To: Chairman Getman, Commissioners Deaver, Makel, Scott, and Swanson

From: John W. Wallace, Senior Staff Counsel
           Luisa Menchaca, Assistant General Counsel
           Sue Ellen Wooldridge, General Counsel

Subject: Materiality Standards for Real Property Economic Interests--Regulations 18704.2 and 18705.2 (Conflicts Project, Phase 2, Project D).

Date: September 14, 2000

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 (absent an express exception). (Section 87103.) In Phase 1 of the Conflict of Interest Regulations Improvement Project, the Commission enacted an eight-step analysis for officials to use to determine if they have a conflict of interest. The first six steps are used to actually determine if a conflict of interest exists. Steps seven and eight provide two exceptions to the conflict of interest/disqualification requirement. This project concerns steps four and five in the standard analysis as applied to real property in which an official has an economic interest.

Step Four: Are the public official’s economic interests directly or indirectly involved in the governmental decision?

Step Five: Under the applicable standard, will the financial effect on the official’s economic interest be material?

Under former regulations 18704.2 and 18705.2, the standards for materiality differed depending on whether the real property in which the official had an interest was directly or indirectly involved in a governmental decision. Where the real property in which the official had an interest was directly involved in a decision, the effect was considered material if there was any financial effect on the real property.[1]

With respect to real property in which the official has an interest that was indirectly involved in a decision, regulation 18705.2 applied a variety of tests depending on the specific facts and circumstances of the decision. For example, where the real property in which the official had an interest was located within a 300 foot radius of the boundaries (or the proposed boundaries) of the property which was the subject of the decision, or the decision involved construction of, or improvements to, streets, water, sewer, storm drainage or similar facilities, and the real property in which the official had an interest would receive new or substantially improved services, the effect was considered material if there would be any financial effect on the real property in which the official had an interest.

Where the real property in which the official had an interest was located outside a radius of 300 feet, but within 2,500 feet, of the boundaries (or the proposed boundaries) of the property which was the subject of the decision and for decisions which might affect an interest in real property but which do not involve a subject property from which the distances can be determined, the effect was material if the effect was $10,000 or more on the fair market value of the real property in which the official had an interest, or $1,000 on the rental value of the property in a 12 month period.

If the real property in which the official had an interest was located entirely beyond a 2,500 foot radius of the boundaries (or the proposed boundaries) of the property which was the subject of the decision, the effect was presumed not to be material unless there were specific circumstances regarding the decision which made it reasonably foreseeable that the fair market value of the property would be affected by $10,000 or more, or the rental value of the property by $1,000 in a 12 month period. Additionally, the regulation incorporated a "public generally" concept in that it required that the effect on the real property in which the official had an interest not be substantially the same as the effect upon at least 25 percent of all the properties which were within a 2,500 foot radius of the boundaries of the real property in which the official had an interest; or that there were not at least 10 properties under separate ownership within a 2,500 foot radius of the property in which the official had an interest.

At the July 2000, Commission meeting, the Commission made several major substantive decisions that change the scope and substance of the materiality standards applicable to real property.

The Commission decided to relocate two provisions formerly located in regulation 18705.2(b) (pertaining to real property interests that were indirectly involved in a decision) to regulation 18704.2(a) (defining when real property is directly involved in the decision). These provisions dealt specifically with (a) real property located within 300 feet of the boundaries (or proposed boundaries) of the real property which is the subject of the governmental decision, and (b) decisions involving the construction of, or improvements to, streets, water, sewer, storm drainage or similar facilities. As you will recall, the rationale for relocating the two provisions was that while placed in regulation 18705.2(b), the two provisions applied the same materiality standard as is provided for decisions directly affecting real property in which an official has an interest.

In connection with this relocation of text, the Commission also decided to increase the distance at which property is considered directly involved from 300 feet to 500 feet.

With respect to the "indirect standard" in regulation 18705.2(b), the Commission decided to reject the existing rule utilizing two zones (300- 2,500 feet and beyond 2,500 feet). Instead, the Commission adopted a single zone, which extends beyond 500 feet of the subject property. The Commission requested that staff return with language for this new unified zone.

Consistent with the direction provided by the Commission at the July 2000 Commission Meeting, the regulatory language has been revised. We have attached copies of regulations 18704.2 and 18705.2 with text enhancements to reflect previously made decisions. Strikeout type indicates which options the Commission rejected.

Regulation 18704.2, Decision 5: Regulation 18704.2 is being presented with no new decisions for the Commission. However, we are asking that the Commission review Decision 5 in regulation 18704.2 to confirm the decision made by the Commission at its July 2000 meeting. This matter was considered at the end of a long discussion on the proposed amendments. As a consequence, the actual decision made is unclear from the minimal dialog that occurred at that time the decision was made.

The issue can be boiled down into two simple questions:

(1) For purposes of determining whether a financial effect on real property that is leased by a public official (but owned by a third party) is material, should the applicable materiality standard be the same as provided for all other property in regulation 18704.2. Staff recommended this approach. The result of this approach, should the Commission select it, would be as follows:

(2) In the alternative, the Commission may treat the leased property in all cases as indirectly involved in the decision. The result of this change in regulation 18704.2 would be as follows:

If the Commission determines to "treat leaseholds as indirectly involved interests," staff will make conforming changes to both regulation 18704.2 and regulation 18705.2, and present this language with the final adoption package in December 2000.

Regulation 18705.2, Decision 1: Staff is presenting a final set of options with respect to this regulation. At the July 2000 Commission meeting, the Commission directed staff to redraft regulation 18705.2(b) consistent with policy decisions made at that meeting. Included with this memorandum is new subdivision (b) language. We have provided three options. Generally, all three options incorporate the former language of regulation 18705.2 that was applicable to property located "entirely beyond a 2,500 foot radius of the boundaries (or proposed boundaries) of the property which is the subject of the decision" as the Commission directed.

In addition, all three options start with the premise that when the real property in which the official has an interest is located beyond 500 feet of the real property that is the subject of a decision, then the effect of the decision is presumed not to be material. To better understand the effect of this presumption, it is useful to look to the California Evidence Code. Evidence Code section 600(a) defines "presumption" as "an assumption of fact that the law requires to be made from another fact or group of facts found or otherwise established in the action."

In other words, if the fact is that the real property in which the official has an interest is beyond 500 feet of the real property that is the subject of the decision, it is assumed that the effect will not be material. Evidence Code section 604 provides, in pertinent part: "The effect of a presumption affecting the burden of producing evidence is to require the trier of fact to assume the existence of the presumed fact unless and until evidence is introduced which would support a finding of its nonexistence, in which case the trier of fact shall determine the existence or nonexistence of the presumed fact from the evidence and without regard to the presumption." In other words, a complainant will now have the burden of producing evidence to rebut the assumption that the effect is not material.

Option (a): Option (a) is the most simple of the three options. It strips the materiality standard in subdivision (b) of the dollar thresholds and the other numerical measures used to determine materiality in the past. In effect, materiality is not defined at all in this option. The problem with this option, when placed in the context of a presumption against any material financial effect, is that it may have unintended effects that are disadvantageous to public officials. This unintended effect can be best illustrated through an example:

Under the prior law, the councilmember would only be required to disqualify himself or herself if the effect on the fair market value of the councilmember’s property would be $10,000 or more or the effect on the rental value of the councilmember’s real property would be by $1,000 or more per 12-month period. Many officials would seek the advice of an appraiser, not because this was required by the Act, but because they wished to have protection afforded by the independent appraisal.

Under option (a), without the dollar thresholds, the test is simply whether there are specific circumstances regarding the decision, its effect, and the nature of the real property in which the councilmember has an interest, which make it reasonably foreseeable that the fair market value or the rental value of the real property in which the councilmember has an interest will be material. If the presumption is rebutted by a showing of specific circumstances regarding the decision which make it reasonably foreseeable that the effect will be material, the councilmember is left trying to prove that despite these special circumstances, the effect of the decision will not be material. However, what is "material" is not defined.

Option (b): Option (b) would reintroduce the definition of materiality under prior law. This avoids the problem discussed above. Now, rather than simply showing unusual circumstances to rebut the presumption of no material financial effect, the presumption will be rebutted only where it is demonstrated that there are these unique circumstances and it is reasonably foreseeable that the financial effect caused by the decision will be: (1) $10,000 or more on the fair market value of the real property in which the official has an interest; or (2) $1,000 or more on the rental value of the property in a 12 month period.

Option (c): Option (c) contains language provided by the Enforcement Division. This option has a major advantage over the option (a) in that it attempts to establish a definition of materiality that includes factors rather than dollar thresholds. This provides a brighter line than no definition at all. However, it does share the disadvantage of not providing guidance in determining materiality once one or more of those factors are shown to exist.

Staff Recommendation: For the reasons noted above, we recommend option (b).

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