Custodia Bank's master account lawsuit against Fed likely to advance

The Federal Reserve System could find itself in unfamiliar territory: having to defend its process for granting master accounts at trial.

Judge Scott Skavdahl of the U.S. District Court for the District of Wyoming said he likely would not dismiss the lawsuit Custodia Bank filed against the Fed board and Federal Reserve Bank of Kansas City earlier this year. 

Following oral arguments from all three parties on Friday afternoon, Skavdahl declined to issue a ruling from the bench on the Fed's motion to dismiss the lawsuit. He noted that the scope of the suit might be adjusted but the matter would likely survive "in some form."

"I understand there's a lot of very competent and extremely bright and far more learned and skilled finance, banking and regulatory individuals in the world and they're looking at this, but I just don't see why we are looking at a length of time that's equal to the gestation of an elephant to figure this out with all those bright people," Skavdahl said.

Skavdahl said he would review the documents submitted by the parties and have a final decision rendered "as quickly as possible" so both sides could move forward accordingly.

Custodia, a Wyoming-chartered special-purpose depository, sued the Fed in June, hoping to compel it to make a decision on the company's roughly two-year-old application for a master account with the Kansas City Fed. 

In August, the Fed filed a motion to dismiss the case on the grounds that Custodia's business model — which aims to provide crypto-custody and digital-asset payment services — was the "first of its kind," and therefore requires more time for the Kansas City Fed to review. 

Should Custodia's suit against the Fed go to trial, it would be the first master account litigation to go that far. Previous challenges filed by Fourth Corner Credit Union, a Colorado-based credit union serving the state's legal cannabis industry, and The Narrow Bank, a Connecticut bank that sought to hold all of its customers' deposits in risk-free reserves at the Fed, were dismissed.

On Friday, the two sides sparred over whether the Fed had an obligation to grant an account to Custodia because of its state-chartered status; if Custodia had actually been harmed by the protracted review process; whether reserve banks should be considered agencies and therefore subject to the Administrative Procedure Act — which would mean it should have rendered a decision within 12 months; and which institution was at fault for the delay, the Kansas City Fed or the Fed board in Washington.

The Fed lawyers argued that Congress made only the Fed board an agency of government, while the 12 reserve banks were incorporated as private entities. Even though the reserve banks enact the Fed's rules and implement monetary policy, they are independent, the central bank's lawyers said, and each has the authority to make decisions about which institutions should be granted master accounts.

Skavdahl said the layering of authorities and responsibilities made it difficult to determine which part of the system bears ultimate responsibility for managing master account policies.

"Here's my quandary in this, from a legal perspective:The Federal Reserve Bank of Kansas City is not an agency, and the Federal Reserve Board of Governors ain't calling the shots, so it's kind of like mercury — I'm trying to put my thumb on it but it just squirts," he said. "Where does the buck stop?"

Skavdahl said the question of the statutes that apply to the Fed and the reserve banks and their relevance in this particular case are yet to be determined.