In September, reports about excessive trading behavior and potential insider trading came into question for members of the Federal Reserve. Two of the biggest individual stock investors in the Fed have since stepped down from their post. The Federal Reserve Office of Inspector General (OIG) is looking into whether the trading was even legal.
A question of ethics is one thing, but a question of legality is another. Is it illegal for Fed employees to trade, and what are the limitations on investment activity for Federal Reserve officials?
Inspector General probes trading activity of Fed officials
The OIG has announced that it is conducting a review of the legalities of trading activity for senior Fed officials, including regional Fed presidents whose portfolios have recently come under fire.
The Federal Reserve operates under a book of ethics. Fed Chair Jerome Powell has already announced that he's conducting an investigation into the ethics of individual stock trading. However, OIG is more concerned about legality.
The legalities will depend on the intricacies of insider trading potentially taking place. Government officials and political figures have historically been able to get away with insider trading (unlike private sector employees like the Netflix trio). However, the current probe could change the status quo.
Two regional Fed presidents and a Central Bank VP at the forefront of the inquiry
Dallas Central Bank president Robert Kaplan, Boston Central Bank president Eric Rosengren, and Fed Vice Chair Richard Clarida were all in the limelight for their highly active individual stock portfolios in 2020. Specifically, they heavily traded individual stocks before and during the COVID-19 pandemic.
Kaplan traded $1 million+ in individual stocks in 2020. Rosengren was heavily invested in real estate and mortgage-backed securities. All together, Fed officials traded millions. Once the reports leaked, Fed officials vowed to sell off their stocks before the fourth quarter. But as September inched on, Kaplan and Rosengren both announced that they were retiring from their positions by early October.
Despite their allegiance to their investment portfolios, their trades occurred during their time as Fed employees. That means both Kaplan and Rosengren will remain in the Inspector General's investigation of trading legalities.
The question of ethics and legality
Whether it was wrong or right for Fed employees to trade individual stocks on the basis of projected economic shifts during the tumultuous and deadly COVID-19 pandemic is one thing.
However, insider trading is illegal. It's possible that officials used nonpublic information to inform their trades. The Fed's heavy involvement in economic emergency measures during the COVID-19 pandemic (including purchasing of mortgage-backed securities and hundreds of billions in Treasury bonds) show clear bias on behalf of stock traders in the organization.
A Fed spokesman told reporters, "As part of our comprehensive review, we began discussions last week with the Office of Inspector General for the Federal Reserve Board (OIG) to initiate an independent review of whether trading activity by certain senior officials was in compliance with both the relevant ethics rules and the law."
At the very least, the Fed's ethics rulebook will likely be rewritten. At most, Fed officials could potentially be indicted for insider trading.
Editor's note: An earlier version of this story incorrectly stated the DOJ Inspector General was conducting an investigation into the legality of Fed employees' trading; this review is being conducted by the Federal Reserve's inspector general.