Tribunal on Trial David Bosco
A Court in a Storm Aaron Kuriloff
To Have and Hold a Green Card Melissa Nann Burke
A Fix for Junkies Jay Dixit
Setback in Stone Collin Campbell
The Prudent Jurist By William H. Simon
A Wink and a Nod By Len Costa
A Wink and a Nod
A new scandal exposes the problem with blind trusts.
SENATE MAJORITY LEADER BILL FRIST expected to spend this past autumn concentrating on his anticipated run for president in 2008. Instead, he was distracted by allegations that he had recently engaged in improper financial dealings. It came to light in September that Frist had, back in June, directed trustees of his family's 13 blind trustswhich had a combined value of between $7 million and $35 millionto sell all the stock held in HCA, Inc., the publicly traded hospital company founded by his father and brother. Just days after the sale was completed, a disappointing earnings report sent the company's shares tumbling by about 9 percent. The timing of the sale was suspicious enough that the Justice Department and the Securities and Exchange Commission opened separate investigations to determine if Frist was guilty of insider trading.
With a blind trust, an official can temporarily transfer control of any assets that present him with a potential conflict between his dual interests as an investor and as a public servant. He signs over responsibility to an independent trustee, typically an attorney or a banker, who is supposed to exercise complete discretion over those assets. The official can set limited guidelines for how he wishes his assets to be managed, but all subsequent communications between the official and the trustee are, in theory at least, sharply curtailed. With the majority of blind trusts, the official is entitled to know only the most basic information about the trust, like changes in its total market value and the net income or loss it generates. Most transactions involving the trust are supposed to take place without the knowledge or consent of the official.
The logic behind the blind trust is straightforward: If a government official doesn't know the contents of his personal portfolio, his private interests won't compromise his public duties. Blind trusts are designed to strike a balance. Forcing a public servant to liquidate all assets that could lead him to have a conflict might impose a financial burden on him and, in general, might diminish enthusiasm for government service. Conversely, when there isn't a sell-off rule, it isn't always practical to require that an official recuse himself from any matter that could affect the performance of a financial asset he owns.
But Frist's situation was different. He received regular written updates from his trustees and was privy to detailed information about transactions in his accounts. It appears that his blind trusts weren't all that blind, and his case has cast a needed spotlight on how these legal instruments are used by United States officials.
IN TRUSTS, THE SPLIT OF OWNERSHIP between trustee and beneficiary is the key. The title of the trust is held by a trustee while the fruits of it go to a beneficiary. Legal ownership is separated from beneficial ownership. With a blind trust, the trustee, who is the legal owner under the trust, does not tell the beneficial owner, also known as the settlor (or, in plain English, as the once and future owner), what investments are made with the trust's assets or what investment steps are taken with them. The blind trust is descended from the very first trusts. During the Middle Ages, English common law developed a mechanism known as the "use." The idea was to allow Franciscan Friars, who had taken vows of poverty, to "use" property without holding title to it. The blind trust is an updated version of the "use," but serving the opposite purpose: It allows the beneficiary to hold property but not control it.
President Lyndon B. Johnson is generally credited with being the first elected U.S. official to execute a blind trust. When Johnson took office in 1963, concerns were raised about his family's ownership of KTBC, a radio and television station in Austin, Tex., that was the cornerstone of the family's wealth. Johnson's staff urged him to sell the station, but for sentimental and financial reasons the president and the first lady were reluctant to part with it. Lady Bird Johnson had bought KTBC in 1943, and the shares were in her name.
The task of finding a solution fell to Sheldon Cohen, then a 36-year-old tax partner at Arnold, Fortas & Porter, the law firm co-founded by Abe Fortas, a Johnson confidant. During the Kennedy Administration, Cohen had created the first ever blind trusts for several cabinet undersecretaries, including a State Department official who owned shares in Latin American business interests. For the Johnsons, Cohen devised a blind trust based on the standard grantor trust, under which the owner still owns the assets and can revoke the instrument at any time. In 1964, Johnson appointed Cohen commissioner of the Internal Revenue Service.
Under the terms of the trust document, Lady Bird Johnson temporarily transferred control of her shares of KTCB to two Texas lawyers who were old family friends. She gave the trustees complete discretion over the shares, including the right to sell them, though they didn't. (Cohen says that if there was any unstated agreement by the lawyers not to sell the shares, he wasn't aware of it.) The Johnsons kept direct control only of the family ranch, some additional property in Texas, and an undisclosed amount of tax-free municipal bonds.
LYNDON JOHNSON ESTABLISHED A PRECEDENT that his successors have generally followed. But it wasn't until 1978 and the passage of the Ethics in Government Act that blind trusts were formally introduced as an option for officials in the executive branch looking to sidestep potential conflicts of interest. The act said that trustees must be independent of the official and that assets transferred into the trust must be free of restrictions on their sale or transfer. It further stipulated that the official was to receive no information from the trustee, apart from quarterly updates on the cash value and net income or loss of the trust and any other data the official might need to complete his tax returns. To enforce these and other rules, the act created the Office of Government Ethics, now an independent federal agency.
Under House and Senate rules, members of Congress are permitted to set up blind trusts, and in addition to Frist, 17 senators and several members of the House now employ them. The Senate and the House use the same rules that govern executive branch blind trusts, but enforcement by an independent agency is not an optionthe Constitution grants Congress the sole authority to regulate itselfand Congress has never been very effective at applying its ethics rules to itself. This lack of vigilance seems to be at the heart of the Frist case.
Frist claims that his trusts were "totally blind," but there was definitely a seeing-eye component to them: It is now known that Frist received periodic updates from his trustees that appear to have gone well beyond what Senate rules permit. In a series of letters written to Frist between 2001 and 2005 and filed with the Senate Ethics Committee, the trustees informed him when HCA stock and other shares were purchased or sold on behalf of the trusts.
Frist says that he consulted with outside counsel and the Senate Ethics Committee staff before selling his HCA shares and that he committed no violation in disposing of them. He says that he acted in accordance with a rule that allows public officials to direct trustees to sell any assets in a blind trust that might create a conflict of interest as a result of a "subsequent assumption of duties." In offering this rationale, Frist was alluding to his possible presidential bid.
Because the election is three years away and Frist is hardly a shoo-in for the Republican nomination, let alone the presidency, it's not hard to question the logic of the senator's defense. But the larger point is that when the majority leader of the U.S. Senate is under investigation for possible insider trading via his blind trusts, it suggests that these instruments are not serving their stated purpose, at least not for members of Congress.
Many legal experts and good-government advocates still contend that blind trusts can be an effective safeguard against conflicts of interest; they point to the successful use of blind trusts in the executive branch and believe that, if Congress were to adopt the same culture of strict enforcement, abuses like those allegedly committed by Frist would be far less likely.
But among other legal ethicists and government watchdogs, there is growing concern that Congressional blind trusts are making worse the problem that they were meant to solve. On the classic theory that sunlight is the best disinfectant, these ethicists suggest that requiring public officials to fully disclose their financial assets could be a more effective way of rooting out potential conflicts of interest.
On one point, though, both sides agree: Blind trusts that aren't really blind represent the worst of all optionslimited public disclosure, ample room for abuse, and a legal stamp of approval.