Representative Garrett Questions the SIFI Designation Authority Granted to FSOC by Dodd-Frank

At the American Enterprise Institute Lunch Conference, Representative Scott Garrett (R-NJ) delivered the keynote speech, in which he discussed issues and concerns surrounding the Financial Stability Oversight Council (“FSOC”) and its authority to designate systemically important financial institutions (“SIFIs”). 

According to Representative Garrett, the rationale behind the creation of the FSOC sounded good in theory; however, the agency has many problems.  While the FSOC’s functional authority appears to be limited to designating nearly any nonbank financial company, activity or practice as a systemic threat to the U.S. financial system, and to recommending additional regulations, Representative Garrett stated, the consequences of this authority are significant and could have a negative impact on U.S. taxpayers and the economy. 

Representative Garrett posed a series of questions that framed his concerns regarding the FSOC’s operation, structure and actions:

  1. Should the FSOC be subject to the same transparency and accountability standards that we demand of other parts of the federal government? According to Representative Garrett, yes; currently, however, the agency is a “complete black box” that does not allow Members of Congress and other non-principal financial regulators to attend its meetings, is not subject to the Government in the Sunshine Act or the Federal Advisory Committee Act and does not release substantive transcripts of its meetings. 
  2. Should the FSOC be structured in a way that increases White House political control over financial regulation? Representative Garrett stated that the current voting members of the FSOC are the President’s appointees, and called the FSOC “a collection of ‘Yes Men’ for the desired outcome of the Department of Treasury, the White House, and the Federal Reserve.”
  3. Should the foreign Financial Stability Board (“FSB”), the U.S. Department of Treasury and the Board of Governors of the Federal Reserve System (“FRB”) designate U.S. companies as global SIFIs before our domestic process through the FSOC makes a determination? Representative Garrett explained that there are two places in which U.S. companies can be deemed systemically important: the FSOC and globally through the FSB.  While the FSB has no legal authority in the U.S., it has already designated a number of insurance companies as global systemically important insurers (“GSIIs”), even though the FSOC has not yet designated them.  Representative Garrett stated that this process is concerning and could have a significant impact on the process of the FSOC, which is currently reviewing the asset management industry.
  4. Should the regulator with the greatest expertise in a certain type of business, market or activity be the regulator of that business, market or activity? While this seems to be an easy question, Representative Garrett said, in a post-Dodd-Frank world, the answer is no longer clear. According to Representative Garrett, when a nonbank financial entity is designated as systemically important, the next step is not tailored regulation by that firm’s primary regulator.  Instead, Dodd-Frank allows designated firms to be subject to “enhanced” prudential regulation by the FRB.  Representative Garrett explained that the likely reason for this is “the apparent desire by the Fed and many others to de-risk the entire financial system and place it under a government safety net so wide and thick that no firm and no market ever fails again,” which has a negative impact on investment and growth.  
  5. Should the FSOC provide clear criteria to U.S. companies regarding the parameters used to determine how and why a designation is made and what steps a company can take to avoid designation? There are currently no clear rules or criteria to determine when a nonbank financial institution qualifies as a systemic risk to the financial system, Representative Garrett said, and there is no guidance to companies about what changes they can make to their business model to avoid being designated or reversing the designation. 

Representative Garrett added that only after these questions are addressed can the broader question be answered: whether the FSOC should have the ability to designate nonbanks as SIFIs in the first place.

Lofchie Comment:  Representative Garrett’s remarks underestimate the degree of arbitrary authority that the FSOC has been provided under Dodd-Frank.  Section 113 of Dodd-Frank authorizes the FSOC to deem a nonbank company to be an “SIFI” after consideration of the “nature, scope, size, scale, concentration and interconnectedness, or mix, of the activities of the nonbank company.  Further, in making its determination, the FSOC may consider “any other risk-related factors that [the FSOC] deems appropriate.” 

This is simply not “law” as it ordinarily functions. There are no objective standards in Dodd-Frank Section 113. In this regard, the FSOC’s power is completely different from that within every other similar provision of financial regulatory statutes in U.S. law – all of which are tied to objective measures, such as the type of activity that they conduct (e.g., banking, sales of securities and custody of financial assets). Although Section 113(h) purports to provide for judicial review of the FSOC’s determination, that provision is meaningless because the statute contains no objective standards that a court would be capable of reviewing. For example, there is no definition of the term “interconnectedness” (and in fact there are numerous economic measures of the term, and such measures can produce widely varying results over time). Lack of such a definition renders a court incapable of reviewing the FSOC’s judgment, since there is no standard against which that judgment can be measured.  (This speech by Federal Reserve Board Chair Yellen may provide the reader with some sense of the ambiguity of the definition of the term “interconnected”; according to Chair Yellen, there had been 624 studies of the concept in the several years preceding the speech.)

See:  Representative Garrett’s Speech
Related news:  House Subcommittee Chair Garrett Delivers Opening Remarks at Oversight of SEC Hearing, Focuses on FSOC and NMS (April 30, 2014).