Conflict of Interest Advice for the Real Estate Professional Public Official

by

Conflict of Interest Advice for the Real Estate Professional Public Official

By Roy Hanley and Teresa L. Highsmith*

I. INTRODUCTION

There is an old saying that goes something like this: "The appearance of impropriety often depends on whose ox is being gored." As public attorneys, we are regularly tasked to provide instant guidance when a public speaker raises concerns that a public official should recuse himself or herself on an issue because of an apparent conflict of interest. This concern arises frequently when the public official is also a real estate professional, which can add an extra layer of complexity to the conflict analysis.

Public officials who are also real estate professionals do indeed have a complicated existence under the ethical regulatory scheme in California which includes not only the Political Reform Act (PRA)1 and Fair Political Practices Commission (FPPC) regulations,2 but all their own real estate and broker licensing regulations.3 All public officials have a duty to make a good faith effort to assess whether their economic interests will experience a material financial effect pursuant to the monetary thresholds laid out in the PRA and FPPC regulations.4 Since public officials who are real estate professionals are often accused that their business interests in the community create a conflict prohibiting their participation in the decision at hand, such public officials should create a record of having made that analysis – preferably in consultation with the FPPC – prior to taking any action.

We know this works. Jerry Clay, Sr. served four terms as an Atascadero city council member. He was working as a real estate agent when first elected. His friend suggested that, before he even started serving his term, he check with the FPPC to make sure he understood the applicable rules. He wrote to the FPPC (on his own with no legal guidance) and in his words, tried to think of every situation that could happen or come up in his real estate business to get some advice on what the rules were. He received his general advice letter in response, kept it, studied it, and did his best to follow it.5 Eventually an accusation of illegal participation was made, and the FPPC investigator came to town for an interview. Mr. Clay brought the tattered, dog eared, highlighted and underlined general advice letter with him and at each question, defended his position based on the well-worn document. Instead of merely closing the investigation, the FPPC put his clearance in writing. He had been carrying his record of good faith determination with him for years.

The purpose of this article is to help public officials who are real estate professionals identify and understand what types of issues to think about so they can avoid participating in decisions when they may not legally do so. Such public officials should also develop a game plan in advance of participating in a decision, which may include seeking a general opinion from the FPPC, just as Mr. Clay did. The guidance of the agency’s attorney is not a "get out of jail free" card in the event that the FPPC later determines that a public official did in fact have a conflict of interest which should have precluded participation.6 Public attorneys have no legal authority to rule whether a public official has a conflict of interest requiring recusal – that determination is left to the FPPC. And while public attorneys may be asked to divine when participation will be legal, but appear improper so that abstention (rather than legally-required recusal) is in order anyway, such a decision is a political determination best made by the public official.

Fortunately, there are tools available for such public officials to use as guides for their conduct. First and foremost, a public official may seek both informal and formal advice from the FPPC without cost or penalty. The advice must be sought before, and not after participation or the FPPC will, at a minimum, decline the request and may even transfer the requesting party to enforcement. Whenever possible, a public official should seek formal advice. Formal advice takes longer – 21 working days, or more for good cause – but so long as the facts given to the FPPC are both accurate and complete, the formal advice can be relied upon by the requesting public official as a defense against an allegation by the FPPC that participation was in violation.7

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II. THE FPPC REGULATIONS AND THE NEW 4-STEP ANALYSIS

As a starting point, FPPC Regulation §18701.1 states that "Possession of a real estate. . . license, or any other professional license, without regard to the official’s business activity or likely business activity, does not in itself make a material financial effect on the official’s economic interest reasonably foreseeable." This regulation makes clear that possession of a real estate or broker license alone does not create an impermissible conflict under the FPPC regulations.8 As described in more detail below, a conflict of interest arises when the nature of the official’s actual or likely business activity makes a material financial effect, resulting from the potential decision, reasonably foreseeable. Each potential vote must be analyzed in light of the actual and likely business activities of the individual involved and the actual nature of the issues or project being considered.

If the public official believes that he or she has a potential conflict of interest, the official should consult the FPPC’s new 4-Step test:9

A. Step 1: "Is it reasonably foreseeable that the governmental decision will have a financial effect on any of the public official’s financial interests?"

Under Step 1, the official must first identify whether he or she has a "financial interest" which might be impacted by the governmental decision. FPPC Regulation 18700.1 provides a list of sources of income to brokers and agents to help identify any "financial interest." For a broker, such sources of income include the person the broker represents in the transaction, potentially the person represented by an agent, any brokerage business entity through which the broker conducts business and any person who receives a finder’s or other type of referral fee, or who makes a referral pursuant to a contract with the broker. For an agent, the sources of income include the brokerage business entity under which the agent works, the person the agent represents in the transaction, and similarly any person who receives a finder’s fee, etc., as for a broker.

Note that a source of income of $500 or more in the past 12 months is sufficient to disqualify a public official from participation in a decision impacting the source of that income. For the real estate professional, this rule would include a legally enforceable promise of a commission, even if that commission has not yet been received. This concept of a "promise of income" can be overlooked by real estate professionals and thus become a major trap door when they make these good faith determinations.10

Second, the public official must determine whether it is "reasonably foreseeable" that the decision could have a financial effect on his or her financial interest. Reasonable foreseeability does not require certainty nor even substantial likelihood, but it is also more than a mere possibility.11 The determination of when the likelihood is a mere possibility as opposed to reasonably foreseeable may be like Justice Stewart’s infamous definition of obscenity:12 the FPPC knows it when they see it, and someone in the public is going to see it even if they don’t actually know it. If you don’t get formal advice, have a written record of how you went about your good faith determinations before you voted.

Commissions and the opportunity for future personal income for real estate professionals becomes an issue in the analysis of what is "reasonably foreseeable" in the first test of our analysis. For real estate professionals, certain decisions just by their nature create the opportunity for future personal income. Large subdivisions, general plan amendments, road improvement projects, specific plans, sign ordinances and many other situations create the need to have a record of having made the good faith analysis before you participate. The FPPC’s non-exclusive list of elements to consider in determining whether or not a financial effect is reasonably foreseeable. These include13:

  1. "The extent to which the official or the official’s source of income has engaged, is engaged, or plans on engaging in business activity in the jurisdiction;
  2. The market share held by the official or the official’s source of income in the jurisdiction;
  3. The extent to which the official or the official’s source of income has competition for business in the jurisdiction;
  4. The scope of the governmental decision in question; and
  5. The extent to which the occurrence of the material financial effect is contingent upon intervening events, not including future governmental decisions by the official’s agency, or any other agency appointed by or subject to the budgetary control of the official’s agency."14

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If there is no reasonably foreseeable financial effect of the decision on your financial interest, the official may vote. If there is a reasonably foreseeable financial effect on a source of income to the public official, the official must proceed to Step 2.

B. Step 2: "Will the reasonably foreseeable financial effect be material?"

To make that "materiality" determination, the official should consult Regulation 18702, which identifies five different financial interests which may be impacted, and then further directs you to the different standards of "materiality" that apply to each of these five types of financial interests.15 The official should apply these rules to determine whether the decision will have a material effect on the official’s particular financial interest. If the answer is "no" to all of these, the official may vote. If the answer is "yes," to this question, the official must proceed to Step 3.

C. Step 3: "Can the public official demonstrate that the material financial effect on the public official’s financial interest is indistinguishable from its effect on the public generally?"

For Step 3, the official must be able to affirmatively prove that the impact of the decision on your financial interest is not unique compared to a significant segment of the public. Regulation 18703 gives the official explicit guidance on making that determination and a general rule of thumb is that if 25% or more of the businesses, persons or real property in the jurisdiction would be similarly impacted, then the answer to this test is "yes" and the official may vote. If the answer is "no," the official must proceed to Step 4.16

D. Step 4: "If after applying the three step analysis and determining the public official has a conflict of interest, absent an exception, he or she may not make, participate in making, or in any way attempt to use his or her official position to influence the governmental decision."

Step 4 reminds us that in addition to being prohibited from voting, the real estate professional must also avoid any participation in or use of the official position to merely influence the governmental decision. To see what you must avoid doing in addition to abstaining from voting, you are directed to Regulation 18704.

Of course, there are also two exceptions to be considered based upon facts and circumstances: legally required participation17 and the so-called "rule of necessity,"18 and proper segmentation of a decision.19 While neither of these two exceptions is within the scope of this article, we note that the instances when legal participation would be required are very limited.20 We also note that there are many instances in which segmentation has been successfully used to allow participation on parts of a decision, but recommend that this exception be well thought out and researched ahead of time.

Importantly, these conflict of interest determinations are very fact specific, both as to the decision in question as well as to the nature of the financial interest. While it is impossible to cover all the variables in one article, the following are examples of advice real estate professionals have sought from the FPPC over the years:

  • Is the development such a major development that its impacts are material even though the project is 1.3 miles away from you or your financial interest?21
  • Are you in a small jurisdiction? Be careful in reading past opinions based upon a small jurisdiction analysis. That regulation has been repealed22 A real estate agent that works part-time and has an extremely small chance of representing someone who might buy a new house in a subdivision might be able to participate in approving that subdivision or other decisions involving it, such as creating an assessment district, even though there is some "mere possibility" that this could occur in the future.23 By contrast, an agent with a large share of the residential market might not be able to participate even if they serve on the same city council and have the exact same license.
  • Will an update of a housing element increase the number of units for sale and potentially affect your income?24
  • Will a vote on impact fees affect your income or a source of income?25
  • Does one of your clients want to participate in a first time homeowner buyer program your city is setting up?26
  • May you vote on regulations concerning the type and manner of all signs, including real estate signs?27
  • May you vote on whether or not to adopt conceptual plans?28
  • May you vote on whether or not to conduct an environmental study even if you should not vote on whether or not to construct the improvements themselves?29

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As demonstrated by the foregoing list, there are many formal letters of advice given by the FPPC to real estate professionals over the years. Although most of those involved the use of the former 8-point test, the change to a 4-Step test was not made for reasons substantive to the rules and regulations, but to make the test more understandable and user friendly. Again, public officials are cautioned that FPPC advice given to one public official is only a defense for the official who requested and received the letter. While these letters do not have that type of legal precedence, they are a great source to remind public officials what they need to think about, and a great guide for identifying what type of information the public official has to collect and present to the FPPC to get effective formal advice.30

III. CONCLUSION

Like Mr. Clay, real estate professionals who are public officials should prepare a written request for a general advice letter from the FPPC, explaining the parameters of their real estate practice and posing some of the hypothetical decisions they may be asked to make as discussed in this article. If it is not possible to get a formal FPPC opinion prior to a specific decision, public officials should remember that they cannot get into trouble with the FPPC for abstaining when their participation is not legally required.31

*Roy Hanley is an attorney with Hanley and Fleishman LLP. The firm is city attorney for the cities of Solvang, Pismo Beach and Guadalupe.

*Terri Highsmith is a shareholder in the law firm of Colantuono, Highsmith & Whatley, P.C., and serves as City Attorney to the cities of Barstow, Sierra Madre and South Pasadena, and provides labor and employment advice to several cities in Northern and South California.

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Notes:

1. Gov. Code §§ 81000-91015.

2. 2 Cal Code of Regs. §§ 18110-18997.

3. Bus. & Prof. Code §§ 10000-11288 and 2 Cal Code of Regs. title 10. See also California Bureau of Real Estate website, dre.ca.gov.

4. Luna Advice Letter July 11, 2006 FPPC File No. I-06-112

5. FPPC Advice Ltr. No. I-96-335.

6. The State Bar, in Cal. Eth. Op. 2001-156 has applied California Professional Rules of Conduct to city attorneys as follows: As public agency attorneys, we do not represent public officials as individuals. We are often called upon to give some guidance in these areas, but must always caution officials to seek their own counsel and remind them that our advice is not a defense in legal proceedings if those that do have the power to make rulings disagree with our advice.

7. The defense is very personal to the public official making the request. While it is both wise and instructive to review FPPC formal opinions to other public officials made in the past, one public official cannot use a formal letter written to another public official as a defense. It is better to use the prior advice as a guide for the type of information to document for the FPPC in your own request.

8. As stated, this article does not address any real estate broker and licensing regulations. For attorneys, some consideration must be given to State Bar Ethics Formal Opinion No. 1981-63 which says that a lawyer serving as a city council member has an ethical duty to avoid the appearance of impropriety.

9. 2 Cal Code of Regs. § 18700(d).

10. 2 Cal Code of Regs. § 18701.1(a)(1).

11. Luna Advice Letter July 11,2006 cited above in endnote 3.

12. Jacobellis v. State of Ohio (1964) 378 U.S. 184, 197 (J. Stewart concurring).

13. 2 Cal Code of Regs. § 18706; Norton Advice Letter June 15 2012.

14. Id.

15. The five types of financial interests are: interest as a business entity (§ 18702.1); real property (§ 18702.2); source of income (§ 18702.3); source of gifts (§ 18702.4); and personal finances (§ 18702.5).

16. Note that in small jurisdictions there used to be a separate test to apply to determine if you can demonstrate that the effect on the official’s interest is indistinguishable from its effect on the general public if the source of conflict is the personal residence of the official. Cal Code of Regs § 18707.10, repealed. While opinions citing this former regulation might be instructive for other purposes, there no longer exists this different test in regards to small jurisdictions.

17. Gov. Code § 87101.

18. 2 Cal Code of Regs. §18705 (subpart (e) of the basic rule).

19. 2 Cal Code of Regs. §18706 (subpart (f) of the basic rule).

20. One common example is where enough members of the board have a conflict such that it is permissible to qualify enough members to form a quorum.

21. FPPC Advice Ltr. No. A-15-185, October 13, 2015, advising that the answer was yes, and there was a conflict.

22. The small jurisdiction regulation was repealed effective June of 2015.

23. FPPC Advice Ltr No. I-06-112, July 11, 2006, advising a mere possibility and participation is legal.

24. FPPC Advice Ltr A-02-076, August 22, 2002, advising Planning Commissioner Debra Giordano that it was permissible as her firm was a small two person firm and had a 3% share of the residential market.

25. See FPPC Advice Ltr A-05-222, December 29, 2005, advising City Councilmember Becky Hill that participation was permissible.

26. FPPC Advice Ltr I-13-060, June 27, 2013, advising Steven Mecum in Lindsay, that participation was permissible.

27. See FPPC Advice Ltr A-05-091, June 8, 2005, advising two members of the City Council in Milpitas that participation was permissible.

28. See FPPC Advice Ltr I-15-175, September 25, 2015, advising the particular council member participation that was permissible.

29. See FPPC Advice Ltr A-04-104, June 7, 2004, advising a member of the Lokeford Community Services District that participation at the study level was permissible.

30. See FPPC Informal Assistance File No. I-13-099, August 16, 2013 as an example of a general advice letter that can serve as an example for how to pose questions to the FPPC.

31. Gov. Code § 1090 et seq. forbids public officials from entering into contracts with their entity. It is beyond the scope of this article. For more information regarding § 1090, see Shawn Mason, FPPC Update for the League of California Cities (Oct. 1, 2015) for the six part test the FPPC uses to make determinations on the application of §1090 and Roy Hanley, Government Code § 1090 – When No Really Means No, 34 Pub. LJ 4 (Fall 2012).