The unjustified absence of federal fraud protection in the labor market.

• Author: Greenfield, Kent

CONTENTS

1. A COMPARISON OF FEDERAL ANTIFRAUD PROTECTION IN THE CAPITAL AND LABOR MARKETS

   1. The Common Law Background

   2. Federal Fraud Protection in the Capital Markets

      1. The Basic Legal Framework

      2. The Rationales for, and Continuing Importance of,

      Federal Protection

   3. Federal Fraud Protection in the Labor Market

2. THE IMPORTANCE OF ACCURATE INFORMATION IN THE LABOR

   MARKET

   1. The Basic Model

   2. Job Security as an Endogenous Variable

   3. Some Additional Costs of Fraud in the Labor Market

3. THE POSSIBILITY OF MARKET SELF-CORRECTION

4. THE DIFFICULTIES OF RELYING ON COMMON LAW REMEDIES

   1. Why Contract Law Is Not Enough

   2. The Level of Protection in Tort

   1. The Section 301 Preemption Problem

   2. The ERISA Preemption Problem

   3. The Apparent Presumption Against Workers Using

   Tort Law To Protect Themselves from Fraud

   a. White v. National Steel Corp.

   i. Constructive Fraud

   ii. Actual Fraud

   b. Grounds for Hope in the Common Law?

5. EXPLORING A REGULATORY RESPONSE

   1. The Costs and Benefits of Antifraud Regulation in

      the Labor Market

      1. The Costs

      2. The Benefits

   2. The Possibility of State, Rather than Federal,

      Regulation

   3. The Contours of a Proposed Model Statute

6. CONCLUSION

   Imagine a steel company struggling to stay afloat against strong national and international competition. The company has an outdated production facility in Youngstown, Ohio, and faces two related problems: the need for an infusion of capital to upgrade the facility and the need to maintain employee morale and productivity. A company official meets with people who are interested in making an equity investment in the company. One potential investor asks whether the company is currently profitable and whether the company plans to stay in business for the long term. The official answers, "The company has been profitable, and there are no plans for shutting down our operation." The investors make a sizable equity contribution. Later that day, the official meets with the employees of the Youngstown facility. Employees considering job offers at a new plant down the street ask whether the facility is currently profitable and whether the company plans to keep the plant operating for the long term. The official answers, "The Youngstown facility has been profitable, and there are no plans for shutting down our operation." The employees decline the job offers elsewhere and continue working at the Youngstown facility.

   Now assume that the answers to both questions were lies. The official knew that neither the company nor the plant was profitable and that plans were in the works to shut down the plant and liquidate the company. The official lied to the potential investors in order to gain a capital infusion to satisfy other creditors holding short-term obligations. The official lied to the workers to keep them working diligently while the company went though its death throes. The company does eventually shut down, and the securities held by the investors lose a significant portion of their value while the workers lose their jobs.

   Both the capital investors and the workers have suffered damage because of the official's lies. Can they do anything about it? For the capital investors, the answer is a resounding yes. Federal law offers significant protection against fraud in the capital market. In this hypothetical, the capital investors would likely have a claim against the official and the company under several provisions of federal law, including section 10(b) of the 1934 Securities Exchange Act(1) and the Securities Exchange Commission's Rule 10b-5.(2) The workers, however, are not the beneficiaries of any federal law protecting them from such fraud in the labor market and would be left without a federal cause of action against the company or the official.(3) This Article argues that this difference in treatment, previously unanalyzed,(4) is unjustified.

   This hypothetical is derived from an actual case arising from the closing of two United States Steel facilities in Youngstown in the late 1970s and early 1980s.(5) The corporation had operated two large steel mills in Youngstown since the turn of the century. In the fall of 1977, the workers in these mills and the Youngstown community generally were worried about rumors that the two factories were to be closed. These rumors were not groundless. In later litigation, U.S. Steel itself introduced exhibits of never-mailed letters dated August 25, 1977, announcing the closing of both plants.(6)

   Nonetheless, management answered the rumors by assuring employees that shutdowns were not definite and stated on several occasions that the plants could be saved if the workers improved productivity. "Hotline" telephones were strategically placed in the two plants so that employees could listen to prerecorded messages from management. The first such message told the workers that there were "no immediate plans to permanently shut down" either factory and that the mills' "continued operation" was "absolutely dependent upon their being profit-makers."(7) Randall Walthius, an agent of U.S. Steel, told the press that there were studies under way "aimed at making the Youngstown facilities profitable" and that it would be "on the basis of the plants' profitability that they will continue to operate."(8)

   The steelworkers responded to these representations as the company must have hoped: They improved productivity and cut costs. In April 1978, plant superintendent William Kirwan stated on the hotline that his plant had made a profit during the previous month, thus showing that the goal of profitability was "attainable."(9) Kirwan told the press later that month that the company would "be doing business here for some time to come."(10) In both May and June 1978, Kirwan made similar profitability reports.(11) By the end of 1978, Kirwan was able to record a statement on the hotline recounting the year's successes: "[E]arly in 1978 we initiated significant changes in our operations in order to make Youngstown Works profitable and once again a viable plant.... [W]e have attained our 1978 goal which was `survival' and now we embark on the 1979 goal which is `revival.'"(12)

   The company also made representations to the general public that the plants had righted themselves. For example, in a letter to the editor of the Wall Street Journal published in April 1979, company management boasted that a "complete turn-around has been achieved at Youngstown in the past year."(13) The letter asserted that a report that the Youngstown plants were eroding corporate profits was "nonsense" and "fiction."(14) These assurances continued throughout 1979.(15) Indeed, the Chairman of the Board of U.S. Steel, David Roderick, emphasized in mid-June that, "[s]imply stated, we have no plans for shutting down our Youngstown operation."(16)

   The employees appeared to rely on the company's representations. They improved their productivity, allowed management to adjust seniority policy to save money, and waived grievances when management combined some jobs.(17) Moreover, individual employees depended on the company's representations to make important personal decisions. One employee, Frank Georges, bought a new house on November 27, 1979, the day the Board of Directors of U.S. Steel met in New York and voted to close both Youngstown plants. The decision would put 3500 employees out of work. Georges heard the news as he was driving home from the bank.(18)

   The employees and their labor union sought legal recourse. Joined by the Congressman from the affected district and the Ittorney General of Ohio, the union sued to enjoin the closure. The employees argued that statements made by the company constituted an enforceable promise to keep the plants open as long as the plants were profitable.(19) This claim was rejected by the courts, which accepted the company's argument that, despite its earlier comments to the contrary, the plants were not profitable. Even though there was some evidence that U.S. Steel had changed its definition of profit over time,(20) neither the federal district court nor the Sixth Circuit was willing "to exchange its own view of the parameters of profitability for that of the corporation."(21) The workers argued that, based on reliance interests, a "property right has arisen from the long-established relation between the community ... and Plaintiffs, on the one hand, and Defendant on the other."(22) After some initial statements admitting sympathy for this claim, the district court decided that there was no precedent for such a property right and that it lacked power to create such a legal claim.(23) The Sixth Circuit affirmed the lower court's holding.(24)

   It is possible that David Roderick did not actually know of plans to close the Youngstown plants when he made his statement only six months before the announcement of the shutdown was made. Perhaps U.S. Steel used the same definition of profit when company officials claimed the facilities were profitable as when they closed them for lack of profitability. But it is also possible that officials of U.S. Steel either told their workers incomplete truths or complete untruths.

   While it is common for chief executive officers to acknowledge that they and their companies have obligations to be honest to their employees,(25) there are abundant examples of companies that mislead their employees. These companies may cause their employees to believe, for instance, that their jobs are more secure than they in fact are,(26) that their jobs will be better than they actually turn out to be,(27) or that their health benefits are assured after retirement when in fact they can be revoked at the will of the company.(28) In these cases, would the law have something to say about the companies' actions? Should it?

   Part I of this Article begins the analysis of these questions by sketching the common law background of the tort of deceit and by comparing the differences in the (high) level of protection against...