WASHINGTON -- Bank holding companies are not shielded from enforcement actions by regulators, even after they are under bancruptcy protection, the Supreme Court unanimously ruled yesterday.
But the high court stopped short of endorisng a controversial Federal Reserve Board regulation, leaving to another day the question of the legality of the agency's so-called source-of-strength doctrine.
The court 's decision in the case, Board of Governors of the Federal Reserve System v. MCorp Financial Inc., nevertheless provided the central bank with broad latitude to regulate banking firms.
"On the whole, I see this as a major victory for the Fred," said Geoffrey P. Miller, Kirkland & Ellis professor at the University of Chicago Law School. He said that by not considering the merits of the Fed's regulation, the court "did the Fed a favor."
He said the Fed "had a pretty weak case," noting that there was no specific statutory authorization for the rule when it was adopted.
The Fed published the regulation in 1984, requiring all holding companies to "serve as a source of financial and managerial strength" to their banks. The Fed clarified the policy in 1987, asserting that a holding company's failure to provide assistance to a failed or failing subsidiary bank "would generally be viewed as an unsafe and unsound banking practice."
MCorp challenged the Fed rule in 1988, when the agency in temporary orders told the holding company to shore up its banks. MCorp filed for bankruptcy and sought an injunction barring the Fed from taking enforcement actions.
A federal district court ruled the Fed no longer had authority over MCorp because the firm had been "entrusted to the authority of the bankruptcy court." The U.S. Court of Appeals for the Fifth Circuit went further, ruling the agency exceeded its authority when it tried to make MCorp funnel money into its troubled banks.
In yesterday's ruling, delivered by Justice John Paul Stevens, the court said the district court erroneously assumed jurisdiction in the case. Justice Stevens was joined in his opinion by all the other justices except Clarence Thomas, who was not on the bench when the case was argued.
After cataloging the Fed's extensive regulatory powers, the court noted that the Financial Institutions Supervisory Act of 1966 specifically denies courts jurisdiction "to affect by injunction or otherwise the issuance or enforcement of any notice or order ... or to review, modify, suspend, terminate, or set aside any such notice or order."
The law does allow holding companies to get temporary orders set aside while administrative proceedings are pending, and to appeal final orders -- two factors not at issue in the case.
MCorp, however, had argued that once it entered bankruptcy, it was entitled to protection from the Fed's enforcement actions. Bankruptcy filings generally serve as an automatic stay of many judicial and administrative proceedings. But the court yesterday said the bankruptcy code's automatic stay provisions "will not reach proceedings to enforce a 'governmental unit's police or regulatory power.'" a category that encompasses the Fed's actions.
The court left open the possibility MCorp ultimately could prevail in its challenge of the Fed's source-of-strength regulation. "If and when the board finds that MCorp has violated that regulation, MCorp will have, in the court of appeals, an unquestioned right to review of both the regulation and its application."
Until then, legal scholars said yesterday, the Fed has gained a potent tool to use against bank management. The MCorp ruling appears to give the Fed the ability to threaten enforcement actions -- without actually taking them -- forcing holding companies into voluntary compliance. Holding companies, in turn, cannot under the ruling appeal threatened actions.
"If holding companies can't challenge threatened actions, then they'd have to call the Fed's bluff and get a formal enforcement action issued against them," Mr. Miller said. "But that's not desirable because then the Fed would be mad and would seek all sorts of penalties. The effect of the ruling is to give the Fed powerful bargaining leverage."