This story was originally published by ProPublica.
A committee that includes senior Federal Reserve officials reviewed and overturned a bank examiner’s finding that Goldman Sachs lacked a firm-wide policy to prevent conflicts of interest, according to a top Fed official.
Bill Dudley, the head of the Federal Reserve Bank of New York, disclosed the action by the “Operating Committee” in a little-noticed aspect of his testimony last month before the U.S. Senate. Dudley said the panel was part of a new effort by the Fed to raise standards across the board by comparing the practices and health of the nation’s banks against each other.
In his testimony, Dudley provided the Fed’s most detailed account to date of how it reversed the conclusions of Carmen Segarra, a New York Fed bank examiner who asserted that Goldman lacked the Fed’s recommended firm-wide policy to prevent conflicts of interest. Dudley told the senators that the Operating Committee had “fully vetted” Segarra’s finding but said “there was this lack of willingness to agree.” He said that while he encourages examiners to speak up, their views must be “fact based.”
New documents and secret recordings shed more light on the facts Segarra marshaled to support her position. The examiner, for example, compared Goldman’s approach to conflicts with that of Barclays and Morgan Stanley. She found that, unlike with Goldman, the policies of both banks were detailed, specific and clearly addressed to the entire firm.
ProPublica also found that:
Goldman executives acknowledged to Segarra that they had no single firm-wide policy on conflicts of interest, according to official meeting minutes she kept.
Segarra formally presented her findings in a session with specialized Fed examiners stationed at nine of the too-big-to-fail banks. They agreed that Goldman did not have the sort of policy recommended in Fed guidelines, according to Segarra and another examiner who was present.
In disputing her finding just before she was fired, the senior Fed official overseeing Goldman Sachs pointed to the code of conduct for employees displayed on Goldman’s website, saying it amounted to a firm-wide policy. Goldman’s code of conduct at the time did not contain characteristics that were found in the conflicts policies of other banks that experts consider best practices. The Goldman code addressed conflicts involving employees’ personal holdings but not those that could arise from the firm’s deals.
Segarra was not called to testify at the Senate hearing. And in his appearance, Dudley did not detail specifically what evidence the Operating Committee considered in overruling Segarra, on what basis the decision was made, or whether it considered any of Segarra’s documentation or examination findings.
”I think the position of the senior supervisors was that there was a conflict-of-interest policy, and that is what the debate was about,” Dudley said.
As ProPublica and This American Life previously reported, Segarra secretly recorded 46 hours of internal meetings while at the Fed after encountering resistance to her examination into Goldman.
At the hearing, David Beim, a Columbia University professor, testified that the recordings “illustrated in Technicolor” the problems he found in the 2009 study of the New York Fed’s culture that Dudley had commissioned. Among other things, the study said examiners were afraid to speak up and that findings were being watered down by higher-ups and an over-reliance on consensus.
“It does suggest to me that not as much change has happened as I would have hoped and that indeed, there is a continuing cultural problem and culture is slow to change,” Beim told the senators.
Partly in response to concerns about examiner independence raised by Segarra’s case, the Federal Reserve Board has launched two reviews into whether information from frontline examiners is being heard by top decision-makers at the New York Fed and other regional reserve banks.
Asked about the issue, Federal Reserve Chairwoman Janet Yellen voiced strong support of Dudley. But Yellen also said that when examiners are at odds about what’s taking place in a bank, “it is important that there be channels by which they can make sure that disagreements are fed up to the highest levels.”
(AP Photo/Richard Drew)
At the heart of the dispute over Segarra’s findings is one of the most vexing and prevalent problems on Wall Street: conflicts of interest. Among its peers, Goldman stands out for its frequent run-ins over the issue.
This month, the bank was among 10 Wall Street firms that were fined a total of $43.5 million for allegedly using the promise of favorable research, which was supposed to be impartial, to win business for their investment-banking divisions. The firms paid small fines without admitting wrongdoing.
During a hearing in November, senators accused Goldman of deliberately pushing up the price of aluminum and giving confidential information to traders in the metal, providing them an unfair advantage. Goldman denied the allegation; two other firms also were criticized at the hearing.
In 2010, the Securities and Exchange Commission hit Goldman with a record $550 million fine related to conflicts in structuring mortgage bonds. The next year, the firm faced a shareholder lawsuit over a deal involving its advisory role to energy company El Paso in its sale to Kinder Morgan. Goldman held a $4 billion stake in Kinder Morgan. A judge harshly chastised the bank for its handling of the conflict.
Segarra started at the New York Fed on Oct. 31, 2011, as a senior examiner for legal and compliance issues. Her bosses instructed Segarra to examine Goldman’s conflicts-of-interest policy as of Nov. 1, 2011, after the bank’s issues with conflicts landed in media reports.
Conflicts not only can result in fines or lawsuits; they also can threaten a bank’s reputation, potentially imperiling its safety and soundness. Official guidance from the Fed recommends that banks have a global policy – that is, one that applies firm-wide – to deal with conflicts of interest.
Five experts interviewed by ProPublica said the best policies have common characteristics: They define what a conflict is; explain how everyone in the firm is covered; identify roles and responsibilities; offer examples; provide ways to escalate conflicts to senior management; and track compliance.
“This is not hard,” Segarra said in an interview. Before joining the New York Fed, she had worked for years helping banks comply with rules and regulations. “Most big firms have this.”
The national business ethics survey consistently ranks conflicts of interest as one of the top three types of misconduct observed by employees, according to Patricia Harned, CEO of the Ethics and Compliance Officer Association. “The conflicts-of-interest policy should apply from the board of directors to the first level employee,” said Harned. “You need to spell out what you have to avoid.”
The basis for Segarra’s examination of Goldman was a Fed Supervision and Regulation Letter known as SR 08-8 that specifically called for firm-wide policies in key areas including conflicts. In 2009, a review by the Federal Reserve Board had found fault with the New York Fed’s efforts to ensure that banks followed the guidance.
In the course of her examination, Segarra said she asked her peers at other big banks to provide her with the conflicts-of-interest policies for the firms they covered. Her goal was to do the kind of comparisons Dudley praised in his recent Senate testimony.
The New York Fed typically teams up banks based on common characteristics. The idea is to identify best practices and expose shortcomings. If one bank is weaker than its twin in a specific area, the laggard can be encouraged to raise its game. For example, big retail banks JPMorgan Chase and Citigroup are compared. Foreign banks are also paired: Deutsche Bank with Barclays; Credit Suisse with UBS. Goldman, as a broker dealer, is paired with another large broker dealer, Morgan Stanley, according to former examiners.
ProPublica obtained Morgan Stanley’s policy, dated April 2011. It contained most of the best practices identified by experts. It was firm-wide and posted on the company’s intranet for every employee to see. Called “Morgan Stanley Global Conflicts of Interest Policy,” it applied to all employees of Morgan Stanley, offered a definition, spelled out roles and responsibilities, described how potential conflicts should be escalated and provided for annual reviews. The policy featured 20 different examples of potential conflicts.
Segarra said she knew that Goldman was capable of writing a similar global policy because she had seen one. The firm’s policy for vendors, for example, was called “Goldman Sachs Firmwide Vendor Management Program” and had many of the same features found in Morgan Stanley’s conflicts policy.
When Goldman was asked for its conflict-of-interest policy, a bank executive said it did not have a single policy, according to official minutes taken by Segarra in a meeting between supervisors and bank executives. It took months and several requests, Segarra said, before Goldman responded to her request for “copies of conflicts of interest policies, procedures, and risk assessments applicable to all [six] GS divisions … as of November 1, 2011.”
Goldman eventually provided hundreds of pages of documents. The bank said that as part of recommendations from the firm’s Business Standards Committee, it was updating its policies. Two of its six divisions had new conflict-of-interest policies as of December 2011. The Investment Management Division was “in the final stages of completion,” and a full policy was unavailable.