Court considers role of bank regulators in syndicated loan case

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Judges in a case that could rewrite banks' role in the syndicated loan market heard oral arguments Thursday, and those arguments centered largely on federal banking regulators' intentions and potential fears regarding the multi-trillion dollar market. 

The notional value of the syndicated loan market has skyrocketed in recent years, but an appeal in the Kirschner, v. JPMorgan Chase Bank, N.A. lawsuit could redefine those loans as securities. That would mean more costly and strict oversight from the Securities and Exchange Commission, a new reality that would drastically redefine how banks make money in the business.

In oral arguments held on Thursday, the judges for the United States Court of Appeals for the Second Circuit questioned the current regulatory regime of these kinds of syndicated loans. 

The judges asked why the Securities and Exchange Commission hasn't weighed in on the case, and where banking agencies — notably the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Federal Reserve — stand on applying higher regulatory standards to syndicated loans. If the banking regulators saw a problem in the market, the judges asked, why have they not addressed it via rulemaking? 

"I don't know if they could, but what I do know is that they haven't," said Christopher Johnson at McKool Smith, the lawyer for the plaintiff. "And currently there's no regulatory regime." 

Johnson, arguing that these syndicated loans should be considered securities, said that's an issue better handled in the discovery phase of a trial. The Second Circuit could send the case back to a lower court, which would initiate that discovery phase.

The lawyer for the defendant, Jeffrey B. Wall, a partner at Sullivan & Cromwell, referenced interagency guidance issued in 2013 directing banks to improve risk management and underwriting standards for leveraged loans. That guidance, however, was effectively nullified after the Government Accountability Office ruled several years later that it should have been treated as a rule under the Congressional Review Act. 

"All of it's overseen by the banking regulators who have overseen it for the last thirty years," Wall said. "This is what banks do. It is much more sensible under the purview of the OCC." 

Since then, the agencies haven't issued anything substantive on syndicated loans or leveraged lending, although some reports and comments from regulators have pointed to leveraged lending as a potential problem in the financial system. 

"The banking regulators don't see any problem in the loan market and there isn't any problem to date because of the way that market has developed," Wall said. 

Wall argued that the market has grown around what he said is a widely-understood assumption that syndicated loans are loans, not securities, and that the organizations and people who operate in this market are aware of this. 

"No one disputes that these markets have grown up in parallel and that the products bear some similarities, but they have long been understood to be different," Wall said. "High-yield bonds or securities are handled by the SEC, leveraged loans and syndicated loans are handled by the banking regulators because at the end of the day, they're loans, they're not securities." 

Johnson, for the plaintiff, said that a lower court should more fundamentally reconsider how it classifies loans versus securities, especially given the market's rapid growth and similarities to other financial instruments compared to similarities with more traditional loans. 

"The banks have developed this market, and they do not want it regulated by the SEC," he said.