatment” under the Clean Air Act—giving California special power to regulate a major national industry and exercise sovereign authority that the Act withdraws from every other state, when California has no unique interest¹⁰¹—violates the Constitution’s intent to hold all states equal.¹⁰² In a separate brief, a group of private petitioners, including the American Fuel & Petrochemical Manufacturers and Clean Fuels Development Coalition, argued that the equal sovereignty principle does not allow the federal government to give only one state the authority to regulate national and international issues.¹⁰³ They claimed that any mandate to shift the nation’s automobile fleet to electric vehicles must come from Congress, because such a shift would “substantially restructure the American automobile market, petroleum industry, agricultural sectors, and the electric grid, at enormous cost and risk.”¹⁰⁴ The private petitioners cited the recent West Virginia v. EPA decision, which essentially restricted the EPA’s authority to regulate GHG emissions from power plants.¹⁰⁵ Applying the major questions doctrine,¹⁰⁶ the Court held that the EPA must point to “clear congressional authorization”¹⁰⁷ to justify its regulatory authority in “extraordinary cases” when the EPA asserts broad authority in an area of “economic and political significance.”¹⁰⁸ The Court concluded that the EPA does not have the authority to “substantially restructure the American energy market . . . .”¹⁰⁹ If the EPA cannot upend energy generation in the country, as West Virginia v. EPA held, then, the petitioners argued, California similarly cannot “upend the transportation and energy sectors.”¹¹⁰ The petitioners further argued that section 177 also allows California to shape national industries, which may burden the states that decline to adopt California’s standards.¹¹¹

On the other hand, several electric utility providers, clean energy industry groups, and auto manufacturers have backed California.¹¹² A few automakers have indicated that they support the more stringent California standards. In July 2019, CARB reached a voluntary agreement with four major automakers—BMW of North America, Ford, Honda, and Volkswagen Group of America—to adopt a modified version of the GHG standards.¹¹³ Building on this voluntary framework, in 2020, Volvo joined the four automakers in agreeing to a 17% emissions cut through the 2026 model year.¹¹⁴ The automakers filed a motion to intervene to defend the EPA’s March 2022 decision.¹¹⁵

To date, the Supreme Court has not addressed the constitutionality of the Clean Air Act under the equal sovereignty principle. In its 2019 decision revoking the 2013 California waiver, the Trump administration’s EPA interpreted the statutory criteria in the context of the equal sovereignty principle, explaining that section 209(b)(1) provides “extraordinary treatment” to California and therefore should be interpreted to require a “state-specific particularized” pollution problem.¹¹⁶ In contrast, in its 2022 waiver grant, the Biden administration’s EPA noted that it has historically declined to consider constitutional issues, reviewing the waiver solely based on the section 209(b)(1) criteria because the statute and legislative history reflect a broad policy of deference to California to address its air quality problems.¹¹⁷ Although equal sovereignty presented a new constitutional argument, the EPA limited its role in evaluating waiver requests to “the criteria that Congress directed EPA to review.”¹¹⁸ Nevertheless, the Biden administration’s EPA briefly addressed the equal sovereignty principle, arguing that the waiver does not impose a burden on any state and that Section 177, in enabling other states to adopt California’s standards, undermines the notion that the section 209(b)(1) waiver treats California in an extraordinary manner.¹¹⁹ Rather, in deliberately compromising between having one national standard and fifty different state standards by authorizing just two—the federal standard and California’s standards—Congress allowed California to be a “laboratory for innovation” and address the state’s extraordinary pollution problems, while ensuring that automakers were not overburdened with varying state standards.¹²⁰

D. California’s Advanced Clean Cars II Regulations

California recently promulgated the Advanced Clean Cars II (“ACC II”) regulations in the shadow of the pending Ohio v. EPA lawsuit. ACC II stems from an executive order Governor Gavin Newsom signed in September 2020 directing CARB to develop regulations contributing to the goal that 100% of in-state sales of new passenger cars and trucks will be zero-emission by 2035.¹²¹ As a result of the executive order, on August 25, 2022, CARB promulgated a new regulation, the ACC II program, phasing out all sales of new fossil fuel cars by 2035.¹²² The regulation requires that automakers increase the percentage of electric vehicles progressively, nearly tripling it to 35% by 2026 and reaching 100% by 2035 (see Figure 1).¹²³

Figure 1. Percentage of new vehicle sales that must be zero-emission vehicles

The ACC II regulations amend the ZEV and LEV standards for model years 2026–2035,¹²⁴ following the ACC I regulations, which address model year 2015–2025 vehicles.¹²⁵ CARB estimates that the new regulations will reduce vehicle GHG emissions by more than 50% by 2040.¹²⁶ Thus, the decision from Ohio v. EPA will have implications for California’s ability to implement standards including the ACC II program going forward.

E. The Equal Sovereignty Principle

The Supreme Court didn’t develop the equal sovereignty principle as a meaningful concept until Shelby County v. Holder in 2013,¹²⁷ in which the Supreme Court held a statute (the Voting Rights Act) unconstitutional based on the equal sovereignty principle for the first time. The Court did not clarify what constitutional provision this principle is based on.¹²⁸ Although the Constitution requires equal treatment among the states in particular contexts,¹²⁹ no provision explicitly requires Congress to treat all states equally as a general matter.¹³⁰ This absence of an explicit statement could mean that the founders did not intend to establish a generally applicable equal sovereignty principle.¹³¹ Critics of Shelby County have claimed that the Supreme Court invented the equal sovereignty principle to achieve political ends.¹³² Other scholars argue that questions about the sovereign power of the states have existed since the drafting of the U.S. Constitution.¹³³ Many scholars agree there is some support for the principle in the historical record and constitutional doctrine, but they doubt that is sufficient for it to be considered a “fundamental” principle, as Shelby County claims.¹³⁴ This Section traces the history of how courts have applied the equal sovereignty principle, from the context of admitting new states into the Union to voting rights.

1. Origins: The Equal Footing Doctrine—New Admission of States

The equal sovereignty principle dates back to the equal footing doctrine referenced in Article IV, Section 3 of the Constitution: “New States may be admitted by the Congress into this Union; but no new State shall be formed or erected within the Jurisdiction of any other State . . . without the Consent of the Legislatures of the States concerned as well as of the Congress.”¹³⁵ The Northwest Ordinance of 1787, which provided a path toward statehood for the territories northwest of the Ohio River,¹³⁶ further required that these states be admitted “on an equal footing with the original States in all respects whatever,” on the condition that the new state constitutions and governments were “republican, and in conformity to the principles contained in these articles . . . .”¹³⁷

Several court cases also interpret the Constitution to support the equal sovereignty principle. Pollard’s Lessee v. Hagan held that Congress must admit every state into the Union on the same terms and with the same powers as the original states.¹³⁸ Every state must be “admitted into the union on an equal footing with the original states,¹³⁹ with “equal sovereign rights.”¹⁴⁰ Further, the court held that “no compact” can “diminish or enlarge” the rights a state has when it enters the Union.¹⁴¹ Northwest Austin v. Holder referenced this case as support for the historic tradition that all states enjoy equal sovereignty.¹⁴² Coyle v. Smith held that states, not Congress, have sovereignty to choose where to locate their state capital: the United States “was and is a union of States, equal in power, dignity and authority, each competent to exert that residuum of sovereignty not delegated to the United States by the Constitution itself.”¹⁴³ No state is “less or greater . . . in dignity or power” than another.¹⁴⁴ Thus, Congress may not unequally limit or expand the states’ political and sovereign power.¹⁴⁵ Indeed, “the constitutional equality of the States is essential to the harmonious operation of the scheme upon which the Republic was organized.”¹⁴⁶ Thus, these cases establish the origins of the equal sovereignty principle in the admission of new states into the Union.

2. Equal Sovereignty Applied to Voting Rights

When the equal sovereignty principle was brought up in the context of the Voting Rights Act, courts had to determine whether the principle applied outside the state admission context.

Congress designed the Voting Rights Act of 1965 to address continuing voting discrimination after the Civil War.¹⁴⁷ The Fifteenth Amendment to the Constitution, ratified in 1870, prohibited voting discrimination based on race,¹⁴⁸ and Congress subsequently enacted the Enforcement Act of 1870, which prohibited obstruction of the exercise of the right to vote.¹⁴⁹ However, enforcement of the law was ineffective, and throughout Reconstruction, many southern states continued to enact tests designed to prevent Black people from voting.¹⁵⁰ To address this continuing discrimination, section 5 of the Voting Rights Act established a preclearance requirement, mandating that the federal government approve all new voting regulations to ensure that they did not perpetuate racial discrimination.¹⁵¹ However, the preclearance requirement only applied to states with a history of voting discrimination, as determined by the coverage formula in section 4 of the Voting Rights Act.¹⁵² The coverage formula implicated states located primarily in the South; thus, a select group of states were subject to more stringent requirements than other states when seeking to change their voting laws.

In its 1966 decision in South Carolina v. Katzenbach, the Supreme Court rejected the notion that the equal sovereignty principle prohibited differential treatment in the voting rights context. The Court held that the equal sovereignty principle only applied to situations involving the admission of new states, not the Voting Rights Act: “The doctrine of the equality of States . . . applies only to the terms upon which States are admitted to the Union, and not to the remedies for local evils which have subsequently appeared.”¹⁵³ The Court observed that Congress passed the Voting Rights Act in response to the “insidious and pervasive evil” of racial discrimination in voting,¹⁵⁴ and thus held that the Voting Rights Act was a constitutional and appropriate means for carrying out the Fifteenth Amendment.¹⁵⁵

Fourteen years later in City of Rome v. United States, the Supreme Court again upheld the Voting Rights Act as constitutional, finding that the Reconstruction Amendments were “specifically designed as an expansion of federal power and an intrusion on state sovereignty,” and thus, Congress had the authority to regulate state and local voting.¹⁵⁶ The Court cited Fitzpatrick v. Bitzer, which held that the principle of state sovereignty embodied by the Eleventh Amendment is “necessarily limited by the enforcement provisions of section 5 of the Fourteenth Amendment.”¹⁵⁷ However, the Court would later apply the equal sovereignty principle to invalidate part of the Voting Rights Act.

3. Shelby County v. Holder—Equal Sovereignty as a General Principle

Only two Supreme Court cases discuss equal sovereignty as a general principle.¹⁵⁸ Northwest Austin v. Holder,¹⁵⁹ though still a voting rights case, applied the equal sovereignty principle more broadly in 2009, laying the foundation for Shelby County v. Holder¹⁶⁰ to overrule Voting Rights Act section 4 in 2013.¹⁶¹

In Northwest Austin, the Supreme Court observed that the section 4 coverage formula of the Voting Rights Act went against the “historic tradition that all the States enjoy ‘equal sovereignty’ ” by differentiating between the states.¹⁶² The Court acknowledged that differentiating between states is sometimes justified, citing Katzenbach as an example.¹⁶³ However, it held that departing from “the fundamental principle of equal sovereignty requires a showing that a statute’s disparate geographic coverage is sufficiently related to the problem that it targets.”¹⁶⁴ Thus, the equal sovereignty principle limits Congress’s ability to subject different states to unequal burdens, at least without sufficient justification.¹⁶⁵ The Court also noted that the Act “imposes current burdens and must be justified by current needs.”¹⁶⁶ While the Court ultimately resolved the case on statutory grounds,¹⁶⁷ it expressed concern that sections 4 and 5 of the Voting Rights Act raised “serious constitutional questions.”¹⁶⁸ The Court observed that improved conditions in the South since 1965 may distinguish the case from Katzenbach because current conditions in 2009 may no longer reflect the discriminatory state actions that Congress meant for section 5 to address, and cited a lower racial gap in voter registration as an example to show that the coverage formula may rely on outdated statistics.¹⁶⁹ The Court also observed that the Voting Rights Act’s preclearance requirements “authorize[d] federal intrusion into sensitive areas of state and local policymaking” and imposed “substantial ‘federalism costs.’ ”¹⁷⁰

These concerns formed the basis for Shelby County to hold that section 4 of the Voting Rights Act was unconstitutional because it departed from the “fundamental principle” of equal sovereignty.¹⁷¹ The Supreme Court found the “fundamental principle of equal sovereignty” to be “highly pertinent in assessing subsequent disparate treatment of States.”¹⁷² The Court adopted the guidelines Northwest Austin set—namely, that the Voting Rights Act “imposes current burdens and must be justified by current needs,” and that “a departure from the fundamental principle of equal sovereignty requires a showing that a statute’s disparate geographic coverage is sufficiently related to the problem that it targets.”¹⁷³ The Court also distinguished the case from Katzenbach. Whereas in Katzenbach, the coverage formula was “relevant to the problem” of voting discrimination at the time,¹⁷⁴ here, the coverage formula was not updated to reflect contemporary improvements in voting participation, including higher voter registration and turnout numbers.¹⁷⁵ The Court concluded that Congress did not sufficiently justify its reauthorization of the “extraordinary and unprecedented features” of the Voting Rights Act;¹⁷⁶ thus, the Court held that the coverage formula no longer met the test introduced in Northwest Austin.¹⁷⁷

Shelby County, the only Supreme Court case to apply the test established in Northwest Austin, gave little guidance on how to apply the equal sovereignty principle in future cases, other than indicating that the law should rely on “current data reflecting current needs” when the degree of voting discrimination that prompted the original passage of the Voting Rights Act had changed.¹⁷⁸ The Supreme Court has not decided an equal sovereignty challenge since Shelby County, leaving lower courts to interpret how to apply the equal sovereignty principle outside the voting rights context.

II. APPLYING THE SHELBY COUNTY TEST TO THE CLEAN AIR ACT

Under the Northwest Austin test that Shelby County applied (the “Shelby County test”), the statute “must be justified by current needs,” and if federal legislation departs from the “fundamental principle of equal sovereignty,” it “requires a showing that a statute’s disparate geographic coverage is sufficiently related to the problem that it targets.”¹⁷⁹ This Part argues that the equal sovereignty principle likely does not apply to the Clean Air Act, thus the Shelby County test should not even apply. But even if it were to apply and the Shelby County test is triggered, this Part concludes that the principle does not invalidate section 209(b)(1) of the Clean Air Act because California’s current needs continue to justify its differential treatment. California’s unique exemption is sufficiently related to the public health problem that the Clean Air Act waiver provision targets; allowing California broad discretion to regulate motor vehicle emissions directly contributes to Congress’s goal of addressing public health threats from motor vehicle pollution in the state.

A. The Equal Sovereignty Principle Likely Does Not Apply to the Clean Air Act

This Section argues that the scope of the Shelby County test is limited and likely does not apply to the Clean Air Act. Shelby County emphasizes that the equal sovereignty principle applies to federal laws that “authorize[] federal intrusion into sensitive areas of state and local policymaking.”¹⁸⁰ The Supreme Court thus applied the equal sovereignty principle to the Voting Rights Act because it determined that election regulation was a sensitive area of state policymaking. Highlighting the “extraordinary” nature of the Voting Rights Act’s preclearance provisions,¹⁸¹ the Court noted that the law suspends “all changes to state election law—however innocuous—until they have been precleared by federal authorities . . . .”¹⁸² The federal government must explicitly grant states permission to implement voting laws that they “would otherwise have the right to enact and execute on their own . . . .”¹⁸³ Because the Voting Rights Act intruded into a sensitive area of state policymaking that had traditionally been the exclusive province of the states, the Court limited Congress’s authority under the Fifteenth Amendment to restrict states’ election procedures disparately.

Professor Leah Litman goes even farther to posit that only federal action that lessens the dignity of a state or group of states triggers the Shelby County conception of equal sovereignty.¹⁸⁴ Under this narrower interpretation, Litman argues that laws will violate equal sovereignty only if they single out particular states that have behaved in morally-blameworthy ways, limiting the scope of the principle to legislation enacted under the Reconstruction Amendments.¹⁸⁵ Under this interpretation, the equal sovereignty principle primarily serves as a check on the Fourteenth and Fifteenth Amendments and should only apply in cases similar to those involving voting rights, in which the dignity of human beings is at stake.¹⁸⁶

Since Shelby County, a few weak equal sovereignty claims have been made in the lower courts in areas outside of voting rights, and the courts have distinguished these cases from Shelby County. For example, in Mayhew v. Burwell, the U.S. Court of Appeals for the First Circuit held that the equal sovereignty principle does not apply to Medicaid laws.¹⁸⁷ Perhaps most relevant to the Clean Air Act waiver is National Collegiate Athletic Association (NCAA) v. Governor of New Jersey, which addressed the constitutionality of the Professional and Amateur Sports Protection Act of 1992 (“PASPA”).¹⁸⁸ PASPA prohibits states from licensing sports gambling, except for states that had gambling operations prior to the Act’s passage, which only includes Nevada.¹⁸⁹ The U.S. Court of Appeals for the Third Circuit determined that the equal sovereignty principle does not apply to PASPA, distinguishing the Voting Rights Act from PASPA by finding that regulating gambling via the Commerce Clause is “not of the same nature” as regulating elections via the Reconstruction Amendments.¹⁹⁰ The court held that the Commerce Clause allowed Congress to enact laws “aimed at matters of national concern and finding national solutions will necessarily affect states differently,”¹⁹¹ such that federal Commerce Clause regulation “does not require geographic uniformity.”¹⁹² The court found that applying Shelby County to all situations is “overly broad” and that the equal sovereignty principle does not apply outside “the context of ‘sensitive areas of state and local policymaking.’ ”¹⁹³

Similar to PASPA, Congress acted pursuant to its Commerce Clause authority in passing the Clean Air Act to regulate motor vehicle emissions; thus, Congress is exercising the federal power of regulating interstate commerce and can treat states differently in the process.¹⁹⁴ The Clean Air Act likely does not intrude into “sensitive areas of state and local policymaking” as the Voting Rights Act does. Regulating motor vehicles has not traditionally been the exclusive province of the states. Three agencies set federal and state vehicle emissions standards: the EPA, the National Highway Traffic Safety Administration, and CARB.¹⁹⁵ Section 209(a) of the Clean Air Act explicitly provides for federal preemption, prohibiting states from adopting their own motor vehicle regulations.¹⁹⁶ Regulating motor vehicle emissions affects interstate commerce because air pollution crosses state borders.¹⁹⁷ Thus, like PASPA, the Clean Air Act does not intrude into a sensitive area of policymaking traditionally occupied by the states.

At its core, the outcome the petitioners demand in Ohio v. EPA is inconsistent with the fundamental principle of equal sovereignty. Without the waiver, the Clean Air Act defaults to only federal standards and federal preemption, leaving states with no choice but to adopt the federal standard. Thus, invalidating the California waiver—as petitioners seek to do—gives states fewer choices. It fails to promote the principle of equal sovereignty, which arguably protects the power of the states to enact policies that differ from those of the federal government.¹⁹⁸ In her amicus brief, Professor Litman noted that the petitioners’ invocation of the equal sovereignty principle is inconsistent with its history because the petitioners’ arguments would result in less authority and flexibility for the states, and more coercive authority for the federal government.¹⁹⁹ By allowing California to promulgate more stringent standards and allowing other states to choose between the federal and California standards, Congress has offered those states more options, not fewer. This is likely not an abuse of state sovereignty.²⁰⁰ By arguing for an expansion of federal preemption, thereby preempting more state legislative and policy goals, the petitioners seek a result that does not promote state sovereignty and instead runs contrary to the equal sovereignty principle’s historical use as a limit on congressional power.²⁰¹

Congressional debates regarding California’s special status indicate that Congress clearly considered the equal sovereignty problem and rejected it. In 1970, members of the House of Representatives expressed concern that all states should have the “same right that the State of California has in setting standards that they deem necessary for the health and safety of their people.”²⁰² Representatives of other states, including Pennsylvania and New York, argued that their air quality problems were worse than California’s, so they too should have the power to create state regulations exceeding federal standards.²⁰³ Thus, proper application of the equal sovereignty principle would allow all states to promulgate their own motor vehicles emissions regulations. Congress was more concerned about other states not being able to promulgate their own motor vehicles emissions standards than about California having special privileges. In contrast, in Ohio v. EPA, the petitioner states attempt to prevent California from enacting more stringent policies that could benefit other states, thus flipping the use of the equal sovereignty principle to make it more difficult for states to enact their own policies.

The Supreme Court has suggested in Shelby County that the equal sovereignty principle does not extend to all areas of the law, and this Section concludes that the equal sovereignty principle does not apply to the Clean Air Act. However, even if it were to apply, the Clean Air Act waiver provision passes the Shelby County test and remains constitutional, as analyzed in the next Section.

B. Even if the Equal Sovereignty Principle Applies to the Clean Air Act, It Does Not Invalidate Section 209(b)(1) of the Clean Air Act

Even if the equal sovereignty principle were to apply to the Clean Air Act, the Clean Air Act waiver provision remains constitutional. Applying the Shelby County test, the Clean Air Act waiver likely departs from the “fundamental principle of equal sovereignty” in creating a differential in its treatment of states’ political authority. As a result, the “statute’s disparate geographic coverage” must be “sufficiently related to the problem that it targets.” This Section concludes that this criterion is met; thus, the waiver provision remains constitutional. Congress had strong justifications for granting California an exemption that continue to remain relevant. First, the Clean Air Act targets not only smog in one region of California, but also the broader problem of public health from automobile emissions. Second, allowing California to implement more stringent motor vehicle regulations would directly help address this broader problem. California faces new and increasingly formidable threats from climate change, which have exacerbated the existing problems that initially compelled California’s motor vehicle regulations. Allowing California broad discretion to regulate GHG emissions is directly related to Congress’s goal of addressing the public health threats from motor vehicle pollution in California because the effects of GHG emissions and smog are interrelated and affect one another. This Section thus concludes that California’s current needs continue to justify Congress’s differential treatment of California—maintaining, and perhaps even strengthening, section 209(b)’s relevance in the twenty-first century.

1. By Treating States’ Political Authority Differently, the Clean Air Act Waiver Likely Violates the Equal Sovereignty Principle

The equal sovereignty principle does not require the federal government to treat states equally in every scenario, but requires that all states have equal political authority.²⁰⁴ Black’s Law Dictionary defines “sovereignty” as “[s]upreme dominion, authority, or rule”²⁰⁵ and “state sovereignty” as “[t]he right of a state to self-government; the supreme authority exercised by each state.”²⁰⁶ The Court in Shelby County explained that “[s]tates retain broad autonomy . . . in structuring their governments and pursuing legislative objectives,”²⁰⁷ referencing the Tenth Amendment and federalism principles as crucial in preserving the “integrity, dignity, and residual sovereignty of the States.”²⁰⁸ In United States v. Texas, the Supreme Court noted that the equal footing doctrine applies to political rights and sovereignty, but not economic issues.²⁰⁹ The Court observed that the equal footing doctrine was not designed to eliminate diversity in economic aspects such as area, location, and geology, but rather to “create parity as respects political standing and sovereignty.”²¹⁰ Thus, Congress violates the equal sovereignty principle when it limits the political power of a particular subset of states.²¹¹

Legislation that prohibits some states but not others from enacting laws about the same topic likely would violate the equal sovereignty principle. For example, the Voting Rights Act limits only southern states’ ability to regulate elections and PASPA permits only Nevada to legalize sports betting;²¹² thus, these laws would in theory violate the principle. Similarly, the Clean Air Act treats California’s sovereign authority differently from the other states. By permitting only California to regulate motor vehicles and promulgate new motor vehicles emissions standards, while limiting other states to either adopt the California or federal standards, the Clean Air Act waiver arguably limits other states’ rights to govern themselves in the area of motor vehicles, as well as transportation and energy more broadly. Rather than allow all states with certain air quality conditions to set regulations, the Clean Air Act allowed the state that first adopted its own motor vehicle regulations to continue setting the standard for new regulations.²¹³ Thus, if we were to apply the equal sovereignty principle to the Clean Air Act, the Clean Air Act likely departs from the equal sovereignty principle by exhibiting disparate treatment of the states’ political authority pertaining to motor vehicle regulations.

2. Nevertheless, the Clean Air Act Waiver Provision Remains Constitutional Because Its Disparate Geographic Coverage Favoring California Is “Sufficiently Related to the Problem that It Targets”

Violating the equal sovereignty principle does not automatically invalidate a law as unconstitutional. However, it triggers heighted scrutiny, meaning that Congress must justify the disparate treatment of the states as unequal sovereigns²¹⁴ by showing that the differential treatment is sufficiently related to the problem the law is addressing.²¹⁵ This higher standard “ensures that when Congress limits the sovereign power of some of the states in ways that do not apply to others, it has a good reason to do so.”²¹⁶

In Shelby County, the Supreme Court concluded that the coverage formula, while perhaps justified in 1965, was no longer justified in 2006 when Congress reauthorized the Voting Rights Act.²¹⁷ Because the coverage formula continued to distinguish states “based on ‘decades-old data and eradicated practices,’ ” including the past use of literacy tests that “have been banned nationwide for over 40 years” and on racial disparity in “voter registration and turnout in the 1960s and early 1970s” that no longer persisted, the Court held that the 2006 reauthorization statute’s disparate geographic coverage was not sufficiently related to the problem of twenty-first century racial discrimination in voting that it targeted, so “current needs” no longer justified it.²¹⁸ Thus, the Court found circumstances in 2013 to be sufficiently changed to render the coverage formula unconstitutional.²¹⁹

Applying this line of reasoning to the Clean Air Act, the petitioners in Ohio v. EPA claim that because California has transitioned to regulating GHG emissions, the waiver provision is no longer sufficiently related to the problem that it targets because California’s standards are targeting climate change, which is global, not state-specific, in nature: “[C]limate change is not an acute California problem.”²²⁰ This Section counteracts this argument and asserts that the waiver provision continues to be sufficiently related to the problem that it targets, distinguishing California’s motor vehicle regulations from the voting regulations at issue in Shelby County. First, the Clean Air Act targets not only smog in one region of California, but also the broader problem of public health from automobile emissions. Second, allowing California to implement more stringent motor vehicle regulations would directly help address this broader problem. California faces new and increasingly formidable threats from climate change that have exacerbated the existing problems that initially compelled California’s motor vehicle regulations. The effects of GHG and smog pollution are directly interrelated and affect one another; thus, addressing GHG emissions is directly related to Congress’s goal of addressing the public health threats from motor vehicle pollution in California. This Section therefore concludes that California’s current needs continue to justify the state’s differential treatment.

i. The Clean Air Act Targets the Broad Problem of Public Health Threats from Automobile Emissions

How courts frame the problem that Congress is targeting can shape their determination of whether a statute is constitutional. In NCAA v. Governor of New Jersey, the U.S. Court of Appeals for the Third Circuit held that even if the equal sovereignty principle were to apply to Commerce Clause legislation, PASPA passed the Shelby County test because its “true purpose” was to “stop the spread of state-sanctioned sports gambling,” rather than eliminate it altogether.²²¹ Because PASPA was drafted in neutral terms, any state that already supported gambling could continue to do so, and Congress likely knew that Nevada was the only state that had existing gambling operations.²²² PASPA’s disparate geographic coverage was therefore justified: “Targeting only states where the practice did not exist is . . . precisely tailored to address the problem.”²²³ If the court had defined the problem PASPA was targeting as eliminating all sports gambling, Nevada’s exemption would be harder to justify, and the statute would likely be unconstitutional for not being sufficiently related to the problem. However, because the court defined the problem as halting the spread of sports gambling, the Third Circuit’s analysis was a stronger one.

In Ohio v. EPA, the petitioners argue that the problem Congress designed the Clean Air Act to target was a narrow, California-specific problem.²²⁴ However, while smog may have been the impetus for the legislation,²²⁵ Congress also intended a broader goal of enabling California to use its developing expertise in vehicle pollution to develop innovative regulatory programs and serve as a leader in automobile emissions regulations.²²⁶ In 1967, Congress acknowledged California’s serious air quality problems as well as its role as a laboratory for emissions control technology for the country.²²⁷ The Senate Report concluded that with California’s experience in control systems and design, the waiver provision will allow California to “continue to be the testing area” for more stringent standards, potentially strengthening federal standards and benefiting all states.²²⁸

Multiple instances from the Congressional Record suggest that the broader problem Congress intended to target was the public health threats caused by motor vehicle pollution.²²⁹ Congress could have amended the Clean Air Act in 1977 to restrict the waiver provision. Instead, it ratified and strengthened the waiver by giving California the flexibility to adopt a complete program of motor vehicle emission controls.²³⁰ The original 1967 waiver provision required the EPA Administrator to grant a waiver “unless he finds that such State does not require standards more stringent than applicable Federal standards . . . .”²³¹ In contrast, the amended version requires that the EPA grant the waiver “if the State determines that the State standards will be, in the aggregate, at least as protective of public health and welfare as applicable Federal standards.”²³² Congress intentionally granted California deference in creating motor vehicle standards in order to “afford California the broadest possible discretion in selecting the best means to protect the health of its citizens and the public welfare.”²³³ The amendment “confers broad discretion” on California to “weigh the degree of health hazards from various pollutants and the degree of emission reduction achievable for various pollutants with various emission control technologies and standards.”²³⁴ Congress made clear that the EPA should defer to California’s policy decisions, unless they are overwhelmingly arbitrary and capricious: the EPA Administrator “is not to overturn California’s judgment lightly. Nor is he to substitute his judgment for that of the State. There must be clear and compelling evidence that the State acted unreasonably in evaluating the relative risks of various pollutants . . . .”²³⁵ The EPA recognized in its 2013 waiver decision that Congress allowed it only limited review based on the section 209(b)(1) criteria to “ensure that the federal government did not second-guess state policy choices.”²³⁶ As the EPA affirmed, “Congress recognized that California could serve as a pioneer and a laboratory for the nation in setting new motor vehicle emission standards.”²³⁷ Thus, as long as the regulations protect the health of California residents, the EPA should defer to California on the scope of those regulations.

ii. Allowing California Broad Discretion to Regulate GHG Emissions Is Sufficiently Related to Addressing the Public Health Threats from Motor Vehicle Pollution in California

In Shelby County, the Voting Rights Act coverage formula factored in states’ voting discrimination history, which consisted of specific, unchangeable factors.²³⁸ In contrast, Congress noted that California’s circumstances can change: if California no longer faces “compelling and extraordinary” conditions, it can no longer establish its own standards.²³⁹ This possibility creates a built-in mechanism to continually evaluate whether California needs its separate regulations²⁴⁰ and whether the waiver provision is “justified by current needs.”²⁴¹ Recognizing “the unique problems facing California as a result of its climate and topography,” Congress noted in 1967 that only California has demonstrated “compelling and extraordinary circumstances sufficiently different from the Nation as a whole to justify standards on automobile emissions which may, from time to time, need [to] be more stringent than national standards.”²⁴² The petitioners in Ohio v. EPA treat GHG emissions as if they are a separate and mutually exclusive concept from smog and criteria pollutants, claiming that because California has shifted from regulations to reduce local smog problems to regulations to reduce GHGs and address global climate change, the waiver provision no longer justifies California’s exemption.²⁴³ On the contrary, this Section argues that the effects of GHG emissions and smog pollution are interrelated and affect one another. Thus, addressing GHG emissions is directly related to Congress’s goal of addressing the public health threats from motor vehicle pollution in California.

Given the history of California’s early motor vehicle regulations and Congress’s interest in having California as a “laboratory for innovation” while not overburdening automobile manufacturers by forcing them to comply with multiple state standards, Congress intentionally struck a balance by authorizing just two standards: the national standard and the California standard.²⁴⁴ This compromise would allow California to continue to innovate and improve its air quality without creating a practical nightmare for automakers and interstate commerce.²⁴⁵ Congress deliberately exempted California from federal preemption of motor vehicle regulations because of its “pioneering role in regulating automobile-related emissions, which pre-dated the Federal effort.”²⁴⁶ Because California had already adopted a robust air quality program and established its own motor vehicle emission standards prior to the passage of the federal Clean Air Act, it had expertise in emissions regulations that other states did not have.²⁴⁷

California’s large automobile market and economy continue to justify its disparate treatment. At the time Congress passed the Clean Air Act waiver, it recognized the “presence and growth of California’s vehicle population, whose emissions were thought to be responsible for ninety percent of the air pollution in certain parts of California.”²⁴⁸ Congress noted the large effect of vehicles on local air pollution: “Motor vehicles are responsible for about 90 percent of the smog in the Los Angeles County, some 56 percent in the San Francisco Bay area, and about 50 percent in San Diego.”²⁴⁹ Congress also noted that because of its large size, California has “an economy large enough to support separate standards.”²⁵⁰ Thus, California’s market was large enough that automobile companies could still make a sizable profit while producing cars to meet California’s more stringent environmental requirements.²⁵¹ There were twice as many vehicles in California as in any other state, including New York.²⁵² Today, California continues to be the largest automobile market in the United States; if the state were a country, it would be the tenth largest auto market in the world.²⁵³ California makes up 11% of U.S. new light-duty vehicle sales, and combined with the states that have already adopted its LEV rules, makes up 40.1% of U.S. new light-duty vehicle sales.²⁵⁴ Forty-three percent of ZEVs sold in the U.S. are sold in California.²⁵⁵

California’s unique topography and climate conditions have also contributed to the air pollution problems exacerbated by climate change. The legislative history indicates that Congress granted California an exemption to regulate motor vehicle emissions primarily because California was facing unique, severe air pollution problems across the state, particularly in the Los Angeles area.²⁵⁶ California’s air pollution problem was among “the most pervasive and acute in the Nation” at the time.²⁵⁷ Geographical and climatic factors were consistently cited as “compelling and extraordinary” factors during the House debate, including the “unique problems facing California as the result of numerous thermal inversions that occur within that State because of its geography and prevailing winds pattern.”²⁵⁸ Rep. Holifield noted that California has a unique problem due to an atmospheric inversion which “the peculiar topography of the metropolitan area of Los Angeles County” has caused to some extent by keeping smog in the area and surrounding counties.²⁵⁹ Even though members of Congress recognized that air pollution also affects other states in concerning ways,²⁶⁰ they agreed that California’s distinct conditions and topography continue to contribute to the unique effects of pollution in the state, creating a critical need for air pollution control.²⁶¹ As CARB established, California’s ozone levels will be exacerbated by higher temperatures from global warming, and “there is general consensus that temperature increases from climate change will exacerbate the historic climate, topography, and population factors conducive to smog formation in California, which were the driving forces behind Congress’s inclusion of the waiver provision.”²⁶²

Most significantly, climate change has only exacerbated the air pollution and smog problems that initially compelled California’s motor vehicle regulations and the Clean Air Act waiver. Automobiles emit both GHGs and smog-forming emissions including nitrogen oxide, carbon monoxide, and particulate matter.²⁶³ The 2021 report of the United Nations’ Intergovernmental Panel on Climate Change (“IPCC”) reflects the latest scientific consensus that climate change is both a local and global problem.²⁶⁴ The report establishes a connection between climate change and intensifying weather extremes including heat waves and droughts.²⁶⁵ Additionally, GHGs contribute to respiratory disease from smog and air pollution.²⁶⁶ GHG emissions lead to hotter global temperatures,²⁶⁷ which is expected to enhance the formation of ground-level ozone (a main component of smog).²⁶⁸ Exposure to ozone can cause respiratory problems²⁶⁹ and aggravate lung diseases including asthma, particularly within more vulnerable groups.²⁷⁰ Thus, GHGs can worsen exposure to ground-level ozone and smog, which is associated with increased mortality from respiratory and cardiovascular diseases.²⁷¹ As a result, it has been well established that GHGs and smog are interrelated and affect air quality separately and together.²⁷²

Contrary to what the petitioners claim, climate change continues to uniquely affect California as an “acute California problem.”²⁷³ While GHG emissions from California cars can “become one part of the global pool of GHG emissions,”²⁷⁴ this global pool eventually affects local conditions. The EPA recognized CARB’s strong evidence that California is “particularly impacted by climate change, including increasing risks from record-setting fires, heat waves, storm surges, sea-level rise, water supply shortages and extreme heat,” and that “GHG emissions contribute to local air pollution.”²⁷⁵ Climate change impacts ozone exacerbation and wildfires, which affect local air quality.²⁷⁶ California continues to have a serious smog problem, exacerbated by climate change.²⁷⁷ Seven of the ten cities with the worst air pollution nationwide are in California.²⁷⁸ Ten million Californians in the San Joaquin Valley and Los Angeles air basins currently live under “severe non-attainment” conditions for ozone, where people suffer unusually high rates of asthma and cardiopulmonary disease.²⁷⁹ Climate change has increased the number of hot days that can result in smog events and exacerbate wildfires.²⁸⁰ Thus, smog exacerbates climate change, which in turn exacerbates smog, and GHGs—which lead to climate change—continue to pose a direct and local threat.²⁸¹ As the 2022 EPA decision concluded, the 2019 EPA decision to withdraw the 2013 EPA waiver grant failed to properly consider “the nature and magnitude of California’s serious air quality problems, including the interrelationship between criteria and GHG pollution.”²⁸² The EPA noted that the 2019 record contained evidence that GHG emissions can lead to locally elevated carbon dioxide concentrations with local impacts such as ocean acidification, in addition to the longer-term global impacts from global emissions.²⁸³ Thus, just like smog, climate change poses serious threats to the public health and safety of residents in California. As a result, ZEV regulations are crucial in protecting the public health and safety of Californians.

Even adopting the 2019 EPA’s narrow “local nexus” test, which required that the California waiver only applies to measures that address conditions “extraordinary” with respect to California, or those with a specific connection to local features and emissions peculiar to California,²⁸⁴ California’s ZEV standard meets this test in directly addressing local air pollutant conditions by reducing criteria pollutant emissions. California’s 2020 Executive Order and resulting ACC II regulations made clear that California intended to regulate both GHG emissions and smog pollutants. The 2020 Executive Order states that zero emissions technologies “reduce both greenhouse gas emissions and toxic air pollutants,”²⁸⁵ and the ACC II regulations require new vehicles to “produce zero exhaust emissions of any criteria pollutant (or precursor pollutant) or greenhouse gas . . . .”²⁸⁶ California’s more stringent standards will thus continue to achieve critical reductions in conventional criteria pollution and help the state address public health problems caused by smog and soot.²⁸⁷ Congress has not provided any indication that California cannot take measures to reduce criteria pollutants and GHGs. Transportation is the largest source of air pollution in the state, responsible for nearly 40% of GHG emissions, 80% of nitrogen oxide pollution, and 90% of diesel particulate matter pollution.²⁸⁸ The EPA concluded that GHG measures are relevant to addressing local criteria pollutant issues²⁸⁹ and that regulations to reduce GHGs often simultaneously address smog-forming pollutants like nitrogen oxide.²⁹⁰ The legislative history provides no basis for the claim that California cannot mitigate climate change threats or address environmental problems within their boundaries as soon as the problems extend beyond them.²⁹¹ In fact, Congress expressed an interest in allowing California to “continue its already excellent program” and continue to be the testing area of motor vehicle standards, which is expected to benefit its people and the nation by strengthening federal standards.²⁹² The Senate report reflected opposition to displacing California’s right to set more stringent standards, as justified by California’s “unique problems and pioneering efforts.”²⁹³ Members of Congress concurred with the principle that California’s advances in air pollution regulation should not be nullified and that the state’s progress should not be impeded. Congressman John Dingell stated: “To penalize California for being ahead of the rest of the country in combating the menace of air pollution is totally incomprehensible.”²⁹⁴ The Ninth Circuit has also stated that California should be “encouraged to continue and to expand its efforts . . . to lower carbon emissions.”²⁹⁵ Thus, Congress’s reasons for granting California a waiver continue to be compelling and extraordinary, and California’s current needs continue to remain relevant as ever in justifying the Clean Air Act waiver provision.

Congress did not justify the Clean Air Act waiver provision based on whether pollution problems were of a more local or global nature, but rather on the unique effects of smog in the Los Angeles area.²⁹⁶ This emphasis suggests that Congress intended to give California the flexibility to adopt motor vehicle standards that the state determines are needed to address air pollution in the state, regardless of whether those problems might also be global in nature.²⁹⁷ Thus, California’s problems are serious enough and its efforts are such a model for the nation that a waiver provision is necessary in order for California to adequately protect public health. More recently, Congress’s clarification in the 2022 Inflation Reduction Act that GHGs are pollutants regulated under the Clean Air Act suggests that Congress intends the Clean Air Act to include GHGs.²⁹⁸ This further strengthens the argument that California is acting within the scope of the Clean Air Act in regulating GHGs through its innovative motor vehicle program.

CONCLUSION

The equal sovereignty argument is a new attempt to invalidate the Clean Air Act waiver provision and California’s ability to regulate motor vehicle emissions. As of this Note, no court has specifically addressed the constitutionality of the Clean Air Act under the equal sovereignty principle, and the decision is pending for Ohio v. EPA, which is expected to address this constitutional question.

This Note concludes that the equal sovereignty principle does not apply to the Clean Air Act, but even if it were to apply, it does not invalidate section 209(b)(1). Distinguishing from the outcome in Shelby County, the Clean Air Act waiver provision remains constitutional because granting California an exemption is “sufficiently related to the problem that it targets.” First, the Clean Air Act targets the broader problem of public health from automobile emissions. Second, allowing California to implement more stringent motor vehicle regulations will directly help address this problem. Congress had strong justifications for granting California an exemption which continue to remain compelling and relevant today. California’s history with air pollution control, its large economy, and its characteristic geographic and climate conditions put the state in a unique position to influence the automobile market and address GHG emissions. California faces new and increasingly formidable threats from climate change, which have exacerbated the existing problems that initially compelled California’s motor vehicle regulations. Allowing California broad discretion to regulate GHG emissions is directly related to Congress’s goal of addressing the public health threats from motor vehicle pollution in California because the effects of GHGs and smog are directly related and affect one another. Even as California’s motor vehicle regulations have shifted from reducing local smog by regulating criteria pollutants to reducing GHG emissions by eliminating gasoline-powered cars, California’s current needs continue to justify its differential treatment—maintaining, and perhaps even strengthening, section 209(b)(1)’s relevance in the twenty-first century.

The court’s decision on whether section 209(b)(1) of the Clean Air Act remains constitutionally valid will determine the extent to which California can continue to realize the localized benefits of the Clean Air Act while helping accelerate the nation’s transition towards a clean energy economy. It will also have implications for California’s ability to continue to regulate GHG emissions as a leader in addressing the most pressing environmental issues of the day.

Is the court going to handcuff California’s ability to protect the health and safety of its residents in the name of equal sovereignty? That was not the intention of Congress when it discussed equal sovereignty concerns pertaining to the Clean Air Act waiver. On the contrary, Congress debated whether other states should also be able to enact more stringent standards than the federal government, which would be the more reasonable remedy if the Clean Air Act waiver provision were deemed unconstitutional per equal sovereignty, as the petitioners demand.

To strengthen the ability of motor vehicle regulations to withstand future court challenges, California could emphasize criteria pollutants in its regulations. Since criteria pollutants have been more directly linked to local air pollution issues and Congress originally implemented the waiver provision in response to regional smog problems, this change could make it more difficult to challenge a regulation on the basis of it only regulating climate change. It will likely be simpler to show that the disparate treatment of California is sufficiently related to the problem that the Clean Air Act targets if legislators explicitly provide how they expect the regulations to affect local air quality as well as the local co-benefits of implementing them. For example, replacing internal combustion passenger vehicles with EVs will reduce not only GHG emissions, but also criteria pollutants including nitrogen oxides that are emitted.

California’s motor vehicle standards alone may not reverse or solve climate change, but the EPA has a duty to take steps to slow or reduce it.²⁹⁹ Allowing California to continue to promulgate innovative, forward-looking motor vehicle standards is crucial to its ability to lead the country as a “laboratory of innovation,” as Congress intended, and address the urgent environment and public health consequences of motor vehicle pollution.

97 S. Cal. L. Rev. 165

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Justine Huang*

* Senior Editor, Southern California Law Review, Volume 97; J.D. Candidate 2024, University of Southern California Gould School of Law; B.A. Economics 2019, Wellesley College. A special thank you to Professor Robin Craig for her thoughtful guidance, my friends and family for their consistent support and encouragement, and the Southern California Law Review editors for their thorough feedback.

The Healthcure System: A Regional Accountable Care Model to Remedy Healthcare’s Pricing Problem

March 2024March 2024Christopher A.G. LoCascio*

INTRODUCTION

The most sinister game show in American life commences every time a hospital provides care, draws up an eye-popping bill, and asks its patient how it will be paid.¹ Imagine waking up from a medically induced coma to the words, “Will that be cash or card?” In its own sick twist of the three-legged race, the healthcare system effectively binds patients’ ability to navigate the costs of their care, such that even those with insurance are often left hobbling for answers to the questions, what must I pay and why? The stakes are ever graver for those underinsured or uninsured. In this game, the winners are not those who make it out alive, but those who can afford to keep on living.

In a properly functioning market, supply and demand would theoretically prevent a hospital from wildly inflating its prices, such as charging a patient approximately $200.00 for a routine blood test that would otherwise cost $13.00, but the reality is that healthcare is no such market.² As Princeton Professor Uwe Reinhart put it, “In effect, [patients] enter that market like blindfolded shoppers pushed into a department store to shop around smartly for whatever item they might want or, in the case of health care, need.”³

Patients cannot expect to make informed decisions when they lack reliable pricing information before seeking care, but this is just one of the many market failures that drives the ever-skyrocketing costs of American healthcare.⁴ Hospital administrators themselves often fail to grasp the true costs of their services, as do doctors when ordering tests and writing prescriptions.⁵ In fact, healthcare providers often have financial and legal incentives to overtreat their patients, at the patients’ expense.⁶ When providers are paid based on the services they render, in what is known as the “fee-for-service” payment model, providers that do more, make more.⁷ In the fear of the dreaded medical malpractice lawsuit, providers have an incentive to cover their bases and test for everything, no matter the cost.⁸ Even insurance companies, which foot the providers’ bills, stand to gain from exaggerated costs.⁹ Unlike insurance companies in other sectors, which derive profit by spending as little of policyholders’ premiums as possible, health insurance companies have incentives to maximize their spending because regulations cap their profits at a certain percentage of their expenditures.¹⁰ Essentially, insurers earn more when they spend as much of their beneficiaries’ premiums as possible.¹¹ In what is perhaps the most perplexing market failure of them all, individuals continue to pay the rising premiums, copays, coinsurance, and taxes that feed the hungry, hungry healthcare hippo.¹² Yet, the pricing problem snuck up on no one—the rubbery, rotund river beast of a healthcare system has slowly barreled through America’s regulatory swamp for a century as landlocked policymakers repeatedly tried and failed to halt its growth by trying different reimbursement models, competition enhancements, and delivery programs.¹³

The most promising opportunity to impose downward cost pressure on the healthcare system came in 2010 with the advent of the Accountable Care Organization (“ACO”) concept as part of the Patient Prevention and Affordable Care Act (“ACA”).¹⁴ ACOs are networks of healthcare providers that coordinate care, integrate finance and delivery, and share in financial gains and losses.¹⁵ A primary goal of the ACO is to achieve a more cost-efficient system that incentivizes preventive care and integrated treatment while limiting incentives to drive up costs.¹⁶ While they come in many forms, ACOs often accomplish cost savings by allocating a set amount of money to providers for each patient they treat, known as capitated payments, thereby exposing providers to the risk of outspending that amount if they do not keep costs down.¹⁷ In essence, ACOs are financially accountable for the care of a particular population.¹⁸

ACOs remain a largely underdeveloped concept with as-yet-unsolved complications.¹⁹ For instance, the Center for Medicare & Medicaid Innovation (“CMMI”) pilots a wide variety of ACO models, ranging from “one-way risk” models with no downside and modest upside to “two-way risk” models with varying levels of risk and reward.²⁰ Providers are free to choose how much risk of cost overruns they would like to take on, and they get to keep a proportionate amount of any cost savings.²¹ For example, one ACO may choose a one-way risk model with a 0% risk of losing money and a 3% share of cost savings, whereas another ACO may choose a two-way risk model that exposes it to a 10% risk of any cost overruns but entitles it to 30% of any cost savings.²² Naturally, the more risk a provider faces, the greater the incentive to cut costs.²³ The prospect of a greater reward has not proven persuasive for ACOs to adopt riskier models, however, and all but the least risky models have struggled to attract provider participation.²⁴ Moreover, ACOs fail to address the demand-side concern of consumers’ continued payment for health insurance despite increases in rates—a phenomenon known as the price inelasticity of health insurance premiums.²⁵ Equally alarming among these concerns is the antitrust component.²⁶ In an environment in which providers are already consolidating, ACOs stand to exacerbate a shrinking market and empower consolidated provider networks to wield unmatched pricing power.²⁷

Despite the promise of new models, the healthcare system remains in a precarious position. The ACA has been left on unstable footing following the repeal of the individual mandate tax penalty in 2017²⁸ and efforts to either fully repeal or replace the law altogether.²⁹ Meanwhile, insurance premiums have continued to rise.³⁰

This Note proposes a novel framework from which to develop pilot programs for future healthcare regulations and legislation. In doing so, this Note will identify certain regulatory factors that contribute to, or at least fail to stop, the upward march of healthcare prices, and propose a novel alternative model that delivers on the three pillars of healthcare: broad access, low cost, and high quality.³¹ Here, access refers to both access to coverage of costs and access to care. Quality refers to both the breadth of covered benefits and health outcomes.

This Note takes a law and economics approach to healthcare, focusing on the information asymmetry, moral hazards, principal-agent problems, adverse selection, and misaligned incentives that contribute to healthcare’s current market failures.³² To solve these problems, this Note prescribes a new outcomes-based model that aligns the incentives of patients and providers by tying provider funding to certain health indicators. The proposed healthcare model, titled the Healthcure System, achieves universal coverage through regional healthcare districts that draw on the funding model of employer-based insurance, the cost-cutting features of ACOs, the monopoly regulation of public utilities, the accountability of special districts, the mixed public and private partnership of government-sponsored enterprises, and the structure of the corporate form. Under this approach, regional healthcare districts replace private insurance companies, and the districts offer universal coverage to all within the region in return for a direct healthcare tax. The districts pay providers in a capitated payment model, similar to paying a lump sum for each patient, instead of the fee-for-service model that pays per service rendered. The outcomes-based component consists of back-end, per-event incentive payments—which reward providers for each successful treatment—and additional payments that resemble dividends based on the overall health of the region. Providers get additional funding through government adjustment payments if they operate in underserved communities. The result is a synthesis of burgeoning knowledge on finance and governance in healthcare law and economics into the first model of its kind.

This Note proceeds in six parts. Part I traces the development of healthcare regulations from their inception in the early twentieth century and outlines the corresponding rise in healthcare costs. Part II discusses the various economic concepts and challenges that underlie the increase in costs. Part III explains how the Healthcure System achieves access by establishing universal coverage risk pools based on region and price elasticity by reducing individual healthcare expenditures to one income-based payment. Part IV describes the model’s downward price pressures through a new governance model that combines integrated finance and delivery with public electoral accountability. Part V explores how the Healthcure System enhances quality by aligning the incentives of patients and providers through a capitation and incentive payment model. Part VI considers the legal path and obstacles facing the implementation of the Healthcure System before concluding the Note.

I. BACKGROUND

Healthcare was once an unregulated and uninsured marketplace consisting of independent doctors making house calls in exchange for modest out-of-pocket fees.³³ The low cost of this relatively unsophisticated care sustained a functioning market until the early 1900s, when a combination of increasingly complex medical care, growing demand, and rising quality standards led to a surge in the average family’s medical expenses.³⁴

An early insurance market grew organically out of a need to spread out costs and risks by making regular payments to guarantee access to care without financial barrier when it was needed.³⁵ As insurers increasingly became intermediary payers between patients and healthcare providers, a “cost plus” reimbursement methodology emerged that paid doctors whatever “reasonable and customary charges” they set and covered hospital costs plus an additional negotiated rate payment.³⁶ The cost plus model supercharged the already-upward trend in healthcare costs by creating incentives to treat more and charge more.³⁷

The 1940s saw the addition of employers as an integral layer to the increasingly complicated healthcare funding landscape. Amid World War II’s labor shortage and inflation, Congress enacted the Stabilization Act in 1942 to place limits on wage increases, but it carved out an exception that allowed employers to offer fringe benefits like health insurance up to the value of five percent of wages.³⁸ In 1951, the Internal Revenue Service (“IRS”) adopted a rule making employer-paid insurance premiums a tax-deductible business expense.³⁹ Health insurance thus became a form of tax-free compensation that employers could offer their employees.⁴⁰ Once private health insurers instituted provisions requiring that a substantial majority of employees participate in the employer-sponsored plan, insurers had a risk pool of working-age adults that avoided disproportionate inclusion of higher-risk individuals who tend to consume more in medical expenses, such as those in the general population who are too old or ill to work.⁴¹ Using the employee risk pool as a guide, insurers then set a standardized premium rate for all participants, regardless of participants’ individual health histories, under what is known as “community rating.”⁴² Essentially, an employee with a clean bill of health paid the same premium as an employee who previously battled cancer. At the same time, labor unions negotiated rapidly increased employer-paid percentages of insurance premiums, achieving 100% coverage at some of the largest automobile manufacturers by 1961.⁴³ In 1974, the Employee Retirement Income Security Act of 1974 (“ERISA”) further solidified employer-provided healthcare by creating a nationally uniform regulatory scheme for multistate employers, imposing fiduciary duties on employer health plans, and providing beneficiaries with a positive right to sue for recovery of denied benefits.⁴⁴

The rise in healthcare costs significantly impacted two populations that tend to lack employer-based health insurance: the elderly and the poor. Congress responded with the Social Security Amendments of 1965 that established the Medicare and Medicaid programs, a pair of national insurance programs that positioned the federal government as the single largest third-party payer in healthcare.⁴⁵ Despite its outsize role in the industry, the federal government initially made no changes to the healthcare business model and adopted the same cost plus reimbursement model that had driven up costs in the private insurance industry.⁴⁶

Lawmakers have struggled to reign in the cost of the healthcare fee-for-service model since the 1970s, when they sought to incentivize adoption of the health maintenance organization (“HMO”) model that had been pioneered by the Ross-Loos Medical Group and the Kaiser Foundation Health Plan.⁴⁷ The HMO is the archetypal organizational form of coordinated care in which a network of providers deliver a comprehensive benefit package for a fixed premium.⁴⁸ The primary advantage of HMOs is the integration of finance and delivery of healthcare within the defined network of providers who cut down on costs by managing utilization and provider payments.⁴⁹ A key component of the HMO model is “managed care,” which comprises of “gatekeeping, capitation reimbursement, utilization review, clinical practice guidelines, and selective physician contracting.”⁵⁰ The Health Maintenance Organization Act of 1973 encouraged adoption of HMOs by funding the expansion of HMOs and requiring large employers to offer an HMO benefit option in addition to fee-for-service plans.⁵¹ Despite HMOs’ success at cutting costs, concerns over provider incentives to reduce access to services or diminish patient control ultimately led to the downfall of most HMOs and a return to healthcare cost inflation within two decades.⁵²

The nature of healthcare evolved in the mid-twentieth century as policyholders sought coverage of medical expenses beyond hospital visits and catastrophic illness. Insurers implemented new forms of sharing the increased costs of new “major medical” coverage with individuals through deductibles, an annual dollar amount that a policyholder must pay before insurance begins covering costs, and co-payments, a share of healthcare service costs paid by policyholders each time they use a service.⁵³ On paper, insurers had strong reasons for implementing cost sharing in healthcare. As individuals took on more of their healthcare costs, insurers could not only offset some of their expenditures, but also adjust their offerings with lower premiums or higher annual coverage limits.⁵⁴ Cost-sharing measures also looked to solve the “moral hazard” problem that arises when individuals seek medical care that they may not need because they do not bear any of the cost.⁵⁵ Once individuals had to pay each time they visited a doctor or got an X-ray, they would “think twice” and presumably seek fewer services.⁵⁶

Healthcare coverage reached an inflection point in the 1980s, at which point the rapid growth in access to health insurance and care began to move in the opposite direction. Employer-sponsored health coverage reached its peak in 1980, when it covered 79.4% of the U.S. population under sixty-five.⁵⁷ By 2018, employer-sponsored coverage of the same population had fallen to 58.1%.⁵⁸ As fewer employers offered insurance, access to private plans did not grow to cover the difference—the rate of uninsured grew from 12% in 1980 to 18.2% in 2010, with the majority of the growth occurring in Medicare and Medicaid enrollment.⁵⁹

Regulators saw an opportunity to cut healthcare costs with market-based interventions that realign competition across the industry. In the early 1990s, President Clinton introduced the Health Security Act that built on economist Alain Enthoven’s concept of managed competition.⁶⁰ Under managed competition, sponsor agencies or “alliances” (such as employers, Medicare, or Medicaid) act as referees between the competing health plans available to the sponsors’ members, determining benefits, prices, enrollment, and more.⁶¹ Sponsors focus competition on the price of annual premiums rather than individual services, with the goal of creating price-elastic demand.⁶² Price-elastic demand occurs when individuals reduce demand as prices go up, and this incentivizes sellers to keep prices as low as possible.⁶³ Naturally, regulators try to avoid price inelasticity, which occurs when a seller can increase prices without reducing demand.⁶⁴ Managed competition also pursues cost cutting by dividing providers into competing economic units and imposing market forces to compel them to become efficient delivery systems.⁶⁵ While President Clinton’s proposal would have introduced the American healthcare system to a new phase of managed care, the bill failed, and it would be another sixteen years before Congress would pass large-scale healthcare reform.⁶⁶

When President Obama signed the ACA in 2010, it represented the most significant healthcare reform package since President Johnson’s Great Society gave Americans Medicare and Medicaid.⁶⁷ Rather than deconstructing the healthcare system to cut costs as President Clinton had attempted to do a generation prior, the ACA primarily focused on increasing access to health insurance and improving the quality of health benefits. The ACA created a new marketplace for health insurance plans that aimed to streamline the insurance purchase process and required that plans offer ten essential health benefits to all who sign up.⁶⁸

The ACA took a carrot and stick approach to expanding health coverage in what is known as the “three-legged stool.”⁶⁹ The first leg required insurance companies to adopt community rating with guaranteed issue of ten essential health benefits for all who seek coverage.⁷⁰ Those who did not buy into the health insurance market, either through the marketplace or another avenue such as an employer, were subject to the second leg: a tax penalty known as the “individual mandate.”⁷¹ Many who signed up, however, enjoyed tax credits—the third leg—to help cover their premiums and cost sharing, such as co-pays, deductibles, and coinsurance.⁷² As a result, twenty million individuals gained health insurance in its first five years.⁷³

More than any other aspect of the ACA, the individual mandate faced intense legal and political scrutiny. An array of court battles culminated in NFIB v. Sebelius, a 2012 Supreme Court decision that upheld the constitutionality of the individual mandate.⁷⁴ In his opinion, Chief Justice Roberts wrote that although the individual mandate fails as an exercise of Congress’s Commerce Clause power, “it is reasonable to construe what Congress has done as increasing taxes on those who have a certain amount of income, but choose to go without health insurance. Such legislation is within Congress’s power to tax.”⁷⁵ Constitutionality was not enough to save the individual mandate, however, and Congress repealed the tax penalty in 2017.⁷⁶ The ACA itself came just one Senate vote short of repeal,⁷⁷ and there remain efforts to replace it.⁷⁸

II. ECONOMIC CHALLENGES AND SOLUTIONS IN HEALTHCARE: FROM ACOS TO HEALTHCARE DISTRICTS

A. Diagnosing Healthcare’s Market Failures

Healthcare represents not only a lifeline for individuals, but also for the American economy.⁷⁹ In 1960, healthcare expenditures accounted for 5% of the nation’s gross domestic product (“GDP”).⁸⁰ By 2022, that figure had risen to 17.3%.⁸¹ Some of the increase can be attributed to positive developments in care and coverage. But economists point out that healthcare spending also results from fundamental problems in the healthcare market. In an efficient healthcare market, rational and fully informed individuals could purchase healthcare services they need from fair, perfectly competing sellers.⁸² Healthcare resources could be allocated efficiently in a world in which people can shop around for healthcare, with the full scope of information on the prices and quality of each provider’s services, and the ability to then pay for those services directly. As Americans learned in the early-twentieth century, when complex healthcare emerged and insurance developed to pay for it, such a world is a fiction. The healthcare system that resulted was one fraught with market failures that have driven costs upward, and healthcare reform to this point has failed to stem the tide.

For many, the loss of the individual mandate spelled the end of the ACA.⁸³ In theory, the less-risky population of younger, healthier individuals could pull themselves out of risk pools and skip health insurance in a phenomenon that economists call “adverse selection.” With risk pools more heavily concentrated with older and sicker individuals, as the theory goes, prices would increase.⁸⁴ Increased prices would lead more people to withdraw from the health insurance market, and the so-called “adverse selection death spiral” would lead to a collapse of the market altogether. It turns out that one of healthcare’s greatest problems is what has propped up the system post-mandate: price inelasticity.

Healthcare suffers from price inelasticity because when healthcare costs go up, individuals do not drop insurance coverage, they just drop going to the doctor. By 2010, the uninsured non-elderly population reached its peak at 17.8% before the passage of the ACA.⁸⁵ The law’s drafters understandably made it a priority to bring the number of uninsured down, and on that front the law has been largely successful to date.⁸⁶ In 2018, the uninsured rate dropped to 11%,⁸⁷ and by 2022 the non-elderly uninsured rate reached 9.6%, the lowest level on record.⁸⁸

Yet, increased coverage did not spell increased access to care. One survey found that in 2001, 19% of adults reported putting off needed care due to costs, but even with the passage of the ACA, by 2022, that figure had risen to 38%.⁸⁹ Another survey reported that 40% of Americans skipped a recommended medical test or treatment due to cost, and 40% of Americans have cited cost as the reason for going without routine physicals or other preventive care.⁹⁰

Not all insurance plans are the same, and the differing approaches to cost sharing exposes the disparity in access to care across the healthcare system and the problems that arise from a lack of reliable pricing information. Cost sharing comes in various forms, including percentages of medical service costs or fixed rates set by insurance companies according to a particular service, such as $20 for a physician visit or $150 for a hospital stay. Alternatively, one might pay $150 or 20% for a hospital stay, depending on the type of plan one has. The disparity in insurance can be seen in the enrollment trends in the ACA insurance marketplace, in which the middle “silver” tier has seen declines in enrollment, the “gold” tier has seen modest gains, and the lowest “bronze” tier has seen significant increases.⁹¹ Whereas set rates, rather than percentages, for healthcare services shields individuals from unexpected costs, it simultaneously hides the complex and mysterious world of medical billing.

The key takeaway is this: price elasticity of demand occurs in the provision of healthcare services, rather than in the provision of insurance coverage.⁹² More Americans than ever have health insurance, but a great deal of those with coverage forgo the added out-of-pocket costs that come with seeking healthcare services.⁹³ And while that reduced demand for services might compel providers to reduce prices in an efficient market, they have made up the difference by continuing to increase prices and extracting more money per service for those who do seek treatment.⁹⁴ Individuals with reduced cost sharing, such as set rates for services, face a reduced barrier to services and do not encounter the prices that keep others away.

Because individuals are not the only payers in the health insurance market, price elasticity could ostensibly come from insurers or employers. In theory, employers ought to balk at rising healthcare costs, but economists have suggested that they pass on the additional costs to employees.⁹⁵ In an era of high inflation, employers can pass on healthcare costs easily through smaller nominal wage increases.⁹⁶ Between 2009 and 2019, worker contributions to employer-sponsored premiums rose 59% and employer contributions rose 54%, while employers’ share of the total premium held steady at 73%.⁹⁷ Employees absorb the increased prices charged by providers in a way that is largely hidden from them—employees cannot readily know how much they would earn in the absence of healthcare cost increases.⁹⁸ Evidence suggests the passing of these costs to employees, combined with rising wage inequality, “significantly reduced the percentage of compensation.”⁹⁹ If providers can increase prices that individuals will ultimately bear, without some other market basis like a proportionate loss in demand or increase in value, the provider gets away with earning what economists call “rents,” or excess prices beyond the minimum price a seller would otherwise be paid in the market.¹⁰⁰ Not only is this harmful to individuals, in that it represents an inefficient allocation of resources, rent-seeking behavior evinces a level of monopolistic power by providers in the market.¹⁰¹ Were prices elastic, the number of insured individuals would decrease as prices rose. Over that same period, however, more people have gained insurance.¹⁰² While the growth in healthcare coverage is a positive development, it represents a worrying trend when paired with increased prices. The brakes that traditionally keep prices low—the threat of losing paying customers once prices exceed what they are willing to pay—either do not exist or have not been reached.

With market failures taking out downward cost pressures from individuals and employers, insurers stand as the apparent last line of defense against rising healthcare costs. The traditional insurance business model incentivizes cost efficiency—policyholders pay insurers set premiums, and insurers have the incentive to pay as little of those premiums out as reimbursement for services in order to retain the greatest possible profit margin. The ACA turned this model on its head when it mandated a “medical loss ratio”—a requirement that insurance companies spend 80–85% of premium dollars on medical care-related expenses, thereby tying the amount they get to keep (including profits) to a percentage of care dollars spent.¹⁰³

The healthcare marketplace insulates individuals from many of the direct costs of healthcare, and the lack of robust price competition for insurance means that insurers may continue to raise premiums to accommodate the high healthcare prices that net them greater profits.¹⁰⁴ Insurers can take advantage of market failures to pursue the perverse incentives of a medical loss ratio policy that was meant to decrease costs but instead incentivizes them to spend as much as they can.¹⁰⁵ Furthermore, insurers have an additional incentive to keep costs as high as their premiums can bear because high prices set a high barrier to entry for other potential competing insurers.¹⁰⁶ These incentives expose the pitfalls of cost-based regulations instead of incentive-based ones, as proposed here.¹⁰⁷

Insurers cannot overpay for services if they are not charged such high prices in the first place. Whereas cost sharing effectively curbed the threat of moral hazard when individuals seek out more medical services than they need because they do not bear the cost, another moral hazard problem arose in the form of provider billing and overtreatment.

The cost-sharing measures implemented by insurers essentially traded one moral hazard problem for another. Insurers overcorrected the moral hazard problem by disincentivizing individuals from seeking treatment, instead incentivizing doctors to overtreat those that do come in.¹⁰⁸ In its worst incarnation, physician-induced demand can rack up healthcare expenses when patients do not know any better, and insurers put few, if any, brakes on unnecessary charges.¹⁰⁹ A major factor that has enabled healthcare providers to charge ever-higher prices is the lack of transparency around the prices of services between patients, insurers, and even providers.¹¹⁰

One contributor to healthcare’s price inelasticity is the varying difficulty that consumers, providers, employers, and insurers have with understanding the price of healthcare services, or what economists call “information asymmetry.” Throughout healthcare, there are discrepancies in the amount of information available to transacting parties.¹¹¹ For instance, doctors typically have more information about the care they can provide than patients. Similarly, healthcare providers generally have more information about the costs of their services than insurers. The discrepancies in information create inefficiencies that drive up costs. When patients seek healthcare services, they likely do not know the cost of the services beforehand.¹¹² Depending on their insurance plan, patients can either anticipate paying their insurance plan’s set rate co-pays or face the surprise bill for a percentage of the services they incurred. Information asymmetry gives rise to a principal-agent problem, in which the physician-agent has incentives to use the information asymmetry for the physician’s financial benefit.¹¹³

A primary culprit of increased healthcare prices is the mysterious and unscientific hospital “chargemaster” system. Chargemasters are automated systems traditionally employed by large healthcare providers such as hospitals to set price markups and generate the sticker prices for their various services.¹¹⁴ Few, if any, in the hospital administration are involved with the setting of the prices, and even doctors generally are not informed of the prices of the services they perform.¹¹⁵ Here, a type of information asymmetry even occurs within providers. Yet, chargemasters set the baseline price from which insurance companies negotiate down to a level the insurer is willing to pay. Those with less bargaining power, such as uninsured individuals, may face the full chargemaster price without the assistance of medical billing consultants to negotiate on their behalf. The result often leads to newsworthy charges such as 675% price hikes.¹¹⁶

Providers capitalize on information asymmetry by using chargemasters to extract the highest possible prices, and they have few disincentives to do otherwise. As discussed earlier, many patients never see their medical bills aside from standardized, insurer-set co-pays. One might reasonably expect the other payers in the healthcare system—employers and insurers—to thus bear the sensitivity to providers’ exorbitant costs and apply downward price pressures. Unfortunately, the confluence of healthcare’s market failures renders those pressures toothless.

Efforts over the past decade to improve price transparency will not likely affect individuals’ healthcare decision-making process in a significant enough way because patients are not the ones making many of the decisions about their care.¹¹⁷ Revealing chargemaster prices, for instance, likely matters more to insurers and employers, as well as smaller hospitals that seek to charge comparable prices to larger competitors, than it would to consumers.¹¹⁸

The goals of universal access, low cost, and high quality can be achieved with a model that addresses the information asymmetry, principal-agent problem, misaligned incentives, adverse selection, poor competition, price inelasticity, and antitrust concerns that plague healthcare today.

B. Finding a Cure in Accountability

Enter the Healthcure System, an entirely new healthcare model proposed by this Note that adapts the best features of ACOs, incentive payment models, and employer-provided health plans while abandoning fee-for-service cost plus payments, private health insurers, complexity of multiple payment sources, incentives for providers to overtreat, and the power of providers to increase prices by consolidating and reducing competition.

Historically, healthcare reform has consisted of attempts to achieve two of the three pillars: cost, quality, and access. The ideal healthcare system keeps costs low for individuals and providers (whether someone can afford their healthcare costs and whether providers reign in the costs of their services), maintains high quality by making available a breadth of healthcare benefits with strong outcomes (whether a particular ailment is covered and whether a treatment has a high likelihood of success), and ensures that the greatest possible population has access to care and coverage of costs (whether most are able to easily visit a doctor or hospital and will they have a means of paying for their treatment). Medicare focused on cost and access by providing insurance to all who reach a certain age, but it has historically lacked important quality indicators such as coverage of prescriptions, dental, vision, long-term care, and nursing home care.¹¹⁹ The proposed Clinton health reforms of the 1990s focused on cost and quality by managing competition and guaranteeing benefits, but they did not address a growing number of uninsured.¹²⁰ The ACA focused on quality and access by guaranteeing ten essential health benefits and expanding access to Medicaid and a private insurance marketplace, but it left intact the payment methods that have driven prices upward.¹²¹ The Healthcure System rebuts the presumption that no model can achieve all three.

Under the Healthcure System, all residents within a particular region make payments (essentially a healthcare tax) to a healthcare district—a corporate entity that encompasses all of the healthcare providers in the region. Each region would be determined by the state legislature based on population and concentration of providers and should account for the equitable distribution of resources when doing so.¹²² The healthcare district coordinates payment and care for residents of the region, employing a front-end per capita payment and back-end incentive payments system that encourages providers to not rack up unnecessary costs but still have an incentive to provide cost-effective quality care. Healthcare districts largely take the place of private health insurers and employer-paid plans, instead centralizing each individual’s healthcare costs into one monthly income-based payment. Each healthcare district’s board of directors sets this progressive healthcare tax rate for the region, and if that percentage exceeds what residents are willing to pay, individuals may vote out the directors during staggered biennial elections or, if feasible, avoid living in the district.

This Note makes some acknowledgments from the start. First, healthcare delivery is inherently local—patients are realistically constrained to choosing providers near them, and healthcare costs are significantly influenced by local factors. Rather than share the struggles Medicare has had with accounting for regional differentiation in markets for medical services, products, and employment when calculating reimbursement, each healthcare district only concerns itself with negotiating local pricing with local providers for local beneficiaries. Districts are therefore organized around a large enough population to distribute risk in a risk pool while also encompassing the entirety of a local market (that is, all of the providers that would compete with one another for individuals in the region). In densely populated states, there may be healthcare districts proportionate to the number of counties, but in more rural areas, districts could theoretically be the size of a state. Second, provider consolidation is inevitable and comes with benefits despite its drawbacks. The upside of a fully functional ACO is the imposition of cost sensitivity on the providers who are responsible for the decision-making behind those costs. Providers would need to evaluate, for instance, whether to use an expensive treatment based on its likelihood of success, rather than indiscriminately prescribing costly remedies, because they can no longer rely on a third-party payer to just foot the bill. Such integration of finance and delivery can act as a powerful downward cost pressure that can alleviate the current upward incentives to overtreat and overprice. Although consolidation also breeds upward price pressures in the form of reducing competition, Healthcure makes use of other downward cost pressures such as regional competition, price elasticity, public accountability, and a market for supplemental benefits to counterbalance antitrust pricing concerns. Third, incentive payments must account for both event-specific outcomes (rewarding providers when a particular treatment works, for example) and community outcomes (rewarding providers for overall health gains in a region) in order to fully align the incentives of payments and providers.

III. ACCESS: ADOPTING A REGIONAL FOCUS TO DELIVER EMPLOYER-STYLE UNIVERSAL COVERAGE

In a sense, access is the ultimate aim of healthcare reform: it encompasses both cost and quality to a certain degree. High cost is often a barrier to access to coverage, and poor-quality coverage often keeps people from access to care. Any discussion of access in the healthcare system must account for both coverage (as in an individual’s participation in some support system to cover healthcare costs) and care (which accounts for the kinds of healthcare services available to an individual). Both are of major concern in the current United States healthcare system. In early 2023, 7.7% of Americans did not have access to health insurance.¹²³ Furthermore, studies have shown that low-income and marginalized communities see a disproportionate decline in access to care from higher odds of losing healthcare facilities.¹²⁴ Healthcure addresses access by co-opting one of the original drivers of health insurance adoption: employer-sponsored health plans.

As evidenced by the public concerns over whether individuals would be able to keep their insurance plans at the time the ACA was passed,¹²⁵ such employer plans have achieved a level of ubiquity in American society that any reform that upends the status quo would be well-advised to consider. The Healthcure System shares two key elements with employer-sponsored health plans: community rating and income contributions.

A. Expanding the Risk Pool from Coworkers to Neighbors: A Regional Approach

Today’s healthcare landscape is filled with geographically mismatched systems and entities. When individuals seek care, they are generally constrained to providers within their immediate vicinity. These individuals may participate in health plans through employers that also provide coverage to employees located in other states. Insurance marketplaces through the ACA, on the other hand, are constrained to markets within each state. Meanwhile, the single largest payer in the country—the Medicare system of the federal government—operates nationwide but uses a litany of processes to account for regional disparities in costs. To put it simply, healthcare is inescapably local, and the first step to crafting an efficient healthcare system is recognizing the value of a regional approach.

At its core, the Healthcure System consists of smaller, regional systems that naturally incorporate the idiosyncrasies of their localities in healthcare finance and delivery. Although healthcare districts do not currently exist as envisioned for the Healthcure System here, the concept of regional healthcare districts is not entirely new. Regional health districts under the Healthcure System trace their roots to a different kind of healthcare district employed by state governments to coordinate healthcare in rural areas.¹²⁶ Funded by either general taxes or special taxes, traditional healthcare districts are local governments that operate healthcare facilities, establish managed care, contract with providers, or take on any other health-related service for a community.¹²⁷

Any third-party payer that collects funds from a population to distribute medical services must consider risk. The delicate balance between risk and ratemaking can have significant implications for access if those with higher health risks face significantly higher rates (or exclusion from the market altogether). Such was the consequence of experience rating, a method used by health insurers to determine eligibility and rates based on an assessment of one’s health risks. Insurers engaged in favorable selection, attempting to insure healthier individuals and avoid sicker people. Prior to the ACA, those with certain preexisting conditions would face unaffordable premiums or even exclusion from certain health plans. To avoid locking out those with the most medical need from the insurance system, and thereby exposing them to insurmountable out-of-pocket costs, the ACA banned experience rating in all circumstances except age and tobacco use. To counteract the risk imbalance that would result from removing the experience rating mechanism plans could use to reduce risk, especially on small plans, the ACA promised economies of scale that could accommodate high-risk individuals but spread exposure across a larger risk pool. Insurers had the individual mandate to thank in part for the uptick in larger, healthier risk pools, as it compelled those who might otherwise go without health insurance to do so or face tax penalties.¹²⁸

While the ACA expanded coverage for those who did not otherwise have access, employer-sponsored health coverage still dominates. Employers cover approximately 50% of the U.S. population.¹²⁹ Of those who have access to employer-sponsored coverage, 77% participate in the employer’s group.¹³⁰ In the mid-twentieth century, employer-sponsored plans drove rapid growth in health coverage, but today they are fraught with drawbacks. Employer plans are responsible for additional complications in the payment structure, buffering individuals from the cost of their care by passing on the costs through reduced wages, shifting compensation from paychecks to health plan contributions, limiting coverage to those employed, and constraining risk pools. Studies have shown that the upward cost pressure problems of employer plans are exacerbated in markets with fewer insurance carriers because carriers take advantage of the lack of competition by negotiating higher premiums, especially with employers experiencing profit shocks.¹³¹ Moreover, the costs of researching different plans and transitioning to new ones often keep those in employer plans from switching, thereby reducing competition that could impose downward price pressure.¹³²

Even before it was mandated by the ACA, individuals were exposed to community rating by their employer health plans. Rather than engaging in experience rating, which evaluates risk based on the individual health histories of each ratepayer and charges them accordingly, traditional employer plans distribute risk across a group and charge each member the same rate.¹³³ Because community rating does not take into account health histories, the primary mechanism by which to manage risk is to achieve scale.¹³⁴ Employer plans are limited by the group of enrollees at a particular firm.

Given the local limitations of healthcare delivery, the Healthcure System’s answer to risk distribution is to expand it from the silos of individual employers to the very limits of a particular region. The general wisdom is that when allocating risk, the larger the risk pool, the better. Although community rating across organizations provides some semblance of risk distribution, it pales in comparison to the distribution across an entire region at all employers except for the largest of firms. The Healthcure System’s expansion of risk pools enables healthcare districts to enjoy the cost savings of the risk distribution.

B. Simplifying Beneficiary Healthcare Costs to Induce Price Elasticity and Protect Affordability

The “Affordable” in Affordable Care Act may be the most significant undelivered promise of the law. What the ACA did not address is the complex web of payment sources that underlies the entire system. Whereas insurance premiums are the primary focus of the cost debate, and deservedly so, they do not account for the entirety of an individual’s healthcare expenses.

It is this mixture of cost types that shields individuals from grasping the full scope of their healthcare expenditures and buffers their sensitivity to the exorbitant charges providers make for their services.¹³⁵ The Healthcure System narrows each individual’s health expenses to a percentage of one’s income—the starkest representation of one’s ability to pay. The percentage is set by each healthcare district and may be adjusted annually by its board of directors. Income contributions have a low-income threshold—individuals with an income below a certain dollar amount pay nothing, and as one’s income crosses the threshold, the percentage gradually rises up to the base percentage that is broadly applied across the district. All residents in a region have access to the district’s health benefits, regardless of income level. To avoid adverse selection of high earners fleeing from risk pools, a high-income cap places a limit on the dollar amount a family may contribute to the healthcare district’s base benefits. While healthcare districts adopt the ten essential health benefits as defined by the ACA and offer them to all residents, those who wish to supplement their benefits may purchase a supplemental plan on an open market similar to Medigap supplemental coverage for Medicare.¹³⁶

The extent of the current healthcare system’s price inelasticity was tested when Congress repealed the individual mandate. With the flick of President Trump’s pen, those who would otherwise leave the market due to high prices could all of a sudden do just that. However, as healthcare costs continued to rise, enrollment did not precipitously decline.¹³⁷ Even with the loss of the individual mandate, price inelasticity may still rely on the buffer between individuals and their healthcare costs to insulate them from the price sensitivity that might otherwise drive them from the market.

The Healthcure System’s approach to individual payment achieves price sensitivity by wrapping up all healthcare costs into one tax payment that is broadly applied to all residents in the healthcare district. The current mix of individual premiums, employer contributions, co-pays, deductibles, coinsurance, and government tax credits all obscure the cost of healthcare to the individual. However, when all that individuals must consider is a particular tax, their understanding of health expenses gains a clarity with which they can impose downward price pressures.

Downward price pressures on the demand side of the Healthcure System consist of individual choice between healthcare districts and public election of district boards of directors. Instead of imposing cost sharing through co-pays for each medical service rendered, Healthcure incentivizes individuals to consider healthcare tax costs when choosing where to live. If a particular healthcare district sets too high of an income contribution rate for its residents, individuals may choose not to move to that particular district. But moving may not always be feasible or desirable, so those who reside in the district can express their objection to high income percentages by voting out the board of directors and electing a board committed to cutting costs.

Traditional cost sharing does not sufficiently cause individuals to better consider which healthcare services they should seek because they lack the information needed to make that determination and will always lack that information in the absence of the training of a medical professional.¹³⁸ Cost sharing on the service level thus results not in cost savings, but in worse health outcomes when people forgo treatment due to cost. Instead, price sensitivity should be focused on what individuals can make informed decisions about and fully understand. For most, that is the total amount they are able to pay for their healthcare tax.

C. Possible Equity Implications of a Regional Model

The deontological debate over whether healthcare constitutes a commodity, a right, or something in between extends far beyond the scope of this Note. But the law and economics approach taken here does not ignore the ethical implications of equity in its design of a more efficient healthcare system. Policymaking necessarily has ethical and economic consequences, and this Note presents the Healthcure System as a means of compelling providers to become fairer market actors, guaranteeing egalitarian access to healthcare, enhancing competition, and reducing costs.

The general thrust of the Healthcure System model is its introduction of new accountability measures into a healthcare landscape where there are currently few. This lack of accountability, whether it be in hospital pricing or insurers’ willingness to pay, affects every individual regardless of whether they choose to participate in the insurance market. This is true of any market—the actions of firms do not exist in a vacuum without influencing supply and demand for all market participants.¹³⁹ The imperative for broad public accountability in the market for widgets, however, does not measure up to the imperative in a healthcare industry that every individual is likely to transact with at some point. For healthcare providers to be truly accountable, they must be accountable to everyone, not just their customers. By bringing all individuals under a universal coverage model, the Healthcure System’s accountability measures can internalize the externalities of the healthcare market. In other words, no longer will insurers and providers suscept the uninsured to price inflation.

In its effort to provide universal coverage, the Healthcure System sets forth regional healthcare districts that collect taxes from residents and distribute those funds to providers for the provision of services. Notwithstanding its unique policy prescriptions, the Healthcure System would be wise to adopt some of the innovations of the ACA, such as the guaranteed issue of essential health benefits. All health insurance plans were required to offer ten services as part of their benefit packages under the ACA: (1) ambulance; (2) emergency; (3) hospitalization; (4) maternity and newborn care; (5) mental health and substance use disorder; (6) prescription drugs; (7) rehabilitative and habilitative services and devices; (8) lab work; (9) preventive, wellness, and chronic disease management; and (10) pediatric services including oral and vision care.¹⁴⁰ Additionally, the ACA ensured that insurers could not turn away or even raise premiums for those with preexisting health conditions. Although the ACA may not have done enough to stem rising costs, it did take significant steps toward improving access to health coverage and the quality of the benefits provided.

A regional, tax-funded healthcare system raises concerns over provider concentration and equity between regions with different income levels. These concerns predate the proposed reforms offered here, but this Note does not seek to entrench an already inequitable system. On the contrary, the Healthcure System can act as a vehicle for identifying areas with inequitable access to healthcare and delivering targeted financial support in the form of supplemental government adjustment payments.

The Health Resources & Service Administration (“HRSA”) currently uses two designations to identify areas of need in the healthcare system: Medically Underserved Areas/Populations (“MUA/P”) and Health Professional Shortage Areas (“HPSAs”).¹⁴¹ Additionally, Medicaid identifies hospitals that serve large numbers of Medicaid and uninsured individuals and directs supplemental payments through the Disproportionate Share Hospital (“DSH”) program.¹⁴² These programs may be rolled into healthcare districts, which can more easily collect data on the community’s needs due to the coordinated care of all the providers in the region. Federal and state governments can then issue adjustment payments to those districts with the most need, and the payments can come in the form of block grants, incentives to recruit physicians, infrastructure and capital improvement funding, equipment, and even technical assistance and consultation. Further, government payments could subsidize the costs of patients visiting other healthcare districts to make use of equipment, services, or specialists that their underserved district may lack. The district could evaluate the cost of purchasing access to equipment, services, or specialists in other districts and the demand for them, and if cost-effective, petition the government to subsidize the acquisition of them for the underserved district. In this way, the Healthcure System can play an active role in improving health equity in a given region.

Another concern arises over the district’s control over pricing and the potential for monopsony. Whereas monopoly power enables a seller to set prices above what a perfect market would dictate, monopsony power on the buyer side enables one to counterbalance monopoly rent seeking.¹⁴³ But a monopsonist need not face a monopoly on the other side of the transaction in order to wield its power, and in the healthcare context, a single-payer such as a government can lead providers to withdraw supply in response to lack of price power.¹⁴⁴ It is not difficult to imagine how low-income districts may be disproportionately susceptible to constrained supply if they pay providers less than neighboring districts. Government adjustment payments are just one way districts can avoid these circumstances.

Here, the board of a healthcare district also has work to do to protect individuals’ access to care. One way to fight the possibility of constrained supply is through the system’s per-event incentive payment structure that rewards providers for seeing more patients, rather than rewarding them based on the number of services administered through fee-for-service.

An additional safeguard would be a requirement that providers offer essential health benefits if they are to participate in a supplemental coverage market not subject to price controls by the district. Providers could offer supplemental coverage in a private market for services not otherwise available through the district. The districts must ensure there is no overlap of services between the essential benefits they offer and the supplemental benefits offered by providers because an overlap would open the door for a conflict of interest. If providers’ supplemental services competed with those offered by the district, then providers will have incentives to reduce district essential benefits made available to everyone, offer lesser-quality district benefits, or otherwise push individuals toward its supplemental offerings (which would ostensibly be more lucrative for the providers).

IV. COST: INNOVATING A NEW HEALTHCARE DISTRICT GOVERNANCE MODEL WITH PUBLIC AND FINANCIAL ACCOUNTABILITY FROM STAKEHOLDERS

Although not a centerpiece of the ACA, a modest provision in section 3022 now stands as one of the most promising elements of the ACA left standing, one that opened the door to a new organizational form dedicated to accountable care: the ACO.¹⁴⁵ When providers come together to form an ACO, they commit to coordinating care and sharing in the responsibility for financial and quality outcomes for a certain population of patients.¹⁴⁶ Not only can ACOs deliver improved health outcomes by sharing information between doctors, hospitals, and other providers, thereby reducing unnecessary or redundant treatment, but they can also reduce costs.

The healthcare market traditionally imposes on insurers—not providers—the risk of losing money when healthcare costs exceed the amounts collected from individual premiums. As discussed earlier, market failures have led to a system in which healthcare providers face no downside to overtreating patients and often have incentives to charge as high of prices as possible.¹⁴⁷ Thus, the system imposes few, if any, brakes on runaway healthcare costs, and those costs are ultimately passed to individuals in the form of increased premiums, greater cost sharing, and reduced wage gains.¹⁴⁸ ACOs flip this relationship on its head by shifting risk to the providers who are largely responsible for making decisions about and incurring the costs of care in the first place. Rather than rewarding providers based on the number of services provided, as the traditional fee-for-service model incentivized, ACOs offer providers financial incentives for hitting cost-savings targets and meeting quality benchmarks. In theory, the goal is to align incentives in the healthcare market so that all benefit from low-cost, high-quality care.

In concert with the Medicare Shared Savings Program (“MSSP”), the federal government incentivizes cost cutting by offering providers who organize under an ACO model a share of any cost savings they generate from efficient service delivery.¹⁴⁹ The Centers for Medicare & Medicaid Services (“CMS”) offer several levels of shared savings, and the ACO shares a proportionate amount of risk of cost overages according to the level it joins.¹⁵⁰

The upside of the ACO is so great that it could—with the right adjustments—avoid the upward cost pressures that come with traditional private insurers.¹⁵¹ MSSP reported $1.8 billion in net savings in 2022 after making incentive payments to participating ACOs.¹⁵² On its face, that number represents a laudable achievement and proof of concept for ACOs, but it does not fully capture the state of the program. The number of participating ACOs shrank from 561 in 2018 to 456 in 2023,¹⁵³ and economists point out that the savings figure is largely the product of selective participation.¹⁵⁴ Due to the voluntary nature of MSSP, higher-spending ACOs have disproportionately exited the program and lower-spending ACOs have entered. The result is a skewed program that provides incentive payments to smaller, potentially less-efficient providers and falls short of imposing meaningful cost savings on the large providers most responsible for the healthcare system’s increasing costs.¹⁵⁵

A key selling point of ACOs is the integration of finance and delivery among a network of providers, but adverse selection stands in the way of achieving that integration at scale. Healthcare districts may solve the selective participation problem by automatically enrolling all providers and individuals to participate in the district’s network. Such a mandate creates a new set of challenges when considering the varying interests of individual, hospital, and physician stakeholders.

On one side, individuals are responsible for paying healthcare taxes to pay for their access to the district’s provider network and essential health benefits. In their pursuit of quality care at the lowest possible cost, individuals may voice their preferences through choice of provider, district in which to live, and elected directors of the district. In this regard, districts take on qualities resembling special districts.

On the other side, a mix of independently run private for-profit and not-for-profit healthcare providers compete with one another for patients, and they may make different business decisions in light of that competition. To require these providers to join forces might exacerbate provider consolidation and raise antitrust concerns that they might wield too much pricing power in their regional market. In light of this, healthcare districts could take cues from public utilities in the administration of a regulated monopoly on healthcare.

A reasonable objection to the mandated participation of healthcare providers is the restriction on the freedom of private businesses to transact in an open market. With traditional ACOs, providers choose with whom they would form a network; in contrast, healthcare districts bring together all neighboring providers to coordinate. Concerns over the agency of providers are warranted, and it is precisely these concerns that encourage the consideration of the corporate form as a source of inspiration to protect these interests.

The formation of special districts and regulation of corporations are largely functions of state law.¹⁵⁶ When legislating the creation of healthcare districts, state lawmakers will need to consider an organizational form tailored to the idiosyncrasies of healthcare. Whereas the ACO is the archetypal structure from which healthcare districts are designed, the districts must take on characteristics of both public and private entities to overcome the market failures and regulatory shortcomings that otherwise keep ACOs from achieving the integration of finance and delivery at scale today.

A. Public Governance as a Counterweight to Consolidated Provider Market Power

At the center of the ACO adverse selection problem is the gap between, on the one hand, the good governance principles that CMS inspires through incentives for cost-savings, and on the other, the financial motives for avoiding participation in ACOs due to the risk of cost overages. As a means of broad institutional change, MSSP’s ACO program is a portrait in weak governance.¹⁵⁷ In the tripartite scheme of healthcare governance between individuals, providers, and government, the government’s role in enacting ACOs is more akin to making a series of suggestions than outright rulemaking.¹⁵⁸

Despite the federal government’s soft touch when it comes to pushing providers to participate in a two-way risk MSSP model, industry watchers have raised antitrust concerns over ACOs’ potential to exacerbate provider consolidation.¹⁵⁹ Therein lies an inherent conflict within the very concept of the ACO: while ACOs strive to achieve a reduction in costs, they simultaneously enable increased prices by encouraging providers to join forces and reduce competition.¹⁶⁰ With fewer competitors on price, ACOs can theoretically wield more market power and raise prices with impunity.¹⁶¹

A conflict thus arose between CMS’s encouragement of ACO formation and the Department of Justice’s (“DOJ”) antitrust enforcement role. Where the two federal agencies stood diametrically opposed, the DOJ capitulated to CMS and issued a policy statement effectively taking a hands-off approach to antitrust enforcement when providers are organized in an ACO.¹⁶² Notwithstanding the multitude of market failures that have largely eviscerated price competition in healthcare, the fact remains that a traditional ACO could adopt a one-sided risk model that imposes no risk for cost overages while enjoying the lax antitrust rule enforcement that comes with participating in MSSP.

Provider consolidation was a growing trend in healthcare even before the ACA took effect, but it has ramped up in the years since.¹⁶³ In the two-year span between 2016 and 2018, physician affiliation with vertically integrated health systems jumped 11%,¹⁶⁴ and the number has doubled over the past decade.¹⁶⁵ The movement toward vertical integration, in which entities along a supply chain such as doctors and hospitals align under one entity, can be a positive development for cost efficiencies and care coordination. After all, coordination is a central component of the ACO model. But consolidation inevitably results in price increases in the absence of downward cost pressures such as ACO cost sharing and strong antitrust regulation, especially when entities such as nearby hospitals horizontally integrate and cease competition.¹⁶⁶ With ACOs increasingly opting for one-way risk models and the DOJ relaxing antitrust enforcement, the current system does not pose much of a barrier to increased prices.

The Healthcure System’s mandate to form provider networks by region would not mark the first time a government sanctioned a geographic monopoly over a particular market. The regulation of public utilities arose from the recognition that some businesses operate in the public interest and regulations would ensure that “all must be served, adequate facilities must be provided, reasonable rates must be charged, and no discriminations must be made” when the free market alone would not.¹⁶⁷ Historically, sectors of public interest, such as transportation, communications, electricity, and water, invited regulation as utilities when they were dominated by large businesses with enough market power to exploit customers.¹⁶⁸ The similarity of circumstances in healthcare today has raised the question of whether medicine should be regulated as a public utility.

The difficulty with applying public utility regulation to medicine lies with its traditional business model: while its rates and service may be mandated by the government, a utility remains a private business that charges a rate based on use.¹⁶⁹ For instance, an electricity company may be required to supply energy to all homes in a given region. Not all of those homes may choose to purchase that energy, however, and if they do, they pay an amount proportionate to the amount they consume.¹⁷⁰ In healthcare, pay-per-use is fraught with complications, most prominently the information asymmetry problem that keeps patients from fully understanding their healthcare services and costs.¹⁷¹ Patients are simply not equipped to make many choices about constraining their use of healthcare services, especially when they occur in emergency situations.

In the bargain between public utilities and their regulating agencies is the grant of a monopoly to provide services in a given region in exchange for a duty to serve everyone, often at certain price levels.¹⁷² The monopoly bestows exclusive access to the market and ensures supply to the populace, but it does not compel demand. Consumers are not required to purchase the services or purchase a certain amount. To do so could run afoul of the Supreme Court’s Commerce Clause analysis in Sebelius, which would have struck down the individual mandate to purchase health insurance as an overstepping of Congress’s authority had it not been deemed a form of taxation.¹⁷³ It is in this respect that the public utility model falls short of its usefulness in a healthcare system that provides universal coverage—the model must reckon with the public’s expectations of electoral accountability in the face of taxation.

The inextricable relationship between taxation and voting traces its roots to an early moment in American history when colonists protested their lack of electoral representation by turning Boston Harbor into the world’s largest teacup.¹⁷⁴ One can imagine the fervor with which Americans might destroy crates of stethoscopes and gauze bandages in protest of healthcare taxes without a say in how those taxes are spent. The establishment of a specialized entity that lays taxes and delivers services to a particular population naturally invokes a governmental structure—in particular, the ubiquitous local public entities such as school districts and water districts. These special districts are generally governed by a board of elected representatives charged with hiring managers, monitoring the quality of services rendered, and tending to the responsible expenditure of public funds.¹⁷⁵ When applied to the concept of a healthcare district, the election of directors carries the potential to apply accountability measures that, in tandem with improved consumer price sensitivity, can impose downward cost pressures that counteract the market power of consolidated providers.

The public election of a district’s board of directors is a step toward accountability, but it begs the question: Accountability to whom? In theory, popularly elected directors stand to lose their jobs should taxes exceed what constituents deem acceptable or services fail to meet the desired level of quality. Directors always face the possibility that constituents may vote them out of office. These are conditions under which directors are seemingly incentivized to govern in a manner that is responsive to voter concerns. Indeed, free and fair elections are a hallmark of American democratic governance but so is the pervasive influence of special interests in the electoral process. Individuals do not comprise the entirety of the stakeholder population with an interest in a healthcare district’s decision-making. Providers, and the healthcare industry as a whole, will almost assuredly seek political influence to promote their interests. Such influence peddling can range from the standard fare of lobbyists sharing their expertise to financial contributions to candidates. It is the latter activity that concerned Reinhardt and led him to reject a single-payer model at the federal level “because [the United States federal] government is too corrupt. Medicare is a large insurance company whose board of directors (Ways and Means and Senate Finance) accept payments from vendors to the company. In the private market, that would get you into trouble.”¹⁷⁶ A purely governmental form does not appear wise when a taxing entity is susceptible to corrupt influence and capable of generating profits. Additional measures are in order to best ensure individuals’ interests remain protected.

B. Drawing on Private Organizational Forms to Balance Stakeholder Interests

A board of directors elected at the local level can be responsive to the ethical concerns of the electorate and its preferences regarding the allocation of resources.¹⁷⁷ Yet corruption, or even just the undue influence of interests other than that of individual voters, can stand in the way of public accountability.¹⁷⁸ This is only of concern if the interests of the public and the third-parties are not aligned, and providers’ interest in financial rewards stand to do just that.

As envisioned here, healthcare districts do not force providers to take on nonprofit status. The Healthcure System takes a general approach of noninterference with for-profit providers, recognizing that the pursuit of profits, when earned legitimately and not by taking advantage of market failures, may incentivize innovation and new efficiencies.¹⁷⁹ In Part IV, this Note instead proposes an aligned incentives payment structure that rewards providers for delivering on cost savings and outcomes measures.

While purely governmental entities are not profit-making ventures, it is not as though governments do not transact with private, for-profit entities.¹⁸⁰ Taxpayer dollars provide profits to contractors regularly.¹⁸¹ Yet, contractors willingly enter the public bidding process for government contracts with some expectation of their profit margins at the outset, and if the business proposition does not meet their business objectives, they can refrain from participating in the competitive bid.¹⁸² Here, a governmental structure does not suffice for healthcare districts because the relationship between districts and providers is not a contractual one entered into voluntarily. To realize the goals of aligned incentives and accountability, the Healthcure System devises that all providers retain their organizational form while uniting under the single healthcare district entity in which they share a financial stake. Because healthcare districts compel providers to provide services (to avoid the adverse selection problem of ACOs) and control their payment, providers lose a great deal of their pricing power. Although the districts can attempt to offset the pricing restrictions with promises of increased scale, it is nevertheless reasonable to expect that providers will seek to maximize their financial reward with the highest possible incentive payments.

Thus, an incentive payment model cannot fully rectify the tension between public interest and provider profit motive. The public utility model excels in accommodating a regulated monopoly that provides services in the public interest, but it fails to fulfill the need for electoral representation of a public taxed for their healthcare costs. The special district model does a better job of incorporating democratic ideals into the provider of specialized public services, but it cannot accommodate the profit-generating motive that some providers inevitably seek, such as individual physicians’ practices.

Where public entities fall short of balancing stakeholder interests, state legislators can look to variations on private organizational forms for guidance.

1. Allocating Rights and Responsibilities Between Patients and Providers

The underpinnings of the Healthcure System’s financial model are an amalgamation of seemingly conflicting revenue collection and distribution streams that do not lend themselves to a cut-and-dry organizational form. Starting with the residents of a healthcare district, individual tax payments form the inflow of capital with which a district procures healthcare services. All told, a district’s residents are stakeholders as (1) financial supporters, (2) beneficiaries of its services, and (3) electors of its board of directors. Once a healthcare district collects taxes, it distributes funds to private provider entities. All healthcare providers in the region are likewise stakeholders, as they (1) provide services to residents, (2) operate under the governance of the district’s board of directors, (3) receive funding from the district, and (4) share in the gains and losses of the district.

Yet, where one party has voting rights to elect a board of directors, and another lacks that right but bears exposure to the financial decisions the board makes, there arises a principal-agent problem.¹⁸³ The question then turns to how to legally organize such an entity.

In the private sector, the corporate form offers a number of options for interested parties to organize around a shared mission. Like governments, corporations are governed by representatives elected by a constituency of interested parties.¹⁸⁴ Those parties—the holders of shares of ownership in the corporation—need not retain the same rights and responsibilities as one another.¹⁸⁵ When for-profit corporations wish to assign different rights to different shareholders, they may issue preferred stock or create a dual-class share structure.¹⁸⁶ As such, certain shareholders may have priority over others when it comes to receiving financial distributions from the corporation, or they may have the right to vote on certain business matters that other classes of shareholders do not.

Ultimately, though, shareholders are owners of the corporation, and to regard individuals and providers as “owners” of a healthcare district opens the door to questions about the relative amounts of shares they hold and whether they can be transferred.¹⁸⁷ The concept of owning an entity that has the power to tax and regulate an industry confers power that would undermine electoral accountability to the public.

Other forms also offer distinct benefits but ultimately fail in their application to healthcare districts. A partnership, for instance, offers even more flexibility to cleave apart interested parties into distinct, nonoverlapping roles. Hypothetically, a healthcare district could make individuals partners or members of the manager-managed organization. These members can then assign their rights to distributions to providers while retaining their management rights.¹⁸⁸ An analog to the public’s role in a corporation might be a limited shareholder with a subscription (accounting for tax payments as the subscribed consideration) and retained voting rights but assigned distribution rights to providers. Another possible route for potential exploration is the treatment of providers as creditors to the healthcare district, or a complex contractual (or “contractarian”) relationship that binds individuals, providers, and districts, thereby avoiding the corporate form altogether.¹⁸⁹

This futile exercise represents a microcosm of an ongoing debate in health law. Clearly, a healthcare district is not conducive to cleanly applying a preexisting public or private form, but in light of the struggle between patient and provider interests, the healthcare industry has grappled with the limits of organizational forms for decades.¹⁹⁰ This is where a public-private partnership delivers useful inspiration.

Federal and state governments have established a variety of instrumentalities that skirt the line between public entity and private business. Although the United States has traditionally shunned the kinds of government-owned corporations that are prevalent in other parts of the world,¹⁹¹ federal corporations are still prominent fixtures in American life.¹⁹² Amtrak is one such quasi-corporation,¹⁹³ as are government-sponsored enterprises like the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).¹⁹⁴ Unlike a special district, a government corporation can be “[a] self-funding, self-perpetuating, profit-making corporation [that] enjoys a degree of potential, and perpetual, independence undreamed of in most agencies.”¹⁹⁵ Some of these entities feature characteristics particularly useful for the conception of healthcare districts, such as the ability to distribute dividends and a mixed ownership structure split between a preferred-stock-holding government and common-stock-holding private investors.¹⁹⁶ While the latter opens up a world of possibilities with respect to organizing private healthcare providers in healthcare district, it simultaneously raises questions over who and what guides the district’s decision-making.

The distribution of interests and rights presents healthcare districts with a distinct principal-agent problem, or perhaps stated more accurately, a principal-agent-principal problem.¹⁹⁷ When those principals have different interests, or “heterogenous preferences,” they must reckon with coordination costs in the form of agents’ difficulty with determining the right goals.¹⁹⁸ Confronted with such agency costs, organizations generally look to legal constraints on agents and corresponding enforcement mechanisms.¹⁹⁹ This Note will next explore the bounds of a healthcare district’s director’s role in light of their principals’ heterogenous preferences, asking whether directors can simultaneously act in the best interests of both individuals and providers.

2. Fiduciary Duties of Directors and Stakeholder Health Maximization

The election of a public official often involves what political scientists call a “mandate,” or the set of policy priorities that form a candidate’s platform and which the candidate is expected to implement upon election.²⁰⁰ Elected officials are often judged by how they deliver on the promises they made to voters on the campaign trail. Should they fail, they may lose reelection or even a recall election.

The elected representatives of corporations are guided by the ubiquitous and often legally enforced commitment to “shareholder wealth maximization” or “shareholder primacy.”²⁰¹ Delivering value to shareholders is the utmost concern, and a failure to adhere to this principle could result in liability for breach of fiduciary duty.²⁰² The representatives of nonprofit corporations, on the other hand, are guided by the organization’s mission.²⁰³ Directors are generally motivated, at least in large part, by an interest in maintaining tax-exempt status and adhering to the nonprofit’s stated mission in its articles of incorporation and IRS filings.²⁰⁴

The goals of a for-profit corporation and a nonprofit organization are not difficult to discern. But what if an entity comprises both? How should a board of directors square the push and pull of seemingly competing goals?

Healthcare today is dominated by entities that, on paper, appear to be either for-profit or nonprofit, but the rapid growth of nonprofit hospitals has blurred the line between them. The lack of an explicit profit motive does not stop nonprofit hospitals from generating enormous revenue exceeding their costs—but instead of distributing the funds to shareholders, they must instead reinvest the funds.²⁰⁵ ACOs particularly struggle with the conflicts of differing business models because their provider networks may consist of a mixture of for-profit and nonprofit entities.²⁰⁶ The Healthcure System proposed here is no different.

In an era of skyrocketing healthcare costs, health law experts have begun to reevaluate organizational forms in healthcare to better accommodate missions beyond shareholder wealth maximization. The public benefit corporation is a form available in some states, and it allows corporations to augment shareholder wealth maximization and express an additional mission.²⁰⁷ The form essentially provides “cover” to directors in the event that shareholders bring a lawsuit alleging a breach of fiduciary duty for taking actions not in the interest of shareholder wealth maximization.²⁰⁸ If the directors can point to a stated mission of the public benefit corporation as the motivating factor behind a challenged action, they will be shielded from liability.²⁰⁹

A full exploration of alternative corporate forms reaches far beyond the scope of this Note, but to the extent that some bear on healthcare, it will be useful to acknowledge prior efforts to develop novel forms. Dayna B. Matthew argued for a “fiduciary medicine model” that imposes new fiduciary duties on health care organizations, such as considerations of larger systemic duties and an expansion of fiduciary law to modern health care delivery systems.²¹⁰ Terry Corbett articulated a new legal form for ACOs based on the benefit corporation form. This form, the health care benefit corporation (“HCBC”), promotes accountability through legally enforceable mission primacy that can supersede the pursuit of profits.²¹¹

Accountability measures may even be found in antitrust. Rather than combat consolidation outright, the Healthcure System brings providers together and seeks downward price pressures elsewhere. This would seem to throw antitrust enforcement mechanisms out the window, such as blocking mergers or forcing divestitures in closely competing entities, but antitrust principles may serve some use when considering the role of the board of directors.²¹² Accordingly, “conduct remedies” that pertain to the behavior of consolidated entities can protect against price increases in the absence of traditional structural remedies.²¹³ For instance, states may direct healthcare districts to set an overall expenditure growth target that can be tied to the region’s economy and enforced by the state attorney general’s office as part of its antitrust enforcement.

Ultimately, though, the Healthcure System offers its own theory on which to base director fiduciary duties: what this Note calls “stakeholder health maximization.” Intentionally analogous to shareholder wealth maximization, stakeholder health maximization would be the paramount aim of healthcare district directors and is intended to orient their decision-making toward the constant improvement of health outcomes. Every decision, at its core, must be grounded in an effort to positively impact the health of the community. Cost savings, for instance, can be justified under stakeholder health maximization because the reduction of costs allows for improved allocation of scare resources: additional funds mean more people can get more care and better care. Conversely, efforts by providers to extract higher incentive payments without a justification based on health outcomes result in waste that would otherwise fund care.

With stakeholder health maximization as its guide, a healthcare district’s board of directors can navigate the distinct interests of its stakeholders with a potentially reduced risk of conflict. It is a path forward for balancing the three pillars of cost, quality, and access, even when stakeholders might push to prioritize one pillar over the rest. That is, as long as boards remain answerable to their constituents.

Director fealty to the public is as much an open question in elections of Congress as it is in the proposed healthcare district. There is no easy answer. The Supreme Court has made it clear that there is no path for constraining the rights of business entities such as for-profit healthcare providers to engage in political speech.²¹⁴ Ultimately, representative governance requires trust in the democratic process, and while the Healthcure System certainly relies on that trust, it is bolstered by protections such as stakeholder health maximization and an incentive payment model to help ensure that patient and provider interests are aligned.²¹⁵

V. QUALITY: ALIGNING THE INCENTIVES OF PROVIDERS AND PATIENTS TO DRIVE COST-EFFECTIVE, VALUE-BASED CARE

For the purposes of this Note, quality refers to both the scope of benefits available to individuals as well as the health outcomes of those benefits. Up to this point, this Note has explored the tax-based revenue stream and novel governance model of healthcare districts, but it has yet to describe how these features translate to cost savings and outcomes improvements. The third and final piece of the Healthcure System directly addresses the misaligned incentives of the traditional fee-for-service provider reimbursement model by replacing it with a three-part outcomes-based incentive structure.

A century’s worth of refinement of the managed care model and the recent piloting of ACOs have led to a moment in which the healthcare system can finally capitalize on the cost-efficiencies of vertical integration. Doing so will require the full participation of providers in the risk and reward to counteract the adverse selection and moral hazard problems that plague the system today.²¹⁶ The Healthcure System’s approach to healthcare payment reform draws on an integrated model that has been successfully implemented in California for over seventy-five years by the nonprofit health system Kaiser Permanente (“KP”).²¹⁷

KP is made up of three separate entities linked together by exclusive contract to share financial incentives, coordinate care, and manage the health of a population. These entities—the not-for-profit Kaiser Foundation Hospitals (“KFH”), the for-profit medical groups (made up of physicians), and the not-for-profit Kaiser Foundation Health Plan (the insurance company)—share board members and leadership to seamlessly coordinate the allocation of capital between them.²¹⁸ The KP model explicitly rejects fee-for-service and its unnecessary incentive on increasing quantity of services over quality, instead using a capitated model of payment. The capitation system consists of the health plan making monthly payments of a set dollar amount calculated per enrollee, regardless of whether they seek services.²¹⁹

If this arrangement sounds familiar, it is because the KP model is one of the earliest in a long lineage of managed care models that counts ACOs and the Enthoven-inspired Health Security proposal of the 1990s as siblings.²²⁰ This Note proposes a further refinement on the model, adding the layers of electoral accountability and novel governance as previously discussed, as well as a dividend payment scheme that emphasizes the shared responsibility of health within a particular region.

Under the Healthcure System’s stakeholder health maximization model, payments to providers consist of capitated payments as well as back-end payments based on outcomes and cost savings. The capitated payments provide hospitals a lump sum per event, and the provider then bears the cost of all services rendered during the patient’s event. But incentives to keep costs as low as possible can only serve a partial role in delivering an aligned-incentives payment structure. On their own, capitated payments can incentivize “bare minimum” treatment that would fulfill a district’s essential health benefits guarantee but disincentivize a great deal of innovative, risky, or even preventive treatments. Furthermore, there will surely be instances when an individual’s course of treatment exceeds the capitated payment a provider receives. While this is a risk the system is designed to handle, the system should equally incentivize providers to go above and beyond with their treatment and reward them when successful. Accordingly, the Healthcure System includes back-end payments in two forms: (1) event-based outcomes incentive payments and (2) regional dividends based on the overall population’s health benchmarks. Event-based incentives offer payments based on each service provided to a patient. Suppose a doctor’s treatments for a patient exceed the capitated payment for a particular illness, but they successfully treat the illness. The event-based outcomes incentive makes the treatment a financially sustainable one. The incentive payments may be calculated using similar formulas to those employed by the Medicare Quality Payment Program Merit Based Incentive Payments System.²²¹ But even worthwhile treatments may not always be successful, and there are strong policy reasons for encouraging best practices on a macro scale. Regional dividends reward providers for positive health trends across a community. Such dividends can encourage providers to collaborate and promote wellness beyond their particular practice. Moreover, the state or federal government may make additional adjustment payments in certain cases, such as rural healthcare districts, low-income districts, or catastrophic regional events such as natural disasters.

The result is a multi-payer, universal access healthcare system that ensures providers’ basic costs are covered, with downward price pressure to keep those costs as low as possible, while rewarding positive health outcomes and best practices with incentive payments from healthcare districts.

VI. PRACTICAL CONCERNS OF IMPLEMENTING HEALTHCARE DISTRICTS

The Healthcure System model proposed in this Note is nothing short of a radical rethinking of the overall structure of the healthcare system. To implement it on a state or even national scale would likely mean a reform package even larger than the ACA. As such, there are a number of practical barriers that would need to be overcome for a successful transition to take place.

This Note provides a general overview of the basic structure of the Healthcure System and a broad survey of the economic, legal, and policy considerations it implicates. Additional study will yield a better understanding of its practical applications, particularly through empirical modeling of its operation in various regions. Another topic for exploration is the refinement of formulas with which to draw healthcare districts, calculate healthcare tax rates, set incentive and dividend payment rates, and determine the startup funding necessary for regions to transition into healthcare districts.

The Healthcure System involves a litany of issues of state law, further increasing the challenge of consistent deployment across the United States. One can look to the resistance of states to participate in the Medicaid expansion of the ACA as a preview of the challenge ahead.²²² Even financial support from the federal government may not be enough to convince some states to adopt the plan, especially if it is seen as a comparable expansion of coverage through a public program. A related objection is the Healthcure System’s reliance on community rating instead of an actuarial fairness approach that attempts to price healthcare based on use.

Another topic ripe for exploration is the role of Medicare and Medicaid in the model proposed here. The MSSP’s ACO program served as a jumping-off point for the Healthcure System, but the scope of this Note does not include how it might incorporate or augment Medicare or Medicaid. Further study could evaluate whether there are additional efficiencies to be found by merging the public insurance programs with the Healthcure System.

Perhaps the single most significant objection to the Healthcure System is the general resistance to a substantial disruption to the healthcare system. Voters were so concerned that the ACA would make them change their health insurance that President Obama made the promise, “If you like your health care plan, you’ll be able to keep your health care plan” a central part of his pitch.²²³ This Note’s proposal upends healthcare by design. It is an effort to stave off unsustainable increases in healthcare costs by correcting market failures that are endemic to the status quo. A possible approach to easing the transition might be a gradual implementation of healthcare districts over a period of years, offering incentives to individuals who join early before all are eventually enrolled. Of course, this presents its own host of problems, namely a selective participation problem in which the risk pool may be concentrated with higher-risk individuals. A sound implementation plan would stave off such concerns by making every effort to allow individuals to keep their doctors, thereby reducing an otherwise significant barrier to enrollment.

CONCLUSION

This Note calls its proposed model the Healthcure System because it represents a fundamental fix to some of the most pervasive economic failings of healthcare in the United States. The Healthcure System aims to create downward pressures on cost by introducing three accountability measures: (1) accountability through price-elastic demand; (2) accountability to a population of voters; and (3) accountability through the aligned interests of stakeholders in an incentive payment structure. It does so by setting forth a novel organizational form that uniquely caters to the interest of patients and providers, and guides healthcare district directors to govern in the name of stakeholder health maximization. Although it would represent a monumental reform with an undoubtedly difficult challenge of federal and state lawmaking, the Healthcure System’s regional approach to universal healthcare access and reduced costs could finally deliver broad access, low cost, and high-quality healthcare to an ailing and priced-out America.

96 S. Cal. L. Rev. 1251

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Christopher A.G. LoCascio*

* Editor-in-Chief, Southern California Law Review, Volume 96; J.D. 2023, University of Southern California Gould School of Law; B.A. Political Science and English 2014, University of California, Riverside. Thank you to Professor Ankit Shah, Professor Jonathan Barnett, the editors of the Southern California Law Review, my family, friends, and classmates for your support throughout this Note’s writing and editing process.

INTRODUCTION

I. PUBLIC NUISANCE: A BRIEF HISTORY

A. Common Law Origins in England

B. Public Nuisance in the United States

C. Public Nuisance in California

II. THE OPIOID EPIDEMIC

A. A Brief History

B. The Opioid Litigation

III. THE OPIOID EPIDEMIC IN SAN FRANCISCO

IV. OPIOID ADDICTION INTERFERES WITH PUBLIC RIGHTS

A. Opioid Addiction Interferes with Public Space

1. Opioid Addiction and Homelessness

2. Opioid Addiction and Methamphetamine Use

3. Opioid Addiction and the High Cost of Abatement

B. Opioid Addiction Interferes with Public Morals

C. Distinguishing Opioids with Other Products

D. Addressing Counter Arguments

1. Proximate Cause Objection

2. The Role of Public Policy

3. Concerns About a Flood of Litigation

CONCLUSION

97 S. Cal. L. Rev. 767

INTRODUCTION

I. BACKGROUND

A. Government Funding and Tax-Exempt Status for Private Religious Colleges

B. Title IX and the Religious Exemption

1. “Controlled by a Religious Organization”

2. Conflict Between “Religious Tenets” and Title IX

II. ARGUMENT AND ANALYSIS

CONCLUSION

97 S. Cal. L. Rev. 737

97 S. Cal. L. Rev. 537

INTRODUCTION

97 S. Cal. L. Rev. 495

INTRODUCTION

I. MODERN LAW OF JUDICIAL PEREMPTORY DISQUALIFICATION

A. Federal Law

B. California Law

1. California Code of Civil Procedure Section 170.6

2. Judicial Rules

3. Comparison to Peremptory Juror Challenges

C. Comparison Between California Law and Other States’ Law

II. THE POLICY TRADE-OFFS

A. Public Confidence in the Judiciary

B. Abuse of the Challenge

C. Intimidation of Judges

D. Discrimination Against Judges

III. EMPIRICAL FINDINGS IN CALIFORNIA

A. Research Methodology

B. Preliminary Empirical Data

IV. ALTERNATIVES TO CALIFORNIA’S JUDICIAL PEREMPTORY CHALLENGE

A. Existing Alternative Procedures

1. The Panel-Exclusion Approach

2. The Interlocutory Appeal Approach

3. The Independent Judge Approach

B. The Proposed Alternative Procedure

V. RECOMMENDATIONS FOR FUTURE RESEARCH

CONCLUSION

97 S. Cal. L. Rev. 253

INTRODUCTION

I. CONSTITUTIONAL LIMITATIONS OF GUN CONTROL

A. The Trilogy of Modern Second Amendment Jurisprudence

1. The Necessity of an Individual Right

2. The Pre-Existence Doctrine: Finding the Individual Right in Text and History

3. Market Share as Constitutionality: The Common Use Doctrine

4. Incorporation

5. The Third Act: Applying Heller to Public Carry Licensing

B. Summary of Second Amendment Precedent

II. SOUTH AFRICA’S GUN CONTROL SYSTEM

III. THE MODEL FIREARMS CONTROL ACT

A. Chapter 1: Definitions, License Requirement, Eligibility Certificate

B. Chapter 2: Types of Licenses and Use of Firearms

C. Chapter 3: Use and Transportation of Firearms

IV. CONSTITUTIONALITY

A. “Longstanding Prohibitions”

1. Prohibition on Firearm Possession by Felons

2. Prohibiting Firearm Possession for Certain Non-Felonies

B. Regulation of Different Classes of Arms

1. Purpose-Based Licensing

2. High-Capacity Magazines and Semi-Automatic Rifles