The guidelines, which were first proposed in October
, were intended to limit the trading activity of top policymakers, their staff, and members of their own immediate family. Since then, the Federal Open Market Committee voted the regulations into force, no doubt hoping to draw a line under the crisis and restore confidence in the central bank.
But what precisely do these new rules entail – and will they be enough to stem the perception that the Fed is nothing but a law unto itself?
What Started It All?
Problems first surfaced in 2020, when a trio of top Fed officials – former Vice Chair of the Federal Reserve, Richard Clarida; former President of the Federal Reserve Bank of Dallas, Robert Steven Kaplan; and former President of the Federal Reserve Bank of Boston, Eric S. Rosengren – were suspected to have breached ethical guidelines in respect to a number of trades made by the three men.
Given that these officials were responsible for decisions as important as setting interest rates and conducting their bank’s COVID-19 emergency lending schemes, the fall-out from the revelations was swift and scathing. Elizabeth Warren, a United States senator from Massachusetts, alluded to a “culture of corruption” at the Fed, with Jerome Powell, chair of the Federal Reserve, quick to request the drawing-up of new ethical rules and standards.
Reaction to the allegations saw both Kaplan and Rosengren step down from their previously held positions. Financial disclosures pertaining to the two officials indicated that the former Fed executives had made considerable profits from trades which took place when the Reserve was desperately implementing moves to stabilize the market in the face of a global pandemic.
Kaplan was reported to have initiated trades that were worth around $1 million at the time in various stocks and funds, including investments in Facebook
(now Meta), Johnson & Johnson
. In addition, Rosengren had allegedly been trading funds that had an interest in mortgage-backed bonds – precisely the same kind of investment that the Fed had been pouring hundreds of billions of dollars’ into in 2021.
It should be noted that the actions of Kaplan and Rosengren were permitted under Fed rules in place at the time. However, the Federal Reserve also cautions against any behavior which appears to raise questions around seeming conflicts of interest.
Richard Clarida’s behavior raised suspicion in February 2020 when he sold over $1 million of shares in a stock fund he owned, only to buy them back again a few days later. Unfortunately, for Clarida, he had just happened to buy them back the day before the Fed announced a major plan to help buffer the economy from the effects of the coronavirus pandemic. Clarida would go on to step down two weeks early from his role at the Fed board of governors.
Calming The Storm
In a bid to stop the ethics scandal from snowballing into a bigger crisis, the Federal Reserve introduced a revised policy that sought to essentially ban any investment by high-ranking officials into individual stocks and bonds
Under the new policy, senior officials are limited to investments only in diversified vehicles such as exchange-traded funds, mutual funds and college savings funds, and must seek prior approval for such trades from ethics officers beforehand. They are also banned from buying or selling any assets in the run-up to policy meetings, and must hold any investments for a minimum of one year.
Furthermore, officials are precluded from purchasing sector-specific funds, commodities, foreign currencies, cryptocurrencies, derivatives contracts, and are not entitled to buy securities on margin or engage in any kind of short selling.
Other rules state that no trading can take place during times of heightened financial stress, and regional presidents must disclose transactions on the basis that staff and officials of the Board of Governors are already currently subject to.
The policies take effect from May 1 this year, and individuals affected by the change have 12 months to divest their prohibited holdings, while new Fed employees will have just six months.
Do The Measures Go Far Enough?
It’s encouraging to see the speed with which the Federal Reserve reacted to these events. Indeed, the rules were unanimously approved when the Federal Open Market Committee met a few weeks ago, and it is hoped that the integrity and impartiality of the Committee’s role can be restored to full public confidence in time.
However, it’s still not clear what sanctions will be available to reprimand officials that fall short of the new policies – and there doesn’t appear to be any oversight process in place to monitor employees. In fact, any alleged violations of the ethics code will only be handled on a case-by-case basis, so it remains to be seen how successful these efforts will be.
The current Fed Chair, Jerome Powell, believes that the new, tougher approach to ethics raises the bar compared to the status quo beforehand. Indeed, the rules now apply to Washington governors and regional bank presidents, as well as members of the Federal Open Market Committee, managers of the Fed’s System Open Market Account, and the husbands, wives and minor children of those affected.
Improper or suspicious financial practices are increasingly becoming an important political matter now, with the highly publicized share-trading successes of some of Capitol Hill’s most prominent political figures having led to calls for greater and more stringent disclosure.
There’s even a bipartisan movement that wants to completely ban members of Congress from trading any stocks at all.
While there’s push back to these plans at the moment, the simple fact that it’s even being discussed in the public square is enough of a signal to demonstrate how strongly felt the issue is.
As the specter of corruption rears its ugly head again, the Fed’s own internal attempts to regulate this unsavory aspect of the markets may ultimately prove futile. With rising inflation and increasing living costs on the horizon, the tolerance of politicians and citizens alike for perceived injustices will wane.
Can Federal Reserve Employees Buy Stocks?
The rules, while robust, still don’t entirely stop Federal Reserve employees from buying stocks. They do, however, make it much more difficult to turn a quick profit, and should discourage the kind of questionable trading practices that got Clarida, Kaplan and Rosengren in trouble in the first place.