. . .

(I) Directly or indirectly acquiring or controlling, whether as principal, on behalf of 1 or more entities (including entities, other than a depository institution or subsidiary of a depository institution, that the bank holding company controls) or otherwise, shares, assets, or ownership interests (including debt or equity securities, partnership interests, trust certificates or other instruments representing ownership) of a company or other entity, whether or not constituting control of such company or entity, engaged in any activity not authorized pursuant to this section if-

(i) the shares, assets, or ownership interests are not acquired or held by a depository institution or a subsidiary of a depository institution;

(ii) such shares, assets, or ownership interests are acquired and held by an insurance company that is predominantly engaged in underwriting life, accident and health, or property and casualty insurance (other than credit-related insurance) or providing and issuing annuities;

(iii) such shares, assets, or ownership interests represent an investment made in the ordinary course of business of such insurance company in accordance with relevant State law governing such investments; and

(iv) during the period such shares, assets, or ownership interests are held, the bank holding company does not routinely manage or operate such company except as may be necessary or required to obtain a reasonable return on investment.

12 U.S.C. §§ 1843(k)(4)(B), (I).

These provisions were added to the BHCA by the Gramm-Leach-Bliley Act, Pub. L. 106-102, § 103(a), 113 Stat. 1338, 1342-45 (1999). The purpose of Gramm-Leach-Bliley was to repeal the Glass-Steagall Act's prohibition on banks affiliating with securities firms and other financial institutions, and thus to “enhance competition in the financial services industry.”

The Federal Reserve promulgated regulations to implement Gramm-Leach-Bliley. See Regulation Y, Bank Holding Companies & Change in Bank Control, 66 Fed. Reg. 400 (Jan. 3, 2001) (codified at 12 C.F.R. § 225). Referring to the activities listed above, the Federal Reserve indicated that they may be conducted “at any location in the United States or at any location outside of the United States subject to the laws of the jurisdiction in which the activity is conducted.” This regulation was in place for nine years before Dodd-Frank incorporated the BHCA definition of “financial in nature.” When the Federal Reserve later promulgated regulations specifically for Dodd-Frank, those regulations parroted the statutory definitions above. See 78 Fed. Reg. 20,756, 20,778, 20,781 (Apr. 5, 2013).

To be “predominantly engaged” in financial activities, a company must satisfy either of two tests under Dodd-Frank Section 102. See 12 U.S.C. § 5311(a)(6). Under the first test, 85 percent or more of a company's “consolidated annual gross revenues” must be “derived” from activities that are “financial in nature.” Under the second test, 85 percent or more of the “consolidated assets of the company” must be “related to activities that are financial in nature.” If either test is satisfied, a company is “predominantly engaged” in financial activities and eligible for designation by FSOC.

Eligible companies may be designated by FSOC for enhanced supervision under either of two determination standards: (1) when “material financial distress” at a company “could pose a threat to the financial stability of the United States”; or (2) when the very “nature, scope, size, scale, concentration, interconnectedness, or mix of the [company's] activities” could pose the same threat. 12 U.S.C. § 5323(a)(1). The FSOC relied only on the First Determination Standard when designating MetLife.

Congress identified 10 factors that the FSOC must consider when assessing whether material financial distress at a company could pose a threat to the national economy:

(A) the extent of the leverage of the company;

(B) the extent and nature of the off-balance-sheet exposures of the company;

(C) the extent and nature of the transactions and relationships of the company with other significant nonbank financial companies and significant bank holding companies;

(D) the importance of the company as a source of credit for households, businesses, and state and local governments and as a source of liquidity for the United States financial system;

(E) the importance of the company as a source of credit for lowincome, minority, or underserved communities, and the impact that the failure of such company would have on the availability of credit in such communities;

(F) the extent to which assets are managed rather than owned by the company, and the extent to which ownership of assets under management is diffuse;

(G) the nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company;

(H) the degree to which the company is already regulated by one or more primary financial regulatory agencies;

(I) the amount and nature of the financial assets of the company;

(J) the amount and types of the liabilities of the company, including the degree of reliance on short-term funding.

12 U.S.C. § 5323(a)(2). In addition, the FSOC “shall consider . . . any other risk-related factors that [it] deems appropriate.” 12 U.S.C.§ 5323(a)(2)(K).

Upon designation, a company becomes subject to “enhanced supervision” and “prudential standards” that are not yet set by the Federal Reserve. See generally 12 U.S.C. § 5365. The prudential standards include, at a minimum:

(i) risk-based capital requirements and leverage limits, [subject to limited exception];

(ii) liquidity requirements;

(iii) overall risk management requirements;

(iv) resolution plan and credit exposure report requirements; and

(v) concentration limits.

12 U.S.C.§ 5365(b)(1)(A). The Federal Reserve may also establish “additional standards,” such as:

(i) a contingent capital requirement;

(ii) enhanced public disclosures; [and]

(iii) short-term debt limits.

12 U.S.C.§ 5365(b)(1)(B). Further, the Federal Reserve is authorized to establish “such other prudential standards as [it] determines are appropriate.” 12 U.S.C.§ 5365(b)(1)(B)(iv).

No specific prudential standards had been established by the Federal Reserve for MetLife when it was designated by the FSOC.

The FSOC promulgated through formal rulemaking both a Final Rule and an Appendix to that Rule, entitled “[FSOC] Guidance for Nonbank Financial Company Determinations” (the “Guidance”). The FSOC issued an advanced notice of proposed rulemaking, 75 Fed. Reg. 61,653 (Oct. 6, 2010) (“ANPR”), and two further notices of proposed rulemaking, 76 Fed. Reg. 4,555 (Jan. 26, 2011) (“1st NPR”) and 76 Fed. Reg. 64,264 (Oct. 18, 2011) (“2d NPR”). The Final Rule was published on April 11, 2012. See 77 Fed. Reg. 21,637 (FR), codified at 12 C.F.R. § 1310. Along with its second notice of proposed rulemaking, the FSOC had also proposed the Guidance. Public comments were received on the Guidance, see FR at 21,640-47, which was somewhat modified in the Final Rule. See FR at 21,656-62, codified at 12 C.F.R. § 1310 App. A.

In its first notice of proposed rulemaking, the FSOC reorganized the 10 statutory factors into six “categories” of consideration:

(1) Interconnectedness;

(2) Substitutability;

(3) Size;

(4) Leverage;

(5) Liquidity Risk and Maturity Mismatch; and

(6) Existing Regulatory Scrutiny.

1st NPR at 4,560. According to the FSOC, the first three categories “seek to assess the potential for spillovers from the firm's distress to the broader financial system or real economy.” The second three categories “seek to assess how vulnerable a company is to financial distress.” The FSOC reasoned that companies “that are highly leveraged, that have a high degree of liquidity risk or maturity mismatch, and that are under little or no regulatory scrutiny are more vulnerable to financial distress.”

This characterization of the second three factors remained in the Final Rule. See FR at 21,641 (“The remaining three categories . . . seek to assess the vulnerability of a nonbank financial company to financial distress.”).

In its Guidance, the FSOC explained how it interpreted the term “could pose a threat to the financial stability of the United States”:

The Council will consider a “threat to the financial stability of the United States” to exist if there would be an impairment of financial intermediation or of financial market functioning that would be sufficiently severe to inflict significant damage on the broader economy.

2d NPR at 64,277. This definition was unchanged in the Final Rule, FR at 21,657, codified at 12 C.F.R. § 1310 App. A.II.a.

The FSOC further elaborated that “significant damage on the broader economy” might be inflicted through any of three “transmission channels”:

(1) Exposure,

(2) Asset Liquidation, or

(3) Critical Function or Service.

In designating MetLife, the FSOC relied on the Exposure and Asset Liquidation channels. The Guidance defined the Exposure channel:

A nonbank financial company's creditors, counterparties, investors, or other market participants have exposure to the nonbank financial company that is significant enough to materially impair those creditors, counterparties, investors, or other market participants and thereby pose a threat to U.S. financial stability.

12 C.F.R. § 1310 App. A.II.a. The Guidance added that the FSOC “expects to consider metrics including total consolidated assets, credit default swaps outstanding, derivative liabilities, total debt outstanding, and leverage ratio” in its analysis of Exposure. 

The Guidance also defined Asset Liquidation and described how financial distress might destabilize the United States through that channel:

A nonbank financial company holds assets that, if liquidated quickly, would cause a fall in asset prices and thereby significantly disrupt trading or funding in key markets or cause significant losses or funding problems for other firms with similar holdings. This channel would likely be most relevant for a nonbank financial company whose funding and liquid asset profile makes it likely that it would be forced to liquidate assets quickly when it comes under financial pressure. For example, this could be the case if a large nonbank financial company relies heavily on short-term funding. In its initial analysis of nonbank financial companies with respect to this channel, [FSOC] expects to consider metrics including total consolidated assets and short-term debt ratio.                         

The Guidance unveiled a phased analytical process which FSOC “expect[ed] generally” to follow. During Stage 1, a “set of uniform quantitative metrics” would be applied “to a broad group of nonbank financial companies” for the purpose of identifying “a group of nonbank financial companies that are most likely to satisfy one of the Determination Standards.” The Guidance stated that this preliminary analysis would be based solely on “existing public and regulatory sources.” In Stage 1, the FSOC intended to “apply thresholds that relate to the framework categories of size, interconnectedness, leverage, and liquidity risk and maturity mismatch.” The Guidance indicated that “[t]hese thresholds are intended to measure both the susceptibility of a nonbank financial company to financial distress and the potential for that nonbank financial company's financial distress to spread throughout the financial system.”

A further evaluation would be conducted at Stage 2, during which the selected group of nonbank financial companies would be “analyzed and prioritized.” Stage 2 was to be “based on a wide range of quantitative and qualitative information available to [the FSOC] primarily through public and regulatory sources.” The FSOC would consult with “primary financial regulatory agencies or home country supervisors,” including those for “each significant subsidiary,” and would rely on information from the Office of Financial Research and the FSOC's member agencies.

A company was notified that it was under scrutiny when it was selected for a Stage 3 “in-depth evaluation.” At that point, the company was invited to submit information and request a hearing.

MetLife's Designation

On July 16, 2013, the FSOC notified MetLife that it was being considered for designation, i.e., that it had reached Stage 3. Between September 2013 and September 2014, the FSOC met with MetLife's representatives 12 times, and MetLife submitted more than 21,000 pages of materials for evaluation.

On September 4, 2014, the FSOC voted to make a proposed determination regarding MetLife. A hearing was held on November 3, 2014, before and after which MetLife was allowed to submit additional materials on its behalf.

On December 18, 2014, the FSOC voted 9-1 to designate MetLife under Dodd-Frank Section 113. On that same day, MetLife was given the FSOC's Explanation of the Basis of Final Determination (“Final Determination” or “FD”). The FSOC determined that MetLife was eligible for designation under Dodd-Frank Section 102(a)(6), 12 U.S.C. § 5311(a)(6).

The FSOC based its designation on the First Determination Standard, i.e., the FSOC concluded that “material financial distress” at MetLife “could pose a threat to the financial stability of the United States.” The FSOC did not expressly rely on MetLife's nature, scope, size, scale, concentration, interconnectedness, or the mix of its activities to forecast such a threat.

The FSOC analyzed instead whether material financial distress could spread through the Exposure or Asset Liquidation channels.

The Final Determination reached four primary conclusions. First, exposed counterparties could suffer significant losses if MetLife experienced material financial distress. Second, the same financial distress might prompt MetLife to liquidate assets quickly and thereby disrupt capital markets. Third, existing regulatory scrutiny would not be able to stop either threat from being realized. Fourth, MetLife's complexity would hamper its resolution and thus “prolong uncertainty, requiring complex coordination among numerous regulators, receivers, or courts that would have to disentangle a vast web of intercompany agreements.”

MetLife challenged the designation in the U.S. District Court for the District of Columbia.

The District Court's Decision

The district court rescinded the FSOC's designation of MetLife.

In its decision, the district court concluded as an initial matter that MetLife was eligible for designation, rejecting MetLife's contention that its foreign activities could not qualify as “financial” under Section 4(k) of the BHCA.

It then explained that it was rescinding the Final Determination on two grounds. First, it said, the FSOC “made critical departures from two of the standards it adopted in its Guidance, never explaining such departures or even recognizing them as such.” In particular, the district court found that, during the designation process, two of the FSOC's definitions “were ignored or, at least, abandoned.” The district court found that the FSOC had reversed itself, without explaining why, on whether MetLife's vulnerability to financial distress would be considered and on what it means to threaten the financial stability of the United States.

According to the district court, the FSOC “never explained why it abandoned the Guidance and refused to evaluate MetLife's vulnerability to material financial distress.” The Final Determination, therefore, was arbitrary and capricious and had to be rescinded on that basis alone, the district court declared.

Additionally, the district court found, the FSOC had “purposefully omitted any consideration of the cost of designation to MetLife,” which it found to be “unreasonable.” The district court found that the FSOC had “assumed the upside benefits of designation (even without specific standards from the Federal Reserve) but not the downside costs of its decision.”

In the district court's view, the FSOC's actions were “arbitrary and capricious,” and the district court rescinded the Final Designation and entered judgment in favor of MetLife.

The case is MetLife, Inc. v. Financial Stability Oversight Council, No. 15-0045 (RMC) (D. D.C. March 30, 2016).

The Government's Response

The government has said that it will appeal the district court's decision. In a statement, Treasury Secretary Jacob J. Lew said:

I strongly disagree with the court's ruling. This decision leaves one of the largest and most highly interconnected financial companies in the world subject to even less oversight than before the financial crisis.

After a thorough review, FSOC determined that material financial distress at the company could threaten U.S. financial stability – the threshold for heightened supervision under Wall Street Reform. The heads of every U.S. financial regulatory agency concurred in this judgment. In overturning the conclusions of experienced financial regulators, the court imposed new requirements that Congress never enacted, and contradicted key policy lessons from the financial crisis. In particular, we should bear in mind three key points.

First, the financial crisis demonstrated that even the strongest firms can collapse quickly and with little warning. It is FSOC's duty to address the risks associated with very low probability events, just as the failure of AIG or Lehman Brothers would have been considered highly unlikely before the financial crisis. If the Council only responds to risks after they are likely to threaten financial stability, we will pave the way for the next crisis.

Second, the financial crisis showed that direct and predictable counterparty losses are often not the means by which the failure of a financial company could destabilize markets and threaten the U.S. economy. Instead, market disruptions or contagion can arise from the aggregate effects of direct and indirect exposures to a large, highly interconnected financial institution.

Third, Congress chose not to require FSOC to conduct a formal cost-benefit analysis of designations for good reasons. Such a requirement would impair the Council's ability to address the risks of a future financial crisis that could severely damage the financial system and the U.S. economy. As we have learned, the far-reaching damage of a financial crisis is difficult to predict and can cause massive economic pain to families and firms across the United States.

Wall Street Reform was enacted in response to serious problems identified during the financial crisis, and to protect taxpayers from having to bear the enormous burdens of another crisis. Regulators previously did not have the tools to understand and respond to the risks posed by the distress of companies such as MetLife. In using these tools, FSOC has taken a deliberative and data-driven approach, relying on a careful analysis of available information, including intensive engagement with each company and its regulators to evaluate how the firm's distress could affect the financial system.

Some opponents of financial reform have hailed the court's decision as a win for our financial system. This is wrong and dangerously ignores the lessons of the financial crisis. FSOC's authority to designate nonbank financial companies is a critical tool to address potential threats to financial stability, and it has made our financial system safer and more resilient. We intend to continue defending vigorously the process and the integrity of FSOC's work, and I am confident that we will prevail.

MetLife's Statement

MetLife's chairman, president, and chief executive officer, Steven A. Kandarian, said in a statement that the ruling, “validates MetLife's decision to seek judicial review of our SIFI designation. From the beginning, MetLife has said that its business model does not pose a threat to the financial stability of the United States. This decision is a win for MetLife's customers, employees and shareholders.”