Community Rights Counsel: Taking Back Community Rights

The Honorable Patrick J. Leahy
Chairman
Senate Judiciary Committee
United States Senate
Washington, DC 20510

The Honorable Orrin G. Hatch
Ranking Member
Senate Judiciary Committee
United States Senate
Washington, DC 20510

I am writing to bring to your attention very serious legal and ethical issues that stem from Third-Circuit nominee Judge D. Brooks Smith’s decision to issue important rulings in two cases in which Mid-State Bank had a very substantial financial interest.[1] At the time of these rulings, Judge Smith's wife was an officer at Mid-State Bank and jointly the Smiths held between $100,000 and $250,000 in stock in Keystone Financial, Inc., Mid-State's parent company. The most important of these rulings was deemed “economic blackmail” by poor rural school districts in western Pennsylvania victimized by the ruling, reversed by another district court judge and ultimately ruled “improper” by the Third Circuit. While eventually disqualifying himself from the cases, Judge Smith never disclosed his large financial stock in the bank.

Financial advisor John Gardner Black managed assets of dozens of small school districts in rural Pennsylvania. He committed what the Securities and Exchange Commission called the biggest fraud against municipalities in Pennsylvania history. Black deceived his clients and illegally invested in highly volatile derivative securities, and he lost over $70 million dollars in taxpayer money trusted to his care by the school districts. Black was also accused of diverting millions of dollars in taxpayers' money for his own personal and business use. Black recently pled guilty to many of these charges and was sentenced to serve four years in a federal penitentiary.[2]

Mid-State Bank reportly helped Black perpetrate this fraud by serving as Black’s "back office" and acting as custodian of the local governments’ money lost by Black. The Bank apparently hid Black’s fraud by issuing reports showing no losses to the local governments while reporting the actual value of the assets to Black. In December of 1999, Mid-State and its holding company, Keystone Financial Services Inc, paid Black’s local government clients approximately $51 million dollars to settle civil fraud cases filed against the bank stemming from their participation in Black’s fraud.[3] Settlement of these civil fraud cases contributed significantly to a 49% decrease in the value of Keystone's stock.[4]

Black’s fraud was revealed in a random SEC audit performed in mid-1997. Upon discovering Black’s undisclosed losses, the SEC filed civil proceedings to suspend Black’s license as a securities trader and freeze his clients’ assets.[5] While not charging Mid-State, the complaint details Mid-State's central role in Black's fraud. Complaint (Sept. 26, 1997). In particular, the Complaint explains that an investment company run by Black used numerous related accounts at Mid-State Bank to shift money around, invest illegally in high-risk derivative securities and hide his losses. Black maintained with Mid-State Bank "Custodial Accounts," a "Main Account" and a "Collateral Account." Complaint at ¶¶ 25 -26. Most of the school districts entrusting their money to Black had deposited their money into a Custodial Account, where it was supposed to be held in the name of the school district. Id. Black then transferred the money to the Main Account, where it was pooled with the money of other school districts. Id.

Black invested the money from the Main Account in risky securities that were illegal under state law, which requires municipalities to make only secure investments. Black then deposited these securities into the Collateral Account. The Main Account and the Collateral Account suffered investment losses of at least $50 million (Complaint at ¶ 30), losses Black hid by sending the school district's fraudulent reports of the assets held in these accounts. Complaint at ¶¶ 30-41. Black also misappropriated approximately $2 million from the Main Account for his personal and business expenses. Complaint at ¶¶ 42-45.

The SEC’s complaint was supported by a declaration signed by William Meck, the SEC auditor that discovered Black’s fraud. Meck’s Declaration mentions Mid-State by name five times, providing more detail about the Bank’s central role in Black’s fraud. Filed with the Meck Declaration is a schedule of assets invested with Black as of July 31, 1997 that lists Mid-State Bank sixty-six separate times as the custodian of a total of $156 million invested by local school districts.[6] Also filed with the Meck Declaration is an account statement issued by Mid-State Bank to Black indicating that it only held $87 million in its collateral account.[7]

As custodian of the money entrusted to Black by the school districts and lost by Black, Mid-State was an obvious, deep-pocket target for legal action by the defrauded school districts. Indeed, within weeks of the filing of SEC v. Black (two weeks before Judge Smith's recusal), a local paper ran a front-page story reporting that Black’s local government clients were considering legal action against Mid-State in order to recover the losses and keep the schools financially sound. [8] These suits would ultimately extract more than $50 million from Mid-State and send the bank’s stock plummeting. From the outset, Mid-State, its officers and its shareholders all had important financial interests in the outcome of SEC v. Black. [9] In particular, it was in Mid-State’s financial interest to see that blame in the case rested as much as possible on Black and as little as possible on Mid-State and to preserve in the case assets that could be used to compensate the school districts that had entrusted their money to Mid-State’s care.

Judge Brooks Smith’s wife, Karen Smith, served before, during and after SEC v. Black as a high-ranking officer of Mid-State Bank. The Smiths had (and still have) a significant portion of their assets tied up in Mid-State stock and its holding company. Specifically, Judge Smith’s financial disclosure report for 1997 indicates that the Smiths jointly held between $100,000 and $250,000 worth of stock in Mid-State’s parent, Keystone Financial Services Inc. and that Karen Smith held between $100,000 and $250,000 in a Mid-State 401(k) account.[10] Judge Smith’s disclosure forms do not indicate any other assets worth more than $50,000. Thus, upwards of 50% of the Smith’s net worth was tied to the bank’s prospects.

Despite being required by law to know of his financial investments (to avoid ruling in cases in which he would have a conflict) and the fact that his wife presumably left every work day for employment at Mid-State Bank, Judge Smith issued important orders in cases involving Black’s fraud.

In fact, between September 30^th and October 27^th, Judge Smith issued 15 orders in SEC v. Black, including several important orders denying intervention to school districts and banks trying to obtain access to assets safely held outside of the pooled account at Mid-State.

For example, on October 7^th, Lancasterand Penn Manor School Districtsfiled a motion to intervene and a motion for relief from the freeze of their assets. Lancaster and Penn Manor argued explicitly that because they kept their money away from Mid-State, their money was safe and should be released. For example, they asserted that “Lancaster and Penn Manor hold their funds, securities and assets in accounts at Dauphin Deposit Bank & Trust Company that are separate and distinct from the Mid-State Bank Collateral Account * * *.” [11] Later, they reminded the Court that “the alleged misrepresentation of the value of the [securities] held in the Collateral Account maintained at Mid-State Bank is not applicable to the deposits and securities held by Dauphin Deposit Bank."[12] Smith denied Lancaster and Penn Manor’s motion to intervene on October 8th, the day after it was filed. He denied their motion for release of their frozen assets on October 30th (see below).

By October 14, the SEC had issued a subpoena to Mid-State Bank, through its parent, Keystone,[13] demanding production of “any and all documents that relate, refer, or pertain to the following accounts maintained at Mid-State Bank in the name of John G. Black * * *.” This subpoena was attached to a pleading filed with Judge Smith by the SEC on October 20th.[14]

By October 27^th, Smith irrefutably knew of Mid-State’s central role in Black’s fraud.

On that day, Smith issued an order that mentions Mid-State Bank by name twice in a three-page order. Even more significantly, this order recognizes that the court- appointed trustee (former Pennsylvania Governor and former U.S. Attorney General Dick Thornburgh)[15] had found it necessary to take the extraordinary step of divesting Mid-State Bank of custody of the $86 million in assets remaining at Mid-State and place these assets into the control of PNC Bank. By the time he issued this order, Smith was clearly aware both that Mid-State was significantly involved in SEC v. Black and that the trustee did not think that Mid-State could be trusted as the custodian of the assets frozen by the court (thus the transfer of assets to PNC Bank).

By the 27th, Judge Smith also had evidence before him that Mid-State Bank was more than a passive participant in Black’s fraud. On that day, Smith received a report from Thornburgh which stated: “Mid-State Bank carried an aggregate market value of $157,622,923.12 in reports for [Black’s] Clients. In the Mid-State report to [Black], the market value totaled $86,307,513.87.”[16] In other words, the trustee was alleging that Mid-State Bank knew that Black was violating Pennsylvania law by failing to fully collateralize the school district's investments and issued fraudulent statements to these school district's to keep Black from being found out.

Smith nonetheless continued presiding over SEC v. Black for four more days and, during this critical period, Smith issued important and controversial orders benefiting Mid-State and further shifting the public perception of responsibility to Black.[17]

Most importantly in two orders, one issued on October 27^th and the other issued on October 30^th, Smith kept in the court’s control approximately $77 million invested by school districts that refused to deposit their money with Mid-State Bank.[18] As discussed above, these school districts argued passionately to Judge Smith that their money was safe, secure and unharmed by the losses suffered in the pooled account at Mid-State Bank and should, therefore, be immediately released to them. Instead, Smith decided to keep frozen 50 percent of the assets of all the school districts, even those outside the pooled account at Mid-State. To even get half their money, these school districts had to “consent in writing to the continuation of this Court’s Order of September 26, 1997 in all respects as to the remaining balance in its respective bank.” Order at 2 ( Oct. 27, 1997 . Having thus made his order effectively challenge proof, Smith then denied the motions filed by non-Mid-State school districts as "moot."[19]

Smith’s improper (see next paragraph) rulings clearly advanced the interests of Mid-State Bank: his ruling preserved $77 million for potential use in reducing the losses suffered by the school districts that deposited their money in custodial accounts at Mid-State.

This point is important enough to explain in detail. School districts like the Tyrone School District (a Mid-State customer) were arguing to Judge Smith that the losses should be shared by all Black investors on a pro-rata basis.[20] On the other hand, non-Mid-State school districts like Lancaster and Penn Manor were asking Judge Smith to release all their money to them immediately.[21] If Tyrone and other Mid-State school districts had gotten their way, non-Mid-State school districts would have contributed more than $37 million to minimize the losses suffered by Mid-State school districts.[22] If, on the other hand, Lancaster, Penn Manor and others got their money back, then, as the SEC explained to Judge Smith, "the ultimate issue as to who may be entitled to these funds will be moot."[23] By siding with the Mid-State school districts over the non-Mid-State school districts', Judge Smith preserved in SEC v. Black a very large pot of money that could have dramatically reduced Mid-State's litigation exposure stemming from this matter. Recall that Mid-State ultimately paid $51 million to settled civil fraud claims brought by school districts like Tyrone seeking recovery of all $71 million. If a pro-rata allocation had been followed, the most these Mid-State school districts could have sought from Mid-State was $34 million.[24]

Even putting aside, however, Judge Smith's interests in Mid-State, these orders were still quite inappropriate. Smith "improperly" (the Third Circuit later determined) kept within the Court’s control $77 million desperately needed by poor rural school districts. Moreover Smith sought to make this improper freeze challenge-proof by requiring innocent school districts to waive their right to challenge the freeze on their remaining assets in order to get some of their money back.

As one school district decried at the time, Smith’s order constituted “economic blackmail." [25] Rather than comply with this order, this school district boldly refused the money and instead challenged the propriety of Smith’s order. When Smith turned over the case to Judge Donetta Ambrose, also of the Western District of Pennsylvania, Ambrose reviewed this challenge and determined that Smith had improperly held these non-pooled assets in the case. The Third Circuit affirmed Judge Ambrose, concluding: "[c]ase law * * * supports the District Court's determination that the freeze as to these [non-pooled] funds was improper."[26] The Court simply had no right to keep in the case the money controlled by innocent third-parties like Lancaster and Penn Manor.

On October 30^th, Smith again ruled in a way that advanced Mid-State’s interests by denying the contested portions of a motion filed by Black for the release of a portion of his frozen personal assets for use in paying counsel fees and living expenses. Black sought access to assets he accrued decades before the alleged fraud, assets not ill-gotten and thus, in his opinion, improperly frozen by the court. Smith concluded, however, that the continued freeze was necessary to preserve these assets for “any disgorgement order that the district court could properly issue” [27] (Memorandum and Order at 5 (Oct. 30, 1997)).

To summarize, it was in Mid-State's strategic legal and financial interests to reduce by as much as possible the losses suffered by the school districts that had entrusted their money to Mid-State via Black.[28] There were two avenues for doing this, one was for the court to keep as many of Black's assets in the case as possible for a disgorgement order and the other was to keep in the case as much money from school districts that had NOT trusted their money to Mid-State care. Judge Smith's orders dated October 27th and October 30th significantly advanced Mid-State's interest in both respects.

On October 31^st, Smith declared himself disqualified from further involvement in SEC v. Black. His terse order released that day states that “it has become evident that a significant portion of the assets at issue are or were in the custody of Mid-State Bank” and that “the wife of the undersigned judge is an officer of the aforementioned bank.” Order of Recusal at 1 ( Oct. 31, 1997 . He concluded that “the relationship of the undersigned’s wife to the aforementioned bank could cause a reasonable observer to question the impartiality of the undersigned judge." Id.

All true, but these facts were evident from the face of the complaint filed on September 26^th. Smith was certainly aware of these facts no later than when he issued his October 27^th twice naming Mid-State. Smith did not vacate any orders he issued in the case, did not explain why over a month had passed before recusing and, most importantly, never disclosed his most serious conflict - his large stock interest in the bank.

Judge Smith Was Bound by Judicial Ethics and the Law to Not Preside in the Case

Federal law requires that a judge remove himself from a case whenever "he knows that he * * * has a financial interest in the subject matter in controversy or in a party to the proceeding, or any other interest that could be substantially affected by the outcome of the proceeding." 28 U.S.C. § 455(b)(4).[29] More generally, the law requires recusal whenever a judge's "impartiality might reasonably be questioned." 28 U.S.C.§ 455(a). The law also requires a judge to "inform himself about his personal and fiduciary financial interests" and not sit on cases in which his interests may be at stake. 28 U.S.C. 455(c).

In short, judges can’t rule in cases in which they have financial interests, and they have to know their financial interests well enough to know when to recuse themselves.

Judges also are bound to "disclose on the record any information that a judge believes the parties or their lawyers might consider relevant to the issue of disqualification, even if the judge believes there is no real basis for disqualification.”[30] This obligation is designed to protect judges from investigations into their personal and financial interests. As one court concluded: "litigants (and, of course, their attorneys) should assume the impartiality of the presiding judge, rather than pore through the judge's private affairs and financial matters * * * litigants and counsel should be able to rely upon judges to comply with their own Canons of Ethics."[31]

The subject matters in controversy in SEC v. Black were Black's fraud and the pool of money entrusted to Black by Pennsylvania school districts. [32] The complaint makes plain that Mid-State Bank was at the center of both matters. Regarding Black's fraud, the complaint establishes, at the very least, that Mid-State Bank had facilitated Black's fraud. Mid-State was the custodian of the money entrusted to Black by Pennsylvania school districts and fraudulently lost.

The complaint further details that Mid-State's permitted Black to transfer school district's assets out of the custodian accounts at Mid-State into a pooled account at Mid-State that invested in securities not permitted by Pennsylvania law. Mid-State held these illegal securities in a Collateral Account and permitted Black to issue to his clients reports that fraudulently overestimated the value of these illegal securities. Mid-State also allowed Black also diverted approximately $2 million from this pooled account for his personal and business uses.

Mid-State's connection with the pool of money frozen by the SEC in SEC v. Black was even more apparent from the SEC's initial filing on September 26th. Mid-State was custodian of a large percentage of the assets invested with Black and frozen by the SEC. It also held the collateral, the value of which Black and (as it turns out) Mid-State inflated to hide his investment losses. The court's order appointing former Attorney General Thornburgh as trustee specifically required “reports setting forth the value of assets held by [Black] in the Collateral Account maintained at Mid-State Bank.” Order Appointing Trustee at 6 ( Sept. 26, 1997.

Mid-State's (and thus Judge Smith's) financial interest in SEC v. Black was thus established from the face of the first documents filed in the case. Judge Smith should have immediately recognized that he was disqualified from presiding over the case.

Binding Supreme Court and the Third Circuit precedent demanded that Judge Smith immediately recuse himself from SEC v. Black. Indeed, both courts have required recusal under 28 U.S.C. § 455 in cases where a judge's interests in the litigation were more diffuse and far less likely to be affected. The leading Supreme Court case is Liljeberg v. Health Services Acquisition Corp. (HSA), 486 U.S. 847 (1988). Liljeberg involved a contract dispute between Liljeberg, a real estate broker and pharmacist, and HSA regarding the construction of a hospital in Kenner, Louisiana . Unmentioned in the complaint and proceedings, Liljeberg was also in negotiations with a non-party, Loyola University , for construction of the same hospital. If Liljeberg had prevailed in the contract suit with HSA, it would probably have entered into a contract with Loyola. Because the presiding judge was a trustee of Loyola University (and thus held a fiduciary interest in Loyola), and because Loyola would potentially benefit from a decision invalidating Liljeberg's contract with HSA, the Supreme Court held that the Judge had "an interest in the litigation" that required recusal, even though the judge professed not to have known of Loyola's interest at the time of his ruling. Id. at 859.

Similarly, in United States v. Nobel, 696 F.2d 231 (3d Cir. 1982), the Third Circuit held that a judge was obligated to recuse himself in a criminal trial in which a judge owned stock in a non-party victim of a crime -- even though the insurance company victim had already been compensated for its loss and could not be enriched by the judge's decision. The Third Circuit held that a "judge who owns a substantial interest in the victim of a crime must disqualify himself or herself in the subsequent criminal proceeding because the strict overarching standard imposed by section 455(a) requires that the appearance of impartiality be maintained."[33]

Under Liljeburg and Nobel, Smith had a clear, unambiguous obligation to recuse as soon as he was aware that Mid-State was the custodian of the money lost by Black and frozen by the SEC. [34] If, as Nobel requires, a judge must recuse where he owns stock in a non-party victim of a crime, even where that victim has been compensated, then a judge must surely recuse where he owns stock in a bank that facilitated a crime and was potentially liable for the proceeds. Indeed, Judge Smith recognized as much in his October 31st recusal order.

The question is, why did Judge Smith issue twenty orders, including orders significantly benefiting Mid-State’s interests before recusing, when the face of the complaint made plain the role of the Bank that employed his wife on a daily basis and in which he staked so many of his assets? Moreover, even if he somehow convinced himself that his interests in Mid-State were not disqualifying, why didn't he at least disclose these interests on the record, as judicial ethical canons require? Finally, in recusing, why did Judge Smith fail to disclose his significant stock interest in Mid-State Bank and fail to vacate his prior orders once he recognized these serious conflicts?

This failure to disclose is both significant and inexcusable.[35] The Supreme Court plainly stated in Liljeberg that recusal can be retroactive, meaning that rulings entered by a disqualified judge must, in certain cases, be overturned.[36] The Supreme Court places the burden on individual judges who identify a conflict "to rectify an oversight and to take the steps necessary to maintain public confidence in the impartiality of the judiciary."[37] This obligation sometimes includes the need to vacate a ruling issued before the conflict was discovered by the judge.[38]

Here, Judge Smith not only failed to vacate the orders tainted by his conflict, he failed altogether to disclose his large stock interest in Mid-State. This interest was far more likely to be affected by the litigation before him than his wife's job and thus would have presented a far stronger case for overturning Smith's ruling in favor of Mid-State. [39] By not disclosing this interest, Judge Smith deprived the parties affected by his orders a very important potential avenue for obtaining relief.[40]

After two years of investigation, the SEC indicted Black on criminal charges in 1999. This indictment was filed by the United States at the U.S. district court in Pittsburgh , but transferred by Judge Ambrose to Judge Smith’s courtroom in Johnstown . Remarkably, despite his earlier recusal, Judge Smith presided over this criminal matter for over 5 months, issued several orders including a detailed trial scheduling order[41] and recused himself again only after Black’s lawyer filed a recusal motion. In granting recusal, Judge Smith again relied entirely on his wife’s status as a Vice President of Mid-States Bank. Judge Smith again failed to disclose his large financial stake in the Bank.

Like the complaint in SEC v. Black, the indictment in U.S. v. Black mentions Mid-State by name on numerous occasions and details Mid-State’s central role in Black’s fraud. As Black's counsel explained in ultimately moving for recusal: “The factual basis for the Indictment is virtually identical to the factual basis for the civil action brought by the Securities and Exchange Commission.” Revised Memorandum of Law in Support of Defendant’s Motion for Recusal at 2 ( Oct. 28, 1999 ).

· A class action civil fraud lawsuit had been filed against Mid-State and Keystone[42] seeking recovery of the $71 million lost by Black and other damages.

· Tyrone School District (the school district Judge Smith attended as a child) and others had filed federal racketeering (RICO) suits against Mid-State and Keystone.[43]

· The court-appointed trustee in SEC v. Black, Dick Thornburgh, had filed a federal civil fraud lawsuit against Mid-State seeking recovery on behalf of the school districts that deposited their money with Mid-State.[44]

These lawsuits received a tremendous amount of publicity between the date of Judge Smith's recusal in SEC v. Black and the filing of U.S. v. Black[45] and posed a serious enough threat to Keystone that, in November 1998, Keystone starting informing the SEC and its stockholders of losses stemming from this litigation that “cannot be reasonably estimated at this point.”[46] These cases all involved the same subject matter as U.S. v. Black – the fraud perpetuated by Black through Mid-State Bank. Because the class action lawsuit was pending while Judge Smith presided over U.S. v. Black, Keystone and Mid-State had an intense financial interest in the proceedings. As noted by Black's counsel: “This case will likely have a substantial impact on the numerous civil cases filed against Mid-State Bank arising out of the same factual scenario, and Mid-State Bank therefore has a keen interest in the outcome of this litigation and the efficacy of their witnesses’ testimony.” Revised Memorandum of Law in Support of Defendant’s Motion for Recusal at 7 ( Oct. 28, 1999 ).

It is difficult to fathom how Judge Smith deemed it possible to preside over U.S. v. Black even for a day. He plainly knew that Mid-State was a central player in Black’s crime,[47] he knew his wife was an officer in Mid-State, and he had to have known that his largest financial asset was stock in Keystone.

These facts appear to establish that Smith knew he had a “financial interest in the subject matter” of U.S. v. Black. Judge Smith owned a significant amount of stock in Keystone, a company that was being sued for $71 million in a pending case charging the company for its role in Black’s crime. Keystone had an intense financial interest in ensuring that nothing came out during the proceedings of U.S. v. Black that could damage their defense of these pending suits. Moreover, U.S. v. Black also involved a forfeiture allegation seeking the “forfeiture of any other property June 18, 1999 ). Again, Keystone, and through the bank Judge Smith, seems clearly to have had a financial interest in any such forfeiture.

At the very least, Judge Smith should have recognized that his “impartiality could reasonably be questioned.” After all, the Third Circuit in Nobel ruled that a judge must recuse if he owns stock in the victim of the crime, even if the victim has already been made whole. Here, Judge Smith was married to an officer and owned stock in a company that was both involved in the criminal activity at issue and battling a pending damages action stemming from this conduct. Certainly, a reasonable observer, knowing all the relevant facts, would question whether Judge Smith could preside over U.S. v. Black free of any concern over the company's interests. Under Liljeburg and Nobel, that is all that is necessary to require recusal under 28 U.S.C. § 455(a). Instead, Judge Smith presided over U.S. v. Black for 5 months and recused himself only upon a motion filed by Black.

Again, Judge Smith exacerbated his problems by failing to disclose the bases for seeking his recusal. Indeed, in his recusal order, Judge Smith admits that he considered recusal at the outset of U.S. v. Black,[48] yet makes clear that he failed even to inform the parties of the bases for seeking his recusal.[49] This appears to be a knowing violation of his ethical obligations that require him to disclose information that "the parties or their lawyers might consider relevant to the issue of disqualification, even if the judge believes there is no real basis for disqualification.”[50] By doing so, Judge Smith forced counsel for Black to go through the time, effort, expense, and litigation risk[51] of moving for Judge Smith’s recusal based primarily on his wife's connection to the bank.[52] Moreover, even when faced with a motion outlining the bank’s financial interest in the litigation,[53] Judge Smith still failed to disclose his most serious conflict stemming from his large financial interest in the bank, granting recusal only on the grounds that his wife was an officer at the bank. Memorandum Order at 1-2 (Nov. 1, 1999).

While many stock conflict cases have been reported in the press in recent years, the vast majority have involved financial interests that could not plausibly have been affected by the results of a pending case or with financial interests that are speculative or diffuse. None of these seemingly mitigating factors apply to this case. Judge Smith personally held a large amount of stock in a relatively small company whose stock ultimately plummeted because of the fraud at issue in SEC v. Black. Mid-State’s interests in the proceeding were or should have been apparent from the face of the complaint. It is particularly tough for Judge Smith to argue that this was an oversight, given that his wife presumably went to work each morning at the bank. This case thus raises the core concern that led Congress to pass 28 U.S.C. § 455: the possibility that a judge might use his office to further his personal or financial well-being.

In 1969, the Senate rejected President Nixon’s nomination of Fifth Circuit Judge Clement Haynsworth to the United States Supreme Court because it was shown that, on several occasions, Judge Haynsworth had ruled in cases in which he had a financial interest.[54] This nomination fight precipitated the passage of 28 U.S.C. § 455, the bright-line legal prohibition against financial conflicts. In 1993, several Republican Senators, including Richard Lugar (R.) voted against the confirmation of Justice Stephen Breyer based on tangential financial conflicts that seem laughable in comparison to the illegal rulings made by Judge Smith.[55] At the time, Senator Arlen Specter called for an amendment to 28 U.S.C. § 455 to make clear that even tangential financial interests are disqualifying. [56]

Commenting only on Judge Smith's rulings in SEC v. Black, preeminent judicial ethics scholars have harshly condemned Judge Smith's actions. Steven Lubet from Northwestern University School of Law calls Judge Smith's conduct "an inexplicable lapse, because the facts are clear and the law is clear and there isn't any question that [Smith] is disqualified, but he continued to sit on this case for 30 days." Stephen Gillers, Vice-Dean of New York University School of Law, has commented "he should have revealed his financial interest in Mid-State and his wife's employment relationship to Mid-State to the parties right away as soon as he learned that Mid-State had an interest in Black's litigations.... The second problem for Judge Smith is that it appears to me Mid-State certainly had an interest in the rulings Judge Smith might make."

Judge Smith's conduct in these two cases seems clearly to raise serious concerns that should be investigated by the Senate Judiciary Committee and considered by all senators before deciding whether to confirm Judge Smith to a lifetime appointment on the federal appellate bench. Thank you for your consideration of these concerns. Do not hesitate to contact me if you and your committee would like more information about these cases or the work of Community Rights Counsel.

Sincerely yours,
Douglas T. Kendall

[1] Community Rights Counsel (CRC) is a non-profit, non-partisan law firm that helps communities defend land-use protections. We have in recent years also assumed a role of a judicial ethics watchdog, identifying stock conflicts in cases issued by federal judges and appearance problems stemming from corporate-funded judicial educational seminars. A recent oversight hearing conducted by the Courts Subcommittee of the House Judiciary Committee focused on several CRC studies on judicial ethics issues. Chairman Howard Coble (R-NC) lauded CRC as "a watchdog, and I mean that as a compliment." CRC began researching Judge Smith's rulings because he has taken more corporate-funded trips than just about any federal judge in America . We came upon the cases discussed in this letter while researching potential conflicts of interest stemming from these trips.

[2] United States v. Black, No. 99-CR-203 (W.D. Pa. 1999).

[3] Mike Bucsko & Eleanor Chute, Black's Bank Offers Settlement of $51 Million, Investors Could Recoup 77 Percent of their Losses, Pittsburgh Post-Gazette, Dec. 9, 1999 , at A1.

[4] Bill Sulon, Lawsuits Add to Annual Loss, Keystone Also Cites Y2k Costs, Harrisburg Patriot, Jan. 19, 2000 , at B10.

[5] SEC v. Black, No. 97-CV-2257 (W.D. Pa. 1997).

[6] Declaration of William R. Meck, Exh. K (Sept. 26, 1997).

[7] Under Pennsylvania law, municipal investments must be 100% collateralized (meaning principal cannot be at risk). This statement issued by Mid-State to Black was thus a red-flag that Mid-State was more than a passive participant in Black’s fraud. All the bank had to do to ascertain that Black’s investments were violating Pennsylvania law was compare the assets in its custodian accounts to the value of the assets in its collateral account.

[8] Paul Bomberger, Schools Try to Untangle Financial Web of Deceit, Lancaster Intelligencer J., Oct 18, 1997 , at A1.

[9] Three months after Judge Smith recused, Mid-State intervened as a party in SEC v. Black.

[10] Judge Smith’s financial disclosure forms (on file at the Administrative Office of the United States Courts) do not indicate the assets held in his wife’s 401(k) account. Because Karen Smith is an officer at Mid-State Bank, it would not be surprising to learn that this retirement account is also heavily invested in bank stock.

[11] Motion to Intervene of the School District of Lancaster and Penn Manor School District , Oct. 7, 1997 at ¶ 9

[12] Id. at ¶ 26.

[13] This explicit reference to Keystone Financial, included in a subpoena that was attached as an exhibit to an important filing of the SEC in response to a motion adjudicated by Judge Smith before recusing, undercuts any potential claim by Judge Smith that he forgot or was unaware that Keystone (the holding company in which the Smith’s owned stock) was Mid-State’s parent. It is also worth noting that the Mid-State statement, referenced above and attached as an exhibit to the Meck Declaration, refers to Mid-State as a “Keystone Community Bank.” Of course such a claim was already patently implausible given that Keystone stock was the Smithss largest single asset and given that Keystone is the holding company for a bank at which Karen Smith was an officer. Finally, it bears repeating that Judge Smith had a legal obligation to keep track of his financial holdings and that this obligation includes a duty to know the subsidiaries of a company in which a judge owns stock. 28 U.S.C. 455(c).

[14] Plaintiff Securities and Exchange Commission's Memorandum in Opposition to Several Motions to Intervene and Motions for Relief from the Temporary Restraining Order, Oct. 20, 1997 , exh. 7. This response by the SEC was specifically ordered by Judge Smith (Order dated Oct. 10, 1997) and was the critical document that Smith had to consider in adjudicating the non-Mid-State school districts request to have their money unfrozen. Judge Smith denied these motions as moot on Oct. 30, 1997 , the day before he recused.

[15] Judge Smith was on travel on September 26, 1997 , the day SEC v. Black was filed. Judge William Standish filled in for him that day and issued ex-parte (Black was not allowed to defend himself) orders freezing all assets in Black’s control and appointing Thornburgh to serve as trustee. Judge Smith took over the case upon his return and issued his first ruling in the case on September 30, 1997 .

[16] Trustee Report, October 27, 1997 , Exh. 1, n.5.

[17] As the Third Circuit has recognized in Moody v. Simmons, 858 F.2d 137, 143 (3^d Cir. 1988), once a judge recognizes that his impartiality could reasonable be questioned “he or she may enter no further orders in the case.”

[18] While these funds were initially frozen by Judge Standish as part of his September 26^th Order, this freeze was entered “ex-parte” meaning that no other parties had the opportunity to contest the freeze before Judge Standish. Judge Smith was the first judicial officer who had the opportunity to hear the argument by non-Mid-State school districts that their money did not belong in the case and the judicial officer responsible for adjudicating the propriety of keeping this money in the case.

[19] Order Denying Motion for Clarification of Temporary Restraining Order, et al, Oct 30, 1997 . Judge Smith's unexplained ruling that these motions were "moot" would be laughable if it were not for the seriousness of the harm suffered by the poor school districts burdened by the ruling. The efforts of the non-Mid-State school districts to get back the money improperly held by the court in SEC v. Black were not rendered moot by the distribution of a portion of their frozen assets. These school districts wanted all their money back, the court held onto $77 million, more than enough to pay the entire losses of Mid-State school districts if so ordered. The only plausible explanation for the court's "mootness" judgment is that Judge Smith hoped that the non-Mid-State school districts would all abide by his condition that they waive their right to challenge the freeze on their remaining assets in order to get half their money. In other words, the motions were moot only if Judge Smith's "economic blackmail" worked.

[20] See Memorandum in Support of Motion to Intervene of Tyrone Area School District at 3, 7 ( Oct. 14, 1997 ). Tyrone argued for intervention for the purposes of "protecting Tyrone's interest in assuring that all districts are treated equally." Tyrone argued that the trustee was not adequately representing its interests because "the Trustee has stated that he may propose preferential treatment of some districts." Later in its motion, Tyrone summarizes: "Tyrone needs to maximize its total recovery. Because Tyrone may be able to maximize its recovery only at the expense of other claimants, Tyrone cannot rely upon the Trustee to represent its interest." In other words, it was in the Tyrone School District ’s interest to keep as many other school districts in the case as possible, because the money of these other school districts could potentially share Tyrone’s losses. As custodian of Tyrone’s money, Mid-State shared Tyrone’s interest in this regard.

[21] See Motion to Intervene of the School District of Lancaster County and Penn Manor School District, ¶ 33 ("The funds and property of the School District of Lancaster and Penn Manor School District should not be subject to any Order or preliminary injunction which prevents them from having access to and the use of those funds.").

[22] The Trustee's report filed on October 27, 1997 lists a total of $261 million in remaining assets of Black's Investment Advisory Clients, with $175 million remaining outside the pooled account at Mid-State and $86 million remaining (of $157 million invested) at the Mid-State pooled account. Trustee Report at 7. If, as Tyrone and others argued, losses were shared pro-rata according to the amount invested with Black, non-Mid-State school districts would bear approximately 53% of the losses, or $37 million.

[23] Plaintiff Securities and Exchange Commission's Memorandum in Opposition to Several Motions to Intervene and Motions for Relief from the Temporary Restraining Order, Oct. 20, 1997 at 13.

[24] While it is possible that, if a pro-rata loss sharing plan were adopted, non-Mid-State school districts would have sued Mid-State for the losses forfeited in SEC v. Black. However, the successfully settled lawsuits brought by Mid-State school districts were premised in large part on the fiduciary relationship the bank owed them because of the bank's role as custodian. Non-Mid-State banks would have had a much tougher road in holding Mid-State accountable.

[25] Mike Bucsko, Districts Warned About Black, Pittsburgh Post-Gazette, Nov. 4, 1997, at B1 ("It's economic blackmail, telling us they will give us half the money if we sign off on the right to ask for a hearing on the case. * * * We're not going to take the $9.3 million with strings attached. We're going to request that we be granted a hearing as soon as possible." (quoting Michael Witherel, District Solicitor, North Hills School District )).

[26] SEC v. Black, 163 F.3d 188, 196 (3rd Cir. 1998).

[27] A disgorgement order is a civil penalty designed to equal the amount of illegal proceeds retained by a perpetrator of civil fraud.

[28] Again this was primarily because the Bank was potentially liable for these losses in suits filed by the school districts that had entrusted their money to Mid-State. Even putting aside, however, the question of legal liability, the Bank had a financial interest in protecting its reputation of custodian of assets, an interest that required the Bank to support recovery efforts by the school districts that had deposited their money at Mid-State.

[29] Even a single share of stock in a company (or its parent) constitutes a financial interest. 28 U.S.C.455(e).

[30] See ABA Model Code of Judicial Conduct, Canon 3(E)(1) cmt. (2000); See also American Textile Mfrs. Inst. v. The Limited, 190 F.3d 729 (1999) ("judges have an ethical duty to 'disclose on the record information which the judge believes the parties or their lawyers might consider relevant to the question of disqualification.'" (quoting Porter v. Singletary, 49 F.3d 1483, 1489 (11th Cir. 1995)).

[31] American Textile Mfrs. Inst. v. The Limited, 190 F.3d 729, 741 (1999) (quoting Porter v. Singletary, 49 F.3d 1483, 1489 (11th Cir. 1995)). See also Liljeberg v. Health Services Acquisition Corp. (HSA), 486 U.S. 847, 864 n. 11 (1988) (noting that it is an "unusual step" for a litigant to review a judge's financial disclosure forms.)

[32] The Third Circuit in U.S. v. Nobel, 696 F.2d 231, 234 (3d Cir. 1982), defines “subject matter in controversy” as encompassing the "matter acted upon," the "matter presented for consideration," and "the topic of dispute in a legal matter."

[33] 696 F.2d at 235-36. Nobel was decided under 455(a) instead of 455(b)(4) because, as mentioned above, prior to the criminal trial, the defendant had agree to repay the insurance company all the funds received as a result of the fraud. Id. at 235. The Court concluded that "[i]n some instances, the resolution of a criminal proceeding might have a substantial effect on the financial affairs of the victim company * * *," but that "under the circumstances in this case, the judge's financial interest in INA was not an interest 'that could be substantially affected by the outcome of the proceeding.'" Id. at 234.

[34] In Nobel, the Third Circuit quoted Department of Energy v. Brimmer, 673 F.2d 1287, 1295 (Em. App. 1982), for the proposition that "[t]he use of the term 'subject matter' suggests that [the portion of 28 U.S.C. 455(b)(4) which prohibits judges from ruling where they have a financial interest in the subject matter in controversy] will be most significant in in rem proceedings." SEC v. Black was, in large part an in rem [about the property] proceeding where the subject matter in question was a pool of money consisting of Black’s assets and the remaining assets of the school districts. As custodian of a large portion of that money, Mid-State (and thus Judge Smith) had a “financial interest in the subject matter.”

[35] As mentioned above, Judge Smith has a legal obligation to keep track of his financial interests. 28 U.S.C. § 455(c). Smith's stock in Mid-State's holding company was worth between $100,000 and $250,000 and was Smith's single largest financial asset. Either Smith ignored completely his obligation under 28 U.S.C. § 455(c) and forgot about his largest financial asset, or he knew of his stock in Mid-State and still failed to disclose this financial interest. Either way, this omission seems inexcusable.

[36] 486 U.S. at 861.

[37] Id.

[38] Id. (chiding a district judge for "his failure to disqualify himself and vacate the judgment after he became aware of the appearance of impropriety"); see also Nobel at 236 (letting a ruling stand despite a conflict under 455(a) where "the district judge * * * made a full disclosure on the record of the relevant facts which now serve as the grounds on which new counsel bases the disqualification claim.").

[39] Stock interests in a party or the subject matter of a case are always disqualifying. In contrast, courts have been very hesitant about demanding recusal where a ruling may affect the job prospects of a member of a judge's family. See, e.g., United States v. Microsoft, 530 U.S. 1301 (2000) (Statement of Chief Justice Rehnquist).

[40] See Liljeberg, 486 U.S. at 866 ("by his silence, Judge Collins deprived respondent of a basis for making a timely motion for a new trial and also deprived it of an issue on direct appeal.") As noted above, litigants and their counsel "should be able to rely upon judges to comply with their own Canons of Ethics" and thus are asked to refrain from "por[ing] through a judge's private affairs and personal matters.")

[41] The orders issued by Judge Smith in U.S. v. Black were procedural and did not substantially benefit either party. Conflict laws, however, make it clear that a disqualified judge is prohibited from making any ruling, no matter how minor and or how unlikely to affect the judge's interests.

[42] Keystone (the holding company in which Smith held stock) was named directly because, by this point, it was clear that Keystone participated directly in Black's fraud. See Bald Eagle Area School District v. Keystone Financial, Inc. 189 F.3d 321, 326 n. 6 (3d Cir. 1999) ("Keystone is Mid-State's corporate parent. Keystone, through its division known as Keystone Financial Trust Operations ("KFTO") maintained central trust accounting functions for Mid-State and other Keystone subsidiaries. Among other things, KFTO processed and accounted for trades, and posted income and other transactions for Mid-State, Devon and FMS. KFTO also prepared and printed account statements for the trust and custodian accounts of its subsidiaries, including Mid-State.”).

[43] Tyrone Area School District v. Mid-State Bank & Trust Co., No. 98-CV-881 (W.D. Pa. 1998).

[44] Izzo v. Mid-State Bank & Trust Co., No. 98-CV-755 (W.D. Pa. 1998).

[45] Two of these three lawsuits were decided by Judge Ambrose of the Western District, the judge that took over SEC v. Black when Judge Smith recused. While U.S. v. Black was before Judge Smith, the Third Circuit on August 31, 1999 issued a published opinion in Bald Eagle Area School District v. Keystone Financial, Inc. 189 F.3d 321 (3d Cir. 1999). While dismissing Bald Eagle's RICO suit in light of a recent passage of the Private Securities Litigation Reform Act (which barred bringing civil securities fraud suits under RICO), the Third Circuit explained in detail Mid-State's central role in Black's fraud. Id. at 323-26. District Court judges receive copies of all published Third Circuit opinions soon after they are issued because these cases constitute binding precedent.

[46] See Keystone Financial, Inc. 10-Q filing (Nov. 13, 1998).

[47] This is clear both from his recusal order in SEC v. Black and the indictment in U.S. v. Black.

[48] "I reviewed the lengthy indictment when this case was first assigned to me. While mindful of my earlier recusal, I still could not conclude that the allegations, by themselves, provided sufficient basis to hand off what I considered my duty." Memorandum Order at 2 ( Nov. 1, 1999 ).

[49] "On July 13, 1999 , I met in chambers with defendant Black's attorney and with the United States Attorney assigned to this case. * * * No issue of recusal was raised at that time either by this court or counsel." Memorandum Order at 2-3 (Nov. 1, 1999).

[50] See ABA Model Code of Judicial Conduct, Canon 3(E)(1) cmt. (2000) ("A judge should disclose on the record information that the judge believes the parties or their lawyers might consider relevant to the issue of disqualification, even if the judge believes there is no real basis for disqualification."); American Textile Mfrs. Inst. v. The Limited, 190 F.3d 729 (6^th Cir. 1999) ("judges have an ethical duty to 'disclose on the record information which the judge believes the parties or their lawyers might consider relevant to the question of disqualification.'" (quoting Porter v. Singletary, 49 F.3d 1483, 1489 (11th Cir. 1995)).

[51] Recusal motions are inherently risky endeavors: no litigant wants to end up litigating a case before a judge they have accused of bias.

[52] The recusal motion also notes that "the Court and Mr. Black's families have been acquainted for a number of years" and that the "Court grew up in Tyrone and went to Tyrone's public schools (Tyrone was one of the school district's defrauded by Black and Mid-State)" and that the "Court's parents own a home in the Tyrone School district and pay property taxes to support the school district." See Memorandum Order at 3-4; Revised Memorandum of Law in Support of Defendant’s Motion for Recusal at 4.

[53] Revised Memorandum of Law in Support of Defendant’s Motion for Recusal at 3-4 (Oct. 28, 1999) (“Since the Court [recused in SEC v. Black], MSB [Mid-State Bank] has been sued in a number of cases by school districts that claim to have lost money by investing with [Black]. In those actions the plaintiff school districts seek to recover tens of millions of dollars of compensatory and punitive damages from MSB. These school districts claim that MSB committed fraud and breached its fiduciary obligations. Obviously, MSB officials would have been crucial witnesses had the SEC action gone to trial and their role will be similarly critical in the upcoming criminal and civil trials.”).

[54] See generally, John P. Frank, Clement Haynsworth, the Senate, and the Supreme Court (U.Va Press, 1991).

[55] Then-Judge Breyer, at the time on the First Circuit, was a “name” in one particular syndicate of Lloyds of London. His syndicate provided “reinsurance” for certain insurance companies in the U.S. that, in turn, insured certain U.S. companies against liabilities incurred in environmental and other claims. Judge Breyer had issued several rulings rejecting environmental claims against U.S companies (none known to be reinsured by Breyer’s syndicate) and it was alleged that, in doing so, Judge Breyer advanced his financial interests (by shielding his Lloyds syndicate from potential liability). One professor of legal ethics testified that these rulings violated 28 U.S.C. 455, although this conclusion was rejected by many other respected ethics experts.

[56] Supreme Court Nomination Hearing for Stephen G. Breyer: Hearing of the Senate Judiciary Committee, 103^rd Cong. (July 14, 1994) (Sen. Arlen Specter (R-PA): “And the question which comes to my mind is whether there are not ramifications which bear on public confidence which should lead us to take another look at the language of the disqualification statute, which calls for disqualification, recusal, on a number of situations. One is, quote, "any other interest that could be substantially affected by the outcome of the proceedings." So that if a judge is to decide Superfund liability, even though it doesn't involve Lloyd's, the judge doesn't have an interest in any corporation, not a party, but those principles could affect a company in which the judge does have an interest, that a broader look ought to be undertaken.” (emphasis added)).