Fed Unveils Stricter Trading Rules Amid Fallout From Ethics Scandal

The Federal Reserve unveiled a sweeping set of changes to its ethics practices on Thursday, outlining new rules governing the types of financial securities that policymakers can own and how they can trade them in response to an ethics scandal that has embroiled the central bank.

Senior Fed officials will not be allowed to hold individual stocks or other securities, and will instead be limited to purchasing diversified investment vehicles like mutual funds, the Fed said in an announcement. Trading activity will be limited in general, and during periods of heightened financial market stress the Fed will declare official trading blackouts.

The announcement amounted to rough guidelines and principles, ones that will be fleshed out and incorporated into official Fed rules in the weeks and months to come. It came as the Fed continued to grapple with fallout from trades made by two regional reserve bank officials in 2020, a year in which the central bank took extraordinary steps to rescue financial markets amid the pandemic.

Robert S. Kaplan traded millions of dollars’ worth of oil and gas stocks and other individual company shares last year while he was head of the Federal Reserve Bank of Dallas, transactions first reported by The Wall Street Journal last month. His colleague, Eric S. Rosengren, bought and sold securities tied to real estate — which are sensitive to Fed policy — in 2020 while running the Federal Reserve Bank of Boston. Both resigned after news of their trades broke and ignited backlash. Mr. Rosengren cited health issues as his reason for retiring early while Mr. Kaplan said he did not want controversy surrounding the transactions to distract from the Fed’s work.

The trades have become a political problem for Jerome H. Powell, the Fed chair, who has faced mounting criticism just as he waits to learn whether the White House will reappoint him as the head of the central bank.

The fact that central bank officials were able to engage in trading in a year when the Fed was actively propping up markets struck many politicians, academics and even former Fed employees as inappropriate because policymakers are privy to vast amounts of financial market information. Democrats and watchdog groups in particular have questioned the Fed’s ethics policies and the culture that allowed the financial activity to happen.

Mr. Powell made his displeasure with the situation clear in public remarks last month and promptly ordered a revamp of the Fed’s ethics rules, which culminated in the new guidelines released on Thursday.

Mr. Powell has also asked for an investigation by the Fed’s independent watchdog, which has agreed to carry out a review. It is unclear when that review will be completed.

But scrutiny has persisted. Senator Elizabeth Warren, a Democrat from Massachusetts, sent a letter to Mr. Powell on Thursday asking for documents after The New York Times reported that the Fed’s ethics office in Washington had sent an email to the reserve banks in March 2020. The email suggested that officials should avoid active trading amid market turmoil and rapid-fire Fed action, and officials appear to have heeded the warning in April before some resumed financial activity later that spring.

The Fed released the text of the email on Thursday afternoon. It asked that officials “please consider observing a trading blackout and avoid making unnecessary securities transactions for at least the next several months, or until F.O.M.C. and Board policy actions return to their regularly scheduled timing.” The email showed that Fed officials realized trading could pose issues for the central bank, which was actively backstopping markets.

The Fed’s new rules could help to reassure the central bank’s critics by making trading limitations more standardized. They will apply to presidents at the 12 reserve banks, governors on the Fed’s seven-seat board in Washington, and senior staff, the Fed said. Beyond curtailing stock ownership, they would also prohibit officials from holding investments in individual bonds or investing in derivatives.

“These tough new rules raise the bar high in order to assure the public we serve that all of our senior officials maintain a single-minded focus on the public mission of the Federal Reserve,” Mr. Powell said in a statement.

Officials will also be restricted in their ability to move money around. Policymakers and senior staff “generally” will be required to provide 45 days of advance notice for security purchases and sales, will need to obtain prior approval for such transactions, and will be asked to hold investments for at least one year, the Fed said.

Reserve bank presidents now will be required to publicly disclose financial transactions within 30 days, which Washington-based policymakers already do.

The Fed will incorporate the new restrictions into rules and policies “over the coming months,” according to the release.

“It seems like a big step in the right direction,” said Sarah Binder, a professor of political science at George Washington University and the co-author of a book on the politics of the Fed. “The devil’s in the details of exactly how these get written and defined.”

The new rules still need to be followed up by the planned external investigation, said Kaleb Nygaard, a senior research associate at the Yale Program on Financial Stability who studies the central bank. And it remains to be seen whether they will resolve the public perception that Fed officials might try to profit from their positions.

“This is in line with what people would think they would be — what they should have been — all along,” he said. “Most of the problem was with perception. It’s really inappropriate and really bad. And it’s hard to know if perception-wise, this will be enough.”

The speed of the changes was surprising for the central bank, which is often a slow-moving and contemplative institution, said David Beckworth, a senior research fellow at the Mercatus Center at George Mason University.

“Yes, they were forced into this — being pushed into the spotlight — but I think the scope is also important,” he said, saying that the new rules check necessary boxes. “It’s unfortunate that this is how this came about: They got their hand caught in the cookie jar. It does seem, at first glance, to cross the t’s and dot the i’s.”

Both the ferocity of the backlash to the Fed’s ethics dilemma and the speed of the review might have owed in part to the sensitive timing. Mr. Powell’s term as chair of the Fed ends early next year, and some progressives who do not want to see him reappointed have seized on the trading issues as they argue that the White House should choose someone new.

Better Markets, a financial watchdog group that has ranked among Mr. Powell’s most strident critics, said in a release following the announcement that the rules do not go far enough.

“The policies must be broader and apply to anyone at the Fed who is in possession of material nonpublic information,” Dennis Kelleher, the group’s chief executive officer, said in an emailed statement. He also said that “new policies cannot be used to whitewash the prior bad judgment, failures of leadership, and violation of the Fed’s own policies if not the law.”

But the updated restrictions likely would have prevented the problems the central bank is now confronting had they been in place last year, several academics said.

“These trading rules show how very seriously the Board of Governors has taken the trading scandal,” said Peter Conti-Brown, a Fed and financial historian and legal scholar at the University of Pennsylvania. “These rules would have eliminated the crisis that the Fed is confronting, had they been in place.”

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