California Fair Political Practices Commission
M E M O R A N D U M
To: Chairman and Commissioners
From: Luisa Menchaca, Assistant General Counsel
John
Vergelli, Staff Counsel, Legal Division
Re: Pre-notice discussion of possible amendments to Regulation 18704.2 and Regulations 18705.2 (Conflicts project phase 2, project 'D').
Date: January 24, 2000
I. Introduction
This project looks at the Commission's rules for deciding whether the reasonably foreseeable financial effects of a governmental decision on real property in which a public official has an economic interest are material. (Regulation 18705.2.) The Commission's rules for deciding whether real property in which a public official has an economic interest is directly or indirectly involved in the governmental decision (Regulation 18704.2) are also discussed because some of the possible "fixes" to the materiality standards involve the interrelationship of the materiality standards to the rules about degree of involvement.
The remainder of this introduction explains the current state of the law, and how it came to be the way it is. Part II of the memo examines a proposal submitted by Rene Auguste Chouteau, the Santa Rosa City Attorney. (His letter to the Commission is included in Appendix A.) Part III examines other ideas for improving this regulation. Part IV has recommendations.
Legal background, and where this work fits in the "eight-step process."
Under the Political Reform Act ("Act"), a public official has a conflict of interest in a governmental decision if it is reasonably foreseeable that the decision will have a material financial effect on one (or more) of his or her economic interests (unless the public generally exception applies). (Section 87103.) The current materiality rules are in the 18705 series of regulations.(1)
"Material" means "important." (Black's Law Dict., 5th ed. 1979, p. 880, col. 2.) Regulation 18705.2 sets out the materiality standards for real property in which a public official has an economic interest. These materiality standards are the answers to the question, "how much of a financial effect on a given parcel of real property is important enough to trigger a conflict?" Pursuant to Section 87103, the regulation measures the materiality of the financial effect on the real property, not on the public official himself or herself, or on the value of the public official's investment in the real property.
The materiality standards are step five in the standard analysis adopted by the Commission in phase 1 of the Conflicts Project. (See Regulations 18700(b), 18700(b)(5).) A person applying these materiality standards will have already done the following analysis:
Step One: Decided that the individual who might have a conflict is a public official and, thus, subject to the conflicts rules in the first place. (Regulations 18700(b)(1), 18701.)
Step Two: Decided that the public official who might have a conflict will be making, participating in making, or influencing a governmental decision and, thus, engaging in the kind of conduct regulated by the conflicts rules. (Regulations 18700(b)(2), 18702 et seq.)
Step Three: Decided that the public official who might have a conflict has an economic interest in real property and, thus, has one of the types of interests that can give rise to a conflict under the Act. (Regulations 18700(b)(3), 18703.2.)
Step Four: Decided whether the real property in which the public official has an economic interest is directly or indirectly involved in the governmental decision the public official would be making, participating in making, or influencing. (Regulations 18700(b)(4), 18704.2.)
Having thus arrived at step 5, there is currently one materiality standard that applies when real property is directly involved (2) in a governmental decision: In such a case, any reasonably foreseeable financial effect from the decision is deemed material. (Regulation 18705.2(a); this is sometimes called a "one-penny" rule, since even a penny's worth of reasonably foreseeable financial effect is material.)
When the real property is indirectly involved, subdivision (b) of the current regulation applies. The premise underlying subdivision (b) is straightforward: The farther the public official's real property is from the real property which is the subject of the governmental decision, the less likely that the financial effect of that decision on the public official's real property will be material. Unfortunately, the implementation of that straightforward premise has proven to be somewhat complex.
The drafters of current subdivision (b) created three zones around the real property which is the subject of the governmental decision, and also created a materiality standard for each zone. Which materiality standard applies to the real property in which a public official has an economic interest depends on which zone it falls into.
The inner zone might be called the "very close" zone. The drafters reasoned that if the real property in which the public official has an economic interest is "very close" to the real property which is the subject of the governmental decision, then one can almost presume that the governmental decision will have a material financial effect on the public official's real property. So, the drafters assigned a very stringent materiality standard to the "very close" zone: the effect of a decision is deemed material, "unless the decision will have no financial effect upon the official's real property." (Regulation 18705.2(b)(1)(A).) This is another version of the "one-penny rule." (See parts III.A and III.B, below.) The drafters chose 300 feet as the outer boundary of the "very close" zone, borrowing that figure from other state law.(3)
The outer zone might be called the "probably-far-enough-away" zone. The drafters reasoned that as the distance from the real property which is the subject of the decision to the public official's real property increases, at some point, the public official's real property is far enough way to presume that a material financial effect is not likely. The drafters picked one-half mile as a radius to describe the inner boundary of this "probably-far-enough-away" zone, and rounded this figure to 2,500 feet.
The drafters factored the "public generally exception" concept into their reasoning: As distance from the real property which is the subject of the decision to the public official's real property increases, there are likely to be more and more properties similarly financially affected by the decision.
Under Regulation 18705.2(b)(2), if the real property in which a public official has an economic interest is more than 2,500 feet from the real property which is the subject of the decision, the financial effect of the decision on the public official's real property is considered material only if two conditions are met:
(1) There are "specific circumstances" indicating a reasonably foreseeable material financial effect using the materiality standards from the "middle zone" rule (see below); and
(2) "The [financial] effect will not be substantially the same as the effect upon at least 25 percent of all the properties which are within a 2,500 foot radius of" the public official's real property or there are not at least 10 properties under separate ownership within a 2,500 foot radius of the public official's real property.
Between the "very close" zone and the "probably-far-enough-away" zone, Regulation 18705.2(b) creates a "middle zone" (300 feet to 2,500 feet, Regulation 18705.2(b)(1)(C)). In this "middle zone," the drafters reasoned that no presumptions were supportable because of the wide variety of possible governmental decisions, of real property interests, and of interrelationships of the decisions and properties. In the scheme of subdivision (b), the public officials must "confront the analysis" if their real property is located in the "middle zone."(4)
The analysis which must be confronted is this: the public official must decide if it is reasonably foreseeable that the governmental decision will increase or decrease the fair market value of the real property in which he or she has an economic interest by $10,000 or more, or increase or decrease its rental value of the real property by $1,000 or more per 12-month period. (Regulation 18705.2(b)(1)(C).)
It is this "middle-zone" analysis which has created the most problems and controversy over the years--indeed, City Attorney Chouteau (and others) would have you simply abandon it. (See part II, below.)
Regulation 18705.2(b) creates one other materiality standard, one which does not depend on the distance from the public official's real property to the real property which is the subject of the decision. If the "decision involves construction of, or improvements to, streets, water, sewers, storm drainage, or similar facilities, and the real property in which the official will receive new of substantially improved services," then the financial effects of the decision are deemed material. (Regulation 18705.2(b)(1)(B).)
II. City Attorney Chouteau's proposal
City Attorney Chouteau begins by noting that the "circumstance most often encountered by my office is a request by a Council member for advice regarding a project which would be constructed within 2,500 feet of the Council member's personal residence." He explains that hiring an appraiser to conduct the middle zone analysis (see part I, above) is expensive, protracted, and ultimately unreliable.
In his own words, City Attorney Chouteau thus proposes,
"... elimination of the subsection (b)(1)(C) [of Regulation 18705.2], which requires the public official to initial an appraisal process if the project lies between 300 feet and 2,500 feet from his or her property."
He goes on to contend,
"I submit that as a matter of practical application, if projects are within 300 feet of a person's property, there is at least an argument that a particular project will affect the value of the real property in some way. As to projects lying further than 300 feet from a particular piece of property, any effect on the property is highly speculative, and to the average citizen, even the appearance of conflict is not readily apparent."
Although it is not entirely clear from City Attorney Chouteau's original submission, subsequent discussions with other representatives of the regulated community indicate that the proposal contemplates that the current "probably-far-enough-away rule" (Regulation 18705.2(b)(2)) would apply at 300 feet and further.
Several aspects of City Attorney Chouteau's proposal deserve attention. First, his assertion that the "middle zone" analysis (the 300 feet to 2,500 feet rule of Regulation 18705.2(b)(1)(C)) is the most pressing issue in this area seems to be correct. Perhaps the most often-disqualifying economic interests for public officials are their personal residences, an economic interest in real property under the Act. Of course, this observation is not necessarily an indication that there is a "problem" with the law, because personal residences are probably the most widely held economic interest of public officials. However, it clearly points out the need to do the best we can with this regulation.
Second, City Attorney Chouteau asserts, without qualification, that the regulations "require" an appraisal when the public official's real property is in the middle zone. This is not, as a matter of law, correct. The regulation does not, and has never, required an appraisal.
What is true is that many, if not most, public officials and their counsel, feel that they have no choice but to have an appraisal if they are in the "middle zone." At the risk of oversimplifying a long, complex evolution, the following seems to have happened. At some point, a public official faced with the "middle zone" analysis sought advice from the Commission, asking if it would help to have an appraisal. The Commission staff advised that it would. Other public officials read this advice, and similarly sought appraisals. At some point, the Commission staff advised that an appraisal cited in an advice request wasn't adequate because it failed to consider a certain factor. Similar advice followed about other factors in appraisals. The accumulation of this advice about appraisals, combined with the unquestionable difficulty of predicting financial effects in the real world and the inevitable political consequences of allegations of conflicts from opponents, has led cautious public officials to perceive that appraisals are a de facto requirement if their real property economic interest falls in the middle zone.
Clearly, this result was not what the Commission intended when it passed Regulation 18705.2(b)(1)(C). The intent was to establish a financial benchmark, to which the public official could look while asking, "is it reasonably foreseeable that the financial effect of this governmental decision will be above or below the benchmark?" It was never intended that the public official be required to reduce the substantially likely financial effect of a governmental decision to a dollar certain, or even to estimate it's ultimate effect in dollars--only to estimate whether the ultimate effect was substantially likely to be over or under the $10,000 line.
Third, City Attorney Chouteau contends that the financial effects of a governmental decision on real property more than 300 feet from the property which is the subject of the decision are "highly speculative," and do not create even the appearance of a conflict of interest to the average citizen.
Reasonable minds can disagree easily with this assertion. Three hundred feet to 2,500 feet is not that great a distance, easily within line-of-sight for most properties. Real property economic interests tend to be relatively valuable (e.g., a typical public official's home is his or her most significant asset), so people tend to care greatly about what happens nearby. One may easily list a number of typical land uses which if approved within 2,500 feet of real property may have a profound impact on the real property's values: roads, half-way houses, adult-oriented businesses near other businesses, high-density housing near single-family residences, industrial or commercial uses near residential uses, etc. It is fair to say that many will disagree with the assertion that the financial effects of governmental decisions on properties 300 feet to 2,500 feet away are "highly speculative" as a rule.
III. Other ideas for improving Regulation 18705.2
A. Clarifying the multiple, arguably inconsistent, expressions of the "one-penny rule" in the regulation.
As explained above, the "any financial effect" standard in Regulation 18705.2(a), which applies to real property economic interests which are directly involved in a governmental decision, is referred to as the "one-penny rule." Unfortunately, there are actually three "one-penny rules" in the regulation, all of which are worded slightly differently. One way to simplify this regulation would be resolve this situation.
When real property in which a public official has an economic interest is directly involved in a governmental decision (see Regulation 18704.2(a)), the "one-penny" rule is expressed like this:
"Any reasonably foreseeable financial effect on real property in which a public official has an economic interest, and which real property is directly involved in a decision before the official's agency, is deemed material." (Regulation 18705.2(a).)
The "one-penny rule" for indirectly involved real property within 300 feet of the property which is the subject of the governmental decision provides,
"The effect of a decision is material as to real property ... if ... [] The real property in which the public official has an interest, or any part of that real property, is located within a 300 foot radius of the boundaries (or the proposed boundaries) of the property which is the subject of the decision, unless the decision will have no financial effect upon the official's real property interest." (Regulation 18705.2(b)(1)(A), emphasis added.)
Finally, there is the "one-penny rule" for governmental decisions involving improvements such as streets, lights, and sewers:
""The effect of a decision is material as to real property ... if any of the following applies: [] The decision involves the construction of, or improvements to, streets, water, sewer, storm drainage or similar facilities, and the real property in which the official has an interest will receive new or substantially improved services." (Regulation 18705.2(b)(1)(B).)
It is possible to simplify this regulation by changing the way we look at two of these three "one-penny" rules. We already look at real property which is in the "very close" zone (Regulation 18705.2(b)(1)(A)) or which receives new or improved streets, water, sewers, etc. (Regulation 18705.2(b)(1)(B)), respectively, as being the equivalent of real property directly involved in the decision in that real property in those two circumstances already get essentially the same materiality standard as directly involved real properties (i.e., some variation of the "one-penny rule").(5) In this light, these two provisions are already alternative tests for directly involvement of real property in a governmental decision, even though they are located in the materiality standard regulation (step 5), not the degree of involvement regulation (step 4). Given that we already equate those two circumstances with direct involvement, moving the provisions to the degree of involvement regulation for real property economic interests begins to make sense.
In the jargon of the eight-step process, it means moving these two provisions from step 5 to step 4. Option 1 moves current Regulation 18705.2(b)(1)(A) to Regulation 18704.2(a); while option 2 moves Regulation 18705.2(b)(1)(B) to a new subdivision (a)(5) in Regulation 18704.2 (the existing subdivision (a)(5) would be renumbered (a)(6)). The Commission may adopt one of the options without the others.
Whether or not the Commission endorses option 2, the Enforcement Division has proposed to remove the words "or substantially" from the streets, water, sewer, etc. rule. (This is option 2-A in the draft regulation.) Enforcement contends that the adverb makes the rule hard to enforce. That is, they must now prove not just "improved services" to the public official's real property, but "substantially improved services."
Pros. The most significant advantage of options 1 and 2 is simplification. Although to some the proposal will look like a "shell game," merely shuffling the provisions around, there are good reasons to make this change.
First, as already explained, the two affected provisions look more like rules about direct involvement than they look like tests for materiality anyway. Many people think they are already. (See footnote 5, above.) Thus, this change will make the rules a little bit more intuitive.
This is especially true about moving the "streets, water, sewer" rule to step 4 (option 2). If one reads the streets, water, sewer, etc. rule carefully, what it is really saying is that real property which fits its description is directly involved in the decision. The rule (Regulation 18705.2(b)(1)(B)) does not even mention "financial effect," as in measuring the materiality of financial effect.
Second, the move would decrease the number of materiality standards in Regulation 18705.2 from five to three.
The most important benefit of this proposal is that there would be a single expression of the "one-penny rule" for real property economic interests, which would apply when the real property is directly involved--period. (Proposed Regulation 18705.2(a).) The Commission may then modify that rule as it sees fit. (For suggestions for what that single expression of the rule would look like, see part III.B., below.) If the provisions in subdivisions (b)(1)(A) and (b)(1)(B) are moved to step 4, as tests for direct involvement, we need only one expression of the direct involvement materiality standard (i.e., Regulation 18705.2(a)).
As to option 2-a, endorsing Enforcement's proposal would make the rule more of a "brightline" test. Also, this would make the rule "tougher," which is appropriate when a public official is taking a role in a governmental decision which affects his or her own real property (i.e., by providing new or improved streets, lights, sewer, etc., services to the real property).
Cons. Choosing option 1 passes up the opportunity to distinguish between those cases where a public official's real property is itself the subject of the governmental decision and those cases where the property is merely "very close." To some minds, this distinction should be made because the former cases appear to create such a clear conflict. (Note that this criticism applies not just to option 1 in the current proposal, but also to the current state of the regulations--because we presently apply an essentially similar materiality standard to both situations already (i.e., some variation of the "one-penny" rule). (Regulation 18705.2(a) cf. Regulation 18705.2(b)(1)(A).)
Option 2-a has the disadvantage of removing flexibility from the rule. Although adverbs like "substantially" can be criticized as creating too much "wiggle room," they can also be useful safegaurds against absurd results where there is technically "new or improved service" but the upgrade is negligible.
B. Clarifying the materiality standard for directly involved real property.
The history of the Commission's rules about directly involved economic interests indicates the intent was to create presumptions of materiality. The concept of "directly involved" economic interests was added to the regulations in 1985. They were added as part of a comprehensive effort by the Commission to address problems created by earlier conflicts rules which used "subjective" or "loose" materiality standards such as a "freedom from bias" standard and a "significant" financial effect standard. (See Staff Memorandum, July 2, 1985, Re: "2 Cal. Adm. Code Section 18702.1.") The Commission wanted "more objective" monetary standards, but they also wanted simple rules which did not necessarily rely on any kind of financial analysis. This is where the "directly involved" concept came in:
"The proposed regulation ... deals [with the] most 'obvious' or 'direct' conflicts of interest. It covers situations which most everyone agrees present a potential for 'bias,' in which the types of decisions are clearly 'significant,' or in which the entities or individuals affected have, by the nature of participation in the proceedings, shown that they consider the decision to be significant. [] The [proposed regulation] would require disqualification in the following situations: ...." (Ibid.; emphasis added.)
The 1985 staff memorandum to the Commissioners went on to explain situations now familiar as the substance of the rules for deciding when the various types of economic interests are directly involved in governmental decisions. (See Regulations 18704.1(a), 18704.2(a), 18704.3(a), and 18704.4(a).)
In 1988, the Commission revisited the materiality standards again. A July 14, 1988 staff memorandum to the Commissioners included this explanation:
"The specific rules [i.e., the materiality standards] are divided into two groups. The first applies whenever the official's economic interest is directly involved in the decision. Those circumstances dictate disqualification unless it can be shown that there is no financial effect on the official's economic interest which reasonably could result from the decision." (Staff Memorandum, July 14, 1988, Re: "Adoption of Proposed Materiality Regulations;" emphasis added.)
The excerpts from these staff memoranda indicate that the Commission, even though they did not use the word "presumption," was creating presumptions of materiality in these "direct involvement" situations. The purpose behind the direct involvement rules is to allow determinations of materiality to be made without resort to financial analysis where the factual circumstances of the governmental decision and the public official's economic interests almost self-evidently indicate materiality.
While this seems clear, it is also clear that these presumptions are not irrebutable or conclusive. The 1985 staff memo went on to explain that "[d]isqualification is not required when a decision will not have any financial effect on the official, or on the official's interests." This notion is captured in current Regulation 18705(c)(2).(6)
The draft regulation in Appendix B has language (Option 3) which will make it clear that the materiality standard creates a presumption of materiality when real property is directly involved in a governmental decision.
If the Commission makes this clarification, the next question is what the public official must show to rebut the presumption. Option 3-a would implement the "any financial effect" materiality standard currently found in Regulation 18705.2(a). That is, if option 3 and 3-a are adopted, to rebut the presumption of materiality a public official must show that he or she did not know, or have reason to know, that the governmental decision would have any financial effect on his or her real property.
Option 3-b would implement the presumption with a de minimis financial effect standard. That is, if options 3 and 3-b are adopted, to rebut the presumption of materiality a public official must show that he or she did not know, or have reason to know, that the governmental decision would have more than a de minimis financial effect on his or her real property. "De minimis" would be defined as a dollar figure impact on fair market value or fair market rental value. (The notion of a de minimis financial effect materiality standard, which has been suggested by the regulated community, is explored more completely in part III.C, below.)
C. Should the directly involved materiality standard be increased from "any financial effect" to a higher figure?(7)
It has been suggested that the current "any financial effect" materiality standard for directly involved real property is impractically and unreasonably low. This argument takes the following form: The statute (Section 87103) provides there is a conflict only if there is a reasonably foreseeable material financial effect on the real property in which a public official has an economic interest. If the regulations trigger conflicts in situations where the reasonably foreseeable financial effect is immaterial to such real property, then the regulations are not true to the statute, and lead to unnecessary disqualifications of public officials.
Instead, it has been suggested that the Commission replace the "any financial effect" standard with a de minimis financial effect standard. That is, a financial effect would be deemed material if it was more than a de minimis financial effect on the value of the real property. The proponents of this higher standard argue that it would eliminate arguably absurd results such as disqualification where the reasonably foreseeable financial effect of a governmental decision is only tens or hundreds of dollars on a property worth hundreds of thousands of dollars.
The draft revision in Appendix B has optional language which would implement this de minimis financial effect standard for directly involved real property economic interests, either with the clarifying language about presumptions (option 3-b) or without the new language about presumptions (option 4). The alternative implementations both use the approach already taken in the regulation for indirectly involved real property located farther than 300 feet but less than 2,500 feet from the property which is the subject of the governmental decision by focusing on the impact on fair market value and fair market rental value. (See part III.D., below.)
Unfortunately, the proponents of this change have not come forward with a new dollar figure to express this de minimis financial effect standard. One possibility is a figure like one thousand dollars, a round number which arguably captures the basic idea: anything less than one thousand dollars we're not going to worry about.
A change from the "any financial effect" standard to a de minimis financial standard is strongly opposed by the Enforcement Division. Enforcement contends that this proposed materiality standard would be significantly harder to enforce than the current standard.
The Commission, of course, always also has the option of maintaining the present "any financial effect" materiality standard. To do so, the Commission would reject options 3 and 4, and direct the Legal Division staff to bring back the language in the current regulation for the adoption meeting on this project.
Should the dollar thresholds in the materiality standard for real property in the "middle zone" be increased?
Assuming that City Attorney Chouteau's proposal to eliminate the "middle zone" materiality standard (Regulation 18705.2(b)(1)(C)) is not accepted (see part II, above), the question of the dollar figures in the current "middle zone" materiality standard arises.
As explained above, if the real property in which the public official has an economic interest is indirectly involved in the governmental decision, and is more than 300 feet, but less than 2,500 feet from the property which is the subject of the governmental decision, then the materiality standard is a two-part test: (1) increase or decrease in the fair market value of the real property by $10,000 or more, or (2) increase or decrease its rental value of the real property by $1,000 or more per 12-month period. (Regulation 18705.2(b)(1)(C)(i), (ii).)
The intent behind these standards was to establish a financial benchmark, to which the public official could look while asking, "is it reasonably foreseeable that the financial effect of this governmental decision will be above or below the benchmark?" It was never intended that the public official be required to reduce the substantially likely financial effect of a government decision to a dollar certain, or even to estimate its ultimate effect in dollars--only to estimate whether the ultimate effect was substantially likely to be over or under the $10,000 line.
The $10,000 and $1,000 thresholds were adopted by the Commission in 1985. Since then, there has been a dramatic change in the real property markets in California, especially the residential market. (The latter consideration is particularly relevant since so many public officials have homes which constitute economic interests in real property.) It has been suggested that the thresholds in the regulation are simply too low given these changes in the valuations of real property in the past fifteen years.
Options 5-a and 5-b would increase the materiality standards for indirectly involved real property in the "middle zone."
If the Commission endorses the general proposition that the thresholds should be increased, the next question is increased to what? Again, the proponents of this idea in the regulated community have not suggested a new figure.
There is a good argument for a generous increase. First, as explained above, there has been a significant increase in property valuations since 1985.
Second, a relatively generous increase could work to move application of the rule back towards the mode of application contemplated by the Commission when it was adopted. As explained above, the original idea was to draw a line, to which the public official could look while asking, "is it reasonably foreseeable that the financial effect of this governmental decision will be above or below the line?" The kinds of formulaic, detailed inquiries, including appraisals, which seem to be the norm, were never contemplated. By doubling or even tripling the current figures, and making an emphatic policy statement about how this rule is supposed to be applied, the Commission can mitigate some of this damage. If the materiality standard were, for example, a $30,000 increase or decrease in the fair market value of the real property, rather than the current $10,000, a public official (and enforcing authorities) should be more comfortable making the estimation that the regulation contemplates.
Should the rule for leaseholds be clarified?
A public official may have an economic interest in real property by leasing, as well as owning the real property. (Section 82033.(8)) When it comes to deciding whether real property in which a public official has an economic interest because of a lease is directly or indirectly involved in a governmental decision, the regulations are perceived as ambiguous.
The problem flows from the following language in Regulation 18704.2:(9)
"(a) An interest in real property is directly involved in a governmental decision under the following circumstances:
"(1) The decision involves the zoning or rezoning, annexation or deannexation, sale, purchase, or lease, or inclusion in or exclusion from any city, county, district or other local governmental subdivision, of real property in which the official has a direct or indirect interest (other than a leasehold interest) of $1,000 or more, or a similar decision affecting such property;" (Regulation 18704.2 (emphasis added).)
There are more subdivisions under subdivision (a) in Regulation 18704.2, but there are no other explicit exclusions of leasehold interests. Given that the exclusion for leaseholds is in the first subdivision, there is a question as to whether the exclusion from the direct involvement test for real property interests applies only to (a)(1), or also to (a)(2) - (a)(5).(10)
Here's the difference the question makes: If the exclusion for leasehold interests applies only to subdivision (a)(1), then leasehold interests may be directly involved in governmental decisions under (a)(2)-(a)(4). On the other hand, if the exclusion for leaseholds applies to all of subdivision (a), not just subdivision (a)(1), then leaseholds are never to be considered directly involved in a governmental decision.
The ambiguity apparently arises from 1988 amendments to this regulation.(11) Prior to the 1988 amendments, the language in subdivision (a)(1) constituted the entire subdivision. This language expressly excluded leasehold interests from its scope. In 1988, subdivisions (a)(2)-(a)(5) were added to the regulation. The Commission staff has been advising that the language excluding leasehold interests from the scope of the various new subdivisions appears to have been inadvertently omitted. (See, e.g., Dunsford Advice Letter, No. A-97-369.)
Unfortunately, the rulemaking files do not shed much light on the situation. It is apparent from a 1985 staff memorandum that the Commission originally intended to handle leasehold interests separately from ownership interests. (See current Regulation 18705.2(c).) However, there seems to be no available information about the 1988 amendments, and whether there really was an inadvertent omission as explained above.
There are plainly situations in which a public official's leasehold interest in real property could be considered directly involved in a governmental decision. Consider, for example, a public official with a long-term commercial lease in a piece of real property located in a redevelopment area. If the public official owned the real property, it would be considered directly involved in redevelopment decisions, and get the strict materiality standard for directly involved real property economic interests. (Regulation 18705.2(a)(4).) However, if the exclusion for leaseholds from direct involvement applies to all of Regulation 18705.2(a), then the public official with the long-term lease would have an economic interest considered only indirectly involved. One may legitimately question whether the public official with the long-term commercial lease is any less likely to be biased in this scenario than if he or she owned the property.
Option 6 would accept the explanation there was apparently an inadvertent omission in 1988. It would "fix" the "problem" by moving the exclusion for leasehold interests from subdivision (a)(1) to the introductory language in subdivision (a), where it is clear the exclusion applies to all of subdivision (a), not just to (a)(1).
Rejecting Option 6 would remove the exclusion from the regulation entirely. This would mean that real property in which a public official has an economic interest--whether because of ownership or a lease--would be considered directly involved (or not) under one set of rules, period.
The Commission also has the option of maintaining the status quo by directing staff to return with language which accomplishes that.
IV. Recommendations
City Attorney Chouteau's proposal (part II, above):
City Attorney Chouteau's proposal, and the counter-argument that material financial effects are by no means "highly speculative" between 300 feet and 2,500 feet, raise the fundamental question of whether the Commission wants to continue with the basic assumptions behind the real property materiality standards. There does not seem to be any real controversy about having "tough" rules when the public official's real property is directly involved in the governmental decision, or very close to the property which is the subject of the decision. Likewise, there is not much controversy about drawing a line relatively far from the property which is the subject of the decision, and saying that past that line, financial effects are probably not material.
The controversy is about the "middle zone," about which an earlier Commission decided it could not make presumptions. That Commission decided that between "very close" and "probably-far-enough-away" lay a middle ground in which a case-by-case, fact-intensive inquiry was prudent. Case-by-case, fact-intensive inquiries are inevitably difficult, at least in some cases. That is a real "downside" to the current approach, and plainly the motivation for City Attorney Chouteau's proposal.
However, the Legal Division recommends that the benefits of the current regulatory strategy of the real property materiality standards outweigh the costs. First, it is simply real-world common sense to recognize that there is an area around real property which is the subject of a governmental decision in which material financial effects are too possible to ignore, but not so certain as to warrant presumptions. We respectfully disagree with City Attorney Chouteau's assertion that material financial effects beyond 300 feet are so "highly speculative" that we can simply wipe the rule off the books.
Second, a case-by-case approach has the virtue of flexibility. Although it is harder, it is more likely to get "correct" results in a given case than more inflexible rules.
For these reasons, we recommend that the Commission take no further action on City Attorney Chouteau's proposal.
Options 1 and 2 (part III.A., above): Options 1 and 2 simplify the regulation in two ways. First, the two affected provisions, Regulations 18705.2(b)(1)(A) and (B), are really about whether real property is so affected by a governmental decision that it should be considered directly involved, either because it is so close (the former) or because it receives new or improved services (the latter). So, they should be in the regulation that has the other rules about direct involvement, not in the materiality standards regulation, where they are simply confusing. Second, if these two provisions are moved, then the materiality standards regulation is streamlined. Finally, in and of itself, the amendment will not change any substantive results--that is, the amendment does not, in and of itself, create or eliminate conflicts.
Option 2-a would eliminate "wiggle room" afforded by words like "substantially" when a public official is making decisions about his or her own property.
We recommend that the Commission approve Options 1, 2, and 2-a.
Option 3 (part III.B., above): The history of the rule about direct involvement of real property in governmental decisions seems to indicate fairly clearly the Commission intended to create presumptions of materiality in those circumstances. Changing the language in the regulation to make this clear enhances the "brightline" nature of the basic rule, which is clearly what the Commission was striving for. Therefore, we recommend that you approve option 3.
Option 3-a/3-b and option 4 (parts III.C., and III.D., respectively, above): Whether to raise the materiality standard for directly involved real property economic interests from an "any financial effect" standard to a "de minimis" financial effect standard is a difficult policy question. On the one hand, the regulated community's argument that the "one-penny" standard is too low has at least some merit. If the regulation triggers a conflict over a financial effect of only several hundreds of dollars (or less) on a property worth hundreds of thousands of dollars, then a reasonable mind could conclude that the regulation is flawed.
On the other hand, making the change very probably destroys the brightline nature of the current rule. When the Commission created the distinction between directly involved and indirectly involved properties, it did so by identifying circumstances in which the connection between the real property and the governmental decision is very obvious--so obvious that materiality is also very obvious, making resort to financial predictions unnecessary. Thus, the "brightline" is drawn: If a public official has real property in one of those circumstances, the effect of the decision is material. Making the change to a de minimis financial effect standard means adding a layer to this analysis: One must determine not just that the real property is directly involved, but one must also make the financial prediction of whether the financial effect is more or less than de minimis.
Pending further direction, there is no recommendation at this time.
Option 5: We recommend that the Commission approve option 5-a, and increase the materiality standard to $30,000; and that the Commission approve option 5-b, and increase the materiality standard to $2,400 per twelve month period (i.e., $200 per month).
Option 6: Absent compelling testimony from the regulated community, we recommend that it does not make sense to exclude the possibility that a leasehold interest can be directly involved in a governmental decision. A public official with a lease on a parcel of real property, especially a relatively long-term lease, is no less (or more) likely to biased by a governmental decision directly involving that property than is a public official who happens to own the same real property. We recommend that you reject option 6, and remove any distinction between leasehold and ownership real property interest for purposes of applying the directly involved test of Regulation 18704.2(a). (Rejecting option 6 would mean that the wording of the current first paragraph of Regulation 18705.2(c) would remain unchanged.)
1. Regulation 18705.1 for economic interests in business entities; Regulation 18705.2 for economic interests in real property; Regulation 18705.3 for economic interests in sources of income; Regulation 18705.4 for economic interests in sources of gifts; and Regulation 18705.5 for economic interests in personal finances (a.k.a. the "personal financial effect" rule). Only the materiality standards in Regulation 18705.2 are under consideration here; other materiality standards are addressed in other Phase 2 projects.
2. For purposes of assigning materiality standards, the Commission's regulations distinguish between situations where the public official's economic interest is directly involved in a governmental decision and those where the economic interest is indirectly involved in the governmental decision. In the former case, where the risk of bias is greater, a much tougher materiality standard is assigned: any reasonably foreseeable financial effect on the economic interest is deemed material, even a "penny's worth." This rules applies to all economic interests except the economic interest in personal finances (the "personal financial effect rule"). (See Regulations 18705.1(a), 18705.2(a), 18705.3(a), and 18705.4(a).) When the economic interest is indirectly involved, where the risk of bias is relatively less, more lenient materiality standards apply. (See Regulations 18705.1(b), 18705.2(b), 18705.3(b), and 18705.4(b).)
3. Under Government Code Section 65091, all owners of real property within 300 feet of real property which is the subject of certain land-use decisions are entitled to written notice of hearings on the decision. The drafters of Regulation 18705.2(b)(1)(A) borrowed this distance as the radius for the "very close" zone.
4. If, for whatever reason, the distances from the public official's property to the real property which is the subject of the governmental decision cannot be determined, then the regulation provides that the "middle zone" analysis applies. (Regulation 18705.2(b)(3).)
5. Indeed, many people who are otherwise knowledgeable about the Act will tell you that real property within 300 of the property which is the subject of the decision is already considered directly involved, when, technically at least, that is not the case. The point of this observation is that the change proposed here will strike most people as intuitive--they already think it is so--and therefore will simplify the regulation.
6. It is clear that there are no conclusive presumptions of materiality in the regulations. This is so because of Regulation 18705(c), which provides in part,
"(c) Special Rules. Notwithstanding Title 2, California Code of Regulations, sections 18705.1 through 18705.5, inclusive, an official does not have to disqualify himself or herself from a governmental decision if:
...
"(2) Although a conflict of interest would otherwise exist under Title 2, California Code of Regulations, sections 18705.1 through 18705.4, inclusive, and 18706, the decision will have no financial effect on the person or business entity who appears before the official, or on the real property."
7. The analysis in part III. C is relevant if the Commission does not endorse the proposal to create a rebuttable presumption of materiality for directly involved real property in which a public official has an economic interest (part III.B., above). It is relevant whether or not the Commission endorses options 1 and 2, as presented in part III. A., above.
8. Under Regulation 18233, the Commission has excepted month-to-month tenancies; that is, if the public official has only a month-to-month tenancy, he or she does not have an economic interest in the real property.
9. Although this problem arises from language in the degree of involvement regulation for real property (Regulation 18704.2), it has an important impact on the real property materiality standards, which are, of course, the primary focus of this project. This is so because which materiality standard is applied to real property in which a public official has an economic interest because of a lease depends on whether it is considered directly or indirectly involved in the governmental decision.
10. Subdivision (a) of Regulation 18704.2 provides the real property in which a public official has an economic interest is considered directly involved under certain circumstances. Subdivisions (a)(1)-(a)(5) lay out those circumstances. Subdivision (a)(1) covers zoning, rezoning, annexation/deannexation, sale, purchase, lease, or inclusion/exclusion in a governmental subdivision, of the real property. Subdivision (a)(2) covers the licensing, permitting, and other entitlements for the real property. Subdivision (a)(3) covers taxation and fees on the real property. Subdivision (a)(4) and (a)(5) cover redevelopment if the real property is in the redevelopment area.
11. Then numbered Regulation 18702.1(a)(3).