Stephen Friedman, chairman of the New York Federal Reserve Bank's board of directors, resigned on Thursday amid questions about his purchases of stock in his former firm, Goldman Sachs.

Friedman, a retired chairman of Goldman Sachs who has led the New York Fed's board since January 2008, said he quit to prevent criticism about his stock buying from becoming a distraction as the Fed battles a severe U.S. recession.

Although I have been in compliance with the rules, my public service motivated continuation on the Reserve Bank Board is being mischaracterized as improper, he said in a letter of resignation to New York Fed President William Dudley.

The Federal Reserve System has important work to do and does not need this distraction, Friedman said.

The U.S. central bank is comprised of a seven-member Board of Governors in Washington, and 12 regional Fed banks.

Some of the regional directors are appointed by the Washington-based board. Those directors are not allowed to own shares of bank holding companies, a status that Goldman Sachs won in September to secure access to Fed lending facilities.

Friedman bought Goldman shares in December 2008 and in January of this year, which became public with a Wall Street Journal report on Monday.

Friedman obtained a waiver of the bank stock ownership rules, which the Journal said was granted just before he bought stock in January, that allowed him to hold them until the end of this year. Last week, he said he would resign by then.

DEFENDERS AND DETRACTORS

The top lawyer at the New York Fed said Friedman had done nothing wrong.

It is my view that these purchases did not violate any Federal Reserve statute, rule or policy, the bank's general counsel, Thomas Baxter, said in a statement.

Denis Hughes, the deputy chair of the New York Fed's board and president of the New York State AFL-CIO, will now be the acting chair, the New York Fed said.

While the Fed was deciding whether or not to grant Friedman a waiver, he bought 37,300 Goldman shares on December 17, for an average price of $80.78, according to regulatory filings.

On January 22, he bought 15,300 more shares for average prices of $66.19 and $67.12, according to filings with the U.S. Securities and Exchange Commission. The January purchase brought his total holdings to 98,600 shares.

Goldman shares closed on Thursday at $133.73, meaning Friedman has profited handsomely, earning more than $3 million in total on the two purchases.

Clearly he should not have done that (bought more Goldman shares), and probably even before he did that, he should have gotten off the board, said Alfred Broaddus, former president of the Federal Reserve Bank of Richmond.

John Dunbar, a senior fellow at the Center for Public Integrity, a nonprofit watchdog group in Washington, said the stock purchases were a complete conflict of interest.

It is almost comical. If you tried to do that in a more traditional Washington bureaucracy, there is no way on earth you would get away with that, he said.

Fed insiders were also troubled over the situation, which they felt cast a question mark over ethical standards at the central bank.

All the other banks are furious. No one else would have let this happen, said one official at another regional Fed bank. We've always made people leave (to avoid a conflict), said the official, who requested anonymity given the delicacy of the situation.

NEW YORK FED BOARD RANKS THIN

Of all the other regional Fed banks, only Minneapolis said that one of its directors had to apply for a waiver for bank shares he held last fall when a number of former non-bank financial firms sought banking holding company status.

Minneapolis Fed board Deputy Chairman John Marvin, chief executive of Marvin Windows and Doors of Warroad, Minnesota, was granted a waiver for stock he held in Morgan Stanley and Goldman Sachs, a Minneapolis Fed spokeswoman said.

Several regional Fed banks said that their internal practices would have prevented the problem cropping up in the first place. It is our policy to ask them to divest or resign, said a spokeswoman for the Kansas City Fed said.

With Friedman's resignation, the New York Fed's board now has three vacancies. Indra Nooyi, chairman and CEO of PepsiCo, is no longer on the board and former Lehman Brothers chief executive Dick Fuld left in September.

It is rare to have more than one vacancy at any given time.

(Reporting by Kristina Cooke; Additional reporting by Alister Bull in Washington and Ros Krasny in Chicago; Editing by Toni Reinhold)

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