Financial conflict of interest on the federal bench and stock trading by presidents of regional Federal Reserve Banks. Alternate headline – Is there any group of powerful people who bother to follow the rules?

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Major investigative effort by the Wall Street Journal revealed 131 federal judges who own stock in one of the firms appearing before them in 685 lawsuits.

The Journal found that about two thirds of all federal judges disclosed ownership in individual stock. Of those who made such disclosure about one fifth had a conflict of interest but did not recuse themselves.

For CPAs, this illustrates the importance of our independence rules, both independence in fact an independence in appearance.

What shall we call judges who were trading stock of litigants who were appearing in front of them? Perhaps a reasonable label would be integrity impaired fools. Even those judges who had a trivial investment and had a mere procedural motion in front of them have a serious appearance of conflict of interest and thus impaired integrity.

It would be wise for CPAs to read this story as a caution to keep a scrupulous eye on their own independence. The same lessons can be drawn by leaders of nonprofit organization.

The story doesn’t end with the federal judges, but we start there. More discussion in a moment about stock trading by presidents of two regional Federal Reserve Banks, who are the ultimate insiders.

Failures to recuse when federal judges have financial conflicts of interest

The investigative report may be found at the Wall Street Journal, published online 9/28/21:131 Federal Judges Broke the Law by Hearing Cases Where They Had a Financial Interest.

A 1974 federal law requires federal judges to monitor their investments, maintain personal awareness of those investments, and then recuse himself of any case in which they have a financial interest, no matter how small their interest may be.

In spite of a 40-year-old law and in spite of software that checks disclosed ownership against parties to the lawsuit, 12% of federal judges completely blew off the ethical obligation. That means one out of eight judges failed to recuse themselves when they had a financial interest in a case before them.

I’m wondering if there’s any group or category of people in this country who have significant power or influence who actually bother to follow the rules

More specific tallies from the article:

  • About 1,060 – approximate number of federal judges on the bench consisting of about 600 full-time and about 460 semiretired (also called senior judges).
  • About 700 – approximate number of judges who disclosed that they had ownership in specific stocks.
  • 131 – number of judges who had an investment in one of the parties appearing before them, consisting of 129 district judges and 2 Appellate Court judges.

Using those estimates as hard data points indicates approximately 66% of federal judges own individual stock. Of those who disclosed stock ownership, 18.7% had a conflict which should have generated a recusal but did not.

In total about 12.4% of the judges had an ethical & legal violation due to non-recusal when required.

Staggeringly, 61 judges were trading stock in companies while those companies had a case before the judge. Sixty-one.

The stellar performers amongst the judges in terms of highest tally of conflicted cases include judges with the following number of case violations:

  • 138 – first place leader in ethical failures
  • 54 – second-place
  • 44 – third-place
  • 42 – another honorable mention, but not credited in terms of his ranking on the dishonor list

Corrective actions so far include 52 judges advising litigants in 329 lawsuits of the judge’s conflict of interest and giving notice they ought to have recused themselves.

Even though this research has been underway for many months, less than half of the judges have bothered to notify litigants of their ethical failure to recuse themselves.

The cited responses from judges range from flagrant ignorance of the law, to lack of effort to know what stocks they owned, to lack of interest in stocks their spouse owned, to refusing to speak with WSJ reporters, and to shifting blame to the judiciary’s software that checks cases against disclosed ownership.

The federal law that requires federal judges to personally be aware of their stock investments, their spouse’s investments, their children’s investments. The law requires federal judges to recuse themselves if there is any conflict (even one share). The law does not have any penalties for violations.

Any guesses on how many judges will suffer any consequences, other than having their name buried deep in a very long WSJ article? My guess is zero.

Large investment trading by two Presidents of regional Federal Reserve Banks. During the turmoil of the pandemic.

The U.S. Federal Reserve System is a complex entity, subject to limited oversight by Congress and the president. There is a supervising Board of Governors. There are 12 decentralized regional banks which also play a large role in the central bank system.

This week, two of the regional presidents of a Federal Reserve Bank resigned because of extensive stock trading during the pandemic year.

Wall Street Journal – 9/27/21 – Fed Leaders Eric Rosengren, Robert Kaplan to Resign Following Trading Controversy.

The article provides some background on the Federal Reserve system:

“The 12 regional Fed banks are quasi-private institutions that are overseen by the Federal Reserve Board of Governors in Washington. The regional banks have private boards of directors. They collect economic information, engage in community development work and, in the case of the New York Fed, they are responsible for the implementation of monetary policy.”

The regional presidents take turns sitting on the Federal Open Market Committee, which determines key interest rates for the economy.

Boston Fed President, Mr. Rosengren, traded large number of stocks and real estate industry investments last year.

Dallas Fed President, Mr. Kaplan, has traded “many millions” in individual stocks, stock futures, along with interest-rate funds over the last seven years.

The trades have generated significant controversy. The pressure led both of them to resign.

Both of them claimed they were following ethics rules of the Federal Reserve. ‘Tis more the shame if that is true.

NPR, picking up article from AP – 9/27/21 – 2 Top Federal Reserve Officials Retire After Trading Disclosures.

AP article says Mr. Kaplan had at least $1 million of trades in 22 individual stocks and mutual funds. Mr. Rosengren has significant investments in mutual funds holding mortgage-backed securities. That is the underlying class of bonds which the Fed is buying up at the rate of around $120 billion a month. That buying spree, apart from driving inflation and artificially stimulating the economy, increases demand, thus the price of those securities. That in turn will drive up prices on the investments he owns.

Neither Mr. Kaplan nor Mr. Rosengren have positions on the FOMC this year.

CNBC – 9/16/21 – Powell orders ethics review after Fed presidents disclosed multimillion-dollar investments.

Article says Richmond Fed President Thomas Barkin has multiple investments in the $500-$1M range and multiple investments in the over $1M range.

All three articles mentioned in their comments that Fed chairman Jerome Powell harrumph with shock that regional presidents were trading stocks during the pandemic, insisting he will get to the bottom of it, and will diligently research whether there is anything that could possibly be done to tighten up the Fed’s ethics rules just a smidgeon. Yeah, there’s a little sarcasm there.

Why is this a big deal?

Presidents of each Federal Reserve bank, along with many of the senior staff and boatloads of mid-level staff have access to far more information of much richer detail than is available to the market. They have earlier access to better statistics with deeper background than is available to you and me or the people managing our mutual funds.

The regional presidents have access to deliberations on interest-rate policy and are allowed input to setting rates. Those members who are rotated into the FOMC get to actually vote on interest rates.

This is called inside information.

All that information would be exquisitely valuable when deciding whether to buy, say Amazon, knowing confidential information about trends in on-line shopping. Knowing about deep research of the real estate sector and what direction interest rates are likely to go would be extremely valuable in deciding whether to buy, sell, or hold REITs.

Having all the information available to a Fed prez would provide a tremendous edge whether to increase or decrease your portfolio, switch sectors, or whether to sit tight without changes. Knowing where the economy is going before the market gets official stats would be oh so helpful for deciding one’s investment strategy.

I have no beef with someone at the end of their career having many millions of dollars of investments. This is a very good thing. The problem is when the ultimate insiders, who have access to radically better information that the market, are buying, selling, and holding individual securities.

Even if somehow there is no official conflict of interest (it appears the Fed’s rules are so loosey-goosey that their investment activity is not a conflict in fact), the stench of conflict in appearance is rancid.

As I asked early in this article, is there any group of powerful individuals, any collection of people in places of influence anywhere in our country, who actually try to behave ethically?

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