Custodia amends Fed lawsuit, alleges 'coordinated effort' to deny master account

A digital-asset bank that was spurned by the Federal Reserve last month is not giving up its effort to be regulated by the central bank.

Custodia Bank, a Wyoming-chartered bank that specializes in cryptocurrency custody, amended its lawsuit against the Fed and the Federal Reserve Bank of Kansas City on Friday afternoon. In its filing, Custodia argues the institutions have no authority to block it from the central bank's payment system.

The filing comes three weeks after the Kansas City Fed denied Custodia's application for a so-called master account and the Fed denied its bid to become a state-member bank — a status that would have given it an easier path to receiving a so-called master account.

Custodia had been asking the U.S. District Court in Wyoming to force the two institutions to act on its two-year-old applications.

"Even though Custodia's master account application has been decided, Custodia's claims are far from resolved," the bank's filing reads. "The denial of Custodia's master account crystalizes a claim that was already present in Custodia's initial complaint — defendants have no statutory discretion to deny Custodia's master account application."

Custodia initially filed a broad lawsuit in the District Court last June. In it, the bank argued — among other things — that it had been subjected to an unreasonable delay in its bid to obtain a master account at the Kansas City Fed, which would have secured it access to the central bank's various financial services.

Some of Custodia's claims, including those accusing the Fed of violating the separation of powers doctrine, due process and the Appointments Clause of the Constitution, were thrown out in November. But key questions about the Fed's process for handling master account applications remained intact and were poised to be hashed out at trial later this year.

The Fed maintains that its 12 regional banks have sole discretion over granting master accounts to banks in their respective districts. Because the reserve banks are technically private institutions composed of member banks, they are not subject to provisions of the Administrative Procedure Act. Custodia's lawsuit challenges this distinction and questions whether the Fed intervened to stymie its master account application. 

In its latest filing, Custodia raises further questions about the independence of the Federal Reserve System. It notes that last month's decisions from the Fed and the Kansas City Fed coincided with an announcement from the White House on the risks associated with crypto assets. Custodia said the sequence of events appeared to be a "coordinated effort" to block it and other new banks from the regulated banking space.

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"The denial of Custodia's master account application was done at the direction of the [Federal Reserve] Board," the filing reads. "The language in the Kansas City Fed's denial echoed the Board's denial of Custodia's membership application and the White House's statement on crypto-assets."

The filing also notes that the rejections came just two weeks before the Fed was due to provide the court with an administrative record of its actions related to the Custodia master account application. Custodia suggests this was done to "defer any visibility into, or judicial review of, the Board's outsized role" in the process.

The filing also accuses the Fed of applying a double standard to its crypto regulation, pointing to last year's announcement by Bank of New York Mellon that it had opened a crypto-custody business. The fact that the $430 billion-asset bank was able to enter this line of business by simply notifying its lead supervisor point of contact at the Fed raises questions about exactly how concerned theFed is about the systemic risk of digital assets, Custodia argues.

"If such services are truly harmful to the United States banking systems, the participation of an institution as important and entrenched as BNY Mellon — a Global Systematically [sic] Important Bank — would presumably pose a larger threat than a Wyoming-based de novo banking institution like Custodia," the filing reads.

The Fed did not respond to a request for an interview on Friday afternoon. The Kansas City Fed declined to comment on the filing.

Caitlin Long, founder and CEO of Custodia, also published a blog on Friday accusing the Fed of participating in a "misguided crackdown" on crypto assets in the wake of high-profile failures such as the collapse of the exchange FTX.

In the post, Long said she handed over evidence to law enforcement of potential crimes committed by a high-profile figure in the crypto space and warned bank regulators about the threat of runs on crypto-affiliated banks. By rejecting Custodia, she argued, the Fed is missing an opportunity to have a regulated channel in the space. 

"Custodia tried to become federally regulated — the very result bipartisan policymakers claim to want," she wrote. "Yet Custodia has been denied and now disparaged for daring to come through the front door."