High Court to Review Fed's |Source of Strength' Doctrine

WASHINGTON - When the Supreme Court returns to the bench Oct. 7, it will step into the middle of a long-running dispute over whether the Federal Reserve Board can require bank holding companies to pump up ailing subsidiary banks.

The point of contention is a Fed regulation, known informally as the agency's "source of strength" doctrine, requiring holding companies "to use available resources to provide adequate capital to subsidiary banks during periods of financial stress or adversity."

The regulation was struck down on May 15, 1990, by the U.S. Court of Appeals for the Fifth Circuit, which ruled in a case brought by the Dallas-based holding company MCorp that the regulation exceeded the Fed's statutory authority.

The Supreme Court earlier this year agreed to review the appellate court's decision, and the case - Board of Governors of the Federal Reserve System v. MCorp Financial Inc. - is slated to be the second dispute argued before the high court when it begins its 1991-1992 term.

History of Controversy

The rule, formally adopted in 1984 and clarified in 1987, has been controversial from the outset.

The Federal Deposit Insurance Corp., for example, has been a strong critic of the rule. FDIC Chairman L. William Seidman has argued that the regulation could limit the flow of new capital into the banking industry.

In testimony before the House Banking Committee last year, Mr. Seidman said that repeated enforcement of the rule "would reduce market efficiency, restrain the ability of banks to be viable competitors in the financial marketplace and limit the ability to obtain new capital for the banking industry."

But the Fed maintains that the regulation helps ensure that the banking industry is adequately capitalized.

Fed Directive to MCorp

The MCorp case arose in 1988, when the Fed ordered the holding company to transfer about $400 million of its assets to subsidiary banks. MCorp never complied, and 20 of the firm's 25 subsidiary banks eventually failed. They were then seized by the FDIC and sold to Banc One Corp., Columbus, Ohio.

MCorp filed for bankruptcy and sought an injunction barring the Fed from taking further enforcement actions.

The U.S. District Court for the Southern District of Texas ruled that 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 that the Fed exceeded its statutory authority when it tried to make MCorp funnel money into its troubled banks.

The appellate court said the Fed's regulation "can hardly be considered a |generally accepted standard of prudent operation,'" and held that the rule "would amount to a wasting of the holding company's assets in violation of its duty to shareholders."

The ruling was a rare rebuff to the Fed, which generally wins cases that challenge its interpretation of banking statutes. Particularly where the laws are vague, courts usually defer to the agencies.

The Bond Buyer is a sister publication of American Banker.

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