U.S. Senate to Hold Hearings on Border Searches of Laptops

HOME > HEARINGS > JUNE 25, 2008

"Laptop Searches and Other Violations of Privacy Faced by Americans Returning from Overseas Travel " Senate Judiciary Committee Subcommittee on the Constitution, Civil Rights and Property Rights DATE: June 25, 2008 TIME: 09:30 AM ROOM: Select Building-226 OFFICIAL HEARING NOTICE / WITNESS LIST: June 11, 2008 NOTICE OF SUBCOMMITTEE HEARING The Senate Committee on the Judiciary has scheduled a hearing before the Subcommittee on the Constitution on “Laptop Searches and Other Violations of Privacy Faced by Americans Returning from Overseas Travel” for Wednesday, June 25, 2008, at 9:30 a.m. in Room 226 of the Senate Dirksen Office Building. Chairman Feingold will preside. By order of the Chairman

WIth this notice of hearing by the Subcommittee on the Constitution of the U.S. Senate Committee on the Judiciary we have evidence that the laptop searches conducted by the Customs and Border Protection (CBP) service have become a subject of concern at the highest levels of the U.S. government. This, in general, is good news. Some of the senators most concerned with issues of constitutional and civil liberties sit on this subcommittee, e.g., Chairman Feingold himself, Senator Dianne Feinstein of California, Senator Ted Kennedy of Massachusetts (now, of course, at home recovering from brain surgery), and Senator Arlen Spector.

The committee's website does not yet disclose the names of the witnesses to be heard, but we can assume there will be witnesses from the Electronic Frontier Foundation and the Association of Corporate Travel Executives, both of which appeared as amici curiae in the U.S. v. Arnold case (see preceding post on this blog) in opposition to the position of the government that the CBP does not need a reasonable suspicion to search a laptop at the border, together with witnesses from the relevant governmental agencies. One must hope that the hearing will give the public its first opportunity to learn about the policies and practices of the CBP concerning laptop searches and the frequency with which they are being conducted.

Border Laptop Searches -- Assessing the Risk

A Border Laptop Search is a Black Swan

The United States Customs and Border Protection agency (CBP) asserts the unrestricted right to search laptop hard disks at the border. The Fourth and Ninth Circuit Courts of Appeal in the federal judicial system have recently given the CBP a green light to continue such searches. As the law now stands the CBP does not need a court order, a search warrant, a finding of probable cause or even a reasonable suspicion in order search your laptop hard disk. The CBP may pick travelers out for laptop searches entirely at random.

In short, for the laptop-carrying business traveler entering the U.S. from Germany (or anywhere else for that matter) a CBP search of his or her laptop is a Black Swan -- a highly improbable event but one carrying potentially disastrous consequences. See, Taleb, The Black Swan, Random House (2007).

The German business traveler might be tempted to think that CBP is only interested in terrorism, child pornography and drug trafficking and has no interest in searching the laptops of ordinary business travelers. This is wishful thinking. The two cases referred to above (U.S. v. Ickes and U.S. v. Arnold) do happen to have involved child pornography. But that fact was incidental to the holdings in the cases. So far as the facts recited in the two opinions show, the agents who conducted the searches had no idea what they were going to find. Neither traveler was a target of an investigation and neither did anything at the border to draw attention to himself as a potential carrier of child pornography. Mr. Ickes and Mr. Arnold simply had the bad luck to singled out for searches which extended to their laptops. The met the Black Swan.

Furthermore, if you think the CBP is unlikely to search your laptop because you are a respectable, well-dressed traveler, then consider this answer from the CBP website to the question, "How do officers decide which passengers to examine or search?"

Please be aware, some of CBP's biggest seizures have come from inspections of "respectable looking" people, such as grandmothers, corporate executives, college professors, etc. Everyone is subject to a CBP inspection when they arrive in the U.S.

If even grandmothers are potentially suspect, then German venture capitalists and lawyers must be even more so.

And if this sweeping everyone-is-a-potential-suspect attitude were not enough to constitute a risk to business travelers, the CBP has an explicit policy of conducting random inspections of air passengers as shown in this excerpt from the CBP website:

RANDOM EXAMS

One of CBP missions (sic) is to ensure that travelers entering the United States comply with U.S. laws. In support of this mission, CBP conducts random compliance examinations (COMPEX).

Essentially, COMPEX examinations involve random selection of vehicles and/or air passengers that ordinarily would not be selected for an intensive examination. [emphasis added]

...

It is possible that, upon your entry into the United States from a foreign country, you may be selected for a COMPEX examination and experience a slight delay in your Customs processing.

In addition to the policy of random search, CBP is linked with something called "IBIS", a network of other federal government agencies, and uses information from that network to select travelers for inspection:

CBP officers also rely on the Interagency Border Inspection System (IBIS) to determine which individuals to target for secondary examination upon arrival in the United States.

CBP, along with law enforcement and regulatory personnel from 20 other Federal agencies or bureaus, use IBIS. Some of these agencies are the Federal Bureau of Investigation (FBI), Interpol, the Drug Enforcement Administration, the Bureau of Alcohol, Tobacco and Firearms and Explosives, the Internal Revenue Service, the Coast Guard, the Federal Aviation Administration, Secret Service, and the Animal Plant Health Inspection Service. Information from IBIS is also shared with the Department of State for use by Consular Officers at U.S. Embassies and Consulates.

IBIS assists the majority of the traveling public with expeditious clearance at ports of entry while allowing the border enforcement agencies to focus their limited resources on potential non-compliant travelers. IBIS provides the law enforcement community with access to computer-based enforcement files of common interest. [emphasis added]

In other words, data in IBIS can by used to target specific persons for border searches, including, in particular, border searches of laptops. And the list of agencies given in the above quote from the CBP website can be extended to include, e.g., the Securities and Exchange Commission, The Food and Drug Administration and the Department of the Treasury, among others.

Properly understood, as it undoubtedly is by the agencies mentioned, the power of CBP to conduct at-will border searches of laptop hard disks, memory sticks, external hard drives, CD's and handheld devices such as Blackberries is a potent investigative tool for agencies of the federal government. This power gains a special potency from the fact that CBP is able to exercise it free from the legal protections of U.S. law, such as the Fourth Amendment guarantee of freedom from unreasonable searches and seizures, otherwise applicable to searches carried out by these agencies.

Business travelers therefore need to recognize that although the liklihood of a laptop search at the border may be slight (or it may not be -- we do not know, although a lawsuit has been filed to obtain policies and procedures on border laptop searches under the Freedom of Information Act), the consequences of such a search can be enormous. The data captured from your laptop may travel a long way through the channels of the U.S. government, branching into many interested departments along its way. If that data is confidential client information on the laptops of lawyers, sensitive intellectual property or economic information on the laptops of VC's or entrepreneurs, or private health or financial information about the traveler, then the traveler in question must carefully consider his position. You can protect against the extreme impact of a border laptop search, e.g., by leaving your laptop at home or by carrying only non-confidential data, but there is nothing you can do to assure your laptop will not be searched, i.e., that you will not meet the Black Swan.

In subsequent posts we will examine three specific cases in which the possibility of a border laptop search exposes the travelers in question, and their clients or employers, to dangerous risks. We will also consider what measures a traveler might take to minimize the impact of a border laptop search if it should occur.

Ninth Circuit Rules U.S. Can Search Laptop Hard Drives Without Reasonable Suspicion

In a long-awaited decision the Ninth Circuit Court of Appeals held on Monday, April 21, 2008, in United States v. Arnold that a U.S. Customs and Border Protection agent may search the hard drive of a laptop carried by a traveler entering the United States even though the agent lacks any reasonable suspicion that the laptop's hard drive contains illegal data.

The trial court in the case had granted the defendant's motion to suppress evidence of illegal pornography found on his laptop on the basis that laptop searches are not the same as searches of luggage and require that the customs agent have at least a reasonable suspicion of illegal activity before conducting a laptop search.

The government appealed to the Ninth Circuit, and in an unfortunate and misguided opinion by Judge Diarmuid F. O’Scannlain the Ninth Circuit reversed the trial judge and upheld the legality of the search. These excerpts from the opinion illustrate the court's decision:

We must decide whether customs officers at Los Angeles
International Airport may examine the electronic contents of
a passenger’s laptop computer without reasonable suspicion.

[The court then reviewed the case law on border searches]


Therefore, we are satisfied that reasonable suspicion is
not needed for customs officials to search a laptop or other
personal electronic storage devices at the border.

...

We are persuaded by the analysis of our sister circuit and
will follow the reasoning of Ickes [an earlier case decided
by the Fourth Circuit Court of Appeals] in this case.

VI

For the foregoing reasons, the district court’s decision to
grant Arnold’s motion to suppress must be

REVERSED.

The state of the law in the United States as it has developed to date is that two circuit courts of appeal have upheld laptop searches without reasonable suspicion, no circuit courts have ruled to the contrary and the U.S. Supreme Court has not yet considered the question (and it may be years before the Supreme Court does so).

The Customs and Border Protection service is thus entirely free to search your laptop when you enter the United States for any reason or for no reason or at random. Business travelers to the U.S. must recognize this risk and adjust their conduct accordingly.

Laptop Hard Disks May be Searched upon Entering the U.S.

This post departs from the usual theme of this blog in order to bring an alarming practice of the U.S. Customs and Border Protection service (the CBP) to the attention of persons in the European venture capital industry -- fund managers, managers of venture-financed companies, and professionals advising them -- who travel from time to time to the U.S.

A series of recent cases in the federal courts in the U.S. have brought to light the fact that the CBP claims an unrestricted right to search hard disks on laptops of persons entering the U.S. The policy behind the practice is not written down and has no formal guidelines, so far as we know. It is therefore difficult to know anything about it unless one has the bad luck to experience it or has read some of the cases challenging it.

The policy and practice of the CBP, as reflected in the cases now moving through the U.S. courts, may be summarized as follows:

• Customs agents have the unrestricted right to search hard disks on laptops of persons entering the U.S. They do not need probable cause or even a reasonable suspicion to do so. They may act on the basis of hunches, whims or at random. It is the same as searching a traveler's suitcase.
  
• The right to search hard disks extends to searches of other devices or media such as Blackberries, CD's and memory sticks.
• Customs agents conduct such searches by requiring the traveler to open and boot his laptop. The customs agent then takes over and systematically searches files on the laptop's hard disk.
• If the agent finds files of interest he confiscates the traveler's laptop, and the traveler must continue his travel without it.
  
• While it has the laptop in its possession the CBP may create and retain a mirror image of the hard disk.
• Copies of the hard disk may thereafter be circulated by the CBP to other U.S. governmental agencies.
• In due course, the laptop will be mailed back to the traveler, unless criminal charges are brought, in which case it may be retained as evidence.

As it happens, the three principal cases challenging the CBP practice of searching laptops have all involved child pornography. The business traveler from Europe can take no comfort from that fact, however. In one case the search was apparently triggered by nothing more than the fact that the traveler arrived at Los Angeles International Airport from the Phillipines and had a goatee (U.S. v. Arnold). In another case the search was triggered by the fact that the CBP agent spotted a laptop in the back seat of the defendant's car as he crossed the border with his father from Canada to the U.S (In re Boucher).

Recognizing the threat this practice of the CBP poses for business travelers, a business travel organization, the Association of Corporate Travel Executives, intervened and filed a brief on behalf of the traveler in the Arnold case. And just this month (February 2008) a leading U.S. law firm based in Washington, D.C., Arnold & Porter LLP, issued a Client Advisory, entitled "Working on the Plane? How International Travel can Result in Government Officials Examining Your Electronic Data," bringing this risk to the attention of their clients.

The CBP's interest in intercepting pornographic material not only offers no comfort to business travelers it may itself heighten the risk of a laptop search for those travelers whose passports show recent travel to countries known as sex tourism destinations, e.g., Thailand.

To date the results of the cases involving laptop searches are mixed. One appellate court has ruled that the CBP has the unqualified right to search a laptop hard disk and does not need a reasonable suspicion in order to do so (U.S. v. Ickes). The laptop search was likened to a search of a suitcase, which everyone agrees is permissible. The U.S. District Court in the Arnold case went the other way and ruled that the CBP must have a reasonable suspicion of wrongdoing in order to search a laptop, else the search violates the Fourth Amendment. The judge said such a search is not like a search of a laptop, it is like a search of the traveler's own memory. In the case before it the court found that the CBP officer who conducted the search did not have a reasonable suspicion and therefore entered an order suppressing the evidence obtained in the search of Arnold's laptop. The Arnold case is now on appeal to the Ninth Circuit Court of Appeals. It was argued in October 2007 and now awaits decision.

In the Boucher case the traveler had saved his pornographic photos on a separate drive on his laptop and had encrypted the drive using Pretty Good Privacy (PGP). The CBP was unable to break the encryption and access the drive, so the prosecution had a grand jury subpoena issued compelling Boucher to divulge his password. Boucher moved to quash the subpoena on the ground that it violated his Fifth Amendment privilege against self-incrimination. The federal Magistrate hearing the motion agreed and quashed the subpoena. The case contains some important lessons for travelers carrying laptops. We will come back to the question of encryption in a subsequent post.

The probability of a laptop search of an innocent traveler coming into the U.S. from Europe on a business trip may be low. Then again it may not be. We do not know. And we have no way of finding out. Therefore, it is in the interest of business travelers from Europe to proceed with extreme caution when entering the U.S. carrying a laptop.

The Toxic German Venture Capital Tax Regime

If I were to be appointed a deputy minister for venture capital tax policy in the finance ministry of a western European nation, and if I were then mandated to construct a framework of rules designed to suppress and hinder the development in my country of a venture capital industry, I would promulgate a set of rules along the following lines:

Investment Holding Period: I would impose a mandatory minimum holding period of three years for all investments within a venture fund. Venture capital investment is, of course, short to medium term by definition. It is the job of a venture fund investment manager to exit an investment as soon as it is possible to capture a desired gain. This rule would, therefore, put the venture fund manager in conflict with his duty to his investors. This rule would be a stand-alone venture-fund-breaker. But it would be a stealth rule -- only knowledgeable venture industry insiders would appreciate its devastating effect.

No majority holdings: I would prohibit a venture fund from taking a majority interest in a portfolio company. There are times in the lives of many venture investments that an investment manager must take control of a portfolio company in order to save the company and/or protect the fund's investment. Likewise, a venture fund might find itself to be the only possible source of new capital for a struggling start up company under circumstances in which the depressed valuation of the company would lead inevitably to the venture fund's stake exceeding 50% if it were to inject additional capital. This rule would therefore force the venture fund to let the company go under or to lose all or part of its investment notwithstanding its willingness to provide additional capital.

No active participation in management: Venture fund investment managers would be prohibited from taking an active role in the management of their portfolio companies. It is part of the job of venture fund investment managers to bring not just capital but also experience, expertise and special skills to their portfolio companies. Those companies are normally early stage and are often managed by unproven, inexperienced, first-time entrepreneur-managers. This rule would therefore tie an investment manager's hands and force him or her to stand on the sidelines while a portfolio company management team struggled and failed.

No re-investment of gains. Investment managers would be prohibited from re-investing proceeds acquired, e.g., through the IPO or trade sale of a portfolio company. Instead, they would be required to distribute such proceeds to the venture fund's investors. Such a rule would, of course, normally be left to agreement between the managers of the venture fund and its investors. By imposing this rule we would seek to limit the growth of venture funds in our country by allowing them to grow only through infusions of outside capital.

The penalty for violation of any one of these rules would be a re-classification of the venture fund as a trade or business, with the resulting imposition of our standard trade tax. This would dramatically lower the IRR of the venture fund and impair its ability to raise capital. We would further provide that violation of any of the rules in connection with even one portfolio company would subject the entire fund, and all of its investments, to re-classification as a trade or business.

As deputy minister for venture capital tax policy I would confidently tell the Finance Minister that we had hereby crafted a framework that could not fail to limit the growth of the venture capital industry in our country. Our proposed regime would simultaneously restrict the ability of venture fund investment managers to rationally conduct their business and would inhibit the flow of capital from outside investors into venture funds based in our country.

German readers will recognize, of course, that this regime is in fact the regime adopted by the German Finance Ministry. It helps explain why at least one leading German venture fund has left the country and re-incorporated itself elsewhere and why 50% of the members of the German venture capital association are considering doing likewise.

On the face of it, it is absurd to think that the motivation given above, to deliberately suppress the development of a venture capital industry in Germany, is in fact the motivation of the German Finance Ministry. Yet, if that is not in fact the policy, then it is difficult to see what is the policy.

A possible alternative explanation is that the tax policy officials within the ministry are simply profoundly ignorant of the nature and character of venture capital investment. That, too, is implausible. These officials have had voluminous input from the venture industry, have seen the public studies showing Germany at or near the bottom of venture-capital-friendly jurisdictions within the European Union, and have witnessed the withering of the venture capital industry in their country over the last seven years. This regime, which is so toxic to the venture industry, is no accident.

Whatever the true German policy may be the result is painfully clear: (1) no sensible venture fund group would today form a fund in Germany, and (2) no institutional investor that had done its due diligence and fully understood the German rules would invest in a German venture fund.

So far as it appears at this time, the battle is over. These are the new rules, and there is no liklihood that they will change in the foreseeable future.

One Half of German Funds are Considering Leaving Germany

In an extraordinary and little-noticed announcement on May 11, 2007, the BVK, the German Private Equity and Venture Capital Association, released the results of a poll of its members showing that fully 50% of the membership are considering moving their funds out of Germany.

The cause of this discontent is of course the unsatisfactory and unworkable legal and tax framework within which German funds are forced to operate -- what we refer to in this blog as the Toxic German Legal Landscape for venture capital and private equity.

These views of the BVK membership are not merely theoretical. Some major German funds have already left Germany; for example, the current Chairman of the Board of the BVK, Rolf Dienst of Wellington Partners has recently moved his own fund out of Germany.

One should bear in mind that the BVK only has 185 members, a tiny number of venture capital and private equity funds in a country which has the world's fourth largest economy (after the U.S., Japan and China). That is to say, an already weak domestic German venture capital/private equity industry is about to become weaker.

The poll taken by the BVK was taken in part to demonstrate to the Bundesministerium der Finanzen (BMF) the seriousness of the German legal and tax situation for the industry. The poll was released on May 11.

On May 31, 2007, the BMF announced its decision to apply the VAT to the management fees of German venture capital and private equity funds. Clearly the BVK's poll did not have the intended effect. The BMF is either not listening or is unmoved.

It is difficult to escape the conclusion that, taken in the broader European context wherein other countries are moving positively to create favorable legal and tax regimes for investment funds, the BMF has take a policy decision that the venture capital/private equity industry is not an appropriate industry for Germany.

Another Shot in the Foot by the Bundesministerium der Finanzen

The response of the tax bar in Germany to the April 1, 2004, to the imposition of VAT on management fees was to create a work-around known as the "priority profit share." This work around, though artificial, worked and was tolerated by the BMF. On May 31, 2007, however, the BMF ended its tolerance and published an administrative pronouncement on its website declaring that as of June 1, 2008, the priority profit share will be subject to the 19% VAT.

It appears that the BMF has taken a policy decision that venture capital is not an appropriate form of financing for Germany.