The Federal Reserve's internal watchdog has discovered that some regional bank directors received policy briefings around Federal Open Market Committee (FOMC) meetings, with those exchanges potentially involving non-public confidential information and raising concerns about conflicts of interest. The Fed's internal oversight body is warning that regional bank board members may have access to non-public information they should not receive before and after policy meetings, and the central bank needs to strengthen its protective measures.

According to a report released Wednesday by the Office of Inspector General, board members at the 12 regional reserve banks include private bankers and business figures. The watchdog found that some regional bank directors received briefings from policymakers before and after monetary policy meetings, creating the possibility they could obtain confidential information that might be used for personal benefit. The Inspector General's office stated that new directors need to understand their responsibilities, federal conflict-of-interest laws, and related criminal penalties.

How non-public information flows to regional bank directors

Regional reserve bank boards meet regularly to advise the Fed's Board of Governors on the interest rates commercial banks pay when borrowing through the discount window. Boards typically meet with regional bank presidents and other staff, sometimes hearing the president's recommendation on the discount rate. The discount rate is closely tied to the Fed's benchmark policy rate, and regional bank presidents are also members of the monetary policy-setting body.

While policymakers are prohibited from disclosing information about FOMC meetings, the Inspector General's review of meeting minutes between boards and regional bank presidents found instances where "sensitive FOMC information may have been disclosed to directors." The report cited one example where a regional bank president, speaking with directors the day after a policy meeting concluded, engaged in a "broad discussion" covering expected inflation trends and emerging global economic uncertainties. The watchdog believes such forward-looking economic discussions occurring just days after FOMC meetings "may involve non-public confidential information."

The New York Fed previously adjusted its procedures in response to these concerns. In October 2015, the New York Fed modified its board's discount rate discussion process. Meeting minutes show that then-New York Fed President William Dudley told directors that his discount rate recommendation "could be viewed by some as conveying information about whether the FOMC might adjust the federal funds rate." Since then, the New York Fed president has been excluded from the process of recommending discount rates to directors. The report notes it remains unclear whether other regional banks have also excluded their presidents from discount rate discussions with directors.

In a letter responding to the Inspector General's findings, the Fed's Board of Governors disputed these concerns. Board Secretary Benjamin McDonough and two other senior staff members argued that since system staff and policymakers are barred from providing FOMC confidential information to directors, the briefings do not create a risk of directors accessing confidential information. They also defended the briefings, describing them as "important channels for non-confidential information" that help directors fulfill their responsibilities.

Regional bank appointments under renewed scrutiny

The report also extends its examination to the selection processes for regional bank presidents and board members, focusing on conflict-of-interest issues. Governors at the Fed's Washington headquarters are nominated by the U.S. President and confirmed by the Senate, while the process for selecting the 12 regional bank presidents is relatively opaque and has faced ongoing external scrutiny in recent years.

Regional bank presidents are selected by their bank's board, with final candidates requiring approval from the Fed's Board of Governors. Some regional bank presidential selections have taken unusually long, while other appointments have faced questions over perceptions of potential conflicts of interest. The Inspector General recommended that if regional banks hire external headhunting firms to search for candidates, they should monitor and disclose potential conflicts of interest between those firms and candidates. Currently, there is no requirement to identify or report such conflicts.

In late 2022, Austan Goolsbee's nomination as Chicago Fed president drew questions because his wife was an executive at the headhunting firm hired by the Chicago Fed, creating at least a perceived conflict of interest for some observers. The Chicago Fed said at the time that Goolsbee's wife did not participate in that selection process. In 2015, Patrick Harker's appointment as Philadelphia Fed president similarly sparked widespread concerns about a lack of transparency in the selection process. Harker was a Philadelphia Fed board member at the time and participated in the presidential selection. He initially declined consideration but changed his mind after the board's first choice withdrew near the final stage. Subsequently, Congress required greater public participation and transparency in the selection process.

Today, regional bank presidential selections typically include public forums and disclosure of search committee information, though these measures have not significantly shortened the overall process. The Inspector General also found that the selection mechanisms for some regional bank directors could give one class of directors outsized influence over the overall board composition. The investigation found that in 9 of the 12 regional banks, Class A directors representing banks participate in recruiting or approving Class C directors who represent the public interest. Class C directors are appointed by the Fed's Board of Governors. The report argues that "Class A director involvement in Class C director selection could give member banks inappropriate influence over the overall board composition."

The watchdog therefore recommended that the Fed's Board of Governors provide written guidance to regional banks clarifying the selection process for Class C directors. In its response, the Board of Governors said it would further clarify whether and to what extent Class A directors should participate in recruiting potential Class C director candidates.