Four Takeaways from MetLife's SIFI Legal Challenge

WASHINGTON — In another direct swipe at the government's authority in the Dodd-Frank Act, MetLife's legal challenge of its designation as a "systemically important" firm threatens to undercut the future role of the Financial Stability Oversight Council.

The firm's lawsuit against the FSOC filed Tuesday aired a laundry list of grievances about the designation process, including that MetLife should not have even been under the council's purview. But the outcome of the case in the U.S. District Court for the District of Columbia — the first challenge to any FSOC determination — could be even more far-reaching, serving as a litmus test of the council's authority.

Here are some takeaways from MetLife's complaint:

The case will shape the future of the FSOC
Last month, MetLife became the fourth nonbank company labeled by the council as a "systemically important financial institution." Under the Dodd-Frank Act, which created the FSOC, any institution designated as a SIFI faces added regulatory oversight from the Federal Reserve Board.

But unlike the three previous firms — American International Group, General Electric Capital and Prudential Financial — MetLife is not giving up without a fight. The 79-page complaint it filed said the FSOC's finding that the company would hurt the market if it ran into financial problems "was arbitrary and capricious." Among various claims, the company said the council should not have even been considering MetLife for designation since its activity in foreign markets disqualifies it as a U.S.-based SIFI, and that the FSOC did not adequately assess MetLife's "vulnerability to material financial distress." The complaint also said the FSOC failed to consider "reasonable alternatives" to a company-based designation.

"Despite the repeated statements of key legislators and federal financial regulators that traditional insurance activities do not pose systemic risk to the economy, FSOC provided no reasoned explanation for failing to pursue an activities-based approach for insurance companies," the complaint said.

But legal observers say, regardless of the outcome, the case could have a significant effect on future rulings by the council.

Oliver Ireland, a partner at Morrison & Foerster and former Federal Reserve official, said that if the court sides with the FSOC, it would make any future nonbank designations far more difficult to challenge, while a MetLife victory could force the council to adjust its strategy significantly.

The case "could call into question the whole process. They could call into question aspects of the process that are common to one or more of the designees," Ireland said. "There are a lot of ways this can go."

Tom Vartanian, a partner at Dechert LLP, said how much of an impact the case has is up to the courts and the plaintiffs to decide, though generally courts tend to rule as narrowly as possible in order to avoid "legislating from the bench."

"This is a seminal case in terms of being the first challenge to an FSOC designation and having the court determine what FSOC can do and what it can't do," Vartanian said. "How far it goes depends on the way the parties litigate the case and broadly or narrowly the court decides it."

MetLife faces an uphill battle in convincing the court
The record of plaintiffs suing federal agencies over administrative decisions and winning is not great. The Supreme Court's 1989 decision in Chevron USA v. Natural Resources Defense Council gave regulators a lot of latitude. The case said decisions are presumed to be valid if they meet two legal standards: the statute upon which the rule is based is silent or ambiguous on the matter at hand, and the agency's interpretation of the statute is reasonable.

"The government always starts with the deference that the Supreme Court gives it in the Chevron case. So the standard of arbitrary and capricious is a challenging one to meet," Vartanian said.

But Vartanian added that FSOC is somewhat hampered in defending its SIFI decisions in court since there are no specific regulations on the books dealing with nonbanks designated by the council. He said that may make it difficult for the council to show that a designation made the financial system safer.

"When a court sees that an agency is speculating and making determinations that are not supportable in the record, it can lose that deference pretty quickly," he said.

The case will only embolden lawmakers critical of the FSOC

The 114th Congress has wasted little time introducing and voting on legislation meant to chip away at aspects of Dodd-Frank, including Sen. David Vitter's, R-La., recently proposed bill to limit FSOC's ability to designate nonbanks as SIFIs. MetLife's suit could fuel the political argument that the SIFI designation is harmful and poorly applied.

Some observers said, regardless of the outcome of the case, the case will only intensify the attention of members on Capitol Hill to the council's procedures.

"Congress will be sensitive to the concerns about due process and transparency," said one attorney, who declined to be identified due to a client relationship. "Issues about the designation process are going to be raised in the public forum and people will start raising questions about what has largely been a secretive process."

Karen Shaw Petrou, managing principal at Federal Financial Analytics, said the lawsuit may be a small player in the legislative drama, yet its role could become more significant

"This is going to be very emotional," Petrou said. "There is a view on the liberal wing of the Democratic Party that big banks remain 'too big to fail.' If there is a coalition on the Hill between the conservative Republicans and the liberal Democrats on the SIFI designation … then the political dynamic could be different."

On Tuesday, Rep. Ed Royce, R-Calif., a senior Republican on the House Financial Service Committee, said the suit illustrates structural deficiencies in the U.S. regulatory system that must be fixed.

"Congress owes it to the American insurance consumer to better understand the current state-of-play as it relates to insurance regulation," Royce said. "Robust oversight in the form of briefings and hearings should be a priority for the Financial Services Committee; Congress should ensure that changes in regulatory oversight do not negatively impact the insurance consumer or the competitiveness of American firms."

The case could spur FSOC to do more activities-based systemic designations
Some policymakers and industry insiders have been pushing the FSOC to focus its designations on certain activities, which would direct the heightened regulatory focus to industrywide activities, instead of on specific firms. The council has already signaled it may take that approach with the asset management industry.

MetLife's complaint, which claimed the council did not adequately consider an activities-based assessment, could prod FSOC more in that direction.

"MetLife had been suggesting for some time that a similar approach should be taken toward MetLife and insurers if FSOC thought there was risk, but for reasons that are not clearly explained FSOC declined that activities-based approach it decided to take toward asset managers," said Gene Scalia of Gibson, Dunn & Crutcher, one of the two firms advising the company, in a conference call with reporters. (The other firm is Sullivan & Cromwell.)

In a statement Tuesday, MetLife Chief Executive Steven Kandarian said FSOC's decision to apply the SIFI label to individual firms, rather than the industry in general, leaves competitors with an unfair advantage.

"Adding a new federal standard for just the largest life insurers and retaining a different standard for everyone else will drive up the cost of financial protection for consumers without making the financial system any safer," Kandarian said.

Petrou said a MetLife victory could potentially spur the council to act more holistically in trying to rein activities it views as systemically risky.

"That I think is … increasingly the consensus view, that activity and practice — not designation — is the better framework for systemic regulation," she said.