CPSIA - Schylling Penalty Update

788 days have passed since ANY Democrat in Congress did ANYTHING to help us on the CPSIA. There are only 22 days left until Election Day.

You may recall that I expressed outrage over the mega penalty imposed on Schylling Associates earlier this year (see my posts on February 6, June 8, June 9, and June 10). There were many troubling aspects to this penalty, such as an expired statute of limitations and its arbitrary and massive size. This penalty was quite scary, especially in light of Bob Adler's remark at the March 3rd Commission meeting: "I personally wouldn't want to tie our hands by saying that the only time we can hit you with a big civil penalty is when there was a death or a serious injury. There may be an immense potential for death and serious injury which just through fortuity did not occur." There were no injuries in this case. No one has clarified the "immense potential for death and serious injury" in this ordinary and minor lead-in-paint case.

When you read on, don't forget - you could be next.

I submitted a FOIA request for documents relating to this penalty on June 9th.

Four months later, I received a very partial disclosure of documents from Schylling. The CPSC has not disclosed anything to me directly yet - they routed documents to Schylling who routed them to me, redacted for confidential financial information.

I don’t intend to belabor the inadequacy of the CPSC's disclosure right now, except to note that failure to provide full disclosure is against the explicit policy of the agency. Not that policy or the law matters at the CPSC these days if they want to do something else. It’s great to be King, ain’t it? My original FOIA filing included this paragraph:

“In making this request, I note the following statement in 16 CFR §1015(b): ‘The Commission's policy with respect to requests for records is that disclosure is the rule and withholding is the exception. All records not exempt from disclosure will be made available. Moreover, records which may be exempted from disclosure will be made available as a matter of discretion when disclosure is not prohibited by law or is not against the public interest.’”

Enough whining. I will pursue the missing documents with the CPSC but for now, want to give you a clue on how penalties are being imposed by this agency. Quick summary: my original blogposts above were pretty accurate (we're all screwed).

I was given four documents that were not previously available publicly:

1. Letter of March 5, 2010 to CPSC from Patton Boggs LLP, counsel to Schylling.
2. Letter of March 5, 2010 to Patton Boggs from Cheryl Falvey, General Counsel, CPSC
3. Letter of April 21, 2010 to CPSC from Shook, Hardy & Bacon LLP, counsel to Schylling (missing attachments, see below)
4. Email exchange between Trial Attorney, Office of Compliance and Patton Boggs, counsel to Schylling, from September 4-9, 2009.

Schylling also provided me with the letter dated August 10, 2009 from late Senator Ted Kennedy to the Commission protesting the original suggested penalty of $600,000. The penalty was later to reduced to $200,000, approved, rescinded and then doubled to $400,000 by an angry Commission. [Why they got so angry remains a mystery, but their anger oddly is only tangentially related to this discussion today. All permutations of the penalty were unreasonable - before, during and after the Commission got angry.] Finally, Schylling also provided me with missing attachments from the April 21 letter – hate mail they received.

Here’s what I learned about this penalty:

a. There are few apparent constraints on the CPSC when it comes to arbitrary penalty assessment. That's how Schylling got zinged for $400K and probably explains how Daiso got whacked for $2.05 million.

The big issue confronting the CPSC in deciding on this penalty appears to be the profitability of the company and whether the owners collected too much money from the company. It is worth noting that the CPSC chose to weigh in on owners' salaries and bonuses and ALSO on whether the company DISTRIBUTED too much money to the owners. Cash distributions from a S Corp is a RETURN OF CAPITAL - in other words, that cash is the property of the owners. They are legally free to remove it without corporate law or tax implications (as long as the distribution doesn't bankrupt the company, not an issue in this case).

Do you think it is any business of this federal agency whether YOU take YOUR money out of YOUR company? Apparently it is the CPSC's concern and equally, they assert that they can approve or disapprove such transfers after the fact.

Is there a law somewhere that gives them this power?

There is no evidence in the papers that the CPSC weighed ANY mitigating factors, including the lack of injuries.

The CPSC requested the following documents to assess their penalty:

• Federal tax returns for one entity from 2005-2009 and for another entity for 2008-2009
• Federal tax returns for the three family members employed as executives at the company for 2007-2009.
• Federal tax returns for a family trust over 2007-2009 plus financial statements for such entity.
• Information about ownership structure, all affiliated entities with "explanations as to how each relates to [the others]".
• Consolidating and individual financial statements for each entity for full year 2009 (this request is not entirely clear, but this is my interpretation of what the CPSC requested).

The CPSC said it was trying to assess "Schylling's ability to pay a civil penalty." Was all this information necessary to make that determination or was this an over-reaching fishing expedition into private affairs outside a federal agency's purview?

Hmmm.

The March 5th Patton Boggs letter states "When you informed me on February 24 that the Commission had rescinded its provisional approval of the Schylling settlement, you indicated that there was concern that Schylling had misled the Commission regarding the financials, and/or had made exorbitant payments to its owners. Any such allegation is false."

I find this dialogue chilling. Please consider that the CPSC might have been talking about YOU. And might be talking about you soon.

The Patton Boggs letter pleads "Submitted herewith [is] a chart showing the annual salaries and distributions of the three owners of this S-Corp, 2007-2009 . . . . As this shows, the compensation paid to the owners is well within the reasonableness zone for companies of Schylling's size" and continues "salaries paid to the three owners are reasonable and have not increased - except for modest cost of living adjustments - over the past 4 years." [Emphasis added]

Intrusive? Over-reaching? Humiliating? Ready to do this yourself when the time comes???

Does this agency have too much power? What do you think, Commissar?

[Btw, the fact that the company's testing budget ballooned from $144K in 2006 to $645K in 2009 didn't save them. It was noted in the letter, but the Commission still whacked them with the $400K penalty.]

In the April 21 Shook Hardy letter, counsel to Schylling makes even clearer what was going on here: "The inference appears to be that Schylling could have afforded to pay a higher civil penalty had its principals not taken excessive compensation or that Schylling and its principals attempted to hide the assets of the business prior to action by the CPSC. This view does not reflect the facts."

To judge by these letters, the agency's goal was to hit Schylling as hard as possible without killing it, and so the debate turned to whether Schylling could withstand the blow. The agency questioned owner compensation because Schylling's disclosure might frustrate the plan to hit them with an epic penalty. To defend the mega penalty, the CPSC actually needed to prove that Schylling was playing games with its disclosure, something their lawyers hotly contested. The issue of safety is lost in the hunt for retribution. How far the CPSC has fallen . . . .

My mind wanders . . . might this CPSC also want a big headline? Hold that thought for a little while.

Don't forget, NO ONE was hurt by the products Schylling recalled. The recalls were YEARS OLD by the time the CPSC decided to make an example of Schylling, arguably past the statute of limitations (for those of you who are small-minded enough to care about the Rule of Law). The company's conduct, good or bad, seems irrelevant to the discussion in these pages.

Can you imagine what it would like to defend yourself against this kind of foe? How can you protect yourself against a vengeful government agency unconstrained by checks-and-balances? I can tell you - Schylling was scared "witless". They had no practical ability to litigate, despite the injustice of this excessive and unfair penalty. In the face of undocumented government threats, the ugly reputation of this agency's tactics whispered among practitioners these days, who would face them down? Bet the company - good idea until it's your company.

Let me know when you figure out what you would do.

b. Schylling's ancillary losses or penalties were substantial. The CPSC was also not accountable for its torts or mistakes. Buyer beware!

Can you trust the CPSC today? I think one can form a better opinion of the trustworthiness of this federal agency after reading the Schylling case documents.

Here are a few additional Schylling punishments and penalties noted in the papers:

• They were forced to withdraw from an important acquisition in May 2009 when threatened with a $600,000 cash penalty (which was later cut by two-thirds).
• They incurred massive legal bills, not to mention costs relating to the recalls.
• The highly-publicized remarks of a CPSC spokesman to the Chicago Tribune in which he discussed the "diminished financial condition" of Schylling led to problems with Schylling's lender. This comment to the press violated the confidentiality of discussions between Schylling and the CPSC - but I guess confidentiality that doesn't apply when the Chicago Tribune calls. I am not aware of any apology from the CPSC about this flagrant violation of trust.

The adverse publicity which resulted from the recall, and fed by a publicity-hungry agency desperate to appease the media and Congressional overlords, led to hate mail like this:

"Being Untruthful about lead in paint has cost you our business. We will tell everyone we know that none of your products can be trusted. This will be painful for your bottom dollar sales. The lack of leadership in your company and caring about the bottom dollars is evident. We hope your made in China policy is worth it!"

and

"Actually, This isn't about the RECENT recall, this is about the SNOW JOB recall you never reported. You people are REAL pieces of sh*t, I lived up there when you distributed these toys, you're about to have you ASS sued off. In case you forgot, I'll help you remember that you are MORTAL ! Maybe you need someone to bring some lead into your life you piece of sh*t. I hope you make the right choice as to just what to do with yourself. Technically, this isn't the same damn email XXX got. btw, you people soon enough won't even BE in the toy business."

[Emphasis added]

Do you get mail like this? What do you think about a federal agency engaging in conduct that produces this kind of extreme response . . . for what is essentially a dispute about administrative procedures involving a no-injury recall of a small number of toys several years ago? Did I mention that there is no way to bring this agency to account? Remorseless pursuit of scary headlines leading to threats of violence against toymakers - I guess this is that famous "change you can believe in".

Yes, we can.

Senator Kennedy noted that the penalty was "disproportionate to penalties recently assessed against other substantially larger companies for the same type of violations." Arbitrary and capricious, perhaps? Kennedy provides DATA to back up his assertion, noting CPSC penalties against Family Dollar Stores, Hobby Lobby Stores, First Learning Company, Ltd., Michaels Stores, A&A Global Industries, Raymond Geddes & Co., Downeast Concepts and Mattel (oh, Mattel . . . ) - ranging between 0.001% and 0.316% of sales. The proposed penalty on Schylling - 2% of sales, ultimately reduced to 1.33% of sales.

This letter may be the reason Anne Northup revoked her vote in favor of the $200,000 penalty., even though Kennedy's letter proceeded the decision by almost six months and referred to a penalty THREE TIMES the size presented to the Commission.

Have you done the math in your head about what you would be paying if the CPSC got pissed off at you? Do you have a fund set up to finance this kind of setback? Hmmm.

It's a shame that our legal system provides no way for a company to defend itself against government gone MAD without taking fantastic financial, regulatory or business risks. I fondly remember the days when we had a working legal system in this country and when decisions were subject to review, you know before government power was expanded so dramatically and individual rights were extinguished.

I know, I know, we have to protect the CHILDREN! That makes everything okay. The agency can do no wrong. . . .

I remember those days fondly. I will be thinking of them on November 2nd, too.

In the meantime, I will see if I can get the CPSC to cough up a few more documents for the public to see. They have a policy on this, you know . . . .