New York Fed Fails to Amend Conflict Rules After Dudley Waiver

The Federal Reserve Bank of New York failed to revise conflict-of-interest rules to reflect its responsibility for a broader array of financial firms under the Dodd-Frank Act passed a year ago, the Government Accountability Office said yesterday.

The New York Fed hasn’t changed its “policies and procedures to more fully reflect potential conflicts that could arise with this expanded role,” the GAO said in a report. It showed that a New York Fed official, separately identified as William C. Dudley, now the bank’s president, received a waiver in 2008 to keep shares of insurer American International Group Inc. after it was bailed out by the central bank.

Fed staff will be involved in overseeing a wider range of companies after Dodd-Frank gave it authority over non-bank firms, such as insurers, whose failure could pose a risk to the financial system. That may give rise to potential conflicts like the one involving the ownership of AIG shares by Dudley, who was head of the New York Fed’s markets group in 2008.

“They should simply say that staff -- at least senior staff -- must sell stock in all financial services firms,” said Richard Painter, former White House ethics lawyer for President George W. Bush. “If one waits until a crisis arises, insider-trading law may make it impossible to sell. And recusal may not be a good option for the most senior officials. Waiver of the conflict looks bad -- very bad.”

Stability Council

The Dodd-Frank Act created the Financial Stability Oversight Council, which must designate systemically important firms, and the Fed could require those firms to raise capital and reduce risky practices. General Electric Co. has said it expects its finance units, which include GE Capital Corp., to be subject to Fed regulation. The act was named for its principal authors, Representative Barney Frank of Massachusetts and former Senator Christopher Dodd of Connecticut, both Democrats.

Fed Chairman Ben S. Bernanke has also broadened financial stability responsibility across more divisions inside the central bank. The Fed board’s economic division directors, for example, now have a seat on the Large Institution Supervision Coordinating Committee, which oversees banks such as JPMorgan Chase & Co. and Citigroup Inc.

New York Fed employees are “not permitted to own or control investments in depository institutions or affiliates of depository institutions,” according to the Fed bank’s website. Members of the markets group, which buys and sells securities to carry out monetary policy, are also forbidden to own stock in so-called primary dealers. The 20 primary dealers are counterparties to the central bank’s transactions and include Morgan Stanley and MF Global Holdings Ltd.

Not Expanded

Investment restrictions “continue to focus on traditional Reserve Bank counterparties -- depository institutions or their affiliates and primary dealers,” the GAO said. They “have not been expanded to further restrict employees’ financial interests in certain nonbank institutions that have participated in FRBNY emergency programs and could become eligible for future ones.”

Complying with this recommendation by “expanding the list of restricted investments to address all potential conflicts would be difficult,” Fed Board staff told the GAO.

Still, Scott Alvarez, the Fed Board’s general counsel, said in a letter accompanying the report that the Washington-based Federal Reserve Board and its 12 regional banks will give the GAO’s recommendations “serious attention.” The GAO also said Fed staffers plan “to review and update the Reserve Banks’ Codes of Conduct as needed.”

Identified by Sanders

Dudley, who wasn’t named in the GAO report, was identified by Senator Bernard Sanders, an independent from Vermont. Warren Gunnels, a senior policy adviser for Sanders, said in a telephone interview from Washington that he reviewed the GAO audit before its publication and asked the agency to name the official “to make sure the American people had the most transparent information possible about this report.”

“The Fed has no comprehensive system in place to mitigate the tremendous conflicts of interest that exist,” Gunnels said.

Jack Gutt, a spokesman for the New York Fed, declined to comment on the institution’s policies.

Dudley’s holdings predated his employment at the New York Fed, and he sold his shares after becoming president in January 2009, which was about four months after AIG’s rescue, Gutt said in an e-mailed statement. He received a waiver in part because “had he sold these shares immediately after the interventions it would have the appearance of a conflict,” Gutt said.

The waiver allowed Dudley to keep investments in AIG and General Electric, whose combined value comprised “less than 5 percent of the official’s total financial holdings,” the GAO said. The agency “did not assess the appropriateness” of the decisions to grant waivers and said that “these decisions are case-specific and necessarily require subjective judgments.”

Focus on New York

The GAO said its review of conflict of interest issues for employees focused on the New York Fed, which carried out most of the central bank’s emergency lending programs.

New York Fed ethics lawyers should have ordered Dudley to dispose of his shares before joining the bank, said Painter, a law professor at the University of Minnesota in Minneapolis who advised the Bush administration on then-Treasury Secretary Henry Paulson’s sale of stock in his previous employer, Goldman Sachs Group Inc.

The Fed on Sept. 16, 2008, authorized an $85 billion loan to New York-based AIG to avert the company’s collapse, one day after Lehman Brothers Holdings Inc. filed the largest bankruptcy in U.S. history. The bailout later was expanded to include $182 billion in aid from the U.S. Treasury and the Fed.

The GAO said the Dudley example “highlights the potential for appearance concerns” even if the stake is a small percentage of the person’s total holdings. New York Fed employees who requested permission to retain holdings in companies receiving assistance were “generally allowed” to keep the investments, the GAO said.

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