Should Federal Judges Be Barred From Trading Stocks?

The recently released findings of an investigation conducted by The Wall Street Journal concluded that more than 100 federal judges failed to recuse themselves in nearly 700 different lawsuits, despite the fact that they had a financial interest in the legal matter or matters before them.

In this segment of Backstage Pass, recorded on Oct. 15, Fool contributors Toby Bordelon, Rachel Warren, and Trevor Jennewine discuss whether federal judges should be allowed to trade on the stock market at all. 

Toby Bordelon: Let's move on to our third news story here. Federal judges, guys. Federal judges news today. Not just for their decisions or the content or their case opinions. They are in the news for potential insider trading. A few weeks ago, I actually read an article about judges who had failed to recuse themselves when they should have, because they held stock or a financial interest in companies that are litigants in front of them.

The general rule is if you have an investment and a company is litigating in front of you, you should recuse yourself to avoid any appearance of favoritism. It seems some of the judges forgot the rules or they don't understand them, they claim. But again, federal judges went to law school. I feel like if you went to law school, you should understand the rule, but that's me. But in some cases the system, they have these no computerized recusal and complexism just didn't work the way they were supposed to, it appears.

The judge may have actually put their holdings in and it didn't stand out that you need to recuse yourself from this case. For whatever reason there was a mismatch in the company name or something like that. But the news today [laughs] is that apparently some of these judges, not only did they not recuse themselves, they actively traded stocks of litigants while the case was ongoing. What do we think of this? What's the answer here?

Should we just have a blanket prohibition on stock ownership from judges generally? Or should we move in the direction, for instance, of more accurate and open disclosure for judges? Maybe other political figures like say members of Congress? Something else? What do you guys think? Let's start with you Rachel.

Rachel Warren: Yeah, this was a really interesting story to me. Sadly, this is not something new. I remember reading about, you'd hear of judges that are maybe involved in overseeing a case where a pharmaceutical company is being sued and then it turns out that they own shares of [laughs] the pharmaceutical company. Clearly, there's a bit of a conflict of interest there.

There's so many cases in the past of judges being involved in cases in which they had a direct financial interest. It's not right. The thing is, there's laws that are in place just to stop this type of thing. There has been this major Wall Street Journal investigation.

In one of their recent reportings they wrote, "Nothing bars judges from owning stocks. But federal law since 1974 has prohibited judges from hearing cases that involve a party in which they, their spouses or their minor children have a legal or equitable interest, however small."

There's actually embodied in the U.S. Code that says of all the different reasons why a federal judge should disqualify themselves from a case, one of which he knows that he individually or as a fiduciary, so maybe someone who controls money on behalf of someone else, or his spouse or minor child has a financial interest in the subject matter at points in the proceeding. The law is very, very clear on this. It brought me back to those early days of the pandemic where you were hearing about some of those members of Congress.

I think of that classified COVID briefing. Then suddenly they're selling certain stocks and buying stay-at-home stocks, you know not suspect at all. But I think the thing here is the law is very clear. If indeed this is what happened, this is completely wrong. But the other thing I think that also begs the bigger question is, some of these situations aren't the same across-the-board. There's this question of, I think that there should be tighter regulations governing disclosures and recusals for judges. But should these rules also take into account the extent of the individual's holdings or financial interests in a company?

For example, should the same rules apply for a judge that has one share of a stock which he coud easily divest, versus 100 shares of the stock? I think there needs to be better oversight and better reporting mechanisms in place than there are right now. I understand that some of the judges were saying there was issues with our conflict search screening software or blaming the law clerk, which is a favorite thing to do. [laughs]

Maybe, in fact, that happened in some cases. But I personally don't think that judges should be prohibited from trading on the stock market. I think that's one of the hallmarks to the free market economy.

But I do think there needs to be better regulation or at least better enforcement and oversight of the current laws that there are. I know some experts have suggested that one way that you could mitigate this issue would be to have where judges invest in mutual funds instead of individual stocks. I don't think it smells right.

I think that there definitely needs to be changes in the way that these types of issues are managed because clearly it's not an isolated incident. What do you guys think?

Toby Bordelon: You mentioned the mutual fund thing. I know for government workers, I used to live in DC, so I had a lot of friends who worked in government. When they participated in the government's version, basically 401K plan, they had mutual funds they can invest in. But you don't know what's in them. They're black boxes. That frustrated me. I remember my wife was working for an executive branch department.

I have no idea what's in here, what do I want to do with it? But that was for the logic. We have no idea what's in there, so it's not going to influence you. Those rules tend to be more for the lower-level employees; not for the political appointees, not for the judges, not for the Congress, not for the secretaries. It seems like the higher you are, the more leeway you have. Even though the higher you are, the more influence you have over what's going on.

Rachel Warren: True. [laughs]

Toby Bordelon: It's completely reverse. That is interesting. What do you think, Trevor?

Trevor Jennewine: I like the idea. I think they should be able to participate in the market. Like Rachel mentioned, I absolutely think there needs to be more oversight. I'm not sure who first broke this story, but I know that I started reading headlines like this in early September from The Wall Street Journal. They seemed like they had a new store every single day. I was just looking at an article they published on November 28. They dug back through about a decade's worth of data and they found 131 federal judges had violated the law.

It's not just a few people, 131 federal. They listed all the cases out. They violated the law. They notified all these judges. As of the date of the article, I think 56 of those judges had gone to the courts and said, hey, I shouldn't have heard this case. The implication is that 329 cases could now be opened back up again, so that's a mess. Not all of them were trading during the time, but they have this an infographic that shows each of the judges name. Then the size of the bubble on each name is based on how many times they did trade while they were hearing a relevant case. They called out about 10 of them pretty significantly.

There is about 10 that are way ahead of the rest of the pack, just making lots of trades. I understand that maybe there was a problem with some of the mechanisms they have in place. But at the end of the day, like you said, they're judges. They should probably understand how the rules work and it's concerning that it's such a widespread issue.

Toby Bordelon: Most judges are lawyers. I know that's not necessarily a requirement in every jurisdiction, but most judges are lawyers. You do spend three years in law school learning how to read regulations and part to write regulations in some instances, to interpret regulations. That's their whole job. It's an odd excuse to say, I didn't quite understand what this regulation meant. Well, then why I'm I trusting you to say interpret the Clean Water Act? [laughs]

Rachel Warren: You are right.

Toby Bordelon: There you go. I agree with you, I think they should participate. I don't like a blanket prohibition on stock ownership. That stems from my view that everyone in America, everybody should be stock owners. I think that would get us to a better place and I really do believe that. I would like to find ways to make it work like we do here at The Fool. All of us can own stocks, but we have restrictions, we have regulations, we have reporting obligations, we have disclosure obligations.

You can go to our profiles on Fool.com open it, all three of us, and see what we own. I would like to see something like that for judges, and for members of Congress I think it should be easy. I think I should be able to go to website and see, "What does my member of Congress own?" Like what are their interests, or if I'm litigitant, from a judge, where are this judge's stock holdings and do I need to make a motion to recuse them?

Maybe he doesn't to recuse himself, but if anyone is appearing before him, if through cases, "Hey, you own 500 shares of the company arguing against me, or 500,000 shares, even, I want you not to hear this case, because that's a problem." But if it was open and everyone knew it, then I think we'd have fewer of these issues. I don't know, I think that obviously there is an issue, obviously there is problem here, if the regulation are being followed. We need to think through this and do better with it.