PART 2: OUR WORK

Accountability

YES, THE FED IS AUDITED, AND IT HAS BEEN SINCE ITS FOUNDING

By Michael D. Renfro, Senior Vice President and General Auditor

Michael D. Renfro

Over the past few years, Congress and the general public have been clamoring for the Federal Reserve to be audited. This public outcry is not new: Since the Fed's inception, bills have been introduced in Congress calling for expanded auditing of the Federal Reserve. This demand is probably rooted in the idea that all public entities should be transparent and accountable. The Fed can appear to be neither in the eyes of some people because of the complexity of its monetary policy decisions and its independence from the executive branch. But, in fact, the St. Louis Fed and the other 11 Reserve banks have been subject to auditing ever since the Fed was founded. Here, we'll explore an abbreviated history of this auditing, with a focus on current activities.

The Federal Reserve Act of 1913, which established the Fed, stipulated that the Federal Reserve Board (now called the Board of Governors) should "order an annual audit of each Federal Reserve Bank." The act was not specific on how this examination should be conducted, so staff of the Board took on the role of "bank examiner" by conducting audits of each Reserve bank every year. This approach had some distinct advantages: The examiners were familiar with Fed operations and, therefore, were very knowledgeable about Fed activities. However, this arrangement created an appearance of a lack of independence because the auditors, while not employed directly by the bank being audited, were employees of the Federal Reserve Board.

Congress, in one of its challenges to the Board's auditing approach, proposed in 1954 that what is now known as the Government Accountability Office (GAO) perform an audit of the Board, the Federal Open Market Committee and the Federal Reserve banks. Then-Fed Chairman William McChesney Martin Jr. explained that the Board had been audited for years by a Reserve bank audit department on a rotating basis and recently had contracted with an accounting firm to conduct an independent audit to remove any doubt about impartiality. In addition, another nationally recognized audit firm was hired to accompany the Board examiners on one of their 12 bank audits each year. These arguments were persuasive; the GAO was not granted broad, sweeping audit powers over all aspects of the Fed.

However, challenges regarding the Fed's approach to auditing were ongoing over the next 40 years. Thus, in 1996, the Fed hired an external auditor to conduct an independent audit of two Reserve banks. This was a pilot program to determine whether the concept was beneficial and could be applied more broadly to all 12 Reserve banks. The results were primarily favorable; therefore, the Fed opted to extend the annual external audits to all Reserve banks.

Since then, the use of audited financial statements has expanded to include a combined set of financial statements for all Reserve banks and a full set of footnotes, providing information about the structure of the Fed and definitions and explanations for all financial statement line items. Additionally, while not required for nonpublic entities, the external audit reviews the internal control environment of each Reserve bank in accordance with the framework set up by the Committee of Sponsoring Organizations of the Treadway Commission (a non-Fed body that gives guidance to organizations on internal controls and fraud deterrence). The Fed voluntarily agreed to this review in an effort to be fully transparent and in alignment with the banking institutions that it supervises.

The Board and all Reserve banks publish their financial statements and external audit opinions online or in hard-copy annual reports. (Copies of the St. Louis Fed's financial statements are available at www.stlouisfed.org/ar.) In addition, key aspects of these financial statements are published in an annual report for the entire Federal Reserve System. (This report is published, submitted to Congress annually and placed on the Board's public website.) To further transparency efforts, in August 2012, the Fed began publishing unaudited quarterly financial reports for the Reserve banks, a practice required by the Securities and Exchange Commission only for companies whose stocks are publicly traded on an exchange.

In addition to the annual audits conducted by an external public accounting firm, the Fed is subject to targeted audits by the GAO, the Fed's own Office of Inspector General, the Treasury's Office of Compliance and internal auditors who are housed in all Reserve banks. The internal auditors also work collectively to coordinate audit coverage of select System operations. In 2013, approximately 300 auditors devoted 276,000 hours to conduct audit work throughout the System.

Certainly, the Fed is audited. It is audited often by a variety of groups, both internal and external, and many of the results are published for the consumption of the general public. This growing trend toward more transparency has proved to be extremely helpful in expanding understanding of the Fed's purpose, role and, more recently, the impact on the Fed's balance sheet resulting from the recent financial crisis and the actions taken by the Fed to address it.

Although not listed on the Fed's balance sheet today, accountability and transparency are assets to be valued, protected and fostered if the Fed is to continue to live up to the vision and expectations of the authors of the Federal Reserve Act.