Five Questions About the Federal Reserve Trading Scandal

(Bloomberg Opinion) -- The U.S. Federal Reserve has acted swiftly to adopt new rules regarding the investing and trading activities of senior officials, seeking to resolve what has been the most intense ethical scandal in the central bank's 109-year history. Yet questions remain about what went wrong— questions that must be answered before the Fed can move on.

The trouble began in September 2021, when journalists unearthed financial disclosures showing that Fed officials — most egregiously Robert Kaplan, then president of the Dallas Fed — actively traded individual stocks and financial assets in 2020 while the central bank was undertaking vast market interventions to keep the U.S. and global economy afloat. It deepened when then Vice Chair Richard Clarida later disclosed that he had bought at least $1 million of shares in a U.S. stock fund on the eve of a major Fed announcement in February 2020, after selling a similar amount just a few days earlier. Ultimately, Kaplan, Clarida and Eric Rosengren of the Boston Fed resigned, and a number of senior staff came under scrutiny.

Fed Chair Jerome Powell announced the new rules in October, and the central bank's policy-making committee formally adopted them earlier this month. Policy makers and senior staff members are no longer allowed to own individual stocks and bonds or transact in derivatives. Also, they must provide 45 days' non-retractable notice before making any transactions, must hold investments for at least a year and are completely barred from trading “during periods of heightened financial market stress,” as defined by the chair and general counsel of the Fed's Board of Governors.

The rules are well designed, and much tougher than those governing Congress or the judiciary. But they shed no further light on what actually happened. The public needs to know the whole truth about the Fed officials' trading activity, who knew what when, and what, if anything, anyone tried to do about it. To that end, Chair Powell — at the time under consideration for reappointment but not yet nominated nor guaranteed the post — requested that the Fed's Inspector General produce a definitive account, and promised that he would “play no role” in the investigation.

To satisfy the public and the Fed's Congressional overseers, the Inspector General's report should answer the following questions:

Did investigators receive full access to all individuals, institutions and materials involved? This is a real concern because, for example, the reserve banks aren't legally required to adhere to Freedom of Information Act requests.
What were the exact dates of the officials' transactions? The existing disclosures are troublingly vague, simply saying “multiple” for most assets, meaning the officials made more than one trade during the year. The ethical rules of the time forbade active trading in the 13 days surrounding a scheduled meeting of the policy-making Federal Open Market Committee. But the Fed held dozens of emergency meetings in 2020 and took many actions outside of the preset meeting schedule. Also, the ethics officer of the Board of Governors sent a notice to officials in March, warning against making unnecessary trades.
How were the transactions approved? At least three groups of people beyond the officials in question could have been involved: the ethics officers, the general counsel, and the reserve bank boards of directors. The report should detail what these people knew, when they knew it, whether their formal approval was given and why.
What role did the Fed's Board of Governors play? In January 2021, months before the scandal broke but after the transactions had taken place, the board — in a process led by Governor Lael Brainard — approved all 12 reserve bank presidents for another five-year term. Were the transactions part of the review process? Was anyone on the board (other than Clarida) aware of the transactions?
Are the new rules sufficient? Some have argued that they should limit officials to a single asset allocation or require that assets be placed in a qualified blind trust. I think the rules are adequate, that blind trusts are not as effective as they sound and that the marginal benefit of single asset allocation is not worth the cost. But the Inspector General should formally weigh in.

The trading scandal has cast a shadow over the Fed. If the central bank wants to maintain the high degree of political and public support it has historically enjoyed, the Inspector General's report must offer the necessary illumination.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Kaleb Nygaard is a senior research associate at the Yale Program on Financial Stability and the host of two podcasts, "The Bankster" and "The Reserve."