The Office of Government Ethics (no, that is not an oxymoron) oversees public and confidential financial disclosures for the executive branch. It also administers the blind trust and certificate of divestiture programs for the executive branch. (The House Committee on Standards of Official Conduct monitor the U.S. House of Representatives and the Senate Select Committee on Ethics monitors Senators and Senate officers and employees.) With the upcoming election expect to hear more about these concepts.
In general, senior officers and employees aspiring to enter the executive branch are required to take actions to comply with ethics laws about conflicting financial interests and impartiality. In general, conflict of interest laws prohibit senior government officials from holding investments that could benefit from decisions they make. They may divest, seek an exemption, or put assets in a blind trust.
If Harry Wholesome is destined to become Secretary of Gadgets, and he holds a majority of the stock in Widgets, Inc., and Widgets is a major supplier to the Gadget Department; Harry would have a clear conflict of interest being a Cabinet member with the ability, in his new position, to throw business to Widgets. Harry must sell his Widget stock before taking office.
The situation is easily resolved if Harry sells his Widget stock. But what if he doesn't want to do that because he will have to pay a big capital gains tax? Congress feared that imposing the tax burden would prevent qualified and desirable candidates for seeking positions in the executive branch, so they enacted Section 1043 of the Internal Revenue Code which provides a way to avoid paying that tax. If you sell property at a gain according to a Certificate of Divestiture issued by the Office of Government Ethics (OGE) and purchase replacement property you can elect to defer part or all of the realized gain. Your basis in the replacement property is reduced by the amount of the gain. Permitted replacement property is any obligation of the United States or any open end diversified mutual fund approved by the OGE.
A Certificate of Divestiture is applied for through the ethics officer of the employee's particular agency. It must be issued before holdings are sold and will only be granted if the sale is required to comply with ethics requirements.
Take the example of Henry Paulson, former CEO of Goldman Sachs, who became Treasury Secretary under President George W. Bush. At the time of Paulson's nomination it was reported that he owned Goldman Sachs stock valued at $700 million. He applied for and received a Certificate of Divestiture and was able to diversify that huge holding and pay no capital gains tax. If he holds on to his investments until death, they will get a basis step-up to date of death value; and no one will ever pay income tax on all that gain. In Paulson's case, he hit the jackpot. Not only did he get that tax break, but he sold before the price of Goldman plummeted. The tax break was estimated to be a savings of $100 million in tax. Is that what made him take the job, to get the tax break?
Then there is Federal Reserve Chairman Alan Greenspan who divested all his holdings and put his cash into government bonds.
Another approach to satisfy the conflict of interest requirements is for the executive branch employee to place assets (including investment income) into a qualified trust. There are two types: a Qualified Blind Trust and a Qualified Diversified Trust. A blind trust is one in which the trustees have full discretion over the investment of the assets and the trust beneficiary has no knowledge of the holdings of the trust and no right to intervene in their handling. By turning over your assets to an independent trustee, any potential conflicts of interest are resolved because you are not involved in managing or having any say in the assets. The trust is considered "blind" because, through the trustee's sale of transferred assets and the purchase of new ones, the public officer is shielded from knowledge of the specific assets of the trust. No particular interest in the trust could act as an influence on the duties the officer performs for the government.
According to OGE an independent trustee cannot be affiliated with, associated with, related to or subject to the control or influence of anyone who has a beneficial interest in the trust. The trustee cannot be a current or former investment advisor, partner, accountant, attorney, or relative.
The trustee of the blind trust may apply for a Certificate of Divestiture to obtain the deferral of capital gains tax. Once in the blind trust, the funds must be invested in a diversified fund such as a stock mutual fund - or a portfolio of marketable securities so diversified that it does not pose a conflict of interest because no specific action can significantly affect the value of the whole portfolio.
