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Ethical Investing For Federal Officials

After approval by the appropriate supervisory ethics office, a blind trust will be effective as a device to avoid financial conflicts of interest, provided it meets these requirements established by the Ethics in Government Act of 1978:

  • Within 30 days after the trust is established, the official must file the trust agreement and a list of all assets originally transferred to the trust, and their categories of value, with the appropriate supervisory ethics office.
  • The trustee must be a financial institution, CPA, attorney, broker or investment adviser who is independent of the federal official or any person interested in the trust.
  • Assets must be placed in trust with no restrictions on their sale or disposition at the discretion of the trustee.
  • Assets originally transferred to the trust are still to be considered “financial interests” of the official until disposed of or their value becomes less than $1,000.
  • The trustee is prohibited from consulting or communicating with the beneficiaries or other interested parties in the trust concerning the identity of any asset, except to inform the official when an original asset has been disposed of or its value has become less than $1,000. Only information on the value and income of the trust as a whole may be conveyed to the official and interested parties.

Imagine that a congressman voting on the recent economic stimulus bill, with its substantial funding for infrastructure improvements, owns stock worth $1 million in Caterpillar, which will surely benefit from that spending. Is he voting in the public’s interest, or his own?

Investing for federal officials, whether presidents or members of Congress, is much more complicated than investing for average Americans. This is because of potential financial conflicts of interest. Public servants owe undivided loyalty to the people and their government. Their decisions should not be influenced in any way by personal financial interests.

The federal criminal code, in 18 U.S.C. §208, provides that a government official who has a “financial interest” that may be affected by participation in a matter related to federal law shall not participate in such a matter, unless he is able to avoid the conflict of interest in one of the manners described below. A financial interest is any ownership or security interest in property or a business and can include stocks, bonds, partnership interests, property rights, derivatives and compensation agreements.

In the wake of the Watergate and other scandals of the 1970s, the American people began to lose faith in the ethics of their government officials. Congress passed the Ethics in Government Act of 1978 to address federal conflicts of interest. The act established the Office of Government Ethics (OGE), which issues regulations pertaining to, among other matters, addressing financial conflicts. The federal criminal code, in conjunction with the Ethics in Government Act, creates a body of federal laws and regulations that govern how an official presented with a financial conflict of interest should act.

In addition, both houses of Congress have their own supervisory ethics offices, the Select Committee on Ethics for the Senate and the Committee on Standards of Official Conduct for the House. Finally, officials may seek to avoid conflicts because of potential political repercussions , and many may do so simply because of personal reservations.

Federal officials have several options when faced with potential financial conflicts of interest. The first is recusal, which means that the official simply does not participate in whatever government activity causes a conflict. When recusal is not a realistic option, the official can request a waiver from the appropriate supervisory ethics office allowing him to continue work on the project. Waivers usually are granted, because the potential conflict is deemed to be immaterial or unlikely.

The most obvious way to remove a conflict of interest is to sell the asset in question. Recent deputy secretary of defense appointee William J. Lynn, a former Washington lobbyist and senior vice president of Raytheon (a major defense contractor), owned Raytheon incentive stock options valued between $500,001 and $1 million and unvested restricted stock valued between $250,001 and $500,000. Having the second highest-ranking civilian at the Pentagon doling out defense contracts while possessing a financial interest in a military supplier would be a conflict of interest. Lynn disclosed the holdings and agreed to sell the restricted Raytheon stock as a condition of his appointment. He also will forfeit any unvested restricted stock that does not vest within 90 days after his confirmation.

However, selling the asset may not always be a viable option. It may be too burdensome on the official to liquidate his holdings, particularly if he has a concentrated position in a longtime family business. Any requirement to liquidate such investments would likely reduce interest in public service.

Another option to avoid a potential conflict of interest related to a financial interest is to establish a “qualified blind trust.” While no federal law requires people to place assets into blind trusts on taking office, it is fairly common among high-ranking government officials. Establishing a blind trust makes sense for a person who has significant assets and many potential conflicts. An official can choose to voluntarily create such a trust, or be required to create one as a remedial action reviewed and approved by the OGE. Presidents would find it quite difficult to recuse themselves or obtain waivers for many of the vast responsibilities of their office, so they commonly employ blind trusts. In fact, President Obama’s five predecessors all employed blind trusts. The current president has not yet filed any financial disclosures since taking office.

In a blind trust, the official transfers assets to a trust that has an independent trustee. The trustee controls and manages the assets with the restriction that the trustee cannot communicate anything about the specific assets in the trust to the official. Most blind trusts allow the official to know only the most basic information, such as the taxable income and total fair market value. Communications from the official typically are limited to requests for cash from the trust to satisfy living expenses.

Establishing and funding a blind trust does not necessarily keep an official out of trouble. In 2005, then-Senate Majority Leader Bill Frist, R-Tenn., instructed the trustee of his blind trust to sell shares in HCA Inc., the hospital company his father and brother founded, days before a disappointing earnings report sent the stock tumbling. While a Securities and Exchange Commission investigation was closed in 2007 without any charges against Frist, the negative publicity may have contributed in part to Frist’s decision not to seek reelection in 2006, and not to pursue a presidential bid in 2008.

For the trust to be a “qualified blind trust” for conflict-of-interest purposes, the official must receive prior approval of the trust instrument and the trustee from the appropriate ethics office. The requirements for a qualified blind trust are detailed in the accompanying story.

Assets transferred to a blind trust are considered “financial interests” until the trust disposes of those assets. This can pose problems. If the official is unwilling to dispose of the assets, there is no point in establishing a blind trust, because the trustee must sell the assets to remove the conflict of interest. If the official has a large unrealized taxable gain in an asset, the gain would be triggered by the sale. Officials must weigh potential conflict avoidance and privacy against the tax costs of incurring large gains.

Another benefit of blind trusts is that they can ease reporting burdens, as the official would only be required to include the overall value of the trust and any assets originally transferred to the trust in his public disclosure reports. For example, certain senior officials and employees of the executive branch are required to file reports disclosing their financial interests, as well as those of their spouses and dependent children.

For a federal official in the public eye, investment holdings can present serious conflicts of interest. Through the methods of recusal, waivers, liquidation and qualified blind trusts, an official can greatly reduce the likelihood of being tarnished by scandal related to his or her investments. While the systems in place are not perfect, they give the public some protection against its representatives acting in their own best interests, rather than in those of the people they are meant to serve.

Vice President Eric Meeermann, who is based in our Stamford, Connecticut office, is the author of several chapters in our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 11, "Social Security And Medicare"; Chapter 18, "Philanthropy"; and Chapter 19, "A Second Act: Starting A New Venture." He was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.