Bloomberg News

GAO Says Fed Banks Can Improve Conflicts Policy, Diversity

October 19, 2011

(Updates with Bernanke response in sixth paragraph, adds emergency lending programs in paragraphs 10-12.)

Oct. 19 (Bloomberg) -- The Federal Reserve needs to improve transparency at its regional banks and strengthen policies governing conflicts of interest, a Government Accountability Office report found.

The report, released today in Washington, recommended that all 12 reserve banks “clearly document the roles and responsibilities of the directors, including restrictions on their involvement in supervision and regulation activities, in their bylaws.” It also highlighted the lack of economic and racial diversity on reserve bank boards.

Senator Bernard Sanders, a Vermont Independent, said the GAO’s findings pointed to an “unacceptable” level of influence by financial leaders over their regulators. “Not only do they run the banks, they run the institutions that regulate the banks,” Sanders said in an emailed statement. Sanders wrote the legislation requiring the audit in the Dodd-Frank Act passed last year.

The report made four recommendations aimed at enhancing diversity of Federal Reserve bank boards, strengthening policies for managing conflicts of interest and enhancing transparency. One recommendation calls on the reserve banks to “make public key governance documents, such as bylaws, ethics policies, and committee assignments by posting them to their Web sites.”

The report also urged the Fed to “broaden their pools of potential candidates for directors, such as including officers who are below the senior executive level at their organizations.”

Make Waivers Public

The report said that reserve banks need to describe and disclose the restrictions on and roles of directors, and make any waivers they are granted public. Finally, reserve banks should make more information about directors, such as eligibility requirements, publicly available.

Fed Chairman Ben S. Bernanke, in a reply included with the report, said the recommendations “all have merit” and the Fed “will work to implement each of them.”

Bernanke noted that the report found there “was no special treatment” of firms in loans through the discount window or through emergency lending facilities. Further, the report found no instance where a director was involved in a supervisory matter related to an institution where that director may have had an affiliation, the Fed chairman said in his letter.

Issue in Congress

The governance of Fed banks is still an issue in Congress, where the senior Democrat on the House Financial Services Committee, Barney Frank of Massachusetts, wants to eliminate reserve bank presidents’ votes on monetary policy decisions.

Of the five regional presidents who are currently voting members of the Federal Open Market Committee, the Fed panel that sets interest rates, “all of them were selected by boards where representatives of private and financial institutions account for the majority of board members,” Frank said in a memo released on the House committee’s Web site.

The Fed revised its rules for reserve bank directors in 2009 after potential conflicts emerged during the 2008-2009 financial crisis involving former Goldman Sachs Group Inc. Chairman Stephen Friedman. Even so, the GAO said, the Fed needs to take “additional steps to strengthen controls designed to manage conflicts of interest” and to increase public disclosure of directors’ roles and responsibilities.

‘Appearance of Conflict’

The GAO said director representation as mandated by the Federal Reserve Act “creates an appearance of conflict of interest.” This is because so-called Class A directors represent member banks, and Class B directors are elected by member banks. Class A and B directors might own stock in banks that are supervised by the Fed “while also overseeing aspects of the reserve banks’ operations, including the bank presidents’ evaluation and salary and personnel decisions for the supervision and regulation function,” the report said.

The report focused on the governance role of directors at reserve banks. Some of the institutions that borrowed from the Fed’s emergency programs, which included $3.3 trillion in aid provided to stem the worst financial panic since the Great Depression, had senior officers and stockholders serving on Fed bank boards, the report said.

These relationships “contributed to questions” about Fed bank governance and conflicts of interest, the report said. “We identified at least 18 former and current Class A, B and C directors from nine reserve banks who were affiliated with institutions that used at least one emergency program,” the report said.

‘Reputational Risk’

Before Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008, Chief Executive Officer Richard Fuld met with then-New York Fed President Timothy F. Geithner and “the chairman about Lehman’s deteriorating financial condition, without the full board, and concluded that FRBNY faced reputational risk regardless of the action taken,” the report said.

“Under Federal Reserve Board practice, Reserve Bank directors affiliated with troubled financial institutions are encouraged to resign or risk removal from the board,” the GAO said. Fed officials told the GAO that Fuld “voluntarily” resigned before Lehman Brothers went bankrupt, the report said.

Each of the Fed’s 12 regional banks has a nine-member board of directors, or 108 directors for the total system. The GAO surveyed 91 of the directors and found that 56 had at least some experience in the financial industry and 86 also held board positions at public and private companies, public and private universities, and nonprofit organizations.

Emergency Programs

The GAO said its review “did not reveal that Reserve Bank directors received nonpublic information on the emergency programs.” The GAO said it reviewed minutes from the meetings and said that discussion of emergency programs occurred after their public announcement.

The report said the regional banks have no requirements for directors to periodically disclose their financial interests, though directors who do not represent banks are required to submit annual certifications that they have no prohibited affiliations.

Though directors can seek waivers from the Fed’s board of governors in Washington when conflicts arise, the GAO said there is no standardized procedure at the regional banks for waiver requests.

“Without a formal process in place to consider a request for a waiver from Federal Reserve Board policies, reserve banks risk inconsistent treatment of requests and being exposed to questions about their governance practice and the integrity of their decisions and actions,” the report said. “A crisis situation may create unanticipated conflicts without providing time for comprehensive actions before a decision must be made.”

Publicizing Waivers

The report said the central bank should publicize all such waivers, noting that this requirement applies to public companies listed on the New York Stock Exchange.

The report recommended that the Federal Reserve Board encourage reserve banks to consider ways to broaden the pools of potential candidates for directors. It found that minorities accounted for 15 of 108 director positions in 2010, three of which were minority women.

“The Federal Reserve Board has made it a priority to encourage selection of directors that represent broad and diverse perspectives,” Bernanke said in his written response. “We will continue to explore ways that the Federal Reserve can broaden the pool of potential candidates.”

--With assistance from Joshua Zumbrun in Washington. Editors: Gail DeGeorge, Christopher Wellisz,

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Joshua Zumbrun in Washington at jzumbrun@bloomberg.net; Caroline Salas Gage in New York at csalas1@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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