To determine the extent to which the current system of appointing Reserve Bank directors effectively ensures that they are elected without discrimination on the basis of race, creed, color, sex, or national origin, and that, for some directors, they are elected with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers, as required by section 4 of the Federal Reserve Act, we reviewed the Reserve Banks’ processes for identification, nomination, and selection of directors. We created a descriptive profile of the demographic characteristics, including race, gender, and industry, of Reserve Bank directors from 2006 through 2010. We used (1) the demographic characteristics of directors obtained from the Federal Reserve Board, and (2) the demographic characteristics of executives who would likely meet the criteria for potential directors using Equal Employment Opportunity Commission (EEOC) data. We determined whether the diversity trends of Reserve Bank directors are generally consistent with the trends illustrated by the Employer Information Report (EEO-1) data. The EEO-1 data represent the pool of potential candidates with the requisite skills and experience from which the Federa Reserve generally selects directors. To assess the reliability of the Federal Reserve Board data, we interviewed Federal Reserve Board staf about steps they took to maintain the integrity and reliability of the database. To assess the reliability of the EEO-1 data, we reviewed documentation related to the data and interviewed EEOC officials on the methods used to collect data and checks performed to ensure data reliability. We believe that these data are sufficiently reliable for the purpose of our analysis. Also, to obtain baseline information from all current directors on a cross section of high-level issues, we conducted a web-based survey of the 105 Reserve Bank directors that served for thefull year during 2010. Of the 105 directors surveyed, 91 responded to the survey overall. However, the number of responses to individual questio ns varied. We collected and summarized additional information from thesedirectors, such as their other board positions, prior employment, an education. For a full description of the methodology of the survey, see appendix II. To assess the extent to which Federal Reserve Banks’ processes for identification, nomination, and selection of directors resu in diversity, we reviewed documentation on the process and interview officials from Federal Reserve Board and Reserve Banks. To examine whether there are actual or potential conflicts of interests created when certain directors of Reserve Banks are elected by member banks, we reviewed and summarized the selection procedures for Reserve Bank directors, and their roles and responsibilities identified in current Federal Reserve System documents and those included in the Federal Reserve Act. We surveyed all Reserve Bank directors who served for the full year during 2010 to collect their perception of their roles and responsibilities and to determine whether they are aware of any past or present conflict of interest. Also, we interviewed selected Reserve Bank directors and Reserve Bank officials from each Reserve Bank to collect information on directors’ roles and responsibilities, any conflict of interest concerns and procedures for addressing the appearance of or actual conflicts, and potential changes to Reserve Bank governance. Specifically, at each of the 12 Reserve Banks, we interviewed at least one director from each class (A, B, and C), all board and audit committee chairs, the president, general counsel or ethics officer, and corporate secretary. In addition, to identify any discussions on instances of potential or actual conflicts of interest during board meetings, we reviewed board minutes for each of the 12 Reserve Banks for the period of November 2007 to October 2010. To address the Reserve Bank directors’ involvement in the establishment and operations of the Federal Reserve emergency programs, we leveraged our work from the recent Federal Reserve Emergency Program review, which conducted related work under the Dodd-Frank Act. We reviewed relevant documents from each of the 12 Reserve Banks, including bylaws, procurement policies and any policies for waivers to the Federal Reserve Board’s policies on director eligibility, qualifications, and rotation. We also reviewed Reserve Bank board minutes to help determine the extent of the directors’ involvement in any activities associated with the emergency programs and supervision and regulation matters. In addition, we interviewed a sample of directors and relevant Reserve Bank officials as noted earlier to determine the directors’ involvement in the implementation and operation of the programs. To compare Reserve Bank governance practices with the practices of selected organizations, we reviewed literature on current best practices for governance within major financial institutions, analyzed similar institutions in other countries or the United States to evaluate best practices or alternative structures, and relied on the results of our work done for our other objectives. We examined how the Federal Reserve System’s governance practices compare with relevant practices at selected foreign central banks, a self-regulatory organization, a government-sponsored enterprise, and several large bank holding companies. For the foreign central banks, we contacted officials at foreign central banks in Australia, Canada, the European Union, and the United Kingdom to obtain governance documents and we analyzed governance policies and practices in order to compare governance of the Reserve Banks with governance of other foreign central banks. We spoke to academic researchers knowledgeable about central bank governance. We verified the accuracy of our analysis and interpretations of governance documents by requesting comments on the relevant draft sections from each of the central banks included in our review. We incorporated their comments as appropriate. For the self-regulatory organization and the government-sponsored entity, we identified and analyzed the relevant governance policies and practices of the Financial Industry Regulation Authority (FINRA) and for the cooperative system, the Federal Home Loan Banks (FHLBanks). To verify the accuracy of our analysis, we spoke with officials from these entities and obtained comments on the relevant sections of a draft of this report. Finally, for private corporations, we interviewed an industry group and some academic researchers knowledgeable about corporate governance and analyzed the governance practices of the 10 largest bank holding companies and compared them with the governance policies and practices of the previously discussed organizations. We conducted this performance audit from July 2010 to July 2011 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. The Federal Reserve Act of 1913 established the Federal Reserve System as the country’s central bank. The Federal Reserve Act made the Federal Reserve System an independent, decentralized bank to better ensure that monetary policy would be based on a broad economic perspective from all regions of the country. The Federal Reserve Board has defined the term “monetary policy” as the actions undertaken by a central bank, such as the Federal Reserve System, to influence the availability and cost of money and credit to help promote national economic goals. The Federal Reserve Act of 1913, as amended, gave the Federal Reserve System responsibility for setting monetary policy. The Federal Reserve System consists of three parts: the Federal Reserve Board, Reserve Banks, and the FOMC. The Federal Reserve Board is a federal agency located in Washington, D.C., that is responsible for maintaining the stability of financial markets; supervising financial, bank, and thrift holding companies, state-chartered banks that are members of the Federal Reserve System, and the U.S. operations of foreign banking organizations; establishing monetary policy; and providing general supervision over the operations of the Reserve Banks. The top officials of the Federal Reserve Board are the seven members of the Board of Governors who are appointed by the President and confirmed by the U.S. Senate. Although the Federal Reserve Board is required to report to Congress on its activities, its decisions do not have to be approved by either the President or Congress. The Federal Reserve System is divided into 12 districts. Each district is served by a regional Reserve Bank. Most Reserve Banks have one or more branches, adding to a total of 24 branches (see fig. 1). Unlike the Federal Reserve Board, the Reserve Banks are not federal agencies. Each Reserve Bank is a federally chartered corporation with a board of directors and member banks who are stockholders in the Reserve Banks. The membership of each Reserve Bank board of directors is determined by a process established by statute that is intended to ensure that each bank board represents both the public and member banks in its district. Under the Federal Reserve Act, Reserve Banks are subject to the general supervision of the Federal Reserve Board. The Federal Reserve Board has delegated some of its supervisory responsibilities to the Reserve Banks, such as responsibility for examining bank and thrift holding companies and state member banks under rules, regulations and policies established by the Federal Reserve Board. The Federal Reserve Act authorizes the Reserve Banks to make discount window loans, in accordance with the rules and regulations prescribed by the Federal Reserve Board, and to execute monetary policy operations at the direction of the FOMC. The Reserve Banks also provide payment services, such as check clearing and wire transfers, to depository institutions, the Treasury, and government agencies. The provision of these payment services to depository institutions is subject to the full cost recovery provisions of the Monetary Control Act of 1980. Reserve Banks also provide cash services to financial institutions and serve as the Treasury’s Fiscal Agent. The FOMC plays a central role in the execution of the Federal Reserve System’s monetary policy mandate to promote price stability and maximum employment. The FOMC consists of the seven members of the Board of Governors, the President of the Federal Reserve Bank of New York, and four other Reserve Bank presidents who serve on a rotating basis. All presidents participate in FOMC deliberations even though not all vote. The FOMC is responsible for directing open market operations to influence the total amount of money and credit available in the economy. The Federal Reserve Bank of New York (FRBNY) carries out FOMC directives on open market operations by engaging in purchases or sales of certain securities, typically U.S. government securities, in the secondary market. The Federal Reserve Board and the Reserve Banks are subject to an annual independent audit of their financial statements by a public accounting firm. In addition, each Reserve Bank has an internal auditor who is responsible to the Reserve Bank’s board of directors. The Federal Reserve Board’s Division of Reserve Bank Operations and Payment Systems (RBOPS) performs periodic examinations on 4 of 12 Reserve Banks each year on a range of oversight activities and assesses compliance with Federal Reserve Board policies. The Federal Reserve Board’s Office of Inspector General also conducts audits, reviews, and investigations related to the Federal Reserve Board’s programs and operations, including those programs and operations that have been delegated to the Reserve Banks by the Federal Reserve Board. Finally, we may conduct a number of reviews each year to look at specific aspects of the Federal Reserve System’s activities. All national banks—U.S. commercial banks that are chartered by the federal government through the Office of the Comptroller of the Currency—are required to be members of the Federal Reserve System. Banks chartered by the states may elect to become members of the Federal Reserve System if they meet certain requirements set by the Federal Reserve Board. Member banks must subscribe to stock in their Reserve Bank in an amount that is related to the size of the member bank. Holding of the stock does not confer any rights of ownership and the member bank may not sell or trade the Federal Reserve district bank stock. Member banks receive a statutory fixed annual dividend of 6 percent on their stock and may vote for six of the nine members of the board of directors of the Reserve Bank. Governance can be broadly described as the process of providing leadership, direction, and accountability in fulfilling an organization’s mission, meeting objectives, and providing stewardship of an organization’s resources. Because the Reserve Bank boards are supervised by the Federal Reserve Board and their authority is constrained by both provisions of the Federal Reserve Act and guidelines of the Federal Reserve Board, among other things, they are not typical corporate boards of directors. However, Reserve Bank boards are the focal points of the Reserve Banks’ governance framework that also includes the broad oversight of the Federal Reserve Board. The Federal Reserve Act established nine-member boards of directors to govern each of the 12 Reserve Banks. Each board is split equally into three classes. Class A directors represent the member banks, while Class B and C directors represent the public with, as required by the Federal Reserve Act, “due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers.” As required by the Federal Reserve Act, six of the nine directors, Class A and Class B, are elected by the member banks, and the remaining three, the Class C directors, are appointed by the Federal Reserve Board. Figure 2 illustrates how the directors of the Reserve Banks are chosen and their roles in appointing Reserve Bank presidents. The process for selecting the boards of directors of the Reserve Banks is outlined in the Federal Reserve Act. The Federal Reserve Act requires that the member banks of each Reserve Bank District be classified into three groups consisting of banks of similar capitalization—small, medium, and large. Each group is responsible for one of the three Class A directorships and one of the three Class B directorships. Each member bank in the group may nominate a candidate for an open directorship within its group. Once nominations close, each member bank in the group receives the list of nominees and a ballot to vote in the election. Directors serve 3-year terms, and the terms are staggered so that one position in each class becomes vacant every year. Although directors can be reelected to an indefinite number of terms, the Federal Reserve Board recommends that the Reserve Banks follow a limit of two consecutive appointments for a given director. The Federal Reserve Act does not prescribe how the Federal Reserve Board is to identify and appoint the candidates for Class C directors. Pursuant to the Federal Reserve Act, one Class C director, who must be a person of “tested banking experience,” is designated by the Federal Reserve Board as chairman of the Reserve Bank board of directors, and the Federal Reserve Board also designates another Class C director as deputy chairman. The Federal Reserve Act provides that the chairman of the board, like all Class C directors, cannot be an officer, director, employee, or stockholder of any bank. The Federal Reserve Board policy extends this limitation to prevent affiliations by Class B and Class C directors with any thrift, credit union, bank holding company, foreign bank, and other similar institutions and affiliates. Additionally, the Federal Reserve Act states that Class C directors must have been residents of the district of their Reserve Bank for 2 years prior to appointment. As with the election of Class A and B directors, the appointment of Class C directors is staggered so that one director position becomes vacant every year. The Federal Reserve Board has established a policy of appointing a given Class C director to no more than two terms. See table 1 for a detailed description of the requirements for selection of all three classes of directors. Nine of the 12 Reserve Banks also have branch offices, which provide banking services, and in some cases house supervision employees. The branches are subject to the governance of the Reserve Banks and their boards of directors, as well as to oversight from the Federal Reserve Board. Twenty-three of the 24 branches have boards of seven directors, four of which are appointed by the Reserve Bank and three of which are appointed by the Federal Reserve Board. One branch (Helena) comprised five directors, three of which are appointed by the Reserve Bank, and two of which are appointed by the Federal Reserve Board. The chair of the branch office board is selected from the members appointed by the Federal Reserve Board. This report focuses primarily on the governance practices at the Reserve Banks and not branch offices. The three principal functions of Reserve Bank directors are to (1) participate in the formulation of national monetary and credit policies; (2) oversee the general management of the Reserve Bank, including its branches; and (3) act as a link between the Federal Reserve Bank and the community. The Reserve Bank boards have the ability to influence the nation’s monetary policy in three primary ways (1) by providing input on economic conditions to the Reserve Bank president, which is used by some presidents in their reports to the FOMC about regional economic conditions; (2) by participating in the establishment every 2 weeks of a discount rate recommendation sent to the Federal Reserve Board for its consideration; and (3) for the Class B and C directors, by appointing the Reserve Bank president and first vice president.  Beige Books: The Reserve Banks publish a Summary of Commentary on Current Economic Conditions, informally known as the Beige Book, eight times per year. The Beige Book is a compilation of reports on current district economic conditions filed by each Reserve Bank drawing on its network of district contacts. Reserve Banks’ directors’ observations on the economy may be included in the Reserve Bank’s Beige Book report. The Reserve Banks take turns summarizing economic information for the Beige Book and writing the report’s summary. The FOMC and the Federal Reserve Board use the Beige Books—which are published 2 weeks before each FOMC meeting—to inform their decisions on discount rates and the Federal Funds Rate target.  Discount rate: The Federal Reserve Act authorizes each Reserve Bank to establish, subject to review and determination by the Federal Reserve Board, discount rates. The statute provides that each Reserve Bank shall establish such rates every 14 days or more often if deemed necessary by the Federal Reserve Board. Reserve Bank directors typically conduct a conference call every 14 days, unless they are holding an in-person meeting, to vote on the discount rate. The rate established by the Reserve Bank must be approved by the Federal Reserve Board.  Reserve Bank president: Each Reserve Bank board’s Class B and Class C directors appoint, with the approval of the Federal Reserve Board, the president of their Reserve Bank. The president of the Reserve Bank uses the information (s)he gathers from the Reserve Bank’s board of directors, research department, and a variety of other sources to influence monetary policy through (her)his position on the FOMC. The FOMC sets the Federal Funds Rate target and monitors and directs the Open Market Operations necessary to achieve that rate. All of the 12 Reserve Bank presidents attend and participate in deliberations at each meeting of the FOMC. As noted earlier, the president of FRBNY has a permanent voting position and the other 11 presidents rotate, on an annual basis, among four voting positions on the FOMC. Figure 3 illustrates how the members of the FOMC are selected. The recent financial crisis that began around mid-2007 was the most severe that the United States has experienced since the Great Depression. A number of financial institutions were threatened with failure and some failed. The crisis also affected businesses and individuals, who found it increasingly difficult to obtain credit as cash-strapped banks held on to their assets. By late summer of 2008, the potential ramifications of the financial crisis included the continued failure of financial institutions, increased losses of individual wealth, reduced corporate investments, and further tightening of credit that would exacerbate the emerging global economic slowdown that was beginning to take shape. Between late 2007 and early 2009, the Federal Reserve Board created more than a dozen new emergency programs to stabilize financial markets and authorized the Reserve Banks to provide financial assistance to avert the failures of a few individual institutions. In many cases, the decisions by the Federal Reserve Board, the FOMC, and the Reserve Banks about the authorization of, the initial terms of, and implementation of the Federal Reserve System’s emergency assistance were made over the course of only days or weeks as the Federal Reserve Board sought to act quickly to address rapidly deteriorating market conditions. FRBNY implemented most of these emergency activities under authorization from the Federal Reserve Board. (See app. I for more information on the emergency programs and the Reserve Banks’ involvement in their implementation). According to the U.S. Census Bureau, the U.S. population has become more racially and ethnically diverse in the last 10 years. Between 2000 and 2010, the Asian population experienced the fastest rate of growth and the white population experienced the slowest rate of growth. In the 2010 Census, 97 percent of all respondents (299.7 million) reported only one race. The largest group reported was white (223.6 million), accounting for 72 percent of all people living in the United States. The African-American population was 38.9 million and represented 13 percent of the total population. There were 2.9 million respondents who indicated American Indian and Alaska Native (0.9 percent). Approximately 14.7 million (about 5 percent of all respondents) identified their race as Asian. In 2010, there were 50.5 million Hispanics in the United States, composing 16 percent of the total population. Between 2000 and 2010, the Hispanic population grew by 43 percent—rising from 35.3 million in 2000, when this group made up 13 percent of the total population. The non-Hispanic population grew relatively slower over the decade, about 5 percent. The Federal Reserve Act of 1913 as enacted did not include demographic diversity requirements. The act specified that the three Class A directors were to be chosen by and be representative of the stockholding banks. Further, the three Class B directors were to be actively engaged in their district in commerce, agriculture, or some other industrial pursuit, and the three Class C directors were appointed by the Federal Reserve Board. The Federal Reserve Reform Act of 1977 amended the Federal Reserve Act to add the present antidiscrimination requirements and to expand the economic diversity provisions to agriculture, commerce, industry, services, labor, and consumer representation for Class B and C directors. According to the legislative history of the Reform Act, these changes were made to help broaden Reserve Bank board representation to include women and minorities, as well as industries and other interest groups. The Federal Reserve Board maintains a database of current and past directors that is used to track demographic information voluntarily provided by directors. Information in this database is entered by the individual Reserve Banks and managed by the Federal Reserve Board. We analyzed demographic characteristics of bank (head office) and branch directors who served at some time during 2006 through 2010 to present a profile of director demographic characteristics. Figure 4 shows the representation of head office directors from 2006 through 2010 using Federal Reserve Board data. Over the 5-year period, we found that generally the representation of women and minority head office directors has remained limited. For example, in 2006, minorities accounted for 13 of 108 director positions; and in 2010 they accounted for 15 of 108 director positions. More specifically, in 2010, head office directors comprised 78 white men, 15 white women, 12 minority men, and 3 minority women. We also analyzed the total number of female and minority directors serving from 2006 through 2010 by class. As shown in figure 4, Class B and Class C directors were more diverse in gender, race, and ethnicity than Class A directors. For example, of the 202 directors serving from 2006 through 2010, 7 Class A directors were female, while there were approximately twice that number of female Class B and C directors, respectively—16 Class B and 16 Class C female directors. Furthermore, there were 3 minority Class A directors, while there were 14 minority Class B and 9 minority Class C directors. Several Reserve Bank officials we spoke with told us that Class B and Class C directors are a source of both economic and demographic diversity on Reserve Bank boards. Figure 5 shows the representation of branch directors from 2006 through 2010. Over the 5-year period we also found that generally, the representation of women and minority branch directors has also remained limited. For example, in 2006, minorities accounted for 40 of 182 director positions; and in 2010, they accounted for 30 of the 164 positions. More specifically, in 2010, branch directors comprised 97 white men, 37 white women, 22 minority men, and 8 minority women. The data show that labor and consumer groups are less represented than other industry groups on both head office and branch boards. As shown in figure 4, from 2006 through 2010, 5 of the 202 head office directors served as consumer representatives and 6 of the 202 head office directors served as labor representatives. As shown in figure 5, from 2006 through 2010, 11 of the 309 branch directors served as consumer representatives and 4 of the 309 branch directors served as labor representatives. The Federal Reserve Board has encouraged Reserve Banks to recruit directors from consumer and labor organizations. For example, in a February 2010 memo to Reserve Bank presidents on director recruitment, the Federal Reserve Board listed recruiting leaders from these two industry groups as a “high priority.” Despite these efforts, two Reserve Bank officials we spoke with said recruiting consumer and labor representatives is a challenge because many of them are politically active and the Federal Reserve Board policy, which restricts a director’s political activity, would generally require them to give up such activities while serving on the board. As shown in figure 6, Federal Reserve Board data show that generally, representation of minority and female directors varied somewhat across districts. For example, of the 16 head office directors serving from 2006 through 2010 at both Federal Reserve Bank of Dallas and Federal Reserve Bank of Kansas City, 2 were women; and of the 18 head office directors serving from 2006 through 2010 at Federal Reserve Bank of Boston, 5 were women. One Reserve Bank corporate secretary we spoke with said that it was difficult to recruit diverse candidates within his district because of a lack of overall diversity in the region. To obtain information from all current directors on a cross section of high- level issues, we conducted a web-based survey of the 105 Reserve Bank directors that served for the full year during 2010. We collected and summarized additional demographic information for 2010 directors, such as their prior work experience, education, and other board positions. Many Reserve Bank directors responding to the survey typically had experience in the finance industry and almost all currently serve on a variety of other boards. At least 56 have had some financial industry experience. After the financial industry, the next most reported work experiences by industry were manufacturing; professional, scientific, and technical services; retail trade; and real estate and rental leasing. The vast majority of the directors who responded to the survey reported that they had completed a bachelor’s degree. More specifically, over half of the directors responding to the survey (55) reported that they had completed some type of advanced degree, such as a master’s, juris doctor, or doctorate. In 2010, 86 of 91 Reserve Bank directors responding to our survey served on a variety of nonprofit, private, and public company boards. For example, directors held board positions at public and private universities; for-profit companies such as Loews Corporation, Safeway, Inc., and Energizer Holdings; and nonprofit organizations such as the Ford Foundation and Ronald McDonald House Charities. We analyzed EEOC’s EEO-1 data for employers with 100 or more employees from 2007 through 2009. The EEO-1 data provide information on racial/ethnic and gender representation for various occupations within a broad range of industries. We used the EEO-1 “executive and senior level officials and managers” job category as the basis for our analysis because this is the category of employees from which Reserve Banks would most likely recruit directors. EEOC defines the job category of executive and senior level officials and managers as individuals residing in the highest levels of organizations who plan, direct, and formulate policies, and provide overall direction for the development and delivery of products and services. Figure 7 provides EEO-1 data for individual minority groups and illustrates their trend in representation at the management level, which varied by group. As shown in figure 7, among all EEO-1 reporters, senior management representation by whites and Asians increased from 2007 through 2009. For example, whites accounted for 87.4 percent of all industry senior management positions in 2007; and they accounted for 88.6 percent of senior managers in 2009. Moreover, while representation by Asians also increased during this period, African Americans and Hispanics in senior management decreased steadily. For example, Hispanics accounted for 4.5 percent of all industry senior management positions in 2007; and they accounted for 3.5 percent in 2009. Representation for “Other” races remained constant from 2007 through 2009. Figure 7 also compares race and ethnicity and gender between the EEO- 1 and Federal Reserve Board datasets. EEO-1 data show that the pool of senior managers—a possible pipeline for potential Federal Reserve directors—has limited diversity. For example, minorities accounted for 12.6 percent of all senior management positions in 2007 and 11.4 percent in 2009. Similarly, minorities accounted for 12.4 percent of Federal Reserve directors in 2009. As shown in figure 8, diversity was limited among senior-level management in the commercial banking industry. Because Class A directors are nominated and elected by the member banks in each Federal Reserve district to represent the stockholding banks, they are generally officers or directors of a member commercial bank. EEO-1 data show that, on average, the pool of senior managers in the commercial banking industry, a source that provides the pool of candidates for Class A directors, is less diverse than senior management in terms of race and ethnicity in all other industries combined. In 2009, the percentage of senior management positions held by minorities ranged from an average of 9.6 percent for commercial banking institutions to an average of 11.5 percent for all other industries combined. However, the average percentage of positions held by women was relatively consistent between commercial banking institutions and all other industries, 29.0 percent and 28.3 percent, respectively. Reserve Bank officials said they generally focus their search on senior executives. To explore whether Reserve Banks expanding their search to include nonexecutives would increase diversity, we spoke with officials and directors about their views on this matter. Several Reserve Bank executives and directors told us that having senior executives on the board of directors helps elevate the stature of the board. In addition, they said that individuals working at the top of their organization may have a broader view of how their industry is being affected by the economy. On the other hand, one Reserve Bank official told us that he felt looking below the executive level for potential directors was important. Further, at one Reserve Bank, the corporate secretary told us the bank actively looks for directors who may not be senior-level executives in an attempt to increase diversity. At another Reserve Bank, the corporate secretary stated that the bank has had nonexecutives serve on the board both currently and in the past. In previous work on diversity in the financial services industry, we found that individuals holding positions one level below senior management were more diverse than senior management. According to this work, EEOC data showed that generally, management-level representation by minority women and men increased from 11.1 percent to 17.4 percent from 1993 through 2008. However, these EEOC data overstated minority representation at senior management levels, because the category included midlevel management positions, such as assistant branch manager, that may have greater minority representation. In 2008, EEOC reported revised data for senior-level positions only, which showed that minorities held 10 percent of such positions compared with 17.4 percent of all management positions. This suggests that by broadening its pool of potential candidates below the executive level, Reserve Banks may be able to attract more diverse director candidates with potentially more diverse backgrounds and perspectives on the economy. We also analyzed EEO-1 data by Federal Reserve district to determine district-level trends in senior management across all industries. This analysis demonstrates that diversity of senior managers in the Federal Reserve districts varies. As shown in figure 9, certain Federal Reserve districts’ territories are somewhat more diverse than others at the senior management level. For example, in 2009, the percentage of senior management positions held by minorities ranged from a high of 18.7 percent within the Federal Reserve Bank of San Francisco’s territory to a low of 4.0 percent within the Federal Reserve Bank of Minneapolis territory, indicating that diversity among senior managers does vary by district. Reserve Banks select candidates to fill director vacancies based upon criteria in the Federal Reserve Act and guidance from the Federal Reserve Board. The act provides requirements for the nomination and election of directors. The act requires that member banks of each district be classified into three groups consisting of banks of similar capitalization—small, medium, and large. The member banks in each group nominate and elect one Class A director to represent that group’s banks and one Class B director to represent the public. After the candidates are identified and a list of their names is forwarded to the member banks, each bank may cast one vote for a Class A director and one vote for a Class B director. Class C directors, who also represent the public, are recommended by the Reserve Banks and appointed by the Federal Reserve Board. The Federal Reserve Board also provides guidance on director election and eligibility requirements in the Federal Reserve Administrative Manual (FRAM). Additionally, the act specifies that all directors shall be chosen without discrimination as to race, creed, color, sex, or national origin and that Class B and Class C directors who represent the public shall be elected “with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers.” Each year the Federal Reserve Board provides a memorandum to Reserve Banks with priority objectives for the recruitment of individuals with independent and diverse views and potential sources from which to obtain diverse directors. In addition, it distributes a yearly report on the demographic and industry characteristics of directors to each of the Reserve Banks for their use as they seek to identify and consider potential candidates. Reserve Banks review the current demographics and areas of expertise of their boards when selecting candidates to fill director vacancies. At each Reserve Bank, the corporate secretary works collaboratively with the president and other senior bank staff to assess the demographics of their board and identify areas where additional representation may be needed. Several Reserve Bank officials with whom we spoke told us they also consider geography and educational background as selection criteria, in addition to those outlined in the act. Three Reserve Bank officials told us that while they strive to find diverse candidates from a variety of industries, they also want to find people who have the skills and knowledge that will fill a gap in the board’s existing knowledge and skill set. Additionally, Reserve Bank officials said they generally focus their search on senior executives, usually chief executive officers (CEO) or presidents. For example, of the 108 directors serving in 2010, 82 were the president or CEO of their company. Further, we identified at least 23 who were employed by Fortune 500 companies in 2010. Three Reserve Bank officials we spoke with indicated that CEOs generally have a better familiarity with the economic and business community of their district than less senior managers. However, as discussed previously, while having executives on the boards may elevate the stature of the board, it may limit the diversity of the pool of potential candidates. Reserve Banks identify potential director candidates in a variety of ways and often use different recruitment methods. In general, Reserve Banks use a combination of personal networking and community outreach efforts to identify potential candidates. Two directors with whom we spoke told us they have recommended personal or business acquaintances they believe would be qualified to serve as directors. In addition, some Reserve Banks contact former directors for help in identifying possible candidates. Several Reserve Bank presidents and senior staff also attend community roundtables and forums to network and identify potential candidates. Several Reserve Banks use their advisory councils and branch boards as a source for potential candidates. One Reserve Bank official told us that they look for candidates in a variety of industry lists such as a Forbes’ magazine list of the most powerful women in business. At another Reserve Bank, member banks of the states represented in the district have agreed to a rotating nomination process for Class A and Class B directors to help ensure geographic representation. That is, when it is one particular state’s turn to nominate a candidate, the state’s Banking Association identifies potential candidates. At least one Class C director said he self-identified for the position and approached the Reserve Bank to express his interest in serving on the board when a vacancy came up. Some Reserve Banks also use nominating committees to identify qualified director candidates. These committees may do so by recruiting candidates to fill vacant seats on the board, reviewing candidates recommended by the Reserve Banks and others, or conducting inquiries into the backgrounds and qualifications of potential candidates. Five Reserve Banks use nominating committees to identify potential candidates. For example, one Reserve Bank has a nominating committee that considers candidates for the Federal Reserve Board-appointed Class C directors. At another Reserve Bank, the nominating committee currently consists of three Class C directors and two Class A directors that meet to consider and make recommendations concerning board membership for all classes of directors. Guidelines in the FRAM require that nominating committees recommending Class A and Class B director candidates not include Reserve Bank officers and employees. Typically, a Reserve Bank identifies and vets potential candidates for Class A and B directors, and communicates their names and credentials to member banks for their nomination and election. Reserve Banks generally submit an open call for nominations to the district’s voting banks, even if they also have a nominating committee. Typically, the member banks will elect the Class A and B candidates identified and vetted by the Reserve Bank’s nominating committee. However, member banks can nominate and elect a candidate that has not been vetted by the Reserve Bank. In such cases, the bank will inform the nominee of a director’s eligibility requirements, to determine if the candidate is eligible to serve, if elected. We found that member bank voter turnout was often low at some Reserve Banks. Although the Federal Reserve Act sets forth specific procedures and voting requirements for director elections, shareholder elections of Reserve Bank directors do not have a requirement for a minimum number of votes. The Federal Reserve Board requires every Reserve Bank to provide a slate of at least two candidates for each Class C vacancy to the Federal Reserve Board for appointment. Typically, the Federal Reserve Board will appoint a candidate from the slate provided by the Reserve Banks to serve as a Class C director. However, the Federal Reserve Board may ask for further explanation of why Reserve Banks selected certain candidates or ask for alternative candidates. Several Reserve Banks indicated that recruiting directors for several groups—specifically women, minority, and labor or consumer representatives—can be challenging. According to Reserve Bank officials, recruiting labor and consumer representatives is particularly difficult because many of them are politically active and the Federal Reserve Board policy generally restricts a director’s political activity. They also noted that Reserve Bank directors’ roles and responsibilities can be time consuming and that compensation is low compared with that available in other opportunities to serve on private boards. After the passage of the Sarbanes-Oxley Act in 2002, directors are limited in the number of public company boards on which they can serve; therefore, Reserve Banks compete with other private corporations for these directors’ time, especially women and minorities. In addition, some individuals do not want to divest of their stock holdings in the banking- related industry (which would be required for Class C) and also may not wish to refrain from political participation, according to Federal Reserve System officials. As we have previously reported, many private and public organizations have recognized the importance of recruiting and retaining minority and women candidates for key positions as the U.S. workforce has become increasingly diverse. Some Reserve Bank officials told us that many organizations are searching for diverse directors to have on their boards, and the Reserve Banks are competing with private corporations for the same small pool of qualified individuals. Although the policies of private corporate boards we reviewed do not have specific requirements for board diversity, the Securities and Exchange Commission (SEC) recently started requiring companies to identify steps taken to ensure diversity of their boards in their proxy statement to shareholders. In our review of the proxy statements from the 10 largest bank holding companies in 2010, we found that companies generally did not list specific steps taken to identify and select diverse board members (see app. IV for a list of the 10 largest bank holding companies included in our review). Rather they provided a broad statement about diversity. For example, one company stated, “The Committee evaluates diversity in a broad sense, recognizing the benefits of racial and gender diversity, but also considering the breadth of backgrounds, skills, and experiences that directors and candidates may bring to our Board.” Having a demographically and economically diverse board strengthens an organization by bringing a wider variety of perspectives and approaches to the organization. While officials at some Reserve Banks told us they consider candidates who are not chief-level executives (i.e., not chief financial officers, chief operating officers, or executive vice presidents), the vast majority of directors in 2010 held such positions in their organizations. By broadening their pool of candidates, Reserve Banks may be able to improve diversity, and ultimately public representation, on the Reserve Bank boards. Such diversification can help ensure that the Federal Reserve System receives a broader spectrum of information useful for the formation and execution of monetary policy and the oversight of Reserve Bank operations. From the creation of the Federal Reserve System, the Federal Reserve Act has required the Reserve Banks to include Class A directors on their boards to be representative of the member banks, as each of the Reserve Banks is owned by the member banks in its district. While Class A directors are not required to be officers or employees of member banks, in practice, most Class A directors are officers or directors of member banks in the district. The requirement to have representatives of member banks creates an appearance of a conflict of interest because, as noted previously, the Federal Reserve System has supervisory authority over state-chartered member banks and bank holding companies. Conflicts of interest involving directors have been historically addressed through both federal law and Federal Reserve System policies and procedures, such as by defining roles and responsibilities and implementing codes of conduct to identify, manage, and mitigate potential conflicts. Nevertheless, directors’ affiliations with financial firms and former directors’ business relationships with Reserve Banks continue to pose reputational risks to the Federal Reserve System. When the Federal Reserve System played a key role in providing assistance to financial institutions during the 2007-2009 financial crisis, Reserve Bank board governance came under scrutiny because, among other things, a number of director-affiliated banks and nonbank financial institutions participated in the Federal Reserve System’s emergency programs. Since then, Congress, the Federal Reserve Board, and Reserve Banks have made a number of changes to the policies and procedures that address Reserve Bank governance. However, without more complete documentation of the directors’ roles and responsibilities with regard to the supervision and regulation functions, as well as increased public disclosure on governance practices to enhance accountability and transparency, questions about Reserve Bank governance will remain. The three classes of Reserve Bank directors have varying degrees of involvement in the financial services industry, and their affiliations with financial companies could create reputational risk for the Reserve Banks. In addition, relationships between current and former directors and interactions between former directors and the Reserve Banks could also raise questions about the independence of the directors and actions of the Reserve Banks. Finally, questions about directors’ involvement in the emergency programs authorized by the Federal Reserve Board during the financial crisis spurred allegations of conflicts of interest. As we reported in our July 2010 report on the emergency programs, our review found that the boards of directors generally were not directly involved in the development and implementation of emergency programs. Federal Reserve Bank directors often serve on the boards of a variety of financial firms as well as those of nonprofit, private, and public companies. For example, in 2010, 86 of 91 Reserve Bank directors responding to our survey held board positions at public and private companies, public and private universities, and nonprofit organizations. As noted earlier, our survey indicated that most of the Reserve Banks have directors who have held positions at financial services firms or insurance companies as well as banks. This includes Class A directors who are officials of banks that hold stock in the Reserve Bank, and Class C directors, who are required by the Federal Reserve Act to be persons of tested banking experience, which the Federal Reserve Board says has come to be interpreted as requiring familiarity with banking or financial services. In addition, as the financial services industry has evolved, more companies are involved in financial services or otherwise interconnected with financial institutions. These changes have resulted in a few Class B and Class C directors who were previously employed by financial institutions or have served on their boards. A recent example that raised questions about affiliations, and the nature of director affiliations with financial firms, involved the then-FRBNY chairman in late 2008, who was former chairman and a current board member and shareholder of the Goldman Sachs Group, Inc. (Goldman Sachs). As illustrated in figure 10, when the then-FRBNY chairman joined the FRBNY board as a Class C director in January 2008, Goldman Sachs was an investment bank outside the supervisory authority of the Federal Reserve System. However, in September 2008, in response to the unfolding financial crisis, Goldman Sachs applied for and was approved by the Federal Reserve Board to become a bank holding company. As a result, under Federal Reserve Board policy, the then-FRBNY chairman became ineligible to serve as a Class C director because he was then a director and stockholder of a bank holding company. Without consultation with the full FRBNY board, FRBNY sought a waiver to allow the then-FRBNY chairman to continue to serve on the board. According to an FRBNY official, FRBNY sought the waiver in October 2008 for a number of reasons. First, finding a new chairman during the financial crisis would have been difficult, given that FRBNY already had one director vacancy on its board at the time. Further, the event leading to the need for a waiver was unexpected and unforeseen. In late November 2008, an additional concern was raised that the then-FRBNY president was expected to be nominated as the Secretary of the Treasury, thereby raising the potential that FRBNY would be searching for both a new president and a new chairman simultaneously, with the added complication that, as the chair of the FRBNY board, the then-FRBNY chairman would be heading the search committee for a new president. The waiver was granted by the Federal Reserve Board in January 2009 on the basis of these considerations. However, the Federal Reserve Board was unaware that the then-FRBNY chairman had purchased additional shares in Goldman Sachs via an automatic stock purchase program. The then-FRBNY chair resigned in May 2009. As discussed later, on the basis of this waiver experience, the Federal Reserve Board decided to develop and institute a formal policy governing the treatment of situations in which Class B or C directors’ stockholdings unexpectedly become impermissible. This policy has since been adopted. FRBNY also changed its policy, which would require that waivers be discussed by the board of directors before going to the Federal Reserve Board. Federal Reserve Board officials told us that after receiving the waiver request from FRBNY, they contacted other Reserve Bank boards to determine whether any other directors held stocks in companies that had recently converted to bank holding companies. According to these officials, this review identified a director from the Federal Reserve Bank of Minneapolis who held less than $100,000 in stock in Merrill Lynch & Co., Inc., an investment bank, which had been acquired by Bank of America, a bank holding company. This director remained on the board and a waiver was granted by the Federal Reserve Board, but nonetheless, he subsequently divested the shares in January 2009. Another situation that raised questions about affiliations involved a FRBNY Class B director. The director was the Chief Executive Officer of Lehman Brothers Holdings, Inc. (Lehman), an investment bank that experienced significant financial problems during the unfolding financial crisis and ultimately failed. An FRBNY official said that he met with the FRBNY president and chairman about Lehman’s deteriorating financial condition, without the full board, and concluded that FRBNY faced reputational risk regardless of the action taken. Specifically, it was concluded that although the board of directors was not involved in approving and implementing the emergency programs, a recusal from board meetings by the Lehman director might not have managed the appearance of a conflict and a public resignation might have sent a negative signal to the market and hastened the collapse of the firm. Under Federal Reserve Board practice, Reserve Bank directors affiliated with troubled financial institutions are encouraged to resign or risk removal from the board. Federal Reserve System officials said that the director voluntarily resigned before Lehman filed for bankruptcy. Although directors’ affiliations with financial firms do not necessarily create conflicts of interest, they may complicate the directors’ relationships with the Reserve Banks and increase public scrutiny of them. One issue relates to directors’ communications with Reserve Bank officials in their roles as senior executives of their companies. These situations have raised questions as to whether directors have greater access to Reserve Bank officials than other financial institution officials and whether they have influence over matters that may affect banks or institutions with which they are affiliated. Reserve Bank officials with whom we spoke said that there are no restrictions on directors communicating with Reserve Bank staff about their respective banks or holding companies in their capacity as officials of the bank nor are there restrictions on conversations about the financial markets. However, according to Federal Reserve Board officials, members of the Reserve Bank board of directors are not granted special access to supervisory staff, and it has been the practice of the Federal Reserve Board and the Reserve Banks to restrict their involvement in supervision issues. Further, Reserve Bank officials said that requests from other financial institutions to meet with Reserve Bank staff are processed in the same manner as those from the directors. As discussed later, the financial crisis highlighted situations where directors were in contact with Reserve Bank staff in their capacity as representatives of their financial institutions and market participants. After completing their terms, directors who had represented member banks or who have affiliations with other financial institutions may maintain contact with Federal Reserve Bank officials for various reasons. FRBNY officials said that actions such as the Reserve Banks’ management of such communications may help safeguard against improprieties. For example, during the 2008 financial crisis, the company of a former FRBNY director was negotiating with FRBNY regarding assets the Reserve Bank had acquired when it extended credit against the assets of Bear Stearns Companies, Inc. The former director felt that there was a miscommunication and contacted a number of FRBNY staff he knew to discuss the issue. The director’s preexisting relationship with FRBNY raised questions about the appropriateness of FRBNY’s actions in its negotiations with the former director’s firm. Recently, FRBNY implemented a procedure to document contacts involving directors by reporting calls and their content in a memo to the chairman of the board’s Audit and Operational Risk Committee. Reserve Bank officials said that many of the Reserve Banks maintain programs to keep in touch with former directors. These can be formal programs such as annual holiday functions or informal ways to continue to seek former directors’ views on the economy and their industries. Reserve Bank officials described these contacts as “unobjectionable.” A former Federal Reserve Board governor with whom we spoke also thought that these contacts are appropriate. As discussed later, indirect connections between directors’ firms and Reserve Banks when the firms used the emergency programs or acted as service providers have also raised questions. The Federal Reserve Board, and in some cases, the FOMC, authorized the creation and modification of most of the emergency programs under authorities granted by the Federal Reserve Act. Although a number of Reserve Bank directors were affiliated with institutions that borrowed from the emergency programs, we did not find evidence that Reserve Bank boards of directors participated directly in making any decisions about authorizing, setting the terms of, or approving a borrower’s participation in the emergency programs. Our review did not reveal that Reserve Bank directors received nonpublic information on the emergency programs. A review of minutes from the 12 Reserve Bank board meetings during the unfolding crisis revealed that discussions of emergency programs during board meetings appeared to have occurred after the emergency programs had been publicly announced. Further, presentations by Reserve Bank staff generally covered explanations of the related emergency lending authority, administration of the program, descriptive information about the programs’ operations and risks, and the impact on the Reserve Banks’ balance sheets. Moreover, Federal Reserve Board officials and Reserve Bank directors from all 12 Reserve Banks with whom we spoke told us that the Reserve Bank boards did not play a role in the creation or implementation of the emergency programs. Federal Reserve Board officials also pointed out that all Reserve Bank directors are prohibited from disclosing nonpublic information related to the programs and such disclosures may risk violating insider trading laws. While all Reserve Banks implemented the Term Auction Facility, FRBNY implemented the majority of the emergency programs. A number of FRBNY’s directors played a limited oversight role as prescribed in a written Audit and Operational Risk Committee (AORC) protocol that states the oversight by the directors was focused on operational risks. For example, according to FRBNY officials, FRBNY staff periodically briefed the committee on the composition of an asset portfolio that was created to assist Bear Stearns when it was near failure to help ensure that the directors were aware of how the bank was managing certain high-risk assets. FRBNY has five directors on the audit committee. During the financial crisis, at least one Class A director served on this committee at any given time. According to FRBNY officials, to help ensure that one class of directors does not have undue influence, FRBNY strengthened its governance structure by revising its AORC charter to permit only two out of five committee members to be Class A directors. Although implemented after the unwinding of many of the emergency programs, the enhanced standards helped mitigate the appearance of actual and potential director conflicts by ensuring that Class A directors are not the majority on the AORC. Appendix III provides more information on the Reserve Bank committees. As mentioned earlier, in their role as market participants, some FRBNY directors were consulted by FRBNY management and staff as certain emergency facilities were being created. According to FRBNY officials, a director providing information to FRBNY management and staff in his or her role as chief executive officer of an institution does not equate to “participating personally and substantially”—as defined by 18 U.S.C. § 208, discussed below—because the director is not playing a direct role with respect to approving a program or providing a recommendation. According to FRBNY officials, FRBNY’s Capital Markets Group contacted representatives from primary dealers, commercial paper issuers, and other institutions to gain a sense of how to design and calibrate some of the emergency programs. For example, FRBNY officials said that General Electric Company (General Electric), whose chief executive officer was serving as a Class B director at the time, was one of the largest issuers of commercial paper and General Electric was one of the companies FRBNY consulted when creating the emergency program to assist with the commercial paper market. FRBNY officials said they contacted institutions for this purpose irrespective of whether one of FRBNY’s directors was affiliated with the institution. Some of the institutions that borrowed from the emergency programs had senior executives and stockholders that served on Reserve Banks’ board of directors. These relationships contributed to questions about Reserve Bank governance and also raised concerns about conflicts of interest. We identified at least 18 former and current Class A, B, and C directors from 9 Reserve Banks who were affiliated with institutions that used at least one emergency program. In those cases, 11 Class A directors who served between 2008 and 2010 worked for member banks that used an emergency program. There are 2 Class B directors who served between 2008 and 2010 and worked for companies that used an emergency program. Similarly, one Class C director who served between 2008 and 2009 was affiliated with a company that used at least one program. In addition, there are 4 former Class A directors who served between 2006 and 2007 whose companies used the emergency facilities. The Term Auction Facility was the most commonly used facility. According to Federal Reserve Board officials, the Federal Reserve Board allowed borrowers to access its emergency programs only if they satisfied publicly announced eligibility criteria. Thus, Reserve Banks granted access to borrowing institutions affiliated with Reserve Bank directors only if these institutions satisfied the proper criteria, regardless of potential director-affiliated outreach or whether the institution was affiliated with a director. As we reported in our July report, our analysis did not find evidence indicating a systemic bias toward favoring one or more eligible institutions. While some institutions that borrowed from these programs were affiliated with a Reserve Bank director, these institutions were subject to the same terms and conditions as those that had no such affiliation. As another example, the Chief Executive Officer of JP Morgan Chase & Co. (JP Morgan Chase) served on the FRBNY board of directors at the same time that his bank participated in various emergency programs and served as one of the clearing banks for emergency lending programs. According to Federal Reserve Board officials, there are only two entities, including JP Morgan Chase, that offer services as clearing banks for triparty repurchase agreements and both banks served as clearing banks for the emergency programs. Similarly, Lehman’s Chief Executive Officer served on the FRBNY board while Lehman’s broker-dealer subsidiary participated in emergency programs such as the Primary Dealer Credit Facility. Having the Class A directors, who represent member banks, and the Class B directors, who are elected by member banks, as required by the Federal Reserve Act, creates an appearance of a conflict of interest. This is because Class A or B directors might own stock in banks or Class A directors might work for banks that are supervised by the Reserve Bank while also overseeing aspects of the Reserve Banks’ operations, including the bank presidents’ evaluation and salary and personnel decisions for the supervision and regulation function. In addition, Class B directors are involved in the president selection process. In turn, the president oversees the supervision and regulation function, which regulates the member banks that vote for the Class A and B directors. The president also may serve on the FOMC. Conflicts of interest involving directors have been historically addressed through both federal law and Federal Reserve System policies and procedures. First, individuals serving on the boards of directors of the Reserve Banks are generally subject to the federal criminal conflict-of- interest restrictions in section 208 of title 18 of the U.S. Code and its implementing regulations. 18 U.S.C. § 208 generally prohibits Reserve Bank directors from participating personally and substantially in their official capacities in any matter in which, to their knowledge, they have a financial interest, if the particular matter will have a direct and predictable effect on that interest. The Office of Government Ethics regulations implementing 18 U.S.C. § 208 include provisions concerning divestiture, disqualification (recusal), and waivers or exemptions from disqualification. The regulations also provide that Reserve Bank directors may participate in specified matters, even though they may be particular matters in which they have a disqualifying financial interest. These matters concern the establishment of rates to be charged to member banks for all advances and discounts; consideration of monetary policy matters and other matters of broad applicability; and approval or ratification of extensions of credit, advances or discounts to healthy depository institutions, or in certain conditions, to depository institutions in hazardous condition. As the rulemaking for these exemptions notes, because of their ties to the financial services industry and their communities, it is likely that at least some directors will have financial conflicts with their duties, and the exemptions adopted by the Office of Government Ethics were necessary to resolve any possible conflict between the directors’ statutorily mandated function and the performance of their official duties. The Federal Reserve Board and Reserve Banks have policies and procedures to identify, manage, and mitigate conflicts of interest that could result from a Reserve Bank director having financial or other interests that conflict with the interests of the Reserve Bank. These steps include defining the roles and responsibilities of directors to avoid conflicts, managing and mitigating conflicts of interest through adherence to federal law and the Federal Reserve board’s conflict-of-interest policies, and establishing internal controls and policies to identify and manage potential conflicts. The Federal Reserve Board, within the requirements of the Federal Reserve Act, defines Reserve Bank directors’ overall roles and responsibilities. In doing so, it manages and mitigates conflicts with respect to directors’ involvement with bank supervision and regulation by precluding director involvement in institution-specific supervision matters and establishes restrictions on directors’ interaction with the Reserve Banks’ supervision and regulation function. Additionally the Federal Reserve Board monitors the performance of the Supervision and Regulation Department of the Reserve Banks. Actual or potential conflicts of interest could arise if directors were consulted about supervisory matters because of their stock ownership or affiliation with the supervised entity or with a competitor or customer of the supervised entity. Our analysis of the board minutes, interviews, and survey of Reserve Bank directors reveals that interaction between the directors and the supervision and regulation staff was generally limited and that the directors were not involved in the day-to-day operations of supervision and regulation or specific bank supervisory matters such as bank examination ratings or potential enforcement actions. Reserve Bank officials and directors told us that when supervision and regulation staff report on the operations in board meetings, they do not provide details on examination issues or identify institutions by name. Our review of board minutes showed a few instances where supervision and regulation staff shared summary information concerning the general condition of banking institutions in the district. According to Federal Reserve Board and Reserve Bank officials, because the Federal Reserve Board has delegated the examination of bank and financial holding companies, member banks, and affiliates to the Reserve Bank staff, the staff report through the Reserve Bank presidents to the Federal Reserve Board and not directly to the boards of directors of the Reserve Bank. Further, although Supervision and Regulation generally reviews and approves member bank applications to purchase other banks or establish branch offices, among other things, applications that involve institutions affiliated with a Reserve Bank director are approved by the Federal Reserve Board. As an example, Goldman Sachs’s application to become a bank holding company in September 2008 was reviewed by the Federal Reserve Board because one of the company’s directors was also a director on the board of the Reserve Bank. Questions also have been raised about the role of the Reserve Bank board in approving the Reserve Banks’ discount window lending and whether conflicts of interest arise because officials from member banks that borrow from the discount window may serve as Class A directors on Reserve Bank boards. To avoid this potential conflict, no boards take part in loan approval, although some boards ratify loans that have already been granted under the discount window on a quarterly basis. Moreover, directors and Reserve Bank officials we spoke with said that Class A directors recuse themselves from the loan approval discussion when their institution has borrowed. As explained more fully earlier, Reserve Bank directors are subject to the federal criminal conflict of interest restrictions under 18 U.S.C. § 208, which generally prohibits Reserve Bank directors from participating personally and substantially in their official capacities in any matter in which, to their knowledge, they have a financial interest, if the particular matter will have a direct and predictable effect on that interest. In addition, Reserve Bank directors are expected to follow relevant policies in the FRAM developed by the Federal Reserve Board. As stated in the FRAM’s “Guide to Conduct for Directors of the Federal Reserve Banks and Branches,” directors are expected to be “above reproach” in their personal financial dealings and should never use information they obtain as directors for personal gain. The FRAM states that in carrying out their responsibilities, directors should avoid any action that might result in or create the appearance of (1) affecting adversely the confidence of the public in the integrity of the Federal Reserve System, (2) using their position as director for private gain, or (3) giving unwarranted preferential treatment to any organization or person. Moreover, it states that directors should strictly preserve the confidentiality of Reserve Bank and Federal Reserve System information, and should avoid making public statements that suggest the nature of any monetary policy action that has not been officially disclosed. Directors also are expected to adhere to high ethical standards of conduct. In addition, directors are also expected to comply fully with all applicable laws and regulations governing their actions as directors and in their conduct outside of the Federal Reserve System. The FRAM also prohibits directors from engaging in certain types of political activities. As a general principle, it states that directors should not engage in any political activity or serve in any public office where such activity or service might be interpreted as associating the Reserve Bank or the Federal Reserve System with any political party or partisan political activity, might embarrass the Reserve Bank or the Federal Reserve System in the conduct of its operations, or might raise any question as to the independence of the individual’s judgment or ability to perform his or her duties with the Reserve Bank or System. The Federal Reserve Board’s policy does not prohibit directors from participating in activities as individual voters or as members of nonpartisan public service bodies when that would not be potentially embarrassing to the Federal Reserve System. The Reserve Banks have internal controls, including annual certifications, oaths, and affirmations, to help the banks monitor directors’ compliance with the FRAM and conflict of interest policies and procedures. These mechanisms require directors to report new directorships or affiliations, and to reaffirm that they are free of conflicts of interest. While directors are not required to disclose their financial holdings, Reserve Banks provide updates to directors whenever there is a change to the list of prohibited investments and affiliations (based on institutions that become bank holding companies or other institutions supervised by the Federal Reserve System). Also, during the directors’ selection process, Reserve Bank officials conduct a background check using publicly available information on the directors and the financial status of the directors’ companies. Once directors are on the board, the Reserve Banks rely on the directors to self report any actual or potential conflicts of interest. Additionally, the directors receive training at the beginning of their terms, from both the Reserve Bank and the Federal Reserve Board. The Federal Reserve Board training includes meetings where the directors are able to meet the Board of Governors, Federal Reserve Board staff, and other directors from across the system. The training provided by the Reserve Banks includes information on the FRAM’s “Guide to Conduct for Directors of Federal Reserve Banks and Branches,” roles and responsibilities, ethics, oaths, affidavits, and certifications. Many directors also receive ethics training annually, in addition to the beginning of their terms. Reserve Banks provide training to directors to guide them in determining what investments/affiliations may be prohibited. The Federal Reserve Board also offers midterm training to all directors, which officials said is generally well attended. According to Federal Reserve Board and Reserve Bank officials with whom we spoke, the most likely potential conflict of interest involves procurement matters, and the Reserve Banks have taken a variety of steps to address them. Some Reserve Bank boards are involved in approving the bank’s vendor contracts. Because some directors are affiliated with businesses in the banks’ district that may offer services the Reserve Bank seeks, they could potentially have a conflict of interest if their firms or competitors were to compete for the contracts. To help ensure that procurement practices are untainted by actual or potential conflicts of interest from directors, the Federal Reserve Board requires all of the Reserve Banks to have procurement policies that provide guidance for directors that includes the role of directors in procurements, the nature of the procurement, an education program for directors, written procedures for the directors to follow for recusal, written certification process, and record keeping of training materials and attendance, recusals, and procurement certifications. Our review noted that all banks require the directors to sign certifications stating whether or not they have a conflict of interest with a procurement that is being considered. All Reserve Banks have processes and certifications to help ensure that directors do not have conflicts. Likewise, all Reserve Banks have delegated certain procurement decisions to management. We compared the Federal Reserve System’s ethics and related policies and practices with those of other organizations, including other central banks, a self-regulatory organization whose members serve on its board of directors, a government-sponsored enterprise, and large bank holding companies. See appendix IV for a list of the 10 largest bank holding companies included in our review. The authorizing laws, policies, and procedures for all four central banks we studied, like the authorizing law, policies, and procedures for the Federal Reserve System, included provisions relating to ethical behavior and conduct. All four central banks and the U.S. Reserve Banks emphasized that directors must demonstrate a high level of ethical conduct and adhere to applicable laws and regulations, but policies for managing conflicts of interest varied. For example, the Reserve Bank of Australia waives all conflict of interest requirements for its board, and allows directors to participate in policy deliberations as long as they disclose their interests to the bank annually. However, the Reserve Bank of Australia prohibits directors from working for or having a material financial interest in private financial companies in Australia. Conversely, the Bank of Canada Act requires that directors (1) disclose any material interest in writing or in the minutes of board meetings, (2) disclose the conflict as quickly as possible after the conflict is discovered or realized, and (3) not vote in any resolution or action related to the conflict. Directors must also avoid or withdraw from participation in any activity or situation that places them in a real, potential, or apparent conflict of interest. The Bank of Canada prohibits directors from having affiliations with entities that perform clearing and settlement functions in the financial services industry, serving as a dealer for government securities, or being government employees. Table 2 provides additional information on the ethics and conflict-of-interest practices of the central banks we reviewed. Reserve Banks’ ethics policies were generally consistent with those of FINRA and those required of the FHLBanks and public companies listed on the New York Stock Exchange (NYSE). FINRA prohibits directors who have a substantial financial interest or are affiliated with a regulated entity from participating in any regulatory matter, disciplinary action, investigation, or decision regarding an application from that entity for an exemption. The Federal Housing Finance Agency—FHLBanks’ regulator—requires that FHLBanks have a conflict of interest policy and that directors promptly disclose any actual or apparent conflicts of interest and recuse themselves from issues in which they have a conflict. Public companies listed on the NYSE—including the 10 largest bank holding companies included in our review—must adopt and disclose a code of business conduct and ethics. The code must contain a policy that prohibits conflicts of interest and allows directors to communicate potential conflicts with the company. Table 3 shows the ethics and conflict of interest practices of the comparable organizations we reviewed. Federal Reserve Banks do not require directors to periodically disclose their financial interests. Officials at the Federal Reserve Board stated that directors were doing a civic duty by serving on a Reserve Bank board and that the Federal Reserve Board does not want to make it burdensome for them to serve. The officials also noted that directors’ investments may change frequently, so keeping accurate information on all investments would be difficult. Class C directors submit an annual certification stating that they do not have any prohibited stockholdings. Although Federal Reserve Bank directors do not submit an annual disclosure of non- financial interests, both Class B and Class C directors are required to submit an annual certification stating that they do not have any prohibited affiliations. The directors are required to notify the corporate secretary if there are any changes in their affiliations or stockholdings, as appropriate. All four central banks we reviewed required directors to disclose some information about their personal affiliations with other organizations, such as other directorships. The Reserve Bank of Australia requires directors to disclose material personal financial interests—including financial and nonfinancial—to the treasurer on a yearly basis. The European Central Bank (ECB) requires all Governing Council members (i.e., Executive Board members and governors of the National Central Banks) to annually disclose their public and private affiliations, and Executive Board members must also complete a yearly financial disclosure. FINRA governors annually disclose their relationships with other organizations, such as other directorships, but do not typically provide financial information annually, according to FINRA officials. FHLBanks are required to file an annual report on Form 10-K with the Securities and Exchange Commission. This form includes information about the directors’ other directorships on the boards of publicly traded companies or investment companies. Most FHLBanks do not require directors to file a comprehensive annual financial disclosure, but most of the banks require directors to sign an annual certification agreeing to adhere to the ethics policies. All public companies—including the bank holding companies we reviewed—are also required by SEC to file a Form 10-K, which includes information about any other directorships of board members. Other comparable organizations had a variety of policies on waiving ethics and related requirements. Central banks in our review varied in the extent to which they had policies or procedures for directors to apply for waivers to their ethics policies. The Bank of Canada does not have a waiver process. An official at the bank stated that waivers would be inconsistent with the bank’s conflict of interest policy, which requires that directors avoid or withdraw from participation in any activity that places the director in a real, potential, or apparent conflict of interest. The European Central Bank Code of Conduct instructs Governing Council members to seek counsel from an ethics adviser if a conflict arises. The adviser either decides the issue or forwards it to the Governing Council. The NYSE requires that listed companies, including the large bank holding companies we reviewed, promptly disclose any waivers of codes of conduct for directors or executive directors. Only boards and board committees can grant waivers, which must be disclosed to shareholders within 4 business days, using either a press release, the institutional website, or an SEC Form 8-K. FINRA’s code of conduct for directors states the board must approve waivers from the code. However, FINRA officials told us that in practice, its governors have chosen to manage conflicts through recusal rather than seeking waivers. About half of the FHLBanks reported that they have a process in place for directors to request a waiver of the code of conduct. There are two types of waivers relevant to Reserve Bank directors. First, as discussed earlier, the Federal Reserve Board can grant waivers to directors in connection with 18 U.S.C. §208, pursuant to applicable federal regulations. Second, Reserve Banks may request waivers from the Federal Reserve Board’s policies related to director eligibility, qualifications and rotation, such as allowing directors to remain on the Reserve Bank board despite having a prohibited investment or other prohibited affiliation. Federal Reserve Board officials said they have received few waiver requests. According to the officials, the Federal Reserve Board waiver process permits Reserve Banks to make informal inquiries of Federal Reserve Board staff as to whether a given action would be appropriate. The officials noted that most of the time Reserve Banks’ questions could be resolved without an official waiver request. Additionally, Reserve Bank officials told us that they frequently receive questions from directors about the policies, which they either discuss and handle internally, or contact the ethics officer or corporate secretary at the Federal Reserve Board to determine the appropriate actions that should be taken. For example, one director checked with the general counsel at the Reserve Bank to discuss a situation in which family members had inherited bank stock that was held in a trust for which the director was named trustee. The general counsel discussed the issue with relevant officials at the Reserve Bank and advised the director to resign his position in the trust so that he would not have a conflict of interest. Not all Reserve Banks have procedures in place for directors to request a waiver of the eligibility policy from the Federal Reserve Board. We found that the Reserve Banks are not required to have a waiver request process and only FRBNY has a formal process in place to review waiver requests. An official from one Reserve Bank told us that the bank does not have a formal process for considering waiver requests nor has it had directors who needed to request a waiver from the Federal Reserve Board. When FRBNY sought the waiver on behalf of the then-FRBNY chairman from the Federal Reserve Board, FRBNY did not have a formal waiver process and did not consult with the board of directors before making a waiver request to the Federal Reserve Board. An FRBNY official told us that in hindsight the board should have been involved. On the basis of this experience, FRBNY implemented a formal waiver process. While we recognize that the need to request a waiver from Federal Reserve Board policies may be rare, a crisis situation may create unanticipated conflicts without providing time for comprehensive actions before a decision must be made. However, without a formal process in place to consider a request for a waiver from Federal Reserve Board policies, Reserve Banks risk inconsistent treatment of requests and being exposed to questions about their governance practice and the integrity of their decisions and actions. If waivers to policies are granted, making the process and decisions transparent is vital. Given the public nature of Reserve Bank activities, disclosing waivers provided to directors is one way to improve transparency and accountability and reduce the appearance of conflicts of interest. Public companies listed on the NYSE are required to promptly disclose any waivers of the code of conduct for directors and executive officers, which can be made only by the board or a committee of the board. To the extent that a waiver of the code of conduct is granted, the waiver must be disclosed to shareholders within 4 business days of the decision, by distributing a press release, providing website disclosure, or filing a report with SEC. Reserve Banks are not required to disclose information to the public about waivers of the policy on director eligibility and qualifications for one of their directors that were granted by the Federal Reserve Board. As demonstrated during the recent financial crisis and the waiver request for the then-FRBNY chairman, a lack of transparency around the waiver request process and outcome contributed to greater distrust of Reserve Bank governance. Congress and the Federal Reserve System have taken steps aimed at improving Reserve Bank governance. The Dodd-Frank Act, enacted on July 21, 2010, made several amendments to the Federal Reserve Act. One of these amendments changed the selection process for Reserve Bank presidents and first vice presidents. Before the amendment, all directors acted to appoint the president of the Reserve Bank, subject to the approval of the Federal Reserve Board. This created the appearance of a conflict because the Class A directors voted to appoint the Reserve Bank president, who would play a role in supervision and regulation and may be a voting member of the FOMC. After the amendment, only Class B directors (who are elected by district member banks to represent the public) and Class C directors (who are appointed by the Federal Reserve Board to represent the public) may appoint the Reserve Bank presidents. Class A directors, who are elected by member banks to represent member banks, may no longer appoint presidents of the Federal Reserve Banks. This same change also affects the appointment of the first vice president. In part because of the financial crisis that started in mid 2007 and the increased scrutiny of the Federal Reserve System, the Federal Reserve Board conducted a study of the governance of the Federal Reserve Banks, which included a review of the roles and responsibilities of the Reserve Bank directors. In November 2009, the results of this study were presented to the Reserve Bank presidents, corporate secretaries, and board chairmen, which led some banks to conduct reviews of the roles and responsibilities of their bank directors. As a result of the Federal Reserve Board review, the board revised two policies governing directors. First, the board amended the eligibility policy to explicitly address situations in which Class B or C directors’ stockholdings unexpectedly become impermissible, such as if a company in which a director holds stock converts to a bank holding company. Before this revision, the Federal Reserve Board did not have a formal policy governing the treatment of such situations. The revised policy requires directors to resign from the board or divest their interests within 60 days from the time the Reserve Bank or director learned about an impermissible situation. During this time, the director would have to recuse himself or herself from all duties related to service as a Reserve Bank director until the affiliation is severed. Second, the Federal Reserve Board revised its policy on director conduct by requiring Reserve Banks to adopt a policy that governs instances when directors are involved with procurement, as discussed previously. Since this Federal Reserve Board study and the Dodd-Frank Act amendments, all of the Reserve Banks have changed the directors’ roles to remove the Class A directors from the process of appointing the bank president. In addition, some banks have included additional restrictions on Class A directors’ involvement in supervision and regulation personnel and other matters. For example, the Federal Reserve Banks of New York, Richmond, and Minneapolis restricted Class A directors’ involvement in personnel appointments for supervision and regulation. Moreover, after the recent study, the board of the Federal Reserve Bank of St. Louis reevaluated its procedures so that the Class A directors are not involved with personnel matters related to the senior vice president of its supervision and regulation function, or any institution-specific matters. According to Federal Reserve System officials, it has been a standing practice, predating the enactment of the Dodd-Frank Act, that Reserve Bank directors do not vote on institution-specific supervisory matters. Beyond that practice, the Federal Reserve Banks of New York, Richmond, St. Louis, and Minneapolis recently revised their bylaws to include the role of their boards of directors with regard to supervision and regulation. FRBNY made clear that Class A directors are prohibited from voting on appointment, termination, and compensation of employees in the Financial Institutions Supervision group. Federal Reserve Bank of Richmond stated directors cannot vote on institution-specific supervision and regulation matters and that Class A directors should not vote on the budget for the supervision and regulation function and matters related to senior personnel in that function. Federal Reserve Bank of St. Louis states that actions by the board of directors related to oversight of the supervision and regulation function shall be upon a vote of a majority of the Class B and Class C directors present at any such meeting. Similarly, Federal Reserve Bank of Minneapolis stated that directors are not involved in institution-specific supervision and regulation matters and Class A and Class B directors should not vote on matters of an administrative nature. Although there are restrictions on directors’ involvement in supervision and regulation matters, the Reserve Banks are not required to document the directors’ roles in their bylaws. As a result, 8 of the 12 Reserve Banks have not documented the extent of board of directors’ involvement in supervision and regulation in their bylaws. The Federal Reserve Banks of Boston, Chicago, Cleveland, Dallas, Kansas City, Philadelphia, and San Francisco do not document the directors’ roles and responsibilities to further clarify the extent of their involvement in supervision and regulation matters. Although Reserve Bank directors may be cognizant of their roles and responsibilities, a lack of a clear statement in the bylaws on the directors’ involvement in supervision and regulation matters could contribute to lack of clarity around the directors’ roles, create confusion for the public, and lead to questions about Reserve Bank governance. Moreover, by documenting the roles of directors with regard to such matters, the Federal Reserve System could help enhance the public’s understanding of the roles of the directors and reduce the appearance of conflicts of interest. Some officials, directors, and academics with whom we spoke also suggested potential changes to the Reserve Bank board structure that could further strengthen governance, but these changes would involve tradeoffs. First, some suggested that increasing the number of directors appointed by the Federal Reserve Board who represent the public could help alleviate the appearance of member bank control. This could be accomplished by expanding the Reserve Bank board size by increasing the number of Class C directors or by adding a fourth class of 3 directors appointed by the Federal Reserve Board. By adding 3 more appointed directors to the Reserve Bank board, the boards would have an equal number of directors elected by member banks and directors appointed by the Federal Reserve Board, therefore eliminating the perception of member bank control of the boards. We have previously reported that board size is not one-size-fits-all and should be based on the needs and complexity of the organization. As discussed later in the report, board size for other public and private organizations varies, but a board size of 12 members would still be within the range of board sizes at other comparable organizations such as central banks, self-regulatory organizations, and large bank holding companies. A larger board could also enhance opportunities for diverse candidates. However, adding 3 board members would create more positions for Reserve Banks to fill, and it may be more difficult for some of the Reserve Banks to fill these positions. As of September 16, 2011, there were two director positions in the 12 Reserve Banks open. Additionally, some Reserve Bank officials and directors stated that a larger board size could reduce the opportunity for directors to participate in the meeting and may increase absences or decrease committee participation because directors could feel that their contributions were less important because there were more directors to accomplish the necessary board work. Additionally, an increase in the size of the Reserve Bank board would require an amendment to the Federal Reserve Act. Second, some Reserve Bank officials and directors suggested that the Federal Reserve Board could appoint Class B directors to represent the public rather than having them elected by member banks. The perception of conflicts of interest and member bank control could be reduced by making this change. However, we heard from several academics and Reserve Bank officials that the current system provides a set of checks and balances between the Federal Reserve Board in Washington, D.C., and the 12 Reserve Banks and their members. By allowing the Federal Reserve Board to appoint two-thirds of the Reserve Bank boards, the balance of power would shift to the Federal Reserve Board. Officials and directors we spoke with emphasized the importance of regional input in the Federal Reserve System, which includes the ability of the regions to select their representatives on the Reserve Bank board. Additionally, as discussed earlier, while the FRAM prohibits bank officials and employees from serving on nomination committees for Class A and B directors, Reserve Bank officials told us that they played a significant role in the identification, vetting, and recruiting of Class B directors before they are nominated and elected by member banks. Because Reserve Bank officials are involved in the identification and vetting process for both types of candidates, whether changing the selection process for Class B directors would change the outcome significantly is unclear. Additionally, allowing the Federal Reserve Board to appoint the Class B directors would require an amendment to the Federal Reserve Act. Congress, academics, and others have offered a number of ways to change the structure of the Federal Reserve System, which would have implications for governance and ongoing concerns about conflicts of interest. First, some academics and others have commented that the Reserve Banks should become offices or branches of the Federal Reserve Board rather than independent entities within the system, which would eliminate the boards of directors, or they said the boards of directors should be converted into advisory councils. One academic told us that making them branches would help address concerns about the current governance structure because it would eliminate the need for boards of directors and thereby eliminate conflicts. As an example, the central bank of Germany follows this model. However, others we interviewed noted that this would concentrate all of the power and influence with the Federal Reserve Board. Moreover, it would increase the size of the federal agency. In addition, others have said that converting boards to advisory councils in the districts would undermine governance by reducing the responsibility of the boards and would make it harder to attract quality candidates to serve on the councils. Second, some have questioned the need for 12 Reserve Banks given changes in the financial markets and advances in technology. The views of Federal Reserve System officials varied. A few of the individuals we interviewed thought there could be fewer banks because the current structure was outdated and reflected a U.S. economy that existed 100 years ago. However, others believe that the structure is still appropriate given differences in regional economies and perspectives. Federal Reserve System officials also point to the greater efficiencies that have been implemented through the Reserve Banks’ consolidation of certain ongoing operations such as check clearing and information technology. Third, some in Congress and others recommended that the Federal Reserve System’s role in supervision and regulation be eliminated, which would have eliminated concerns about conflicts of interest involving directors affiliated with institutions supervised by the Reserve Banks. Some believe that the central bank should be focused exclusively on monetary policy and that supervision and regulation should be conducted by another regulatory entity. Others viewed the two functions as critically intertwined, and ultimately, this approach to reform was not pursued by Congress in the Dodd-Frank Act. Rather, the Federal Reserve System’s supervisory role was increased to include thrift holding companies and systemically important financial institutions. Others have taken a less sweeping approach to reform by questioning the Federal Reserve Board’s delegation of supervision to the Reserve Banks. However, consolidating supervision with the Federal Reserve Board would require a substantial increase in the federal workforce for the Federal Reserve Board to conduct this function. Currently, the supervision and regulation staff at the Reserve Banks are not federal employees because they are employees of the Reserve Banks and not the Federal Reserve Board. Rather, the Reserve Bank supervision and regulation staff act under authority delegated from and are overseen by the Federal Reserve Board. With the exception of the delegation of authority, these other structural changes involve policy decisions that would require changes to the Federal Reserve Act. Reserve Bank boards are generally similar in size, composition, and term lengths and limits to the boards of comparable organizations. Additionally, they employ similar accountability measures, such as annual performance reviews of the organization and management, as other comparable organizations. However, Reserve Banks lack transparency in their governance practices compared with those of other organizations we reviewed. For example, while most all of the other organizations we reviewed make key governance documents, such as board bylaws, ethics policies, committee mission statements, and committee assignments, available to the public, most Reserve Banks do not post this information on their websites. As previously discussed, the size of Reserve Bank boards is established by the Federal Reserve Act of 1913 and sets each board’s size at nine directors. The size of the Reserve Bank boards is within the range of board sizes and composition that we identified at comparable organizations. As we have seen, the boards of the organizations we studied had from 9 to 23 members (see table 4). Neither the NYSE nor SEC has size requirements for the boards of listed and public companies, and most of the bank holding companies we reviewed included provisions in their bylaws that allowed for flexibility in board size. For example, one company’s bylaws state the board has the authority to determine the number of directors and that the number should be in the range of 13 to 19, with the flexibility to increase the size as needs and circumstances change. The number of allowable directors under the bylaws of bank holding companies we studied ranged from 3 to 36, while the actual number of directors on the boards of bank holding companies included in our study ranged from 11 to 15. According to NYSE, independence for directors means having no material relationship with the listed company, either directly or as a partner, shareholder, or officer of an organization that has a relationship with the company. Central bank literature typically refers to independence in terms of the central bank being independent of the government; therefore, independent directors are those who do not work for the central bank or other government entity. Independence is an important aspect of board governance because it provides accountability and an outside perspective. Further, the Organisation for Economic Co-operation and Development (OECD) notes that boards must be able to exercise objective judgment in order to fulfill their duties and that, to accomplish this goal, a sufficient number of board members should be independent of management. Reserve Bank directors have varying levels of independence. As discussed earlier in this report, Class C directors are appointed by the Federal Reserve Board. These directors are independent—that is, they are not employees or managers of the Reserve Banks at which they serve, nor are they a partner, shareholder, or officer of an organization that has a relationship with the Reserve Bank, such as a member bank. Class B directors are elected by member banks and are statutorily required to represent the public. They meet almost all of the independence requirements listed above, with the exception that they can be a stockholder in a bank. Class A directors, who represent the member banks that elect them, are the least independent of the Reserve Bank directors. Some have questioned whether Reserve Bank boards have enough independence from the member banks that the Reserve Banks supervise. FINRA’s bylaws balance public and industry representation by requiring that members representing the public outnumber those representing industry on the board. No FHLBank managers serve on the FHLBank boards, and by law at least two-fifths of the directors must be independent and not affiliated with member banks. Additionally, at least two of the independent directors must be “public interest” directors with at least 4 years of experience representing community or consumer interests in banking services, credit needs, housing, or consumer financial protections. Reserve Bank directors’ term lengths and limits were also within the range of term lengths and limits we observed for other comparable entities. For example, both Reserve Bank and FINRA directors can serve up to two consecutive 3-year terms. At the other four central banks we reviewed, independent directors—who are not government or central bank officials, or for the ECB, the board members from national central banks—served 3- to 5-year terms. Other board members (including governors and other government officials) served 5- to 8-year terms. FHLB directors may serve up to three consecutive 4-year terms. The NYSE and SEC do not have requirements for listed or public companies regarding term length or limits. Two of the large bank holding companies we reviewed opted to have directors serve 1-year terms so that each director had to be reelected by the stockholders each year, but none of the companies enacted term limits for their directors. One company noted in its annual proxy statement that although term limits might be a source of fresh ideas and viewpoints, they had the disadvantage of potentially reducing the knowledge and insight that experienced directors gained over time. Another bank holding company’s proxy statement said that the company favored monitoring individual director performance over term limits. Selection procedures for directors varied across the entities we examined. As we have discussed, Federal Reserve Bank boards consist of both appointed and elected directors. However, all the boards of the four central banks we reviewed had directors who were appointed to the board by various entities. For example, for the ECB Executive Board, members are nominated by the governments of euro-area member states. Both the ECB’s Governing Council and the European Parliament are consulted on prospective candidates and issue opinions on them. The European Parliament holds a hearing for the nominated candidate, and the European Council (only member states that have adopted the euro) votes to appoint a new Executive Board member. The 17 euro-area National Central Bank governors who are members of the Governing Council in addition to the 6 Executive Board members are selected according to national procedures. The directors of the Reserve Bank of Australia and independent directors of the Bank of Canada are appointed by the Treasurer and Minister of Finance, respectively. The Queen of England appoints governors and nonexecutive directors to the Court of Directors at the Bank of England. The other comparable organizations we studied had a combination of elected and appointed members and used nominating committees as part of the director selection process. FINRA’s bylaws require that all members be nominated by a committee and certified by the corporate secretary. Of the 10 industry directors, 7 are elected by their constituents. The 3 remaining industry directors and all of the public directors are appointed by FINRA’s Board of Governors after nomination by the committee. FHLBank member directors are nominated and voted on by member institutions within their state, whereas independent directors are nominated by the FHLBank’s board of directors, after consultation with its Advisory Council, and elected by the FHLBanks’ members at-large. Companies listed on the NYSE must have nominating/corporate governance committees composed entirely of independent directors to identify qualified individuals and select them or recommend them to the board for selection. Stockholders elect the directors of the 10 largest bank holding companies we reviewed. Like the Reserve Banks, other comparable entities also considered skills and experience as key factors in selecting board members. Reserve Banks recruit directors in accordance with the requirements in the Federal Reserve Act, which stipulate that directors shall be chosen without discrimination as to race, creed, color, sex, or national origin and that Class B and Class C directors who represent the public shall be elected “with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers.” Some Reserve Bank officials told us that while they strive to find diverse candidates from a variety of industries, they primarily want to find people who have the skills and knowledge that will fill gaps in the board’s existing knowledge and skill set. Similarly, all four central banks we reviewed had skill or experience qualifications for board members. For example, the Bank of Canada focuses on the collective skills of the board of directors in areas such as accounting, human resources, corporate governance, and financial markets. FHLBanks and FINRA also look for directors with particular skills and experience to complement the boards. FHLBank nonmember directors are required to have experience in, or knowledge of, one or more of the following areas: auditing and accounting, derivatives, financial management, organizational management, project development, risk management practices, and the law. FINRA officials stated that they had no written qualifications but added that for each opening they analyzed the type of expertise the board lacked—for example, technological, legal, or academic—to identify skills that would complement the existing expertise. SEC requires public companies to disclose information about the qualifications of directors and nominees for director and to provide reasons why each should serve but does not require specific types of experience or expertise. As with the Federal Reserve Banks, none of the comparable entities had specific requirements for gender or race and ethnic diversity for their boards. One central bank required that directors represent different geographies and industries within the country. As discussed earlier, public companies must report in their proxy and information statement on how the nominating committee considered diversity when reviewing candidates for director. In our analysis of the 10 largest bank holding companies in 2010, proxy statements indicated that companies primarily value candidates that will bring complementary skills and experience to the board but also consider diversity in selecting them. Reserve Banks and comparable institutions, both public and private, have a variety of accountability measures in place, including annual performance reviews of the organization and management, internal and self-assessments, and external audits. All 12 Reserve Bank boards conduct bankwide performance reviews on a yearly basis. Similarly, a committee of the board at the Bank of England—the Committee of the Court (NedCo)—is responsible for reviewing the bank’s performance in relation to its objectives and strategy, monitoring the extent to which its financial management objectives are met, reviewing the procedures of the Monetary Policy Committee and the bank’s internal controls, and determining the pay and terms of employment of the governors, executive directors and external Monetary Policy Committee members. To a large extent, NedCo’s work is done through the Court of Directors; it is chaired by the Court’s chairman and consists of all nonexecutive members. Internal reviews and self-assessments are also part of board accountability practices across the institutions that we reviewed. Within the Federal Reserve System, the Federal Reserve Board relies on RBOPS to oversee Reserve Banks’ management and operations. RBOPS reviews each Reserve Bank at least every 3 years. In addition, 6 of the 12 Federal Reserve Bank boards of directors conduct an annual self-evaluation. Some of the other organizations that we reviewed had similar evaluations conducted by their boards. For example, the Bank of similar evaluations conducted by their boards. For example, the Bank of Canada’s board conducts an annual self-assessment through one-on-one interviews between each director and the lead director, supported by a survey that solicits directors’ views on various elements of the board’s operations, governance, and effectiveness. The survey is completed electronically and aggregated results are distributed to directors for discussion in open session. The board also has developed and maintains a skills map of the current directors’ competencies and takes note of any gaps or deficiencies. Further, companies listed on the NYSE must adopt corporate governance guidelines that include provisions for the board to conduct a self-evaluation at least annually to determine whether it and its committees are functioning effectively. Reserve Bank boards and publicly listed companies also hold meetings of nonmanagement directors to promote accountability by encouraging nonmanagement directors to serve as a more effective check on management. All Federal Reserve Bank boards have executive committees that vary across banks in terms of the composition of Class A, B, and C directors (see app. III for more information on the Reserve Bank committees). The NYSE requires that nonmanagement directors of each listed company meet at regularly scheduled executive sessions without management. Some of the organizations that we reviewed, including the Federal Reserve Banks, had audit committees in place. Each Reserve Bank has an audit committee that oversees the bank’s internal auditor and reviews and approves the annual audit plan. The audit committee is also responsible for coordinating with external auditors and helping ensure that audit recommendations and concerns are properly addressed. Similarly, the Bank of England has two committees that play a role in accountability. First, as previously discussed, the Committee of the Court, NedCo, is responsible for conducting a performance assessment of the central bank. Second, the Risk and Audit Committee provides independent assurance to the Court of Directors that the bank’s internal controls are appropriate. The committee meets regularly and reviews the work of internal and external auditors, annual financial statements, and the appropriateness of the accounting policies and procedures adopted. It also makes recommendations on the appointment of the external auditors, including their independence and fees, and reviews the bank’s risk matrix and specific business controls. The Reserve Bank of Australia and the Bank of Canada also have audit committees that play a role similar to that of the Reserve Banks’ committees. FINRA’s bylaws require the board to have an audit committee of four or five governors, none of them officers or employees of the corporation and including at least two public governors. The audit committee’s functions are similar to those of committees at other organizations previously discussed. Finally, NYSE-listed companies are required to have audit committees with at least three independent members. NYSE guidelines stipulate that audit committees must assist with board oversight of the company’s financial statements, compliance with legal and regulatory requirements, the independent auditor’s qualifications and independence, and the performance of the company’s internal audit function and independent auditors. The audit committees are also responsible for SEC’s required disclosures on committee activity. Governance practices should be transparent to protect organizational reputation and help ensure accountability. Reserve Bank governance practices lack transparency compared with those of comparable institutions that we reviewed. We have previously reported that good governance, transparency, and accountability are critical in both the private and public sectors. In the private sector, they promote efficiency and effectiveness in the capital and credit markets, and overall economic growth, both domestically and internationally. In the public sector, they are essential to the effective and credible functioning of a healthy democracy and to fulfilling the government’s responsibility to citizens and taxpayers. Additionally, the World Bank, the International Monetary Fund, OECD, and other researchers agree that transparency is an important principle in good governance. While the Federal Reserve System has begun to increase the disclosure of information, more can be done to enhance the transparency of the Reserve Banks’ governance practices. Most Reserve Banks do not routinely disclose governance practices to the public, while most comparable institutions we reviewed do. For example, all four central banks we studied had public websites that displayed information about board governance, including information about the committee structure and conflict of interest policies. FINRA bylaws, including committee mission statements and conflict-of-interest rules, are also available on the FINRA website. The Federal Housing Finance Agency does not have any reporting requirements for FHLBanks, and while FHLBanks vary in what they publish on their websites, most provide some information. For example, three-quarters of the FHLBanks post information about their code of ethics, bylaws, or both, and half provide information about the election process, including time frames and independent director applications. One-third of the FHLBanks post biographical information about the directors beyond the director’s company, position, and location. 6 of the 12 FHLBanks post information about the board committees—either a description of each committee and its purpose or board members serving on each committee, and six FHLBanks publish the audit committee charter on their websites. Publicly traded companies were subject to the most stringent disclosure guidelines of the institutions we examined. The NYSE requires that listed companies publicly disclose corporate governance guidelines that address director qualification standards, responsibilities, compensation, and access to management and independent advisers, as well as director orientation and continuing education, management succession, and annual performance evaluations of the board. Corporate websites must be accessible from the United States, must clearly indicate in the English language the location of governance documents, and documents must be available in printable versions in English. By comparison, few of the Reserve Banks post information about board governance, such as committee structure and assignments, or conflict of interest and ethics policies on their websites. While the Federal Reserve Board notes vacant positions among its list of Reserve Bank board directors, the Reserve Banks do not publish information about vacant director positions on their websites. Additionally, all Reserve Banks have publicly accessible websites, but most banks post only the names, titles, and employers of current directors rather than richer biographical information. Four of the Reserve Banks provide descriptions of the board and their roles, and two banks post more comprehensive information. For example, FRBNY includes the board’s bylaws, biographies for current board members, the members and charters of each of the board’s committees, and the bank president’s daily schedule. Federal Reserve Bank of Kansas City posts information about the directors’ selection and roles, biographies for current directors, and lists alumni directors from 1992 to the present. A few individuals we spoke with noted that, in particular, Reserve Banks could be more transparent about director elections. One researcher stated that as a result of the lack of transparency around the director election process, there is a lack of understanding of how and why directors were chosen to serve on Reserve Bank boards. This can also cause increased concern about potential conflicts of interest among the directors because how and why certain individuals were selected for the board is not clear to the public. Further, in our survey of Reserve Bank directors, one director noted that transparency around the election process should be improved. The director noted that the topic was not discussed in board meetings or executive sessions of board meetings. Federal Reserve Board officials said that two Reserve Banks are publicly announcing board vacancies, but because Class A and B directors are elected by the member banks, Class C directors were the only vacancies for which the general public could apply. Further, officials said that while they could enhance transparency by advertising a vacant Class C position, the nature of the job and the need for a specific skill set generally meant that it was better for the banks themselves to recruit candidates instead of publicly seeking applications. Enhanced transparency of the director selection process, including posting director vacancies and selection procedures, could not only make the election process more transparent but also help increase the diversity of the candidate pool. Some of the institutions we reviewed have taken steps to increase transparency of their director selection process. Two of the central banks we reviewed publicized and solicited applications for governor/director positions. It was announced in July 2008 that the Bank of England would advertise vacant positions. Additionally, in Canada, a government website permits individuals to submit their names for consideration as directors of government. Also ministers responsible for entities requiring directors maintain a pool of all eligible candidates, so the Minister of Finance develops this pool of candidates for the Bank of Canada. As previously noted, about half of the FHLBanks publish information on their websites about the director election process and provide applications for potential candidates to submit to be considered by the nomination committee. Further, as previously mentioned, some Members of Congress and others raised questions about the governance of the Reserve Banks, including the selection and roles of directors. Improving the transparency of the Reserve Bank director selection process is one way to help address concerns about Reserve Bank governance. The Federal Reserve System has taken some important steps to increase transparency. For example, the Federal Reserve Board has recently taken steps to increase transparency of the monetary policy-making process. In March, the Federal Reserve Board announced that the Chairman would hold press briefings four times per year to present the Federal Open Market Committee’s current economic projections and to provide additional context for its policy decisions. The first press conference was held in April 2011. Additionally, some Reserve Banks have begun placing additional information about governance arrangements on their public websites. The Federal Reserve Board describes these postings as a recent trend and said that FRBNY has been a leader in this area. Further, the Reserve Bank boards conduct community outreach that focuses primarily on financial literacy and informing the public on their role in monetary policy. One of the three main roles for Reserve Bank directors is to be a liaison between the bank and the community. Several directors and bank officials told us that they believe that public outreach was necessary to help reduce the public’s misperception about the roles and responsibilities of the Reserve Banks. In our survey of Reserve Bank directors, some directors noted that outreach should be continued to create a more transparent environment and strengthen governance. For example, one director said that one way to strengthen Reserve Bank governance was to continue to foster an environment of transparency, with open and frequent communication. Further, the director noted that not everyone understood the difference between monetary and fiscal policy and that the Reserve Banks could help to educate the general public and the media. One director also noted that outreach activities generated goodwill and awareness throughout the community and the district and led to better public representation on Reserve Bank boards. Additionally, another director noted that the Reserve Banks needed to continue their outreach to educate the public about monetary policy and the need for an independent Federal Reserve System but cited the Reserve Banks’ budget constraints as a limitation to their outreach efforts. Officials at the Federal Reserve Board noted that the Federal Reserve System functions more effectively and efficiently when each Reserve Bank is implementing good governance procedures because good corporate governance is a key element in improving economic efficiency. Additionally, in a time when the relationships between directors and financial firms are being questioned, transparent governance practices can help in managing reputational risk. Moreover, when there is increased public interest in governance, the Federal Reserve System would be well served by making clear the roles and responsibilities of Reserve Bank directors. Moreover, without more public disclosure of governance arrangements, such as board bylaws and conflict-of-interest policies, there will be continued concerns about Reserve Bank governance. The Federal Reserve System was designed as a decentralized entity with a governmental institution and 12 separately incorporated Reserve Banks. Under this public-private partnership, the Reserve Bank directors serve a role in bringing information from their communities to inform the monetary policy deliberations of the central bank and helping oversee the operations of the Reserve Banks. The directors, like the Federal Reserve Board, are also part of the governance framework of the Reserve Banks. However, the operations and governance of the Federal Reserve System came to the forefront during the 2007-2009 financial crisis when it played a prominent role in stabilizing financial markets through the use of its emergency lending authorities. These unprecedented actions resulted in Congress and the public raising questions about the Reserve Banks’ governance practices and potential conflicts of interest involving the directors. Specifically, some questioned how well the Reserve Bank boards represent the public, which in part could be measured by the economic and demographic diversity of the directors. Our analysis shows that from 2006 through 2010 labor and consumer groups tended to be less represented than other industry groups on both head office and branch boards. While the Federal Reserve Board encouraged the Reserve Banks to recruit directors from consumer and labor organizations, restrictions on directors’ political activities appeared to be a challenge in recruiting representatives from these organizations, who tend to be politically active. Our analysis also shows that while there is some variation among the Reserve Banks in the representation of women and minorities at head office and branch boards, overall, it has remained limited. Although it is difficult to know whether the board’s decisions would have been different had there been greater diversity on the boards, the public that the board represents is becoming increasingly diverse. Officials from most Reserve Banks generally focus their search for candidates on senior corporate executives, who are perceived to have a relatively broad perspective on the economy. However, seeking directors from among senior or chief- level executives may contribute to the limited diversity on the boards because as our analysis of EEOC data shows, diversity at the senior executive level is more limited than at the senior manager level across industries. To the extent that director searches are limited to chief-level executives, the Reserve Banks not only limit the diversity of the pool of potential candidates but also risk limiting the perspectives shared about the economy in the formation of monetary policy. The statutory requirement for three classes of directors was intended to provide representation of both stockholding banks and the public. However, the existence of Class A and to a lesser extent Class B directors on the boards creates an appearance of a conflict of interest, particularly in matters involving supervision and regulation. Moreover, directors from all three classes could have past and current affiliations with financial institutions. These affiliations have given rise to relationships that pose reputational risk to the Reserve Banks. While director conflicts can be identified and managed, interconnectedness between directors and financial institutions cannot be eliminated; therefore, ongoing challenges remain. For example, the credibility of the Federal Reserve System will be affected by the perceived effectiveness of its ability to manage conflict issues. While the Federal Reserve System has recognized the importance of public perception and made changes to Reserve Bank governance practices, more could be done to increase the flow of information on the directors’ roles to the public and strengthen controls. Specifically, greater transparency could assist the public in understanding the roles and functioning of the Reserve Bank boards, such as clarifying the limited nature of Reserve Bank directors’ involvement in supervision and regulation operations with a statement in the Reserve Bank board bylaws could help to improve the public’s confidence in Reserve Bank governance. While waivers are one way the Federal Reserve System mitigates conflicts involving Federal Reserve Board eligibility requirements, not all Reserve Banks have procedures for requesting a waiver from the Federal Reserve Board. Moreover, if waivers are granted, there is no requirement to make that information public. Failing to make the process and decisions more transparent can decrease confidence in the Federal Reserve System and has resulted in questions about the integrity of Reserve Banks’ operations and the appearance of conflicts of interest. Finally, while the Federal Reserve System has taken steps to increase transparency of governance practices as well as transparency overall, Reserve Bank governance practices were generally not as transparent as those of other central banks and financial institutions that we studied. In a time when the Federal Reserve System’s emergency actions have resulted in relationships between Reserve Banks and directors and the relationships between directors and financial firms being questioned, more transparent governance practices are essential to the effective and credible functioning of the Reserve Banks and the Federal Reserve System as a whole. While the Federal Reserve System has taken some steps to increase the transparency of its governance practices, such as conducting quarterly press conferences after the FOMC meetings, additional actions such as making key governance documents easily accessible to the public could enhance transparency and protect organizational reputation. Moreover, without more public disclosure of governance arrangements, such as board of director bylaws and director eligibility and ethics policies, there may be continued concerns about Reserve Bank governance and the integrity of the Federal Reserve System. While the Federal Reserve System recently has made changes to Reserve Bank governance, it can take additional steps to strengthen controls designed to manage conflicts of interest involving Reserve Bank directors and increase public disclosure of directors’ roles and responsibilities. As such, we recommend that the Chairman of the Federal Reserve Board take the following four actions:  To help enhance economic and demographic diversity and broaden perspectives among Reserve Bank directors who are elected to represent the public, encourage all Reserve Banks to consider ways to broaden their pools of potential candidates for directors, such as including officers who are below the senior executive level at their organizations.  To further promote transparency, direct all Reserve Banks to clearly document the roles and responsibilities of the directors, including restrictions on their involvement in supervision and regulation activities, in their bylaws.  As part of the Federal Reserve System’s continued focus on strengthening governance practices, develop, document, and require all Reserve Banks to adopt a process for requesting waivers from the Federal Reserve Board director eligibility policy and ethics policy for directors. Further, consider requiring Reserve Banks to publicly disclose waivers that are granted to the extent disclosure would not violate a director’s personal privacy.  To enhance the transparency of Reserve Bank board governance, direct the Reserve Banks to make key governance documents, such as such as board of director bylaws, committee charters and membership, and Federal Reserve Board director eligibility policy and ethics policy, available on their websites or otherwise easily accessible to the public. We provided copies of this draft report to the Federal Reserve Board and the 12 Federal Reserve Banks for their review and comment. The Federal Reserve Board and the Reserve Banks provided written comments that we have reprinted in appendixes V and VI, respectively. The Federal Reserve Board and Reserve Banks also provided technical comments that we have incorporated as appropriate. In its written comments, the Federal Reserve Board agreed that our recommendations have merit and to work to implement each of them. In particular, regarding our first recommendation on broadening the pools of candidates for the Reserve Bank directors, the Federal Reserve Board stated that, as we did in the report, several of the Reserve Banks are already considering qualified candidates who are not chief executives, as we have recommended, and the Federal Reserve Board will continue to explore ways to broaden the pool of candidates to increase diversity on Reserve Bank boards. We believe that diverse perspectives can enhance the formation of monetary policies. With respect to our three recommendations to improve transparency, the Federal Reserve Board stated that it will work with the Reserve Banks to consider ways to more clearly include the directors’ roles and responsibilities in the bylaws and the Federal Reserve System will continue to ensure that Reserve Bank directors are fully aware of their roles and the policies that govern their positions on the Reserve Bank boards. Further, as we noted in the report, the Federal Reserve Board stated that in 2009 it adopted a process for Reserve Banks to request waivers from the eligibility policy and will consider adopting a process for waivers to the Guide to Conduct as well. In addition, it will consider making public any waivers granted, with due regard for protecting personal privacy. The Federal Reserve Board also stated that it will post various Reserve Bank director-related publications on its website and will work with the Reserve Banks to make available to the public other relevant governance documents and information. We believe that greater transparency could assist the public in understanding the roles and functioning of the Reserve Bank boards and help increase public confidence in the Federal Reserve System. In its written comments, the Federal Reserve Banks stated that diversity and transparency are attributes valued and supported uniformly by all Reserve Banks. They stated that they welcomed our recommendation for Reserve Banks to consider ways to broaden the pool of potential candidates and reiterated that some Reserve Banks have already been considering qualified candidates who are not chief executives. They also agreed that transparency could be enhanced by our other recommendations. We are sending copies of this report to the majority and minority leaders of the Senate and the House of Representatives, appropriate congressional committees, the Board of Governors of the Federal Reserve System, the 12 Federal Reserve Banks, and other interested parties. In addition, the report is available at no charge on the GAO website at http://www.gao.gov. If you or your staffs have any questions about this report, please contact Orice Williams Brown at williamso@gao.gov or (202) 512-8678. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix VII. Between late 2007 and early 2009, the Federal Reserve Board created more than a dozen new emergency programs to stabilize financial markets and provided financial assistance to avert the failures of a few individual institutions. The Federal Reserve Board authorized most of this emergency assistance under emergency authority contained in section 13(3) of the Federal Reserve Act. Three of the programs covered by this review—Term Auction Facility (TAF), dollar swap lines with foreign central banks, and the Agency Mortgage-Backed Securities (MBS) Purchase program—were authorized under other provisions of the Federal Reserve Act that do not require a determination that emergency conditions exist, although the swap lines and the Agency MBS Purchase Program did require authorization by the Federal Open Market Committee (FOMC). In many cases, the decisions by the Federal Reserve Board, the FOMC, and the Reserve Banks about the authorization, initial terms of, and implementation of the Federal Reserve System’s emergency assistance were made over the course of only days or weeks as the Federal Reserve Board sought to act quickly to address rapidly deteriorating market conditions. As illustrated in table 5, the Federal Reserve Bank of New York (FRBNY) implemented most of these emergency activities under authorization from the Federal Reserve Board. In 2009, FRBNY, at the direction of the FOMC, began large-scale purchases of MBS issued by the housing government-sponsored enterprises, Fannie Mae and Freddie Mac, or guaranteed by Ginnie Mae. Purchases of these agency MBS were intended to provide support to the mortgage and housing markets and to foster improved conditions in financial markets more generally. Most of the Federal Reserve Board’s broad-based emergency programs closed on February 1, 2010. Figure 11 provides a timeline for the establishment, modification, and termination of Federal Reserve System emergency programs subject to this review. In the months before the authorization of TAF and new swap line arrangements, which were the first of the emergency programs subject to this review, the Federal Reserve Board took steps to ease emerging strains in credit markets through its traditional monetary policy tools. In late summer 2007, sudden strains in term interbank lending markets emerged primarily due to intensifying investor concerns about commercial banks’ actual exposures to various mortgage-related securities. The cost of term funding (loans provided at terms of 1 month or longer) spiked suddenly in August 2007, and commercial banks increasingly had to borrow overnight to meet their funding needs. The Federal Reserve Board feared that the disorderly functioning of interbank lending markets would impair the ability of commercial banks to provide credit to households and businesses. To ease stresses in these markets, on August 17, 2007, the Federal Reserve Board made two temporary changes to the terms at which Reserve Banks extended loans through the discount window. First, it approved the reduction of the discount rate—the interest rate at which the Reserve Banks extended collateralized loans at the discount window—by 50 basis points. Second, to address specific strains in term-funding markets, the Federal Reserve Board approved extending the discount window lending term from overnight to up to 30 days, with the possibility of renewal. According to a Federal Reserve Board study, this change initially resulted in little additional borrowing from the discount window. In addition to the discount window changes, starting in September 2007, the FOMC announced a series of reductions in the target federal funds rate—the FOMC-established target interest rate that banks charge each other for loans. In October 2007, tension in term funding subsided temporarily. However, issues reappeared in late November and early December, possibly driven in part by a seasonal contraction in the supply of year-end funding. On December 12, 2007, the Federal Reserve Board announced the creation of TAF to address continuing disruptions in U.S. term interbank lending markets. The Federal Reserve Board authorized Reserve Banks to extend credit through TAF by revising the regulations governing Reserve Bank discount window lending. TAF was intended to help provide term funding to depository institutions eligible to borrow from the discount window. In contrast to the traditional discount window program, which loaned funds to individual institutions at the discount rate, TAF was designed to auction loans to many eligible institutions at once at a market-determined interest rate. Federal Reserve Board officials noted that one important advantage of this auction approach was that it could address concerns among eligible borrowers about the perceived stigma of discount window borrowing. Federal Reserve Board officials noted that an institution might be reluctant to borrow from the discount window out of concern that its creditors and other counterparties might become aware of its discount window use and perceive it as a sign of distress. The auction format allowed banks to approach the Reserve Banks collectively rather than individually and obtain funds at an interest rate set by auction rather than at a premium set by the Federal Reserve Board. Additionally, whereas discount window loan funds could be obtained immediately by an institution facing severe funding pressures, TAF borrowers did not receive loan funds until 3 days after the auction. For these reasons, TAF-eligible borrowers may have attached less of a stigma to auctions than to traditional discount window borrowing. The first TAF auction was held on December 17, 2007, with subsequent auctions occurring approximately every 2 weeks until the final TAF auction on March 8, 2010. Concurrent with the announcement of TAF, the FOMC announced the establishment of dollar swap arrangements with two foreign central banks to address similar disruptions in dollar funding markets abroad. In a typical swap line transaction, FRBNY exchanged dollars for the foreign central bank’s currency at the prevailing exchange rate, and the foreign central bank agreed to buy back its currency (to “unwind” the exchange) at this same exchange rate at an agreed upon future date. The market for interbank funding in U.S. dollars is global, and many foreign banks hold U.S.-dollar-denominated assets and fund these assets by borrowing in U.S. dollars. In contrast to U.S. commercial banks, foreign banks did not hold significant U.S.-dollar deposits, and as a result, dollar funding disruptions were particularly acute for many foreign banks during the recent crisis. In December 2007, the European Central Bank and Swiss National Bank requested dollar swap arrangements with the Federal Reserve System to increase their ability to provide U.S. dollar loans to banks in their jurisdictions. Federal Reserve Board staff memorandums recommending that the FOMC approve these swap arrangements noted that continuing tension in dollar funding markets abroad could further exacerbate tensions in U.S. funding markets. On December 6, 2007, the FOMC approved requests from the European Central Bank and Sw National Bank and authorized FRBNY to establish temporary swap lines under section 14 of the Federal Reserve Act. During 2008, the FOMC iss approved temporary swap lines with 12 other foreign central banks. FRBNY’s swap lines with the 14 central banks closed on February 1, 2010. In May 2010, to address the re-emergence of strains in dollar funding markets, FRBNY reopened swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank through January 2011. On December 21, 2010, the FOMC announced an extension of these lines through August 1, 2011. On June 29, 2011, the Federal Reserve Board announced an extension of these swap lines through August 1, 2012. In early March 2008, the Federal Reserve Board observed growing tension in the repurchase agreement markets—large, short-term collateralized funding markets—that many financial institutions rely on to finance a wide range of securities. Under a repurchase agreement, a borrowing institution generally acquires funds by selling securities to a lending institution and agreeing to repurchase the securities after a specified time at a given price. The securities, in effect, are collateral provided by the borrower to the lender. In the event of a borrower’s default on the repurchase transaction, the lender would be able to take (and sell) the collateral provided by the borrower. Lenders typically will not provide a loan for the full market value of the posted securities, and the difference between the values of the securities and the loan is called a margin or haircut. This deduction is intended to protect the lenders against a decline in the price of the securities provided as collateral. In early March, the Federal Reserve Board found that repurchase agreement lenders were requiring higher haircuts for loans against a range of securities and were becoming reluctant to lend against mortgage-related securities. As a result, many financial institutions increasingly had to rely on higher-quality collateral, such as U.S. Treasury securities, to obtain cash in these markets, and a shortage of such high-quality collateral emerged. In March 2008, the Federal Reserve Board cited “unusual and exigent circumstances” in invoking section 13(3) of the Federal Reserve Act to authorize FRBNY to implement four emergency actions to address deteriorating conditions in these markets: (1) TSLF, (2) a bridge loan to Bear Stearns, (3) a commitment to lend up to $30 billion against Bear Stearns assets that resulted in the creation of Maiden Lane LLC, and (4) PDCF. On March 11, 2008, the Federal Reserve Board announced the creation of the TSLF to auction 28-day loans of U.S. Treasury securities to primary dealers to increase the amount of high-quality collateral available for these dealers to borrow against in the repurchase agreement markets. Through competitive auctions that allowed dealers to bid a fee to exchange harder-to-finance collateral for easier-to-finance Treasury securities, TSLF was intended to promote confidence among lenders and to reduce the need for dealers to sell illiquid assets into the markets, which could have further depressed the prices of these assets and contributed to a downward price spiral. TSLF auctioned loans of Treasury securities against two schedules of collateral. Schedule 1 collateral included treasuries, agency debt, and agency MBS collateral that FRBNY accepted in repurchase agreements for traditional open market operations with primary dealers. Schedule 2 included schedule 1 collateral as well as a broader range of assets, including highly rated mortgage-backed securities. The Federal Reserve Board determined that providing funding support for private mortgage-backed securities through the schedule 2 auctions fell outside the scope of FRBNY’s authority to conduct its securities lending program under section 14 of the Federal Reserve Act. Accordingly, for the first time during this crisis, the Federal Reserve Board invoked section 13(3) of the Federal Reserve Act to authorize the extension of credit, in this case in the form of Treasury securities, to nondepository institutions—in this case, the primary dealers. As discussed later in this appendix the Federal Reserve Board later expanded the range of collateral eligible for TSLF as the crisis intensified. TSLF closed on February 1, 2010. Shortly following the announcement of TSLF, the Federal Reserve Board invoked its emergency authority for a second time to authorize an emergency loan to avert a disorderly failure of Bear Stearns. TSLF was announced on March 11, 2008, and the first TSLF auction was held on March 27, 2008. Federal Reserve Board officials noted that although TSLF was announced to address market tensions affecting many firms, some market participants concluded that its establishment was driven by specific concerns about Bear Stearns. Over a few days, Bear Stearns experienced a run on its liquidity as many of its lenders grew concerned that the firm would suffer greater losses in the future and stopped providing funding to the firm, even on a fully secured basis with high- quality assets provided as collateral. Late on Thursday, March 13, 2008, the senior management of Bear Stearns notified the Federal Reserve that it would likely have to file for bankruptcy protection the following day unless the Federal Reserve provided the firm with an emergency loan. The Federal Reserve Board feared that the sudden failure of Bear Stearns could have serious adverse impacts on markets in which Bear Stearns was a significant participant, including the repurchase agreements market. In particular, a Bear Stearns failure may have threatened the liquidity and solvency of other large institutions that relied heavily on short-term secured funding markets. On Friday, March 14, 2008, the Federal Reserve Board voted to authorize FRBNY to provide a $12.9 billion loan to Bear Stearns through JP Morgan Chase Bank, National Association, the largest bank subsidiary of JP Morgan Chase & Co. (JPMC), and to accept $13.8 billion of Bear Stearns assets as collateral. This back-to-back loan transaction was repaid on Monday, March 17, 2008, with almost $4 million of interest. This emergency loan enabled Bear Stearns to avoid bankruptcy and continue to operate through the weekend. This provided time for potential acquirers, including JPMC, to assess Bear Stearns’s financial condition and for FRBNY to prepare a new liquidity program, PDCF, to address strains that could emerge from a possible Bear Stearns bankruptcy announcement the following Monday. Federal Reserve Board and FRBNY officials hoped that bankruptcy could be averted by the announcement that a private sector firm would acquire Bear Stearns and stand behind its liabilities when the markets reopened on the following Monday. On Sunday, March 16, 2008, the Federal Reserve Board announced that FRBNY would lend up to $30 billion against certain Bear Stearns assets to facilitate JPMC’s acquisition of Bear Stearns. Over the weekend, JPMC had emerged as the only viable acquirer of Bear Stearns. In congressional testimony, Timothy Geithner, who was the President of FRBNY in March 2008, provided the following account: “Bear approached several major financial institutions, beginning on March 13. Those discussions intensified on Friday and Saturday. Bear’s management provided us with periodic progress reports about a possible merger. Although several different institutions expressed interest in acquiring all or part of Bear, it was clear that the size of Bear, the apparent risk in its balance sheet, and the limited amount of time available for a possible acquirer to conduct due diligence compounded the difficulty. Ultimately, only JPMorgan Chase was willing to consider an offer of a binding commitment to acquire the firm and to stand behind Bear’s substantial short-term obligations.” According to FRBNY officials, on the morning of Sunday, March 16, 2008, JPMC’s Chief Executive Officer told FRBNY that the merger would be possible only if certain mortgage-related assets were taken off Bear Stearns’s balance sheet. Negotiations between JPMC and FRBNY senior management resulted in a preliminary agreement under which FRBNY would make a $30 billion nonrecourse loan to JPMC collateralized by these Bear Stearns assets. A March 16, 2008, letter from then-FRBNY president Geithner to JPMC’s Chief Executive Officer documented the terms of the preliminary agreement. Significant issues that threatened to unravel the merger agreement emerged soon after the announcement. Bear Stearns board members and shareholders thought JPMC’s offer to purchase the firm at $2 per share was too low and threatened to vote against the merger. Perceived ambiguity in the terms of the merger agreement raised further concerns that JPMC could be forced to stand behind Bear Stearns’s obligations even in the event that the merger was rejected. Moreover, some Bear Stearns counterparties stopped trading with Bear Stearns because of uncertainty about whether JPMC would honor certain Bear Stearns obligations. FRBNY also had concerns with the level of protection provided under the preliminary lending agreement, under which FRBNY had agreed to lend on a nonrecourse basis against risky collateral. The risks of an unraveled merger agreement included a possible Bear Stearns bankruptcy and losses for JPMC, which might have been legally required to stand behind the obligations of a failed institution. Recognizing the risk that an unraveled merger posed to JPMC and the broader financial markets, FRBNY officials sought to renegotiate the lending agreement. During the following week, the terms of this agreement were renegotiated, resulting in the creation of a new lending structure in the form of Maiden Lane LLC. From March 17 to March 24, 2008, FRBNY, JPMC, and Bear Stearns engaged in dual track negotiations to address each party’s concerns with the preliminary merger and lending agreements. On March 24, 2008, FRBNY and JPMC agreed to a new lending structure that incorporated greater loss protections for FRBNY. Specifically, FRBNY created a special-purpose vehicle (SPV), Maiden Lane LLC, that used proceeds from a $28.82 billion FRBNY senior loan and a $1.15 billion JPMC subordinated loan to purchase Bear Stearns assets. While one team of Federal Reserve Board and FRBNY staff worked on options to avert a Bear Stearns failure, another team worked to ready PDCF for launch by Monday, March 17, 2008, when Federal Reserve Board officials feared a Bear Stearns bankruptcy announcement might trigger runs on the liquidity of other primary dealers. The liquidity support from TSLF would not become available until the first TSLF auction later in the month. On March 16, 2008, the Federal Reserve Board announced the creation of PDCF to provide overnight collateralized cash loans to the primary dealers. FRBNY quickly implemented PDCF by leveraging its existing legal and operational infrastructure for its existing repurchase agreement relationships with the primary dealers. Although the Bear Stearns bankruptcy was averted, PDCF commenced operation on March 17, 2008, and in its first week extended loans to 10 primary dealers. Bear Stearns was consistently the largest PDCF borrower until June 2008. Eligible PDCF collateral initially included investment-grade corporate securities, municipal securities, and asset-backed securities, including mortgage-backed securities. The Federal Reserve Board authorized an expansion of collateral types eligible for PDCF loans later in the crisis. This program was terminated on February 1, 2010. In September 2008, the bankruptcy of Lehman Brothers triggered an intensification of the financial crisis, and the Federal Reserve Board modified the terms for its existing liquidity programs to address worsening conditions. On September 14, 2008, shortly before Lehman Brothers announced it would file for bankruptcy, the Federal Reserve Board announced changes to TSLF and PDCF to provide expanded liquidity support to primary dealers. Specifically, the Federal Reserve Board announced that TSLF-eligible collateral would be expanded to include all investment-grade debt securities and PDCF-eligible collateral would be expanded to include all securities eligible to be pledged in the triparty repurchase agreements system, including noninvestment grade securities and equities. In addition, TSLF schedule 2 auctions would take place weekly rather than only biweekly. On September 21, 2008, the Federal Reserve Board announced that it would extend credit—on terms similar to those applicable for PDCF loans—to the U.S. and London broker-dealer subsidiaries of Merrill Lynch & Co. (Merrill Lynch), Goldman Sachs Group Inc. (Goldman Sachs), and Morgan Stanley to provide support to these subsidiaries as they became part of bank holding companies that would be regulated by the Federal Reserve System. On September 29, 2008, the Federal Reserve Board also announced expanded support through TAF and the dollar swap lines. Specifically, the Federal Reserve Board doubled the amount of funds that would be available in each TAF auction cycle from $150 billion to $300 billion, and the FOMC authorized a $330 billion expansion of the swap line arrangements with foreign central banks. In the months following Lehman’s bankruptcy, the Federal Reserve Board authorized several new liquidity programs under section 13(3) of the Federal Reserve Act to provide support to other key funding markets, such as the commercial paper and the asset-backed security markets. In contrast to earlier emergency programs that represented relatively modest extensions of established Federal Reserve System lending or open market operation activities, these newer programs incorporated more novel design features and targeted new market participants with which the Reserve Banks had not historically transacted. As was the case with the earlier programs, many of these newer programs were designed and launched under extraordinary time constraints as the Federal Reserve Board sought to address rapidly deteriorating market conditions. In order of their announcement, these programs included (1) Asset- Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) to provide liquidity support to money market mutual funds (MMMF) in meeting redemption demands from investors and to foster liquidity in the asset-backed commercial paper (ABCP) market, (2) Commercial Paper Funding Facility (CPFF) to provide a liquidity backstop to eligible issuers of commercial paper, (3) the Money Market Investor Funding Facility (MMIFF) to serve as an additional backstop for MMMFs, and (4) the Term Asset-Backed Securities Loan Facility (TALF) to assist certain securitization markets that supported the flow of credit to households and businesses. On September 19, 2008, the Federal Reserve Board authorized FRBB to establish AMLF to provide liquidity support to MMMFs facing redemption pressures. According to FRBB staff, the processes and procedures to implement AMLF were designed over the weekend before FRBB commenced operation of AMLF on September 22, 2008. MMMFs were a major source of short-term credit for financial institutions, including through MMMFs’ purchases and holdings of ABCP. ABCP continued to be an important source of funding for many businesses. Following the announcement that a large MMMF had “broken the buck”—net asset value fell below $1 per share—as a result of losses on Lehman’s commercial paper, other MMMFs faced a large wave of redemption requests as investors sought to limit their potential exposures to the financial sector. The Federal Reserve Board was concerned that attempts by MMMFs to raise cash through forced sales of ABCP and other assets into illiquid markets could further depress the prices of these assets and exacerbate strains in short-term funding markets. AMLF’s design, which relied on intermediary borrowers to use Reserve Bank loans to fund the same-day purchase of eligible ABCP from MMMFs, reflected the need to overcome practical constraints in lending to MMMFs directly. According to Federal Reserve System officials, MMMFs would have had limited capacity to borrow directly from the Reserve Banks in amounts that would be sufficient to meet redemption requests because of statutory and fund- specific limitations on fund borrowing. To quickly support the MMMF market, the Federal Reserve Board authorized loans to entities that conduct funding and custodial activities, which include holding and administering the accounts with MMMF assets, with MMMFs to fund the purchase of ABCP from MMMFs. Eligible borrowers were identified as discount-window-eligible depository institutions (U.S. depository institutions and U.S. branches and agencies of foreign banks) and U.S. bank holding companies and their U.S. broker-dealer affiliates. The interest rate on AMLF loans was lower than the returns on eligible ABCP, providing incentives for eligible intermediary borrowers to participate. AMLF closed on February 1, 2010. On October 7, 2008, the Federal Reserve Board announced the creation of CPFF to provide a liquidity backstop to U.S. issuers of commercial paper. Commercial paper is an important source of short-term funding for U.S. financial and nonfinancial businesses. CPFF became operational on October 27, 2008, and was operated by FRBNY. In establishing CPFF, FRBNY created an SPV that was to directly purchase new issues of eligible ABCP and unsecured commercial paper with the proceeds of loans it received from FRBNY for that purpose. In the weeks leading up to CPFF’s announcement, the commercial paper markets showed clear signs of strain: the volume of commercial paper outstanding declined, interest rates on longer-term commercial paper increased significantly, and increasing amounts of commercial paper were issued on an overnight basis as money market funds and other investors became reluctant to purchase commercial paper at longer-dated maturities. During this time, MMMFs faced a surge of redemption demands from investors concerned about losses on presumably safe instruments. The Federal Reserve Board concluded that disruptions in the commercial paper markets, combined with tension in other credit markets, threatened the broader economy as many large commercial paper issuers promoted the flow of credit to households and businesses. By standing ready to purchase eligible commercial paper, CPFF was intended to eliminate much of the risk that commercial paper issuers would be unable to issue new commercial paper to replace their maturing commercial paper obligations. By reducing this risk, CPFF was expected to encourage investors to continue or resume their purchases of commercial paper at longer maturities. CPFF closed on February 1, 2010. On October 21, 2008, the Federal Reserve Board authorized FRBNY to work with the private sector to create MMIFF to serve as an additional backstop for MMMFs. MMIFF complemented AMLF by standing ready to purchase a broader range of short-term debt instruments held by MMMFs, including certificates of deposit and bank notes. MMIFF’s design featured a complex lending structure through which five SPVs would purchase eligible instruments from eligible funds. In contrast to other Federal Reserve Board programs that created SPVs, MMIFF SPVs were set up and managed by private sector entities. According to FRBNY staff, JPMC, in collaboration with other firms that sponsored large MMMFs, brought the idea for an MMIFF-like facility to FRBNY in early October 2008, FRBNY worked with JPMC to set up the MMIFF SPVs but did not contract directly with JPMC or the firm that managed the MMIFF program. While MMIFF became operational in late November 2008, it was never used. In November 2008, the Federal Reserve Board authorized FRBNY to create TALF to reopen the securitization markets in an effort to improve access to credit for consumers and businesses. During the recent financial crisis, the value of many asset-backed securities (ABS) dropped precipitously, bringing originations in the securitization markets to a virtual halt. Problems in the securitization markets threatened to make it more difficult for households and small businesses to access the credit that they needed to, among other things, buy cars and homes and expand inventories and operations. TALF provided nonrecourse loans to eligible U.S. companies and individuals in return for collateral in the form of securities that could be forfeited if the loans were not repaid. TALF was one of the more operationally complex programs, and the first TALF subscription was not held until March 2009. In contrast to other programs that had been launched in days or weeks, TALF required several months of preparation to refine program terms and conditions and consider how to leverage vendor firms to best achieve TALF policy objectives. TALF closed on June 30, 2010. In late 2008 and early 2009, the Federal Reserve Board again invoked its authority under section 13(3) of the Federal Reserve Act to authorize assistance to avert the failures of three institutions that it determined to be systemically significant (1) American International Group, Inc. (AIG); (2) Citigroup, Inc. (Citigroup); and (3) Bank of America Corporation (Bank of America). In September 2008, the Federal Reserve Board and the Treasury determined through analysis of information provided by AIG and insurance regulators, as well as publicly available information, that market events could cause AIG to fail, which would pose systemic risk to financial markets. The Federal Reserve Board and subsequently Treasury took steps to ensure that AIG obtained sufficient liquidity and could complete an orderly sale of some of its operating assets and continue to meet its obligations. On September 16, 2008, one day after the Lehman Brothers bankruptcy announcement, the Federal Reserve Board authorized FRBNY to provide a revolving credit facility (RCF) of up to $85 billion to help AIG meet its obligations. The AIG RCF was created to provide AIG with a revolving loan that AIG and its subsidiaries could use to address strains on their liquidity. The announcement of this assistance followed a downgrade of the firm’s credit rating, which had prompted collateral calls by its counterparties and raised concerns that a rapid failure of the company would further destabilize financial markets. Two key sources of AIG’s difficulties were AIG Financial Products Corp. (AIGFP) and a securities lending program operated by insurance subsidiaries of AIG. AIGFP faced growing collateral calls on credit default swaps it had written on collateralized debt obligations (CDO). Meanwhile, AIG faced demands on its liquidity from securities lending counterparties who were returning borrowed securities and demanding that AIG return their cash collateral. Despite the announcement of the AIG RCF, AIG’s condition continued to decline rapidly in fall 2008. On subsequent occasions, the Federal Reserve Board invoked section 13(3) of the Federal Reserve Act to authorize either new assistance or a restructuring of existing assistance to AIG.  First, in October 2008, the Federal Reserve Board authorized the creation of the securities borrowing facility (SBF) to provide up to $37.8 billion of direct funding support to a securities lending program operated by AIG’s domestic insurance companies. From October 8, 2008, through December 11, 2008, FRBNY provided cash loans to AIG’s domestic life insurance companies, collateralized by investment grade debt obligations. In November 2008, as part of plans to restructure the assistance to AIG to further strengthen its financial condition, and once again avert the failure of the company, the Federal Reserve Board and Treasury restructured AIG’s debt. Under the restructured terms, Treasury purchased $40 billion in shares of AIG preferred stock and the cash from the sale was used to pay down a portion of AIG’s outstanding balance from the AIG RCF. The limit on the facility also was reduced to $60 billion, and other changes were made.  Also in November 2008, the Federal Reserve Board authorized the creation of two SPVs—Maiden Lane II LLC and Maiden Lane III LLC—to purchase certain AIG-related assets. Similar to Maiden Lane LLC, these SPVs funded most of these asset purchases with a senior loan from FRBNY. Maiden Lane II replaced the AIG SBF and served as a longer-term solution to the liquidity problems facing AIG’s securities lending program. Maiden Lane III purchased the underlying CDOs from AIG counterparties in connection with the termination of credit default swap contracts issued by AIGFP and thus the elimination of liquidity drain from collateral calls on the credit default swaps sold by AIGFP. In March 2009, the Federal Reserve Board and Treasury announced plans to further restructure AIG’s assistance. According to the Federal Reserve Board, debt owed by AIG on the AIG RCF would be reduced by $25 billion in exchange for FRBNY’s receipt of preferred equity interests totaling $25 billion in two SPVs. AIG created both SPVs to hold the outstanding common stock of two life insurance company subsidiaries—American Life Insurance Company and AIA Group Limited.  Also in March 2009, the Federal Reserve Board authorized FRBNY to provide additional liquidity to AIG by extending credit by purchasing a contemplated securitization of income from certain AIG life insurance operations. FRBNY staff said this life insurance securitization option was abandoned for a number of reasons, including that it would have required FRBNY to manage a long-term exposure to life insurance businesses with which it had little experience. On November 23, 2008, the Federal Reserve Board authorized FRBNY to provide a lending commitment to Citigroup as part of a package of coordinated actions by Treasury, FDIC, and the Federal Reserve Board to avert a disorderly failure of the company. As discussed in our April 2010 report on Treasury’s use of the systemic risk determination, Treasury, FDIC, and the Federal Reserve Board said they provided emergency assistance to Citigroup because they were concerned that the failure of a firm of Citigroup’s size and interconnectedness would have had systemic implications. FRBNY agreed to lend against the residual value of approximately $300 billion of Citigroup assets if losses on these assets exceeded certain thresholds. On the basis of analyses by the various parties and an outside vendor, FRBNY determined that it would be unlikely that losses on the Citigroup “ring-fence” assets would reach the amount at which FRBNY would be obligated to provide a loan. At Citigroup’s request, Treasury, FDIC, and FRBNY agreed to terminate this loss sharing agreement in December 2009. As part of the termination agreement, Citigroup agreed to pay a $50 million termination fee to FRBNY. FRBNY never provided a loan to Citigroup under this lending commitment. On January 15, 2009, the Federal Reserve Board authorized FRBR to provide a lending commitment to Bank of America. As with Citigroup, the Federal Reserve Board authorized this assistance as part of a coordinated effort with Treasury and FDIC to assist an institution that the agencies determined to be systemically important. The circumstances surrounding the agencies’ decision to provide this arrangement for Bank of America, however, were somewhat different and were the subject of congressional hearings. While the Citigroup loss-sharing agreement emerged during a weekend over which the agencies attempted to avert an impending failure of the firm, the agencies’ discussions with Bank of America about a possible similar arrangement occurred over several weeks during which Bank of America was not facing imminent failure. According to Federal Reserve Board officials, possible assistance for Bank of America was first discussed in late December 2008 when Bank of America management raised concerns about the financial impact of completing the merger with Merrill Lynch, which was expected at the time to announce larger than anticipated losses (and did in fact announce these losses the following month). Following the January 1, 2009, completion of Bank of America’s acquisition of Merrill Lynch, the Federal Reserve Board and the other agencies agreed to provide a loss-sharing agreement on selected Merrill Lynch and Bank of America assets to assure markets that unusually large losses on these assets would not destabilize Bank of America. On September 21, 2009, the agencies and FRBR terminated the agreement in principle to enter into a loss sharing agreement with Bank of America. The agreement was never finalized, and FRBR never provided a loan to Bank of America under this lending commitment. As part of the agreement to terminate the agreement in principle, Bank of America paid $57 million to FRBR in compensation for out-of-pocket expenses incurred by FRBR and an amount equal to the commitment fees required by the agreement. On November 25, 2008, the FOMC announced that FRBNY would purchase up to $500 billion of agency mortgage-backed securities to support the housing market and the broader economy. The FOMC authorized the Agency MBS program under its authority to direct open market operations under section 14 of Federal Reserve Act. By purchasing MBS securities with longer maturities, the Agency MBS program was intended to lower long-term interest rates and to improve conditions in mortgage and other financial markets. The Agency MBS program commenced purchases on January 5, 2009, a little more than a month after the initial announcement. FRBNY staff noted that a key operational challenge for the program was its size. FRBNY hired external investment managers to provide execution support and advisory services needed to help execute purchases on such a large scale. In March 2009, the FOMC increased the total amount of planned purchases from $500 billion to up to $1.25 trillion. The program executed its final purchases in March 2010 and settlement was completed in August 2010. On several occasions, the Federal Reserve Board authorized extensions of its emergency loan programs, and most of these programs closed on February 1, 2010. For example, AMLF, PDCF, and TSLF were extended three times. The Federal Reserve Board cited continuing disruptions in financial markets in announcing each of these extensions. Table 6 provides a summary of the extensions for the emergency programs. We conducted a brief Web-based survey of all Federal Reserve Bank (FRB) directors that served in 2010. The purpose of this survey was to gather basic information from FRB directors to fulfill GAO’s congressional mandate to assess Federal Reserve Bank governance. Specifically, the survey asked about each director’s (1) educational and professional background; (2) roles and responsibilities as a FRB director; and (3) opinions on FRB governance. The survey questions and summary results can be found below. We sent a survey to all 105 directors that served for the full year during 2010. We received completed surveys from 91 directors (87 percent response rate). The web-based survey was administered from April 4, 2011, to May 6, 2011. Directors were sent an e-mail invitation to complete the survey on a GAO web server using a unique username and password. Nonrespondents received a reminder e-mail from GAO to complete the survey. We also contacted the corporate secretaries at every bank and asked them to encourage their directors to participate in the survey. Even though we received responses from a majority of directors in all 12 banks, it is possible some bias may exist in certain survey responses if characteristics of respondents differed from those of nonrespondents in ways that affect the responses (e.g., if any knew of a potential conflict of interest at their bank they may or may not be less likely to respond to the survey). The practical difficulties of conducting any survey may introduce additional nonsampling errors, such as difficulties interpreting a particular question, which can introduce unwanted variability into the survey results. We took steps to minimize nonsampling errors by pretesting the questionnaire with three directors in February and March 2011. We conducted pretests to make sure that the questions were clear and unbiased and that the questionnaire did not place an undue burden on respondents. An independent reviewer within GAO also reviewed a draft of the questionnaire prior to its administration. We made appropriate revisions to the content and format of the questionnaire after the pretests and independent review. All data analysis programs were independently verified for accuracy. We are interested in learning about the breadth of experience that Federal Reserve Bank directors bring to their positions on the Board. 1. How many years have you served as a Federal Reserve Bank head office director? 2. Educational Background of Federal Reserve Bank directors. Degrees Associate’s degree (for example: AA, AS) Bachelor’s degree (for example: BA,BS) At least one Advanced Degree (Master’s, Professional, or Doctorate) Professional degree (for example: MD, DDS, JD) Doctorate (for example: PhD, EdD) 3. Work experience of Federal Reserve Bank directors. Mining, Quarrying, and Oil and Gas Extraction Information (Publishing, Broadcasting, and Telecommunications) Financial Services (directors who selected at least one of the following five categories) Credit Intermediation and Related Activities Securities, Commodity Contracts, and Other Financial Investments and Related Activities Insurance Carriers and Related Activities Funds, Trusts, and Other Financial Vehicles Offices of bank or other holding companies/ Corporate, Subsidiary, and Regional Managing Offices Real Estate and Rental and Leasing Professional, Scientific, and Technical Services (Legal, accounting, consulting, design, advertising, and public relations services) 4. Do you currently serve on any other boards (i.e., nonprofit, private or public company boards)? 5. Has someone from your current employer served as a Federal Reserve Bank (FRB) board director in the past 10 years? We are interested in learning about your duties as a Federal Reserve Bank director. 6. As a FRB Director, which of the following do you primarily represent? (check only one box) Seven directors provided an open-ended response to describe who they represent. Four directors indicated that their constituencies included the public, their business or industry, and other businesses or industries in the district. The other three directors listed food manufacturing and private equity, labor, transportation, communications, construction, and the public sector, and civic leadership and the nonprofit sector as the industries that they represent. 7. The three principal functions of FRB directors are listed below. Within each of these principal functions, which activities have you been involved in at your FRB? (check one box per question) 8. How frequently do you communicate with the following Reserve Bank personnel while carrying out your official duties? (check one box per person) In the open-ended question that asked directors to specify what “other” FRB staff with whom they interacted, directors listed the following staff members: assistants to senior management, executive vice president of operations, vice president of Information Technology, assistant general auditor, librarian, Federal Reserve Information Technology officers, members of the Federal Reserve Board, presidents of other Reserve Banks, other staff as questions arise, and vice president of Human Resources/Diversity. 9. In the past year, in your role as a director, have you been involved in any Division of Supervision and Regulation matters in which you did any of the following: (check one box per question) Supervision and Regulation Activities  Were involved in making decisions about specific banks that the FRB supervises?  Received general information about the supervisory status of banks in the district?  Received supervisory information about the status of any specific banks?  Were involved in making personnel decisions about pay or promotion for employees in the Division of Supervision and Regulation?  Were involved in making decisions about the budget for the Division of Supervision and Regulation?  Had other involvement with the Division of Supervision and Regulation not described above? GAO asked directors who answered “yes” to any of these questions to explain their answer. We analyzed the open ended answers for this question and no improper conflicts of interest were identified. 10. The following questions are about the FRB’s code or standards of conduct for directors (code). Did you do any of the following? (check one box per question) Standard of Conduct  Receive training on the code at your FRB at the beginning of your term in office?  Receive training on the code in Washington, D.C. at the beginning of your term in office? Sign an oath of office at the beginning of your term agreeing to adhere to the code?  Receive an annual briefing on the code of conduct by a member of the bank’s senior management? Sign an annual certification agreeing to adhere to the code? GAO asked directors who answered “no” to any of the above questions to provide an explanation. Four directors stated they were unable to attend the training in Washington, D.C. Two directors said they attended the training but did not receive training on the code of conduct and two other directors said they did not recall if they signed an annual certification. 11. Are you aware of any past or current conflicts of interest with any FRB directors in your district? GAO asked directors who responded “yes” to this question to explain the conflict and how it was resolved. Five directors provided responses to this open-ended question on the survey. Two of the responses described actual or potential conflicts of interest involving procurement matters and the directors recused themselves from voting on the matter. One of those directors also noted that the CEO of Lehman Brothers, Inc., resigned as a director because the company was requesting assistance from the FRB. Another described a director who resigned because he expressed a desire to be involved in a political campaign. One director declined a board position at another entity because of perceived conflicts of interest. Another director noted that the board was apprised of a potential conflict of interest between a branch director and FRB auditors, and that the situation was resolved and reported to the Audit Committee. We are interested in learning about your views on how, if at all, Federal Reserve Bank governance practices could be strengthened. 12. In terms of Federal Reserve Bank governance, how would you strengthen achievement in the following areas, if at all? Please include examples of practices in your district or from other relevant board experience that may assist the Federal Reserve System in strengthening achievement in the following areas. a. Improve public representation on FRB Boards? b. Eliminate actual or potential conflicts of interest of Reserve Bank directors? c. Increase the availability of information useful for the formation and execution of monetary policy? d. Increase the effectiveness or efficiency of reserve banks? The open-ended responses were analyzed and included as examples in the report when appropriate. The Reserve Bank boards use committees to help oversee the operations of the Reserve Banks and their branches. The Federal Reserve Board requires all Reserve Banks to have standing audit committees and as needed search committees for the selection and appointment of a president. The Reserve Banks use various other committees, including budget and governance committees. Total Assets as of 12/31/10 (Dollars in thousands) In addition to the contact named above, Karen Tremba (Assistant Director), Sonja Bensen, Kathleen Boggs, Tania Calhoun, Emily Chalmers, Helen Culbertson, Rachel DeMarcus, Heather Hampton, Grace Haskins, Camille Keith, Jill Lacey, Marc Molino, Rubin Montes de Oca, and Andrew Stavisky made significant contributions to this report.

Summary: Events surrounding the 2007 financial crisis raised questions about the governance of the 12 Federal Reserve Banks (Reserve Banks), particularly the boards of directors' roles in activities related to supervision and regulation. The Dodd-Frank Wall Street Reform and Consumer Protection Act required GAO to review the governance of the Reserve Banks. This report (1) analyzes the level of diversity on the boards of directors and assesses the extent to which the process of identifying possible directors and appointing them results in diversity on the boards, (2) evaluates the effectiveness of policies and practices for identifying and managing conflicts of interest for Reserve Bank directors, and (3) compares Reserve Bank governance practices with the practices of selected organizations. The Federal Reserve Act requires each Reserve Bank to be governed by a nine-member board--three Class A directors elected by member banks to represent their interests, three Class B directors elected by member banks to represent the public, and three Class C directors that are appointed by the Federal Reserve Board to represent the public. The diversity of Reserve Bank boards was limited from 2006 to 2010. For example, in 2006 minorities accounted for 13 of 108 director positions, and in 2010 they accounted for 15 of 108 director positions. Specifically, in 2010 Reserve Bank directors included 78 white men, 15 white women, 12 minority men, and 3 minority women. According to the Federal Reserve Act, Class B and C directors are to be elected with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumer representation. During this period, labor and consumer groups had less representation than other industries. In 2010, 56 of the 91 directors that responded to GAO's survey had financial markets experience. Reserve Banks generally review the current demographics of their boards and use a combination of personal networking and community outreach efforts to identify potential candidates for directors. Reserve Bank officials said that they generally limit their director search efforts to senior executives. GAO's analysis of Equal Employment Opportunity Commission data found that diversity among senior executives is generally limited. While some Reserve Banks recruit more broadly, GAO recommends that the Federal Reserve Board encourage all Reserve Banks to consider ways to help enhance the economic and demographic diversity of perspectives on the boards, including by broadening their potential candidate pool. The Federal Reserve System mitigates and manages the actual and potential conflicts of interest by, among other things, defining the directors' roles and responsibilities, monitoring adherence to conflict-of-interest policies, and establishing internal controls to identify and manage potential conflicts. Reserve Bank directors are often affiliated with a variety of financial firms, nonprofits, and private and public companies. As the financial services industry evolves, more companies are becoming involved in financial services or interconnected with financial institutions. As a result, directors of all three classes can have ties to the financial sector. While these relationships may not give rise to actual conflicts of interest, they can create the appearance of a conflict as illustrated by the participation of director-affiliated institutions in the Federal Reserve System's emergency programs. To increase transparency, GAO recommends that all Reserve Banks clearly document the directors' role in supervision and regulation activities in their bylaws. One option for addressing directors' conflicts of interest is for the Reserve Bank to request a waiver from the Federal Reserve Board, which, according to officials, is rare. Most Reserve Banks do not have a process for formally requesting such waivers. To strengthen governance practices and increase transparency, GAO recommends that the Reserve Banks develop and document a process for requesting conflict waivers for directors. The Federal Reserve System's governance practices are generally similar to those of selected central banks and comparable institutions such as bank holding companies and have similar selection procedures for directors. However, Reserve Bank governance practices tend to be less transparent than those of these institutions. For instance, comparable organizations make information on their board committees and ethics policies available on their websites; most Reserve banks do not.