November 25, 2009 / 3:04 PM / 10 years ago

In nod to critics, Fed restricts stock ownership

WASHINGTON (Reuters) - The Federal Reserve said on Wednesday it will no longer allow directors at regional Fed banks to own shares in financial firms, following controversy over a former Goldman Sachs CEO who bought that firm’s stock while leading the New York Fed’s Board.

The decision comes as the central bank’s future hangs in the balance, with reform bills in the House of Representatives and Senate envisioning vastly different functions for the institution.

It was the latest effort by the Fed to respond to an eruption of criticism it has been too cozy with Wall Street and failed to do enough to protect consumers from risky lending practices.

“It tells me they are feeling a little bit squeezed,” said Paul Markowski, president of Global Research Partners in Goldens Bridge, N.Y.

In May, Stephen Friedman, the former head of investment giant Goldman Sachs, resigned from his role as chairman of the board of the New York Federal Reserve Bank after concerns emerged over his ownership of Goldman stock.

Under prior rules, regional Fed directors selected by the central bank’s Board of Governors, such as Friedman, were barred from owning shares in Fed-regulated banks.

In Friedman’s case, his ownership of Goldman stock came to violate that policy once the firm, gripped by the financial crisis, was forced to become a bank holding company in order to qualify for direct aid from both Treasury and the Fed.

With this experience in mind, the new share ownership rules encompass a broader definition of stock that cannot be held.

The episode proved embarrassing for the central bank and spurred an internal Fed review of its governance practices aimed at weeding out any potential conflicts of interest. The New York Fed played an instrumental role in rescuing Wall Street, helping Goldman’s stock post a rapid recovery.

A proposal by Senator Christopher Dodd of Connecticut would no longer allow regional Fed directors to be appointed by the banks they supervise. Instead, the chairmen of the regional boards would be appointed directly by the U.S. president.

The new regulations will apply to all the directors of the Fed’s 12 regional banks, including those who are intended to represent the public interest. Previously, those directors, who cannot be officers, directors or employees of a bank, faced no restriction on holding bank stock.

The prohibitions were extended “to encompass bank holding companies and other financially related entities to ensure that Reserve Bank boards reflect an appropriate cross section of industry and the public,” the Fed said in a statement.

In addition, if an officer owns stock in a nonfinancial firm that begins to issue financial shares, he or she must either sell the stock or resign from the board, the Fed said.

Reporting by Pedro Nicolaci da Costa and David Lawder; Editing by Andrew Hay

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