Legal Affairs

The Corporate Tax is Dying!

Cecille Isidro — Thu, 03 Mar 2005 04:00:00 -0500

The corporate income tax has always had enemies. Introduced in 1909 as an effort to close the country's worst budget gap since the Civil War, economists and capitalists almost immediately began to argue that it was inefficient and slowed down business. More recently, Presidents Reagan and Carter, as well as conservative economist Milton Friedman and liberal economist Lester Thurow, have all recommended that the country scrap it. In May 2001, then-Treasury Secretary Paul O'Neill called the tax system of the United States an "abomination" and proposed the abolition of the corporate income tax.

Efforts to repeal it, however, haven't gone far. Taxpayers have long been more frustrated by the taxes they must each pay personally, such as property and individual income taxes. The corporate income tax just doesn't sting the way writing a check on April 15 does.

But there is a long list of shortcomings associated with corporate taxes. Many companies pay more for their accountants' time than they do in taxes, and the Congressional Budget Office has estimated that because of the many inefficiencies the corporate tax creates, it drains as much from the economy as it actually collects. These facts, combined with the country's increased recognition of the incentives that drive American companies abroad, mean that the corporate income tax finally seems to be on its way out.

The corporate tax entered a world without commercial airplanes, much less e-mail. At the time, if a company set up its headquarters in Chicago, its top executives likely couldn't even get to Bermuda. Now a Chicago company can relocate its entire headquarters there with limited effort. This ease of mobility has brought global competition, and companies can leave countries that aren't friendly places to do business.

Unfortunately, however, American corporate tax rates are higher than those imposed by most of our trading partners, and that disadvantage takes its toll. Meanwhile, lower corporate tax rates connect to higher growth. Ireland's recent economic success, where per capital GDP went from well below European Union averages to well above, is attributed in part to the country's reducing its top corporate tax rates from over 40 percent to 12.5 percent.

U.S. corporate earnings are also subject to double taxation. If Microsoft makes a dollar, the federal government takes a cut before the profit can be passed on to Bill Gates, other employees, or other shareholders -- at which point the government takes another cut. From the shareholders' perspective, as partial owners of the corporation, they bear part of the first round of taxes on corporate income, and they bear the second on income received through dividends. Whether you view these taxes as distinct or as duplication, it would be more efficient if the government took a single bigger bite at one point.

Compounding the problem is that in order to reduce the problem of double taxation, many of our trading partners have gone further to integrate their individual and corporate income taxes than we have. For example, Germany exempts 50 percent of dividend income from the income tax, and Greece has eliminated it entirely. Though a measure to reduce the U.S. tax rate on dividend income was recently made law, the change is only a temporary one.

Companies incorporated in the United States face still another challenge. The U.S. tax system is a worldwide system, meaning that the federal government taxes the income of U.S. companies no matter where it is earned. If a company is headquartered in Hartford and has manufacturing plants in Mexico City and Guangzhou, money the company earns abroad is taxed as if it were earned here. Most other industrialized countries use territorial systems where companies pay taxes only on what they earn domestically. This gives companies an incentive to structure themselves as subsidiaries of foreign corporations in low- or no-tax countries. Although companies that choose this course of action risk being denounced as Benedict Arnolds, the tax savings still seems compelling to many of them.

Rather than engaging in a fundamental debate about the corporate income tax, Congress has often addressed aspects of it and tried to plug corporate tax holes by reducing tax rates or providing additional deductions to companies. But even on the rare occasions when these efforts prove successful, a new leak has invariably been sprung somewhere else. Consider the 2004 corporate tax bill. The World Trade Organization determined that part of the U.S. tax system had to be changed to comply with international law and to prevent what the WTO considered to be the illegal subsidization of American goods. Attempts to keep any company or industry from being overly burdened in the process led to a bill with a hodgepodge of tax breaks for tackle box producers, NASCAR track owners, and barge operators.

It may seem inappropriate to float the idea of getting rid of the tax at a time when corporate America's reputation has dropped precipitously. The Enron scandal, United Airlines's pilfering of its employees' pension fund, and the Tyco collapse make it unlikely that Congress would find much support for giving American businesses a free tax pass. They are already getting a pretty good deal, it would seem, given that the percentage of federal revenues coming from corporate taxes has dropped from one third during WWII, and over a quarter during the 1950s, to only 9 percent today.

With large budget deficits also projected to last ad infinitum, politicians who want to maintain old spending programs or develop new ones have to offset the costs -- which makes it even more unlikely that the Congress will now go for eliminating the corporate tax. It has political support, it is administratively feasible, and it has been a part of the American tax system for decades.

But, as the old-but-valid economics adage goes, corporations don't pay taxes, people do. While corporate CFOs may write the checks, the real burden -- or, in economic parlance, the incidence of the corporate tax -- falls elsewhere. Corporations are merely legal entities structured to pass along profits to their owners and investors. Taxes are just another cost of doing business, one that is also passed along, just as when the price of one of the inputs increases for a company. If the cost of cocoa were to go up, that would be compensated for with some combination of responses -- an increase in the price of Hershey's Kisses, a few Hershey's employees losing wages, or a decline in the quarterly dividend of shareholders. The same thing would happen if Hershey's had to pay higher taxes. The cost to consumers would be hidden, but that doesn't reduce the costs to those who bear them.

It's safe to bet that the corporate tax will contribute far less revenue to the bottom line of the U.S. government in the next decade than in the last one. That trend is well underway and, if the corporate tax rate doesn't change, companies will continue to have a big incentive to leave the country, reducing what they pay to the U.S. government as a result.

But there are still a few reasons why we should be careful in eliminating the corporate tax. First of all, current budget deficits leave no room for further tax cuts. With federal revenues as a share of GDP at their lowest level of the past five decades, tax increases would be far more appropriate. If Congress is to reduce or eliminate the corporate tax, then the move needs to be accompanied by a way of increasing revenue, like broadening the income tax base or introducing what is known as a consumption tax. While many consumption taxes are highly regressive, a "progressive consumption tax" with tax rates levied on spending would be both efficient and fair.

Second, the corporate tax is relatively progressive, since much of it is passed on to shareholders, who tend to be well off. Reducing or eliminating the tax out of economic good sense should not have the undesirable effect of shifting the overall tax burden away from the wealthiest to those on the lower end of the income spectrum. With inequality growing, the tax system should be made more progressive, not less.

Finally, eliminating the corporate tax could allow individuals to incorporate and avoid income taxes. It might be hard to imagine your next door neighbor going to the trouble, but for professional athletes and movie stars, corporations created as tax shelters could spring up with abundance. That the corporate tax serves as a backstop against sheltering income is probably the strongest reason today for keeping the tax. At the very least, it argues for keeping the move toward extinction a gradual and managed one.

But arguments for working carefully to eliminate the tax are different from arguments that we should keep it, and there are few of those. The longstanding arguments against the tax -- for example its inefficiency and complexity -- are still there. And now they've been joined by the argument that the tax, in an age of globalization, is driving companies out of the country. All of that combined means that it's finally time to rid the country of a bad economic policy that has been around for nearly 100 years.

A Crime with a Name

Cecille Isidro — Tue, 01 Mar 2005 00:00:00 -0500

Guy Horton has seen people doing forced labor in Burma's jungle, smelled the rotting corpses of villagers killed by bayonets, and heard the cries of a small child being tossed by government troops into a burning hut. But it was something seemingly trivial that convinced the 53-year-old British human rights researcher that he was witnessing genocide.

In 2000, Horton was trekking on a fact-finding tour through Karen state, in the Texas-sized country of Burma. He came upon a village of bamboo huts that government troops had torched. While picking through the ashes of the village, he found a metal cooking pot, upside down, with its bottom smashed in. Until that point, Horton had assumed that he was witnessing the spasms of a 50-year-old war between the ethnic minorities in the jungle and the ethnic majority that controls Burma's government. But the pot led him to a new theory-that the State Peace and Development Council, the junta that runs the country, had come up with a calculated strategy to wipe out the minorities and empty the land. While the villagers who had escaped into the jungle might return and rebuild their homes, they would no longer have the means to cook and sustain themselves.

Horton became interested in Burma in 1998 when he rekindled a childhood friendship with the now-deceased husband of Aung San Suu Kyi, who had won the Nobel Peace Prize in 1991 for her efforts to bring democracy to Burma. Interest turned to obsession, and Horton has spent the past seven years documenting the junta's crimes, recently on behalf of the Netherlands government and a British nonprofit group.

Horton is coy about what he has been doing in this period, and why a former radio reporter based in Eastern Europe turned into a crusader for human rights. He has fought his way through Burma's jungles, which are largely forbidden to Westerners, interviewing victims and taking videos of razed villages. But having been beaten once by soldiers of the junta, Horton worries that additional revelations could place him at greater risk. More importantly, he doesn't want the story of a Westerner to detract from the Asian realities he is determined to expose.

Horton plans to present to the United Nations this spring the results of his investigation-a 600-page indictment of the Burmese regime, now known as the State Peace and Development Council, or SPDC, along with hours of video footage edited by Images Asia, a respected documentary film company. Based on guidance from a key legal adviser in the case against Slobodan Milosevic, Horton will argue that the violence in the Southeast Asian nation now amounts to genocide, defined in the 1948 Convention on the Prevention and Punishment of the Crime of Genocide by the U.N. as any attempt, whether successful or not, "to destroy, in whole or in part, a national, ethnical, racial, or religious group."

Genocide is the most potent term in international law, evoking images of Nazi gas chambers and Rwandan machetes. Burma's adversity is less dramatic than those catastrophes, and Horton may well be rebuffed. But then again, at first so was Raphael Lemkin, a Holocaust survivor whose multi-volume catalogue of genocides throughout history and relentless lobbying helped inspire the genocide convention.

Colonized by the British in the 19th century, Burma was governed as a province of the Indian Empire until 1937. It gained independence in 1948. Bordered primarily by China, India, and Thailand, Burma has recently been defined by its struggle for democracy against the military dictators who have run the country since 1962.

The best hope for democracy came in 1988 when government mismanagement-including a move based on astrological signs to make the country's currency divisible by the number nine-led to mass street demonstrations. The junta nearly collapsed, but retained control by slaughtering several thousand students who were protesting in Rangoon, Burma's capital. Two years later, the government held elections, apparently to curry international favor. Aung San Suu Kyi became leader of the newfound National League for Democracy, which won more than 80 percent of the vote. She was soon put under house arrest, where she has remained, with a few breaks, ever since. Not long after jailing Suu Kyi, the junta renamed the country "Myanmar," the historical name for the pre-colonial kingdom controlled by the Burmans. But most of the world's nations, acknowledging the wishes of the duly elected government, continue to call the country Burma.

The leaders of the current government are ethnically Burman, a group that comprises somewhere around three-fifths of the country's population of 40 million. That number is a loose estimate, however, since Burma hasn't had a thorough census since 1941. The rest of the country is an ethnic melange, cramped within haphazard borders drawn by Britain in the late 19th century. Of the country's 14 political regions, seven are "divisions" populated largely by Burmans and the other seven are "states" named after the ethnic groups that predominate inside them.

Horton is making his case on behalf of three ethnic groups. The Karen and Shan each compose just under 10 percent of the population, and the Karenni make up about 1 percent. All three groups cluster in the east and have languages and cultural traditions distinct from the Burmans. There are crucial religious differences too. The Burmans are Buddhists, while many Karen and Karenni are Christian. Other groups in Burma have faced oppression, including the Rohingyas, a Muslim group in the west that the junta has twice tried to drive out of the country. But the discrimination against the Rohingyas is likely not genocidal, because the government's main goal is apparently not to wipe them out.

The three groups in Horton's brief sided with the British during World War II, when the Burmans joined forces with the Japanese. Tensions simmered when Britain granted Burma its independence after the war, and finally exploded in December 1948, when the Karen attacked Rangoon and tried to secede. There were similar uprisings in Shan state and also in Karenni state, where rebel leaders claimed that the British had granted them national sovereignty. The battles between the government and insurgent armies continued intermittently for decades, worsening in 1988 after hardliners took over the weakened junta. By 1995, the SPDC had conquered much of the east and had driven many of the ethnic minorities into refugee camps on the Thai side of the border.

According to the 1948 convention, in order to prove the junta guilty, Horton must demonstrate that it has committed genocide in one of five ways. The first is "killing members of the group." Most experts estimate that several thousand ethnic minorities have been killed annually for the past 50 years. In a rare moment of candor in 1989, the chairman of the junta acknowledged that the death toll "would reach as high as millions." He was discussing total deaths in the long-running battle, including Burman soldiers, but a high percentage of the dead are ethnic minorities.

The junta doesn't widely practice two of the other methods of genocide-sterilization and kidnapping children-but it regularly carries out the remaining two: "causing serious bodily or mental harm to members of the group" and "deliberately inflicting on the group conditions of life calculated to bring about its physical destruction."

In addition, Horton must establish that there is an attempt to destroy an ethnic group at least "in part," a hazily defined threshold that the atrocities in Burma would seem to meet. According to a recent report by the Thailand/Burma Border Consortium, of the 250,000 surviving Karenni, 88,000 are living on the run in Burma's jungles. Another 25,000 are stuck in Thai refugee camps. In the estimate of the Karen Human Rights Group, an organization based in Thailand, the number of Karen villagers able to live free of massive government oppression in their native state is zero.

The Burmese Junta divides the territory in the Karen, Shan, and Karenni states into three classifications: black zones, where the insurgents maintain nominal control and mobile villages; brown zones, where land is contested; and white zones, where the SPDC troops, known as the Tatmadaw, control everything. The black zones, which make up about 10 percent of the regions in which the Shan, Karenni, and Karen live, are rapidly shrinking. The brown zones and the white zones each compose 45 percent of the ethnic regions.

In the black zones, the Tatmadaw harasses the minorities to the extent that it can. Soldiers block medical supplies from reaching these areas, and they try to kill the people who bring them from Thailand. Nai Aye Lwin, a 33-year-old doctor based at a Thai clinic, slips across the border unarmed a few times every year with medical supplies in a backpack, bringing antimalarial quinine to villagers and making bamboo splints for people maimed by land mines. Though he doesn't carry a gun, he has been shot at and believes that, if captured, he would be killed. The Tatmadaw has also targeted medical clinics in the refugee camps in Thailand. In 1996, the SPDC tried to kill an esteemed malaria researcher working in Burmese refugee camps in Thailand. The researcher escaped by hiding underground.

Attacks and raids are the Tatmadaw's preferred approach in the brown zones. Because the terrain is often impassable by vehicle, the soldiers typically approach on foot. The villagers, on constant lookout, usually spot them and flee into the jungle. An empty village is vulnerable, however. The soldiers often burn entire communities, even though the villagers build their huts far apart to make it harder for them to catch fire. Before leaving, the soldiers often kill the livestock they don't eat and plant land mines around the village to harm those who return.

As a result, hundreds of thousands of Karen, Karenni, and Shan have been pushed into nearby jungles where they live as what the U.N. classifies as Internally Displaced People. Families in these impoverished regions are barely able to survive even when they are left alone. On the run, it's much harder. The lucky subsist on a diet of leaves and jungle animals like snakes. The rest starve. Kwa Say, an IDP who spent 10 years living in the forest, said that all of his peers "were killed by the [SPDC] or by malaria."

The Tatmadaw wreak the most damage where their control is greatest-in the white zones. Executions are common, forced labor is ubiquitous, and rape is pervasive.

Daw Aye Tum, a 50-year-old woman in the Mae La refugee camp in Thailand near the Burmese border, was unable to sit still in an interview last fall as she described what she'd been through. She picked her nose, scratched her eyes, coughed, spat on the floor, and smoked. Her village in Karen state was occupied by government soldiers from the time she was a young woman to when she fled five years ago. She was forced to do road work and carry loads for soldiers until she became head of the village. Then, she had to assign villagers to forced labor in order to meet the government's quotas. Workers whom the soldiers deemed too slow or too weak were beaten. Aye Tum remembers one neighbor dying of exhaustion.

The brutality could be more direct as well. Aye Tum recalled when SPDC soldiers buried four of her fellow villagers up to their necks in the middle of the village and beat them to death with shovels, claiming the villagers had aided insurgents.

Dozens of refugees interviewed in Thailand echoed Aye Tum's experience with forced labor. Naw Mumu, a 19-year-old Karen who lives in the Umphiur refugee camp, said that she began clearing and building roads for the SPDC when she was 10. "Whoever could handle a shovel would go," she said. Naw Bobo Sweet, a 51-year-old mother of six in the same camp, said that she performed forced labor "every week, and every month" of her life after Burmese troops arrived in her village in 1991 and forced her to relocate to a new, tightly controlled village. Bobo Sweet fled that village with her family six years ago.

The tasks forced on villagers go beyond road work and basic portering. Naw Mumu, a Christian, said that SPDC troops forced her and her fellow villagers to knock down their church. Saw Tamla Wah, who lives in the Mae La camp, had to raze a neighboring village's rice paddies.

Major Thawng Za Lian, a Christian former soldier in the SPDC's army who defected after being told that converting to Buddhism was his only chance at promotion, said that he has witnessed many of these offenses. Lian said that in 1995 he worked in the southern regions of Karen state, protecting a pipeline being built into Thailand to transport natural gas for the French company Total and the American company Unocal. He knew that the region had once had many villages, but when he arrived, "There were no villages. The houses were all collapsed, and the people had all been chased out by the army."

Lian added that forced labor was frequently used, and he admitted that he had drafted Karen villagers to move the army's munitions. Lacking sufficient trucks or helicopters, the army needed people to carry its supplies. Almost none of them were paid.

Rape is often the vehicle for the savagery of the SPDC. A 2002 report by the Shan Women's Action Network, which was also substantiated by the U.S. State Department, notes that "rape is officially condoned as a weapon of war." Burma defines ethnicity through the father, so a child born as a result of rape means one less minority and one more Burman. But the soldiers have other purposes besides diluting bloodlines. According to the same 2002 report, 10 soldiers in Shan state tied a man to a tree and proceeded to take turns raping his 7-months-pregnant wife close enough for him to hear what was happening. "This is about humiliating the local population and saying 'We are destroying your community and your women,' " said Charm Tong, who contributed to the report.

To Horton, all of this adds up to genocide. "Forced labor isn't genocide; relocation isn't genocide; taking food isn't genocide; torture isn't genocide," he said. "But all of them combined mean that you can't survive."

Horton can demonstrate a longstanding government policy of "Burmanization," the effort to make all of the ethnic minorities adapt to the norms, values, and culture of the majority. The government bans schools from teaching in the native languages of their students and prohibits cultural festivals as well. According to Charm Tong, traditional dance is often forbidden in Shan state and villagers are made to watch Burman dance ceremonies. "What is the SPDC's intention? It's not to kill every Karen. Even the Nazis did not succeed in killing every Jew," said May Oo, a Karen teacher. "What they want to do is to kill the literature, kill the roots, kill anything that we could point to."

But Burmanization is a far cry from genocide, and the convention requires proof of intent of destruction. Horton has documents showing that dozens of commanders ordered specific massacres, and he can point to a 1992 speech by Ket Sein, the junta's health minister, who reportedly declared in front of a large group in Rangoon: "In 10 years, all Karen will be dead. If you want to see a Karen, you will have to go to a museum in Rangoon."

But not surprisingly, few official documents lay out a deliberate campaign of genocide commissioned at the highest levels. According to Major Lian, soldiers were taught about the international rules of war and then warned not to write anything down if they violated them. "If there is something that is not in accordance with the law, that would be given by oral orders," he said. "For example, in the battlefield, if the village has to be burned, that order would be given orally."

The crux of Horton's case is that abuses this prolonged and widespread couldn't have happened because of a few rogue commanders. In 1998, a special rapporteur for human rights in Burma observed at the U.N. that violations this systemic are "the result of policy at the highest level entailing political and legal responsibility."

The Junta, on the other hand, characterizes the Karen, Karenni, and Shan as losers in a series of civil wars who prefer battle to compromise and who could end the violence by submitting. "Only when all the national races cherish and love their motherland will they be able to live together with unity and solidarity," said Than Shwe, the leader of the junta, in 2003. In support of this view, oppression has abated in some areas where rebel groups have laid down their weapons. Supporters of the junta also point out that many ethnic minorities prosper in the country. The only neurosurgeon in Burma, for example, is Karen.

As the junta also insists, the insurgents have committed their share of sins. Simon Po, a former soldier for the Karen insurgency who now lives in Thailand, said that when they captured a soldier of the junta, they'd sometimes torture him, but "usually, we'd just kill him with a knife."

Horton can't dismiss these arguments, particularly when they are voiced by activists who genuinely want to reform and would seem to be his natural allies. The president of the U.S.-based Free Burma Coalition, Zarni (many Burmese have just one name), believes Horton's analysis is distorted, and that the ethnic groups and the junta are engaged in a deep-rooted battle over resources and political power. The minorities want sovereignty, whereas the junta wants to keep the country whole. "The conflict is deeply political with ethnic dimensions, not the other way around, as in Bosnia or Rwanda," Zarni said.

Other skeptics worry that Horton's quest could distract from the central aim of bringing democracy to Burma. May Oo, who studied law in the United States before going back to the Thailand-Burma border where she teaches at a school for refugees, said that she has wanted to push a claim of genocide against the junta since the mid-1990s, but that American activists have dissuaded her. She said she was told "not to rock the boat because it would divert attention from the democracy movement." Another concern is that the junta would be less likely to accept a political settlement if it feared it would be tried for genocide.

Whether the destruction in Burma meets the legal definition of genocide strikes many of Horton's critics as beside the point. They see the word as a political, more than legal, tool whose visceral strength must be protected from overuse. Applying the term to the situation in Burma now could dilute the term's power for application in more dramatic cases, like the slaughter of Black Africans by Arabs in Darfur, Sudan. Matthew Daley, a State Department official who worked on Asian affairs from the late 1970s to 2004, said, "There is no country that we are more prepared to criticize than Burma," but he added that no one in the U. S. government wanted to use the term "genocide" while he was there. David Steinberg, a professor at Georgetown University and a respected historian of Burma, said that it "debases the term" to describe the numerous abuses in Burma as genocide.

The Genocide Convention, however, was intended to apply to places where there's a genus (the Greek word for people) and a cide (the Latin root for killing). If people want an unadulterated term for what the Nazis did to the Jews-which Winston Church famously called "a crime without a name"-there is one: holocaust. Genocide is also much more than a rhetorical device. It's the rare crime that the international community has effectively punished. Rwandans and Serbs now sit in prisons because they violated the convention.

In April, Horton plans to travel to the United States, Canada, and Holland to line up allies and explore how best to present his legal arguments. At the moment, he has little real support beyond two Christian groups in England called Christian Solidarity Worldwide and the Jubilee Campaign.

His preferred option is to convince one of the nations that has ratified the genocide convention to bring a case against the junta in the U.N.'s International Court of Justice. Horton could also ask the U.N. to set up a commission of inquiry to determine if genocide has occurred in Burma, as a preliminary step to bringing formal charges. Either of these scenarios could help provide legal justification for an internationally sanctioned invasion or a peaceful intervention to remove the junta from power. Horton's advocacy might also prompt additional sanctions against Burma or greater assistance for the refugees and IDPs. Right now, almost no international assistance goes across the Thailand-Burma border.

Horton knows that however he brings the case, his arguments will be judged based on his answers to a series of questions: Are these ethnic groups being destroyed at least "in part"? Is the SPDC doing one of the five things proscribed by the genocide convention? Does the junta have an intent to commit genocide? While he's sure the answer to each is yes, Horton bristles at having to meet what he considers a legalistic challenge. "When the SPDC comes into a village, they burn the houses, rape the women, and kill the chickens," he said. "They don't worry about these categories."...

Common Denominator

Cecille Isidro — Sat, 01 Jan 2005 00:00:00 -0500

Malaysia and Indonesia couldn't be called twins, but they might be called siblings. The adjacent Southeast Asian nations possess similar natural resources and their citizens speak similar languages and follow similar strains of Islam. But Malaysia's economy is prospering while Indonesia's is floundering. Malaysia's stock market is far more vibrant than its neighbor's, and its average resident is three times richer.

Economists might explain these divergent paths by pointing to the countries' different responses to the Asian financial crisis of the mid-1990s. Sociologists might find a cultural explanation in the close-knit community of Chinese immigrants who are the most powerful force in Malaysia's business community. Historians might point out that Malaysia's struggle for independence was much less bloody than Indonesia's.

Another explanation lies in the countries' legal systems, however. Malaysia was a British colony and its legal system is based on the common law: the set of rules, norms, and procedures that has guided the legal system of England and the British Empire for about nine centuries. Indonesia was a Dutch colony and its legal system derives from French civil law, a set of statutes and principles written under Napoleon in the early 19th century and imposed upon the lands he conquered, including the Netherlands.

According to research published by a group of scholars beginning in 1998, countries that come from a French civil law tradition struggle to create effective financial markets, while countries with a British common law tradition succeed far more frequently. While the scholars conducting the research are economists rather than lawyers, their theory has jolted the legal academy, leading to the creation of a new academic specialty called "law and finance" and turning the authors of the theory into the most cited economists in the world over the past decade.

The evidence supporting their theory is hardly absolute. For starters, some civil law countries handily outperform common law ones. Although it may not stack up well against Malaysia, Indonesia looks positively affluent when compared with common law countries like Ghana or Sierra Leone. The logic underlying the theory isn't universally accepted either. Legal and economic scholars alike have attacked nearly every premise and conclusion, though the frequency and fury of the attacks seem to be evidence as much of its importance as of its flaws. If true, the theory provides more than just a new way of looking at legal history-it also gives Indonesians gazing across the South China Sea at their far richer neighbor insight into how they might catch up.

The idea that legal origin can explain national market differences comes from four economists who are referred to in their field by the acronym LLSV: Rafael La Porta of Dartmouth's Tuck School of Business, Florencio Lopez-de-Silanes of the Yale School of Management, Andrei Shleifer of Harvard's economics department, and Robert Vishny of the University of Chicago's business school. Though the law is at the heart of their theory, none of the scholars has a J.D. "We're all lawyer wannabes," Lopez-de-Silanes said recently.

Shleifer organized the group, and he's the best known of the four. In 1975, at age 15, he immigrated to the United States from Russia and soon entered Harvard, claiming to have learned English by watching Charlie's Angels on television. He earned tenure at Harvard before turning 30. In 1999, Shleifer won the John Bates Clark medal as the most accomplished economist under 40, an award second in prestige only to the Nobel Prize in the profession. He's also recently gained notoriety for a scandal over whether it was illegal for him to personally invest money into the same Russian markets that he was helping to design in the mid-1990s, while funded by a government grant. (Lopez-de-SIlanes also ran into trouble after this article went to press. He recently lost tenure at Yale University because of alleged double billing.)

Shleifer and Vishny were graduate students together at the University of Chicago, and in 1994 they founded an investment firm that now manages about $25 billion. Shleifer later met Lopez-de-Silanes and La Porta when they were his students at Harvard. Asked how much the group knew about common law and civil law when the project commenced, Shleifer said, "Nothing, literally." But the scholars did have an instinct that the nature of laws could explain important national differences. Three of the group's four members grew up in countries whose economies collapsed in their adult lives in large part due to corruption that legal systems failed to stop: La Porta is from Argentina, Lopez-de-Silanes is from Mexico, and Shleifer is from Russia.

LLSV's initial work examined why some government regulations of markets succeed in creating and maintaining an environment where people want to invest, and others don't. Intrigued by what seemed like patterns related to legal history, LLSV built a database that included every country with a stock market in the world and then classified each country's legal origins. The group then ran mathematical tests to determine correlations between legal origin and other variables like measures of corruption and indices of shareholder rights. In 1998, their first major paper, "Law and Finance," set off a firestorm.

Though there are other systems with international scope-Islamic theocratic law, for example-most countries' legal systems derive from either French civil law or English common law. Legal scholars had of course already cataloged the differences between the two, but until "Law and Finance," no one had tried to link these differences to the success or failure of financial markets. Nor had anyone ever mathematically examined the differences between the two systems.

LLSV's main tool was regression analysis, a mathematical technique in which many variables are plugged into a program that sorts out which ones are correlated and which ones are not. Using regression analysis, for example, you could plug in the heights, weights, and eye colors of 100 people. The results would show that height and weight are correlated (the taller you are, the more you're likely to weigh) but that weight and eye color are not.

Using this tool, "Law and Finance" showed that common law countries protect both shareholders and creditors better than civil law countries do, and they also tend to be less corrupt. LLSV took dozens of specific financial indicators-ranging from key gauges, like the odds that a company's assets will be confiscated by the state, to smaller measures, like whether shareholders can vote at company meetings-and regressed them all against legal origin. The regressions showed that the measures that indicate high investor and creditor protection or low corruption connect to common law origin, just as height connects to weight. The measures that represent low protection and high corruption connect to civil law origin.

The regression didn't show that common law necessarily makes people richer, but it did represent a crucial link in a chain of logic that could connect legal origin to prosperity. When shareholders have more rights, people are more likely to invest in markets, because they have more protections against dishonest executives. When creditors have more rights, they are more likely to lend money, which spurs markets to grow. And when countries are free from corruption, investors put more money into them. The LLSV scholars weren't the first to recognize that shareholder and creditor rights spur economic growth, or that corruption stunts it, but they were the first to connect these conditions to a country's legal system and to do so using cold, hard numbers.

There's nothing in the common law per se at significantly protects shareholders-common law doesn't come with a shareholder's bill of rights. Nor is there a mandate for corruption embedded in civil law. "Law and Finance," then, raised as big a question as the one it claimed to answer: Why is a country's legal system so powerful a factor in determining its economic development?

In subsequent papers, LLSV has set out to solve that mystery. The most compelling theory they've developed has to do with the power both systems afford their judiciaries. Common law judges are, on balance, far more powerful than their counterparts in civil law countries. Since judges tend to be a country's most reliable check on the other parts of its government, common law countries grant less power to their executives than civil law countries do. And in developing nations, corruption is generally perpetuated from the top.

The difference in the power that the two systems grant their judges is rooted in their respective histories. French civil law derives from the Napoleonic code, published in 1804 by scholars eager to wrest power from the judiciary. Before the country's revolution, France's courts had earned reputations for elitism and corruption. Influenced by popular discontent with much of the judiciary, Napoleon attempted to write a statutory code that was essentially judge-proof. Judges draw their influence from their power to interpret laws. Napoleon's code stripped them of this prerogative; his code favored the writing of a new law over a judge's interpretation of an old one. Consequently, compared to common law countries, civil law countries have weak judiciaries-and long statute books.

Common law was similarly influenced by a violent revolution that pitted the people against the crown. But in the years leading up to England's Glorious Revolution in the late 17th century, the judiciary tended to side with the people and against the Stuarts, who had tried to eliminate an independent judiciary. When the revolution came, the new government gave the judiciary far more power than France did a century later. Courts could interpret laws and even overrule the executive branch.

Legal historians didn't need LLSV to tell them all this. They knew that common and civil law countries differ fundamentally in the roles that judiciaries play. But LLSV was hardly content just to recite the old histories and anecdotes. They went back to their calculators and, in a 2003 paper titled "Judicial Checks and Balances," they demonstrated mathematically that common law countries give judges more independence, which in turn correlates with the sound economic policies they had examined in "Law and Finance." The paper compared factors like whether judges in a country's highest court system have life tenure against measures of what LLSV called economic freedom, such as whether people have secure property rights. The numbers showed that judicial independence closely correlates with common law legal origins. It also correlates strongly with economic freedom and investor protection.

Again, the idea that judicial independence was related to economic freedom wasn't revolutionary. You can find arguments for judicial independence in The Federalist Papers. But James Madison didn't back up his theories with regression analysis.

LLSV gained notoriety and presticge with "Law and Finance," and they've built on it, as co-authors publishing close to a dozen papers since. According to Essential Science Indicators, a research service that tracks publications, over the past 10 years, Shleifer's papers have been cited more frequently than any other academic writing about business or economics topics. Vishny is a close second, with Lopez-de-Silanes in seventh place, and La Porta in eighth.

From their first publication, the quartet had clearly uncovered something deeply original and surprising, and the legal academy reacted with a combination of fascination and disdain. Lawyers are generally trained to answer narrow questions with detailed intellectual or historical analysis. LLSV had ventured to answer a far-reaching question with sweeping mathematical analysis, and they had done so in a decidedly pro-market framework. ("We use the term 'good' in this paper to stand for good-for-capitalist-development," they wrote in one paper.) Their approach pricked up the ears of the legal academy-and raised its hackles. Soon after the first drafts of "Law and Finance" began circulating, LLSV was presenting the paper at conferences around the world and, according to La Porta, receiving "a lot of hate mail."

"The first time that I saw LLSV's work I had two thoughts. The first was, Why didn't I think of this? It's such a simple, brilliant thing to do," said Mark West, a professor of law at the University of Michigan. "The second thought was: This is just way too simple. . . . I can't run regressions [analyzing] the houses in my subdivision. They are running regressions on countries."

West has published a widely read paper mocking LLSV's work. "LLSV controlled for GDP growth and the logarithm of real GNP," he notes dryly. "In this model, I control for a potentially more relevant development-related factor in this context: the number of professional soccer players per capita." With bravado no doubt inspired by LLSV's work, West then takes the parody a step further, attempting to prove that civil law countries fare better than common law ones in international soccer tournaments. The paper is the most widely read comment on LLSV's work on the Social Science Research Network.

But West has launched substantive attacks on LLSV's actual findings as well, believing that they have relied heavily on oversimplification in order to make their analyses work. He points to Japan, which LLSV codes simply as a German civil law country. But the foundation of Japan's legal code comes from China. Some of it did come from Germany during the late 19th century, but still other sections came from elsewhere. The laws covering corporate conduct, for example, were imported from Illinois state law by professors from the University of Chicago during Japan's postwar reconstruction. "You can't code an entire legal system with all of its societal baggage into one entry on a spreadsheet," said West. "That's just wrong."

Other scholars don't question the data so much as the hypotheses LLSV draws from it. They point out the thinness of the quartet's explanation that common law correlates with judicial independence, which in turn correlates with economic liberalism. "The puzzle was less the econometric results than their explanation for the differences. I think it's fair to say that most lawyers, whether trained in common or civil law countries, thought the explanation was nanve," said Ronald Gilson, a law professor at Stanford.

The LLSV scholars admit that this latter point is a weakness that they have yet to fully resolve. Not all the links in their chain of logic are steel. Though they've shown that having a strong tradition of judicial review does correlate with sound economic regulations, for instance, it's a weak enough correlation that the authors know other factors are in play. Think again of height and weight: The two are related, but there are other variables-a fondness for exercise, a taste for chocolate crullers-that can determine how much you weigh.

The LLSV scholars acknowledge these weaknesses in their research. They have little patience, however, for most of their critics in the legal academy, who they believe look through microscopes, not telescopes. According to Lopez-de-Silanes, you can't come up with a theory about the way the world works if you're fretting over whether Canada has been miscategorized as a common law country because Quebec uses civil law. Lawyers worry about such issues, Lopez-de-Silanes said, so they don't have to come up with grand theories. "Lawyers don't do empirical work," said Shleifer. "They just argue with each other."

Yet strong criticisms of LLSV's work have also been leveled by members of their own discipline. One of the most compelling critiques of their theory comes from economists Luigi Zingales of the University of Chicago and Raghuram G. Rajan of the International Monetary Fund. They argue that even if you accept that there are distinctions between countries with common law and civil law origins, that doesn't necessarily mean that legal origins are the cause of those distinctions. According to a paper Zingales and Rajan published in 2003, France had a much more developed stock market than Britain or the U.S. in the early 20th century. It lagged for much of the remainder of the century, but is now catching up. If civil law is fundamentally flawed, you would expect that France would have continued to lag at about the same rate.

To Zingales, the differences that LLSV has shown may not come from something intrinsic to common law or civil law, but rather from some other correlated factor. Correlation is not the same thing as causation, especially when you are looking at complicated global trends. It is said that in the decades between the two world wars, German intelligence agencies divided the world into countries where people tucked in their shirts and countries where they didn't. That classification made some sense because people in industrialized countries feared that loose shirttails could get stuck in machinery. But it didn't mean that a country could mandate that its citizens tuck in their shirts and vault its way into the league of industrialized nations.

Similarly, common law may be linked to strong markets without causing them. Common law countries tend to speak English (a big advantage in the latter half of the 20th century, given American economic dominance) and tend to be Protestant (scholars dating back to Max Weber have connected Protestantism with hard work). Many historians also believe that the British did a much better job than the French of finding economically viable locations to set up colonies. "What LLSV has done is a very clever relabeling of things," said Zingales. "We all know that Anglo-American countries are different. You can call it the English language, the English tradition, and you can code it in all sorts of ways."

The LLSV scholars counter that they have built their regression models to try to take all of these variables into account. In one paper, they compared religious affiliation with legal origin and found that civil law origin has much more of an impact on markets than Catholicism does, just as height has more of an impact on weight than bone density does. It's not possible, however, to control a regression for every factor. Until they can come up with a clear and convincing explanation for what precisely it is about common law that causes the differences they've found, scholars will continue to assail their theory.

The policy implications of the debate over what factors spur economic success make it more than a shouting match echoing inside the ivory tower; they are what lured LLSV into the scrum. "I am from Mexico, and the first goal I have in my life is to make it look nice," said Lopez-de-Silanes. La Porta added that the quartet deliberately chose to look at variables that could lead to solutions. They wanted to avoid focusing on religion, for example, because converting a country from Catholicism to Protestantism isn't possible, at least not for a group of economists. Altering shareholder regulations, on the other hand, isn't out of the question. "[We] look at things that the policy-maker can change," said La Porta.

It's not clear, however, that LLSV's work can translate into practical policy change-in part because their work is so sweeping. Their contention is that civil law leads to profoundly flawed outcomes-that's not something a policy-maker can easily fix. LLSV hasn't discovered a disease in the soil that, once identified, can be eradicated. They've discovered a more fundamental problem: There's something wrong with the region's climate. Consequently, LLSV can't offer an easy prescription. Civil law countries can't just switch over to common law, asking all their judges to throw out their code books. "If you fly into the Cote d'Ivoire, where the new government is just holding on by its fingertips, is the first thing out of your mouth going to be, 'Junk your legal system and adopt the British's'? Not even close," said Roger Noll, an economics professor at Stanford.

Though they may wish otherwise, LLSV has not produced a recipe for success that government ministers in developing countries can follow. What they have done is provide a giant statistical brief in support of the ideas of John Locke and James Madison, and they've updated those ideas for a world that's as interested in economic success as liberty. Creating a judicial branch that can check the executive and the legislature doesn't just protect individual rights and prevent the persecution of the government's political opponents. It improves your stock market.

If 18th-century reasoning can't convince modern constitution writers and lawmakers of the utility of protecting private property and putting judicial checks on other government branches, maybe 21st-century statistics-and economic enticements-can. Indonesia's market won't improve if the new finance minister comes into office this winter with a list of regulations culled from LLSV papers. But Indonesia's stock market might improve over time if the minister has read LLSV's papers and thought about the larger principles of judicial independence and judicial review they espouse.

This, at least, is the path being taken by the French government, for obvious reasons the most elegant and persistent defender of civil law. Initially, the French government ignored LLSV's findings. Then it dismissed them. Starting last summer, it began funding research through its Ministry of Rights and Justice into what the country can learn from LLSV.

Empty Suits

Cecille Isidro — Fri, 01 Oct 2004 00:00:00 -0400

The Association of Trial Lawyers of America has just lost New York senator Charles Schumer. It wanted his vote to block a major new tort reform bill. But the Democrat Schumer's gone and he does not want to be found. Not by ATLA and not by the media, whose calls he and his staff have avoided since he switched sides.

The Class Action Fairness bill, which Schumer long opposed and now supports, would move almost all class action suits, such as those filed over credit card overcharges or defective merchandise sales, from state courts to federal ones, even if all the plaintiffs are in a single state. Between backlogs on federal dockets and a historic lack of interest of federal judges in such suits, say trial lawyers, this move would nearly end class action suits.

In May, Schumer co-signed a letter with another Democrat, Connecticut's Christopher Dodd, promising GOP Senate leader Bill Frist they both would support "class action fairness," which President George W. Bush and America's business lobbies very much want. Dodd is beholden to the insurance industry in his state and his defection isn't shocking. But Schumer? It's unusual for a liberal Democratic senator from New York to turn his back on the friendly financiers at ATLA, long considered one of the mainstays of the national Democratic Party, and particularly of New York's. In late May, ATLA reps assured me that Schumer had not jumped ship. After the senator's defection, Carlton Carl, ATLA's director of media relations, said, "Senator Schumer unfortunately decided to support the class action legislation, but has also indicated he may support some consumer-friendly amendments."

What Carl can't say, but what some of his colleagues in this battle will say off the record, is that the defections are a consequence of the depth to which trial lawyer reputations have sunk in the public's eye. With the public turned against trial lawyers, in significant part because of ATLA's failure to promote them, Democrats desirous of showing pro-business inclinations have little to lose in supporting tort reform. Thus, Schumer is lost.

Founded in 1946, ATLA has been considered one of the most formidable lobbying forces in Washington for decades. Through the '80s and early '90s, it beat back Congressional and state efforts to cap jury awards, and it stopped attempts to make plaintiffs pay if they lost their cases. At the same time, and against the odds, ATLA stalwarts won settlements in cases brought by victims of Agent Orange. From 1990 to 2004, ATLA gave more money to federal political candidates than all but three other organizations.

But now when insiders talk about ATLA's public relations strategy, they talk about its "m.o." Not modus operandi, but missed opportunities. A line attributed to Winston Churchill nicely characterizes ATLA's current ineffectiveness. Describing his political nemesis Clement Attlee, Churchill purportedly said, "An empty taxi arrived at 10 Downing Street, and, when the door was opened, Attlee got out." This time it isn't Attlee, but ATLA.

How badly has the reputation of ATLA members declined? One clue appears on ATLA's website. In an apparent plea for understanding, ATLA's home page now touts a section called "Proud to Be a Trial Lawyer." ATLA members also often stay in the background at events supporting groups of victims visiting Congress. They fear "tarnishing" the situation and undercutting the cause.

An eyebrow-raising example of the declining reputation of trial lawyers is that, in mid-June, members of the American Medical Association -- doctors who have no official compunctions about treating murderers -- debated whether to withhold medical treatment from trial lawyers and their spouses. The resolution at their annual convention was a silly gesture of defiance against the contribution made by successful civil actions to high malpractice insurance premiums, and it was withdrawn prior to the vote. But even its presence on the agenda was an embarrassment to trial lawyers. "Given that he's a trial lawyer, people are surprised that John Edwards doesn't have horns and a tail," said plaintiff's lawyer Jonathan Cuneo, referring to the Democratic vice presidential nominee and one-time trial lawyer who has come under heavy attack for his former profession.

Corporations support the other side and it has more money, yes. But ATLA isn't poor by any stretch. It has faltered for tactical reasons. It has refused to compromise on legislation when doing so would have been prudent. It has done a poor job of promoting the virtues of trial lawyers, whose work product is often the only source of true information about corporate misbehavior and who have gotten real victims real medical care payments. When environmental and pharmaceutical regulators have failed to protect the public, trial lawyers have become the enforcers.

ATLA hasn't capitalized on the profession's virtues because the organization has refused to distance itself from "bottom feeders" -- plaintiff's attorneys who are among the last to arrive at problem issues, do no original work of their own, and get settlements for healthy victims. Consequently, the brave plaintiff's lawyers who defend children maimed by the product of a drug company find themselves lumped together with the people who sue McDonald's over fatty fries.

Carl said that the organization cannot suggest that some behavior and certain kinds of lawsuits are unseemly. He may be right that drawing a line is hard. But it's not impossible, and ATLA's failure to draw it is a big reason why even good-guy trial lawyers are now seen as bad guys.

More likely, ATLA is unaware of its own demise and hasn't begun to react. Most lobbies in Washington try to cast as wide a net as possible. PhRMA, the lobby for the pharmaceutical industry, represents drug companies that disclose every danger of every drug and companies with an ethic that encourages hiding info. But PhRMA's allies are in power on Capitol Hill and in the White House and they control Washington's agenda. ATLA's allies aren't in power in government, or in the media. It's going to need to throw some people out of the tent to succeed again.

The decline of ATLA started in 1994 when Republicans took over Congress and pushed the Contract With America, calling for the passage of a "common sense legal reform act" that would have emasculated Americans' ability to seek damages from corporations in court. Then, GOP donors filled the coffers of the American Tort Reform Association, founded in 1986 to limit jury awards. Financial contributions from corporations and industry groups also supported "think tanks" set up to give a polished imprimatur to studies showing the high cost of lawsuits to the economy.

ATLA won some early battles. In the first months of 1995, the chairman of the Senate Commerce Committee bewailed his inability to pass "loser pays" litigation, damned the trial lawyers lobby for blocking product-liability reform, and said, "We don't have [enough] votes on any of them." A poll in March 1995, paid for by ATLA, showed that 77 percent of Americans opposed tort reform.

But the tide turned, and the Senate passed one of the bills the senator had bemoaned. Now the numbers are reversed. A poll publicized by ATRA last year showed that seven and a half times as many people support tort reform as oppose it. Whether that number is precise, it's clear that ATLA is on the defensive. Today, tort reform bills dealing with malpractice, product liability, standards for evidence in cases dealing with corporations, or award sizes have passed in almost every state.

The Contract's program hasn't been fully realized, but its supporters have passed pieces of the law, and they keep picking up supporters, as with Schumer, and have pursued their goals relentlessly in Congress. One of ATLA's affiliated employees said of the constant influx of bills, "It leads to the Perils of Pauline every two to three weeks."

In April, ATLA "won" a fight in the Senate over a bill limiting certain pain and suffering damages by losing only 49-48, a close enough margin to prevent supporters from stopping a filibuster. In May, no victory could be conjured from the defeat: malpractice caps passed in the House by a 229-197 vote. When Schumer and Dodd, along with Louisiana Democrat Mary Landrieu, switched sides to work with ATRA, no Republicans switched to ATLA's side against the Class Action Fairness Act.

Part of ATLA's slippage comes because of its structure. The organization's presidency turns over every year, creating organizational disarray and recent infighting, according to people who have worked closely with it. The organization also tries to run itself like it's part of the Republican Party, with top-down mandates. It doesn't act like its part of the Democratic Party, reaching out to far-flung and disparate coalitions that politicians like Schumer can't afford to alienate.

ATLA doesn't seem interested in coalitions even when they come knocking at its door. Last year, a congressman pushed a bill to add $25 million for government-sponsored research on pulmonary hypertension, the usually fatal lung disease that can be caused by a drug that was part of the notorious Phen-Fen combination, a diet drug over which trial lawyers won hundreds of millions of dollars in the late '90s. To get this issue on the table, GOP Representative Kevin Brady of Houston was approached and lobbied not by ATLA but by a group of diet drug victims and the Pulmonary Hypertension Association. There was no ATLA presence and no group of trial lawyers marching on Congress to push for this small victory. Perhaps as a consequence, there's still no companion bill in the Senate.

A deeper problem is that ATLA is locked in a Capitol Hill

The Sword of Spitzer

Cecille Isidro — Sat, 01 May 2004 00:00:00 -0400

A little-known law called the Martin Act gives New York's attorney general extraordinary power, yet for 75 years this Excalibur has been left to rust in its scabbard. Now, Eliot Spitzer is wielding it against the biggest players on Wall Street. Should such a powerful weapon be left in anyone's hands?

For three-quarters of a century, an unspoken gentleman's agreement bound the moneymen of Wall Street and the New York attorney general's office. The AG got to use an astonishingly powerful state securities law called the Martin Act, but not against the big boys. Acceptable targets through the years included shady pharmacists, Ponzi schemes, and peddlers of fraudulent Salvador Dali lithographs.

Two years ago, Eliot Spitzer, New York's current attorney general, broke the deal. He took the Martin Act, the securities legislation that is the legal equivalent of King Arthur's Excalibur, and plunged it into the guts of Merrill Lynch. Then he turned his saber on Salomon Smith Barney and the rest of New York's investment banking industry. This past fall he speared several large players in both the hedge fund and mutual fund industries. Others worry that they will face similar fates in the remaining two years of Spitzer's present term. They should.

The purpose of the Martin Act is to arm the New York attorney general to combat financial fraud. It empowers him to subpoena any document he wants from anyone doing business in the state; to keep an investigation totally secret or to make it totally public; and to choose between filing civil or criminal charges whenever he wants. People called in for questioning during Martin Act investigations do not have a right to counsel or a right against self-incrimination. Combined, the act's powers exceed those given any regulator in any other state.

Now for the scary part: To win a case, the AG doesn't have to prove that the defendant intended to defraud anyone, that a transaction took place, or that anyone actually was defrauded. Plus, when the prosecution is over, trial lawyers can gain access to the hoards of documents that the act has churned up and use them as the basis for civil suits. "It's the legal equivalent of a weapon of mass destruction," said a lawyer at a major New York firm who represents defendants in Martin Act cases (and who didn't want his name used because he feared retribution by Spitzer). "The damage that can be done under the statute is unlimited."

Spitzer and his allies, of course, see the law the opposite way, lauding its unlimited capacity for good. Given the deep slumber of the SEC and other important financial regulators since 2000, the glaring improprieties of mutual funds and stock analysts-improprieties that disproportionately harm small, trusting investors-might not have been documented and addressed if Spitzer hadn't forcefully applied the Martin Act.

Either way, there's no question that a little-known New York law, intentionally rendered anemic when first passed in 1921, has morphed into something remarkable, helped along the way by ambitious supporters, neglectful opponents, and generous court rulings. The Martin Act has also given Spitzer the stature he needs to run for governor of New York in 2006-and perhaps, one day, something higher.

The first state statute cracking down on fraud in securities, or speculative investments, was passed in Kansas in 1911. It was nicknamed a "blue-sky" law after hustlers who, the story went, would sell shares of the blue sky if they could. Other states quickly followed, pushed by public concern about fraud as well as by self-interested lobbying from small banks, which worried that money which would otherwise be deposited was being put into securities.

By the end of World War I, the state that served as home to the world's financial capital decided it had to join in. Swindlers stalked Gotham's streets, fleecing the people who were investing with solo speculators and putting money into the stock market for the first time in a burst of postwar patriotic fervor. Much as when shares of Amazon.com hit the NASDAQ, newcomers were everywhere-and they quite frequently lost their bowlers.

New York's legislature was one of the last to pass a blue-sky law, letting through a deliberately enfeebled version. It gave the AG power to counter fraud once it was committed, but left that office with minimal control over who could sell securities in the first place. To the big financial companies that dominated New York politics, a registration law was a bureaucratic burden to be avoided. A simple fraud statute seemed like a good way to swat down small-time sharks and keep the field open for themselves. The weak law went into force in May 1921, bearing the name of Louis M. Martin, its sponsor in the state assembly.

New York barely made use of Martin's act for the first four years of its life, spending almost nothing on enforcement. The attorney general did try to apply it on several occasions in 1923, going after firms like the Multi-Insert Mailing Machine Corporation, which sold stock after spuriously claiming to have developed machines that addressed, folded, and handled envelopes. But he was tripped up by a clause in the Martin Act that granted automatic immunity to anyone who testified under it or even answered questions. "It is said that the Martin law has teeth. It has, but they are an ill-fitting set of false teeth," snapped New York City's district attorney Joab Banton to The New York Times.

In 1925, the law found its first aggressive user, Attorney General Albert Ottinger, who was also successful in pushing for legislation that dramatically limited the act's immunity provisions. Spitzer's forebear in many ways, Ottinger sought out high-profile fraud cases and used the Martin Act to shut down the Consolidated Stock Exchange, a lowbrow offshoot of the New York Stock Exchange. His actions riled major financiers and led to several prominent court challenges. "In this proceeding, if such it may be called, the Attorney General is . . . the complainant, the prosecuting officer and the magistrate before whom the proceeding is instituted," wrote Louis Marshall, a prominent constitutional lawyer, who led the charge against the act.

But Ottinger beat Marshall in the courts and continued his crackdown. At the end of his term, the AG summed up his political record as follows: "Hammer, hammer, hammer, at every manner and means of fraud and dishonesty, the prevention and assertion of which the Legislature has assigned to the Attorney General." Despite the popularity of Ottinger's hammering, however, he lost a close race for the governor's office in 1928 to a former assistant secretary of the Navy named Franklin Delano Roosevelt.

Ottinger left a two-part legacy for Spitzer. He'd set an example for how an AG could use the Martin Act with vigor. And the court challenges he'd faced ended up bolstering the law. The judges who heard them believed that fraud was so endemic that the law needed to be broadened. In the 1926 case People v. Federated Radio Corp., the New York Supreme Court declared proof of fraudulent intent unnecessary for prosecution under the act. Following up, in People v. F.H. Smith Co., the court gave prosecutors a practically blank check by saying that the act should "be liberally and sympathetically construed in order that its beneficial purpose may, so far as possible, be attained." Since then, courts have liberally interpreted every important term in the act-including "security," "material," "public offering," and "fraud"-and have declared that they don't have the authority to review the attorney general's discretion under the act because he is the state's chief law enforcement officer.

Despite its broad powers, the Martin Act was left dormant in the 1930s and 1940s. Then, in 1955, another hyperambitious attorney general, Jacob Javits, hurdled into office. Javits hadn't campaigned against securities fraud, but he saw a great political opportunity. He quickly assigned a lawyer named David Clurman, three years out of Columbia Law School, to rewrite the statute. Clurman decided to make the law as fierce as he could, using as his template mail-fraud statutes written by Learned Hand early in the century before he became a judge. The bluntness of Hand's laws intrigued Clurman. "They just said, 'thou shalt not commit fraud,' " he observed in a recent interview.

Clurman drafted a provision giving the attorney general the power to prosecute people criminally, in addition to civilly, and inserted clauses relieving the AG of the responsibility to prove that any buyer was actually defrauded or that any sale actually took place-allowing the AG to prosecute scams before they had any victims. Clurman also wrote in the broadest definitions of fraud he could think of. And he did his best to avoid ambiguity about the law's intent. "If I repeat myself three times in one paragraph, the court knows what I'm talking about," he said. "I'm not interested in writing well. I am interested in winning cases."

Javits didn't get to use his new weapon. Like Ottinger before him and Spitzer after, he had his eye on a higher office, and two years after becoming AG he moved on to the U.S. Senate. His successors, Louis Lefkowitz and Robert Abrams, largely left the dignitaries of Wall Street alone over terms that together spanned 36 years. With two exceptions from the '70s-Lefkowitz's investigation of financial auditors for failing to conduct surprise audits and his arrest of several American Stock Exchange traders for cooking their books-both AGs limited their focus to quirky hustlers.

A 1978 report sums up the state of the Martin Act before Spitzer. In the late 1950s, the AG's office "was concerned with uranium boiler rooms and promoters of shady Canadian mining stock," wrote Orestes Mihaly, a lead prosecutor under both Lefkowitz and Abrams. Over the years, criminal prosecutions under the Martin Act had expanded to cover "cheats and swindlers" including "the perpetrators of Ponzi schemes upon upstate New York farmers" as well as "rock festival promoters" and "commodity option boiler rooms." In the mid-1970s, Mihaly added, the AG's office was "investigating the latest in investment scams-diamonds and worm farms."

These investigations benefited the public, and often they were daringly carried out. But they used the act only as a tool to go after small-time fraud. And by the end of Abrams's term in 1993, budget cuts had severely reduced the staff of lawyers prosecuting Martin Act cases, sending the act into hibernation. Asked why he didn't use the law aggressively, Oliver Koppell, Abrams's successor, noted that no one on his staff proposed a Martin Act charge to him. He added, "I didn't know it had all these powers."

The Act's long siesta helps explain its current strength. A conservative court or one aligned with Wall Street could well have blunted much of the law's edge. But few high-profile cases have come before New York's courts at times when they might have been inclined to dull the Martin Act's sharpest elements. The law's laxity about registering sellers of securities also helped. Always loath to make doing business tougher, Wall Street has had a compelling reason not to call for the Martin Act's replacement with, for example, the Uniform Securities Act, a standardized blue-sky law followed in 37 other states and jurisdictions that has higher registration standards than the Martin Act but vests much less power in the state AG.

All of this history meant that in 1998, the Martin Act lay ready and resting, waiting for the right young knight to take it into battle.

Eliot Spitzer first ran for attorney general in 1994, at age 35. He had decent qualifications: The son of a very rich real-estate tycoon, he'd excelled at Princeton and Harvard Law School and gained some prominence while working for Manhattan district attorney Robert Morgenthau. There, Spitzer ran a sting on the Gambinos, a mob family that controlled shipping in New York City's garment industry. Ingeniously, the assistant DA set up and managed his own sweatshop, which enabled him to penetrate the family and then bust it for illegally restraining trade.

But Spitzer wasn't a natural politician. "I thought that Eliot would be a professor or a mergers-and-acquisitions lawyer," said Alan Dershowitz, whom Spitzer had helped represent the accused murderer Claus von Bulow after law school. In his first race for AG, Spitzer spent millions of his family's money and campaigned on some creative ideas that now seem ahead of the curve, like stamping numbers on bullets to make them traceable. But he never got traction and showed no common touch. When asked about his favorite Beatle, for example, he mentioned Brahms. He came in fourth out of four in the Democratic primary.

Undeterred, he ran again in 1998. "He felt it was better to lose for a good office and try again if he must than to win for a lower one and rot away," said Dick Morris, a Spitzer family friend and Bill Clinton's former political adviser. Spitzer spent millions more of his family's money and ultimately won a nasty race against the incumbent Republican, Dennis Vacco. At the end, trailing in the polls, Spitzer claimed that his opponent had insulted Hispanics and, he implied, Jews as well. Ironically (it now seems), Vacco accused Spitzer of violating the Martin Act by borrowing money against an apartment building he owned without telling the tenants.

Once in office, Spitzer showed the same tactical creativity and original thinking he had shown in the sting that nailed the Gambinos. He used an obscure section of the Clean Air Act to challenge Midwestern power plants that were polluting New York's air. He sued gun manufacturers under public nuisance laws, which no state had done before. When he took on General Electric for defiling the Hudson River in 1999, he didn't accuse the company of pollution, for which the evidence was mixed. Instead, he charged GE with disrupting river traffic, a move that led the company to agree to dredge the river's most contaminated section.

Given his tenacity and cleverness, Spitzer was perfectly positioned to rediscover a little-known law that gave the AG extraordinary powers. When a securities lawyer and fellow Morgenthau alum named Eric Dinallo talked about the Martin Act during a job interview, Spitzer grasped its potential in a way that his predecessors hadn't. Not long after, Spitzer and his team demonstrated the law's force and effect when they went through the e-mails of a blowhard stock analyst at Merrill Lynch named Henry Blodget.

In January 2001, Dinallo sent a memo to Spitzer laying out proposed priorities for the coming year. Investigating stock analysts was at the top of the list. Two months later, a Queens pediatrician named Debases Kanjilal brought a case against Merrill, arguing that following Blodget's advice about Internet stocks had led him to lose half a million dollars.

The AG's office started a Martin Act investigation in April. But it didn't crank into full gear until July, when Merrill settled the case on terms highly favorable to Kanjilal, suggesting that the company had something to hide. After that settlement Spitzer's team got in touch with Kanjilal's lawyer, Jacob Zamansky. "They really needed to be walked through the business, so I basically drew a map for them, where the bodies were buried, where the conflicts were," the lawyer said.

Early documents and interviews yielded little, but Spitzer's team kept digging and subpoenaing more information. It called in Blodget for lengthy interviews late that summer.

Under the Martin Act, any refusal by Blodget to answer a question posed in the interviews would, unless rebutted, count as proof that he had committed fraud. In addition, Blodget had no right to counsel. Spitzer let him bring a lawyer to the interviews, but the rule still had an effect. "When you are in one of these sessions, they make it clear that you don't have a right to be there and you are there at their pleasure," said a defense lawyer.

Eventually, after subpoenaing every e-mail Merrill's Internet analysts had sent since 1997, the Spitzer team found the mother lode: e-mails from Blodget and others showing that their stock recommendations were influenced by whether the companies in question had promised banking business to Merrill. At one point, in a fit of pique, Blodget had written to the head of Merrill's research department threatening to "just start calling the stocks . . . like we see them, no matter what the ancillary business consequences are."

With that smoking gun in hand, Spitzer soon had Merrill negotiating over possible settlement terms, including how the e-mails should become public and what the company could do to rebuild the wall between its analysts and its bankers. In early April 2002, though, the two sides hit an impasse. With negotiations stalled, Merrill pulled out a big weapon, dispatching former New York mayor Rudy Giuliani to lobby Spitzer. The attorney general, however, pulled out Excalibur.

The same morning that he spoke with Giuliani, Spitzer quietly sent Eric Dinallo to see a New York state supreme court justice, bearing a 38-page complaint against Merrill. With the justice's signature, the Merrill investigation would be conducted under a different section of the Martin Act, and the private negotiations would be replaced with a public investigation-to be analyzed nightly on CNBC.

By midday, to the company's utter surprise and consternation, Spitzer had put out a press release about "a shocking betrayal of trust by one of Wall Street's most trusted names." Merrill's stock price plummeted and its market value dropped $5 billion in a week. For a few anxious hours until a judge stayed his order, Merrill thought that it would have to shut down its entire division that managed assets because of a law that prohibits such activities while a company is under court order. Imagine a wrestler in a tight spot who gets the referee to tie his opponent's legs together: Like that wrestler Spitzer suddenly found himself with all the leverage. Merrill could do nothing but settle on Spitzer's terms. The deal was done within a few weeks.

With Wall Street trembling over Merrill's fate, Spitzer used the Martin Act to bring a similar public case against Salomon Smith Barney and then against the entire investment banking industry. New York's 10 biggest investment firms were forced to pay a total of $1.4 billion in fines. Spitzer next deployed the act to crack down on hedge funds. Then, reacting to a tip from an insider, he nailed the mutual fund industry for its practices of late trading and market timing, which skimmed profits from small investors while passing windfall profits to a lucky few big ones.

Spitzer's boldness has attracted great attention, and talent, to his office. "When we were prosecuting worm farms, it didn't make the front page of The Times, and law students weren't coming to us," said Assistant Attorney General Elizabeth Block, who has worked in the office since 1978. Now, "it's the attorney general and his staff of 15 lawyers going up against the whole mutual fund industry."

That energy isn't likely to dissipate. With two years left in his present term, Spitzer will probably run the Martin Act through a few more opponents.

The public has clearly benefited from Spitzer's merciless investigations. Future stock analysts won't act as scurrilously as Blodget and his colleagues did. Mutual funds will take better care not to siphon money from their small investors. Other hucksters no doubt have been and will be deterred by the flames that engulfed Merrill Lynch.

Just as important, Spitzer acted when Wall Street had hypnotized a number of other watchdogs, in particular the SEC. Harvey Pitt, the SEC chair when Spitzer took on Merrill, was more inclined to serve tea and cookies than subpoenas to financiers. The whistleblower who alerted the attorney general's office to the mutual fund industry scams, Noreen Harrington, says that she approached Spitzer because she didn't trust the SEC to act on her tip.

Spitzer also took a bold political risk, something few Democrats have done in recent years. "You rarely run for attorney general successfully by prosecuting the biggest corporations in your state, represented by the best law firms, with the best PR firms spinning it," said Scott Harshbarger, a former Massachusetts AG.

Spitzer does have sharp critics, particularly off the record. "He's completely reckless and he's completely ruthless. He's a pig and he'll screw you for everything he can to get publicity," said a former director at a major Wall Street corporation. The criticisms may be self-interested, but they have a point to make about Spitzer's overreach. Blodget and his ilk were a sideshow in the dot-com collapse, and their crimes were known to many. A month before Spitzer launched his Martin Act investigation, The New York Times wrote that Blodget was "following Wall Street's custom" when he gave positive ratings to the stocks of companies that chose Merrill to manage their IPOs.

Merrill was certainly in the wrong, but the AG used the Martin Act to almost put one of the nation's most important financial firms out of business for what were venial sins, not mortal ones. When Merrill's customers tried to follow Spitzer's lead by suing the company for losses suffered because of suspect advice-suits that might not have been possible without the documents Spitzer had unearthed-they found themselves tossed out of court. "The facts and circumstances," wrote U.S. District Judge Milton Pollack last July in one such case, "show beyond doubt that the plaintiffs brought their own losses upon themselves when they knowingly spun an extremely high-stakes wheel of fortune."

It's also not clear that Spitzer's fraud squad is the best way to regulate markets, and it's odd that a state-elected official has the power to bring about huge swings in the Nikkei Index, as Spitzer did in April 2002. In addition, the penalties that Spitzer has imposed in the mutual fund case don't seem to match the harms. As part of the settlements with mutual fund companies, Spitzer has demanded that the funds reduce their fees, arguing that the fee structure was inextricably linked to the crimes since small investors were charged relatively more than big ones. That was nice for investors and appealing to voters, but it was a bit incongruous. High fees had little to do with the original problem, and demanding their reduction was a bit like busting a restaurant for health-code violations and then demanding that it lower its prices.

Ultimately, Spitzer may leave an entirely different legacy than his foremost forebear did. Albert Ottinger strengthened the Martin Act, but abandoned a promising political career after losing his bid for governor in 1928. Spitzer, on the other hand, is one of the most popular politicians in the state, thanks to the investigations that the Martin Act made possible. He won re-election in 2002 by 35 points over his Republican opponent, and he has already raised impressive sums for his next race. In the 2004 Democratic primary season, his name was floated for both vice president and U.S. attorney general.

But if Spitzer's timing is good for him, it may not be good for his chosen weapon. He unleashed the Martin Act's wrath on Wall Street at a time when conservatives control most of the country's political system. Last summer, and then again this winter, Congress tried to pass a bill that would have prevented states from settling with Wall Street on terms that differ from SEC regulations. The efforts were beaten back largely because Spitzer called out the Republicans for spending decades trumpeting state power, only to reel in the states once they had taken control of Capitol Hill. Still, expect the federal legislation to have several more lives.

Yet Spitzer is nonchalant about what could happen to the Martin Act once his term ends. At a recent speech to alumni of New York University School of Law, he admitted the potential pitfalls of allowing 50 states to regulate the international financial markets. Diminishing the states' power would be okay, he said, as long as it didn't happen in "the next three years"-a period that conveniently stretches until January 2007, when Spitzer might well have a new job in Albany. Later in the speech, he reiterated his point with striking confidence. "In three more years," he said, "I'll move on to other things."

Spitzer's victories may mark the beginning of the end for the Martin Act. It's also possible, though, that with Spitzer gone the act will return to its former quiescence. Legend has it that after King Arthur fought his final battle, he had Excalibur thrown back into the lake in which he had found it.

Your Cellphone is a Homing Device

Cecille Isidro — Tue, 01 Jul 2003 03:00:00 -0400

If you purchased a new cellphone over the past 18 months or so, odds are that one of the features listed in small print on the side of the box was "E911 capable." Or, as in the case of my latest Motorola, "Location technology for piece [sic] of mind." Perhaps you asked the salesman to explain the feature, and he replied that it means that cops can home in on your phone in case of an emergency, a potentially important perk should you ever find your hand pinned beneath an immovable boulder in rural Utah, as Aron Ralston did recently. Assuming he could have gotten a signal, an E911-capable phone might have saved the young backpacker the pain of having to amputate his own arm.

What your salesman probably failed to tell you -- and may not even realize -- is that an E911-capable phone can give your wireless carrier continual updates on your location. The phone is embedded with a Global Positioning System chip, which can calculate your coordinates to within a few yards by receiving signals from satellites. GPS technology gave U.S. military commanders a vital edge during Gulf War II, and sailors and pilots depend on it as well. In the E911-capable phone, the GPS chip does not wait until it senses danger, springing to life when catastrophe strikes; it's switched on whenever your handset is powered up and is always ready to transmit your location data back to a wireless carrier's computers. Verizon or T-Mobile can figure out which manicurist you visit just as easily as they can pinpoint a stranded motorist on Highway 59.

So what's preventing them from doing so, at the behest of either direct marketers or, perhaps more chillingly, the police? Not the law, which is essentially mum on the subject of location-data privacy. As often happens with emergent technology, the law has struggled to keep pace with the gizmo. No federal statute is keeping your wireless provider from informing Dunkin' Donuts that your visits to Starbucks have been dropping off and you may be ripe for a special coupon offer. Nor are cops explicitly required to obtain a judicial warrant before compiling a record of where you sneaked off to last Thursday night. Despite such obvious potential for abuse, the Federal Communications Commission and the Federal Trade Commission, the American consumer's ostensible protectors, show little enthusiasm for stepping into the breach. As things stand now, the only real barrier to the dissemination of your daily movements is the benevolence of the telecommunications industry. A show of hands from those who find this a comforting thought? Anyone?

GPS tracking is already a staple of workplace surveillance, especially for those not bound to desks. Trucking companies have long outfitted their fleets' semis with devices that monitor how long and how frequently a driver stops to rest. Now the vogue is for smarter GPS versions, which can pinpoint exactly where each truck stops en route. A New York Times article reported on a Texas company that busted an employee whose vehicles had been spending on-the-job time in the parking lot of a strip club.

The difference between that and E911 tracking is the nature of the relationship between the tracker and the trackee. Private-sector employees are essentially at the mercy of their bosses, a power dynamic that the courts have affirmed again and again. When using company-issued equipment, there is no "expectation of privacy," perhaps the most important legal test in deciding whether incriminating data was obtained lawfully. That's why The Times was able to check the cellphone records of the disgraced reporter Jayson Blair, who was fired for fabricating interviews and facts. The records revealed that on days that Blair professed to be reporting from West Virginia or Maryland, his calls were routed through cellphone towers in New York -- ironclad evidence that he'd never actually left home.

Obviously, Verizon and I have a vendor-customer relationship, not a boss-underling one. But the matter is complicated by the public nature of E911 information: It is designed to be shared with emergency services. So a police-friendly judge could easily decide that with this third, governmental player involved, no cellphone user should count on privacy, at least as far as location data goes. Which way the courts will lean, though, is anybody's guess; as of this writing, no criminal case involving E911 has yet materialized.

Handwringing over prickly privacy issues has, of course, inspired many books in recent years. The most popular viewpoint is that espoused in Jeffrey Rosen's The Unwanted Gaze: that electronic records are too accessible and that laws are needed to guarantee that certain data will rarely see the light of day. A smaller -- and, frankly, geekier -- crowd advances the thesis of David Brin's The Transparent Society, which amounts to the following: "Privacy is vanishing. Get over it." Brin, a sci-fi author, contends that the end of privacy as we know it needn't necessarily mean an Orwellian future, because technology will allow citizens to monitor the authorities, too.

Much of the academic discourse has focused on what can be termed "fixed surveillance": websites that track user preferences, bosses who covertly scrutinize employee performance, companies that leak employee medical records to insurers. Tracking a person's physical movement throughout the day is a new type of violation, one that naturally conjures up rather nasty comparisons to the East German Stasi and similarly thuggish outfits. It's one thing for Amazon.com to suggest that, judging by my past CD purchases, I may enjoy the new Mobb Deep album, and quite another for Amazon to spam my phone with a message beginning, "We notice you are standing in a Tower Records store. Did you know that Amazon is selling the new Mobb Deep album for $2 less than Tower?"

The wireless industry has a name for such custom-tailored hawking: "location-based services," or LBS. The idea is that GPS chips can be used to locate friends, find the nearest pizzeria, or ensure that Junior is really at the library rather than a keg party. One estimate expects LBS to be a $15 billion market by 2007, a much-needed boost for the flagging telecom sector.

That may be fine for some consumers, but what about those who'd rather opt out of the tracking? The industry's promise is that LBS customers will have to give explicit permission for their data to be shared with third parties. This is certainly in the spirit of the Wireless Communications and Public Safety Act of 1999, which anticipated that all cellphone carriers will feature E911 technology by 2006. The law stipulated that E911 data -- that is, an individual's second-by-second GPS coordinates -- could only be used for nonemergency purposes if "express prior authorization" was provided by the consumer.

"But no one clearly understands what that means," explains David Sobel, general counsel for the Electronic Privacy Information Center, which has repeatedly petitioned the FCC for a clarification of the law's language -- to no avail. " 'Express prior authorization' has never been fleshed out." Think about the consent process in the realm of software law, where a user must click "I agree" to a licensing agreement in order to install the program. A user irked by some aspect of the agreement can select "I do not agree," but that prevents the software from being installed, which makes the product essentially worthless. There's nothing stopping a cellphone carrier from instituting a telecom equivalent of the shrinkwrap license -- when you break the seal on the box and activate the phone, you agree to abide by the company's conditions. One of those could easily be, "I authorize for my location data to be shared with third parties."

This could very well be the case with my Motorola, one of those spiffy picture phones advertised on TV every 60 seconds. The thick user's guide makes no mention of the GPS chip's privacy implications; Verizon Wireless's website is devoid of any specific language relating to location privacy. The technology industry's attitude toward end-user licenses seems to be "Don't worry, it's too complicated for you to understand." When I asked to be pointed in the direction of Verizon's E911 privacy policy, a company spokesman named Jeffrey Nelson told me, "We don't have a policy, because we're not offering any location-based services at this time." I pushed a little, pointing out that the phones are still GPS-enabled and thus remain able to collect data. "What I can say," Nelson responded, "is that in all of our internal discussions, we do acknowledge the importance of very healthy opt-in promises."

The libertarian counterargument would be that the market will ultimately favor privacy, since most consumers would balk at onerous privacy terms. Smart companies will eventually differentiate themselves from the pack by getting serious about privacy, and the advantage will go to the carrier that can honestly claim, "We're the ones who protect your data, unlike the folks at XYZ Communications, who sell your restaurant habits to the highest bidder." Governmental privacy laws, this line of logic goes, are an unnecessary burden on the private sector.

But laissez faire hasn't really worked as a way of protecting consumers online. Partly it's their own fault. Consumers do a poor job of reading and understanding the privacy statements of the websites they visit. Given the complexity of these sites, though, can you blame them? No one would shop online, or even surf, if it meant reading a long slab of legalese for each site. Cookies? Registration forms that ask for a home address, age, and income? Anything to get that cool Shockwave game a little faster. John Soma, a University of Denver law professor and the author of Computer Technology and the Law, explains that consumers are easily seduced into giving up their privacy: "If you were at a McDonald's in downtown Denver, and you agreed to give everyone three free Big Macs, fries, and a shake if they'd sign away their DNA, you'd have 200 people lined up." Since medical information is considered more sensitive than, say, mere web browsing habits -- think of how your insurance company would love to factor your genetic predispositions into their actuarial tables -- the inducements to obtain other types of data needn't be that lavish. And once signed away, privacy is hard to recoup.

Consumers may also be quite willing to accept an erosion in privacy in exchange for a sweet enough reward. Take the growth of wireless "communities," groups of cellphone users who swap text messages about The Lord of the Rings, pro basketball, or whatever interests they share. As a recent Marketplace report noted, these groups need corporate sponsorship to survive and grow, since most draw no revenue. If the choice eventually comes down to catching the latest Frodo Baggins gossip or staving off Kmart spam, many aficionados will accept the spam. Finnish hunters are already signing up in droves for "dog radar," which allows them to use their cellphones to pinpoint their wandering hounds, who bear GPS locators in their collars. It would take a cold heart to give up on protecting Fido merely because he gives away your location when you take him for a walk.

Then there are LBS companies like Calgary's Cell-Loc, which plans to pitch its location service to worried parents. "I have a daughter turning 16, and I know I'm getting her a cellphone for her birthday," one Cell-Loc employee told The Toronto Star. "She'll be like, 'Great, Mom, thanks for the phone.' I'll be like, 'No problem, I'm going to be tracking your every step.' "

Corporate data collectors do their best to present a trustworthy image, but they haven't always been entirely forthcoming about the details of their practices. Early adopters of the TiVo digital video recorder knew that the box somehow uses the Internet, since it needs to be plugged into a telephone jack. But it wasn't until the Privacy Foundation attached a "sniffer" to a test unit that TiVo's true nature was revealed. Every night, the recorder transmits the day's viewing records back to the company's servers -- which channels were viewed when, when the volume was turned up and down, even the device's internal temperature. (That's not to mention TiVo's habit of recommending shows to viewers based on their past viewing habits, a feature that has famously vexed homophobes, who worry that a peek at a Miss America pageant will convince their box to recommend "gay" fare.) None of this was revealed in TiVo's brochure, which contained only a vague privacy pledge that records are stripped of identification markers -- and a statement that the company's privacy policy was subject to change.

Despite Congressional testimony by Privacy Foundation founder Richard M. Smith, the TiVo revelation stirred only the barest of public outcries and did nothing to push forward privacy legislation. That's not a surprise, as Congress has always been slow to recognize the privacy implications of new technologies. Unauthorized wiretapping wasn't outlawed until 1967, 91 years after "Mr. Watson, come here, I want to see you," and 77 years after Louis Brandeis and Samuel Warren's famous Harvard Law Review article on the importance of privacy as a legal concept. As Rosen writes in The Unwanted Gaze, "The politics of privacy tends to be largely reactive, fired by heartstring-tugging anecdotes that capture the public imagination." Not until after The Washington City Paper published Judge Robert Bork's video-rental records in 1987, for example, did Congress pass the Video Privacy Protection Act, which outlawed that kind of disclosure. At the intersection of privacy and technology, the legislative wheels require considerable grease to start turning.

There's also a substantial anti-privacy lobby, composed of industry front groups that view tough privacy laws as potential revenue killers. The Online Privacy Alliance and the Privacy Council may sound like muckraking Naderite organizations, but they're pure "Astroturf," fake grass-roots lobbies that hammer home the message that privacy restrictions hurt American business.

Law enforcement likewise views privacy laws as an impediment, especially now that it has grown accustomed to accessing location data virtually at will. Take the MetroCard, the only way for New York City commuters to pay their transit fares since the elimination of tokens. Unbeknownst to the vast majority of straphangers, the humble MetroCard is essentially a floppy disk, uniquely identified by a serial number on the flip side. Each time a subway rider swipes the card, the turnstile reads the bevy of information stored on the card's magnetic stripe, such as serial number, value, and expiration date. That data is then relayed back to the Metropolitan Transportation Authority's central computers, which also record the passenger's station and entry time; the stated reason is that this allows for free transfers between buses and subways. (Bus fare machines communicate with MTA computers wirelessly.) Police have been taking full advantage of this location info to confirm or destroy alibis; in 2000, The Daily News estimated that detectives were requesting that roughly 1,000 MetroCard records be checked each year.

A mere request seems sufficient for the MTA to fork over the data. The authority learned its lesson back in 1997, when it initially balked at a New York Police Department request to view the E-ZPass toll records of a murder suspect; the cops wanted to see whether or not he'd crossed the Verrazano Narrows Bridge around the time of the crime. The MTA demanded that the NYPD obtain a subpoena, but then-Justice Colleen McMahon of the State Supreme Court disagreed. She ruled that "a reasonable person holds no expectation of confidentiality" when using E-ZPass on a public highway, and an administrative subpoena -- a simple OK from a police higher-up -- was enough to compel the MTA to hand over the goods.

What McMahon was advancing, in effect, was an extension of the rationale behind the rules governing "pen register" and "trap and trace" surveillance of phone lines. While police need a warrant to listen in on the content of calls, they do not need judicial warrants to monitor the phone numbers a person calls or is called from. The phone company already knows what numbers you are dialing, and their existence as a knowing third party means that you should not expect this data to be kept private -- or so the logic goes. On the Verrazano Narrows Bridge, how could a toll transaction between a driver and the MTA be private, since the bridge is a public space with a zillion other drivers (third parties all) around to witness it? It doesn't take a genius to see how this argument could be extended to location data obtained through E911; if the emergency operator can get access to your GPS coordinates, how can you expect privacy? It's not like the cops are asking to know what you talked about, only where you were.

The 2002 Washington State case State v. Jackson is perhaps the only other instance of the use of location data being contested on appeal, and the conclusion was similar. In the absence of laws specifically addressing GPS, the court ruled that the police didn't need a warrant to attach a tracking device to a suspect's vehicles. The vehicle was in plain view, and the cops weren't intercepting any "communication"; in other words, the tracking conformed to the "trap and trace" standards. Never mind the obvious stretch of applying wiretap laws from the 1960s to such a novel technology.

Any time the police are allowed to act without obtaining a judicial warrant, it is natural to be concerned about whom they're accountable to. How much evidence must a detective present before he or she is given access to someone's subway habits? How easy would it be for the men and women of the 10th Precinct, right behind my apartment in New York City, to find out that I'm fond of taking the F train to East Broadway on Sunday mornings? How about the GPS data from my Motorola? The NYPD's lips are apparently sealed about this matter; despite repeated phone calls and a formal written request, spokesman Detective Walter Burnes did not respond to questions.

The Department of Justice is equally silent on the topic. I submitted a request to the organization's press office for information about the FBI's methods of obtaining location data from a target's GPS-enabled phone, but received no response. David Sobel was not surprised by my defeat, as his organization, EPIC, has been asking for the exact same clarification for well over a year now. Without a potentially precedent-setting case moving through the federal justice system, however, the Justice Department's silence is at least understandable. You get away with what you can.

If new laws aren't forthcoming, perhaps our location-data guardians will be those twin pillars of federal bureaucracy, the FCC and the FTC. Wireless communications are the former's responsibility, and the FCC's official mission, as set out in the 1934 act that created it, is to protect the "public interest." Yet under Bush-appointed chairman Michael Powell, an avowed fan of laissez faire, the FCC has shown little interest in employing its rule-making powers to take responsibility for protecting the privacy of cellphone users. Last August, the FCC turned down a request from the Cellular Telecommunications Industry Association to draw up location-data privacy rules. (Though it is an industry group, the CTIA believes that federal rules -- lenient ones, if it has its way -- would convince consumers that LBS isn't as menacing as it sounds.) The commission explained that it did "not wish to artificially constrain the still-developing market for location-based services."

So all hopes rest with the FTC, charged with holding companies to their contractual word. This is exactly the sort of oversight that's required for the libertarian fantasy to come true. If a cellphone carrier is going to one-up its competitors by positioning itself as a stickler for privacy, there need to be consequences if it breaks its pledge. In Connecticut, the Department of Consumer Protection took a step in the direction of punishing privacy violations in February 2002 when it backed a suit against Acme Rent-a-Car for using GPS monitors installed in its autos to fine renters for exceeding the speed limit. The department successfully argued that Acme's contracts were not upfront about this monitoring, and the company discontinued its policy.

Optimistic that the FTC would confirm that, in lieu of federal statutes on the matter, it would take the lead in making sure no one finds out that I enjoy the occasional Taco Bell feast, I called the agency. Staff members seemed mystified at the prospect of scrutinizing a company's location-privacy policy. I started with a gruff Consumer Protection staffer, high in the hierarchy. He was obviously less than pleased to hear from me. "Never dealt with an issue like that . . . I don't have anyone that's readily available to talk to you," he said, before kicking me down to the Office of Public Affairs.

Despite my appeals to speak with an actual lawyer, an FTC spokeswoman rebuffed my every request -- and, in true government style, passed the buck. "Talk to the F-C-C," she added, enunciating each letter to emphasize her irritation. Clearly, E911 is not an issue to which the FTC has given much thought.

Back to square one, then: no clear laws, no bureaucratic oversight, a permissive judiciary. Aside from saying "Trust us," industry's response is to push technological safeguards, like GPS phones equipped with "I AM HERE" buttons. If you don't want to be bothered, don't press that button when the handset starts flashing. Trouble is, this doesn't really shut off the GPS chip -- the satellites still know where you are. They just won't remind you of that fact.

When it comes to consumer protections, technology simply doesn't have the teeth necessary for the job -- especially when the safeguards in question are manufactured by the same folks who'd love to peddle your location data. But until some privacy Waterloo embarrasses the law into catching up, technology is what we're stuck with. The legendary hacker zine Phrack recently published a how-to guide on building a GPS-jamming device. Maybe I'll head to RadioShack this weekend and pick up the parts. And I'll leave the cellphone at home when I go -- the only surefire way to opt out.

For the Record

Cecille Isidro — Tue, 01 Jul 2003 00:00:00 -0400

In a drab room of a secluded office building in Ghana, 10 secretaries are engaged in a mundane task. They're sitting at wooden desks with huge stacks of paper piled in front of them, typing handwritten legal documents into their computers. When they complete a file, they send it downstairs for proofreading by lawyers in the firm that sponsors the work.

For a decade, those working on the project have entered and proofread 80,000 pages of legal records. They've entered every word from each year of the available Ghana Law Reports, the country's official record of high court, appeals, and supreme court rulings going back to 1959, and all of the issues of Ghana's law reviews, including the University of Ghana Law Journal, dating back to 1964. They've compiled a list of Ghana's laws and regulatory notices. They've also created compendiums on human rights, business, and major Ghanaian cases. Their work is now for sale on CD-ROMs.

Kojo Bentsi-Enchill has overseen this ambitious undertaking. A tall, graceful 53-year-old man with a soothing voice, Bentsi-Enchill founded Bentsi-Enchill & Letsa, one of Ghana's most prestigious law firms, in 1990. The clients of the 15-lawyer firm include mining companies, large banks, and foreign investors and it turns a pretty good profit, but Bentsi-Enchill has nearly bankrupted it on several occasions in his quest to compile a database of Ghana's legal history. (At times, he has moved the database's operations into the basement of his house to save money.) The project has consumed most of his weekends, and many of his weeks, for the past decade. Yet he considers it time well spent, because he believes that an online legal database is essential to the West African nation's stability. Universal access to the law, he thinks, could make Ghana's legal system fairer and deepen its nascent democracy. As he put it, "A law-savvy populace is surely harder to dupe or deprive of its rights than a law-ignorant populace."

Twenty million people belonging to six major ethnic groups live in Ghana. Though neither the biggest nor the most important country in Africa, Ghana has often been an exemplar for the continent. The former British colony led the rush to independence, winning its freedom in 1957 and becoming a republic in 1960. It has had three consecutive democratic elections, each one fairer than the last. It has a free press. More than a dozen newspapers, ranging from the sober to the scandalous, vie for attention at kiosks in cities like Sekondi-Takoradi, Cape Coast, and Accra, the capital. Ghana has managed to remain peaceful in a very tough neighborhood. Just a few hours' bus ride to the east, Nigeria is periodically stricken by ethnic riots, disrupting its political stability and oil supply. And to the west, neighboring Ivory Coast has spent the last six months tottering on the edge of the sort of civil war that has devastated Sierra Leone and Liberia.

But Ghana's virtues don't include a functional system of legal oversight. It has no Freedom of Information Act, for example, and cabinet ministers can write regulatory notices that pass into law without being vetted by the public. The Ghana Law Reports have not been published since 1994, and combined multiyear indexes of the reports don't exist, so lawyers have to pore through every index in the Supreme Court's musty law library to find cases on a topic. Ghana's second-largest city, Kumasi, doesn't even have a law library.

The nearly $2 billion budget of the Ghanaian government is unlikely to make up for these inadequacies. Total per capita income is $390 a year, and government expenditures on the entire legal sector were about $2.5 million in 2001, what a good New York lawyer might earn in a year. The organization that produces the law reports has a staff of four who write in longhand.

The absence of good legal records can lead to bad decision making. A search of Ghana's law reports on Bentsi-Enchill's CD-ROMs suggests that judges often unwittingly violate the law. "Per incuriam" -- which denotes a decision made because of carelessness -- turns up 235 times. The U.S. legal system governs 14 times as many people, but a search of cases on the LexisNexis database turned up only 12 instances of the phrase.

A judge who is not on top of the relevant law may delay a trial to allow himself time for more research. (Indeed, in 1998, the most recent year for which records are available, Ghana's courts rolled over more criminal cases to the following year than they tried or disposed of.) A judge who knows that few people will scrutinize his legal reasoning is more likely to take a bribe than one mindful of observers armed with casebooks and citations.

Ghana's Legal system is a mix of tribal law and British common law. The balance between the two depends in large part on how far a village is from a city with a court. Tribal law predominates in rural areas. "Customary courts" conduct business in all of the nation's 50-odd languages, and each village has its own justice system. Under Ghana's constitution, a village's laws are allowed to differ from, but not directly conflict with, the country's national code. In most villages, local chiefs make a determination of guilt in minor cases such as squabbles over property boundaries or accusations of theft, and they decide the penalties.

In Patriensa, a village toward the south, for example, Chief Nana Yaw Amponsa will consider any matter from anyone in the village who brings him $4, a couple of days' wages for a farmer, or a suitable gift, like a piece of jewelry or some yams. If Chief Amponsa and the six elders he consults -- one from each of the village's major clans -- find a defendant guilty, that person is fined up to $12 and asked to give the chief a bottle of schnapps.

Almost all offenses that reach the level of a felony (such as assault or serious fraud) are decided by the formal court system, which is modeled after Britain's. Judges and lawyers speak English and dress in the black robes and white wigs that Ghana adopted during the days of British colonial rule in the early 20th century. Judges interpret Ghana's constitution, which was first written in 1960 and has been suspended or rewritten six times since then. The current version, from 1992, has survived longer than any of the previous ones. In printed form, it is also the best-selling book in Ghana. Judges in Ghana are bound by the principle of stare decisis, which requires that their decisions be based on earlier rulings. But their knowledge of precedent is limited to the case law that they can find.

In Kumasi, 23 soccer players were recently tried on charges of riotous behavior for allegedly threatening to burn down a police station after being arrested. The trial was as high-profile as they get in Kumasi -- the courtroom was packed with bystanders dressed in everything from flowing black caftans to baggy jeans and worn-out T-shirts. The defense attorney, Kwame Anyimadu-Antwi, planned to argue that the soccer players' chants were covered by freedom of speech, but he did not know if that form of legal protection had ever been interpreted to encompass threats of violence on this scale. Anyimadu-Antwi had a vague memory of similar cases, but he couldn't scan the Ghana Law Reports because his collection is missing 34 of the last 44 years. The presiding circuit judge, Ernest Yaw Obimpeh, might not have known all the laws relevant to the case. Sitting in his chambers with Ghana's coat of arms on prominent display, Obimpeh said, "There are a thousand and one laws passed, and I don't think anyone has access to them."

The United States faced a similar problem a century ago, and it was a traveling salesman, John West, who came up with a solution. West noticed that businessmen in Minnesota couldn't track down crucial state court decisions establishing, for instance, that contracts transmitted by telegraph are as valid as written ones. The newsletter West created in 1872 to report these judgments served as the foundation for the contemporary legal database Westlaw, which is searched nearly a million times every day.

Bentsi-Enchill is the son of Kwamena Bentsi-Enchill, a former Ghanaian Supreme Court justice who lost his job when a military government abolished the court in 1972. (It was reinstated in 1977.) He also wrote the first modern textbook on Ghanaian law and influenced "choice of law" rules, which govern whether customary or common law is applied. As a child, Bentsi-Enchill knew he wanted to be a lawyer, but his father wanted him to come up with a better reason than filial imitation. Eventually, he came up with one that satisfied his father: "It's as good a way of helping one's country as any."

Bentsi-Enchill grew up in the same two-story house in downtown Accra where he lives now. He attended high school in England but returned to Ghana, at his father's prompting, to earn degrees in political science and law at the University of Ghana at Legon, the country's top university. Afterward, he went back to England to do postgraduate research at Cambridge University on the law of mining concessions. He then moved to New York, where he worked as a foreign associate at the law firm of Shearman & Sterling. He was struck by how online legal databases improved the work ethic and research of his colleagues. "It ensured that there was no excuse for not being thorough," he recalled.

While abroad, Bentsi-Enchill kept an eye on his home country as it underwent the worst financial and judicial crisis in its history. Army officers staged coups in 1978, 1979, and 1981. In 1982, three judges who had displeased the military government were kidnapped, murdered, burned, and then tossed by the side of a country road.

In 1988, once Ghana had stabilized, Bentsi-Enchill returned home. He founded his law firm and began a center that provided typing and other services for business clients. After a few years, Bentsi-Enchill became convinced that the absence of good legal libraries was impeding the justice system. From afar, he had witnessed how Ghana's previous military government had undermined order by flouting the courts. Back home, he began to wonder: If military governments can destroy legal institutions, could legal information organized by citizens deter military governments?

The answer seemed to lie in the computers at his office that were sitting idle at night. Seeing an opportunity to do good, and perhaps to do well, he hired secretaries to type in old legal reports after hours. "We had the computers, and we had the employees," he said from behind his desk as he glanced over a prototype of an online legal journal he wants to create. "I had the passion and the willingness, so I said, Why not?"

He established DataCenta, a subsidiary to his law firm, to take charge of the database. He also wrote Ghana's first legal dictionary, which contains statutory definitions. He even inspired one of his law firm partners, Ace Ankomah, to put together the first consolidated index of the Ghana Law Reports. Regarding the database, Ankomah said, "The product is where it is because my partner is crazy. Any sane person would have given up years ago."

DataCenta has won a few grants to support it, but the law firm provided 95 percent of the $300,000 required to build the database. The biggest challenge it faces is not financial but structural. The government of Ghana claims ownership over all legal documents and materials published by the court system. Bentsi-Enchill has to win licenses from the government and pay royalties to publish court proceedings.

CD-ROMs of the database are now on sale at prices ranging from $60 for those containing information about regulatory notices to several thousand dollars for multiuser access to the Ghana Law Reports. This year, for the first time, DataCenta might break even. Bentsi-Enchill is negotiating with the company that owns LexisNexis to make Ghana's legal records available to LexisNexis subscribers around the world. But he would prefer to get a grant that would allow him to put the entire project online for free.

Anyimadu-Antwi has ordered a CD-ROM of the law reports because he believes it will improve his ability to defend his clients. Bentsi-Enchill said that the people he represents at international companies have become enthusiastic users. A small group of judges frequently call his firm to ask the lawyers to search the CD-ROMs for information on past cases.

But the database hasn't transformed Ghana's legal culture. Bentsi-Enchill doesn't have the money to advertise his database, and even if he did, few Ghanaians and fewer lawyers and judges would have the computers necessary or the means to buy the CD-ROMs. Ghana is one of the most wired countries in Africa, but that distinction should be put in perspective: New York City has as many Internet connections as all of sub-Saharan Africa. Only educated, English-speaking, urban Ghanaians have Internet access, and most of them use torturously slow modem connections.

Rural Ghana has few computers and is deeply rooted in tribal customs. Bentsi-Enchill's firm recently advised a chief in a town in the western region to get an injunction against a company that wants to raze the post office and a school to set up a gold surface-mining facility. But the chief decided not to take his advice, and chose instead to try to persuade the company to obey ancient edicts that give him the power to decide which buildings should be erected and which destroyed. The townspeople are deeply attached to their chief -- even though bulldozers could be sent in to tear down parts of their community.

Bentsi-Enchill concedes that his database is "an element of change, not a guarantor of it." He has finished typing for the moment, but his task is far from complete. He must now convince his countrymen that a CD-ROM can offer them hope -- and more power than a chief.

Last Words

Cecille Isidro — Sun, 01 Dec 2002 00:00:00 -0500

It was odd for a man to be pacing around his front yard in the wee hours of a chilly October morning. As Seattle police and paramedics pulled closer, however, they noticed something even stranger: The pacing man, 29-year-old Donyea Jones, was burned so badly, the flesh was literally melting off his frame. "My wife poured gasoline on me and lit me on fire," he explained calmly before being rushed to nearby Harborview Medical Center, where he died of his injuries several hours later.

Tonya Michelle Jones, who'd called 911 at least four times, was arrested at the scene. The pair had apparently been fighting for days over Donyea's alleged infidelity, and they were no longer sleeping in the same bedroom. The night before, when he was high on marijuana, Donyea had threatened Tonya with a gun. Tonya pled not guilty to her husband's murder, insisting that Donyea must have tried to incinerate her as she dozed after drinking heavily. Perhaps, she said, he'd spilled gasoline on himself accidentally and then, stopping to enjoy a cigarette before carrying out his murderous deed, set himself ablaze.

Physical evidence implicating Tonya was scarce. But the prosecution had something even more powerful at its disposal: Donyea's deathbed statement that his wife had done him in. Technically hearsay, since Donyea couldn't take the witness stand, the accusation was admissible as the "dying declaration" of a murder victim -- under an exception to the rule that keeps most hearsay testimony out of court. A police officer who had interviewed Donyea at the hospital testified about what he had said, sealing Tonya's conviction for second-degree murder in November 2000.

Lorraine Roberts, Tonya's attorney, was distressed that the jury would take Donyea, through the police officer, at his word. The dead man had a history of beating his wife and of attempting suicide, and he had allegedly changed key details of his story several times in the hours before his death -- sometimes Tonya tossed the gasoline as he was walking away from her, other times he was sitting on a bed. "But it was extremely difficult for these jurors to get past, 'Why would anybody say something like that if it weren't true?'" Roberts said. "We had no one to cross-examine.... There was absolutely no way to fight this. It's probably one of the worst things that can happen to a defendant."

Countless detective novels and Matlock reruns hinge on the accusatory words of a murder victim, choked out as life ebbs away. Staring eternity in the face, could someone like Donyea Jones be vindictive enough to leave a legacy of vengeance by accusing an innocent person of murder? Most people seem to believe the answer is no. After all, Christianity teaches that St. Peter shoos away liars from the gates of heaven, perhaps strengthening our conviction that a dying person just wouldn't fib.

That thinking is as archaic as the medieval English courts where the principle of Nemo moriturus praesumitur mentiri -- a dying person is not presumed to lie -- originated. During the 12th-century reign of Richard the Lionhearted, when Christianity infused daily life, courts may have been justified in assuming that murder victims would be afraid to risk God's wrath by uttering false last words. In a secularized modern America, however, as Charles W. Quick noted in a classic article on dying declarations, "Anger, wish for revenge, and plain

Under the Microscope

Cecille Isidro — Mon, 01 Jul 2002 00:00:00 -0400

Frayed news clippings from murder trials, blowups of spent bullets, and collages culled from medical textbooks adorn the corridors of the Connecticut State Forensic Science Laboratory. One of the macabre mementos is a poster-sized array of photos connected to an old attempted homicide. In a corner of the frame is a snapshot of a state trooper's jacket, badly creased and caked with dirt; in the opposite corner is a close-up of a tractor-trailer that's also in need of a wash.

A prank gone awry made that truck's driver a cop killer. "There was a process called

From Russia with Lopht

Cecille Isidro — Wed, 01 May 2002 00:00:00 -0400

Had Alexey Vladimirovich Ivanov been born in Chicago rather than Chelyabinsk, he'd likely be well on his way to joining the geek elite. His three-page resume lists computer skills that would dazzle any Silicon Valley headhunter. According to his employment history, Ivanov began working at a regional telephone company in Russia while still in his mid-teens, installing Web servers and Cisco routers. His programming talents include tricky languages like C++ and Perl, and he has mastered 18 difference operating systems, from Linux to Solaris. But Chelyabinsk, a Stalinist burg located in the Ural Mountains, is a pretty bleak place to grow up. The town has twice endured nuclear catastrophe -- an arms plant dumped waste in a local lake for years, and in 1957 a nearby nuclear weapons factory showered the vicinity with 70 tons of radioactive dust -- making Chelyabinsk one of the world's most polluted cities. Investors run from its poisonous legacy, so Chelyabinsk relies on the basics of a Soviet-era economy, munitions and metallurgy. "There is not actually to much places where person can use his computer skills for significant amount of money," sighs Ivanov, 21, who mastered computers while horsing around in a lab a Chelyabinsk university, where his mother once taught history. "It is very difficult to get a job."

Given his dim prospects in Russia, the e-mails that Ivanov began receiving in June 2000 seemed especially wondrous. The messages came from Invita Security, a Seattle-based company on the lookout for "security talent" -- an industry euphemism for hackers. Invita was familiar with Ivanov's work as co-founder of a kontora, or unofficial company, known as tech.net.ru. Part Web design firm, part freelance security consultancy, tech.net.ru was reputed to be an audacious cracker of American networks. After compromising a company's severs, Ivanov would contact its system administrator and request money -- usually upwards of $5,000 -- in exchange for revealing security holes.

The Invita executives said they were seeking hackers who could exploit security flaws in the networks of potential clients, who would then feel a need to enlist Invita's services. The company especially welcomed foreign hackers, who could operate beyond the reach of the FBI; it asked Ivanov to prove his prowess by hacking Invita's own computers, which he did with ease. Impressed, Invita asked Ivanov ad his 26-year old tech.net.ru partner, Vasiliy Gorshkov, to fly to Seattle to discuss job offers.

On November 10, 2000, just hours after landing at SeaTac Airport, Ivanov and Gorshkov were arrested and charged with conspiracy, computer fraud, hacking, and extortion. Invita was not a shady security company at all, but part of the ingenious FBI sting designed to ensnare the two Russians. To federal prosecutors, the pair were among the Internet's most brazen outlaws. Ivanov now sits in a Hartford prison, preparing for a trial that could help define a wide-open area of law. The case could also help determine how far investigators patrolling cyberspace's anarchic nooks and crannies can bend privacy rules, international treaties, and constitutional law governing searches and seizures.

For the FBI, luring Ivanov and Gorshkov to the United States was a first, small victory in the campaign against the cybercrime that flourishes behind the former Iron Curtain. Russia, Ukraine, and Romania are hotbeds for hackers, many of who get their start pirating Western software; in Russia, where nearly 90 percent of software is bootlegged, a Microsoft Windows CD retails for less than $2. Since online fees in Russia can hit $1.20 per hour -- a steep price in a country where even college professors like Ivanov's mother earn abut $150 a month -- kids often steal Internet Service Provider passwords using tips most likely gleaned from the 50,000-circulation Khaker, one of Russia's most popular hacker magazines. An epidemic of stolen passwords forced America Online and CompuServe to abandon their Russian operations in 1997.

In the West, mischievous teen geeks usually mature into law-abiding adults -- today's password thief is tomorrow's Java programmer. In Russia, however, where as many as half of the country's software companies may have collapsed in 1998, upward mobility through legitimate tech work is rate. "There is a very large group of educated individuals in Eastern Europe, people that have degrees in computer science, in mathematics," says Arif Alikhan of the computer crimes section at the U.S. Attorney's office in Los Angeles. "And I think the economic circumstances sometimes make it very, very attractive to commit crimes."

Russian mafiosi recruit hackers to plunder credit card numbers from e-commerce sites, but freelance electronic blackmail is also commonplace. Last March, for example, the Justice Department warned that hacker gangs in Russia and Ukraine had stolen more than 1 million credit card numbers from American servers. In October 2000, a cyber-raid on Microsoft that exposed top-secret source code was traced to St. Petersburg. And in August of the same year, two Kazakh men were arrested in London for trying to extort $200,000 from Michael Bloomberg, the billionaire turned New York City mayor, whose passwords they had filched.

Prosecutors allege that tech.net.ru's schemes ranged from larceny to blackmail. A government trial brief states that Ivanov and Gorshkov set up a website, PayPai.com, to trick customers of the online payment service PayPal. Thousands of PayPal users got e-mails with links to PayPai.com, where they were prompted to enter their account details, including the user names and passwords. The lawyers say the two Russians used the account information to purchase computer parts and other goods, which they had shipped to nearby Kazakhstan.

In the Wild West-like Russian hinterlands, hustling like this is part of the survival game. But tech.net.ru may have been unusually reckless and greedy. Ivanov is said to have hacked into perhaps dozens of American networks, exploiting unpatched holes in Windows NT servers and using programs like L0phtCrack, a legendary tool developed by a hacker collective based in Cambridge, Mass., that's often used to crack passwords. According to prosecutors, Ivanov would then notify a network's system administrator of lapses, identifying himself as a member of "The Expert Group of Protection Against Hackers." The e-mail would end with a not-so-subtle demand for a payoff in exchange for tips on how to improve security.

If an administrator didn't respond favorably, Ivanov allegedly turned cranky. On February 3, 2000, for example, after a Connecticut company called the Online Information Bureau rebuffed his initial solicitation, Ivanov sent a follow-up:

[Name redacted], now imagine please Somebody hack you network (and not notify you about this), he download Atomic software with more than 300 merchants, transfer money, and after this did 'rm-rf/'[a Unix command that deletes directories] and after this you company be ruined. I don't want this, and because this i notify you about possible hack in you network, if you want you can hire me and i'm always be check security in you network. What you think about this?

Unwilling companies were punished. According to the government's brief, after an ISP called Speakeasy Network repeatedly refused to pay Ivanov for his discoveries, "Ivanov and/or his co-conspirators then deleted files on one of Speakeasy's main computers. In addition, a few months later, a customer of Speakeasy named BP Radio learned that credit card information from its customers had been posted on a Russian website. Speakeasy lost BB Radio's business as a result."

For a supposed mastermind, however, Ivanov -- known online as "subbsta" -- was surprisingly carefree with his identity. Along with his request for $1,000 -- $1,500-a-month job as a "security consultant," he sent photos of himself to Speakeasy. He also befriended Jim Fitzgerald, network manager at CTS Network Services, a San Diego-based ISP that Ivanov hacked in the fall of 1999. Unlike Speakeasy, CTS hired Ivanov as an independent contractor and even gave him a shell account, which enabled him to store files on the company's machines. Fitzgerald and Ivanov corresponded frequently about security issues via e-mail and Internet Relay Chat, which allows for real-time conversations.

Had tech.net.ru been a bit less bold, it might have evaded FBI scrutiny. Companies hate to admit they've been hacked, so they seldom report intrusions. "If some guy comes in and roots your box and defaces your server, people would like to know who that is," says Greg Shipley, the chief technology officer of Neohapsis, a Chicago-based security firm. "But if it involves tracking the intruder across five countries and 20 machines, most people just don't pursue it unless there are huge monetary losses." Yet if a hacker demands too much, Shipley adds, then "he's asking for it."

By the summer of 2000, tech.net.ru seemed to be asking for it. The growing list of alleged victims included ISPs in Washington, Ohio, and Connecticut, as well as banks in Los Angeles and Waco. Stephen C. Schroeder, an assistant U.S. Attorney in the Western District of Washington, says that Russian authorities were contacted several times without result. "The last time I checked, we do not have an extradition treaty with Russia," he says. "In the e-mail correspondence both to the undercover people and the victims, the taunt was repeated over and over again -- We're in Russia, you can't touch us, the FBI can't get us in Russia."' The Russian interior ministry's "Department R," which fights cyber-crime, can barely keep up with the kontoras kontoras in St. Petersburg and Moscow, much less police a distant outpost like Chelyabinsk.

But Ivanov's apparent carelessness gave the FBI its break. Some victimized companies passed along e-mails in which Ivanov made little or no attempt to conceal his identity or contact information. Ivanov's lawyers say Fitzgerald gave key aid to the inquiry by handing the FBI a copy of the contents of the Russian's CTS shell account, where he had imprudently stored 38,000 credit card numbers. Ivanov's biggest misstep, of course, was leaping at Invita's offer; he was so excited by the opportunity that he even suggested bringing his "business partner" -- the previously unknown Gorshkov -- to the meeting. At Invita's "headquarters," the two Russians were asked to hack a test network. The quicker, more computer-savvy Ivanov did most of the work. Meanwhile Gorshkov, his tongue loosened by 30 hours of travel and a touch of vodka, gabbed nonstop. While they boyish-looking Ivanov tapped away on his Toshiba laptop and listened to Russian pop music, the balding Gorshkov mused to FBI agents about the availability of pirated software in Chelyabinsk ("You can buy it almost in any shop…even in supermarket, where they sell milk"), fishy banking practices in Kazakhstan ("There are a lot of, ah, companies of people in Russia that can help you to open any offshore firm or accounts"), the history of tech.net.ru ("Actually, our firm is, initially, it was created as hackers' club"), and the sinister ways of Russia's domestic intelligence agency, a successor to the KGB, ("If they take you, you'll go to jail -- or you'll work for them").

But the agent posing as Invita's president had little success in getting the two to incriminate themselves more specifically. When the agent asked about whether the Russians had access to stolen credit card numbers, for example, Gorshkov answered like a lawyer: "We'll never, when we're here, we'll never say that we got access to credit card numbers…The fact is that, that this kind of question is better discussed in Russia." He also laughingly dodged questions about how tech.net.ru was bankrolled: "Well, it, it's ah, sort of personal question, and here in America not talk about it."

Hoping to interest Invita in his Web design skills, Ivanov showed off an e-commerce site he'd designed for a photo developer. The best tipoff he gave the FBI was an account of how one company paid him $4,000 for demonstrating how a hacker might steal money from its electronic accounts. "They think I can, ah, do something bad for company," said Ivanov. "And, ah, because this, they sent, ah, pack of money to me. For trust."

Extracting confessions from the Russians was not the sting's main goal, however. The Invita network was outfitted with a "sniffer," a surveillance program that logged Ivanov's and Gorshkov's key strokes as they worked. When the pair accessed their home machines in Chelyabinsk to download hacking tools, the sniffer covertly recorded their user names and passwords. The FBI then used that information to hack the Russians' machines and capture 250 gigabytes worth of evidence. They did so without informing Russian authorities, despite a 1997 G-8 agreement that states, "Investigation and prosecution of international high-tech crimes must be coordinated among all concerned States, regardless of where harm has occurred."

On December 1, 2000, three weeks after the arrests, the FBI got a warrant to examine the data they had remotely seized. Investigators found a surfeit of evidence -- over 50,000 credit card numbers swiped from American servers, computer-generated attack logs, and security tools like LophtCrack. They also discovered that the suspects had opened several ISP accounts under the name "Greg Stivenson." In October 2000, a hacker by that name had written several e-mails to officials at PayPal, revealing a rash of security holes. One e-mail translated from Russian concluded: "Now with regard to questions of security, I can help, but all security questions will be decided not by a mere 'thank you,' because a 'thank you' doesn't put food in your mouth."

Gorshkov was held in Seattle to face federal charges in the Western District of Washington, while Ivanov was taken cross-country to stand trial in the District of Connecticut, home base for one of the companies he's accused of hacking. The Connecticut court appointed a veteran Hartford attorney, C. Thomas Furniss, as Ivanov's counsel, and he zeroed in on the question of whether Ivanov may be prosecuted in an American court for a crime he's accused of committing from abroad over the Internet. Furniss points out that no applicable federal laws explicitly address whether U.S. courts can try foreign cybercriminals. "The U.S. doesn't have the power to decide this case," he insists. "The allegation is that he did a bunch of stuff from Russia using the Internet. No country, including the U.S., owns the Internet."

In response, the U.S. government says to forget the ethereal images conjured up by the word "cyberspace." The prosecutor Schroeder argues that American courts can try Ivanov for the same reason that they can try a man who stood on the Canadian side of the border and shot someone in Washington State. "That's a pretty good analogy for sitting in Russia and victimizing networks or servers in the U.S.," he says. He also stresses language in the Computer Fraud and Abuse Act, which was amended in 1996 to expand the reach of federal law to crimes involving any computer "used in interstate or foreign commerce or communication." That authority allows the United States to prosecute foreign hackers who attack American networks, the prosecutor argues.

Furniss's motion to dismiss was denied, but he is considering an appeal. Meanwhile, the 58-year-old lawyer asked for a tech-savvy co-counsel to help him sort through the case. He got attorney Morgan Rueckert, a 32-year-old former tech-support worker at the University of Connecticut Law School. Rueckert says that Ivanov's e-mails to companies in which he'd found security holes were not extortionate, but part of the normal give-and-take between system administrators and the computer whizzes who find their weak spots: "My sense is that many system administrators, some part of them has that same hacking ethic that the hackers do. [They'll] communicate with hackers, they'll enter dialogues with them. In some cases they want to know about security holes that hackers find, and they are willing to pay hackers to disclose security holes so long as there's no damage done and customer or financial information is not compromised."

Rueckert points to Ivanov's warm e-mail relationship with CTS's Jim Fitzgerald as an example of this sort of symbiosis. Fitzgerald allowed Ivanov to maintain a CTS e-mail account in addition to the shell account. Yet when the FBI came knocking, Rueckert says, Fitzgerald turned his back on Ivanov. He helped the bureau trample on his friend's rights under the Fourth Amendment, which limit the government's power to search and seize property while investigating a crime. And he helped the bureau do an end-run around the Electronic Communications Privacy Act, which requires federal agents to obtain a specific warrant or other order before searching a suspect's data. The FBI had a grand-jury subpoena to obtain "any and all information regarding the e-mail address" that Ivanov maintained at CTS. But the order did not mention Ivanov's shell account, a separate digital entity. Fitzgerald illegally handed over the shell account's contents without prompting, Rueckert says, so all the investigation's subsequent findings must be kept out of court.

But Gorshkov's plight in Washington indicates that courts are inclined to grant cyber-cops substantial leeway. Gorshkov's attorneys argued that by waiting to get a warrant until after the data was downloaded, the government overstepped its search-and seizure authority when it hacked tech.net.ru. They also argued that the FBI violated Russian laws, which strictly forbids unauthorized trespass on hard drives. Russia's intelligence agency concurred in a November report which called the FBI's actions "illegal and criminal," though the Russian government has not protested the U.S. prosecution of Gorshkov and Ivanov.

In an order issued last May, U.S. District Judge John C. Coughenour summarily crushed the defense. The government's hack was not a search entitled to Fourth Amendment protection, he wrote, because the files remained on Gorshkov's computer in Chelyabinsk. Coughenour also said that even if the Fourth Amendment did apply to data in a foreign country, the government had good reason to conduct a warrantless search.

"Basically, the ruling says that our police officers can obtain unauthorized access to a computer for law-enforcement purposes, despite the fact that it's overseas or under the jurisdiction of another country," says Jennifer Granick of Stanford Law School's Center for Internet and Society. "That could come back to haunt us, when [foreign police] log onto our citizens' computers [in America] to take evidence to try them under their laws." Russian intelligence agents, for example, might now feel at liberty to hack American machines in the guise of "investigation."

With the evidence from the Invita sting before the jury, Gorshkov stood little chance. His lawyers called just three witnesses. One of them contended that the tech.net.ru was merely a Web design firm. "He identified a Web page that they had designed for a company," recalls Shroeder, who prosecuted the case. "That Web page, incidentally, was hosted on a hacked box that belonged to a school [district] in Michigan." The hack traced back to a computer registered to tech.net.ru. The jury deliberated for less than a day before finding Gorshkov guilty on all 20 counts of the indictment. He is scheduled to be sentenced in June.

Ivanov, meanwhile, is still being held without bail in Hartford, awaiting a trial date. Visa issues and money woes have prevented his family from visiting the United States, so he spends most of his time writing letter home in longhand. He was recently allowed some use of a laptop (no printer, no modem) to assist in preparing for trial. For a young man whose pursuit of a tech job in American may cost him many years behind bars -- he faces a likely sentence of between 10 and 20 years if convicted -- the young Russian maintains a strangely sunny outlook. "I tried to find a job in U.S. since I was about 18," says Ivanov, whose lawyers would not allow him to discuss the specifics of his case. "I could not say that it was easy. The main reason for this was, of course, to get more money for job. Eventually I was successful, and now I have three free meals every day."

His supporters back home have not been as sanguine. As news of the Invita sting spread throughout Eastern Europe's hacker scene, angry notes flooded Khaker's online message board. "Watch out Russian hackers!" Warned one anonymous poster. "You see what kind of lowlife tactics the Americans are capable of, so work more carefully!"