Professor Bainbridge...on law, politics, religion, culture & food

Judicial Recusals Due to Stock Ownership

My friend and colleague Eugene Volokh notes:

The L.A. Times reports that the Exxon Valdez punitive damages case might yield a 4-4 division—with no precedent being set, and the lower court decision being affirmed—because “Justice Samuel A. Alito Jr. withdrew because he holds Exxon stock.” And indeed important cases have in the past yielded 4-4 deadlocks because one Justice owned stock in one of the companies.

This is a pretty bad result, it seems to me: An important issue will be unresolved, the Justices’ time will be wasted, the parties’ money will be wasted, and all over what is likely just a few thousand dollars’ worth of investment.

Isn’t there some better solution, even if we insist that a judge may not own even a small stake in one of the parties? For instance, if the problem is indeed just that the Justice owns actual stock (as opposed to owning a share in some fund that owns the stock), wouldn’t it be much better for the Justice simply to sell the stock if certiorari is granted? This would presumably be little loss for the Justice, who could sell at market rates and lose just the commission (plus perhaps have some taxable capital gain that he might rather have deferred). Nor would the Justice have any enduring bias in favor of the company—it’s not like the past stock ownership created or reflected an emotional relationship that persists even when the stock is sold. Or am I missing something here?

A minor quibble:  The presumption the the Justice would suffer little loss may not hold true when a grant of cert translates into increased costs to the corporation even without an adverse ultimate result, both from litigation costs and bad publicity.

In any case, this used to be a serious problem, as a 2006 WSJ article recounts:

In the early 1970s, Philadelphia lawyer Jan E. DuBois inherited a relatively small amount of stock. Its value grew nearly 50-fold over the next three decades, and he hoped to keep it until he died.

But a problem arose last year for Judge DuBois, now a federal district judge, when the company whose stock he held was bought by a plaintiff in a class-action case over which he had presided since 1999. Forced by conflict-of-interest laws either to drop the case or the investment, Judge DuBois says he faced two unattractive options: disqualify himself from a matter that had consumed years of his and the litigants’ time, or divest himself of the stock and incur a substantial capital-gains tax.

Federal judges have complained for years about paying capital-gains taxes on stock sold to avoid disqualification from cases on their dockets. ...Judicial experts widely agree that the capital-gains tax—currently 15%—can create a perverse incentive for judges to put their portfolios ahead of already-crowded court dockets. “If they want to do the right thing, let’s not make it financially painful for them,” said Charles Geyh, a law professor at Indiana University who follows the judiciary.

In 2006, however, Congress amended Internal Revenue Code section 1043, entitled Sale of property to comply with conflict-of-interest requirements, to provide that:

(a) Nonrecognition of gain. If an eligible person sells any property pursuant to a certificate of divestiture, at the election of the taxpayer, gain from such sale shall be recognized only to the extent that the amount realized on such sale exceeds the cost (to the extent not previously taken into account under this subsection) of any permitted property purchased by the taxpayer during the 60-day period beginning on the date of such sale.

(b) Definitions. For purposes of this section - (1) Eligible person. The term ‘’eligible person’’ means - (A) an officer or employee of the executive branch, or a judicial officer, of the Federal Government… and (B) any spouse or minor or dependent child whose ownership of any property is attributable under any statute, regulation, rule, judicial canon, or executive order referred to in paragraph (2) to a person referred to in subparagraph (A). ...

(3) Permitted property. The term ‘’permitted property’’ means any obligation of the United States or any diversified investment fund approved by regulations issued by the Office of Government Ethics.

Under this provision, a judge thus can divest an asset causing a conflict of interest so as to hear the case and avoid paying capital gains provided the judge dumps any gains from the sale into a Treasury security or an approved mutual fund.

The provision was widely assumed to explain why Chief Justice Roberts first recused himself from the Stoneridge case and then reentered it:

Chief Justice John Roberts Jr. and Justice Stephen Breyer initially recused in the case. According to their 2006 financial disclosure forms, both justices own between $50,001 and $100,000 of stock in Cisco Systems Inc., the parent company of Scientific-Atlanta, one of the respondents in the case.

But rumors have swept through the ranks of the lawyers involved that Roberts or Breyer or both might sell their stock and rejoin the case—driven by the Court’s deeply held desire to bring as full a bench as possible to bear in deciding its cases. Their decision might not be known until close to the time the case is argued on Oct. 9. ...

The notion of justices “unrecusing” and re-entering a case strikes some as attempting to unring a bell, and it is causing discomfort among some judicial ethics experts. But a new—and little-noticed—federal law may be encouraging the practice.

Under the new law—which Roberts urged Congress to pass in his capacity as head of the Judicial Conference—judges can defer the capital gains taxes on stock they sell if they can demonstrate they made the sale to remove a conflict of interest. Executive branch officials have long had this ability, but judges were not allowed the same privilege until the change was included in a tax bill signed into law on Dec. 20.

Roberts may have made use of this new tax-deferral power already, when he recused from—and then rejoined — the antitrust case of Credit Suisse v. Billing last term. He first announced his recusal on Dec. 6, 2006, evidently because of holdings he had in investment firms involved in the case. Then on March 19, Justice Anthony Kennedy recused in the same case after apparently realizing, belatedly, that his son Gregory Kennedy’s compensation as a managing director at Credit Suisse might be affected by the outcome.

Possibly to avoid a seven-member Court, Roberts suddenly rejoined the case on March 26, a day before oral argument. Under federal law, Roberts probably could not have rejoined the case without first curing the conflict—most likely by selling stock. In Stoneridge, all it would take for Roberts and Breyer to participate is to sell their Cisco stock, which they can now do without tax consequences.

Without commenting on any specific case, judicial ethics expert Ronald Rotunda says he does not think judges should be allowed to recuse and unrecuse. “It looks funny; it seems manipulative,” says Rotunda, a professor at George Mason University School of Law. Theoretically, he says, a judge could sell a company’s stock to cure a conflict, then rule in the company’s case, and then buy back the stock at a lower price. “Strategic recusals don’t sound right.”

Steven Lubet, a judicial ethics expert at Northwestern University School of Law, is less critical. Selling the stock cures the conflict, so there is no longer any bar against participation, he says. It might get into a gray area, Lubet adds, only if a judge or justice seems to be “selective” about which cases he rejoins, possibly showing favoritism or animus toward a particular company.

New York University School of Law’s judicial ethics guru Stephen Gillers agrees that at the lower federal court level, where it is easy to replace recused judges with other judges, it could be “unseemly” for a judge to go to great lengths to stay in or re-enter a case. “Traditionally, a judge who is assigned to a case is not supposed to rearrange his or her affairs to keep a case.”

But at the Supreme Court level, where there is no replacement for a recused justice, Gillers thinks the benefit of having a full Court ruling in a case outweighs other concerns. “There may not be as thorough an airing of the issues with only seven justices as there would be with nine,” Gillers says.

It strikes me that Gillers is exactly right. As Eugene correctly notes, “the Justice have any enduring bias in favor of the company—it’s not like the past stock ownership created or reflected an emotional relationship that persists even when the stock is sold.”

The puzzle is why Alito did not take advantage of Section 1043 in this case.