Federal Reserve Tightens Rules on Trading by Officials

The Federal Open Market Committee (FOMC) announced on Feb. 18, 2022, that it had voted unanimously a day earlier to adopt formally a set of comprehensive new rules to govern the investment and trading activity of senior officials of the Federal Reserve System (FRS). These rules, first announced on Oct. 21, 2021, “aim to support public confidence in the impartiality and integrity of the Committee’s work by guarding against even the appearance of any conflict of interest,” per the Fed’s press release.

The new rules were crafted in response to scandals that forced the resignation of two regional Federal Reserve Bank presidents. Both had made trades while the COVID-19 crisis unfolded in 2020 that had the appearance of being based on their inside knowledge of Federal Reserve policy initiatives.

Stated Purpose

The Fed’s press release includes a detailed five-page document presenting the new rules, which were adopted on Feb. 17, 2022 and become effective (with one exception) on May 1, 2022. In its opening section, the document states: “The Federal Open Market Committee (the ‘Committee’) is committed to upholding the highest standards of ethical conduct. Public trust is critical to the successful execution of the Committee’s monetary policy responsibilities. The Committee is therefore adopting stringent restrictions on the investment and trading activities of covered individuals to ensure public confidence in the impartiality and integrity of the Committee’s work.”

Prohibited Activities

Under to new rules, senior Federal Reserve officials may not purchase individual stocks or sector funds. They may not hold investments in individual bonds, federal agency securities, cryptocurrencies, commodities, or foreign currencies. They may not enter into derivatives contracts, engage in short sales, or purchase securities on margin.

Prohibited derivates contracts include, among others, futures, swaps, warrants, and options.

All purchases and sales will be prohibited during “periods of heightened financial market stress.” Existing rules already prohibit Federal Reserve officials from holding bank stocks and U.S. Treasury securities, as well as from engaging in any financial transactions during the blackout periods that surround FOMC meetings. The new rules extend the financial trading blackout period around regularly scheduled FOMC meetings by one day following each meeting to align it with the FOMC’s external communication blackout period.

Exemptions

While holdings of U.S. Treasury Bonds and U.S. Treasury Notes are prohibited, holdings of U.S. Treasury Bills are not. However, they must be held to maturity. Money market mutual funds concentrating on U.S. government securities are also exempt.

Equity securities and equity options of a covered individual’s spouse that are acquired or held in connection with the spouse’s employment are exempt.

Assets held in various defined benefit or defined contribution retirement plans are exempt. Regarding the latter, those established by the federal government are exempt.

Commodities or foreign currencies that are owned for non-investment purposes are exempt.

Exempted trades include: equity securities issued by small businesses, including small family farms; money market mutual funds; qualifying automatic trades; and untaxed distributions from 529 plans, health savings accounts (HSAs), or other similar accounts.

Required Disclosures and Approvals

Senior Federal Reserve officials must provide “non-retractable notice” 45 days in advance of any purchases and sales of securities, obtain prior approval for such transactions, and hold investments for at least one year.

The advance notice must identify the security that will be sold or purchased, the amount or value of the security that will be traded, and a trade date window of no more than seven calendar days for the transaction.

In general, the new rules requiring advance notice and prior approval of securities transactions do not apply to the sorts of exempt securities and transactions listed above. They also do not apply to sales of securities that are necessary for compliance with other ethics laws, rules, or policies.

When the new policy takes effect, regional Federal Reserve Bank presidents must publicly disclose securities transactions within 30 days. This rule already applies to Federal Reserve Board (FRB) members and senior FRB staff. In some cases, the delay may be 45 days.

Financial disclosures filed by regional Federal Reserve Bank presidents will be posted “promptly” on the website of the relevant Reserve Bank. Financial disclosures filed by FRB members will continue to be available on the website of the Office of Government Ethics.

Who’s Covered

Besides FRB members and regional Federal Reserve Bank presidents, the new rules also apply to regional Federal Reserve Bank first vice presidents, regional Federal Reserve Bank research directors, FOMC staff officers, the manager and deputy manager of the System Open Market Account (SOMA), FRB division directors who regularly attend FOMC meetings, any other individual designated by the FRB Chair, and the spouses and minor children of these individuals. Additional staff will become subject to all or parts of these rules after further review and analysis.

The new rules also apply to trusts in which a covered individual or a covered individual’s spouse is the trustee or fiduciary, or otherwise exercises discretionary authority or control over its assets. Some of these “covered trusts,” however, may receive waivers from the appropriate ethics officials.

Effective Dates

The new rules will take effect on May 1, 2022, except that the requirements for advance notice and pre-clearance of transactions will take effect on July 1, 2022. Officials covered by the new rules will have 12 months from the effective date of the rules to dispose of all impermissible holdings, Going forward, newly covered officials will have six months to dispose of all impermissible holdings. The FRB also will vote on changing the codes of conduct at the regional Federal Reserve Banks to conform with the new rules.