2011-22 (October 7, 2011)
Disqualification;
Rule 2.11
 
Issue: May a Judicial Official preside over a case involving a financial institution if the Judicial Official owns collateralized mortgage obligation bonds (hereinafter, CMOs) worth over $5,000 that were issued by the financial institution?
 
Response: According to information provided by or on behalf of the Judicial Official, CMOs are bonds that represent claims to specific cash flows from large pools of home mortgages. While most CMOs are issued by Ginnie Mae (a U.S. government agency), Freddie Mac or Fannie Mae (government-sponsored enterprises), private financial institutions may also issue CMOs (known as private label CMOs). The value of the portfolio in a CMO typically is one billion dollars or more, and an investor does not know which individual mortgages are pooled to create the fund that secures the bond payments the investor receives. In addition, an investor has no control or influence over the mortgages that go into the fund to secure the payments, and nothing that the investor or issuing financial institution does can impact the investment. For example, when Freddie Mac was going bankrupt, the value of its CMOs were not affected. (What does impact a CMO is a change in interest rates, as CMOs typically trade inversely to interest rate changes.) CMOs are analogous to a mutual fund. Unlike a stock investment, an investor in a CMO does not acquire an ownership interest in the issuing entity. Hence, if one owns a private label CMO issued by a financial institution, the return and value of the CMO is not affected by whether the financial institution itself is profitable. While with a typical corporate bond the issuing company is liable for the bond payments, with a CMO it is the mortgage portfolio, not the issuing financial institution that is responsible for making or guaranteeing payments.

Rule 2.11 of the Code of Judicial Conduct requires disqualification if a judge’s impartiality might reasonably be questioned, including but not limited to if a judge has “more than a de minimis interest that could be substantially affected by the proceeding” (Rule 2.11(a)(2)(C)), or if a judge “has an economic interest in the subject matter in controversy or in a party to the proceeding” (Rule 2.11(a)(3)). The term “de minimis” means “an insignificant interest that could not raise a reasonable question regarding the judge’s impartiality.” Code of Judicial Conduct, Terminology (defining “economic interest”). The term “economic interest” is defined in relevant part to include “ownership of more than a de minimis legal or equitable interest.” Code of Judicial Conduct, Terminology (defining “economic interest”). The Code makes clear that unless a judge “participates in the management of such a legal or equitable interest, or the interest could be substantially affected by the outcome of a proceeding before the judge,” the term “economic interest” does not include “an interest in the individual holdings within a mutual or common investment fund,” or “a deposit in a financial institution,” or “an interest in the issuer of government securities held by a judge.” Id.

The Committee concluded that the Judicial Official’s investment in this matter is neither a “more than de minimis interest” under Rule 2.11(a)(2)(C) nor an “economic interest” under Rule 2.11(a)(3), and therefore that the Judicial Official’s CMO investment does not require disqualification. The Judicial Official’s CMO investment is not a “more than de minimis interest” within the meaning of Rule 2.11(a)(2)(C) because any ruling in favor of or against the interests of the financial institution could not affect the value of or return from the CMO investment. The CMO investment is not an “economic interest” within the meaning of Rule 2.11(a)(3) because the Judicial Official has no role in managing the CMO, because the value of the CMO could not be affected by the outcome of the proceeding before the Judicial Official, and because the nature of the Judicial Official’s financial interest is analogous to an interest in the individual holdings of a mutual or common investment fund (which is expressly excluded from the definition of an “economic interest” under the Code).

The Committee concluded that its prior opinion in JE 2011-08 is distinguishable because it concerned a Judicial Official’s direct investment in the stocks or bonds of a financial institution appearing as a party before the Judicial Official. In contrast, the facts before the Committee in this matter do not concern a direct investment in a party and negate any connection between the value of or return from the Judicial Official’s investment and a ruling in favor of or against the financial institution.