In Landmark Ruling, Eastern District of Texas Strikes Down FDA’s Final Rule Regulating Laboratory Developed Tests
In the never-ending saga over the battle to regulate laboratory-developed tests (LDTs), the Eastern District of Texas took the wind out of FDA’s sails on Monday, vacating FDA’s Final Rule that intended to regulate LDTs as medical devices similar to in vitro diagnostic (IVD) tests, which are commercially manufactured and undergo pre-market review by FDA.1 Clinical laboratories can halt their plans, for now, to comply with the Final Rule’s May 6, 2025, deadline to implement certain features of FDA’s medical device quality system regulations.
As summarized in our May 6, 2024, client alert, FDA’s Final Rule was set to dramatically alter the regulatory landscape for LDTs with major regulatory and financial implications to clinical laboratories, patients and health care providers.
Clinical laboratories will see the ruling as a major victory for the laboratory industry. The district court’s ruling also comes as one of the first major checks on FDA’s power in the post-Chevron world following last year’s Supreme Court decision in Loper Bright.
Background and LDT Regulatory Timeline
In 1976, Congress enacted the Medical Device Amendments to the Federal Food, Drug, and Cosmetic Act (FDCA), granting FDA explicit authority to regulate medical devices, which included IVDs developed by manufacturers and sold for commercial purposes to laboratories, health care organizations and consumers.
Separate from FDA’s authority, in 1988 Congress passed the Clinical Laboratory Improvement Amendments (CLIA), creating a statutory framework to certify clinical laboratories through quality, proficiency standards and personnel requirements. The Centers for Medicare and Medicaid Services (CMS) oversees CLIA certification and compliance for most laboratories in the country2 that examine materials derived from the human body for the diagnosis, treatment or prevention of disease or to assess the health of human beings.
For decades, FDA did not attempt to assert authority or regulate laboratories or LDTs, which are defined as IVDs “intended for clinical use and that [are] designed, manufactured and used within a single laboratory that is certified under [CLIA].”3 Starting in 1992, FDA claimed that it could regulate LDTs as medical devices through the issuance of a draft Compliance Policy Guide.4 FDA declined to finalize the guidance, however, and assured laboratories that it did not intend to “routinely” exercise its authority over LDTs.5
FDA next asserted that it had jurisdiction over LDTs in a 1996 preamble to a proposed rule regarding device classification levels for certain active ingredients used for preparing LDTs.6 FDA also recognized in the same preamble that “significant regulatory changes in this area could have negative effects” and that FDA would therefore only focus its oversight on “ingredients . . . that moved in commerce” and other tangible articles. FDA never took any final regulatory action to assert its authority over these tests.
In 2010, FDA held a two-day public meeting soliciting feedback on LDT regulation, hinting that it may consider formally regulating LDTs. Four years later, FDA formally released two draft guidance documents proposing a framework for LDT regulation.7 The guidance documents were not well received by Congress, which criticized FDA for significantly shifting the way LDTs are regulated and directed FDA to suspend any efforts to finalize its guidance documents.8 FDA complied and retreated from enacting any final guidance document.
A few years later, Congress considered two different pieces of legislation — The Verifying Accurate Leading-edge IVCT Development Act (VALID) of 2020 and the Verified Innovative Testing in American Laboratories (VITAL) Act of 2020.9 Both bills proposed different approaches to regulating LDTs that would have created a new regulatory pathway under FDA premarket review or deemed LDTs as “services” to be regulated under CLIA. Both bills failed to pass even after being reintroduced in subsequent Congresses.
With failed attempts to regulate LDTs in Congress, FDA announced its attempt to move forward with regulating virtually all LDTs as medical devices in October 2023, which ultimately led to the Final Rule, effective May 6, 2024.
Shortly after the Final Rule went into effect, the American Clinical Laboratory Association (ACLA) and the Association for Molecular Pathology (AMP) sued FDA in two separate lawsuits challenging that the Final Rule violated the Administrative Procedure Act (APA) because it exceeded FDA’s statutory authority and was arbitrary and capricious. The two cases were consolidated into one.
Summary of Court Ruling
Explaining the storied history of LDT regulation, the district court found no question that Congress had considered the unique regulatory issues raised by clinical laboratories and the tests that they develop and perform, and that Congress chose to regulate these tests as “services” under CLIA. This contrasts with the authority Congress granted FDA to regulate “devices,” which the district court concluded under the FDCA to mean “articles in commerce,” not “services” performed by doctors and laboratories.
Considering the distinct legislative history of medical devices and laboratory services, the district court agreed with the plaintiffs that LDTs are “professional medical services that are qualitatively and categorically different from the tangible goods that FDA may regulate as a ‘device,’” and that medical devices defined under the FDCA only refer to “tangible, physical products.” The district court was further unpersuaded by FDA’s argument that an LDT is an “IVD test system” made up of physical components that meet the definition of a medical device.
Rejecting FDA’s argument on two grounds, the court found that (1) FDA had no statutory authority to alter the definition of a device under the FDCA to expand the definition to include laboratory services, and (2) FDA’s self-created “IVD test system” conflates discrete tangible objects with an assortment of laboratory tools that professionals use to deliver a service. Relying heavily on last year’s Supreme Court decision in Loper Bright, the court closely scrutinized the statute and made it abundantly clear that it was not deferring to FDA’s interpretation of the statute and the authority that FDA was claiming from the statute. The court warned that should it accept FDA’s position, it would lead to limitless implications of FDA oversight on all surgical procedures and physical examinations that use “devices,” giving the term an “extraordinary, expansive meaning with far-reaching consequences.”
The court further noted that, should it accept FDA’s theory that an LDT does in fact meet the definition of a medical device under the FDCA, it would “render[] CLIA largely, if not entirely, pointless.” For these reasons, the court determined that FDA’s “asserted jurisdiction” over LDTs “defies the bedrock principles of statutory interpretation, common sense and longstanding industry practice.” Therefore, the court concluded that the Final Rule exceeds FDA’s authority, is unlawful and should be set aside pursuant to the APA.
Finally, in considering the appropriate remedy, the district court found that the circumstances in this case favor nullifying and revoking the Final Rule instead of remanding the Final Rule back to FDA to modify without vacating. In reaching this conclusion, the court considered the extreme financial impact the Final Rule would have on clinical laboratories as well as the unlikelihood that FDA could justify its decision on remand. Therefore, the Final Rule was vacated in its entirety.
What’s Next?
With the Final Rule now vacated, FDA’s “phaseout” policy to bring LDTs under the same regulatory scheme as IVDs is also terminated. Once the LDT Final Rule went into effect last year, laboratories were subject to a phaseout policy that would have required companies to begin complying with certain medical device requirements, such as medical device reporting and complaint handling, beginning on May 6, 2025.
While it is possible that FDA could appeal the decision, we do not expect the current Administration to do so. Experts had already predicted that President Trump was likely to order FDA to repeal, or not enforce, the Final Rule, as HHS under the first Trump Administration had revoked FDA’s guidance document claiming authority to regulate LDTs as devices.
In light of the district court’s ruling, it seems less likely that Congress, and in particular the Republican controlled House, will attempt to revive the bipartisan VALID Act.
In a town where we are taught to “never say never,” we will keep a watchful eye on the Administration and Congress’s reaction to the court’s ruling.
[1] American Clinical Laboratory Ass’n v. FDA, Case No. 4:24-cv-00479 (E.D. Tex.).
[2] New York and Washington are exempt from CLIA, as they have their own state law regulatory oversight framework, which is enforced by the applicable state agency.
[3] LDT Final Rule, 89 Fed. Reg. 37286, 37289 (May 6, 2024).
[4] See FDA, Draft Compliance Policy Guide: Commercialization of Unapproved In Vitro Diagnostic Devices Labeled for Research and Investigation (Aug. 1992).
[5] Food & Drug Admin., IVD Policy Will Not Include Exemptions for “Standard of Care” Tests, The Gray Sheet (Oct. 11, 1993).
[6] 61 Fed. Reg. 10,484, 10,485 (Mar. 14, 1996).
[7] Food & Drug Admin., FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs), and Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs) (Oct. 2, 2014).
[8] H.R. Rep. No. 114-531, at 72 (2016).
[9] VALID Act of 2020, H.R. 6102, 116th Cong. (2020); VITAL Act of 2020, S. 3512, 116th Cong. (2020).
PTAB Discretion in Flux: Lessons from Stellar LLC v. Motorola Solutions Inc.
Overview
Following the Patent Trial and Appeal Board’s (PTAB) new guidance on discretionary denials, the PTAB proceeding in Stellar LLC v. Motorola Solutions Inc., IPR2024-01208, presents an early case study for PTAB practitioners navigating discretionary denials under 35 U.S.C. § 314(a).
This decision highlights how the PTAB is now weighing Fintiv factors, including Sotera stipulations, the effort the parties have spent on co-pending litigation and the existence of additional invalidity grounds in the litigation. As such, this case offers a lens into how discretionary standards are shifting in practice following the rescission of the Guidance Memo.
Why This Case Matters
This case is notable for three primary reasons:
It tests the boundaries of Fintiv factor analysis after the USPTO issued a new guidance memo on discretionary denials.
It forces consideration of how Sotera stipulations are weighed when parallel litigation includes invalidity contentions based on grounds that cannot be addressed in inter partes review (IPR).
It underscores the importance of timing, completeness and strategic framing, both at the Petition and Patent Owner Preliminary Response stages.
Key Lessons for Practitioners
Sotera Stipulations Are Still Powerful but Not Bulletproof: Although a Sotera stipulation can reduce overlapping issues, it may not fully mitigate the Director’s concerns if the petitioner raises broader invalidity arguments in district court, including prior use system prior art not covered by the stipulation.
Advanced Parallel Litigation Can Prompt Denial: The Director stressed that when a district court case is far along, especially with substantial resources already invested and a trial date that precedes the projected PTAB final written decision, this factor strongly favors denial.
Stay of Litigation Entered After Institution of IPR Does Not Factor Into Discretionary Denial: The Director acknowledged that the underlying litigation had been stayed pending the outcome of the IPR but dismissed that fact in a footnote suggesting that the Director will not give any weight to a stay entered after the institution of IPR proceedings.
Fintiv Factor Analysis Remains the Primary Consideration: The Director’s memo confirms that the Fintiv factors are still the focus of the analysis but that the weighing of these factors may change going forward. As this decision demonstrates, even if certain factors (like a Sotera stipulation) weigh against denial, other factors (like the significant investment in the parallel proceeding) can tip the scales toward discretionarily denying institution.
This decision highlights the need for petitioners and patent owners to recalibrate their strategies considering the evolving PTAB approach toward discretionary denials. Petitioners must act swiftly, frame petitions comprehensively and understand how Sotera stipulations, while still valuable, may no longer be sufficient in cases involving advanced district court proceedings or broader invalidity issues.
For patent owners, this decision underscores the strategic importance of building a robust litigation record early to fortify the Fintiv-based challenges. As the PTAB’s discretionary standards continue to shift, timing, procedural posture and substantive alignment across forums will be critical to succeed.
Environmental YIR: 2024 Regulatory Legacies and Impacts
This report provides an overview of major federal environmental regulations and court decisions of 2024. Landmark U.S. Supreme Court decisions with lasting consequences for environmental policy include Loper Bright Enterprises v. Raimondo, 603 U.S. 369 (2024),1 which ended judicial deference to administrative agencies, and Corner Post v. Federal Reserve, 603 U.S. 799 (2024), which opened the doors of federal courts to many more plaintiffs challenging regulations. These decisions have subsequently bolstered efforts to limit or rollback regulatory actions, both by industry and by members of the Trump administration. The Congressional Review Act (CRA), which allows Congress to rescind or invalidate new regulations, has also been used as the basis for invalidating many of the environmental regulations adopted since August 2024.
Click here to read the full article.
Navigating the Termination of CHNV Parole Programs: Insights on I-9 Reverification and INA Compliance for Employers
On March 25, 2025, the Department of Homeland Security (DHS) announced the termination of the parole processes for citizens or nationals of Cuba, Haiti, Nicaragua, and Venezuela (CHNV parole programs). This decision will affect employers who must navigate the employment eligibility of affected individuals while ensuring compliance with anti-discrimination provisions outlined in the Immigration and Nationality Act (INA). The termination of these programs means that any parole status and employment authorization derived through CHNV parole programs will end by April 24, 2025. Employers must take steps to manage the reverification of affected employees’ employment eligibility without engaging in discriminatory practices.
Understanding the Challenges
As part of the CHNV parole programs, employment authorization documents (EADs) issued to beneficiaries bear the category code (C)(11). However, this code is not exclusive to CHNV beneficiaries, making identification difficult. Additionally, some CHNV beneficiaries may have updated their Forms I-9 with EADs that have validity dates extending beyond April 24, 2025. Employers who wish to ensure compliance face a complex challenge: how to identify affected employees for reverification without inadvertently violating the INA’s anti-discrimination provisions.
Employers who complete and retain paper I-9 forms, do not keep copies of identity and employment authorization documents, and do not participate in E-Verify may find the process particularly challenging. Sorting and extracting Forms I-9 based on “Foreign Passport and Country of Issuance” in Section 1, or by identifying Forms I-9 listing EADs in Section 2, may result in List A displaying overly broad findings, as these methods may capture individuals who are not CHNV beneficiaries and who hold valid employment eligibility.
Legal Compliance Considerations
The INA’s anti-discrimination provisions, particularly 8 USC § 1324b(a)(1)(A) and (a)(6), prohibit employers from treating employees differently based on citizenship, immigration status, or national origin. Employers are also prohibited from requesting additional or different documentation from employees based on these factors. The Department of Justice’s Immigrant and Employee Rights (IER) Section, formerly the Office of Special Counsel (OSC), has emphasized that employers should avoid making employment decisions—including reverification processes—based on an employee’s citizenship, immigration status, or national origin.
In the meantime, employers should consider:
Maintaining thorough records of the reverification process to demonstrate compliance with federal requirements and anti-discrimination provisions.
Conducting internal audits to ensure that no employees are treated differently based on citizenship, immigration status, or national origin during the reverification process.
Providing training to HR personnel and compliance teams on how to handle reverification without violating INA provisions, emphasizing the importance of treating all employees consistently and fairly.
Tracking the expiration dates of employees whose employment eligibility needs to be reverified.
Notifying affected employees of their upcoming need to provide updated documentation, regardless of their citizenship or immigration status. Do not request specific documents or additional information beyond what is required.
Key Takeaways
This issue represents new territory which has not been thoroughly analyzed or reviewed to date by authorities. IER technical guidance may be forthcoming on what U.S. employers should do if a particular classification of employment eligibility is suddenly terminated by the government, but some beneficiaries in that classification have updated their Forms I-9 with employment authorization validity dates that go beyond the termination date (April 24, 2025).
Fifth Circuit Court of Appeals Negates Ruling on Federal Contractor Minimum Wage
On March 28, 2025, the Fifth Circuit Court of Appeals vacated its previous ruling that permitted a $15 per hour minimum wage for federal contractors, shortly after President Donald Trump revoked the Biden administration rule setting that wage rate.
Quick Hits
The Fifth Circuit vacated its decision to uphold a $15 per hour minimum wage for federal contractors.
The court acted shortly after President Trump rescinded a Biden administration rule raising the minimum wage for federal contractors to $15 per hour.
An Obama-era rule establishing a $13.30 per hour minimum wage for federal contractors still stands.
On the website for the U.S. Department of Labor, the agency said it is “no longer enforcing” the final rule that raised the minimum wage for federal contractors to $15 per hour with an annual increase depending on inflation.
As of January 1, 2025, the minimum wage for federal contractors was $17.75 per hour, but that rate is no longer in effect. Therefore, an Obama-era executive order setting the minimum wage for federal contractors at $13.30 per hour now remains in force.
Some federal contracts may be covered by prevailing wage laws, such as the Davis-Bacon Act or the McNamara-O’Hara Service Contract Act. Those prevailing wage laws are still applicable.
Many states have their own minimum wage, and those vary widely.
Background on the Case
In February 2022, Louisiana, Mississippi, and Texas sued the federal government to challenge the Biden-era Executive Order 14026, which directed federal agencies to pay federal contractors a minimum wage of $15 per hour. The states argued the executive order violated the Administrative Procedure Act (APA) and the Federal Property and Administrative Services Act of 1949 (FPASA) because it exceeded the president’s statutory authority. The states also claimed the executive order represented an “unconstitutional exercise of Congress’s spending power.”
On February 4, 2025, the Fifth Circuit Court of Appeals upheld the $15 per hour minimum wage for federal contractors. A three-judge panel ruled that this minimum wage rule was permissible under federal law.
On March 14, 2025, President Trump rescinded the Biden-era executive order that established a $15 per hour minimum wage for federal contractors. In effect, that made the earlier court ruling moot, according to the Fifth Circuit.
Next Steps
Going forward, the Obama-era $13.30 minimum wage rate for federal contractors still stands. Federal contractors operating in multiple states may wish to review their policies and practices to ensure they comply with state minimum wage laws and federal prevailing wage laws. If they use a third-party payroll administrator, they may wish to communicate with the administrator to confirm legal compliance.
Strengthening Government Fraud Enforcement: Administrative False Claims Act Provides Agencies Tool to Bring Fraud Claims
Enacted as part of the recent National Defense Authorization Act (NDAA), the U.S. Congress established a significant new fraud enforcement mechanism, called the Administrative False Claims Act (AFCA), which empowers federal agencies to investigate and adjudicate more fraud cases involving false claims and statements made to the government.
Quick Hits
The Administrative False Claims Act (AFCA) significantly strengthens agencies’ ability to combat fraud involving federal funds by allowing direct prosecutions.
The AFCA raises the maximum claim amount from $150,000 to $1 million, expands definitions of false claims that trigger liability beyond those involving claims for money, and establishes reimbursement guidelines for investigation costs.
The AFCA further broadens liability by including false statements not tied to a claim for payment and extends the timeframe for pursuing allegations of fraud.
On December 23, 2024, then-President Joe Biden signed the 2025 NDAA (also known as the “Servicemember Quality of Life Improvement and National Defense Authorization Act (NDAA) for Fiscal Year 2025”). Buried in the lengthy legislation is a section creating the AFCA, which revamps the underutilized Program Fraud Civil Remedies Act (PFCRA) of 1986. The AFCA expands the types of fraud cases that federal agencies can directly pursue, raising the claim ceiling to $1 million and allowing agencies to recover investigation costs.
Background
The PFCRA was enacted in 1986 to provide administrative agencies with a mechanism to pursue low-dollar-value fraud cases. However, the statute has been underutilized historically. In particular, a 2012 study conducted by the U.S. Government Accountability Office (GAO) revealed that during the fiscal years 2006 to 2010, only five civilian agencies—the U.S. Department of Housing and Urban Development (HUD), U.S. Department of Health and Human Services (HHS), the U.S. Department of Energy, the Corporation for National and Community Service (now named AmeriCorps), and the Nuclear Regulatory Commission—had utilized the PFCRA. Notably, HUD referred 96 percent of the cases, while other agencies referred only six cases over five years, according to the GAO study.
Key Amendments Under the AFCA
The AFCA introduces several significant amendments to strengthen the former PFCRA:
Increased Claim Ceiling—The maximum claim amount has been raised from $150,000 to $1 million, adjusted for inflation.
Conformance With FCA Provisions—The AFCA aligns its provisions with those found in the False Claims Act (FCA), one of the government’s primary tools for combating fraud against the federal government, ensuring consistency in fraud enforcement.
Reverse False Claims—The AFCA expands the definition of a false claim to include claims made to an “authority,” including federal agencies, executive departments, and designated federal entities, “which has the effect of concealing or improperly avoiding or decreasing an obligation to pay or transmit property, services, or money to the authority.”
Reimbursement for Investigation Costs—The AFCA also provides that agencies are reimbursed for the costs of investigations from amounts collected, including “any court or hearing costs,” making it more financially viable for agencies to pursue fraud cases.
Expanded Jurisdiction for Appeals—The AFCA specifies who can hear appeals for agencies without ALJs, broadening the scope of administrative review.
No Qui Tam Provision—However, unlike the FCA, the AFCA does not include a qui tam provision, which allows private individuals, known as “relators” or “whistleblowers,” to file lawsuits on behalf of the government and potentially receive a portion of any recovered damages.
Promulgation of Regulations—The AFCA will further require authorities to promulgate regulations and procedures to carry out the act and its amendments by June 23, 2025.
Revision of Limitations—The AFCA expands the limitation period for pursuing allegations, requiring the person alleged to be liable to be notified of the allegation within six years from the date the violation is alleged to have been committed or within three years after the material facts are discovered or “reasonably should have been known,” but not more than ten years from the date the alleged violation was committed.
Semiannual Reporting—The AFCA also amends the reporting obligations for federal government agencies, departments, and entities, requiring semiannual reports to include data on AFCA claims: the number of cases reported, actions taken—including statistical tables showing pending and resolved cases, average time to resolve cases, and final agency decisions appealed—and instances in which officials reviewing cases declined to proceed.
Next Steps
The AFCA represents a significant shift in administrative fraud enforcement as the federal government under the Trump administration focuses on reducing fraud and waste. The law strengthens and enhances the government’s ability to investigate and prosecute allegations of fraud, particularly those involving smaller dollar amounts, by providing agencies with a mechanism to prosecute allegations of fraud without having to go through the U.S. Department of Justice (DOJ) and the FCA process.
Moreover, the AFCA also expands the scope of potential liability, covering false statements even in the absence of a claim for payment. However, the AFCA lacks a qui tam provision that would incentivize whistleblowers to come forward with false claims allegations.
Moreover, the AFCA provides another antifraud tool as the Trump administration has sought to use the FCA against businesses to stop “illegal” diversity, equity, and inclusion (DEI) programs. There is potential that the AFCA could be used similarly as part of the administration’s efforts.
However, there are still questions regarding the AFCA’s authorization of administrative law judges (ALJs) and other officials to oversee cases. In its 2024 decision in Securities and Exchange Commission v. Jarkesy, the Supreme Court of the United States vacated a civil monetary penalty that was imposed in an ALJ proceeding. The Court found that this penalty violated the defendant’s right to a jury trial under the Seventh Amendment of the U.S. Constitution, raising concerns about the constitutionality of ALJ proceedings, particularly concerning monetary penalties.
Why Reporting Accounting Fraud Will Lead to Future SEC Whistleblower Awards
A recent CNN documentary about the Enron accounting scandal is a stark reminder of the devastation that results when corporate officers cook the books – thousands of employees lost their jobs, individual investors and pension funds lost billions, and the stock market plummeted as investors lost confidence in the accuracy of public company accounting. Most employees that knew about the fraud failed to speak up due to fear of retaliation and a corporate culture characterized by greed and deception. If Enron employees had been protected against retaliation and incentivized to report accounting fraud to the SEC, the SEC may have learned about the fraudulent practices early enough to combat and remedy those practices.
Under the SEC Whistleblower Program, whistleblowers can submit tips anonymously to the SEC through an attorney and be eligible for an award for exposing any material violation of the federal securities laws. Since 2011, the SEC has issued more than $2.2 billion in awards to whistleblowers. The largest SEC whistleblower awards to date are:
$279 million (May 5, 2023)
$114 million (Oct. 22, 2020)
$110 million (Sept. 15, 2021)
This article discusses: 1) how whistleblowers can earn awards for reporting accounting fraud to the SEC; 2) the pervasiveness of accounting fraud at U.S. publicly traded companies; and 3) the SEC’s focus on accounting fraud which, in turn, will lead to future SEC whistleblower awards.
SEC Whistleblower Program
In response to the 2008 financial crisis, Congress passed the Dodd-Frank Act, which created the SEC Whistleblower Program. Under the program, the SEC is required to issue monetary awards to whistleblowers when they provide original information about violations of the federal securities laws (e.g., accounting fraud) that leads to successful SEC enforcement actions with monetary sanctions in excess of $1 million. Whistleblowers are eligible to receive an award of between 10% and 30% of the total monetary sanctions collected in a successful enforcement action. In certain circumstances, even officers, directors, auditors, and accountants may be eligible for awards under the program.
Since the inception of the SEC Whistleblower Program, whistleblower tips have enabled the SEC to bring successful enforcement actions resulting in more than $6 billion in monetary sanctions. In Fiscal Year (FY) 2024 alone, the SEC Office of the Whistleblower awarded more than $255 million to whistleblowers, which included a $98 million award. Also in FY 2024, the SEC received nearly 25,000 whistleblower tips, of which 2,609 related to Corporate Disclosures and Financials. As detailed below, recent data suggest that whistleblower tips related to accounting frauds will likely increase in the coming years due to rampant accounting fraud, violations, and errors.
Whistleblowers Needed: Accounting Fraud is Widespread
In October 2023, a paper titled How Pervasive is Corporate Fraud? estimated that “on average 10% of large publicly traded firms are committing securities fraud every year.” According to the paper:
Accounting violations are widespread: in an average year, 41% of companies misrepresent their financial reports, even when we ignore simple clerical errors. Fortunately, securities fraud is less pervasive. In an average year, 10% of all large public corporations commit (alleged) securities fraud, with a 95% confidence interval between 7 and 14%.
The paper’s findings about the pervasiveness of accounting violations were echoed in a December 2024 Financial Times article titled Accounting errors force US companies to pull statements in record numbers. According to the article:
The number of US companies forced to withdraw financial statements because of accounting errors has surged to a nine-year high, raising questions about why mistakes are going unnoticed by auditors.
In the first 10 months of this year, 140 public companies told investors that previous financial statements were unreliable and had to reissue them with corrected figures, according to data from Ideagen Audit Analytics. That is up from 122 in the same period last year and more than double the figure four years ago. So-called reissuance restatements cover the most serious accounting errors, either because of the size of the mistake or because an issue is of particular concern to investors.
Fortunately for investors, officers, directors, auditors, and accountants can be eligible for awards under the SEC Whistleblower Program, and whistleblower tips – especially from individuals with actual knowledge of the fraud – enable the SEC to quickly detect and halt accounting schemes.
Accounting Fraud in SEC Crosshairs
SEC enforcement actions against accounting violations and improper disclosures often lead to significant penalties. Eligible whistleblowers may receive awards of between 10% and 30% of the monetary sanctions collected in successful enforcement actions. Since 2020, some of the SEC’s largest enforcement actions were brought against companies engaged in accounting violations:
In 2020, General Electric agreed to pay a $200 million penalty for misleading investors by understating losses in its power and insurance businesses.
In 2021, The Kraft Heinz Company agreed to a $62 million penalty to settle charges that it engaged in a long-running expense management scheme that resulted in the restatement of several years of financial reporting
In 2021, Luckin Coffee agreed to pay a $180 million penalty for defrauding investors by materially misstating the company’s revenue, expenses, and net operating loss in an effort to falsely appear to achieve rapid growth and increased profitability and to meet the company’s earnings estimates.
In 2022, accounting firm Ernst & Young agreed to pay a $100 million penalty due to some employees cheating on CPA ethics exams and for misleading SEC investigators.
In 2024, UPS agreed to pay a $45 million penalty for misrepresenting its earnings by improperly valuing its UPS Freight business unit.
Whistleblower tips concerning similar accounting violations have led to, and will continue to lead to, significant whistleblower awards. For more information about reporting accounting fraud to the SEC and earning a whistleblower award, see the following articles:
How to Report Accounting Fraud an Earn an SEC Whistleblower Award
5 Things Whistleblowers Should Know About Reporting Accounting Fraud to the SEC
Improper revenue recognition tops SEC fraud cases
Thompson v. United States (No. 23-1095)
William Blake once observed that “a truth that’s told with bad intent, beats all the lies you can invent.” It turns out the Supreme Court agrees, at least for escaping liability under 18 U.S.C. § 1014. In Thompson v. United States (No. 23-1095), a unanimous court held that this statute criminalizes only false statements and not statements that are misleading but literally true.
Patrick Thompson took out three loans from the Washington Federal Bank for Savings at various times. He first borrowed $110,000 in 2011. Then in 2013, he borrowed an additional $20,000. The year after that, he borrowed $89,000 more. These three loans resulted in a total loan balance of $219,000. In 2017, however, the Washington Federal Bank for Savings failed, and the FDIC assumed responsibility for collecting the bank’s outstanding loans. As part of the FDIC’s collection attempts, Planet Home Lending, the FDIC’s loan servicer, sent Thompson an invoice for $269,120.58, reflecting his principal amount plus unpaid interest.
After receiving the invoice, Thompson called Planet Home Lending and professed confusion as to where the $269,120.58 figure came from. On the call (which, unfortunately for our supposedly befuddled borrower, was recorded) Thompson said “I borrowed the money, I owe the money—but I borrowed…I think it was $110,000.” Thompson later received a call from two FDIC contractors, whose notes of the call reflect that Thompson mentioned borrowing $110,000 for home improvement. He later settled his debt with the FDIC for $219,000—an amount that coincidentally reflected the exact principal amount of the loans he had taken out but apparently could not recall.
Any elation he felt over his $50,000 in interest savings was likely cut short, however, when he was indicted on two counts of violating 18 U.S.C. § 1014. That statute prohibits “knowingly mak[ing] any false statement or report . . . for the purpose of influencing in any way the action of . . . the Federal Deposit Insurance Corporation . . . upon any . . . loan.” One count related to his call to Planet Home Lending, and the second to his call with the FDIC contractors. Apparently secure in his belief in his own veracity, Thompson proceeded to trial. But the jury reached a different conclusion regarding his trustworthiness and convicted him of both counts.
He moved for acquittal or a new trial, arguing that a “conviction for false statements cannot be sustained where, as here, the alleged statements are literally true, even if misleading.” Thompson argued that his statements about borrowing $110,000 were literally true because he had in fact borrowed that amount of money from the Bank, even though he later borrowed more. Cf. Mitch Hedberg (“I used to do drugs. I still do, but I used to too.”). The district court denied the motion, finding that “literal falsity” was not required to violate section 1014 under Seventh Circuit precedent. The Seventh Circuit affirmed, holding that “misleading representations” were criminalized by that statute.
In a unanimous opinion by Chief Justice Roberts, the Supreme Court reversed and remanded. In their view, this was a simple case. The plain text of the statute criminalizes “knowingly mak[ing] any false statement or report.” But “false and misleading are two different things” because a “misleading statement can be true.” And because “a true statement is obviously not false,” misleading-but-true statements are outside the scope of the statute.
Much in the case ultimately turned on whether the natural reading of “false” includes a true but misleading statement. As one of many colorful examples of how even true statements can be misleading, Roberts discussed a hypothetical, which the Government conceded at oral argument, that “[i]f a doctor tells a patient, ‘I’ve done a hundred of these surgeries,’ when 99 of those patients died, the statement—even if true—would be misleading because it might lead people to think those surgeries were successful.” (The statement would be equally true—and equally misleading—if all 100 patients had died, but perhaps the Court thought that even its hapless hypothetical surgeon was unlikely to have botched all his operations). With that recognition in mind, Roberts quickly rejected the Government’s argument made with “dictionary in [one] hand” and “thesaurus in the other hand” that false can also simply mean “deceitful” and that “false and misleading have long been considered synonyms.” Unimpressed with the stack of books the Government brought to bear, the Court observed that this argument merely “point[ed] out the substantial overlap between the two terms.”
Finally, the Chief turned to context and precedent. Starting with the former, Roberts noted that many other criminal statutes do criminalize both false and misleading statements, including “[m]any other statutes enacted in the same period” as section 1014 (like such stalwarts of the federal code as the Perishable Agricultural Commodities Act). This gave rise to the presumption that Congress’s omission of the term “misleading” from section 1014 was deliberate. And as to precedent, Roberts found support in Williams v. United States (1982), where the Court stated that “a conviction under §1014 requires at least two things: (1) the defendant made a statement, and (2) that statement can be characterized as ‘false’ and not ‘true.’”
Justices Alito and Jackson each filed a brief concurrence. Justice Alito emphasized that “context” is key when assessing whether a misleading statement crosses the line into being false. Justice Jackson wrote separately to note that the jury instructions in Thompson’s case had actually been correct, referencing only false statements while making no mention of misleading statements. In her view, then, there was “little for the Seventh Circuit to do on remand but affirm the District Court’s judgment upholding the jury’s guilty verdict.”
Updated SEC Marketing Rule FAQ: Clarification Regarding Presentation of Net Extracted Performance
On March 19, 2025, the Securities and Exchange Commission (SEC) staff issued an update to its frequently asked questions (FAQ)[1] guidance with respect to registered investment advisers’ compliance with Rule 206(4)-1 (Marketing Rule) under the Investment Advisers Act of 1940 (Advisers Act). The FAQ provides new direction for advisers on the presentation of gross and net extracted performance data for a single investment or a group of investments (an “extract”) in marketing materials, as well as guidance as to whether certain portfolio or investment characteristics would constitute “performance” for purposes of the Marketing Rule.
The Marketing Rule originally required the presentation of gross extracted performance to be accompanied by a presentation of net extracted performance. This was made explicitly clear in a prior SEC FAQ published on January 11, 2023.[2] Under the updated FAQ, however, an adviser will now be permitted to present gross extracted performance and refer to certain portfolio or investment characteristics without also presenting corresponding net extracted performance, provided that certain additional requirements are met as described below.
Presentation of Gross and Net Performance of Extracts and Investment Characteristics
Following the release of the Marketing Rule, advisers to private investment funds struggled with the requirement to present net performance data for extracts, as it was unclear from the final rule how fund-level fees and expenses should be applied to specific investments. This led to many advisers taking various diverging approaches in an attempt to comply with the Marketing Rule and a perception among private fund industry participants that such additional disclosures were inherently flawed for resting upon simplistic, if not artificial, assumptions mandated by the Marketing Rule concerning the allocation of fund-level fees and expenses and provided little (if any) practical benefit for investors. Additionally, the Marketing Rule does not define the term “performance”, which led to uncertainty as to whether certain portfolio or investment characteristics (e.g., yield, coupon rate, contribution to return, Sharpe ratio, Sortino ratio and other similar metrics), for which calculating “net” performance may be impossible, misleading or confusing to investors, could actually be included in advisers’ marketing materials.
In the updated FAQ, the SEC staff stated that they would not recommend enforcement action under Rule 206(4)-1(d)(1) of the Advisers Act if an adviser either (i) presents the gross performance of an extract in an advertisement without including the corresponding net performance of the extract or (ii) presents one or more gross characteristics of a portfolio or investment without including the corresponding net characteristics, if each of the following are true:
The extract’s performance or the gross characteristic (as applicable) is clearly identified as being calculated on a gross basis, without the deduction of fees and expenses;
The extract’s performance or the characteristic (as applicable) is accompanied by a presentation of the total portfolio’s gross and net performance, consistent with the requirements of the Marketing Rule;
The total portfolio’s gross and net performance is presented with at least equal prominence to, and in a manner designed to facilitate comparison with, the extract’s or the characteristic’s (as applicable) performance;[3] and
The gross and net performance of the total portfolio is calculated over a period that includes the entire period over which the extract’s or characteristic’s (as applicable) performance is calculated.[4]
While the SEC staff has not provided a definition of “performance” under the Marketing Rule, the staff clarified that total return, time-weighted return, return on investment, internal rate of return, multiple on invested capital and total value to paid-in capital are each considered “performance” and are subject to the full requirements of the Marketing Rule. Additionally, the staff indicated that if a characteristic is not “performance”, then it does need to be shown on a gross basis.
Action Items
The updates to the FAQ represents a marked shift in the SEC’s interpretation and position on extracted performance, and may give advisers additional certainty on how to meet their obligations under the Marketing Rule. Private fund advisers should review their marketing materials that include gross and net performance of extracts or characteristics of a portfolio or investment to ensure the conditions set forth in the FAQ are satisfied.
Please contact your Foley Fund Formation and Investment Management client team for more information and assistance with navigating these Marketing Rule obligations.
[1] Available at: https://www.sec.gov/rules-regulations/staff-guidance/division-investment-management-frequently-asked-questions/marketing-compliance-frequently-asked-questions#_edn6
[2] The prior FAQ from January 11, 2023, which directly contradicts certain aspects of the new FAQ concerning presentation of net extracted performance, has been removed from the SEC’s FAQ webpage.
[3] The SEC clarified that the total portfolio’s gross and net performance do not need to be shown on the same page of an advertisement as the extract or characteristic, but having the total portfolio’s performance precede the extract or characteristic in an advertisement would help to facilitate a comparison between the two.
[4] Because time periods over which extracts and characteristics are calculated may not easily align with the one-, five- and ten-year periods required by Rule 206(4)-1(d)(2) for advertisements to clients other than private funds, the SEC staff further stated that they would not recommend enforcement action if the extract or characteristic is calculated over a single, clearly disclosed period.
FTC Alleges Fintech Cleo AI Deceived Consumers
On March 27, 2025, the Federal Trade Commission (FTC) filed a lawsuit and proposed settlement order resolving claims against Cleo AI, a fintech that operates a personal finance mobile banking application through which it offers consumers instant or same-day cash advances. The FTC alleges that Cleo deceived consumers about how much money they could get and how fast that money could be available, and that Cleo made it difficult for consumers to cancel its subscription service.
Pointing to those allegations, the FTC alleges Cleo (1) violated Section 5 of the Federal Trade Commission Act (FTC Act) by misrepresenting that consumers would receive—or would be likely to receive—a specific cash advance amount “today” or “instantly” and (2) violated the Restore Online Shoppers’ Confidence Act (ROSCA) by failing to conspicuously disclose all material transaction terms before obtaining consumers’ billing information and by failing to provide simple mechanisms to stop recurring charges.
“Cleo misled consumers with promises of fast money, but consumers found they received much less than the advertised hundreds of dollars promised, had to pay more for same day delivery, and then had difficulty canceling,” said Christopher Mufarrige, Director of the FTC’s Bureau of Consumer Protection.
The FTC cites to consumer complaints in support of its action against Cleo, including one stating: “There’s no other way for me to say it. I need my money right now to pay my rent. I have no other option I can’t wait 3 days. I can’t wait 1 day I need it now. I would never have used Cleo if I would have thought I would ever be in this situation.”
The FTC’s Allegations
In its complaint, filed in the U.S. District Court for the Southern District of New York, the FTC alleges that Cleo violated Section 5 of the FTC Act by:
“Up To” Claims. Advertising that its customers would receive “up to $250 in cash advances,” and then, only afterthe consumer subscribes to a plan and Cleo sets the payment date for the subscription, is the consumer informed of the cash advance amount they can actually receive. For “almost all consumers, that amount is much lower than the amount promised in Cleo’s ads.”
Undisclosed Fees. Advertising that its customers would obtain cash advances “today” or “instantly,” when Cleo actually charges an “express fee”—sometimes disclosed in a footnote—of $3.99 to get the cash same-day, and, even then, the cash may not arrive until the next day.
In addition, the FTC’s complaint alleges that Cleo violated Section 4 of ROSCA by:
Inadequate Disclosures. Failing to clearly and conspicuously disclose all material terms before obtaining customers’ billing information.
Inadequate Cancellation Mechanisms. Failing to permit consumers with an outstanding cash advance to cancel their subscriptions through the app.
Proposed Consent Agreement
The FTC’s proposed consent order would be in effect for 10 years and require that Cleo pay $17 million to provide refunds to consumers harmed by the company’s practices. The consent order would restrict Cleo from misleading consumers about material terms of its advances and require that it obtain consumers’ express, informed consent before imposing charges. More specifically, the consent order:
Prohibits Cleo from misrepresenting the amount of funds available to a consumer, when funds will be available, any applicable fees (including the nature, purpose, amount, or use of a fee), consumers’ ability to cancel charges, or the terms of any negative option feature.
Requires Cleo to clearly and conspicuously disclose, prior to obtaining the consumer’s billing information, all material terms, including any charges after a trial period ends, when a consumer must act to prevent charges, the amount the consumer will be charged unless steps are taken to prevent the charge, and information for consumers to find the simple cancellation mechanism.
Requires Cleo provide a simple mechanism for a consumer to cancel the negative option feature, avoid being charged, and immediately stop recurring charges. Such cancellation method must be through the same medium the consumer used to consent to the negative option feature.
The Commission voted 2-0 to issue the Cleo complaint and accept the proposed consent agreement.
Takeaways
The FTC has increased enforcement activities for negative options, such as last year’s enforcement action against Dave, Inc., another cash advance fintech company, which we wrote about previously. This attention on negative options, and consumers’ ability to easily cancel negative options, may provide insight into the FTC’s regulatory agenda, given that the remainder of its Click-to-Cancel Rule takes effect on May 14, 2025.
The FTC recently filed a brief in defense of its Click-to-Cancel Rule, vigorously defending the FTC’s rulemaking against trade association challenges consolidated in the Eighth Circuit. The FTC’s brief puts an end to speculation that the Commission may rethink or roll back the rule given the recent administration change and shifts in FTC leadership.
Businesses should be preparing to adopt changes to implement the Click-to-Cancel Rule, to the extent not already in process. The FTC’s complaint against Cleo should also serve as a reminder that businesses that employ “up to” claims, complex fee structures, or negative option offers should be careful to monitor their conduct in light of developments within the FTC and the other federal and state agencies that police advertising and marketing practices.
Delligatti v. United States (No. 23-825)
Federal law provides a mandatory minimum sentence of five years for a person who uses or carries a firearm during a “crime of violence.” In Delligatti v. United States (No. 23-825), the Supreme Court addressed whether a crime of omission involves the “use” of physical force, thus subjecting a defendant to the sentencing enhancement. A 7-2 Court held that it does.
Salvatore Delligatti is an associate of the Genovese crime family. Delligatti had been hired by a gas station owner to take out a neighborhood bully and suspected police informant. Delligatti, in turn, recruited a local gang to carry out the job and provided them with a gun and a car. Unfortunately for Delligatti, the job was thwarted twice, once when the gang abandoned the plan because there were too many witnesses present, and second by the police, who had discovered the plot. Delligatti was charged with multiple federal offenses, including one count of using or carrying a firearm during a “crime of violence” pursuant to 18 U.S.C. § 924(c).
Section 924(c) states that an offense qualifies as a crime of violence if it “has as an element the use, attempted use, or threatened use of physical force against a person or property of another.” To determine whether an offense falls within Section 924(c), courts employ the so-called categorical approach, asking whether the offense in question always involves the use, attempted use, or threatened use of force. The Government argued that Delligatti’s offense met this requirement because he had committed attempted second-degree murder under New York law. Before trial, Delligatti moved to dismiss his Section 924(c) charge arguing the Government could not establish a predicate crime of violence. The District Court disagreed, holding that there “can be no serious argument” that attempted murder is not a crime of violence. A jury convicted Delligatitti on all counts and he was sentenced to 25 years of imprisonment.
On appeal to the Second Circuit, Delligatti argued that New York’s second-degree murder statute fell outside Section 924(c)’s elements clause because it could be committed either by an affirmative act or by an omission. But the Second Circuit affirmed his conviction, holding that causing (or attempting to cause) bodily injury necessarily involves the use of physical force, even if the injury is caused by an omission. The Supreme Court granted certiorari to decide whether an individual who knowingly or intentionally causes bodily injury or death by failing to take action uses physical force within the meaning of Section 924(c).
Justice Thomas, writing for the majority, held that precedent, congressional intent, and logic refuted Delligatti’s challenge to his conviction. First precedent: In United States v. Castleman (2014), the Court interpreted a statute that prohibited anyone convicted of misdemeanor domestic-violence crimes, which similarly requires the use of physical force, from owning a firearm. In Castleman, the Court held that it was “impossible to cause bodily injury without applying force,” and that this force can be applied directly or indirectly, such as sprinkling poison in a victim’s drink, even though sprinkling poison does not itself involve force. Put differently: whenever someone knowingly causes physical harm, he uses force for the purposes of the statute. (Indeed, Delligatti had conceded that it was possible to use violent force indirectly, such as “when a person tricks another into eating food that has aged to the point of becoming toxic.”)
Justice Thomas then rebuffed Delligatti’s contention that one does not use physical force against another through deliberate inaction. By way of further example, a car owner makes “use” of the rain to wash a car by leaving it out on the street, or a mother who purposefully kills her child by declining to intervene when the child finds and drinks bleach makes “use” of bleach’s poisonous properties. Thomas thus concluded that crimes of omission qualify as a Section 924(c) crime of violence because intentional murder is the prototypical crime of violence, and it has long been understood that “one could commit murder by refusing to perform a legal duty, like feeding one’s child.” He noted that there is a preference for interpretations of Section 924(c) that encompass prototypical crimes of violence over ones that do not. And, at the time of Section 924(c)’s enactment, the principle that even indirect causation of bodily harm involves the use of violent force was well-established in case law, treatises, and various state laws. This violent force could be accomplished with battery-level force, i.e., force satisfied by “even the slightest offensive touching,” or by deceit or other nonviolent means.
In dissent, Justice Gorsuch, joined by Justice Jackson, continued with the majority’s approach of reasoning by example, only this time concluding that Section 924(c) does not reach crimes of omission. He began by asking the reader to imagine “a lifeguard perched on his chair at the beach who spots a swimmer struggling against the waves. Instead of leaping into action, the lifeguard chooses to settle back in his chair, twirl his whistle, and watch the swimmer slip away. The lifeguard may know that his inaction will cause death. Perhaps the swimmer is the lifeguard’s enemy and the lifeguard even wishes to see him die. Either way, the lifeguard is a bad man.” But while the lifeguard may be guilty of any number of serious crimes for his failure to fulfill his legal duty to help the swimmer, the lifeguard’s inaction does not qualify as a “crime of violence.”
Justice Gorsuch reached this conclusion primarily through statutory interpretation. In his view, when Congress enacted Section 924(c), “to use” meant “to employ,” “to convert to one’s service,” or “to avail one’s self of” something, terms that imply action, not inaction, inertia, or nonactivity. In his view, the physical force needed to commit a crime of violence must be a physical act, as well as one that is violent (extreme and severe, as opposed to “mere touching” consistent with battery). So, in the lifeguard example, by remaining in his chair, the lifeguard does not employ “even the merest touching, let alone violent physical force.” And while Gorsuch acknowledged that crimes of omission can still be serious, he explained that Section 924(c) was not written to reach every felony found in the various state codes, so the Court should not stretch the statute’s terms to reach crimes of inaction, inertia, or nonactivity. He also pointed out that when Congress was considering defining crime of violence to require the use of physical force, a Senate report discussed the hypothetical of the operator of a dam who refused to open floodgates during a flood, thereby placing residents upstream in danger, and concluded that the dam operator would not be committing a crime of violence because he did not use physical force. Finally, Gorsuch pointed out that crimes of omission more naturally fit within another subsection of Section 924(c), which the Court held was unconstitutionally vague in United States v. Davis (2019), showing that Congress has had no difficulty addressing crimes of omission elsewhere.
The Supreme Court Finds An Income Tax Statute Unconstitutional – Pollock v. Farmers Loan and Trust Co. 158 U.S. 601 (1895)
The 16th Amendment to the United States Constitution, ratified in 1913, provides as follows: “The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States and without regard to any census or enumeration.” Why the reference to “apportionment”? Why the reference to a census? To answer these questions, it is necessary to turn to one of the most forgotten of forgotten Supreme Court cases, Pollock v. Farmers Loan and Trust Co. 158 U.S. 601 (1895). The case was forgotten because it was rendered moot by the passage of the 16th Amendment. Few today remember that the Supreme Court invalidated an income tax statute passed by Congress in the 1890s.
Until eclipsed by the Great Depression of the early 1930s, the Panic of 1893 was regarded as the greatest economic downturn in American history. Prompted by bankers, bondholders, and other financial interests, the nation’s currency had been on the gold standard for 20 years. This contributed to deflationary pressures that pushed the prices of farm products below farmers’ costs[1]. A wave of farm bankruptcies and foreclosures was followed by widespread unemployment and wage cuts for urban workers, prompting strikes to protest the wage cuts.
The Panic of 1893, like the Stock Market Crash of 1929, was ushered in by a period in which the nation’s wealth was concentrated in the hands of fewer and fewer people. In a 2017 installment of the PBS series The American Experience, titled “The Gilded Age,” the narration discussed the 1890 Census, which revealed that there were approximately 12 million families in America, of whom 4,000 held as much wealth as the combined wealth of approximately 11.6 million other families.
During the 1890s, as had been the case at almost all previous times in American history, the federal government derived most of its revenue from tariffs and excise taxes. In January 1894, a young Congressman from Nebraska named William Jennings Bryan joined a growing contingent that questioned the wisdom of financing the government with an indirect tax on basic goods.[2] Bryan and others reasoned that most people spent most of their income on necessities and that the sellers of many of these necessities passed on the costs of tariffs imposed on those goods to consumers who bought them. It followed that those who spent all or most of their income on living expenses (most Americans) paid taxes on a larger portion of their income than the wealthy, who spent only a fraction of their income on living expenses and were not subject to any tax on their income. It followed that an income tax would be a fairer way to distribute the cost of supporting the federal government. This idea had great appeal in this era of concentrated wealth. Hence, in 1894, Congress passed the first peacetime income tax.[3] Some monied interests saw this law as the first step on the road to socialism and the confiscation of most of their wealth. Hence, the challenge that brought the Pollock case before the Court.
The Court’s majority found that Congress could not tax income from land or money invested in financial assets. This decision rested on some brief and perhaps confusing language in the Constitution. Article I § 2 ¶ 3 says, “Representatives and direct taxes shall be apportioned among the several States which may be included within this Union according to their respective numbers.”[4] Article I §8 ¶1 gives Congress the power “To lay and collect taxes duties, imposts, and excises…to be uniform throughout the United States.”
From these provisions came the distinction between direct taxes, which must be apportioned among the States according to the population as determined by the Census, and indirect ones, such as tariffs, which must be uniform throughout the country. Thus, the crucial question for the Court in Pollock was what constitutes a direct tax.
There was no disagreement among the Justices that an income tax did not lend itself to apportionment among the States according to population. A head tax, a “capitation” in which each individual paid the same amount, was the archetype of a direct tax apportioned according to population. Because some States had aggregate incomes that were greater per capita than others, ensuring that an income tax was apportioned equally among the States on a per capita basis presented some obvious problems. From this reality, the majority, as expressed in Chief Justice Melville Fuller’s opinion, drew a very different conclusion from those of four Justices, who wrote separate dissenting opinions. Most notable among the dissents was that of Justice John Marshall Harlan, which was more in tune with the sentiments of Main Street than of Wall Street.[5]
The majority found that a tax on income derived from rents or earnings from securities or other investments was a direct tax that could not be imposed without violating the apportionment mandate of Article I §2 ¶3 and was, therefore, unconstitutional.
In his dissent, Harlan cited precedents going back to George Washington’s day as authority for his view that direct taxes within the meaning of the Constitution were limited to head taxes and taxes on land. He noted the terrible contortions that would be necessary to apportion a tax on the income from land and other invested personal assets among the States according to population.[6] He concluded that the Framers could not have intended to include such taxes as direct ones within the meaning of Article I §2 ¶3. Pollock, Id. at 652.
What is most notable about Harlan’s dissent is that he eloquently expressed the sentiments that led Congress to pass the 1894 income tax legislation in the first place. Although the majority found that all the provisions of the income tax statute were tainted by the unconstitutional tax on the profits of land and invested capital, the opinion theoretically held open the possibility of taxes on salaries.[7] Thus, in his dissent, Harlan protested that “The practical effect of the decision to-day is to give to certain kinds of property a position of favoritism” Id at 685.
“In the large cities or financial centers of the country there are persons deriving enormous incomes from the renting of houses that have been erected not to be occupied by the owner, but for the sole purpose of being rented. Near by are other persons, trusts, combinations, and corporations, possessing vast quantities of personal property, including bonds and stocks of railroad, telegraph, mining, telephone, banking, coal, oil, gas, and sugar-refining corporations, from which millions upon millions of income are regularly derived. In the same neighborhood are others who own neither real estate, nor invested personal property, nor bonds, nor stocks of any kind, and whose entire income arises from the skill and industry displayed by them in particular callings, trades, or professions, or from the labor of their hands, or the use of their brains. And it is now the law, as this day declared, that …congress cannot tax the personal property of the country, nor the income arising either from real estate or from invested personal property…while it may compel the merchant, the artisan, the workman, the artist, the author, the lawyer, the physician, even the minister of the Gospel, no one of whom happens to own real estate, invested personal property, stock, or bonds, to contribute directly from their respective earnings, gains, and profits, and under the rule of uniformity or equality, for the support of the government.” Id at 672-673.
Harlan’s dissent makes nearly the same point made by William Jennings Bryan in a portion of his famous “Cross of Gold” speech at the Democratic National Convention in Chicago in 1896.[8] In this portion of the speech, Bryan addressed his remarks to the monied interests who supported the gold standard and opposed bimetallism.
“When you come before us and tell us that we shall disturb your business interests, we reply that you have disturbed our interests by your action….The man who is employed for wages is as much a businessman as his employer. The attorney in a country town is as much a businessman as the corporation counsel in a great metropolis. The merchant at the crossroads store is as much a businessman as the merchant in New York. The farmer who goes forth in the morning and toils all day, begins in spring and toils all summer, and by the application of brain and muscle to the natural resources of this country creates wealth, is as much a businessman as the man who goes upon the Board of Trade and bets on the price of grain. The miners who go 1,000 feet into the earth or climb 2,000 feet upon the cliffs and bring forth from their hiding places the precious metals to be poured in the channels of trade are as much businessmen as the few financial magnates who in a backroom corner the money of the world.” [Commager (ed) Documents Of American History, P. 174]
The Main Street v. Wall Street theme was present in both Harlan’s dissent in Pollock and Bryan’s Cross of Gold speech.
It is undoubtedly a good thing that our Constitution cannot be amended easily. Only overwhelming sentiment in favor can secure the two-thirds majorities in both houses of Congress and ratification by the legislatures of three-fourths of the States necessary for an amendment. It took until 1913, 18 years after the Pollock decision, for the 16th Amendment to be passed. However, public support for financing the federal government with an income tax rather than tariffs was likely already building at the time of the decision.
By 1913, what became known as the Progressive Era was in full swing. Woodrow Wilson, of the Progressive wing of the Democratic Party, was President. Theodore Roosevelt of the Progressive wing of the Republican Party had been president from 1901 to 1908. The 17th Amendment, which provides for the direct election of members of the U.S. Senate, another Progressive reform, was also passed in 1913. The Federal Trade Commission, the Interstate Commerce Commission, the Federal Reserve System, and the Clayton Anti-Trust Act were all part of this era of reform. By 1913, Charles Evans Hughes and Oliver Wendell Holmes, two Justices sympathetic to Progressive reforms, were already on the Supreme Court; another Justice with these sympathies, Louis Brandeis, would follow in 1916. With the 16th Amendment in place, Congress passed the Revenue Act of 1913, which simultaneously implemented the income tax and lowered tariffs. [Link & McCormick, Progressivism, James, The Supreme Court In American Life, Chambers, The Tyranny Of Change, and McGerr, A Fierce Discontent].
The Pollock decision was moot, but the sentiments expressed in Harlan’s dissent had prevailed and made a lasting impact on law and public policy.
[1] The underlying cause of the problem was a long-term downward trend in grain prices. This trend was a result of the worldwide expansion of railroads, which opened new land for cultivation, facilitated access to markets, and reduced transportation costs. The decreasing prices they received for their products made the debts American farmers had incurred in earlier years relatively more burdensome. Many farmers viewed the monetization of silver, known as “bimetallism,” as a remedy to the deflationary pressure squeezing them. [Blum, et. al. The National Experience (3rd ed.), PP. 475-476; Parkes, The American Experience, P. 298; Foner, Give Me Liberty, P. 631; Schieber et. al., American Economic History (9th edition), PP. 213-214.; Goodwyn, The Populist Moment, P. 12; Brands, American Colossus, P. 487]
[2] Canellos, The Great Dissenter, P. 108.
[3]. A special emergency income tax existed during the Civil War, which was not continued after the War’s end.
[4] What followed, although not relevant here, was the language embodying the infamous Three-Fifths Compromise.
[5] See generally, Canellos, supra Chapter 14, and Urofsky, Dissent and the Supreme Court at PP. 126-128.
[6] Such as imposing a higher rate on States with lower aggregate incomes from these sources so that the amount paid per capita was equal.
[7] This possibility would require the tax on salaries to be categorized as an indirect tax within the meaning of Article I §8 ¶1, or the contortions needed to apportion it equally among the States according to population would also apply to it.
[8] This speech is considered one of American history’s greatest speeches. Bryan was 36 years old and not one of the leading contenders for the Party’s nomination for President at the time. The speech electrified the Convention. There was pandemonium on the floor and in the galleries. Bryan was carried around the hall on the shoulders of elated delegates for 25 minutes and instantly vaulted over all the other candidates to become the Party’s nominee. The language quoted above was merely part of the build-up to the dramatic final words of the speech, “You shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.” [See H.W. Brands, American Colossus, PP. 547-548; Lears, Rebirth of a Nation, PP. 186-187; Cashman, America in the Gilded Age, PP. 332-334, and Wikipedia Article “Cross of Gold Speech” accessed 3/25/25.]