May 7 (Bloomberg) -- Stephen Friedman, chairman of the New York Federal Reserve Bank’s board of directors, resigned from his position effective immediately to avoid the appearance of a conflict of interest.

Friedman, a retired chairman and current member of Goldman Sachs Group Inc.’s board, had been granted a waiver to keep serving after Goldman Sachs became a bank holding company in September, a change that would have normally barred Friedman from serving as a director appointed to represent the public. Last month, he planned to depart at the end of the year.

A former economic adviser under President George W. Bush, Friedman leaves after calls by U.S. lawmakers for greater scrutiny of the regional Fed banks and the appointment of the institutions’ presidents. His purchases of Goldman Sachs shares in December and January were criticized by a senator.

“Although I have been in compliance with the rules, my public service-motivated continuation on the Reserve Bank Board is being mischaracterized as improper,” Friedman said in a letter to Fed officials, posted today on the New York Fed’s Web site. “The Federal Reserve System has important work to do and does not need this distraction.”

Denis Hughes, formerly the board’s deputy chair, is serving as acting chair, the New York Fed said in a statement. Friedman led the search committee for the bank’s new president after Timothy Geithner’s departure to become Treasury Secretary. The New York Fed appointed William Dudley, a former Goldman economist, as president in January.

Advisory Board

Friedman didn’t immediately respond to a request for comment. He also served as director of the National Economic Council in the Bush administration from 2002 to 2004, and as chairman of the President’s Foreign Intelligence Advisory Board.

“Steve Friedman is a valued member of our board and we look forward to continuing to benefit from his insight and guidance,” said Lucas van Praag, a Goldman Sachs spokesman.

Thomas Baxter, general counsel of the New York Fed, said in the Fed’s statement that Friedman’s purchases of Goldman shares in December and January, “did not violate any Federal Reserve statute, rule or policy.”

Senator Richard Shelby of Alabama, the ranking Republican on the Senate Banking Committee, said Friedman’s purchases of Goldman stock were “deeply disturbing,” according to an article this week in the Wall Street Journal.

‘Right Thing’

Resigning is the “right thing for him to do,” said former St. Louis Fed President William Poole, who is now a senior fellow with the Cato Institute. “At the St. Louis Fed, we absolutely would never have considered making an exception.”

Poole, a Bloomberg contributor, said he was “astonished” to learn of Friedman’s situation from news reports. “It does seem to me to be totally inconsistent with the plain language of the Federal Reserve Act.”

The Senate passed a nonbinding budget amendment by a 96-2 vote last month that in part called for “an evaluation of the appropriate number and the associated costs” of the regional Fed banks. The measure was proposed by Shelby and Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat.

Massachusetts Representative Barney Frank, chairman of the House Financial Services Committee, said last year that he planned to probe how the 12 regional Fed presidents are appointed and their role in setting interest rates.

Private Entities

The New York Fed is one of 12 regional Fed banks which, along with the Board of Governors, make up the Federal Reserve system. They are private entities, each run by a nine-member board of directors.

Friedman, who runs the investment firm Stone Point Capital LLC in New York, was chosen for a three-year term as a Class C director of the Fed bank board in 2008, one of three directors appointed by the Fed’s Board of Governors to represent the public.

Fed rules bar bank executives or stockholders from serving as Class C directors. Goldman Sachs changed its legal status and became a bank holding company in September 2008. At the time, Friedman was granted a waiver to continue serving on the board until the end of 2009.

Along with Class C directors, Class A directors are elected by and represent member banks; and Class B directors are elected by member banks to represent the public. The chairman of the board is a Class C director. The board chooses a bank president.

“Goldman Sachs is like a fraternity,” said Marilyn Cohen, president of Envision Capital Management in Los Angeles. “Everyone seems conflicted every which way. To have the New York Fed chairman making decisions about a company in which he owns shares is unconscionable. At least Friedman understood that it’s over.”

Hughes is president of the New York State AFL-CIO, a position he’s held since 1999.

Friedman’s departure creates a third vacancy on the New York Fed’s board. Other members include JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, General Electric Co. CEO Jeffrey Immelt and Columbia University President Lee Bollinger.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.

Last Updated: May 7, 2009 19:56 EDT