The widening scope of the Financial Stability Oversight Council’s “too big to fail” designations has caused alarm in the financial sector and, in the case of MetLife, inspired legal action.
In response to the 2008 global financial crisis, Congress formed the Financial Stability Oversight Council (“FSOC”) as part of the reforms initiated by the 2010 Dodd-Frank Act. Among its responsibilities, the FSOC designates certain financial firms as “Systematically Important Financial Institutions” (“SIFI”) if those firms’ failures would jeopardize the financial stability of the United States. 1 Such a designation essentially recognizes a firm as “too big to fail” and so subjects it to heightened regulatory scrutiny that is designed to prevent the type of risk-taking that resulted in the 2008 financial collapse and ensuing recession.
Initially, SIFI designations were met with little resistance because they applied only to banks. Given that banks were the primary recipients of government bailouts in 2008, coupled with the liquidity risks inherent in the high leverage banks take on, banks are the clear targets of regulations imposed by SIFI designation. (See David Zaring, Figuring Out if a Financial Institution Is Too Big to Fail, N.Y. Times Deal Book (Nov. 14, 2014), http://www.dealbook.nytimes.com; John Berlau, Disasterous Application of Dodd-Frank Law to Insurance Company, Competitive Enterprise Institute (Sept. 18, 2014), http://www.cei.org.)) Such regulations include the imposition of capital restrictions, credit exposure limits, and debt to equity ratio limits. Regulations of SIFIs further limit the types of acquisitions SIFI firms may make, impose limitations on the ownership of certain types of financial assets, require the creation of a “living will” in preparation for potential bankruptcy, limit investment in private equity and hedge funds, and expose designated firms to stress tests and heightened reporting and examination requirements. 2
Nonbank financial institutions like insurance companies and asset managers do not want to be subject to the bank regulations that will inevitably raise costs for both the firms and purchasers of their services. 3 The recent designation of MetLife as a SIFI in September has resulted in the first legal challenge to the FSOC’s designation procedures. While statutory language is clear that bank holding companies with $50 billion or more in assets qualify as SIFIs, the procedure for nonbank designation is far more qualitative. 4
MetLife’s legal challenge to the FSOC’s designation faces an uphill battle. To win and have their designation reversed, MetLife will have to demonstrate that their designation as SIFI was arbitrary and unreasonable. 5 Proving that their designation was arbitrary and unreasonable will require MetLife to convince the Court that the FSOC needs to provide a cost-benefit analysis that legitimizes the designation with quantifiable data. 6 Yet, the multi-factor test provided by Dodd-Frank does not fully lend itself to quantitative analysis. Hence, the subjectivity of the designation procedure simultaneously invites legal challenges and insulates the designation from those challenges. Furthermore, in its first two nonbank designations, AIG and Prudential, the FSOC provided no cost-benefit analysis and neither firm brought a legal challenge. 7 Finally, in spite of attempts by some members of Congress to rein in the FSOC’s seemingly arbitrary designation, Courts grant significant deference to the expertise of regulatory agencies, particularly to the FSOC. 8 The FSOC’s mandate to protect the stability of the financial system has resulted in Court’s effectively giving it a free pass to act without quantitative substantiation. 9
The effects of SIFI designation on insurance companies like MetLife have yet to be fully understood or realized. However, the outcome of MetLife’s challenge will likely be determinative of courts’ future deference to the FSOC’s designation of systematically important nonbank financial firms. Unbridled freedom to designate nonbanks as systematically important, with little need to provide quantitative justification, could result in a broad expansion of financial regulatory power to other insurance companies, asset management firms and beyond.
See Andy Winkler, Primer: FSOC’s SIFI Designation Process for Nonbank Financial Companies, American Action Forum (Sept. 3, 2014), http://americanactionforum.com. ↩
See Arthur Long, C.F. Muckenfuss, Colin Richard, FSOC Designation: Consequences for Nonbank SIFIs, Gibson Dunn (Apr. 11, 2013), http://www.gibsondunn.com/publications. ↩
See Press Release, MetLife, MetLife Statement on Preliminary SIFI Designation (Sept. 4, 2014), available at http://www.metlife.com/about/press-room. ↩
Cf. Long, supra note 3.) Specifically, Section 113 of Dodd-Frank provides a ten-part multifactor test for the FSOC to consider when making nonbank designations, which can be summed to include: 1) size, 2) interconnectedness, 3) leverage, 4) substitutability, 5) liquidity risk and maturity mismatch and 6) existing regulatory scrutiny. ((Winkler, supra note 1. ↩
Zaring, supra note 2. ↩
Peter J. Wallison, The Laterst Twist in a Regulatory Sham, The Wall Street Journal (Sept. 10, 2014), available at http://online.wsj.com; Zaring, supra note 2. ↩
Zaring, supra note 2. ↩