The Federal Reserve Act of 1913 established the Federal Reserve System as the country’s central bank. The Federal Reserve System consists of the Federal Reserve Board located in Washington, D.C.; 12 Reserve Banks, which have 24 branches located throughout the nation; and the Federal Open Market Committee (FOMC), which is responsible for directing open market operations to influence the total amount of money and credit available in the economy. Each Reserve Bank is a federally chartered corporation with a board of directors. The Federal Reserve Act authorizes the Reserve Banks to make discount window loans, execute monetary policy operations at the direction of the FOMC, and examine bank holding companies and member banks under rules and regulations prescribed by the Federal Reserve Board, among other things. The Federal Reserve Board and the Reserve Banks are self-funded entities that deduct their expenses from their revenue and transfer the remaining amount to Treasury. Federal Reserve System revenues transferred to Treasury have increased substantially in recent years, chiefly as a result of interest income earned from the Federal Reserve System’s large-scale emergency programs. To the extent that Reserve Banks suffer losses on emergency loans, these losses would be deducted from the excess earnings transferred to Treasury. 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—the Term Auction Facility, the dollar swap lines with foreign central banks, and the Agency Mortgage-Backed Securities 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 program did require authorization by the FOMC. In many cases, the decisions by the Federal Reserve Board, the FOMC, and the Reserve Banks about the authorization, initial terms of, or 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. In a few cases, the Federal Reserve Board authorized FRBNY to lend to a limited liability corporation (LLC) to finance the purchase of assets from a single institution. The LLCs created to assist individual institutions were Maiden Lane, Maiden Lane II, and Maiden Lane III. In 2009, FRBNY, at the direction of the FOMC, began large-scale purchases of mortgage-backed securities (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 1 provides a timeline for the establishment, modification, and termination of Federal Reserve System emergency programs subject to this review. The Reserve Banks’ and LLCs’ financial statements, which include the emergency programs’ accounts and activities, and their related financial reporting internal controls, are audited annually by an independent auditing firm. In addition, the Federal Reserve System has a number of internal entities that conduct audits and reviews of the Reserve Banks, including the emergency programs. As shown in figure 2, these other audits and reviews were conducted by the Federal Reserve Board’s Division of Reserve Bank Operations and Payment Systems (RBOPS), the Federal Reserve Board’s Office of Inspector General, and individual Reserve Bank’s internal audit function. The independent financial statement audits and other reviews did not identify significant accounting or financial reporting internal control issues concerning the emergency programs. From 2008 through 2010, vendors were paid $659.4 million across 103 contracts to help establish and operate the Reserve Banks’ emergency programs. The 10 largest contracts accounted for 74 percent of the total amount paid to all vendors. FRBNY was responsible for creating and operating all but two emergency programs and assistance and therefore awarded nearly all of the contracts. See table 2 for the total number and value of contracts for the emergency programs and assistance. As shown in table 2, the Reserve Banks relied on vendors more extensively for programs that assisted single institutions than for broad- based emergency programs. The assistance provided to individual institutions was generally secured by existing assets that either belonged to or were purchased from the institution, its subsidiaries, or counterparties. The Reserve Banks did not have sufficient expertise available to evaluate these assets and therefore used vendors to do so. For example, FRBNY used a vendor to evaluate divestiture scenarios associated with the assistance to AIG. It also hired vendors to manage assets held by the Maiden Lanes. For the broad-based emergency programs, FRBNY hired vendors primarily for transaction-based services and collateral monitoring. Under these programs, the Reserve Banks purchased assets or extended loans in accordance with each program’s terms and conditions. Because of this, the services that vendors provided for these programs were focused more on assisting with transaction execution than analyzing and managing securities, as was the case for the single institution assistance. Most of the contracts, including 8 of the 10 highest-value contracts, were awarded noncompetitively, primarily due to exigent circumstances. These contract awards were consistent with FRBNY’s existing acquisition policy, which applied to all services associated with the emergency programs and single-institution assistance. Under FRBNY policy, noncompetitive processes can be used in special circumstances, such as when a service is available from only one vendor or in exigent circumstances. FRBNY cited exigent circumstances for the majority of the noncompetitive contract awards. FRBNY officials said that the success of a program was often dependent on having vendors in place quickly to begin setting up the operating framework for the program. FRBNY’s policy did not provide additional guidance on the use of competition exceptions, such as seeking as much competition as practicable and limiting the duration of noncompetitive contracts to the exigency period. To better ensure that Reserve Banks do not miss opportunities to obtain competition and receive the most favorable terms for services acquired, we recommended that they revise their acquisition policies to provide such guidance. From 2008 through 2010, vendors were paid $659.4 million through a variety of fee structures. For a significant portion of the fees, program recipients reimbursed the Reserve Banks or the fees were paid from program income. The Reserve Banks generally used traditional market conventions when determining fee structures. For example, investment managers were generally paid a percentage of the portfolio value and law firms were generally paid an hourly rate. Fees for these contracts were subject to negotiation between the Reserve Banks and vendors. For some of the large contracts that were awarded noncompetitively, FRBNY offered vendors a series of counterproposals and was able to negotiate lower fees than initially proposed. During the crisis, FRBNY took steps to manage conflicts of interest related to emergency programs for its employees, program vendors, and members of its Board of Directors, but opportunities exist to strengthen its conflicts policies. Historically, FRBNY has managed potential and actual conflicts of interest for its employees primarily through enforcement of its Code of Conduct, which outlines broad principles for ethical behavior and specific restrictions on financial interests and other activities, such as restrictions on employees’ investments in depository institutions and bank holding companies, and incorporates the requirements of a federal criminal statute and its regulations. During the crisis, FRBNY expanded its guidance and monitoring for employee conflicts. However, while the crisis highlighted the potential for Reserve Banks to provide emergency assistance to a broad range of institutions, FRBNY has not yet revised its conflict policies and procedures to more fully reflect potential conflicts that could arise with this expanded role. For example, specific investment restrictions in FRBNY’s Code of Conduct continue to focus on traditional Reserve Bank counterparties—depository institutions or their affiliates and the primary dealers—and have not been expanded to further restrict employees’ financial interests in certain nonbank institutions that have participated in FRBNY emergency programs and could become eligible for future ones, if warranted. Given the magnitude of the assistance and the public’s heightened attention to the appearance of conflicts related to Reserve Banks’ emergency actions, existing policies and procedures for managing employee conflicts may not be sufficient to avoid the appearance of a conflict in all situations. During our review, Federal Reserve Board and FRBNY staff told us that the Federal Reserve System plans to review and update the Reserve Banks’ Codes of Conduct as needed given the Federal Reserve System’s recently expanded role in regulating systemically significant financial institutions. In light of this ongoing effort, we recommended that the Federal Reserve System consider how potential conflicts from emergency lending could inform any changes. FRBNY managed risks related to vendor conflicts of interest primarily through contract protections and oversight of vendor compliance with these contracts, but these efforts have certain limitations. For example, while FRBNY’s Legal Division negotiated contract provisions intended to help ensure that vendors took appropriate steps to mitigate conflicts of interest related to the services they provided for FRBNY, FRBNY lacked written guidance on protections that should be included to help ensure vendors fully identify and remediate conflicts. Rather than requiring written conflict remediation plans that were specific to the services provided for FRBNY, FRBNY generally reviewed and allowed vendors to rely on their existing enterprisewide policies for identifying conflicts. However, in some situations, FRBNY requested additional program- specific controls be developed. Further, FRBNY’s on-site reviews of vendor compliance in some instances occurred as far as 12 months into a contract. In May 2010, FRBNY implemented a new vendor management policy but had not yet finalized more comprehensive guidance on vendor conflict issues.