October 2, 2017
Definition of Economic Interest
You are a new judge. Your wife and mother-in-law are trustees of a trust created upon the death of your father-in-law. The trust's purpose is to provide for your mother-in-law's needs during her lifetime. Any assets that remain in the trust upon her death will be distributed to your three children, all of whom are minors residing in your household.
The trust assets are contained in an investment account at a major financial services firm. Twenty-five percent of the trust assets are invested in mutual funds, and another 14 percent are invested in Exchange Traded Funds. The remaining (61 percent) of the trust assets are maintained in managed fund accounts at the financial services firm. The managers of the managed funds buy and sell individual securities for the trust. Although the trustees choose the managers of these funds, the trustees do not participate in managing the funds; the fund managers have full discretion to make equity trades at will. Each month, your wife receives a statement of the assets owned by the trust.(1)
You ask whether Rule 2.11(A)(3) of the Code of Judicial Conduct requires you to disqualify yourself from hearing cases in which one of the parties is a company in which the trust holds stock.
Rule 2.11(A)(3) requires a judge to disqualify himself or herself if the judge knows(2) that "he or she, individually or as a fiduciary, or the judge's spouse, domestic partner, parent, or child, or any other member of the judge's family residing in the judge's household, has an economic interest in the subject matter in controversy or is a party to the proceeding." Economic Interest is defined, in relevant part, as "ownership of more than a de minimis legal or equitable interest." Unless the 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 a judge, it does not include, inter alia, (1) an interest in the individual holdings within a mutual or common investment fund."(3)
We begin by considering whether the definition of "mutual or common investment fund" includes Exchange Traded Funds. Such funds are often described as a "species" of mutual funds. Like mutual funds, an ETF pools together investors' money to buy a diversified portfolio. The primary difference is that unlike mutual funds, "ETFs do not sell individual shares directly to, or redeem their individual shares directly from, retail investors. Instead ETF shares are traded throughout the day on national stock exchanges and at market prices that may or may or be the same as the net asset value of the shares."(4) We conclude that an ETF is a mutual fund for purposes of the Code. See, e.g., U.S. Courts, Committee on Codes of Conduct Advisory Opinion No. 106 (concluding that ETFs are a species of mutual funds and should normally be treated as mutual or common investment funds under the Code).
In contrast, a managed account is not encompassed within the exception pertaining to "an interest in the individual holdings within a mutual or common investment fund." The reason is that a managed account is a personalized investment account tailored to the specific needs of the account holder. For purposes of Rule 2.11, it is irrelevant whether your spouse chooses to play an active role in managing the account; the trustees are able to give direction if they choose and the trustees receive monthly itemized statements of the trust's assets.
We note, however, that the definition of "Economic interest" also requires "more than a de minimis legal or equitable interest." We therefore also consider how to define this term. The ABA Model Code defines de minimis, in the context of interests pertaining to disqualification, as "an insignificant interest that could not raise a reasonable question regarding the judge's impartiality." Several jurisdictions have chosen to provide additional guidance by defining de minimis with specificity. The Connecticut Committee on Judicial Ethics has, for example, concluded that ownership of one percent or less of the legal or equitable interest in a party with a fair market value of $5000 or less is de minimis. See Connecticut CJE, Informal Op. 2011-08. The Colorado Code of Judicial Conduct includes the same standard as Connecticut. See also California Code of Judicial Ethics (stating a financial interest is ownership of more than a one percent legal or equitable interest in a party, or a legal or equitable interest in a party of a fair market value exceeding $1,500).
In order to provide guidance for judges as to when an investment is an economic interest under the Code, we define de minimis as ownership of one percent or less of the legal or equitable interest of a party with a fair market value of $5000 or less. An ownership interest in excess of one percent or with a fair market value above $5000 shall be deemed an economic interest unless otherwise specifically
This definition of de minimis interest satisfies the objective standard for disqualification. Of course, a judge may nonetheless be required to disqualify himself or herself if the judge cannot satisfy the subjective standard because, for example, the investment holds such special significance to the judge that the judge concludes that he or she cannot be impartial. See Rule 2.11, Comment .
Thus, disqualification is not required if a party is a company whose shares are or may be included within the portfolio of a mutual fund or ETF in which the trust has invested. Subject to the de minimis exception, you must disqualify yourself from cases where a party is a company in which the trust’s managed account(s) hold stock.
(1) This opinion relies on facts you have provided the Committee of Judicial Ethics. We have not undertaken an independent investigation of this information. If material facts have been omitted or misrepresented, this opinion is without force and effect.
(2) "Know" is defined by the Code as actual knowledge of the fact in question. A person's knowledge may be interred from circumstances.
(3) None of the other exceptions is relevant. The four exceptions are: (1) an interest in the individual holdings within a mutual or common investment fund; (2) an interest in securities held by an educational, religious, charitable, fraternal, or civic organization in which the judge or the judge's spouse, domestic partner, parent, or child serves as a director, an officer, an advisor, or other participant; (3) a deposit in a financial institution or deposits or proprietary interests the judge may maintain as a member of a mutual savings association or credit union, or similar proprietary interests; or (4) an interest in government securities held by the judge.
(4) See Mutual Funds and ETFs: A Guide for Investors. https://www.sec.gov/investor/pubs/sec-guide-to-mutual-funds.pdf
(5) See note 2. No exception applies, however, if the judge participates in management of these legal or equitable interests or the interest could be substantially affected by the outcome of a proceeding before the judge.