How Justices Could Avoid Conflicts Of Interest

The justices of the U.S. Supreme Court are exceptional individuals, but there are still many ways in which they are just like the rest of us.

One example: investing. Like most people, the justices by and large won’t benefit from picking individual stocks. The keys to successful long-term investing are proper diversification, an asset allocation that matches your goals and risk tolerance, and patience. A concentrated stock position rarely serves any of these three goals well.

Holding too much stock in one company, or even one industry, poses obvious risks. Most people’s portfolios are simply too small to support a mix of stocks that is properly diversified among companies, sectors and geographic regions. On top of that, the choice of what stocks to buy and which ones to sell leave investors at risk of being victimized by their own biases and emotions. Those biases also affect professional money managers, so hiring someone to pick stocks for you is not really a good solution.

Like most investors, Supreme Court justices would generally be best served by a portfolio composed mainly of mutual funds. But the justices have an extra incentive to favor mutual funds over individual stocks: Mutual funds almost never present conflicts of interest in cases that come before the court. Stocks, on the other hand, raise such questions all too often.

Bloomberg recently reported that Justice Samuel Alito recused himself from a case the court heard this term because he or his wife owns stock in Johnson Controls Inc., whose subsidiary is a party to the litigation. Justice Stephen Breyer, who did hear arguments in the same case, was unaware that his wife owned stock in the same company. Bloomberg reported that she sold her shares the following day, after a journalist inquired about the holding; Breyer, however, indicated that he plans to take part in the decision. (1) (Justices have personal discretion over when or whether it is appropriate to recuse themselves.)

No one wants conflicts of interest in the nation’s highest court. However, holding direct stock in large companies means it is generally a matter of when, not if, a justice will have to step away. Alito, Breyer and Chief Justice John Roberts, or their close family member, each owned shares in at least a dozen companies as of the end of 2014.

The recusals leave the court open to the possibility of a 4-4 split, and can potentially lead the court to reject appeals it might otherwise consider.

While judicial ethics experts debate the merits of permitting the justices to invest in stocks, the law continues to allow it. But the justices would avoid a lot of problems if they mainly stuck to mutual funds, which avoid nearly all conflict of interest issues by their nature. The STOCK Act, which became law in 2012 and regulates securities transactions by legislative and executive branch officials, explicitly exempts mutual funds from its immediate reporting requirements for just that reason.

The reasons mutual funds shield officials from conflict of interest charges are, by and large, the same reasons they are well-suited for most investors’ needs. A good mutual fund builds in diversification, and the investor does not exercise control over the fund’s overall financial interests. Both the public interest and the official’s ethical standing are insulated from the potential mess – or legal consequences – a conflict of interest can create.

Justices and officials can also consider the alternative of a blind trust. The trust is “blind” because the nominee grants total control of the assets in the trust to an independent trustee, who is not allowed to tell the nominee which assets the trust holds going forward. To avoid conflicts of interest legally, however, the public official must go one step further to ensure the blind trust is “qualified” by government standards. This means that the trustee must be truly independent, which usually means an institutional trustee such as a bank or financial service company. If the justice neither knew nor controlled the trust’s contents, at least in theory, he or she could still avoid conflicts of interest even if the trust held individual stocks.

But blind trusts are a far from perfect answer, especially if the justice already holds a large stock position that the trustee may not be willing or able to dispose promptly. At least the justice could not be accused of using information about the direction of a court case to inform a future trade, since trading would be out of the justice’s hands. Blind trusts are certainly better than nothing, and can work in circumstances where they are used carefully, but even then holding individual stocks is a lot of potential trouble for a relatively small potential reward.

When I was a journalist for The Associated Press, I felt similarly constrained about owning stock in entities I might cover, even though journalists are not legally subject to public disclosure laws. The idea of avoiding conflicts of interest, after all, extends past satisfying legal requirements into the realm of satisfying ethical concerns. So although I was young and had only a very modest investment portfolio at the time, I confined myself exclusively to mutual funds. I never had any cause to regret it. I doubt many people would.