Judge rules against Custodia in Fed master account case

Bloomberg News

Regional Federal Reserve banks have the right to block banks from accessing their financial services, a federal judge in Wyoming ruled last week. 

U.S. District Court Judge Scott Skavdahl ruled against Custodia Bank in its lawsuit against the Federal Reserve Bank of Kansas City and the Federal Reserve Board. The Cheyenne-based digital asset bank had sued the institutions for denying its application for a so-called master account last year.

The decision caps a nearly two-year-long legal battle between Custodia and the Fed. The bank initially filed suit in June 2022, hoping to compel a decision on its long-delayed application for a master account, which would have given it access to the Fed's payments networks and other services. It changed tack last February after its application was formally rejected. It has yet to decide whether or not it will appeal the district court decision.

"Challenging the Fed's strong-arm tactics has always been an uphill battle, but Custodia Bank remains committed to our vision of creating a safe, tech-enabled bank," said Custodia spokesman Nathan Miller in a written statement. "We are reviewing the court's decision and all of our options, including appeal." 

A spokesperson for the Federal Reserve Board declined to comment on the decision.

Skavdahl's decision, which was issued Friday, struck down Custodia's primary argument that, as a legally chartered bank, it was entitled to a master account under the Federal Reserve Act. 

"The court concludes the statutory language is clear and unambiguous, and the Federal Reserve Act does not support Custodia's position for several reasons," Skavdahl wrote.

One of the reasons cited in the decision was an amendment to the National Defense Authorization Act for Fiscal Year 2023, which required the Fed to begin publishing a list of master account holders and to disclose which applications were "approved, rejected, pending, or withdrawn." Skavdahl said the inclusion of "rejected" solidified Congress' stance that reserve banks could deny applicants. 

This interpretation of the amendment drew swift rebuke from some in Washington, including the provision's author, former Sen. Pat Toomey, who called the judge's interpretation "illogical," during an interview with American Banker on Monday.

"Knowing that they did, in fact, approve some, deny others, sometimes reverse themselves as they did in the case of an applicant from Colorado, I simply wanted them to be required to disclose this," Toomey said. "For someone to come along and say the disclosure means you approve of and condone the practice is so illogical. It is a willful refusal to read the English language as it's written."

Toomey, who left Congress at the end of 2022 after choosing not to seek reelection, also noted that Skavdahl's view on this subject has changed materially since last June. After the Fed cited the provision in a motion to dismiss the case, the judge wrote that the amendment "cannot be read as Congress' imprimatur on Federal Reserve Banks holding carte blanche to grant or deny master account applications." 

Regulation and compliance

Puerto Rican bank seeks $150 million in damages in Fed lawsuit

March 4, 2024 6:15 PM

Last week, the judge wrote that the amendment "confirms that Federal Reserve banks may 'reject' applications from depository institutions." He provided no explanation for the shift in interpretation.

"It's nothing less than baffling," Toomey said. "The judge does a complete and absolute 180-degree reversal on his own interpretation of this language with no explanation. How does that happen?"

Last year, former Toomey staffers told American Banker they were misled by Fed staffers when crafting the NDAA amendment. Before being added to the package, the provision had to get approval from the heads of both parties on the Senate Banking Committee and the House Financial Services Committee. During that process, the Fed was consulted about the legislation to ensure its language did not have unintended consequences.

The former Toomey staffers, who were granted anonymity because they still work on Capitol Hill and interact with the Fed, said staffers from the central bank insisted on certain language that was later cited by Fed lawyers in a motion to dismiss the Custodia case.

"They certainly know what our intent was. They know what we were trying to accomplish. They were consulted extensively and had very strong feelings about what the language should say, and then they turn around and go to court and argue that it means something wildly different from what they know, it actually was intended to mean," Toomey said. "You can draw your own conclusions, but that's the fact pattern."

The ruling is the latest in a series of blows against recently chartered banks, also known as de novos, with nontraditional business models in their efforts to secure or maintain master accounts. 

In February, the New York Fed rejected the master account application of The Narrow Bank. The Connecticut-based firm had sought to offer customers accounts with interest rates mirroring the federal funds rate minus a modest haircut. It originally filed in 2017 and had already gone through its own legal battle with the Fed. 

The Custodia decision has already established a precedent for other master account disputes. In a decision issued Saturday, Judge Raymond Patricco of the U.S. District Court for the District of Idaho, dismissed PayServices Bank's case against the San Francisco Fed, citing the Custodia ruling in his conclusion that reserve banks have the discretion to deny master account applicants.

For both the Custodia and PayServices decisions, the presiding judges drew from another recent court case involving a master account dispute — the Guaynabo, Puerto Rico-based Banco San Juan Internacional's suit against the New York Fed. Last October, a federal judge ruled that the reserve bank was within its rights to close the institution's master account based on anti-money-laundering concerns. 

Lawyers for Banco San Juan Internacional declined to comment on the recent rulings. Lawyers listed as representing PayServices could not immediately be reached for comment.