There are profound and heretofore unrecognized implications to the US Supreme Court's decisions in Federal Election Commission v. Akins and Matrixx Initiatives, Inc. v. Siracusano. This article will describe how these decisions are likely to ultimately force the Court to declare that current federal financial reporting violates the Statement and Account Clause of the US Constitution, subverts the right to vote and the right of free speech and eliminates required political accountability.
An informed electorate is the cornerstone of our democracy. Liberty cannot be preserved without a general knowledge among the people of the character and conduct of their rulers. Their use of public money is central to this general knowledge. James Madison was prescient with two remarks. First, he aptly declared: "I believe that there are more instances of the abridgement of the freedom of the people by gradual and silent encroachments of those in power than by violent and sudden usurpations." Second, he noted that "[a] popular Government, without popular information, or the means of acquiring it, is but a Prologue to a Farce or a tragedy; or, perhaps both."
The upcoming election continues a lifetime tradition for most citizens of casting their votes without the benefit of having access to an accurate and complete published account of the total receipts and expenditures of the US government. The Statement and Account Clause requires that "a regular Statement and Account of the receipts and expenditures of all public Money shall be published from time to time." Given that the framers wanted voters to have accurate information about federal spending at what point does the government's publication of false and misleading financial information render a citizen's vote meaningless? When the government is spending at twice the level that it reports to its citizens? Three times? Four times?
The primary reason why the rights to vote and free speech have been infringed upon is that the legislative and executive branches have an interest in expenditure amounts being under-reported. Both branches have controlled financial reporting and thereby public opinion to minimize their accountability for spending. Proper reporting would lead to spending cutbacks, tax increases and/or recriminations for overspending all of which are likely to cause voter dissatisfaction and changes at the polls.
In Akins, the Court dealt with an attempt on the part of a group of voters to compel the Federal Election Commission (FEC) to regulate the American Israel Public Affairs Committee (AIPAC) as a "political committee" within the meaning of federal election law. The voters sought information such as lists of donors, contributions and expenditures that AIPAC would have to disclose if it were regulated.The FEC opposed such regulation. The Court determined that the plaintiffs had been deprived of information and without it; they were less able "to evaluate candidates for public office" and "to evaluate the role" that the financial assistance to candidates "might play in a specific election."
On March 22, 2011, the Supreme Court issued a unanimous decision written by Justice Sonia Sotomayor in the matter of Matrixx Initiatives. The importance of the case is that the Court reaffirmed the traditional tests it laid out in Basic, Inc. v. Levinson and TSC Industries, Inc. v. Northway, Inc. As Justice Sotomayor opined:
Section 10(b) of the Securities and Exchange Act makes it unlawful for any person to "use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."Rule 10b-5 of the act implements this provision by making it unlawful to, among other things, "'make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.'"
To prevail on a section 10(b) claim, a plaintiff must show that the defendant made a statement that was "misleading as to a material fact." In Basic, the Court held that this materiality requirement is satisfied when there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." The Court was "careful not to set too low a standard of materiality" for fear that management would "bury the shareholders in an avalanche of trivial information."
Moreover, it bears emphasis that section 10(b) and rule 10b-5(b) do not create an affirmative duty to disclose any and all material information. Disclosure is required under these provisions only when necessary "to make ... statements made, in the light of the circumstances under which they were made, not misleading."
There is a crucial parallel between federal financial disclosures and those by corporations issuing securities. The broad goal of securities regulation and the Statement and Account Clause is the same: to ensure full and fair disclosure. Louis Brandeis, whose ideas were a major influence on disclosure philosophy of securities regulation, stated that "publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman." The essence of the disclosure philosophy of securities regulation and the Statement and Account Clause is that, when armed with information, investors or voters are well-positioned to evaluate investment opportunities or candidates for public office and to allocate their capital or vote as they see fit. The crux of our federal securities laws and the Statement and Account Clause is that all material information must be disclosed. What other reasonable interpretation can there be of the Clause, particularly the "all Public Money" language?
In TSC Industries, the Court considered a claim of fraud in connection with a proxy solicitation and concluded that "[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." The Court did not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the Court required was a showing of a substantial likelihood that, under the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder.
If we apply the Court's logic in Akins and the Matrixx Initiatives, Basic and TSC Industries securities law disclosure standard to the Statement and Account Clause, the information that a reasonable voter would want and require the government to produce are financial statements that consolidate all material entities and accrue for all costs associated with legally enacted programs. What facts give rise to this conclusion? First, these statements are the only information that will provide a voter with an accurate account of the financial results and financial position of the US government. Second, Congress enacted [PDF] legislation in the 1950s requiring the executive branch to complete the president's budget using cost-based accrual accounting. The executive branch has refused to comply with this legislation. Third, the Sarbanes-Oxley Act of 2002 requires registered companies to disclose "all material off-balance sheet transactions." A reasonable voter would require the government to follow this requirement because to not comply would render the financial statements misleading. Lastly, if a reasonable voter is not supplied with this information it would appear that the voter does not have the political information required by the Constitution to properly evaluate candidates for public office.
It is important to review what the justices said in the single Statement and Account Clause case that reached the Supreme Court. Justice William Douglas' dissent in US v. Richardson, a case in which the Court declined by a 5-4 majority to opine on the meaning of the Statement and Account Clause because the plaintiff lacked standing, describes the importance of the Statement and Account Clause:
The Framers of the Constitution deemed financial information essential if the electorate was to exercise any control over its representatives and meet their new responsibilities as citizens of the Republic ... From the history of the clause it is apparent that the Framers inserted it in the Constitution to give the public knowledge of the way public funds are expended ... The sovereign in this Nation is the People, not the bureaucracy. The statement of accounts of public expenditures goes to the heart of the problem of sovereignty. If taxpayers may not ask that rudimentary question, their sovereignty becomes an empty symbol and a secret bureaucracy is allowed to run our affairs ... Secrecy was the evil at which Art. I, § 9, cl. 7, was aimed.Judge Max Rosenn of the US Court of Appeals for the Third Circuit stated the following in the Richardson case:
The debates at the Constitutional Convention in 1787 and the state ratifying conventions reveal that ... the citizenry should receive some form of accounting from the Government ... Article II, section 3 requires the President "from time to time [to] give to the Congress Information on the State of the Union," and presumably the Framers could have utilized the same informal procedure with regard to the accounting if they had so wished. Instead, they chose to have the statement "published," indicating that they wanted it to be more permanent and widely-circulated than the President's message. The connotation must be that the statement was for the benefit and education of the public as well as coordinate branches of government.Hence, the Constitution confers political status to the Statement and Account Clause that is equal to or greater than the president's required State of the Union Address. The publication of a false statement and account interferes with the right of free speech as it is a required political document for the electorate.
Chief Justice Warren Burger's opinion in Richardson included dicta that appears to have become the gospel for the Court to ignore the provision:
[I]t is clear that Congress has plenary power to exact any reporting and accounting it considers appropriate in the public interest ... Not controlling, but surely not unimportant, are nearly two centuries of acceptance of a reading of cl. 7 as vesting in Congress plenary power to spell out the details of precisely when and with what specificity Executive agencies must report the expenditure of appropriated funds and to exempt certain secret activities from comprehensive public reporting.While these statements are clearly true as it relates to details associated with the nation's financial reports and most assuredly information related to national security matters, Congress has a constitutional obligation to report truthful and complete information with respect to total receipts and expenditures.
St. George Tucker's comments are also instructive with respect to the Statement and Account Clause:
These provisions form a salutary check, not only upon the extravagance, and profusion, in which the executive department might otherwise indulge itself, and its adherents and dependents; but also against misappropriation, which a rapacious, ambitious or otherwise untruthful executive might be disposed to make.Justice Joseph Story averred that the Statement and Account Clause makes Congress's responsibility as guardian of the public treasure "complete and perfect" by requiring an account of receipts and expenditures "that the people may know what money is expended, for what purposes, and by what authority." James Madison thought that "this provision went farther than the constitution of any state in the union, or perhaps in the world."
Currently it is impossible to determine the truth about the government's financial results, as it maintains two sets of books which individually and in the aggregate are grossly misleading. The most well-known is the president's budget, which is cash-based and has little to do with economic reality. Under budget accounting rules, outlays are recorded only when bills are paid. Americans know that real expense is incurred when one makes spending commitments. This is the reason why every publicly traded company is required to use accrual accounting. The little-known alternative is the financial report of the US government, which does not consolidate numerous material government controlled entities or include the full costs of entitlement programs.
The "official" statement and account is the combined statement of receipts, outlays, and balances, which is largely derived from the president's budget. This statement is not known or used by the public including the media, not central to any discussion of the nation's finances and is not viewed as a major financial publication by any recent Congress or administration. The only costs associated with the entitlement programs that are included in the "official" report are current cash outlays. The government calls this the "due and payable approach." Therefore, the budget deficit does not include the multi-trillion dollar annual increases in the present value of our social insurance obligations. Everyone that has a credit card knows that the amount spent in any year is equal to the amount that you paid the credit card company plus or minus the increase or decrease the year-end balance. The government conveniently ignores the second half of such calculation.
The published estimate in the 2011 Financial Report of the sum of the net present value cost of Medicare (alternate scenario), Medicaid and Social Security is $70 trillion. The balance sheet therein indicates that the net liability is $14.8 trillion. When the $70 trillion of off-balance sheet obligations is added the total obligation rises to $85 trillion. This figure represents a multiple of 36 times the 2011 total revenue of $2.4 trillion. The Federal Reserve's June 2012 estimate of the total net worth of "Households and Nonprofits" is $63 trillion. If this entire amount was confiscated the government could not cover its obligations.
Our massive entitlement programs have either permanent appropriations or mandatory authorizing legislation which provides agencies with the authority or requirement to spend money without first requiring committees to enact funding. Permanent appropriations and mandatory authorizing legislation are critical in the context of political accountability because our current legislators can and do wash their hands [PDF] of any responsibility with respect to mandatory spending. When you couple this fact with inadequate financial disclosure political accountability disappears altogether. Voters have no idea what the level of expenditures are and they cannot send the responsible representatives packing because they have retired.
Ben Franklin stated that "[a] small leak will sink a great ship." The Supreme Court will, in all likelihood, have an opportunity to fix this leak. If the Court elects not to address the issue, the nation will continue down the path to financial ruin by ignoring an important constitutional check on power that is fundamental to the right to vote, free speech and political accountability.
Joseph Marren is the President and Chief Executive Officer of KStone Partners, an SEC-registered investment advisor that specializes in managing funds of hedge funds. Previously he was Head of Business Development in the mergers and acquisitions departments at several firms including Sagent Advisors, Citigroup, Credit-Suisse and DLJ. He is the author of two books on mergers and acquisitions, taught at New York University Stern School of Business and is a graduate of Fordham University School of Law.
Suggested citation: Joseph Marren, Importance of Statement and Account Clause Cannot be Overlooked, JURIST - Sidebar, Oct. 23, 2012, http://jurist.org/sidebar/2012/10/joseph-marren-statements-accounts-accountability.php .
This article was prepared for publication by Stephen Krug, an associate editor for JURIST's professional commentary service. Please direct any questions or comments to him at email@example.com