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SCHOOL

OF LAW

LEGAL STUDIES RESEARCH PAPER SERIES PAPER #08-00136

MAY 2008

Business Ethics: Law As A Determinant Of

Business Conduct

VINCENT DI LORENZO

EMAIL COMMENTS TO: [email protected]

ST. JOHN’S UNIVERSITY SCHOOL OF LAW 8000 UTOPIA PARKWAY

QUEENS, NY 11439

This paper can be downloaded without charge at: The Social Science Research Network Electronic Paper Collection

http://ssrn.com/abstract=1134034

Business Ethics: Law As A Determinant

of Business Conduct Vincent Di Lorenzo

ABSTRACT. The Principles of Corporate Governance

require that business conduct conform to the law. In

recent years, news reports of business misconduct have

cast doubt on a conclusion that conformity is the

prevalent practice. This article explores the influence of

law on business conduct by comparing the law’s

requirements and purposes with actual business conduct

in the market. Specifically, it explores whether certain

legal regimes are more effective than others in inducing

greater commitment to legal compliance by corporate

actors. The conclusion drawn is that the prevalent legal

regime – a vague common law or legislative mandate –

is typically associated with corporate conduct that

evades or ignores the law’s mandate or its underlying

purpose.

KEY WORDS: corporate behavior, Corporate Gover-

nance, ethical obligation to comply with law, legal

compliance, Organizational Theory

There is quite clearly no difficulty in explaining why

we are to comply with just laws enacted under a just

constitution. In this case the principles of natural

duty and the principle of fairness establish the req-

uisite duties and obligations.1

Introduction

Are corporations committed to compliance with the

law? Last year marked the tenth anniversary of the

release of the American Law Institute’s Principles of

Corporate Governance.2 The Principles of Corporate

Governance demand a corporate commitment to

compliance with law. The obligation exists even

when corporate profits are not maximized. Thus, the

Principles embrace Rawls’ view of legal obligations.

Do these Principles realistically reflect corporate

activity in the market?

Doubt regarding corporate commitment to

ethical obligations has always existed, particularly

when maximization of profits might be at risk.

However, despite such doubt two views have

singled hope. First, a view has persisted that cor-

porations at least feel compelled to comply with

law. At times violations of law might occur.

However, this was not thought to be the pattern

of behavior for corporations generally. Conscious

violation of law was not the behavior expected.

Second, a view has begun to be echoed that

business corporations are increasingly cognizant of

ethical obligations beyond literal compliance with

law, and increasingly feel compelled to act

accordingly.

This article tests these viewpoints by examining

evidence of actual market conduct. Two questions

are explored: (a) whether corporate conduct dem-

onstrates a commitment to legal compliance,

including a commitment to the law’s underlying

purpose, even when corporate profits are not max-

imized, and (b) whether different legal regimes in-

duce greater commitment to legal compliance. First,

the trappings of commitment to ethical conduct are

examined – e.g., corporate polices and administra-

tive structures. Second, corporate activities in the

market are examined. Four industries and their

Vincent Di Lorenzo is Professor of Law; Senior Fellow, Vin-

centian Center for Church and Society, St. John’s Uni-

versity; J.D. Columbia University (Harlan Fiske Stone

Scholar); Associate Articles Editor, Columbia Journal of Law

and Social Problems. Before joining the faculty at St. John’s

University School of Law, Professor Di Lorenzo was a

member of the faculty at The Wharton School, University of

Pennsylvania, and was associated with a major Wall Street

firm practicing in the real estate-banking department. He is a

member of the American Bar Association and the New York

State Bar Association. Professor Di Lorenzo has authored

many articles and books in the banking, legislation and real

estate areas.

Journal of Business Ethics (2007) 71:275–299 � Springer 2006DOI 10.1007/s10551-006-9139-9

activities in recent years serve as case studies: the

securities industry, the automobile industry, the

pharmaceutical industry, and the mortgage banking

industry. The key finding of this study of corporate

conduct is that corporations are not committed to a

broad ethical obligation to comply with the law

including an obligation to serve the law’s purpose.

Legal mandates are narrowly construed and sought

to be evaded. Underlying public policies are typi-

cally ignored.

Part one – Perspectives on the influence

of law on business conduct

The principles of corporate goverance: Law

as a determinative factor

The American Law Institute’s Principles of Corporate

Governance, released in 1994, summarized, among

other things, the expectations regarding corporate

compliance with law. The Principles reflect the ‘‘...

common understanding of the key legal relationships

in the corporations ...’’3 Section 2.01 of the Principles

of Corporate Governance begin with the view that a

corporation’s primary objective is to enhance cor-

porate profit and shareholder gain. However, the

corporation is obliged to act within the boundaries set

by law even if corporate profit and shareholder gain

are not enhanced.4

The American Law Institute embraced the posi-

tion that the obligation to comply with law is not a

limited duty of literal compliance but should take

into consideration the purposes behind the laws in

question. It explained:

...the corporation, like all other citizens, is under an

obligation to act within the boundaries set by law. In

determining these boundaries the corporation should

not rest simply on past precedents or an unduly literal

reading of statutes and regulations, but should give

weight to all the considerations that the courts would

deem proper to take into account in their determi-

nations, including relevant principles, policies, and

legislative purposes.5

This is an ethical viewpoint that rejects very narrow

interpretations of legal requirements and therefore

rejects attempts to evade legal requirements. In cases

of uncertainty, conduct consistent with the law’s

purpose is the proper standard against which to judge

ethical conduct.

Organizational theory and corporate decisions

Studies have found that various influences play a role

in corporate decisions regarding corporate compli-

ance with law – influences in addition to the legal

mandate or the sanction imposed for violation.6 The

studies have called into question the influence of the

severity of sanctions on legal compliance,7 and

whether the perceived obligation to comply with a

legal mandate is the most important factor deter-

mining corporate conduct.8

Recognition that non-legal factors play an

important role in influencing corporate decisions,

has led some commentators to conclude that law is

unnecessary to induce ethical business conduct.9

However, the deficiency in this conclusion is that it

is an untested hypothesis. This article explores this

issue as well.

Theoretically, legal mandates can control out-

comes if corporations are broadly committed to

compliance with law, including the law’s underlying

purpose. In such a scenario, the legal mandate would

override all other influences on corporate behavior.

This is the assumption in the Principles of Corporate

Governance. This article examines recent corporate

conduct to test this assumption, and to examine

whether the type of legal mandate imposed makes a

difference.

Part two – A market-based study

of corporate conduct

Outward signs of corporate embrace of ethical duties

In recent years, signs of corporate commitment to

ethical obligations beyond literal compliance with

law have surfaced. This has generated hope that

this is emerging as a prevalent standard of conduct

for corporations. The view that corporations are

increasing cognizant of their ethical obligations,

beyond literal compliance with law, is fueled

by surveys of corporate executives and adminis-

trative activity within the corporations. Thus,

the American Management Association’s 2003

Corporate Governance Survey found that in 92%

276 Vincent Di Lorenzo

of publicly traded companies and 67% of privately

held companies the CEO had communicated a

commitment to ethical behavior in the last year

(i.e., since passage of the Sarbanes–Oxley Act of

2002).10. An earlier survey of board of directors’

involvement in creating ethical standards for their

corporations found that such involvement has in-

creased dramatically between 1987 and 1999.11

Finally, the 2003 U.S. Chamber of Commerce

survey of its members, conducted by the Center

for Corporate Citizenship at Boston College, found

that operating with ethical business practices was

cited as ‘‘very important’’ by 87% of respondents

and ‘‘important’’ by an additional 11%.12

Evidence of corporate, administrative action

confirming an increasing recognition of ethical

obligations is also found in the creation of the

position of ethics officer in many corporations.

The Ethics Officer Association member survey,

last conducted in 2000, found only 4% of positions

created before 1986 and more than half created

between 1996 and 1999.13 Moreover, the impor-

tance of various motivations for creating the

positions has changed over time. The percentage

of respondents that cited either meeting best

practices standards or industry trends as a factor

having ‘‘a lot of influence’’ increased 10% and 9%,

respectively, between 1997 and 2000. Yet, the

percentage of respondents that cited either a

government investigation or improving the orga-

nization’s public image as a factor having ‘‘a lot of

influence’’ decreased 11% and 10%, respectively,

between 1997 and 2000.14

Yet, the viewpoint that mainstream corporations

are increasingly cognizant of their ethical obliga-

tions is not universally shared. A contrary view is

that corporate actions may not be consistent with

verbal commitments or administrative appearances

of commitment. A survey of ethics, human re-

sources and legal officers participating in the

Conference Board’s 2003 Ethics Conference found

that fewer than 8% of respondents reported that

companies fire ‘‘great performers’’ who do not live

up to their companies’ values, while nearly 5% of

respondents reported companies promote them,

more than 25% coach them and 22% tolerate

them.15 This article tests these competing view-

points by examining corporate actions in the

marketplace.

Corporate activities in the marketplace

This article examines whether corporate actions in

the market evidence commitment to the law,

including commitment to the law’s underlying

purpose. It also examines whether such commitment

varies depending upon the nature of the legal regime

to which a corporation is subject. Three types of

legal regimes are studied: (a) a vague mandate,

imposed at common law or in legislation, (b) a dis-

closure regime, and (c) a clear mandate, stipulating a

required course of action.

Studied below are the activities of corporations in

four sectors of the U.S. economy – the securities

industry, the automobile industry, pharmaceutical

industry, and the mortgage banking industry.

Industry activities are examined to ascertain corpo-

rate adherence to the letter of the law and its

underlying purpose. The types of legal regimes and

industries studied are:

I began my study by examining recent transgres-

sions of ethical conduct by corporate actors reported

in the news media. Various industries presented

themselves as examples of transgression by many, if

not most, members of the industry, as opposed to

isolated transgressions by one corporation in the

industry. Four of these industries are examined

below. This is admittedly a sample composed of

transgressors. Thus, it does not necessarily provide

Type of legal

regime

Case study

A vague legal

standard

Securities industry case study –

Disclosure of investment risks

Automobile industry case study –

Products liability standard

Pharmaceutical industry case study –

Disclosure of product risks

A disclosure

regime


Government disclosure of risks

A clear legal

standard


Proposed NHTSA regulations

Mortgage banking industry case study

– Stipulated disclosures under

TILA and RESPA, and

– Prohibited activities under

HOEPA

Law As A Determinant of Business Conduct 277

data on how pervasive the problem is among all

corporations. Nonetheless, these are major industries

in the U.S. economy. In each of the four industries

studied, unethical practices occurred among many if

not most of the members of the industry, and the

unethical conduct often took place in a variety of

different types of business transactions in which

industry members were engaged.

In addition there are additional major industries

that similarly were found to engage in unethical

business practices that are not among the four case

studies contained in this article. The insurance

industry is an example. Members of the industry

have settled or are in settlement negotiations over

charges of writing financial contracts to assist other

corporations manipulate earnings and therefore

mislead investors,16 and racial discrimination via

overcharges in the sale of burial insurance policies.17

In addition many insurance companies are under

investigation for sales practices that cheated cus-

tomers out of the best prices for their insurance

policies.18 The commercial banking industry has

settled charges that it aided and abetted fraud by

other corporations such as Enron.19 Major retailers

and service industry members, such as Wal Mart,

face evidence of violations of state labor laws and

child–labor laws.20 The major tobacco companies

have settled accusations or have been found to have

violated their 1998 Master Settlement Agreement

that prohibited advertising that targets minors.21

Finally, numerous corporations in different indus-

tries have settled allegations of fraud through

manipulation of earnings or questionable accounting

practices.22 There are other, similar examples of

transgressions of law reported in the news media.

Thus, the case studies in this article shed light on the

question of whether corporate actors are generally

committed to compliance with legal mandates.

Behavior of corporate actions is explored in varied

contexts. The securities, pharmaceutical and mort-

gage banking industry case studies examine corpo-

rate behavior that harms individuals financially. The

automobile and pharmaceutical industry case studies

examine corporate behavior that harms individuals

physically. In addition, the case studies explore

whether law’s influence on corporate behavior varies

based on the type of legal regime imposed. Three

types of legal regimes are examined: (a) a vague legal

mandate, either in the form of a common law

mandate or a legislative mandate, (b) a disclosure

regime, composed of a disclosure of risks, and (c) a

clear legal mandate, namely one that stipulates the

required response of the corporate actor. Some legal

mandates call for disclosure but the type of disclo-

sures to be made and the circumstances in which

disclosure is required are not clear – i.e., the legal

mandate consists of a vague standard. These are

examined as part of corporate actions in light of a

vague duty, rather than corporate actions in response

to a disclosure obligation. By contrast, the disclosure

regime is one in which disclosure has been made. In

the automobile case study the disclosure is by gov-

ernment and consists of risk of rollovers. The case

study in this regime then examines corporate com-

mitment to other legal obligations, e.g., tort obli-

gations, when faced with such disclosures of risks.

Case study 123 – The securities industry

There are many unethical business practices that

have come to light in the securities industry in recent

years. These include illegal allocation of shares in

initial public offerings,24 trading abuses by mutual

fund companies,25 lack of due diligence by under-

writers leading to defrauding of investors,26 illegal

practices in sales of variable annuities including

market timing, violation of suitability rules, and

inadequate disclosure,27 and sex discrimination.28

This article focuses on misleading reports issued by

securities analysts.

The challenge

Securities analysts evaluate securities and estimate

their value as investments for potential investors.

They collect and review information about the

corporations that they are evaluating including

information found in company documents filed with

the SEC, materials sent to shareholders, trade pub-

lications, and information obtained in interviews

with company officers and employees and visits to

company sites.29 So-called sell-side analysts are

generally employed by brokerage firms and produce

reports and buy–sell recommendations for the firm’s

customers and other investors. The reports include

predictions of future earnings.30

The investors that might rely on the reports and

recommendations are not typically sophisticated


investment entities that regularly trade in securities,

such as mutual funds, hedge funds, insurance com-

panies, or retirement funds. Rather such entities

employ their own, so-called buy-side analysts who

generate reports solely for their employers and not

for the general public.31 In recent decades more and

more individuals have embraced the securities mar-

ket as a vehicle for channeling their savings and

other financial assets.32 Thus, individual investors

and, in many cases, unsophisticated individual

investors are increasingly the recipients of analysts’

reports and recommendations.

Analysts face conflicts of interest on several fronts.

First, they are employed by securities firms and

analysts’ recommendations generate brokerage

commission revenues for their employers.33 In a

related vein, the securities firms typically engage in

the investment banking business as well. Securities

analysts help to develop and maintain relationships

with investment banking clients of the firm, and

therefore generate investment banking fees for their

employers.34 Examples of the conflict of interest

faced by research analysts is provided by the New

York State and SEC investigations of industry

practices. At Merrill Lynch, the head of equity

research solicited information from analysts on their

involvement in investment banking so that their

compensation could be calculated. He said:

We are once against surveying your contributions to

investment banking during the year ... please complete

details on your involvement in the transaction, paying

particular attention to the degree your research cov-

erage played a role in origination, execution and fol-

low-up. Please note as well, your involvement in

advisory work on mergers or acquisitions, especially

where your coverage played a role in securing the

assignment and you made follow up marketing calls to

clients. Please indicate where your research coverage

was pivotal in securing participation in high yield

offerings.35

Similarly, at Morgan Stanley, research analysts were

compensated, in part, based on the degree to which

they helped to generate investment banking business

for the firm. In their annual performance evaluation,

analysts were asked to submit self-evaluations that

often included their involvement in investment

banking, including a description of specific transac-

tions and the fees generated. One analyst’s evaluation

stated ‘‘Bottom line, my highest and best use is to help

[Morgan Stanley] win the best Internet IPO mandates

....’’36

Second, analysts are paid by their employers

based, in large part, on their ability to generate

investment banking business and their reputation

among investors, as reflected in annual Institutional

Investor rankings.37 Curiously, stock picking and

earnings forecast ratings of analysts do not weigh

heavily in these rankings.38

Third, analysts, their employers, and other

employees of the firm commonly have ownership

interest in the companies that the analysts are cov-

ering.39 Thus, given these conflicts of interest, the

challenge is to issue fair, accurate research reports

and recommendations. From the standpoint of

assessing ethical behavior, in some cases inaccurate

reports and recommendations can violate legal pro-

hibitions aimed at protecting investors against

fraudulent practices.

The legal environment

As described below, members of the securities

industry have settled charges of violations of state

antifraud statutes, rules of the New York Stock

Exchange (NYSE) and National Association of

Securities Dealers (NASD), as well as violations of

the federal securities laws. This article examines the

federal securities law as the governing legal regime.

The regime consists of a vague statutory standard. In

that sense the legal regime is not different in form

than the state law40 and the rules of NASD and

NYSE41 that are alleged to be violated and are also

vague legal standards.

The governing statutory standard is found in the

antifraud provisions of the federal securities law. The

settlements reached were based on section 15(c) of the

Securities and Exchange Act of 1934, because the

particular securities in question were traded over-the-

counter. However, section 10(b) of the Act could

have been invoked for securities other than those

traded over-the-counter.42 These statutes prohibit

‘‘... any manipulative, deceptive or other fraudulent

device or contrivance’’ to induce or attempt to induce

the purchase or sale of any security.43


The purpose behind these antifraud provisions is

to protect the average investor against overreaching.

As one leading commentator has explained:

The antifraud provisions are part of a statutory scheme

that resulted from a finding that securities are ‘‘intri-

cate merchandise’’ and a congressional determination

that the public interest demanded legislation that

would recognize the gross inequality of bargaining

power between the professional securities firm and the

average investor. ‘‘The essential objective of securities

legislation is to protect those who do not know

market conditions from the overreachings of those

who do.’’44

In a similar vein, the courts have explained that:

A fundamental purpose, common to these [federal

securities] statutes, was to substitute a philosophy of

full disclosure for the philosophy of caveat emptor and

thus to achieve a high standard of business ethics in the

securities industry.’’45

Thus, the ethical obligation to act in accordance

with the purpose behind the governing law would

require a commitment on the part of securities firms

to insure fair, accurate reports and recommenda-

tions on the part of securities analysts. Did the

securities industry’s actions reflect commitment to

compliance with the law, including its underlying

purpose?

The industry response

Through the late 1990s and thereafter the industry’s

response was to ignore the proscription against

deceptive statements and practices and instead boost

investment banking and brokerage earnings by

overstating predictions of corporate earnings,46 and

maintaining strong ‘‘buy’’ recommendations47 for

stocks despite analysts’ privately held views that the

recommendations were not justified. Also, the

response was frequently to boost personal fortunes

by issuing rosy forecasts for stocks in which the

analyst, the analyst’s employer, or other employees

had an equity stake that they could sell after a lock-

up period.48

Charges alleging such activities have been

brought and have been settled against 12 securities

firms.49 The practices uncovered have been char-

acterized as widespread and continuing for many

years as an industry practice.50 Some examples

illustrate the industry viewpoint that increased

profits was more important than a commitment to

fair and accurate reports and recommendations by

analysts.

At Merrill Lynch, analysts provided Infospace,

Inc. with the firm’s highest rating, but privately the

analysts labeled Infospace ‘‘a powder keg’’ and a

‘‘piece of junk.’’51 Similarly, Merrill Lynch was

urging customers to buy Lifeminders, Inc., while

Merrill Lynch analysts were privately referring to the

company ‘‘... as a ‘p.o.s.’. Let [us] simply say that

p.o.s. is a euphemism for an extremely poor

investment.’’52 At UBS Warburg, positive recom-

mendations were issued by an analyst on Interspeed,

which was one of the firm’s investment banking

clients, but privately the analyst stated that the stock

should be shorted.53 At Salomon Smith Barney,

analyst Grubman reiterated a ‘‘buy’’ recommenda-

tion in February 2001 on Focal, an investment

banking client, and a target price of $30 (twice the

stock price). The same day an institutional investor

e-mailed a research analyst who worked for Grub-

man ‘‘McLeod [McLeod U.S.A Inc.] and Focal are

pigs aren’t they?’’ and asked whether Focal was a

short. The analyst responded, ‘‘Focal definitely ...’’.

In April 2001 Grubman stated privately the need to

downgrade Focal, but nevertheless once again

advised investors to buy Focal.54 At Credit Suisse,

Digital Impact received a ‘‘buy’’ or ‘‘strong buy’’

rating from January 2000 to April 2001, even while

the stock price declined from $50 to less than $2. In

May–September 2001 a new analyst stated privately

he wanted to drop coverage on the company be-

cause of its difficult market environment. However,

he did not drop coverage due to pressure from

investment bankers, and left the buy rating

unchanged until October 2001.55 At Bear Stearns,

Micromuse, Inc. received a ‘‘buy’’ rating while an

analyst of the firm privately characterized the stock

as ‘‘dead money.’’56 At Lehman Brothers an analyst

who covered RSL Communications, Inc. stated

privately ‘‘I have attempted to downgrade RSLC

THREE times over the last year, but have been held

off for banking reasons each time.’’57 At Deutsche

Bank Securities an analyst issued positive recom-

mendations on Oracle, but privately expressed the

view to a large institutional investor that the stock

should be sold. Similarly, an analyst issued a ‘‘market


perform’’ rating on Eprise Corporation while pri-

vately referring to the company as ‘‘permanent

toast.’’58

The persistence of an industry-wide culture of

ignoring the federal antifraud law’s underlying pur-

pose is witnessed in reactions and responses to the

global settlement reached with the SEC. Statements

made soon after the settlement were to the effect

that the securities firms had done nothing that

should be of concern to their clients.59 This reaction

received a rebuke from the SEC.

Similarly, actions taken soon after the settlement

also evidence a culture of ignoring the law’s purposes,

and perhaps its literal requirements. The settlement

prohibited analysts from engaging in marketing or

selling efforts to investors with respect to investment

banking transactions. Yet, Bear Stearns distributed to

clients an Internet ‘‘roadshow’’ broadcast in which

one of its senior analysts glowingly touted iPayment

Inc., a company Bear Stearns was taking public. In

addition Bear Stearns, Citigroup, and other invest-

ment banks distributed analysts’ revenue and earnings

estimates for companies whose initial public offerings

they were underwriting.60 In the latter case, the firms

claimed analysts could, under the settlement, prepare

internal use memoranda and participate in efforts to

educate the sales force. Yet, the reports were being

distributed to investors, and the settlement also stated

that firms could not do indirectly what they are barred

from doing directly.61

Conclusion

A vague statutory standard was not determinative of

analyst conduct in the securities industry. The pur-

pose behind the legal standard was ignored and, at

times, the legal standard itself was violated by many

members of the industry.

Case study 2 – The automobile industry

This article focuses on the dangers posed by the

automobile industry’s design of sport utility vehicles

(SUVs), in particular the deaths and injuries resulting

from rollovers and the incompatibility of SUVs and

passenger automobiles. This is not the only unethical

business practices reported in the automobile

industry in recent years. Consumer finance affiliates

of automobile manufacturers, for example, have

been charged and some have settled suits alleging

racial bias.62 They have also settled claims of fraud-

ulent overcharges imposed on consumers in auto-

mobile leasing programs.63

The challenge in the automobile industry

Recent Congressional hearings, the announcement

of new federal rollover tests, and the first voluntary

industry-wide efforts to address safety concerns have

highlighted the concern with the danger to passen-

gers posed by SUVs and light-trucks. Two concerns

exist – the danger posed by rollovers and the dangers

posed by incompatibility of design.

Rollovers result in about 10,000 deaths and

31,000 serious injuries in the U.S. each year.64 This

has occurred largely in SUVs and other light-trucks

because they are much more likely than passenger

cars to roll over. In 2002, 61% of fatalities among

SUV occupants and 45% in pickups were due to

rollovers, compared with 23% in automobiles.65

Indeed, mid-size SUVs are nine times as likely as

passenger cars to be involved in fatal rollover cra-

shes.66

SUVs and other light-trucks are also more likely to

kill or injure occupants of automobiles when the two

are involved in an accident. This is referred to as the

compability issue. Mid-size SUVs are twice as likely to

kill the occupants of other vehicles in head-on cra-

shes,67 and light-trucks are three times as likely to kill

the occupants of other vehicles.68 Such rates increase

dramatically when SUVs or light-trucks strike the side

of an automobile. When an SUV strikes the side of an

automobile the likelihood of fatality in the car is three

times what it would be if struck by another automo-

bile, and five times what it would be when struck by a

pickup.69


The automobile industry’s response to the issue of

rollovers and incompatibility has occurred in a legal

environment. That environment has changed in re-

cent years, allowing study of the industry’s response in

three legal regimes. The first legal regime was one

characterized by a vague common law mandate. The

legal environment prior to adoption of the TREAD

Act in 200070 contained no legislative or administra-

tive mandate. Automobile manufacturers were not

required by legislation or administrative regulation

to address the rollover or the compability issue.71


However, one legal mandate that did exist was found

at common law, namely products liability law. This

was a vague legal mandate. Liability would be imposed

only if a product was ‘‘defectively designed’’ or

‘‘unreasonably dangerous.’’72 This standard was ap-

plied by the courts so as to require either (a) that the

danger is beyond that contemplated by the ordinary

consumer who purchases the product,73 or (b) that an

alternative design would have made the product sig-

nificantly safer without prohibitive cost increases or

substantial lost utility.74

The purpose behind this products liability stan-

dard speaks of a concern regarding injuries to the

general public. The manufacturer ‘‘... by marketing

his product for use and consumption, has undertaken

and assumed a special responsibility toward any

member of the consuming public who may be

injured by it... [T]he consumer of such products is

entitled to the maximum of protection at the hands

of someone, and the proper person to afford it are

those who market the products.’’75

The TREAD Act altered the legal environment

on the rollover issue. It required development of

rollover tests by November 2002 and disclosure by

the government of the results of such tests.76 Thus,

the second legal environment was governmental

disclosure identifying risky products. The disclosure

was in a published list of vehicles with rollover rat-

ings, available on-line or from the National High-

way Traffic Safety Administration (NHTSA). It was

not accomplished via a sticker affixed to models in a

showroom.77 As a result, it is not certain how aware

consumers were of the rating for particular vehicles

they were considering purchasing. The TREAD Act

did not alter the legal environment on the compat-

ibility issue.

The legal environment was altered once again in

2003, although the alteration was only a proposed

one. In July 2002, the NHTSA began to study

mandatory regulations to be imposed on the auto

industry to address the rollover and compatibility

issue.78 It issued its final rulemaking priorities plan in

July 2003.79 The NHTSA planning document dis-

cussed both rollover and compatibility issues, among

other regulatory priorities. In its chronological listing

of regulatory ‘‘milestones’’ to address the rollover

issue it listed ejection mitigation and door upgrades

as priorities in the 2003–2004 period, and roof

crush protection requirements as a priority in the

2004–2005 period. Stability control systems were

also discussed but NHTSA stated that further

research was needed regarding which systems

achieved the highest benefits and were most effec-

tive. To address the compatibility issue, it listed side

impact protection and other vehicle crashworthiness

compatibility rulemaking efforts, including rigid

barrier and vehicle-to-vehicle testing, as regulatory

priorities in the 2004–2005 period.80 In other

words, there was a threat of a legal environment

characterized by mandatory and clear regulatory

obligations that would be consistently applied to all

manufacturers.

In summary, the automobile industry’s actions

occurred in the context of the following legal

regimes:

The industry response under a vague common law mandate

Given the purpose behind the common law’s man-

date – to offer the maximum of protection against

physical injury – the ethical response of the auto

industry would have been to make design changes

aimed at minimizing injuries and deaths. Yet, this

has not been the response of the automobile indus-

try. Instead the response has been denial – denial that

a safety problem exists, and if it does exist then denial

of responsibility. In the first legal environment – i.e.,

a vague common law mandate-the initial and long-

standing response of the auto industry was to do

nothing. Instead, the industry denied that a problem

exists.81 It denied the problem, if it existed, could be

• The SUV rollover issue:

Pre-2000 Vague common

law mandate

TREAD Act of 2000 Government disclosure

of risks of rollovers

2003 regulations NHTSA

(Proposed, with stability

controls subject to

further study)

Possible, future clear

legal mandate

• The SUV-passenger

automobile

compatibility issue:

Pre-2003 Vague common

law mandate

2003 Regulations

NHTSA (Proposed)

Likely, future clear

legal mandate


alleviated by the industry.82 Finally, it shifted

responsibility and blame to the consumer.83

In sum, the industry response has been inaction

and denial, including denial of responsibility. Under

the vague common law standard auto manufacturers

could always claim that they were complying with

their legal obligation because the vague standard was

not breached. This would be a very narrow inter-

pretation of the duty of legal compliance. This

response occurred in an environment. It occurred in

a business environment in which sales of SUVs and

light trucks accounted for an increasing percent of

market share for U.S. automakers and became their

most profitable products.84

One exception to the typical denial response was

Ford Motor Company, at least in recent years. In

February 2001 Ford rolled out its redesigned 2002

Explorer. Ford widened the distance between the

wheels, added independent rear suspension, and

added ceiling-mounted side air bags that enhanced

its safety.85 Yet, Ford, unlike other automakers, was

not reacting to a legal environment characterized by

a vague legal obligation that subjected it only to

potential liability. Rather it faced and was attempting

to settle about 200 product liability cases involving

rollovers by Ford Explorers after Firestone tires

failed.86 In other words, it faced not merely the

potential but the reality of hundreds of lawsuits each

claiming tens of millions of dollars in damages. Even

in this environment, the changes were not made on

all other SUVs manufactured by Ford. Indeed, the

changes were not even made on all models of Ford

Explorer. They were made only on the four-door

Explorer and not on the more dangerous two-door

Explorer.87 Two years later, the Ford Explorer Sport

Trac had the highest rollover risk of models tested by

the NHTSA for the 2004 model year, and the four-

door Explorer ranked among the five worst per-

forming SUVs tested based on rollover risk.88

Finally, corporate response even when faced with

hundreds of consumer lawsuits has not been wit-

nessed consistently. Some years earlier Ford decided

to make no design changes when faced with hun-

dreds of lawsuits due to the design of the Ford

Bronco.89

The response of the industry was different with

regard to the compability issue. Before 2003, com-

pability continued to be subject to a vague legal

mandate. Yet, in 2000 manufacturers made some

response. The response was primarily to lower the

steel rails on some models, namely three of the 2000

models and six of the 2001–2002 models.90

This was a response. However, it was a very

limited response. The compability issue arises due to

three problems: (a) difference in weight between the

vehicles in a crash, (b) difference in alignment of

bumpers and protective barriers, and (c) greater

stiffness of SUVs and light-trucks. The announced

changes addressed one of the three compability

concerns.91 Moreover, even on the one concern

addressed the changes were made to a small number

of the SUVs and light-trucks sold by the respective

manufacturers.92

Overall then, in the face of a vague legal mandate

the industry made no response for two decades, and

finally a very limited response beginning in 2000.

Industry response under a disclosure regime

In the second legal environment – disclosure of risks

of rollover in identified products – the response was

more varied. One response was to continue to deny

the problem and to deny responsibility.93 At the

same time, another response of some auto manufac-

turers was to make technology available to avoid

rollovers as a customer option.94 This response cost

the manufacturer nothing–nothing in lost profit

margin, since the option was paid for by the cus-

tomer, and nothing in price competitiveness since

comparison would be based on the initial sticker

price. A final response was to design new SUV

models that were able to muster a seemingly

‘‘acceptable’’ rollover rating. Manufacturers rarely

changed existing models, which would be more

costly. Rather, the improvements were made to new

models. Evidence of this response is found in the

published rollover ratings for model years 2001 and

2003. An analysis of such data reveals the following:

Rollover ratings one star to five star95

Number of SUVs

in 2001 ratings

Number of SUVs

in 2003 rating

One star 2 (3.3%) 2 (1.98%)

Two stars 25 (41.6%) 23 (22.77%)

Three stars 32 (53.3%) 71 (70.29%)

Four stars 1 (1.6%) 5 (4.95%)

Five stars 0 (0%) 0 (0%)


The increased number of vehicles rated three stars

were almost exclusively new models.96 Moreover,

these results for SUVs contrast with rollover ratings

for heavy passenger cars and medium passenger cars

in 2001 and 2003. All such rated vehicles received a

rating of either four or five stars.97 The rollover

ratings for the 2005 model year continued this trend.

By 2005 two SUVs continued to be rated one star in

rollover ratings, and 23 continued to earn two stars.

However, there were now 24 that earned four stars

in the NHSTAs 2005 rollover ratings.98

In summary when the legal environment was

changed to include clear disclosure of rollover risks

that were specific to a particular manufacturer and

model, greater response was witnessed than in the

earlier, vague common law regime. However, the

response was still modest. Manufacturers did not

comprehensively address the rollover issue by

modifying existing models or seek four or five star

ratings for most SUV models.

Industry response to the threat of a clear stipulated

government mandate

In the final legal environment – the threat of clear

and mandatory regulatory obligations to address

incompatibility issues – the industry responded

quickly and more comprehensively. In February

2003 automakers announced creation of two

working groups to address the dangers posed by the

compatibility issue – one to minimize risks in head-

on collisions and the other to minimize risks in side-

impact collisions.99 This took place approximately

6 months after the government had first proposed its

rulemaking priorities plan.100 Before the end of the

year the auto manufacturers had already announced a

specific plan to reduce the dangers posed by

incompatibility by redesigning vehicles to reduce the

likelihood SUVs would override front bumpers of

automobiles and requiring all auto makers to make

side air bags standard on all vehicles by 2009.101 In

this legal regime the response was quick and far more

comprehensive than occurred under the earlier legal

regime.102 Later events revealed that the threat of

government regulation was a real threat. In May,

2004 the NHTSA proposed rules to upgrade the

agency’s side impact protection standard that would

likely require side head protection systems such as

head air bags or inflatable air curtains.103

Initially, the industry’s commitment was limited

to responding to the danger posed by the compati-

bility issue. The industry was slower to respond in a

comprehensive manner to the danger posed by the

rollover issue. The 2003 industry-wide commitment

did not address the rollover issue. Instead individual

industry members in recent years began to offer anti-

rollover systems as a standard feature on luxury

models, and as a customer option on some but not all

other models.104 However, the industry’s commit-

ment increased significantly in the 2005 and 2006

model year.105 This slower response can be

explained as a reaction to regulatory priorities.

Compatibility was a higher regulatory priority, as

evidenced by the NHTSA’s 2002 Statement on

Rulemaking Priorities and May 2004 proposed rule

on side impact protection. Addressing rollover

through stability control systems was a lower regu-

latory priority. Eventually, the industry has

responded to both.

Case study 3 – The pharmaceutical industry

This article focuses on charges of deceptive and

misleading direct to consumer advertising of pre-

scription drugs. This is not the only allegation of

unethical business practices on the part of the

pharmaceutical industry in recent years. The phar-

maceutical industry has been charged, and settled

some suits, for promoting prescription drugs for

unapproved uses,106 which is a crime under the

Food, Drug, and Consumer Act.107 It has also faced

suits by private parties and State Attorneys General

for hiding the health risks posed by highly profitable

drugs.108 The industry faces suits by consumer

groups, state, local, and federal authorities charging

that many members of the industry illegally manip-

ulated the Medicare and Medicaid reimbursement

program to overcharge consumers and government

agencies.109 Recently, industry members have faced

allegations, based on investigations by federal

investigators, of repeatedly overcharging public

hospitals and clinics for low-income patients in

violation of the Public Health Service Act.110


The challenge

One of the activities of the pharmaceutical industry

that has recently received attention in the news

media and raises questions about the ethical practices

in the industry has been direct advertising of pre-

scription drugs to consumers. Specifically, doubts

have been raised regarding the accuracy of the

advertisements. The danger posed by misleading

advertisements is a health risk as well as a financial

risk. The health risk is that products whose risks are

not accurately advertised may harm consumers be-

cause they are unaware of such risks.111 For example,

in marketing campaigns for OxyContin the risk of

addiction was not properly disclosed.112 In another

example, GlaxoSmithKline has been accused of

fraudulently suppressing research suggesting the drug

Paxil was ineffective and unsafe for children. At the

same time, the company was accused of false or

misleading advertising by trying to broaden the use

of Paxil beyond its approved use to target mundane

levels of anxiety and self-consciousness.113

Another risk is financial, namely that the drug will

be used instead of less expensive alternatives that, it is

later discovered, are also safer. The financial risk is

that consumers will demand more expensive

advertised products when less expensive alternatives

will serve them equally well.114 Vioxx is the recent

example of this scenario. Due to advertising the drug

became a blockbuster for Merck, with sales of $2.5

billion last year.115 However, it was found to double

patients’ risk of heart attack and strokes – risks that

Merck minimized in its promotional campaigns.116

Medical experts note that much cheaper over-the-

counter pain relievers provide about the same pain

relief as Vioxx without posing such risks.117 Another

example is Nexium, which has been one of the most

heavily promoted drugs based on consumer adver-

tising. It was approved by the FDA as a treatment for

severe acid reflux disease. It is now so commonly

prescribed for heartburn and indigestion that it is one

of the nation’s best selling drugs. Sales in 2003 in the

U.S. were $3.1 billion. Yet, medical experts say that

for most patients over-the-counter heartburn rem-

edies would work just as well.118 A related financial

risk is that consumers will seek drugs for conditions

that do not require medical intervention.119 Given

these risks, the ethical response would be to fully and

accurately disclose all risks and benefits, and to try to

ensure consumers understand the risks and benefits

(or limitations thereon).


The pharmaceutical industry experience with regard

to direct to consumer advertising allows study of

corporate response in a legal regime containing a

vague statutory standard that includes a disclosure

obligation, i.e., disclosure of risks, by members of

the industry. The governing statute requires disclo-

sure of information relating to a drug’s ‘‘side effects,

contraindications, and effectiveness as shall be

required in regulations ...’’ issued by the FDA.120

The regulations require the presentation of ‘‘a true

statement’’ of information relating to side effects,

contraindications and effectiveness.121 ‘‘True state-

ment’’ is defined in the governing regulations to

require advertisements that are not ‘‘false or mis-

leading,’’ do not omit ‘‘material’’ facts, and present a

‘‘fair balance’’ between the risks and the benefits.122

No prior approval by FDA is required for adver-

tisements.123 Since the legal standard is vague it al-

lows corporate actors to claim that their

advertisements are not misleading and are well bal-

anced.

The industry response

In this legal environment, what has been the industry

response? An ethical response would be to safeguard

consumers by being cautious in advertising – i.e.,

clearly disclosing all risks and limiting claims of ben-

efits. As noted above the pharmaceutical industry

might claim that they have been trying to comply

with the law but that their ‘‘wrongdoing’’ arose

inadvertently because of the law’s vagueness. How-

ever, the evidence indicates otherwise. It indicates an

exploitation of the law’s gray area – a desire to

minimize disclosed risks and maximize claims of

benefit. This conclusion comes from evidence of two

types of corporate activities. The first is numerous

violations by the same corporation across an array of

its products. The second is repeated violations by the

same corporation in advertisements for the same

product previously cited by FDA as misleading.

Thus the General Accounting Office Reported:

Since 1997, FDA has issued repeated regulatory letters

to several pharmaceutical companies including 14 to


GlaxoSmithKline, 6 to Schering Corporation, and 5 to

Merck & Co. Some companies have received multiple

regulatory letters over time for new advertisements

promoting the same drug. For example, FDA issued

four separate regulatory letters, one of which was a

warning letter, to stop misleading advertisements for

the allergy drug Flonase marketed by Glaxo Wellcome

in 1999 and 2000. The untitled letters were for

unsubstantiated efficacy claims and for lack of fair

balance. The warning letter was for failure to provide

any risk information on the major side effects and

contraindications of the drug, failure to make adequate

provision for disseminating the product labeling, and

failure to submit the advertisement to FDA. In the past

4 years, FDA has issued four regulatory letters to Pfizer

regarding broadcast and print advertisements for its

cholesterol-lowering drug, Lipitor. Among other

infractions, FDA noted that the advertisements gave

the false impression that Lipitor can reduce heart dis-

ease and falsely claimed that Lipitor is safer than

competing products.124

A third type of activity that demonstrates a lack of

commitment in attempting to comply with the

law’s mandate is evidence of flagrant misrepresen-

tations in disseminated advertisements. For example,

Novartis Pharmaceuticals received a warning letter

from FDA in 1999 regarding Lescol, a cholesterol-

lowering drug, due to advertisements falsely stating

Lescol was as effective as other cholesterol-lowering

agents named in the ad and falsely stating Lescol was

less expensive than other named agents.125 Simi-

larly, the FDAs letter regarding Luxiq, a cream for

treatment of psoriasis and eczema, in 2001 noted

that ads claimed ‘‘highly effective relief in three out

of four patients,’’ and that it reduced symptoms

‘‘within days.’’ However, the clinical trials had

found Luxiq’s success at improving symptoms ran-

ged from 41% to 67% of participants, and the

clinical trial results – i.e., improvements in various

symptoms – were for patients who used it for

4 weeks.126 Another recent example of flagrant

misrepresentation is found in AstraZeneca’s adver-

tisements regarding the safety of Crestor. As was

reported in December 2004:

AstraZeneca’s recent full-page newspaper advertise-

ments defending the safety of its cholesterol-lowering

pill, Crestor, are ‘‘false and misleading,’’ in part be-

cause serious concerns remain about the safety of the

drug, federal drug regulators said Wednesday.

The advertisements stated that ‘‘the F.D.A. has con-

fidence in the safety and efficacy of Crestor’’ and that

the agency ‘‘as recently as last Friday publicly con-

firmed that Crestor is safe and effective.’’ Neither is

true, said a letter from the Food and Drug Adminis-

tration to AstraZeneca.

In fact, days before the advertisements ran, top agency

officials were widely quoted expressing concerns about

Crestor’s safety.127

How widespread is the pharmaceutical industry’s

practice of exploiting the law’s vagueness? This is

difficult to determine. One answer is found in an

evaluation by medical specialists of a sample of print

drug advertisements conducted by Consumers Union.

It found that fewer than half – about 40% – of the

advertisements were honest about efficacy and fairly

described the benefits and risks in the main text.128

Conclusion

The evidence from the pharmaceutical industry

confirms that a vague legal mandate, in this case a

statutory mandate, is ineffective in generating a

strong commitment to legal compliance. Evidence

of avoidance of responsibility is not as pervasive as in

the automobile industry experience under a vague

common law standard. This may be due to the

existence of a regulatory agency that monitors

activity and brings regulatory actions,129 in contrast

to a reliance on private parties to enforce common

law mandates. In addition, evidence of avoidance of

responsibility is not as pervasive as in the securities

industry experience under a vague statutory stan-

dard. This may be due to the nature of the adverse

consequences on the consumer – the danger of

financial loss in the securities industry case study as

opposed to the danger of not only financial loss

but also possible physical injury to the consumer in

the pharmaceutical industry case study. Nonetheless,

the commitment to the legal mandate generated by

the vague statutory standard is not strong.

Case study 4 – The mortgage banking industry

The challenge

The challenge in the mortgage banking industry is to

provide needed funds to borrowers without taking


advantage of their lack of bargaining power, or, at

times, lack of knowledge of or experience with the

credit process. Taking advantage of unsophisticated

borrowers would unfairly deprive them, individu-

ally, and the communities in which they reside of

their equity (equity stripping). The Center for

Responsible Lending, a unit of one of the nation’s

community development lenders, has estimated that

unfair lending practices strip U.S. borrowers of over

$9 billion per year.130


The legislative standard is primarily one of full dis-

closure – in this case full disclosure of the terms of

the transaction. The legal mandate requiring dis-

closure, including the items to be disclosed, is a clear

legal mandate. The current legislative environment

is best understood by first examining the Depository

Institutions Deregulation and Monetary Control Act

of 1980 (DIDMCA).131 Section 501 of the Act

preempted state law limiting the rate of interest and

other charges that may be imposed on first lien

residential mortgages.132 In other words, it pre-

empted clear statutory prohibitions against one form

of overreaching – excessive interest rates.

Thus, after enactment of the DIDMCA the leg-

islative environment was one characterized by dis-

closure. Lenders were required to disclose the terms

of proposed lending arrangements to borrowers. The

borrowers had to then examine, understand, and

assess the fairness of the transaction. This disclosure

regime existed by virtue of two statutes – the Real

Estate Settlement Procedures Act (RESPA)133 and

the Truth-in-Lending Act (TILA).134 RESPA

requires advance disclosure of all charges imposed on

a borrower in a residential real estate transaction

including charges in connection with a mortgage

loan.135 TILA requires prior disclosure of, among

other things, the finance charge, payment schedule,

and the existence of a prepayment penalty in con-

nection with consumer credit transactions including

loans secured by real estate primarily used for per-

sonal, family or household purposes.136

The purpose behind the RESPA disclosures is to

provide consumers with timely information, and to

protect them from ‘‘unnecessarily high settlement

charges caused by certain abusive practices that have

developed in some areas of the country.’’137

In 1994, this legal environment was altered with

enactment of the Home Ownership and Equity

Protection Act (HOEPA).138 HOEPA amended

TILA with respect to non-acquisition mortgages. It

contained additional disclosures, but also added

certain absolute prohibitions. The prohibitions

include prohibitions against (a) prepayment penal-

ties139 (b) lending without regard to borrower’s

ability to repay,140 and (c) refinancing within a one-

year period unless the refinancing is ‘‘in the bor-

rower’s interest.’’141 Such additional disclosure

requirements and prohibitions apply only to certain

high-cost loans, namely (a) loans in which the annual

percentage interest rate on the loan exceeds the yield

on Treasury securities having a comparable period of

maturity by more than 10 percentage points, or (b)

loans in which the points and fees paid by the

consumer exceeds 8% of the loan amount or $400,

whichever is greater.142

The purpose behind HOEPAs requirements and

prohibitions was to tackle the problem of ‘‘reverse

redlining,’’ namely targeting of residents of certain

communities ‘‘for credit on unfair terms.’’143 Spe-

cifically,

Evidence before the Committee indicates that some

high-rate lenders are using non-purchase money

mortgages to take advantage of unsophisticated, low-

income borrowers.144

Thus, the study of the activities of the home mort-

gage industry is a study of actions taken under a clear

legislative mandate – first, in the form of stipulated

disclosures of the terms of the transaction by industry

members, and second, after 1994, a clear prohibition

of certain abusive practices with regard to ‘‘high-

cost’’ loans.

Industry response under a clear legal mandate

One gauge to help us assess commitment to com-

pliance with the law is the number of federal agency

enforcement actions alleging violations of the legis-

lative mandates. The General Accounting Office

studied this question in 2003.145 It found that in the

period 1983–2003, the Federal Trade Commission

filed 19 complaints against mortgage lenders or

brokers alleging deceptive or other illegal prac-

tices.146 The federal bank regulatory agencies filed

one action.147 The Department of Housing and


Urban Development’s Office of RESPA filed three

actions relating to abusive lending.148

Most of the actions filed by these various federal

agencies involved disclosure violations under TILA,

RESPA, or HOEPA.149 However, 7 of the 23

actions enumerated above involve violations of

specific HOEPA prohibitions, namely, the prohibi-

tion against asset based lending. In addition, the

three HUD actions involve violations of specific

RESPA prohibitions against kickbacks and referral

fees. In sum, there were relatively few actions – 24

in all – based on violation of clear legislative

mandates.

Overall, the clear mandates were associated with a

high degree of corporate commitment to compliance.

Overall summary of findings

The case studies presented in this article examine the

influence of various legal regimes on corporate

conduct as evidenced by corporate activity in the

market. The findings are that a vague common law

mandate (e.g., products liability law) appears to be

least effective in inducing corporate commitment to

legal compliance. It was typically associated with

corporate conduct that ignored the legal mandate. A

vague statutory standard (e.g., federal securities

antifraud law), in the context in which the conse-

quence was possible financial injury to the consumer

resulting from noncompliance, was also ineffective in

inducing commitment to legal compliance.

A clear disclosure of risks regime, combined

with a vague common law mandate, was next in

line in terms of effectiveness in inducing corporate

commitment to the applicable common law

mandate. However, disclosure did not significantly

alter the industries’ poor commitment to an

otherwise existing vague common law mandate.

Response was modest.

Not all vague standards exercised little or no

influence on corporate conduct. A vague statutory

standard when combined with regulatory enforce-

ment and a consequence of possible physical injury

resulting from noncompliance was somewhat more

effective in inducing commitment to legal compli-

ance. Nonetheless, it was not, very effective.

The legal regime associated with the greatest

degree of commitment to legal compliance was a

clear legal mandate, namely one that stipulated the

required course of conduct for corporate actors.

These findings contradict the assumption in the

Principles of Corporate Governance that the law deter-

mines corporate conduct. The case studies demon-

strate that the influence of the law can vary from an

important influence to a negligible influence, and

that in most of the legal regimes studied the influ-

ence of the law on corporate conduct was weak.

Conclusion and implications

The case studies in this article document that law is

not necessarily determinative of corporate conduct.

In a regime with a vague legal standard the influence

of law on corporate conduct is weakest. This is

revealing because this type of legal regime is pre-

valent. A legal regime with clear legal standards that

stipulate required action or course of conduct on the

part of members of the industry is the best approach

to generate greater corporate commitment to legal

compliance. This is because the required response is

not open to interpretation and because the legal

mandate directly serves its underlying purpose.

Additional commitment to compliance in such a

regime is generated when there are substantial

enforcement risks and substantial sanctions for non-

compliance with such a clear legal mandate. An

example is found in the proposed government

standards for compatibility between passenger auto-

mobiles and SUVs. The legal standards would stip-

ulate the required response – e.g., align all bumpers,

include side air bags in all automobiles, etc. – and

would serve the underlying purpose of avoiding

physical injury to others. Failure to comply would

lead to an inability to market an entire product line.

However, a clear legal mandate is frequently not

useful or appropriate for legislative or judicial pro-

nouncements. Legal standards in legislation or

common law judicial pronouncements are typically

in general (i.e., vague) terms so that they can be

applied to a variety of factual situations in the future.

In addition, at any point in time the precise corpo-

rate actions appropriate for various members of the

industry or various activities subject to the legal

mandate may not be identical. If so, a specific

requirement as opposed to a general standard is not

appropriate. These benefits of a general standard,


i.e., a vague standard, are, however, the culprit when

it comes to corporate commitment to compliance

with law and its underlying purpose.

Given these findings, what can be done to

increase law’s influence on corporate conduct, apart

from greater clarity and certainty in legal obligations?

The automobile industry case study suggests the

answer lies in greater use of market-based sanctions.

This is an issue for further study.

Notes

1 John Rawls, A Theory of Justice 308 (revised edition

1999).2 American Law Institute, Principles of Corporate

Governance (1994). The Principles were a 16-year pro-

ject of the American Law Institute. Richard B. Smith,

An Underview of the Principles of Corporate Governance, 48

Bus. Law 1297 (1993).3 American Law Institute, Principles of Corporate

Governance, Director’s Foreword (1994).4 Id. § 2.01 (b) (1).5 Id.6 Peter J. May, Compliance Motivations: Affirmative and

Negative Bases, 38 Law & Soc’Y Rev. 41 (2004) (summa-

rizing prior studies regarding the influence of various fac-

tors such as inspection frequency and consistency,

perceived legitimacy of regulations, reputation, and ability

to comply, including costs and competitive effects); Rob-

ert A. Kagan, Neil Cunningham and Dorothy Thornton,

Explaining Corporate Environmental Performance: How Does

Regulation Matter? 37 Law & Soc’Y Rev. 51, 67–69 (2003)

(finding firm-level economic differences and community

pressures as having significant effects on companies’ envi-

ronmental performance); Brent Fisse and John Braithwaite,

The Impact of Publicity on Corporate Offenders 227, 233,

and 243 (1983) (study of adverse publicity and corporate

reaction to it, finding many of the companies studied

introduced substantial reforms in the wake of their adverse

publicity crisis which, although perhaps in only a small

way, would reduce the probability of recurrence of the

offense or wrongdoing. In many cases thorough going re-

form was forsaken for piecemeal changes).7 Id. at 45 and 55–56 (studies are mixed with

respect to findings concerning the effect of level of

sanctions for compelling compliance, and this study

finds that fear of sanctions and fear of legal liability has

little effect); John Braithwaite and Toni Makkai, Test-

ing An Expected Utility Model Corporate Deterrence, 25

Law & Soc’Y Rev. 7, 8, and 24 (1991) (studies have

shown very little support for an effect of the perceived

severity of sanctions on compliance, and this study

confirms this conclusion for organizations). Contra Ste-

ven Klepper and Daniel Nagin, Tax Compliance and

Perceptions of the Risks of Detection and Criminal Prosecu-

tion 23 Law & Soc’y Rev. 209 (1989), and Harold G.

Grasmick and George J. Bryjack, The Deterrent Effect of

Perceived Severity of Punishment, 59 Soc Forces 471

(1980) (risk of criminal prosecution and perceived

severity of sanction does affect conduct).8 May, supra, note 6, at 55 (duty to comply with

legal requirements cited as an important motivation by

respondents, but less important than reputation as a

motivation for compliance, and almost equally impor-

tant to marketplace demands as a motivation).9 See Greg Ip, A Less-Visible Role For the Fed Chief:

Freeing Up Markets. Wall St. J. November 19, 2004 at A8

(quoting a view articulated in the 1960s by Alan Green-

span that it is in the self-interest of every business to

maintain their reputation – a reputation for honest deal-

ings and a quality product – and regulation undermines

this superlatively moral system). E.g., Victor P. Goldberg:

1988, ‘Accountable Accountants: Is Third-Party Liability

Necessary?’ 17 Journal of Legal Studies 295, and Ronald

Gilson and Reineer Kraakman: 1984, ‘The Mechanics of

Market Efficiency’, 70 Va. L. Rev. 549 both arguing that

reputation provides a sufficient incentive for auditors to

detect fraud and imposing is unnecessary.10 AMA 2003 Corporate Governance Survey (Amer-

ican Mgmt. Ass’n, 2003), at http://www.amanet.org/

research/pdfs/Corp_Governance_srvy03.pdf11 A 1999 Conference Board survey of 124 companies

in 22 countries found that in 1987 the board of directors

took part in creating the company’s code of ethics in 21%

of the cases. This rose to 41% in 1991 and 78% in 1998.

Amy Zipkin, ‘Getting Religion on Corporate Ethics’,

New York Times, October 18, 2000, at C1 and C1012 The State of Corporate Citizenship in the United States

10 (The Trustees of Boston College, July 2003), at http://

www.bc.edu/centers/ccc/Media/state_cc_results. pdf13 Year Ethics Officer Position Created The 2000

Member Survey Report II (Ethics Officer Ass’n, Feb.

2001), at http://www.eoa.org/EOA_Resources/Re-

ports/MS2000_(Public Version).pdf.

Before 1986 4%

1986–1987 4%

1988–1989 1%

1990–1991 6%

1992–1993 14%

1994–1995 18%

1996–1997 26%

1998–1999 27%

2000 1%


14 Id. at 15.15 ‘Top Ethics Officers Say They Don’t Train Their

Boards in Ethics’, The Conference Board News (June 17,

2003), at http://www.conference-board.org/utilities/

press.cfm16 Gretchen Morgenson, ‘S.E.C. Wants A Monitor

To Examine A.I.G.’s Books’, New York Times, Novem-

ber 3, 2004, at C1 (American International Group seeks

a settlement; PNC Financial Services Group earlier was

subject of enforcement action); Joseph B. Treaster,

‘A.I.G. Agrees To Big Payment In U.S. Cases’, New

York Times, November 25, 2004, at C1 (AIG agreed to

pay $126 million and accept an independent monitor to

settle SEC and Justice Department investigations into

the sale of insurance used to inflate the appearance of

corporations’ financial strength).17 Jeff Down, ‘Burial Insurance; An Industry Taken

To Task For A Policy of Race Bias’, Newsday, October

10, 2004, at E02 (between 2000 and 2004, 16 major

cases settled involving 14.8 million policies sold by 90

insurance companies and required restitution of more

than $556 million); Carrie Mason-Draffen, ‘Metlife Ex-

pects $250 M Hit in Bias Suit’, Newsday, February 8,

2002, at A7; Joseph B. Treaster, ‘Insurer Agrees It

Overcharged Black Clients’, New York Times, June 22,

2000, at A1 (settlement reached with American General

for overcharges to more than two million black cus-

tomers).18 Andrew Caffrey, Mass. Launches Insurance Probes;

Attorney General, State Agency Look at Sales Practices, Bos-

ton Globe, October 22, 2004, at F1 (investigation

opened into sales practices at 21 Massachusetts-based

subsidiaries of 10 insurance companies regarding contin-

gency payments to brokers); Joseph B. Treaster, ‘Spitzer

Inquiry Expands to Employee-Benefits Insurance’,

New York Times June 12, 2004, at C2 (Aetna, Cegna,

Metlife, and Hartford receive subpoenas as part of

investigation of contingency fees paid to brokers).19 U.S. Securities and Exchange Commission, SEC

Settles Enforcement Proceedings Against J.P. Morgan

Chase and Citigroup, Press Release 2003–87 < http://

www.sec.gov/news/press/2003–87.htm > (both firms

helped Enron mislead investors by characterizing what

were essentially loan proceeds as cash from operating

activities. J.P. Morgan and Citigroup agree to pay $135

million and $120 million, respectively).20 Steven Greenhouse, ‘Lawsuits and Changes At

Wal-Mart’, N.Y. Times November 19, 2004, at A25

(Wal-Mart settled one case involving 69,000 workers in

Colorado for $50 million 4 years ago, and in Oregon a

federal jury found in 2002 that the company had re-

quired off-the-clock work); Steven Greenhouse,

‘Forced to Work Off the Clock, Some Fight Back’,

New York Times, November 19, 2004, at A1 (workers

interviewed say off-the-clock work took place in a vari-

ety of companies in addition to Wal-Mart, including

A&P and J.P. Morgan); Steven Greenhouse, ‘Suits Say

Wal-Mart Forces Workers to Toil off the Clock’, New

York Times June 25, 2002, at A1 (legal claims brought

by employees of Wal Mart in 28 states); Steven Green-

house, ‘In-House Audit Says Wal-Mart Violated Labor

Laws’, New York Times, January 13, 2004, at A16 (re-

cords at 128 Wal-Mart stores point to extensive viola-

tions of child–labor laws and state labor law

regulations); Constance L. Hays, ‘Wal-Mart Plans

Changes To Some Labor Practices’, New York Times,

June 5, 2004, at C2 (responding to a year of criticism,

Wal Mart established a compliance group to oversee

workers’ pay and hours); Steven Greenhouse, ‘Altering

of Worker Time Cards Spurs Growing Number of

Suits’, New York Times, April 4, 2004, at A1 (experts on

compensation say illegal doctoring of hourly employees’

time records is far more prevalent than most Americans

believe, and has led to a growing number of lawsuits

and settlements against a wide range of businesses.).21 Office of New York State Attorney General, Press

Release, Agreement Eliminates Tobacco Advertising

From School Editions of Major News Magazines,

November 10, 2003 < http://www.oag.state.us/press/

2003/nov/nov10a_03.html > (Philip Morris, R.J. Rey-

nolds, Brown and Williamson, and U.S. Smokers To-

bacco); Greg Winter, ‘Tobacco Company Reneged on

Youth Ads, Judge Rules’, New York Times, June 7,

2002, at A18 (California judge rules R.J. Reynolds vio-

lated 1998 tobacco settlement); Bob Egelko, High Court

Tosses Tobacco Firm Appeal, San Francisco Chronicle,

June 10, 2004, at B3 (State Supreme Court rejects R.J.

Reynold’s Appeal of 2002 judgment).22 E.g., Eric Dash, ‘Bristol-Myers Agrees to Settle

Accounting Case’, New York Times, August 5, 2004, at

C1 ($150 million settlement); Almar Latour and Chip

Cummins, ‘Oil Titan Agrees to Settle With U.S. U.K.

Authorities For Overstating Its Reserves’, Wall St. J.,

July 30, 2004, at A3 (Royal Dutch/Shell Group agree

to $150 million penalty); James Bandler, ‘Time Warner,

Expects to Settle AOL Inquires for $510 Million’, Wall

St. J. December 16, 2004, at B10 ($510 million to settle

securities fraud charges with U.S. regulators over

accounting in its America Online unit); ‘Two CA Ex-

Officials Settle SEC Charges’, Wall St. J., November 3,

2004, at B8 (Computer Associates executives agree to

fines to settle SEC charges); Eric Dash, ‘S.E.C. Names

8 in KMart Accounting Case’, New York Times,

December 3, 2004, at C5 (SEC brings accounting fraud

charges against former executives of KMart and suppli-

ers, including executives at PepsiCo., Kodak, and Coca


Cola. Similar charges led to settlements with Royal

Ahold, the large Dutch supermarket group).23 Case Study 1 was a part of a longer study of the

securities industry exploring decision-making heuristics

published in 11 Fordham Journal of Corporate &

Financial Law 765–805 (2006).24 35 BNA, Securities Regulations and L. Report

1642 (October 6, 2003) (settlements between SEC and

J.P. Morgan Chase, FleetBoston, and Credit Suisse First

Bank).25 Testimony of David M. Walker, Comptroller Gen-

eral of the United States, Before the Senate Committee

on Banking, Housing and Urban Affairs, GAO-04–533T

at 2 and 6 March 10, 2004, (as of March 1, 2004, SEC

had formally announced 7 enforcement actions involving

broker-dealers and other firms involved in late trading

schemes, and 12 cases involving market timing activities,

including five that also involved late trading); Christo-

pher Oster, ‘Settlements in Wake of Scandal Include

Payments That Extend Beyond Refund of Tainted Prof-

its’, Wall St. J., June 29, 2004, at D1 (mutual fund com-

panies have agreed to settlements totaling more than $2

billion, and this is sure to grow substantially as ten mu-

tual fund companies have yet to settle).26 E.g., Mitchell Pacelle, ‘Citigroup Will Pay $2.65

Billion To Settle WorldCom Investor Suit’, Wall St. J.,

May 11, 2004, at A1 (settlement with investors in suit

against 17 underwriters, including Citigroup, J.P. Mor-

gan Chase, Deutsche Bank and Bank of America); Kurt

Eichenwald, ‘Jury Convicts 5 Involved In Enron Deal

With Merrill’, New York Times, November 4, 2004, at

C1 (jury found that five defendants, including four for-

mer executives of Merrill Lynch, had conspired to help

Enron report bogus profits. The convicted defendants

include the former head of global investment banking at

Merrill Lynch, and the former head of the firm’s project

and lease finance group).27 Annuities Deal Criticized, Newsday, June 10, 2004,

at A53 (in the past 2 years the NASD had taken more

than 80 disciplinary actions against brokers and invest-

ment firms, including Prudential and American Express,

for abuses in sales of variable annuities); National Asso-

ciation of Securities Dealer, NASD Fines Prudential

$2 million; Orders $9.5 Million to Customers for

Annuity Sales in Violation of NY Insurance Regs, New

Release, January 29, 2004 < http://www.nasd.com >

(involving Prudential Equity Group, formerly known as

Prudential Securities, and Prudential Investment Man-

agement Services).28 Patrick McGeehan, ‘Morgan Stanley Settles Bias

Suit With $54 Million’, New York Times, July 13, 2004,

at A1 (settlement reached with Morgan Stanley; earlier

settlements with Merrill Lynch and Smith Barney

resulted in more than $200 million in payments);

Patrick McGeehan, ‘Merrill Lynch Ordered to Pay For

Sexual Bias’, New York Times, April 21, 2004, at A1.29 The role of securities analysts is summarized in Jill

E. Fisch and Hillary A. Sale: 2003, ‘ The Securities

Analyst As Agent: Rethinking the Regulation of

Analysts’, 88 Iowa L. Rev. 1035, 1040–1042; John L.

Orcutt: 2003, Investor Skepticism v. Investor Confidence:

Why the New Research Analyst Reforms Will Harm Inves-

tors, 81 Denv. U.L. Rev. 1, 7–9.30 Fisch and Sale, Id. at 1042; Orcutt, Id. at 8

(research reports are typically made available only to

clients of the brokerage firm although in recent years

many firms have begun to distribute reports to non-cli-

ents).31 Orcutt, supra note 29, at 8–9 (although buy-side

analysts do use sell-side research as a source of informa-

tion).32 Overall individual investor participation in the

stock market has risen from 30.2 million U.S. share-

owners in 1980 to 84.3 million in 2002. Securities

Industry Association. Key Trends in the Securities

Industry < http://www.sia.com/research/html/key_ind

ustry_trends_.html > (visited November 8, 2004). This

includes individual stock ownership, both inside and

outside employer-sponsored retirement plans, and own-

ership stock of mutual funds. Individual stock owner-

ship outside employer-sponsored retirement plans

extended to 31.5 million shareowners in 2002. Invest-

ment Company Institute and Securities Industry Associ-

ation, Equity Ownership in America 17 (2002).33 Orcutt, supra note 29, at 14–15 (research has

shown that analyst recommendations can have a

substantial impact on both stock prices and trading

volumes, and buy ratings are more likely to

encourage trading volumes); Fisch and Sale, supra

note 29, at 1045–1046 (in today’s world research

departments do not earn revenue; other departments

support them).34 Fisch and Sale, Id. at 1046–7 (analysts have been

used in marketing activities aimed at prospective pur-

chases of new issues of securities); Orcutt, Id. at 19–21

(after a company is taken public, investment banks

compete for additional stock and debt offerings and for

financial advisory work and sell-side analysts can play an

important role in securing fees generated from their

activities).35 Hearing on Corporate Governance, Before the Sub-

comm. On Consumer Affairs, Foreign Commerce and Tour-

ism of the Senate Comm. On Commerce, Science and

Technology, June 26, 2002 (testimony of New York

State Attorney General Eliot Spitzer) < http://

www.oag.state.ny.us/press/2002/jun/testimony7.pdf > .


36 Securities and Exchange Commission, Litigation

Release No. 18117, April 28, 2003 < http://www.sec.-

gov/litigation/litreleases/lr18771.htm > (emphasis in

original).37 Orcutt, supra note 29, at 21–22 (analysts receive a

base salary plus a discretionary year-end bonus that typi-

cally can be 50% or more of the analyst’s base salary).

SECs on-site examinations of nine full service broker-

age firms discovered that in 7 of the nine firms in-

spected investment banking had input into analysts’

bonuses and the analyst hiring process. Testimony of

Laura S. Unger, Acting Chair, Securities and Exchange

Commission, Before the Subcomm. On Capital Mar-

kets, Insurance and Government Sponsored Enterprises,

House Committee on Financial Services, July 31, 2001

< http://www.sec.gov/news/testimony/073101ort-

slu.htm > . The staff inspections also reported ‘‘[i]nter-

views with former analysts revealed that it was well

understood by all of these analysts that they were not

permitted to issue negative opinions about investment

banking clients.’’ Id.38 Orcutt, supra note 29, at 22.39 Id. at 22–25; Fisch and Sale, supra note 29, at 1043–

1044. The SECs on-site inspections of nine full service

brokerage firms found that about one quarter of the ana-

lysts inspected own securities in the companies they cov-

er. Testimony of Laura S. Unger, supra note 37.40 New York’s Martin Act prohibits any ‘‘fraud,

deception, concealment,’’ any ‘‘promise or representa-

tion... which is beyond reasonable expectation or unwar-

ranted by existing circumstances’’ and any false

representation or statement made to induce or promote

the sale of securities. N.Y. Gen. Bus. Law § 352-c (1996).41 E.g., NASD Rules 2210(d)(1)(A) states:

All member communications with the public shall be

based on principles of fair dealing and good faith and

should provide a sound basis for evaluating the facts in

regard to any particular security or securities or type of

security, industry discussed, or service offered. No

material fact or qualification may be omitted if the

omission, in the light of the context of the material

presented, would cause the communications to be

misleading. NASD Rule 2210(d)(1)(B) prohibits

members from making ‘‘[e]xaggerated, unwarranted or

misleading statements or claims’’ in all public com-

munications and states that ‘‘no member shall, directly

or indirectly, publish, circulate or distribute any public

communication that the member knows or has reason

to know contains any untrue statement of a material

fact or is otherwise false or misleading.’’ NYSE Rule

472 provides that:

[n]o members or member organization shall utilize any

communication which contains (i) any untrue state-

ment or omission of a material fact or is otherwise false

or misleading; or (ii) promises of specific results, exag-

gerated or unwarranted claims; or (iii) opinions for

which there is no reasonable basis; or (iv) projections or

forecasts of future events which are not clearly labeled as

forecasts.

42 See Louis Loss and Joel Seligman, Fundamentals

of Securities Regulation 904–907 and 1060–61 (2004)

(broker dealers are subject to section 17(a) of the 1933

Act, Rule 10b-5, and over-the-counter broker dealers

are additionally subject to 15(c) of the 1934 Act).43 15 U.S.C. § 78o(1)(A). See also 15 U.S.C. 78j(b).44 Louis Loss and Joel Seligman, 7 Securities Regula-

tion 3418–9 (1989) (citations omitted)45 S.E.C. v. Capital Gains Research Bureau, Inc.,

375 U.S. 180, 186 (1963).46 Academic studies have confirmed that analysts

consistently overestimated earnings forecasts. Orcutt, su-

pra note 29, at 50. These studies do not isolate the

cause of the overestimates.47 Studies have confirmed overoptimism in buy rec-

ommendations. Orcutt, supra note 29, at 11–13. They

have also found analysts’ recommendations are consis-

tent with their employer’s incentives but not those of

the investing public, Fisch and Sale, supra note 29, at

1045–6, and that independent analysts behavior differ

substantially from analysts employed by securities firms.

Id. at 1051. These studies do not document the cause of

the overoptimism.48 SECs on-site examination of nine full secure bro-

kerage firms found that in 26 of 97 lock-ups reviewed,

research analysts may have issued ‘‘booster shot’’ re-

search reports. Testimony of Laura S. Unger, supra note

37. See generally Orcutt, supra note 29, at 25.49 Securities and Exchange Commission, Ten of Na-

tion’s Top Investment Firms Settle Enforcement Ac-

tions Involving Conflicts of Interest Between Research

and Investment Banking, April 28, 2003 < http://

www.sec.gov/news/press2003–54.htm > (Bear Stearns,

Credit Suisse, Goldman Sachs, Lehman Brothers, J.P.

Morgan, Merrill Lynch, Morgan Stanley, Salomon,

UBS Warburg, Piper Jaffray); Securities and Exchange

Commission, Deutsche Bank Securities Inc. and Tho-

mas Weisel Partners LLC Settle Enforcement Actions

Involving Conflicts of Interest Between Research and

Investment Banking < http://www.sec.gove/news/

press2004–120.htm > .50 E.g., Roel Campos, Commissioner, Securities and

Exchange Commission, Finan. Times, November 20,


2002 (recent disclosures suggest that for years analysts’

research has been improperly influenced by pressure to

issue positive research to attract underwriting and

investment banking business).51 Testimony of New York State Attorney General

Eliot Spitzer, Hearing on Corporate Governance Before

the Subcomm. On Consumer Affairs, Foreign Com-

merce and Tourism, Senate Committee on Commerce,

Science and Technology, June 26, 2002, < http://

www.org.state.ny.us/press/2002/jun/testimony7.pdf > .52 Id.53 Securities and Exchange Commission, Litigation


gov/litgation/litreleases/lr18112.htm > .54 Securities and Exchange Commission, Litigation


gov/litigation/litreleases/lr18111/htm > . In April 2001

Grubman expressed the need to downgrade six telecom

companies. Investment bankers pressured Grubman not

to downgrade the companies, and he did not. He con-

tinued to advise investors to buy the stocks.55 Securities and Exchange Commission, Litigation


gov/litigation/litreleases/lr18110/htm > .56 Securities and Exchange Commission, Litigation






gov/litigation/litreleases/lr18854/htm > .59 Morgan Stanley’s CEO stated ‘‘I don’t see any-

thing in the settlement that will concern the retail

investor about Morgan Stanley.’’ He received a strong

rebuke from SEC Chairman Donaldson and then apol-

ogized for the remark. BNA, Securities Regulation & Law

Report, May 12, 2003 at 789.60 Ann Davis and Randall Smith, ‘Deals & Deal

Makers: Investment Bankers Wrangle Over Gray Areas

In Pact On IPOs’, Wall St. J., May 23, 2003, at C5.61 Id.62 Lee Hawkins, Jr., ‘GM’s Finance Arm is Close To

Setting Racial-Bias Lawsuit’, Wall St. J., January 30,

2004, at 1 (both GMAC and Ford Credit are targets of

lawsuits; Nissan’s U.S. finance arm settled lawsuit last

year); Tim Incantalupo, ‘Does Color Matter?’ Newsday,

March 14, 2004, at E4 (Toyota Credit sued in class ac-

tion claiming African-Americans were routinely over-

charged for auto financing in violation of federal law

banning discrimination in lending).

63 National Association of Attorneys General, Settle-

ment: Thirty-Eight Attorneys General Announce Settle-

ment with Fort Motor Credit Company and Ford,

Lincoln Mercury Dealers over ‘‘Red Carpet’’ Lease

Plan, < http://www.naag.org/issues/20040610-settle-

ment-ford.php > (the settlement may affect more than

150,000 consumers nationwide).64 National Highway Traffic Safety Administration,

Notice of Proposed Rule Making: Consumer Informa-

tion Regulations; Federal Motor Vehicle Safety Stan-

dards; Rollover Resistance (2001)

< www.nhtsa.dot.gov/cars/rules/rulings/Rollover/

2001standards/RolloverResistance.htm > (based on the

2000 Fatality Analysis Reporting System and data from

the 1996–2000 National Automotive Sampling System

Crash worthiness Data System).65 Danny Hakim, ‘Gauging Rollovers on a Track,

and Not Just on Paper’, New York Times, October 8,

2003, at C3.66 ‘Safety of Some SUVs Questioned’, Newsday,

October 15, 2003 at A42 (study by the National High-

way Traffic Safety Administration of fatality data from

1995 to 2000).67 Id.68 Danny Hakim, ‘Rollovers Led the Rise in Traffic

Deaths Last Year’, New York Times, July 18, 2003 at C2.69 Danny Hakim, ‘Tough Questions On Safety for

Automakers at Hearing’, New York Times, February 27,

2003 at C5.70 Pub. L. 106–414.71 Federal regulations require that passenger car

bumpers be within a specified range. However, SUVs

and light-trucks are not defined as passenger cars and

therefore are not subject to these regulations. 49 C.F.R.

§581.72 Howard Latin and Bobby Kasolas, ‘Bad Designs,

Lethal Profits: The Duty to Protect Other Motorists

Against SUV Collision Risks’, 82 Boston University Law

Review 1161, 1184–1185 (2002).73 Restatement of Torts, Second § 402A,

comment i.74 Latin and Kasolas, supra note 72, at 1185–118675 Restatement of Torts, Second § 402A, comment

c. See also discussion of development of products liabil-

ity law in Cronin v. J.B.E. Olson Corporation, 8 Cal.

3d 121, 501 P. 2d 1153, 104 Cal. Rptr. 433 (Sup. Ct.

Cal. 1972), quoting Justice Traynor:

[Public] policy demands that responsibility be fixed

wherever it will most effectively reduce the hazards to

life and health inherent in defective products that reach

the market. Id. at 129.


76 Pub. L. 106–414, Section 12.77 Consumer Information Regulations, Federal Mo-

tor Vehicle Safety Standards; Rollover Prevention, 65

Fed. Reg. 34998, Part VIII Rollover Information Dis-

semination through NCAP (2000).78 National Highway Traffic Safety Administration,

NHTSA Vehicle Safety Rulemaking Priorities: 2002–

2005, 67 Fed. Reg. 48, 599 (2002) (proposal).79 NHTSA Vehicle Rulemaking Priorities and Sup-

porting Research: 2003–2006 < http://www.nhtsa.-

dot.gov/cars/rules/rulings/PriorityPlan/Final/Veh/In-

dex.html > .80 The final rulemaking priorities plan document

was supplemented with a report on initiatives to ad-

dress vehicle compatibility. National Highway Traffic

Safety Administration, Vehicle Compatibility and Roll-

over Integration Project Team (IPT) Plans, 68 Fed.

Reg. 36, 534 (2003), which referenced a report enti-

tled National Highway Traffic Safety Administration,

Initiatives to Address Vehicle Compatibility, June

2003, http://www.nhtsa.dot.gov/people/iptre-

ports.html. The initiatives being studied included

changes in vehicle design to maximize protection

within a collision partner (struck) vehicle. The priori-

ties plan document was also supplemented with a re-

port on initiatives to address rollovers. National

Highway Traffic Safety Administration, Initiatives to

Address the Mitigation of Vehicle Rollover (June

2003), at http://www.nhtsa.dot.gov/people/iptre-

ports.html. The initiatives included a study of various

electronic stability controls and their benefits, an up-

grade of door latch integrity standards, and an upgrade

of roof crush standards.81 A gauge of the earlier industry response was pro-

vided by the surprise that was voiced when Ford finally

acknowledged in 2000 that SUVs may pose safety prob-

lems. See Keith Bradsher, ‘Ford is Conceding S.U.V.

Drawbacks’, New York Times, May 12, 2000, at A1; Keith

Bransher, ‘Ford’s Admission Perplexes the Neighbors in

Henry’s Hometown’, New York Times, May 13, 2000, at

C1 (Ford’s forthright stance took many surprise).82 ‘‘For years, industry executives refused even to

acknowledge a problem. In a 1997 interview, Alexander

Trotman, then chairman and chief executive of Ford,

likened a collision between a car and sport utility to

two rocks smashing together; the bigger rock would

come out ahead, he said, and little could be done.’’

Danny Hakim, ‘Automakers Agree To Work Together

For S.U.V. Safety’, New York Times, February 14, 2003,

at C2. Dr. Ricardo Martinez, head of the National

Highway Traffic Safety Administration noted back in

1998: I’m always amazed when people say, ‘‘It’s pure

physics, we can’t do anything about it,’’ because it’s

[designs changes that could reduce damage to automo-

biles] out there, it’s on the street.’’ Keith Bradsher,

‘Auto Makers Seek to Make Light Trucks Safer in Cra-

shes’, New York Times, May 22, 1998, at D1 (auto mak-

ers should follow the example of the new Mercedes–

Benz ML3 20 sport utility vehicle, which was designed

to inflict less damage on cars).83 ‘‘You ask the industry about rollover, and they say

‘People shouldn’t drink and people should wear their

seat belts. But these are beside-the-point points. There’s

no argument there. We need to ask manufacturers what

they can do in their design to make sure there wasn’t a

rollover to being with.’’ Danny Hakim, ‘The Nation:

By Numbers; S.U.V.s Take a Hit, as Traffic Deaths

Rise’, New York Times, April 27, 2003, Section 4 at 4

(statement of R. David Pittle, senior vice president of

technical policy for Consumers Union).84 Robert H. Frank, ‘Feeling Crash-Resistant in an

S.U.V’, New York Times, May 16, 2000, at A23 (SUVs

now account for some 20 percent of all vehicles sold by

Ford, up from 5% in 1990, and accounted for most of

its record profit of $7.2 billion last year); Danny Hakim,

‘Block That Grill; In the Debate on S.U.V.s, There’s a

New Casualty Count’, New York Times, March 2, 2003,

Section 4 at 5 (the future of G.M., Ford and Chrysler

now depends on SUVs and pickups).85 Keith Bradsher, ‘Changes in Ford Explorer Aim

At Protecting Other Motorists’, New York Times, Au-

gust 4, 2000 at C1; Royal Ford, Ford Lightens Up On

Explorer, For Safety’s Sake, The Boston Globe, Decem-

ber 16, 2000, at C1. See also PBS, Frontline: Rollover:

Unsafe On Any Tire: Chronology < http://

www.pbs.org/wgbh/pages/frontline/shows/rollover/

unsafe/cron.html > (yet CEO Jacques Nasser said none

of the changes were made for safety reasons).86 ‘Jury Rules in Ford’s Favor in Suit Over Sport

Utility’, New York Times, April 6, 2001, at C4; Milo

Geyelin, ‘Ford Will Try to Settle All Pending Rollover

Suits’, Wall Street Journal, January 4, 2001 (Ford trying

to settle all pending rollover suits).87 Anita, Kumar, ‘Ford Leaves 2-Door SUV Un-

changed’. New York Times, July 29, 2001, at 1A (deaths

in the 2 two-door Explorer model are five times higher

than other SUVs including the Ford four-door version).

In the 2002 model year ratings for rollovers, four Ex-

plorer models were rated. Three of the four received a

two star rating – 2 two-door models and 1 four-door

model. Only one, the Ford Explorer four-door 4� 4,

received a three star rating. < www.nhtsa.dot.gov/

NCAP/Cars/2002SUVs.html > .88 Danny Hakim, ‘U.S. Regulators Regulators

Release Vehicle Rollover Data’, New York Times, Au-

gust 10, 2004, at C1.


89 During a deposition in 1989 in a rollover suit

involving a Ford Explorer, Roger Simpson, project

manager for the Explorer, testified that widening the

prototype by 2 in would have made the vehicle more

stable, but Ford decided against the change because it

had already invested more that $500 million in the

existing prototype and delaying the vehicle would have

been too costly. PBS, Frontline: Rollover: Unsafe On

Any Tire: Chronology < http://www.pbs.org/wghh/

pages/frontline/hows/rollover/unsafe/cron.html > . See

also Latin and Kasolas, supra note 71, at 1197 (the Ex-

plorer prototypes failed Ford’s own safety tests, and

Ford’s engineer’s recommended safety improvements,

but the recommendations were ignored).90 Keith Bradsher, ‘Carmaker’s to Alter S.U.V.s to

Reduce Risks to Other Autos’, New York Times, March

21, 2000, at A1 (changes in other models by both U.S.

and foreign auto manufacturers over the 2000–2002

model years consisted of using car-like under bodies in

three models, adding an impact-absorbing bar in two

models, reinforcing the bumper in one model, redesign-

ing the front end to lower it in one model, and extend-

ing the bumper lower in two models). In all, changes

over the 2000–2002 period were announced for 16

models. Id.91 Keith Bradsher, ‘Changes in Ford Explorer Aim

At Protecting Other Motorists’, New York Times, Au-

gust 4, 2000, at C1 (the new Explorer, with a new op-

tional third row of seats, will be 200 pounds heavier).

See also Ford Motor Company, Corporate Citizenship

Reports, 2001 – Our Learning Journey 44

< www.ford.com > . Some SUVs began to be offered

with unit-body design, rather than a stiff pickup truck

frame, and lighter weights, but they were offered in few

models and largely not models of U.S. manufacturers.

SUVs: Safer Up Front? Consumer Reports June 2000 at

50 (BMW X5, Lexus RX300, Nissan Pathfinder, Toy-

ota RAV 4, Mazda Tribute, Ford Escape and Pontiac

Aztek). The average weight difference between passen-

ger cars and SUVs and other light-trucks has been

increasing over the years. In model year 1990, it was

830 pounds and by model year 2001 it had increased to

1130 pounds. Testimony of Jeffrey W. Runge, Admin-

istrator, National Highway Traffic Safety Administra-

tion, before the Senate Committee on Commerce,

Science and Transportation (February 26, 2003)

< www.nhtsa.dot.gov/nhtsa/announce/testimony/SUV-

testimony02–26–03.htm > .92 John O’Dell, ‘First Drive; A Bigger, Better, Safer

Ford Explorer; Best-Selling SUV and its Mercury

Twin Receive A Thorough Remake for 2002’, Los

Angeles Times, December 6, 2000, at G1 (43 models of

SUVs are sold in the U.S. today, and 40 more are

scheduled to enter the market in the next 4 years). In

fact, by 2003 there were 118 models of S.U.Vs for

sale. Jeff McDonald, Popularity of S.U.V.s Can’t Outrun

Controversy; Concerns over Safety, Efficiency Fuel Debate,

San Diego Union – Tribune, June 8, 2003, at A1. It

was estimated that the announced design features

would eventually save 100–300 of the 1000 unneces-

sary deaths that occur each year due to incompatibil-

ity. Keith Bradsher, ‘Carmakers to Alter S.U.V.s to

Reduce Risks to Other Autos’, New York Times,

March 21, 2000, at A1.93 See e.g., Danny Hakim, ‘G.M. Critical of Regula-

tor Questioning S.U.V. Safety’, New York Times, January

16, 2003 at C16 (G.M. repeats the statement that SUVs

are among the safest vehicles on the road, and blames

rollover deaths on occupants not wearing seat belts). See

also, General Motors, G.M. SUVs: Safety and Shared

Responsibility, November 8, 2003 (statement of Bob

Lange, Executive Director, Structure and Safety Integra-

tion < www.gm.com > .94 See e.g., G.M. Adding Anti-Roll System To More

SUVs, Toronto Star, May 18, 2002, at G10 (General

Motors is making a more sophisticated version of its Sta-

bilitrak system available on many of its SUVs this fall).95 2001 Sport Utility Vehicles and 2003 Sport Utility

Vehicles < www.nhtsa.dot.gov/ncap/cars/2001S

UVs.html and 2003SUVs.html > . The National High-

way Traffic Safety Administration explains the meaning

of these ratings as follows:

In a Single Vehicle Crash, a vehicle with a rating

of:

[5 stars] Has a risk of rollover of less than 10%

[4 stars] Has a risk of rollover between 10% and

20%


30%


40%

[1 star] Has a risk of rollover greater than 40%

National Highway Traffic Safety Administration,

Frequently Asked Questions < www.nhtsa.-

dot.gov/ncap/Info.html > .Dr. Jeffrey Runge,

head of the National Highway Traffic Safety

Administration, has said, ‘‘I wouldn’t buy my

kid a two-star rollover vehicle if it was the last

one on Earth.’’ Jeff McDonald, ‘Popularity of

SUVs Can’t Outrun Controversy; Concerns

Over Safety, Efficiency Fuel Debate’, New York

Times, June 8, 2003, at A1.


96 Based on a comparison of reported vehicle ratings

in 2001 and 2003, only four vehicles rated two stars in

2001 were rated three stars in 2003. The rest continued

to receive a two star rating.97 National Highway Traffic Safety Administration,

NCAP Ratings < www.nhtsa.dot.gov/ncap/cars > .98 Jeff Plungis ‘Fed; SUVs Now Safer, Less Prone to

Roll Over’, The Detroit News, June 23, 2005, at 1C (no

SUV earned a five star rating).99 Danny Hakim, ‘Automakers Agree To Work To-

gether For S.U.V. Safety’, New York Times, February

14, 2003, at A1 (the changes would appear in the 2005

models at the earliest).100 National Highway Traffic Safety Administration,

NHTSA Vehicle Safety Rulemaking Priorities: 2002–

2005, 67 Fed. Reg. 48599 (July 19, 2002), referring to

the NHTSA planning document, NHTSA Vehicle Safety

Rulemaking Priorities and Supporting Research: 2003–

2006 < www.nhtsa.dot.gov/cars/rules/rulings/Priority-

Plan/FinalVeh/Index.html > . See also Danny Hakim,

‘Regulators Seek Ways to Make S.U.Vs Safer’, New York

Times, January 30, 2003, at C1. (federal auto regulators

may propose new safety standards aimed at dangers posed

to occupants of passenger cars in collisions with SUVs).101 Alliance of Automobile Manufacturers, Enhancing

Vehicle-to-Vehicle Crash Compatibility: A Set of Com-

mitments for Progress By Automobile Manufacturers

(December 2, 2003), < http://www.autoalliance.org/

safety/crash > . By September 1, 2007 at least 50% of

each manufacturer’s passenger cars and light trucks in-

tended for sale in the U.S. will satisfy front-to-side head

protection criteria and 100% would satisfy them by Sep-

tember 1, 2009. Similarly, by September 1, 2009 100% of

each manufacturer’s light-trucks intended for sale in the

U.S. will meet the front-to-front crash protection geo-

metric alignment criteria.102 Danny Hakim, ‘Automakers To Offer Plan To

Make SUVs Safer In Accidents’, New York Times,

December 2, 2003, at C5 (just under half of 2004 mod-

els offer side air bags, but many are not standard equip-

ment and some offer protection only to the chest area);

Danny Hakim, ‘S.U.Vs To Be Redesigned To Reduce

Risk To Cars’, New York Times, December 4, 2003, at

A1. About a quarter of 2004 models have side airbags as

standard equipment. Id. at C7, See also Jeff Plungis,

‘SUV Safety Fix To Cost Big 3; Pact Aims To Cut

Deaths In Crashes With Cars’, The Detroit News,

December 7, 2003, at 1B (few GM, Ford or Chrysler

models meet the announced guidelines). Royal Ford,

SUV Agreement Set, Auto Companies Promise Crash-Safety

Design Changes, Boston Globe, December 5, 2003, at

D1 (the lower stances could reduce fatalities in colli-

sions by 16 to 28% and side-impact bags could cut

deaths by as much as 45%).103 National Highway Traffic Safety Administration,

Federal Motor Vehicle Safety Standards; Side Impact

Protection; Side Impact Phase – in Reporting Require-

ments; Proposed Rule, 69 Fed. Reg. 27, 989 (2004).

The agency noted that the industry’s announced volun-

tary efforts would meet the proposed requirements be-

fore the new rule would become effective. It also noted

that the proposed regulation was a first step in improv-

ing side impact protection and reducing the risk of

ejection.104 Danny Hakim, ‘The 2 New ‘Must Haves’ of Auto

Safety’, New York Times, November 16, 2004 at C12

(overall stability control was standard on 21.6% of 2005

models and optional on 19.3 percent. At Daimler

Chrysler, it is standard equipment on its Mercedes divi-

sion models, but offered as an option on only three

Chrysler SUV models. Nissan offers stability control on

all its models, more often as an option than as a stan-

dard feature, while its luxury brand, Infiniti offers it as

standard equipment on all models).105 G.M., ‘Ford Target SUV Rollovers’, The Detroit

News, November 12, 2004, at 1A (until now automak-

ers offered stability control mostly as an option and the

spread of stability control has been slower in the U.S.

than in Europe or Japan. However, Toyota made stabil-

ity control equipment standard on all SUVs a year ago.

Honda pledged to make the equipment standard on all

vehicles in the end of 2006. GM announced it will

make the equipment standard on most large SUVs in

2005 and mid-size SUVs in 2006. Ford made the

equipment standard on the 2005 Explorer, Mercury

Mountaineer, Lincoln Aviator and Navigator SUVs);

Jeff Green, ‘Anti-rollover Systems Raise the SUV Stan-

dard’, Newsday, November 28, 2004, at H7 (Chrysler

will make electronic systems that limit rollovers standard

equipment on SUVs by 2006).106 E.g., Gardiner Harris, ‘Pfizer to Pay $430 Million

Over Promoting Drug to Doctors’, New York Times,

May 14, 2004, at C1; Brooke A. Masters, ‘Drug Com-

pany Unit May Face Indictment’, Washington Post, May

31, 2003 at E01 (Schering–Plough and Warner-Lambert

being investigated by federal prosecutors in Massachu-

setts for promoting drugs for uses not approved by the

FDA); Settlement: Fifty Attorneys General Announce

Settlement With Pfizer Over Improper Off-Label Drug

Marketing, < http://www.naag.org/issues/20040513-

settlement-pfizer.php > (Warner Lambert, a subsidiary

of Pfizer, will pay $430 million in settlements to state

and federal authorities for deceptive ‘‘off-label’’ market-

ing practices regarding its blockbuster drug Neurontin).


107 See Note, Another Use of Oxycontin: The Case for

Enhancing Liability for Off-Label Drug Marketing, 83

B.U.L. Rev. 429 (2003).108 E.g., Gardiner Harris, ‘Spitzer Sues A Drug Ma-

ker, Saying it Hid Negative Data’, New York Times,

June 3, 2004, at A1 (GlaxoSmithKline accused of fraud

in concealing negative information about its popular

antidepressant Paxil); Reed Abelson and Jonathan D.

Glater, ‘A Texas Jury Rules Against A Diet Drug’, New

York Times, April 28, 2004, at C1 (jury in Texas hands

down $1 billion verdict against Wyeth due to lung dis-

ease caused by its diet drug, fen-phen. Thousands of

claims have been made charging the drug caused heart

valve damage, and Wyeth has set aside $16 billion to

cover the cost of litigation).109 Consumer Groups Charge Industry – Wide Price

Manipulation, < http://www.prescription-drugs-law-

suits.com/pal-press-03.htm > (14 coalitions of consum-

ers in 11 states filed suit charging 28 U.S. drug

companies with manipulating the ‘‘average wholesale

price’’ of drugs covered by Medicare); Marc Santora,

‘City Sues Drug Companies, Claiming Medicaid Fraud’,

New York Times, August 6, 2004, at B4 (44 pharmaceu-

tical companies sued by New York City over claims

they inflated drug costs for Medicaid patients); Gardiner

Harris, ‘Drug Makers Settled 7 Suits By Whistle Blow-

ers, Group Says’, New York Times, November 6, 2003,

at C8 (drug companies Astra Zeneca, Bayer, Dey,

GlaxoSmithKline, Pfizer and TAP Pharmaceuticals have

paid $1.6 billion since 2001 to settle 7 suits accusing

them of marketing fraud and overbilling Medicare and

Medicaid); Gardiner Harris, ‘Guilty Plea Seen For Drug

Maker’, New York Times, July 16, 2004, at A1 (Scher-

ing-Plough has agreed to pay $350 million in fines and

plead guilty to criminal charges that it cheated the fed-

eral Medicaid program).110 Robert Pear, ‘Investigators Say Drug Makers

Repeatedly Overcharged’, New York Times, June 30,

2004, at A19 (investigators at the inspector general’s of-

fice in the Health and Human Services Department

found overcharges in 31% of the transactions examined).111 ‘‘I consider it a public heath hazard when people

are misled by false claims,’’ said FDA Commissioner

Mark McClellan. Bernadette Tansey, ‘FDA Slaps Drug-

makers for Misleading Claims’, San Francisco Chronicle,

August 9, at B1.An FDA survey of doctors found that

fully 70% of general practitioners believe drug advertis-

ing to consumers ‘‘confuses relative risks and benefits,’’

and 75% said it causes patients ‘‘to think drugs work

better than they really do.’’ Christopher Rowland, A

Dose of Reality: FDA to Rush Firms To Make AdsCclearer

About DrugRrisks, Boston Globe, September 23, 2003,

at D1. AstraZeneca, Pharmacia Corp., Abbott Laborato-

ries, ICN Pharmaceuticals, Eli Lilly & Co. and Icos

Corp. were all recently reprimanded by the FDA for

misleadings consumers and doctors in promoting their

drugs, by downplaying or failing to mention risks and

lacking balance in their promotions. ‘FDA Reprimands

4 Drug Makers for Misleading Promotions’, Los Angeles

Times, January 16, 2002, Part 3 at 3.112 The FDA warned Purdue Pharma LP about the

firm’s marketing campaign for the painkiller OxyContin

that dangerously downplayed the drug’s risks including

its addictive potential. Raja Mishra, OxyContin Ads to

Carry Prominent Warning of Risks, Boston Globe, January

24, 2003, at A1. Purdue Pharma’s advertisements were

primarily directed at doctors.113 David Firn, ‘US Regulators Tell GSK to Withdraw

TV Advert’, Financial Times, June 12, 2004, at 2. FDA has

recently required a black box warning that use of the

drug increases the risk of suicidal thoughts and behavior

among children. This warning applies to other antide-

pressants as well. Shankar Vendantam, ‘Depression Drugs

to Carry A Warning; FDA Orders Notice of Risks for

Youths’, Washington Post, Oct. 16, 2004, at A01.114 The General Accounting Office has documented

that drugs promoted to directly to consumers are often

the best-selling drugs and has estimated that in 2000

about 8.5 million consumers received a prescription

after viewing a [direct-to-consumer] advertisement ask-

ing their physician for the drug. General Accounting

Office, Prescription Drugs: FDA Oversight of Direct-

to-Consumer Advertising Has Limitations, GAO-03–

177 at 11–16 (October 2002) (hereafter referred to as

GAO Report). Ron Pollack, executive director of

Families U.S.A., a national organization of health-care

consumers, has concluded that direct-to-consumer ads

‘‘have been prepared for the purpose of promoting the

most expensive medications, and for the purpose of get-

ting patients to ask their physicians to prescribe those

most expensive drugs.’’ Aparna Jumar, ‘Doctors Split on

Usefulness of Drug Advertising; FDA Survey Highlights

Debate About Whether Feel-Good TV and Print No-

tices Raise Awareness or Sway Patients to Seek Care

They Don’t Need’, Los Angeles Times, January 14, 2003,

Part 1 at 12. In December 2004 Consumer Reports re-

viewed the benefits and costs of cholesterol-reducing

drugs, drugs for heartburn or acid-reflux drugs, and

drugs for arthritis. As for cholesterol-reducing drugs it

found costs of stations varied from 92 cents to more

than $4.50 per day and that the generic lovastatin, cost-

ing 92 cents to $1.31 per day, was the best choice for

reducing LDL by fewer than 40% when taking effec-

tiveness, safety, and cost into account. As for heartburn

and acid reflux disease, costs of drugs varied from 79

cents to more than $8 per day, and that omeprazole,


costing 79 cents per day, was the best choice. It cost

one-fifth as much as the next least expensive drug and

was likely to be just as effective. As for arthritis drugs,

costs varied from $24 to $306 a month, and the best

choices were generic ibuprofen and salsalate, costing

approximately $24 a month. They were much less

expensive and as effective as other medications such as

Celebrex and Bextra. Consumer Reports, Best Buy

Drugs, < http://www.crbestbuydrugs.co > .115 Gina Kolata, ‘A Widely Used Arthritis Drug Is

Withdrawn’, New York Times, October 1, 2004, at A1.116 Barry Meier, ‘For Merck, Defense of a Drug

Crumbles at a Difficult Time’, New York Times, Octo-

ber 1, 2004, at C4.117 Gina Kolata, supra note 115, at C4. This claim is

also true of two other, similar top selling prescription

drugs, Celebrex and Bextra. Barry Meier, ‘Questions

Are Seen On Merck Stance on Pain Drug’s Use’, New

York Times, November 24, 2004, at C3 (Celebrex and

Bextra have not been proven to provide better protec-

tion for gastrointestinal problems. They often cost more

than $2.50 a pill, compared with pennies for older

painkillers that provide similar benefits).118 Stuart Elliott and Nat Ives, ‘Selling Prescription

Drugs to the Consumer’, New York Times, October 12,

2004, at C1.119 A Canadian study published last year in the British

Medical Journal found that patients who request a drug

are more likely to receive it, even though 40% of doc-

tors, when asked later about the treatment, said they

were ambivalent about prescribing a drug for the symp-

toms presented. Karen Palmer, ‘Marketing to the ‘‘Drug

Culture’’; Canny Advertising Boosts Sales’, Toronto Star,

August 31, 2003, at A1. For example, in 2001–2002

$60 million was spent to promote Paxil as a new anti-

shyness drug. Greg Critser, ‘One Nation Under Pills;

They Can Have Our Meds When They Pry Them Out

of Our Cold, Dead Hands’, Los Angels Times, Decem-

ber 15, 2002, Part M at 6.120 21 U.S.C. § 352 (n).121 21 CFR 202.1 (e)(1).122 21 CFR § 202.1 (e) (5). See summary of require-

ments for print and broadcast advertisements in GAO

Report supra note 69, at 7.123 GAO Report supra note 114, at 17.124 Id. at 21. See also ‘TAP Pharmaceutical Products:

FDA Finds Problems With Flashy TV Ads for Prev-

acid’, Chicago Tribune, September 6, 2002, Business sec-

tion at 2 (FDA issued warning letter regarding the acid

reflux medicine Prevacid because it felt TV ads were

deliberately filled with distractions such as strobe-light

graphics that prevented consumers form focusing on

crucial information. Regulators were upset because

TAP Pharmaceuticals, a joint venture between Abbott

Labs and Takeda Chemicals of Japan, had previously

been notified of objections to an earlier Prevacid ad for

similar reasons); Melody Petersen, ‘U.S. Warns Botox

Maker About Its Ads’, New York Times, June 24, 20003,

at C1 (FDA warns Allergen that its ads for Botox mini-

mized the drug’s risks and promoted it for unapproved

uses. Last fall the company had received a letter from

FDA that said it was misleading consumers by overstat-

ing its approved use).125 GAO Report, supra note 114, at 18.126 GAO Report, supra note 114, at 19.127 Gardiner Harris, ‘Federal Drug Agency Calls Ads

for the Cholesterol Pill Crestor ‘False and Misleading,’’

New York Times, December 23, 2004, at A16.128 ‘Drug Advertising: Is this Good Medicine?’ Con-

sumer Reports, June, 1996 at 62. See also FDA survey,

supra, note 111.129 See May, supra note 6, discussing frequency of

inspection as a factor inducing greater compliance.130 Eric Stein, Quantifying the Economic Cost of

Predatory Lending, A Report from the Coalition for

Responsible Lending, July 25, 2001, at http://www.re-

sponsiblelending.org/research/quantity.cfm.131 Pub. L. 96–221 (1980).132 12 U.S.C. § 173f–7a. States could override the

federal preemption during a 3-year period, ending

April, 1983, by adopting a statute explicitly stating that

the federal preemption contained in Section 501 of

DIDMCA did not apply in that state. Fourteen states

chose to override the federal preemption, although in

some states that override was later repealed, 6 Fed.

Banking L. Rep. (CCH) pp. 64–005.133 Pub. L. 93–533 (1974).134 Pub. L. 90–321, Title I (1968). This article does

not examine various legal standards imposed in state

legislation addressing predatory lending that has been

enacted in the last few years.135 12 U.S.C. §§ 2603 and 2602 (3) (defining ‘‘settle-

ment services’’). 24 C.F.R. 3507 (a) (lender must pro-

vide good faith estimate no later than three business

days after an application is received).136 15 U.S.C. § 1602 (f) and (h) (definition of credi-

tor: and ‘‘consumer); 12C.F.R.§ 226.18 (content of dis-

closures in closed-end credit).137 12 U.S.C. § 2601 (a) (Congressional findings and

purpose). See also discussion in S. Rep. No. 93–866

(1974), reprinted at 1974 U.S.C.C.A.N. 6546, 6554.138 Pub. L. 103–325, Title I, subtitle B (1994).139 15 U.S.C. § 1639 (c). However, certain loans

were exempt from this prohibition. Namely, transac-

tions in which the consumer’s total monthly payment

on all obligations does not exceed 50% of the con-


sumer’s monthly gross income as verified by financial

statements, a credit report, payment records, or verifica-

tion from an employer.140 15 U.S.C. 1639 (h). The prohibition is against

engaging in a pattern or practice of such activity.141 15 U.S.C. §1639 (l) (2) (the Board may prohibit

abusive lending practices or practices that are not in the

interest of the borrower), and 12 C.F.R. § 226.34 (a)

(3). This is aimed at avoiding charging of fees in refi-

nancings where the borrower receives no benefit.142 15 U.S.C. 1602 (a a) (1). The Federal Reserve

Board has, pursuant to regulatory authority granted in

the statute, lowered the interest rate trigger to 8% for

first-lien loans. 12 C.F.R. § 226.32.143 S. Rep. No. 103–169, at 21 (1993), reprinted in

1994 U.S.C.C.A.N. 1881, 1905.144 Id. at 22

145 United States General Accounting Office, Con-

sumer Protection: Federal and State Agencies Face

Challenges in Combating Predatory Lending, GAO-04–

280 (January, 2004).146 Id. at 37 (17 of the actions were filed since 1998).147 Id. at 43.148 Id. at 42.149 A complete list of FTC’s actions, including those

involving allegations of disclosure violations, is found in

Appendix I to the GAO Report.

V. Di Lorenzo

St. John’s University

8000 Utopia Parkway, Jamaica,

NY, 11439,

United States


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