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| Consulting Practice of Robert H. Fuhrman, MBA
For a direct link to Mr. Fuhrman's website, click on: To see a copy of Mr. Fuhrman's latest publication, "Practice Advice for Negotiating Settlements of Environmental Civil Penalty Cases," click here. Civil PenaltiesUnder various federal and state laws, alleged violators of environmental requirements may be sued for monetary penalties. In developing their penalty demands, EPA, state regulatory agencies, and citizen groups consider statutorily-identified factors such as the economic benefit the "violator" may have obtained due to noncompliance, the "gravity" (or environmental harm) caused by the violation, the violator's ability-to-pay for both penalties and required pollution control equipment, its history of noncompliance, and "such other factors as justice may require." In some cases, EPA is willing to reduce its monetary demand associated with the gravity component of the penalty if the violator will agree to undertake a "Supplemental Environmental Project" (SEP). (The Agency claims never to offset economic benefit.) EPA uses its "PROJECT" model to calculate the after-tax present value of proposed SEPs, and usually provides less than a dollar-for-dollar credit against penalties associated with "gravity". In negotiations, EPA is usually willing to discuss whether it is using correct inputs in its economic benefit, gravity, ability-to-pay, and SEP calculations. In cases that proceed to trial, DOJ attempts to use economic benefit as the floor for an appropriate penalty and asks judges to consider imposing the maximum fines allowable under the law. However, "economic benefit" often plays a central role in courts' determinations of monetary penalties. Economic Benefit AnalysisTo estimate the total economic savings that a violator may have obtained due to noncompliance, EPA's BEN model calculates the costs that the firm or municipality would have incurred assuming the entity had complied "on-time," and subtracts from that value the costs that actually resulted from "delayed compliance." These two streams of cash flows include the capital investment to purchase required pollution control equipment, the costs of operating and maintaining the equipment through its useful life, and the present value of the cost of replacing and operating the equipment in the future. The difference between the "present value" of "on-time" and "delayed" compliance is assumed to be the economic savings resulting from noncompliance. For corporations, BEN uses a single rate, the "weighted average cost of capital" ("WACC") both to adjust past and future cash flows to the date of assumed penalty payment. (WACC is the weighted average of the component costs of debt and equity for a company, with the respective weights being the percentages of debt and of equity in the firm's capital structure.) For municipalities, EPA uses the municipality's bond rating as the discount/interest forward rate. For cases involving federal agencies, EPA uses U.S. Treasury rates. BEN has been controversial since it was first used in the mid-1980s. The use of the identical rate both for discounting and for adjusting past costs for interest has been a source of significant controversy.
According to EPA's "Guidance on the Distinctions Among Pleading, Negotiating, and Litigating Civil Penalties for Enforcement Cases under the Clean Water Act" (January 19, 1989), "The existence and extent of economic benefit is a factual matter which may be objectively measured in dollars terms." Although EPA has always maintained that its then current BEN methodology was correct, in 1992 EPA substantially changed that methodology by switching from the "cost of equity capital" (approximately 16 percent at the time) to the WACC (then approximately 12 percent) as the basis for the selected discount/interest forward rate. (The lower the discount/interest forward rate, the lower the calculated economic benefit in most cases.) Although both the cost of equity rate and the WACC had been upheld in some adjudicated cases, in 1999, in U.S. v. WCI Steel, 2d 810 (N.D.Ohio 1999), a federal district court judge struck down the use of a firm's WACC as the basis for adjusting past economic savings to present value. Instead, Judge Gwin concluded that the after-tax risk-free rate associated with short-term U.S. Treasury bills should be used for that purpose. This substantially lower interest rate led to a substantially reduced calculation of the company's economic benefit. The WCI decision notwithstanding, EPA has continued to use WACC as the discount/interest forward rate in BEN. In May 2003, Mr. Fuhrman provided economic expert testimony on behalf of the defendant in U.S. v. The New Portland Meadows, LLC, a case heard in U.S. District Court for the District of Oregon in which there was a lot of competing testimony about the appropriate interest forward rate (WACC v. the after-tax, risk-free rate associated with short-term U.S. Treasury bills) to use. In its decision, the Court concluded that: "Treasury's short-term cost of capital … results in a more reasonable estimate of economic benefit."
The U.S. Court of Appeals for the Third Circuit opinion in U.S. v. Allegheny Ludlum Corporation [366 F. 3d 164 (3rd Cir. 2004)] also raised serious questions about the use of WACC as an “interest forward rate” in economic benefit calculations and provided support for use of the after-tax risk-free rate associated with short-term U.S. Treasury bills.
In addition to the issues just discussed, many companies and municipalities also differ with EPA's case-specific assumptions related to other inputs to BEN, such as the relevant capital, one-time, and annual operating and maintenance expenses; the dates of compliance and noncompliance; and the value of operating and maintenance "credits" (or cost savings) that should be reflected in the economic analysis because they would have resulted from on-time compliance. (For a discussion of credits, see the decision in Friends of the Earth v. Laidlaw Environmental Services, January 22, 1997, 44 ERC at 1243-46.)
In negotiating settlements of civil penalty cases, plaintiffs' attorneys frequently rely on EPA's (and, in some cases, a state's) statute-specific settlement policies to place a monetary value on the gravity component of the penalty. In doing so, they avoid the much more difficult task of quantifying damages to human health and the environment. While these policies provide the appearance of objectivity since they allegedly treat similar cases in similar fashion, the policies vest enormous amounts of discretion in the "litigation team" prosecuting the case. Given the team's role, its members are not likely to be totally detached in their assessments of the defendant's situation. In some cases, the policies enable plaintiffs to demand multi-million dollar penalties even in the absence of verifiable damages to human health and the environment, or evidence of willful behavior. EPA has developed civil penalty settlement policies for problems arising under various environmental statutes, including the Clean Air Act (CAA), the Federal Water Pollution Control Act (FWPCA), the Resource Conservation and Recovery Act (RCRA), the Toxics Substances Control Act, the Emergency Planning and Community Right-to-Know Act, and the Comprehensive Environmental Response, Compensation, and Liability Act. Each of these statute-specific policies has unique features. For example, the FWPCA civil penalty policy establishes five criteria for calculation of gravity: a monthly component (the number of months of violation), a significance of violation component (based on the percentage exceedance of the daily maximum, 7-day average, or monthly average requirement), a score based on health and environmental harm, a score for number of violations, and a score for the duration of the period of noncompliance. All of the numerical scores are added together and multiplied by $1000 to determine the gravity component of the penalty. The CAA stationary source civil penalty policy uses a very different framework that places scores on the percentage of the exceedance above the applicable standard, the toxicity of the pollutant, the sensitivity of the environment, and the length of the violation, as well as "importance to the regulatory scheme" and "size of the violator" (which is based on a firm's net worth). The RCRA civil penalty policy is based on two matrices: a gravity-based component and a multi-day component. Each of these matrices attempts to classify the violations as fitting into one of nine boxes organized by "extent of deviation from the requirement" on one axis and "potential for harm" on the other. These boxes are arranged so a violation can be classified as major, moderate, or minor based on each of these criteria. The RCRA penalty policy provides examples to aid in the classification of specific violations. Defendants and their counsel need to be alert to nuances in gravity calculations. Ability-to-Pay AnalysisFirst-time defendants in environmental civil penalty cases sometimes take comfort in EPA's claim that "[t]he Agency will generally not request penalties beyond the means of the violator." Over time, however, they learn that the government makes it very difficult for the defendant to use its financial weakness to its advantage in penalty negotiations. EPA uses its computer software known as "ABEL" to screen defendants' claims that they cannot afford to pay penalties. ABEL is a convenient tool for analyzing three to five years of a corporation's federal tax return data. It produces two types of outputs: (1) a financial profile based on commonly-used financial ratios that indicate the liquidity, solvency, tendency toward bankruptcy, and the general financial health of the firm; and (2) a probability-based forecast of the firm's likely future cash flows, which can be used to assess the likelihood of the entity's ability to pay fines, cleanup costs, and other types of incremental environmental expenditures. EPA's MUNIPAY and INDIPAY models perform similar functions, respectively, for municipalities and individuals, including both sole proprietorships and partnerships. In Beyond ABEL: Ability to Pay Guidance (1993), EPA stated, "When an ABEL run produces a positive result, [EPA] staff can be certain that the entity is able to pay. A negative or ambiguous result, however, does not necessarily indicate that the entity is unable to pay. ABEL may produce a negative result when, in fact, funds are available." For example, the company may be able to pare its expenses and generate additional cash flow, sell off non-essential assets, either assume more debt or refinance debt owed to affiliated parties, reduce the salaries of its officers, or draw upon the financial resources of a parent or affiliated company to pay penalties. Beyond ABEL draws attention to key information in the alleged violator's tax returns and financial statements, and provides step-by-step instructions on how to investigate those issues. As noted in Beyond ABEL, "A final ability to pay assessment will require the user's judgment about the entity's financial capability and the degree of hardship that should be imposed on the violator. Such judgments are by their nature subjective, and will most likely be reached through discussion within the litigation team and enforcement staff." To be most effective when an entity has a real ability-to-pay problem, counsel needs to understand the use and limitations of ABEL, MUNIPAY, and INDIPAY, and to dispute as justified relevant input assumptions. A major shortcoming of all three of EPA's ability-to-pay models is the assumption that past cash flows provide a reliable basis for projecting future cash flows and, thus, a correct basis for assessing ability-to-pay. In reality, a firm, municipality, or individual's current and/or future financial situation may be so different from those of the recent past that the modeling results are highly misleading and lead to incorrect conclusions. In such circumstances, it is particularly important to explain to EPA staff members the reasons the modeling results are not reliable and to provide a more accurate basis for assessing ability-to-pay. Mr. Fuhrman has calculated many corporations' ability-to-pay for civil penalties and injunctive relief. These clients have included over 30 medium-size and small businesses.
Mr. Fuhrman has also performed assessments of public entities' ability-to-pay. For example:
Mr. Fuhrman has also performed ability-to-pay assessments for several individual citizens. In this context he utilized EPA's INDIPAY model and performed other analyses to provide more information on their current and future financial resources and needs. As a result of these and other ability-to-pay consulting engagements, Mr. Fuhrman developed insights and expertise related to EPA's September 30, 1997 "General Policy on Superfund Ability to Pay Determinations." "Wrongful Profits and/or Illegal Competitive Advantages"In U.S. v. Municipal Authority of Union Township and Dean Dairy Products Co., Inc. (M.D. Pa., No. 1:94-0621), U.S. District Court Judge Sylvia H. Rambo expanded the concept of "economic benefit" to include "wrongful profits" obtained through noncompliance. In that case, experts for both the plaintiff and the defendant agreed that there was no economic benefit due to "delayed and/or avoided costs." Nonetheless, Judge Rambo imposed a $4 million penalty on Dean Dairy, which she argued could have achieved compliance by reducing its volume of milk production and foregoing that amount of revenue for the period of noncompliance. In notices published in the Federal Register in 1996 and again in 1999, U.S. EPA expressed interest in removing "wrongful profits and illegal competitive advantages" that it opined it could not calculate with BEN. The notice published at 64 Federal Register 32,948 (1999) provided six hypothetical situations in which EPA believed "wrongful profits and/or illegal competitive advantages" would occur. At the request of ten industry groups, R.H. Fuhrman, working with attorneys from Hale & Dorr, L.L.P., analyzed the six hypotheticals. They concluded that most of the situations identified by EPA actually either fit within the scope of analysis of BEN or were based on assumptions incompatible with mainstream economic theory. They did find, however, there are a few situations in which wrongful profits and illegal competitive advantages could occur. In the summer of 2004, in response to a request by a group of trade associations known as the “Manufacturers Ad Hoc Group,” Mr. Fuhrman to provided comments on the EPA “white paper” prepared for the consideration of EPA’s Science Advisory Board’s “Illegal Competitive Advantage Economic Benefit Advisory Panel.” The members of that group were as follows: the Alliance of Automobile Manufacturers, the American Chemistry Council, the Corporate Environmental Enforcement Council, and the Ready Mix Manufacturers Association. A major thrust of the document Mr. Fuhrman wrote on behalf of the Manufacturers' Ad Hoc Group was that the white paper's linkage of "illegal competitive advantage" to gains in a firm's market share during a period of noncompliance was inappropriate and intellectually difficult if not impossible, to sustain. In September 2005, when the EPA Illegal Competitive Advantage (ICA) Economic Benefit Advisory Panel of the Science Advisory Board completed its review of the EPA white paper, it found the term "illegal competitive advantage" to be "unhelpful." Furthermore, it stated, "Increases in market share will often be difficult to identify in terms of comparing the noncompliance scenario with the counterfactual compliance scenario; and observed increases in market share might be difficult to attribute exclusively to noncompliance."
EPA's PROJECT model is designed to calculate a credit for "supplemental environmental projects" (SEPs) that can be used to reduce the gravity component of a civil penalty. To be approved, an SEP must meet certain criteria articulated by EPA in its "Policy Document on Supplemental Environmental Projects" dated April 10, 1998. One of those criteria is that the project is not one the violator is otherwise required to perform to achieve compliance. Another criterion is that there is a nexus between the type of violation at issue and the proposed project. For example, this relationship may exist if the project is designed to reduce the likelihood that a similar violation will occur in the future; the project reduces the adverse impact to public health or the environment to which the violation contributed; or the project reduces the overall risk to public health or the environment potentially affected by the violation at issue. PROJECT closely mirrors BEN, but is in some important regards inconsistent. For example, PROJECT limits the period of time for which credit may be given for annual, recurring costs. PROJECT calculations also provide no consideration of future replacement cycles. EPA usually provides less than dollar-for-dollar credit for the present value cost of SEPs, whereas EPA attempts to use BEN to recapture all costs saved or avoided due to noncompliance. Negotiating the value of an SEP often requires substantial familiarity both with EPA's enforcement-related economic models and various policy documents.
In order to be successful in negotiating civil penalties, it is helpful for a defendant and its counsel to be armed with a clear understanding of the relevant policies and methodologies on which the agency relies. Regulatory agencies want to be persuaded that a defendant is not hiding facts or otherwise distorting the truth. Similarly, it is usually counterproductive for a defendant to exaggerate the expenses it has undertaken to achieve compliance. "Throwing in the kitchen sink" usually does not impress regulators. Such practices tend to lead to higher calculations of economic benefit. The best thing a defendant and counsel can do is to educate themselves fully on the facts and economics of the case and the relevant interests, policies, and approaches of the regulatory agency. (Injunctive relief and achieving compliance are almost always high on regulators' list of priorities.) To the extent that an agency has relied on erroneous information or drawn incorrect conclusions, defendants can improve their situation by calmly trying to educate regulators about specific facts and circumstances. Depending on the strength of one's argument, sometimes it is better to compromise rather than fight. Defendants need to evaluate their situation in as objective a manner as possible, and that often requires seeking advice from outside service providers, whether they are lawyers, engineers, or economists, or some combination thereof. To see a copy of Mr. Fuhrman's latest publication, "Practice Advice for Negotiating Settlements of Environmental Civil Penalty Cases," click here. Case Management and Expert Witness SearchesOn behalf of the participants in Seneca Economics and Environmental Management, Robert Fuhrman is the point of contact for inquiries concerning case management and expert witness searches. Depending on the exact nature of the request and the availability of suitable expertise within the group, Mr. Fuhrman will consult with relevant members of the network to determine how best to respond to specific inquiries. Each of us is well-qualified to perform litigation support related to our specific areas of expertise. However, case management is a broader concept. It includes development of strategies for accomplishing specific goals involving a wide variety of environmental regulatory, technical, policy, and cost-related concerns. For example, an attorney may be interested in selecting several different consultants to work on various aspects of a highly complex litigation. Members of our network can provide advice on how best to select, manage, and integrate the work products of the selected consultants; review the qualifications of alternative consulting firms and individuals to determine their adequacy; review past expert reports and depositions of competing experts to identify their strengths and weaknesses; interview past clients to assess the performance of individuals under consideration; and serve as a sounding board for the attorney who may lack the technical expertise to perform all the necessary oversight functions during the course of the litigation. Alternatively, a client may want to obtain a second opinion about whether a specific work product is adequate for its intended purpose or whether the client has the correct strategy for dealing with an environmental regulatory body. In such a circumstance, we may be helpful in locating a consultant, a lawyer, a former government employee, or an academic who has appropriate expertise to provide the needed advice. Selected Publications by R. H. Fuhrman
Contact Robert H. Fuhrman: fuhrman@seneca-economics.com |
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