Thursday, October 1, 2009

CPSIA - My Comment Letter on Civil Penalty Factors

October 1, 2009

Todd A. Stevenson
Director, Office of the Secretary
Room 502
U.S. Consumer Product Safety Commission
4330 East West Highway
Bethesda, Maryland 20814

Re: Docket No. CPSC–2009–0068 Civil Penalty Factors

Dear Mr. Stevenson:

I am hereby submitting comments in response to the Solicitation of Comments on Civil Penalty Factors (.Docket No. CPSC–2009–0068) dated September 1, 2009 (the “Factors”). I have previously submitted comments on December 17, 2008 regarding Section 217(b)(2) Civil Penalty Criteria which are posted online at the CPSC website.

The Civil Penalties Factors are Especially Significant for an Administrative Agency. Because the CPSC is an independent federal agency (15 U.S.C. §2053), enormous governmental power is held by the agency. As noted by some commentators, “[independent] agencies typically exercise all three constitutionally divided powers within a single bureaucratic body: That is, agencies legislate (a power vested solely in the legislature by the Constitution) through delegated rulemaking authority; investigate, execute, and enforce such rules (via the executive power these agencies are typically organized under); and apply, interpret, and enforce compliance with such rules (a power separately vested in the judicial branch).” [Footnotes omitted.] See With one agency standing essentially as judge, jury and legislature and with fewer checks-and-balances in place, penalties imposed by the CPSC under the Factors have the potential to be abusive.

The unchecked authority to punish can be damaging to markets regulated by the CPSC. Problems arising out of self-oversight or a possible lack of due process can be anticipated, as well. Without placing clear limits on the CPSC’s authority or process to impose penalties, the agency’s enforcement activities may become economically depressing. The CPSC may believe that large penalties will simply spur the market to uphold its compliance responsibilities: “’These highly publicized toy recalls were among many that helped spur action last year to impose even stricter limits on lead paint on toys,’ said CPSC Chairman Inez Tenenbaum. ‘This penalty should remind importers and retailers that they have always had the same obligation to meet the strict lead limits as the manufacturers.’” [CPSC Press Release dated October 1, 2009.] While that effect will certainly be felt, other less positive impacts will also be generated. Applying the rule of “once burned, twice shy”, we anticipate that retailers will clamp down tightly on compliance, making the sale of low volume items unprofitable and triggering a Darwinian “survival of the fittest” selection in children’s markets. For instance, implementation of new compliance rules at Toys R Us make it difficult or near impossible for small businesses to sell through that retail outlet (16% market share in the U.S. toy market). In addition, other market participants may conclude that the CPSC is now enforcing a strict liability standard and just exit the market altogether, abandoning their customers. The effects will be both direct and indirect.

Arbitrary results are already noticeable. Recent penalties announced for lead or lead-in-paint follow no apparent pattern, are “round numbers” and equate to per-unit penalties ranging between $.01 and $2.17 (July 7 press release). Likewise, recent penalties for drawstring violations have ranged as high as $10.63 per unit (and up to a breathtaking 60% of revenue), again without apparent pattern. These widely varying penalties appear to be arbitrary. A fear of arbitrary penalties is certain to depress markets by discouraging investment in new products or new markets.

The penalty imposed on Target today in the amount of $600,000 provides another chilling example. The Target penalty is the equivalent of $1.10 per unit recalled. The October 2009 penalty applies to sales made between May 2006 and August 2007, and two of the three voluntary recalls resulted from Target’s unprompted, good faith self-reporting. The Settlement Agreement and Order even states: “Target’s quality assurance procedures were reasonable and satisfied the standard of care. Target’s knowledge when the subject products were imported and offered for sale was that they complied with the lead paint standard. Notwithstanding satisfactory pre-production test results, certain units were subsequently found to contain impermissible levels of lead paint.” [Emphasis added] Notably, no lead-in-paint injuries were reported from the Target sales. The agreement also indicates that Target had begun to implement a new multi-stage testing and quality assurance initiative BEFORE the recalled items were manufactured, further confirming Target’s good faith and absence of presumed knowledge. Yet the company was forced to pay a $600,000 penalty for this unfortunate and regrettable incident.

I also understand that many (if not all) penalties were imposed without negotiation, exposing the violative companies to an extended, expensive, highly public and risky investigation (with possible referral to the Department of Justice) if the settlement agreements were not signed. The inherently coercive nature of such demands, with appeal a practical impossibility for all but the largest violators, makes the CPSC’s penalty determination essentially final and non-negotiable. The power of the CPSC to impose penalties needs to be restricted to assure that the threat of penalties will not adversely affect the operation of markets and to eliminate abuse. In the current proposal, the ability of the CPSC to impose penalties is for all practical purposes unfettered. This is neither necessary nor desirable.

In Order to Preserve Flexibility, the Factors Fail to Discount ANY Possible Penalty Scenario. The Discussion has repeated instances where the agency declined to take a common sense position, ostensibly because circumstances exist where a penalty might possibly be merited. For instance, the Discussion states: “Some commenters stated that the Commission should reserve seeking penalties only for the most egregious and dangerous situations and that most violations do not involve bad intentions or ill will. . . . Since the knowledge requirements in the CPSA, FHSA, and FFA include presumed knowledge, as well as actual knowledge, the Commission declines to follow the commenters’ suggestion to seek a penalty only where there is evidence of bad intentions or ill will.” [Another similar formulation is found in the Discussion on Section 1119.4(a)(4).]

I interpret this verbiage to mean that under circumstances where the conduct is NOT egregious (no ill will or bad intentions) and where the hazard is NOT dire, the Commission anticipates that circumstances may exist where a penalty may still be called for. This could occur, for instance, where the company is persistently in violation of law (perhaps because of inadequate operational controls) or had repeated recalls for the same violation. In my opinion, the right way to word the Factors would be to state that the absence of egregious conduct or substantial product hazard would be considered as a significant mitigating factor to be weighed against the presumed knowledge built into the “knowingly” definition (see below). This formulation would lend much greater clarity to the rules and Discussion set forth in the Factors. Unfortunately, if the CPSC wishes to preserve total flexibility, it will eventually act arbitrarily in setting penalties and hence unjustly.

In the same vein, the Factors do not place enough emphasis on consideration of positive factors. While the bad behavior or failures of an offending company should be considered in setting penalties, so should mitigating factors without limitation. For instance, the long term record of compliance should be considered when a violation is up for penalty. The investment in good faith safety practices and supply chain management should mitigate against evidence of non-compliance. The consideration of mitigating factors needs to be explicitly added to the process to ensure that mitigation is part of every penalty deliberation.

The Factors Fail to Recognize the Potential for Myriad Technical Violations of the CPSA, as amended. The Discussion states: “Two commenters suggested that the Commission should evaluate violations of regulatory standards by distinguishing those that do not involve actual risk of harm, but rather the potential risk of harm, differently than those that do involve real potential for significant injury. The Commission declines to accept the suggestion that it distinguish any violations of regulatory standards, rule, or bans in this manner. The promulgation of a mandatory regulation by the Commission, or by Congress when they enact statutory bans and standards, carries with it a corresponding determination that the standard is necessary to address an unreasonable risk of injury presented by the product included within its scope. Violations of such a statutory provision or Commission regulation presents a risk to consumers that has previously been determined to be addressed by compliance with the statute or regulation. If the commenters’ suggestion were followed, the Commission would be classifying certain mandatory standards as more important than others. In addition, the comment does not account for the fact that the Commission can seek penalties for other prohibited act violations (in addition to knowing violations of mandatory rules, standards or bans).”

As noted above, the Factors seem to seek flexibility without acknowledging the common sense reality of the regulated community’s situation. Regulated companies certainly recognize and respect that the entirety of the law must be observed. Nevertheless, because the CPSIA imposes so many tiny, hyper-technical obligations that can be the cause of (multiple) violations, penalties for repeated technical violations is a realistic possibility for almost all companies. If, for instance, a company has 50 violations of the advertising rules because of missing warning labels in catalogs or on a website (out of 10,000 relevant catalog listings), should they be subject to penalty? In my opinion, the Factors should clearly set out that some kind of violations are IN FACT different in nature and that the presumption will be AGAINST penalties in such circumstances. This preserves the ability of the agency to seek penalties for technical violations if the rare circumstances arise that merit such action. Clear statements of a presumption against penalties for technical or other low risk violations avoids terrifying the regulated community with the implicit threat that every violation could be subject to heavy penalty. [Consider the value of this change on the current trend among resale shops to refuse children’s goods.] For regulated companies, this clarification will significantly raise comfort levels and thereby strengthen the healthy operation of the marketplace.

The Definition of “Knowingly” Should Not Expand the Use of Penalties under the CPSIA.

The definition of “knowingly” under Section 20 of the CPSA introduces yet another opportunity for penalty abuse by the agency and should be restrained in the Civil Penalties Factors guidance. Under Section 20 of the CPSA, a “knowing” violation of the law by someone other than a distributor, manufacturer or private labeler will not result in a penalty unless the offender had ACTUAL knowledge. However, for distributors, manufacturers or private labelers, the definition of “knowingly” includes imputed knowledge, allowing virtually unlimited 20-20 hindsight by the CPSC.

The potential for penalty abuse is demonstrated by the penalties announced for lead-in-paint in July. In the publicly-released documents relating to the first nine cases, each offender was apparently forced to sign an agreement admitting a “knowing” violation of the law, despite the fact that the agreements do not document actual knowledge. It appears to me that the imputed reasonable man standard could be described as “woulda, coulda, shoulda” (also known as 20-20 hindsight). Under the imputed knowledge standard, virtually any presumed knowledge can be imputed, especially when determined ex parte as is the practice at the CPSC. In the case of lead-in-paint, all the CPSC needs to do is impute a failed test report to create the illusion of a “knowing” violation (a test that may or may not have been run, even if not legally required). Even a manufacturing error could be subject to a “knowing” violation on this basis (as in, a reasonable man would have controlled for that error). We believe that a lead-in-paint violation backed up with PASSING test reports could also be considered a “knowing” violation since a reasonable man would have (obviously) run a more careful test on the right units to reveal the problem. [Target was cited for a “[failure”] to take adequate action to ensure . . . .”] The opportunity to assess penalties based on imputed knowledge verges on a strict liability standard, which is NOT what the law imposes. If the CPSC wants to impose strict liability penalties, it should say so in plain language.

The issue of how to administer the definition of “knowingly” is especially important in light of the mind-boggling array of possible violations under the law. I would direct your attention to the Discussion section of the Factors in which the prohibited acts are described. ONE example of the new scope of the prohibited acts is set out thus: “The new amendments expand the acts prohibited under the CPSA and give the Commission the ability to enforce violations of the FHSA and FFA as prohibited acts under the CPSA. Thus, the amended CPSA now prohibits the sale, offer for sale, distribution in commerce, or importation into the United States of any consumer product, or other product or substance that is regulated under the CPSA or any other Act enforced by the Commission, that is not in conformity with an applicable consumer product safety rule under the CPSA, or any similar rule, regulation, standard, or ban under any other Act enforced by the Commission. 15 U.S.C. 2068(a)(1).” [Emphasis added] For perspective on the breadth of these requirements, please note that at the ICPHSO conference in February 2009, I asked in a public Q&A session for a list of these requirements and was instructed by a senior CPSC staff person (in front of an audience of several hundred people) to hire a lawyer. No list of these requirements exists to my knowledge. As a member of the regulated community, I fear imputed knowledge of an ever-changing and evolving set of rules, regulations, standards and laws that have not been listed clearly by the regulatory agency.

The CPSC Commission has an obligation to issue clearer guidelines that sets out precisely how imputed knowledge penalties will be assessed. While the Commission may prefer to retain full authority and flexibility for all possible fact scenarios, the ultra-flexible guidelines may create new and unintended victims.

The Definition of “Defect” Needs to be Reconsidered. In the Discussion section of the Factors, the distinction between a product defect and an act of non-compliance has been extinguished. This is very unfortunate and needs to be reversed. While non-compliance can be controlled (at least in theory), product defects cannot always be anticipated, even by appropriate risk management practices. Despite the holding of the Factors on this point, the CPSC is well-aware of this problem and has admitted that it is no better than the regulated community at anticipating the unknown and the unknowable. On May 12, at the CPSC Tracking Labels panel discussion (Second Panel video, beginning at 58:40), John “Gib” Mullan, Assistant Executive Director, Office of Compliance and Field Operations, made the following statement during Q&A: “It’s hard though to predict risk sometimes. I mean, we do this. We don’t always see it coming. If you’d asked me a couple years ago, how safe is that drywall in your house, I would have said, you know, really safe. Man, that’s all safe stuff! But right now we’re dealing with drywall in a big way and that’s something that’s a brand new thing.”

This analysis by Mr. Mullan essentially concedes that product defects cannot be equated with non-compliance since compliance can be planned for but latent product defects cannot be easily anticipated. If the CPSC cannot foresee latent safety issues in familiar products like drywall, the regulated community cannot possibly be held to a higher standard. Presumably, if the CPSC intends to impose unrealistic standards on the regulated community by allowing penalties for product defects, the agency would accept sanctions for its failure to anticipate the drywall problem in Florida and Louisiana. Of course, drywall sanctions would not be fair to the agency, and equating unanticipated product defects with non-compliance under the Factors would be no less unfair.

Given Mr. Mullan’s observation of the difficulty of anticipating certain product defects or product problems, it is hard to comprehend why the agency chose to allow consideration of the complexity of identifying a particular product hazard ONLY IF the business had filed in a timely fashion under Section 15. This is a remarkably inflexible position, given that a business is required to file “immediately” under Section 15(b) (interpreted to be 24 hour notice) if it “obtains information which reasonably supports the conclusion that such product . . . contains a defect which could create a [a product defect which (because of the pattern of defect, the number of defective products distributed in commerce, the severity of the risk, or otherwise) creates a substantial risk of injury to the public] . . . .” In other words, a business has only 24 hours to report information that reasonably supports the conclusion that a serious product defect exists. If the incident is a highly complex situation, it might be difficult or ill-advised to report that quickly (further research might be needed, among other things). Of course, due process reasons may underlie a failure to file in the 24-hour time window, too. For hidden or emerging hazards, this formulation of the Factors is tantamount to saying that NO extenuating circumstances will be considered to mitigate penalties for unanticipated, highly-complex hazards. If that’s the intention of the CPSC, I think the rule would state it directly so that the regulated community can familiarize itself with the policy.

Small Business Impact Guidelines Are Too Vague. The guidance provided by the Factors on the appropriateness of penalties on small businesses is in this author’s opinion so vague as to permit and support any conceivable outcome. The Factors as written seem to express a view that only the size of a penalty will impact small business. I do not agree with this as penalties may have a greater indirect impact on the small business community. In my opinion, the intent of this provision is to ensure that a rational and clearly stated policy on penalties will be designed to encourage the continued investment of the small business community in children’s products. These indirect or collateral impacts can also be regarded as “undue” under the statute.

Small businesses are the economy’s most vulnerable participants. They are the most likely Darwinian victim of any shake-out in the marketplace. The CPSC’s Civil Penalty Factors will form base expectations for small businesses and will certainly affect their decision-making. Small businesses, facing an incomprehensible blizzard of requirements under this ultra-complex law, can be anticipated to fail in substantial ways. [However, it does not follow that small businesses will fail their customers or endanger consumers in general or in greater proportion than large companies.] Small businesses recognize their disadvantage in this new highly complex legal environment and will look to the agency for clues on their likely treatment in the event of regulatory problems. The outpouring of small business protests over the CPSIA in the past two years is evidence of the real fear in this community. For this reason, the vagueness of the Factors in defining the exposure and limits on penalties will ITSELF depress the small business environment.

If a small business has exhibited good faith and its non-compliance does not lead to injury or reasonably foreseeable exposure of the public to risk of injury, the Factors should indicate that there is a presumption against penalties. If a pattern of non-compliance emerges in a series of interactions with the CPSC (e.g., a company clearly is informed of its legal obligations but persists in violating the law), then perhaps penalties can be used to bring the company into compliance. The selective use of penalties makes the issue of protecting small business much easier to administer. Thus, a clear statement of presumptions in setting penalties for small businesses would go far in limiting the impact on this fragile community.

Lack of Focus on the Purpose of Penalties Will Lead to Arbitrary Results. The Discussion in the Factors makes clear that the agency will not take into account the materiality of risk caused by violations or restrict its penalties to egregious conduct. In not restricting penalties in this way, the CPSC opens up all violations to possible assessment of penalties. By considering virtually unlimited options for penalties, the ability of the agency to administer rational, consistent and predictable imposition of penalties will greatly decline. As noted above, penalties assessed this year seem arbitrary. The consequence of arbitrariness could be quite damaging to the regulated markets. These consequences deserve deep consideration by the agency. Once doubt about the fairness, consistency or rationality of “justice” under the civil penalties provision creeps into the mindset of the marketplace, investment decisions will start to be made differently. Business people prefer stable and predictable returns on their investments. If they perceive random justice, fairly or not, in children’s product markets, businesses may choose to shift their investment elsewhere to obtain more certain returns, or take other measures to protect their limited capital (such as draining resources from the company, significantly reducing product development investment expenses or restricting other business innovations).

A useful change in the Factors would be a formalized appeal process which can independently and efficiently consider the merits of objections to penalties. While an independent appeal process may have the effect of limiting the authority of the agency to assess penalties, this process will also build confidence in the fairness of the process and in the agency itself. In the long run, a closer relationship with industry will lead to better safety outcomes, so this investment in mutual satisfaction with fair penalty administration will accrue to the benefit of the agency and consumers at large.

Business Judgment, if Properly Exercised, Should be a Factor in Civil Penalties. I want to reiterate the point I made in my December 17 comment letter that the exercise of business judgment needs to respected by the CPSC and included as a factor in the setting of penalties. The exercise of reasonable business judgment is necessary to administer any operating business. The complexity of the CPSIA and CPSA is well-known and well-documented. Thousands of business questions remain unanswered by the CPSC since passage of the CPSIA almost 14 months ago, leaving open a vast array of legal or factual ambiguities and forcing critical business decisions to be made with great uncertainty. The fact that violations of the CPSIA can create civil or even criminal liability only exacerbates the problems faced by business managers today. Given that circumstance, it would be unfortunate if the CPSC were permitted to exercise 20-20 hindsight on reasonable decision-making. Notably, the Business Judgment Rule was developed to help corporate boards deal with basically the same issue, namely that managers will not exercise judgment if all decisions are subject to liability. A reasonable safe harbor would be a constructive addition to the Factors.

The CPSC needs to recognize that only by cultivating the cooperation of the business community can safety gains be made and held. A fear-based enforcement system will lead to market dropouts and possibly bad behavior to avoid detection. Other federal agencies have long taken the approach of rewarding conscientious behavior and responsible decision-making. The Factors should take into account and respect the exercise of sound business judgment.

The Factors Should Also Take into Account the Actions and Inactions of the CPSC. The Civil Penalty Factors betray a one-sided view of violative behavior under the CPSA and related statutes. While the Factors carefully document a variety of factors in the behavior of the offending company for consideration, it omits extenuating factors such as the behavior of the regulatory agency itself. For instance, right now there are thousands of unanswered questions in the possession of the CPSC, many of which are many months old. What if those unanswered questions relate to a penalty case? What if the pendency of an unanswered question forced a company to make a business judgment that is later deemed violative – is this entirely the company’s fault? There is no Factor enumerated which would introduce the behavior of the CPSC into consideration as a mitigating factor. Mitigating factors that might be relevant include (a) the investment made by the agency in education of a particular subgroup in the regulated community (Did the CPSC give seminars at trade shows or reach out to trade show participants regularly?), (b) the outreach effort made by the agency (Was a liaison office formed? Did the CPSC contact members of the regulatory community for counseling or Q&A? Did it attempt to run seminars on site for regulated companies to help broaden understanding of the complex new laws? Did it answer reasonable questions on a timely basis?), (c) the availability of programs to reward good compliance efforts, (d) the existence of prior disclosure options to eliminate penalties, (e) the rational and consistent pattern of penalties imposed by the CPSC, (f) the ability to appeal penalties to a neutral third party on a reasonable basis (In other words, has the agency attempted to relieve the coercive nature of the current penalty process?), and so on.

Compliance is a two-way street. The idea that compliance is entirely the responsibility of the regulated community and that the regulatory agency has no influence over or any responsibility for compliance results, will not likely stand the test of time. The CPSC can anticipate and address this problem by building a fairer and more equitable penalty system upfront, something that will accrue to the benefit of the agency over time.

We Support the Factors Which Evidence Bad Faith or a Pattern of Non-compliance. The inclusion of factors which reflects the consistent bad behavior of certain companies is long overdue. It is hard to not believe that we owe the existence of the CPSIA in part to repeat offenders of the past. While the purpose of penalties and even a regulatory agency itself could be debated, there is no doubt that these cases involve unnecessary risk to the public and demonstrate an intolerable disrespect for the law.

That said, I do not believe that all infractions demonstrate disrespect for the law or operational incompetence. Careful and balanced factual inquiry is necessary to properly administer justice under the CPSA and to maintain a safe marketplace. I do not think that this factor should be over-played, however, as a market administered with an unrealistic expectation of perfect compliance with an ultra-complex law will be as self-defeating as lax treatment of repeat offenders. Some middle point will produce the best results for all concerned, including consumers.

Thank you for considering my views on this important topic.


Richard Woldenberg
Learning Resources, Inc.
380 North Fairway Drive
Vernon Hills, IL 60061


108Warren Commission said...

Rick --

I just wanted to say thank you for continuing to make the time and effort to communicate the small business's viewpoint to the CPSC.

It is appreciated!


Happymom4 aka Hope Anne said...

Thank you for all you do. Do not get weary in well doing!

Esther said...

Thank you! That is a well written letter.