The 10th Circuit Court of Appeals issued a ruling a couple of weeks ago that has received scant attention, but merits close scrutiny. Cutting through all the "mumbo jumbo" (a hat tip to some of my lawyer-bashing clients), the court found that when it comes to determining a bank's capital levels, the bank's primary federal regulator can set it at any level it chooses, and the decision is not subject to judicial review. "Arbitrary and capricious"? The courts don't recognize the concept when it comes to capital levels. The sky's the limit.
The case arose out a "borrow-short-invest-long" strategy employed by Oklahoma-based Frontier Bank, whose primary federal regulator is the FDIC. The FDIC was concerned with the riskiness of the strategy. The bank and the FDIC negotiated a memorandum of understanding that, among other things, required the bank to maintain a 7% leverage ratio. In 2008, the FDIC determined that such a ration was not high enough and that the strategy was "unsafe and unsound," and when the bank resisted the FDIC's demands, the FDIC filed a notice of charges and the parties were off to the races in an administrative hearing setting.
The administrative law judge who heard the case sided with the FDIC and proposed an order that would require the bank to maintain a 10% tier 1 leverage capital ratio. The FDIC adopted the ALJ's recommendation and the bank appealed to the 10th Circuit, alleging that the FDIC's decision was "arbitrary and capricious" for (among other things) lacking adequate support for the 10% capital ratio requirement. Those are, of course, the magic words under applicable law for providing a basis for appealing such an order.
The Court had the following to say about its ability to review the FDIC's determination of appropriate capital levels of the institutions it supervises.
Congress left the setting of capital levels exclusively to the FDIC’s discretion because there is no “meaningful standard against which to judge the agency’s exercise of discretion.” See Heckler v. Chaney, 470 U.S. 821, 830 (1985); see also 5 U.S.C. § 701(a)(2). Since there is no such standard,
there is no way for us to discern whether the FDIC abused its discretion or acted arbitrarily and capriciously in establishing minimum capital levels for Frontier, regardless of the enforcement procedure the FDIC employed.
[Applicable statutory law] vests this court with jurisdiction to review cease-and-desist orders. But it also explicitly incorporates the APA’s standards for judicial review. Id. While the APA embodies a presumption of judicial review, “[t]his is just a presumption, however, and under § 701(a)(2) agency action is not subject to judicial review ‘to the extent that’ such action ‘is committed to agency discretion by law.’” Madigan, 14 F.3d at 1449 (quoting Lincoln v. Vigil, 508 U.S. 182, 190-91 (1993)). As § 701(a)(2) makes clear, judicial review is not available in those circumstances where the relevant statute “is drawn so that a court would have no meaningful standard against which to judge the agency’s exercise of discretion.” Heckler, 470 U.S. at 830; see Madigan, 14 F.3d at 1449. “In such a case, the statute . . . can be taken to have ‘committed’ the decisionmaking to the agency’s judgment absolutely.” Heckler, 470 U.S. at 830; see Lincoln v. Vigil, 508 U.S. 182, 191 (1993).
Because the International Lending Supervision Act of 1983 vested in each federal banking agency the "ability to set authority to establish such minimum level of capital for a banking institution as the appropriate Federal banking agency, in its discretion, deems to be necessary or appropriate in light of the particular circumstances of the banking institution," the court ruled that the agencies had "sole discretion" to set such levels and, moreover, held that the law gave the court no standard to use to review an agency's determination. Given the lack of a standard for judicial review, the court determined that it had no power to review the decision.
The court further held that the fact that the decision of the regulator was made in the course of a cease-and-desist proceeding, as opposed to a capital directive, is meaningless. Either way, it's up to the sole subjective discretion of the regulator and the court cannot review the regulator's determination.
I found the following passage especially ironic.
The amount of capital a bank needs to weather uncertainty is a subjective judgment
dependent on an informed analysis of the magnitude and likelihood of the attendant risks...Reasonable minds will differ as to appropriate capital levels because they reasonably differ on their assessment of the attendant risks.
What has the concept of "reasonable minds" got to do with the discussion? The court has determined that the decision as to appropriate capital levels for each bank is within the sole discretion of the the bank's primary federal regulator regulator and that the decision is entirely subjective. Whether the capital level determination is based on "my mother made me do it," "Lord Zardoz of the Planet Mongo commands it," or "Simon Says," it's not up for any stinking Monday morning quarterbacking by any two-bit appeals court on the basis that it was "arbitrary and capricious," "without a reasonable basis," "as loony as a fruitcake," or any other rationale employed by those interested in providing a modicum of due process to banks in such matters.
While the opinion addresses several other points of contention between the bank and the FDIC, and slaps the bank down on all of them, the sticking point for those of us daydreaming about the Fifth Amendment is the absolute discretion of the FDIC (and, of course, the OCC, FRB and NCUA) to set capital levels without any ability to challenge those decisions in court. Bankers are used to the fact that challenging regulatory decisions is an uphill battle. What they're not usually expecting is a ninety degree incline.
Unless the bank successfully takes this up to the SCOTUS, I think this might just take a legislative fix.