Basel endgame supporters need a litigation strategy of their own

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In July 2023, three federal banking agencies proposed a long-awaited Basel III endgame rule that would strengthen the U.S. financial system by increasing capital requirements for the country's 37 largest banks. The rule marks the culmination of the United States' implementation of an international framework for safeguarding the banking system in response to the 2008 financial crisis, and it begins to correct the regulatory weaknesses exposed in 2023 by three of the four largest bank failures in U.S. history. 

Unfortunately, megabanks and their allies have responded to the Basel III endgame proposal by threatening to sue the banking agencies if they adopt a final rule. Most notably, the Bank Policy Institute has retained conservative litigator Eugene Scalia to prepare a lawsuit seeking to overturn a final rule. Consistent with industry-led legal challenges to other Biden administration initiatives, the banks appear poised to allege that the Basel III endgame proposal is arbitrary and capricious under the Administrative Procedure Act, or APA, because it lacks a sufficient evidentiary basis and the agencies did not conduct a quantitative cost-benefit analysis. The banks also contend that a Basel III endgame final rule would violate the major questions doctrine and the non-delegation doctrine, among other purported legal deficiencies.

The banks' legal arguments against Basel III endgame are wholly without merit. Indeed, the federal banking agencies provided ample support for the Basel III endgame proposal in a detailed, 155-page preamble in the Federal Register. The proposal did not include a quantitative cost-benefit analysis because it did not have to: the APA does not require an agency to quantify costs and benefits, and Congress has not otherwise imposed a cost-benefit requirement on the federal banking agencies. The major questions doctrine and other conservative legal theories are inapplicable to Basel III endgame because Congress has clearly established the federal banking agencies' authority to prescribe bank capital standards.

The banks' legal claims are especially galling because the Basel III endgame proposal contains more evidentiary support than many of the Trump-era deregulatory rules adopted just a few years ago with the banking sector's full-throated support. For example, the Federal Reserve's 2019 "tailoring" rule that rolled back Dodd-Frank Act safeguards and hastened Silicon Valley Bank's collapse contained only a one-page "impact assessment." Likewise, the banking agencies justified their 2019 weakening of the Volcker Rule by invoking "supervisory experience" or "experience" almost 50 times — a practice they now insist violates the APA. If the Basel III endgame proposal is legally deficient, so too are the vast majority of deregulatory banking rules adopted under the Trump administration with far less analytical support.

Despite the baselessness of their claims, the banks' legal saber-rattling about Basel III endgame appears to have swayed the federal banking agencies. Notoriously concerned about legal risk, the federal banking agencies have signaled that they plan to significantly water down the Basel III endgame proposal — if they finalize it at all. Testifying before Congress this spring, Federal Reserve Chairman Jerome Powell and Vice Chair for Supervision Michael Barr both said that they expect to make "broad and material changes" to the proposal in response to public comments. Press reports suggest that agency officials are considering dialing back the proposed capital increases by 50% or more. In a nod to the banks' legal arguments, Powell has suggested that he "won't hesitate" to withdraw the Basel III endgame proposal and restart from scratch if "that turns out to be the appropriate thing." Thus, simply by raising the prospect of potential litigation, the banking sector appears to have convinced the banking agencies to significantly weaken the proposed rule — and potentially scrap it altogether.

The fact that supporters of strong bank capital rules have, to date, not countered with their own legal strategy has tilted the playing field in favor of the banking sector's efforts to defeat Basel III endgame. For Wall Street reform advocates, developing and implementing a legal strategy is of urgent importance to encourage the banking agencies to adopt a strong Basel III endgame final rule and provide the agencies with legal "cover" to combat the banking sector's baseless claims.

A public-interest litigation strategy supporting Basel III endgame could include a two-prong approach.

First, supporters of strong bank capital rules could prepare a lawsuit alleging that the federal banking agencies did not go far enough in finalizing the Basel III endgame rule. In other words, Wall Street reformers could argue that a weakened final rule arbitrarily and capriciously sets capital requirements for the largest banks too low. This claim would mirror the Sierra Club's and National Resource Defense Counsel's lawsuit against the Securities and Exchange Commission's climate disclosure rule, in which the plaintiffs alleged that the SEC unjustifiably limited the information public companies are required to report.

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Alternatively, or in addition, public-interest advocates could file a lawsuit seeking to overturn Trump administration deregulatory rules that contained meager analytical support. Targets of this lawsuit could include the "tailoring"/Dodd-Frank rollback rule, Volcker Rule rollback, resolution planning rollback, inter-affiliate margin rule (2020) and stress capital buffer/stress testing rollback rule (2020). None of these rules would survive under the purported legal standards the banking sector now seeks to apply to Basel III endgame.

The litigation strategies outlined above could accomplish at least three important objectives. 

First, to the extent that public-interest advocates publicize their litigation strategy in advance, their preparations may increase pressure on the banking agencies to adopt a strong final rule and thereby help offset the influence of the banking sector's baseless litigation strategy.

Second, as the Sierra Club's and NRDC's lawsuit against the SEC's climate disclosure rule demonstrated, a public-interest litigation strategy can be useful in getting industry-led lawsuits transferred out of industry-friendly judicial districts to more neutral territory. Assuming the banking sector sues to overturn the Basel III endgame final rule in an industry-friendly venue such as the 5th Circuit, a competing public-interest lawsuit in a different jurisdiction could force the judiciary to consolidate the suits and conduct a lottery for where the cases will be heard. 

Third, a challenge to the Trump-era rules would help hold a conservative court accountable. If such a court were to overturn Basel III endgame, it would have to throw out many Trump-era rules to maintain consistency.

To be sure, implementing a pro-endgame legal strategy will not be easy. Supporters of strong capital requirements may have to find a willing industry plaintiff — such as a smaller bank or credit union that competes with the megabanks — to establish legal standing. And with public interest groups currently stretched thin fighting other urgent legal battles, funding for a pro-endgame litigation strategy may be difficult to come by.

Despite these potential challenges, Wall Street reformers ought to marshal their resources to implement a pro-capital litigation strategy. The banking sector has targeted Basel III endgame with a well-funded, yet baseless legal campaign that appears to have influenced the banking agencies to water down their proposal. To salvage a strong Basel III endgame rule, supporters of strong capital requirements must step up with a litigation strategy of their own.