Appeals Court Appears Skeptical of MetLife's SIFI Argument
WASHINGTON — Based on questions from appellate judges on Monday morning, MetLife appears to be facing an uphill fight to defend a lower court ruling that found federal regulators erred in designating the firm as a systemically important financial institution.
During oral arguments before the U.S. Court of Appeals for the D.C. Circuit, panel judges appeared sympathetic to Financial Stability Oversight Council arguments that it had the power to designate the insurance giant based on its potential to upset the economy if it later became troubled.
Judge Sri Srinivasan appeared to agree with FSOC representatives, who argued that the Dodd-Frank Act allowed the interagency council to consider the "vulnerability" of the system if a firm became troubled rather than just assessing the current financial status of the firm in question.
"That seems to be your strongest position … that [the vulnerability clause] doesn't go to the likelihood of financial distress, but goes to the implications if the company is in financial distress," Srinivasan said.
That appears to contradict the view of D.C. District Court Judge Rosemary Collyer, who ruled in March that FSOC had gone too far in designating MetLife a SIFI and thus subjecting it to heightened scrutiny by the Federal Reserve.
Collyer ruled that the council had overstepped its own guidance by failing to consider the likelihood that MetLife might actually face financial distress, and instead simply assumed a failure and considered the implications from there. Collyer also argued that the council undertook no consideration of the costs that designation would impose on MetLife. FSOC subsequently appealed the decision.
During Monday's appeals court hearing, Mark Stern, appellate litigation counsel at the Department of Justice, argued that FSOC was bound by the plain reading of Dodd-Frank to consider not only apparent by also hypothetical risks posed by nonbank firms. If FSOC were bound only to designate firms that it could show were financially shaky, financial crises would only be addressed reactively, while the purpose of the statute was to address risks proactively, he said.
"The idea that the council will make a prediction about the financial health of — " Stern began.
"But your prediction is a 100% chance of failure," interjected Judge Raymond Randolph.
"No, the council never said [MetLife] faces a 100% risk of failure," Stern said. "The working assumption is that [the company] is facing insolvency, so the question is, if you're in that position, how is that likely to affect you?"
Two of the three judges on the panel — Srinivasan and Judge Patricia Millett — were appointees of President Barack Obama. Randolph is an appointee of President George H.W. Bush.
Eugene Scalia, a partner at Gibson Dunn who argued the case for MetLife, said the crucial question is not only whether FSOC was wrong for not considering MetLife's vulnerability but that it was willfully ignorant or dismissive of evidence demonstrating that it would not be susceptible to runs or the kinds of distress that FSOC assumes. In particular, Scalia said, MetLife ran stress tests and analyzed its banking partners' stress tests and found that the total failure of MetLife would inflict merely a fraction of the kind of financial impact on the banks that is simulated in the annual stress tests.
But Millett was not impressed, questioning whether such an analysis took into consideration the reasonable assumption that a MetLife failure would take place in the context of a broader economic upheaval.
"Isn't the question, 'What is the impact of MetLife's failure at the time of a severe downturn of the economy?'" Millett asked. "So it's not just that MetLife is an island unto itself. You have to assume that the rest of its [business] partners are themselves facing a severe economic downturn. How does the stress test address that double whammy?"
Srinivasan questioned whether the intricacies of MetLife's argument that it was wrongly designated are somewhat out of proportion, considering that banks are automatically designated as SIFIs when their assets exceed $50 billion and MetLife has more than $900 billion in assets.
Scalia countered that assets to a bank are different than assets to an insurance company — a bank's deposits are much more likely to be subject to runs than an insurance firm.
"The run scenario is a creature of the banking world," Scalia said. "People buy life insurance for completely different reasons."
Dodd-Frank endowed FSOC with the power to designate nonbank entities — which may not be subject to traditional prudential or supervisory standards — as SIFIs. Such entities are then subject to enhanced regulatory oversight by the Fed, though the agency has not yet completed rules outlining what those standards would be.
To date only four nonbanks have been designated as SIFIs: American International Group, Prudential, GE Capital and MetLife. MetLife alone has challenged its designation in court, while GE Capital restructured its business and was de-designated by FSOC earlier this year.
MetLife originally sued FSOC in January 2015, only weeks after the agency designated the insurer as a SIFI. The firm's suit was seen by many observers as a long shot to rescind the designation before Collyer's ruling was handed down in March.
Randolph introduced another wrinkle into the oral argument by asking Stern whether FSOC's designation would be subject to cost-benefit analysis, as is required by a 1990s-era executive order on regulations. Stern responded that he did not believe that FSOC was subject to that executive order, which does not apply to independent agencies, and further does not apply because a designation is not a regulation.
"The regulation is an interpretation of the statute," Randolph said. "The guidance is in an interpretation of a regulation and the designation is an interpretation of the guidance."
Millett similarly asked whether MetLife would have the opportunity to challenge the effects of its designation — namely the enhanced prudential standards and oversight — whenever they were promulgated by the Fed and went into effect. Stern answered that it would have that chance.
"Our job is to make a determination," Stern said. The Fed's final rules governing insurance firms "would certainly be subject to challenge."