Fed Ethics Office Warned Officials to Curb Unnecessary Trading During Rescue

On March 23 last year, as the Federal Reserve was taking extraordinary steps to shore up financial markets at the onset of the pandemic, the central bank’s ethics office in Washington sent out a warning.

Officials might want to avoid unnecessary trading for a few months as the Fed dived deeper into markets, the Board of Governors’ ethics unit suggested in an email, a message that was passed along to regional bank presidents by their own ethics officers.

The guidance came just as the Fed was unveiling a sweeping rescue package aimed at backstopping or rescuing markets, including those for corporate bonds and midsize-business debt. It appears to have been heeded: Most regional presidents and governors of the Fed did not engage in active trading in April, based on their disclosures.

But the recommendation, which was confirmed by a person who saw the email, did not go far enough to prevent a trading scandal that is now engulfing the Fed and being leveraged against its chair, Jerome H. Powell, as the White House mulls whether to reappoint him before his leadership term expires early next year.

The email could pose further trouble for the Fed, which declined to provide a copy, because it shows that central bank ethics officers — and officials in general — were aware that active trading could look bad when the Fed was taking emergency action to try to save markets and its policymakers had vast access to sensitive information. Despite the early warning, some top officials resumed trading after the most proactive phase of the Fed’s rescue ended, based on financial disclosures and background comments from regional bank spokespeople.

Financial disclosures, first reported by The Wall Street Journal, showed that Robert S. Kaplan traded millions of dollars’ worth of individual stocks last year while he was head of the Federal Reserve Bank of Dallas. No dates are provided for those purchases and sales, but a Dallas Fed spokesman has said they did not take place between late March and the end of April.

Another Fed official, Eric S. Rosengren, bought and sold securities tied to real estate while running the Federal Reserve Bank of Boston. Such securities are sensitive to Fed policy, and involve a market that Mr. Rosengren himself warned about in public speeches last year. His trading resumed in May, his disclosures show.

Both Mr. Kaplan and Mr. Rosengren have since resigned from their positions, with Mr. Kaplan saying he did not want controversy around his transactions to distract from the Fed’s work and Mr. Rosengren citing health issues.

While attention to the Fed’s ethics rules — and trading habits — started with its 12 regional branches, journalists and academics have begun to re-examine previously reported trades by Fed officials who sit on its board in Washington.

Richard H. Clarida, the Fed’s vice chair, rebalanced a portfolio toward stocks in late February 2020, just before the Fed signaled that it stood ready to help markets and the economy in the face of the coronavirus pandemic. The timing has raised questions, though the transactions were in line with previous trading he had done. The vice chair has since said he has always acted “honorably and with integrity” while in public office.

Mr. Powell also has faced backlash, primarily from progressives who do not want him reappointed, for selling holdings in a popular and broad stock index last October. The Fed was not rolling out new rescue programs at that time, and a spokeswoman has said Mr. Powell sold the holdings to pay for family expenses. Mr. Powell’s critics argue that he should not have made active financial transactions at all last year.

As the ethics controversy swells, the Fed has been working to stem the fallout.

Mr. Kaplan and Mr. Rosengren announced last month that they would step down, and Mr. Powell has said that “no one is happy” with the situation. He started a review of Fed ethics rules shortly after news of the presidents’ trading broke. He has also asked an independent watchdog to investigate the trades to make sure they complied with ethics rules and the law.

But scrutiny has persisted, in part because Mr. Powell is up for reappointment.

“It speaks to governance, incentives and general attitude,” said Simon Johnson, an economist at the Massachusetts Institute of Technology who previously wrote a post for Project Syndicate supporting Lael Brainard, a leading contender to replace Mr. Powell.

Mr. Johnson, who does not personally know Ms. Brainard, a Fed governor, has been among those flagging Mr. Powell’s transaction to journalists. He has focused on the fact that Mr. Powell sold a stock-based fund while he was in regular contact with the Treasury secretary during an active year for the central bank, and said he thought the trading scandal should factor into the Fed chair’s reappointment chances.

“Presumably, someone in the White House will pay attention and look at the details,” Mr. Johnson said.

Mr. Powell’s October transaction and the questions about it highlight that there is no time when Fed chairs can safely sell assets to raise cash should they need it, said Peter Conti-Brown, a professor and Fed historian at the University of Pennsylvania. That reinforces the need to update the Fed’s rules to eliminate any appearance of conflict by taking discretion away from officials, he said.

“It’s hard for me to fault him that he did it when he did it,” Mr. Conti-Brown said, later adding that “it would be more a scandal for this trade to end Chair Powell’s career as a central banker.”

The board’s March 23 guidance appears to have had some effect, because central bank officials overall conducted little or no active trading during the period last year when they were most active in markets, in March and April.

Mr. Powell’s only dated transactions came in September, October and December. Mr. Clarida’s came in February and August. Ms. Brainard did not report any transactions last year.

Randal K. Quarles, the Fed’s vice chair for supervision at the time, is shown to have bought a financial stake in a fund in early April; a family trust that his wife has an interest in bought an interest in a fund, which the couple sold before the fund purchased any securities, a Fed spokesperson said. Michelle Bowman, a Fed governor, noted a small sale in mid-April. That came from a retirement fund held in her spouse’s health savings account, and reflected the account’s closing as her husband changed jobs, a Fed spokesman said.

At the regional banks, the heads in San Francisco, Minneapolis, Chicago, St. Louis and Kansas City, Mo., noted no disclosures or only college savings plan and retirement contributions last year. John C. Williams, the president of the powerful New York Fed, reported one personal transaction in December.

The Fed president in Richmond, Va., reported private equity and bond transactions in July and August, and the Atlanta Fed president helped buy a property in Utah in June. The Cleveland Fed president reported buying index fund shares in February, but then stopped until November.

The Philadelphia Fed president made several relatively small transactions throughout April and the year, but a spokeswoman for his bank said the spring trades were not active. They involved an automatic liquidation from a legacy fund that occurs every year, an automatic dividend reinvestment and a bond call.

The fact that trading more or less halted last spring is a silver lining, Mr. Conti-Brown said. Regional reserve banks are quasi-private institutions, so it is not unambiguously clear that they must listen to the Board of Governors on such matters.

“This tells us that the board’s ability to oversee ethics in the system is there,” he said. “What is missing is a better set of rules.”