In remarkably unusual public statements, Treasury Secretary Jacob Lew has aggressively criticized U.S. District Court Judge Rosemary Collyer’s legal decision to invalidate the Financial Stability Oversight Council’s designation of MetLife as a systemically important financial institution (SIFI).
Mr. Lew asserts that Judge Collyer overturned FSOC’s conclusion that MetLife is a SIFI and that her decision contradicted key policy lessons from the financial crisis. He’s wrong. Judge Collyer makes no specific determination as to whether MetLife is a SIFI and certainly does not base her judicial decision on the policy lessons of the financial crisis.
Quite simply, the judge found that the council’s decision failed to comply with the “arbitrary and capricious” standard set forth by the Dodd-Frank Act and rooted in the Administrative Procedures Act of 1946 (APA) — a cornerstone piece of legislation that ensures that our government has at least some basis for regulation.
Importantly, Dodd-Frank also provides companies designated as SIFIs with the right to promptly challenge FSOC’s decision in court. MetLife is the only designated company to do so, and Judge Collyer found in its favor on March 30th.The government has already filed an appeal with the D.C. Circuit and the case could ultimately be heard by the Supreme Court.
The Financial Stability Oversight Council is a financial regulatory agency created by Dodd-Frank. It is chaired by Secretary Lew and includes the heads of the eight financial regulatory agencies. One of its principle tasks is to identify financial institutions whose failure could pose a threat to the financial stability of the United States and then designate these entities as SIFIs. The stakes are high for companies designated as systemically important financial institutions because they are subject to enhanced supervision by the Federal Reserve and more stringent capital and liquidity requirements.
Judge Collyer found three procedural failures in FSOC’s designation of MetLife as a SIFI, each of which was sufficient to overturn FSOC’s determination on its own. Whatever the merits of designating a financial institution as systemically important, such determinations should follow the rule of law.
A court must decide if FSOC has properly assessed whether the failure of the designated financial institution could in fact threaten the financial stability of the United States. Judge Collyer found that FSOC did not do so with the rigor required by law. According to Judge Collyer, “every possible effect of MetLife’s imminent insolvency was summarily deemed grave enough to damage the economy.”
Not only did the Financial Stability Oversight Council not abide by legislative requirements, the judge also found that it violated the process required by its own rules. According to the FSOC’s 2012 rule-making and guidance, FSOC said it would consider the likelihood of a non-bank’s failure as part of the designation process. However, the record clearly shows that FSOC failed to consider MetLife’s vulnerability. When an agency takes an action that is directly inconsistent with its own rule-making, longstanding legal doctrine holds that the action is invalid because it is “arbitrary and capricious.”
Indeed, it was not the court that imposed requirements on the Financial Stability Oversight Council, as Mr. Lew argues, it was the FSOC itself. Of course agencies should be bound by their own rules — if agencies were free to disregard their own rulemakings, then their actions would be entirely unpredictable.
Mr. Lew additionally argues that Judge Collyer’s decision requires that FSOC conduct a formal cost-benefit analysis as part of a SIFI designation, even though no such analysis is required by the legislation. But Judge Collyer’s decision does not require a cost-benefit analysis. In Judge Collyer’s view, Dodd-Frank requires that the Financial Stability Oversight Council consider whether a systemically important financial institution designation would pose a risk to MetLife or to financial markets. This is a far lower standard than requiring that the FSOC measure the costs of designation and make sure that they are less than the benefits.
Judge Collyer’s legal decision would simply require that the Financial Stability Oversight Council follow a regulatory process that provides the public with transparency and certainty, instead of arbitrary determinations. Mr. Lew should make sure that FSOC follows the rule of law. Judge Collyer’s legal decision had nothing to do with the question of whether the SIFI designation approach is a legitimate response to the financial crisis.
• Hal S. Scott is professor of international financial systems at Harvard Law School and director of the Committee on Capital Markets Regulation