Legal Comment - September 2006

By: Stephen C. Nick, Eau Claire City Attorney

Stephen Nick is City Attorney for the City of Eau Claire. He recently was designated a Local Government Fellow by the International Municipal Lawyers Association. He is a 1995 graduate of U.W. Law School, president-elect of the Eau Claire County Bar Association and board president for the Children's Museum of Eau Claire.

Captions: Licensing & Regulation 386
Other Licensing & Regulation Captions

No more bankers boxes filled with old pawn slips. No more weekly rounds to the stores to collect and file the slips. And most importantly, no more needle-in-a-haystack searches through the paper files in an attempt to find the right slip when property is reported stolen. The City of Eau Claire put another detective back on the street while cutting costs, protecting its citizens, and improving its ability to solve property crimes. It did so by adopting an updated pawnbroker licensing ordinance requiring pawnbrokers to submit pawn transactions electronically.

Eau Claire, like many cities across the country, already regulated pawnbrokers by requiring a local license, conducting background checks on owners, and enforcing state statutory requirements on the filing of pawn transaction slips. Keeping up on this last task was difficult for a department that had not gained personnel over the last decade, despite the city's consistent growth in population and area. The City and its police department were looking for ways to improve the level of service to citizens with fewer employees and other resources, a challenge all local governments confront with added intensity under the current levy limit restraints.

The department proposed automation of the pawn transaction reporting process. First, the local ordinance had to be updated to require electronic reporting.1 Electronic reporting was a new approach to most local pawnbrokers and one on which statutory regulations provide no guidance.2 Second, the City had to defend against a constitutional challenge brought by several local pawnbrokers. That led the City to the Court of Appeals as an appellant seeking and obtaining reversal of an earlier adverse decision in circuit court.3 Finally, once the ordinance was ruled constitutional, the City successfully worked with pawnbrokers to implement the new local code provisions. After about six months under the new ordinance the positive results are already apparent. It was worth the considerable effort to update what is a long history of pawnbroker regulation.

A Brief History of Pawnbroker Regulation And Resulting Litigation

The classification of pawnbrokers as a distinct business group subject to licensing and related reasonable regulation is well established in Wisconsin and across the country.4 In Wisconsin, the classification is based upon specific state statute. Pawnbrokers are defined and regulated by Wisconsin Statute sec. 134.71. This statute has existed in some form since 1901. In addition to state regulations, the law expressly authorizes municipalities to enact ordinances governing pawnbrokers and other business classifications "if that ordinance is at least as stringent as this section."5 Wisconsin municipalities also enjoy home rule authority to adopt regulations that further matters of local legitimate governmental interest.6 Eau Claire utilized both home rule and the specific statutory grant of authority to support adoption of its local ordinance.

There are numerous decisions across the country affirming legitimate reasons for governments to regulate pawnbrokers.7 However, no reported case law yet exists in Wisconsin on either the constitutionality of the state statute or any local ordinance adopted under the authority it grants. State statute regulates both pawnbrokers and secondhand dealers; the two types of businesses are uniquely defined and treated under the law.8 Eau Claire also decided to treat the two types of business differently, only requiring pawnbrokers to report transactions electronically.9 Other cities have reached a similar conclusion. The city of Duluth, Minnesota saw a need to regulate pawnbrokers but not secondhand dealers in the late 1800s. The ordinance was challenged before the Minnesota Supreme Court, which commented: "[P]awnbrokers' shops are the places where thieves most usually attempt to dispose of stolen property, and whose keepers not infrequently become fences for such goods, - reasons which do not apply with anything like the same force to secondhand stores of other kinds, as, for example, secondhand furniture or secondhand book stores."10 While pawnbrokers are permitted forms of business that provide a desired service to many, there is a strong history of local regulation to further legitimate local purposes, such as theft prevention, recovery of stolen merchandise, and consumer protection.11

Automated Pawn System: A Good Choice for the City

The City looked to Minneapolis-St. Paul, only one and a half hours down the fast growing I-94 corridor, for a possible solution to its pawnbroker challenge. Minneapolis developed and operates Automated Pawn System (APS), a collective, searchable database of pawn transactions. The Minneapolis Police Department created APS in 1997 to reduce administrative costs, improve effectiveness, share pawn transactions electronically, and improve stolen property recovery rates.12 Currently, thirty-two law enforcement agencies contribute pawn transaction data with an additional one hundred agencies using query-only access.13 Eau Claire and Chippewa Falls' police departments are contributing agencies from Wisconsin and several Wisconsin communities participate on a query-only basis.

Eau Claire investigated several on-line pawn transaction database services before selecting APS.14 APS offers agencies a number of advantages over both traditional paper pawn transaction reporting systems and other electronic systems. Compared to traditional paper transaction slips, detectives no longer need to pick up forms at pawn shops, make multiple copies, or search by hand through a large local and regional database for evidence of stolen merchandise. APS replaces these time consuming and less effective efforts with electronic reporting to the police by the pawnbrokers, instant verification whether pawn transaction reports meet all requirements, search capability through all transactions from all reporting agencies, and report generation.

When compared to other electronic services, the City found that APS provided the best service to meet its needs. Geography was a major issue. The City decided to participate in a database shared by other nearby communities in which criminals may attempt to fence stolen property rather than cities in another region where such cross-jurisdictional crime is less likely. There were other advantages as well. APS was believed to generate superior reports for the department to check serial numbers, felony status regarding firearm transactions, and coordination with local ordinance requirements.

A major legal advantage of APS is that it is operated by a law enforcement agency. This is legally significant for any Wisconsin municipality considering such a system. Wisconsin law limits access to pawn transaction forms and other specified filings to other law enforcement agencies.15 It is likely this also permits sharing such information with other law enforcement agencies through a private database provider, but the law remains unclear. Through use of APS, operated by a law enforcement agency, the City avoided this legal restriction, if not entirely the concern by the pawnbrokers that use of electronic reporting would lower privacy barriers kept high by the practical inaccessibility of the paper records. In addition, APS was very accommodating to Eau Claire as a new Wisconsin client. It instituted access restrictions so that only fellow law enforcement agencies could receive Wisconsin data.16 APS did so even though there is not a similar issue in Minnesota based on state legislation that recognizes APS and its ability to share data with some limitations.17 Based on Eau Claire's experience, the APS protocols have worked well, maintaining privacy without any incidents of improper access.

Despite these advantages to the City, Local pawnbrokers did not view the public notices announcing that the city council was considering an updated pawnbroker licensing ordinance with requirements beyond the minimal state statutory standards as welcome news. During several public hearings, owners and employees of these legitimate businesses voiced concern over a number of issues, including: greater government intrusion, loss of privacy for themselves and their customers, cost of necessary software and training, the per transaction fee, exclusion of secondhand dealers from electronic reporting requirements, and the recommendation of APS as the provider over LEADS or some other private service not associated with law enforcement. Council made changes to the ordinance prior to adoption, but not to the pawnbrokers complete satisfaction.

But Is It Constitutional? A Challenge to the Eau Claire Ordinance

A group of local pawnbrokers challenged the constitutionality of the new Eau Claire ordinance. They filed suit on May 27, 2004, alleging the ordinance violated the Equal Protection Clause, imposed an unauthorized tax in the form of a transaction charge, and moved law enforcement records to a different state beyond the control of the local judiciary.18 An Eau Claire Circuit Court judge granted the requested temporary injunction and later ruled the ordinance unconstitutional.19

On appeal the two key issues were briefed more extensively: the Equal Protection claim and the unlawful tax claim. Both issues and the ultimate constitutionality of the ordinance were decided in favor of the City in an unpublished court of appeals decision.20

The standard of review is of prime importance in an Equal Protection challenge to an ordinance or law. It sets the bar the government must meet to sustain the newly adopted law. The approach, the City contended, for properly establishing the standard of review is as follows. First, ordinances, like statutes, are presumed constitutional and must be upheld unless shown unconstitutional beyond a reasonable doubt.21

Second, the court must determine whether any fundamental right or suspect class is involved.22 When a fundamental right or suspect class is not involved, courts apply a rational basis standard to Equal Protection Clause challenges.23 The classification need only rationally relate to a legitimate governmental purpose.24 Where rationality is the test, a statute or ordinance does not violate equal protection simply because the classifications made by the law are imperfect.25 A classification only violates equal protection under the rational basis test if it "is arbitrary and has no reasonable purpose or reflects no justifiable public policy."26

Third, in applying the test the court must resist any temptation to substitute its judgment on proper social policy for that of the legislature.27

Once the Equal Protection analytical standard is established, the task is to provide the reviewing court ample justification for the government action, in this case the reasons or purpose for the new pawnbroker ordinance. The Eau Claire City Council stated three key reasons for the ordinance. The first is to provide increased protection against the proliferation of the sale of stolen property and related criminal activity. The City Council was presented with considerable information during several public hearings on the issues of stolen property and other criminal activity related to pawns versus sales at other businesses that resell used items. A good lesson to take from this case is to thoroughly research local statistics on crime, volume of pawn transactions, and the relationship between the two for consideration by your council or board. Reports by the police department provided a legitimate foundation that the Council took reasoned action in adopting a new regulatory scheme.28 The second purpose is to provide consumer protection regulation in pawn transactions. This purpose is also furthered by state law which treats pawnbrokers and secondhand dealers differently, recognizing that pawns are collateral for high interest loans, not a characteristic present in secondhand dealer sales. The ordinance's third key purpose is to modernize the reporting process already required by statute. Increasing efficiency, tax savings, and improved services to the regulated community and the public are legitimate governmental purposes.29 The City Council found that pawnshops had outgrown the City's ability to effectively identify criminal activity related to pawn transactions. In response to this legitimate governmental interest, the ordinance switched from a paper filing system to an electronic reporting system of substantially the same information required under state statutes.30 The Court of Appeals found these reasons legitimate and found the Eau Claire ordinance did not violate the Equal Protection Clause.

Pawnbrokers claimed the $1.00 per transaction fee charged by APS to operate its system and passed along to pawnbrokers by the ordinance was an unauthorized tax. As municipalities become more creative in recovery of the actual costs of regulation while under pressure to reduce the property tax levy, you can anticipate more legal challenges in this area. Currently, the distinction between a license fee supported by municipal police power and a tax requiring a specific statutory grant of taxing authority is grounded in the substance and purpose of the proposed ordinance.31 Under the Eau Claire ordinance there is no revenue production realized by the City. The fee does not recover the associated police and other city staff time necessary for oversight of pawn transactions. The fee could recover those costs as well and not be a tax, yet the City chose to set the fee at $1.00 to only pass through the APS charge. On this point as well the Court of Appeals agreed with the City that the $1.00 charge is not a tax, but a permissible cost recovery fee.

Implementation and Initial Success

The ordinance finally went fully into effect on October 1, 2005 after a several month implementation period, almost two years after it was enacted. The early results appear to indicate that the ordinance was worth the effort. While the information is preliminary, detectives, with the aid of the ordinance and APS, are reducing crime while gaining the sought after efficiencies. The value of stolen property is down in the City while the amount recovered is up.32 It is taking them much less time to review the same or increased volume of pawn transactions, now only requiring a third to a quarter of one detective's time. Most importantly, the system is helping to solve crimes. A case of stolen jewelry was solved, a bike stolen from the Twin Cities was recovered in Eau Claire and returned, MP3 players, chainsaws, and many other items that may have gone unnoticed in the pile of pawn slips, were found and returned to their rightful owners. Although the ordinance met with some initial resistance, this system is proving a benefit to all by deterring and solving crime using a multi-jurisdictional modern approach, and even doing it at a lower cost to the taxpayers.

Conclusion

Consider reviewing your community's pawnbroker ordinance or adopting a new one. While the decision is unfortunately unpublished, C & C Pawnbrokers, LLC v. City of Eau Claire provides a legal template for court acceptance of modern local pawnbroker regulation.

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Endnotes

1. City of Eau Claire Code sec. 5.04.

2. Wis. Stat. sec. 134.71.

3. C&C Pawnbrokers, LLC v. City of Eau Claire, 280 Wis.2d 559, 694 N.W.2d 510 (Table), 2005 WI App 59 (Unpublished), cert. denied, 282 Wis.2d 723, 700 N.W.2d 274 (Table), 2005 WI 134.

4. McQuillin, Municipal Corporations sec. 24.335 (3d ed.).

5. Wis. Stat. sec. 134.71 (14).

6. Wis. Stat. secs. 62.05 and 61.34.

7. See, e.g., Howell v. Roberts, 656 F. Supp. 1150, 1154-56 (N.D. Ga. 1987) ("The state interests advanced by the statute - recovery of stolen property, investigation and prevention of theft - are compelling.... In the Court's view it is not even arguable that the law regulating pawn shops lacks a rational basis. Therefore, plaintiffs' equal protection claim must fail."); State v. Schaefer, 781 P. 2d. 264, 266 (Mont. 1989) ("Montana has a substantial and important interest in protecting all of its citizens from dishonest pawnbrokers. This purpose is effectuated by requiring accurate and detailed records of transactions in the event authorities need to trace stolen merchandise. The records of transactions also prevent the charging of excessive rates of interest."); Winters v. Board of County Commissioners, 4 F.3d 848, 852-53 (10th Cir. 1993, citing, S & S Pawn Shop, Inc. v. City of Del City, 947 F.2d 432 (10th Cir. 1991) ("Appellant asserts the reporting requirements imposed on pawnbrokers as compared to the confidentiality protections banks enjoy violate the Due Process and Equal Protection clauses as there is no rational basis for disparate treatment.... Economic regulations governing financial institutions violate the Equal Protection clause only if no rational basis supports the regulation. We previously held the regulation of pawnshops is a substantial government interest as they provide a market for stolen property. S & S Pawn Shop, Inc., 947 F.2d at 441-42. Therefore, it is certainly rational for Oklahoma to impose greater disclosure requirements on pawnshops than on banks.")

8. Wis. Stat. sec.134.71.

9. City of Eau Claire Code sec. 5.04.100, et seq.

10. City of Duluth v. Bloom, 55 Minn. 97, 56 N.W. 580, 581 (1893)

11. Some courts have even found these concerns rise to the high level of compelling governmental interests. See, e.g., City of St. Louis v. Liberman, 547 S.W. 2d 452 (MO, 1977).

12.  Automated Pawn System website.

13. Automated Pawn System Law Enforcement Subscriber Information

14. Other on-line reporting systems exist and were reviewed by the Eau Claire Police Department, including l.e.a.d.s.online (Law Enforcement Automated Database Search) and TrackItFindIt (TIFI). The City seriously considered both LEADS and APS. That APS was based in nearby Minneapolis was a major factor in selecting it over LEADS based in Dallas, Texas.

15. "Notwithstanding s. 19.35 (1), a law enforcement agency receiving the original form or inventory or a declaration of ownership may disclose it only to another law enforcement agency." Wis. Stat. sec. 134.71 (8)(e).

16. "Civilian investigative agencies do not have access to any transaction information from Wisconsin stores held in the APS central repository due to Wisconsin data privacy statutes."

17. Sec. 17. Minnesota Statutes 1994, section 13.82, Subd. 18.

18. C&C Pawnbrokers, LLC, et al v. City of Eau Claire (Eau Claire County, 04 CV ­ 355).

19. Decision and Order of the Honorable Eric J. Wahl, Eau Claire County Circuit Court, Branch 2 (August 18, 2004).

20. C&C Pawnbrokers, LLC, 280 Wis.2d 559, 694 N.W.2d 510 (Table), 2005 WI App 59 (Unpublished).

21. Eastman v. City of Madison, 117 Wis. 2d 106, 111, 342 N.W.2d 764, 767 (Ct. App. 1983).

22. Funk v. Wollin Silo & Equipment, Inc., 148 Wis. 2d 59, 69, 435 N.W.2d 244, 248 (1989).

23. Id.

24. Dandridge v. Williams, 397 U.S. 471, 584, 90 S. Ct. 1153, 1161-62 (1970).

25. Id.

26. Kallas Millwork Corp. v. Square D Co., 66 Wis. 2d 382, 225 N.W.2d 454, 458 (1975).

27. State v. Amoco Oil, 97 Wis. 2d 226, 293 N.W.2d 487, 503-04 (1980) ("The court should not substitute its social and economic beliefs for the judgment of the legislative body. The legislature has broad scope to experiment with solutions to economic problems and has the power to regulate injurious commercial and business practices as long as it does not run afoul of the federal constitution, state constitution or federal statutes.")

28. Statistics compiled by the Eau Claire Police Department between 1998 - 2004 demonstrated that pawnbrokers engaged in weekly volumes of transactions not seen in a year at secondhand dealers and that almost 300 criminal stolen property cases involving pawns were investigated while only ten arose at secondhand dealers, with none of those ten resulting in any believed criminal activity.

29. Klaips v. Bergland, 715 F.2d 477, 485 (10th Cir. 1983).

30. Estimates at the time were that detective staff time assigned to monitoring pawn transaction would reduce from three-fourths to one-fourth full time equivalent (FTE). The personnel savings have been realized and the department reports a greater number of crimes solved.

31. Milwaukee v. Hoffmann, 29 Wis. 2d 193,138 N.W.2d 223, 226 (1965) ("The one is made for regulation and the other for revenue. If regulation is the primary purpose the mere fact that incidentally a revenue is also obtained does not make the imposition a tax, although if the imposition clearly and materially exceeds the cost of regulation, inspection or police control, it is generally held to be a tax or an illegal exercise of police power.")

32. 2004 crime statistics: Stolen property valued at $1,357,776, covered property valued at $394,813 compare to 2005 crime statistics of $1,214,315 and $449,723. 2005 Eau Claire Police Department Annual Report.