Ninth Circuit Considers Master Account Arguments
Also: another Jarkesy case, FSOC concerns about credit union resolution, and more
Last Wednesday the United States Court of Appeals for the Ninth Circuit heard oral argument in PayServices Bank v. Federal Reserve Bank of San Francisco. The case is about whether PayServices, a proposed Idaho bank that “focuses almost exclusively on facilitating trade commodities for the small to medium enterprises from and to the United States,” is entitled by law to a master account or whether, as the district court in Idaho held, Reserve Banks instead have discretion to deny master account requests from otherwise eligible institutions.
This post looks at a few of the most interesting exchanges during the course of a pretty lively argument before Judges Tymkovich,1 M. Smith, and Bumatay. Full audio and video of the argument is available online.2
Are Federal Reserve Banks Government Agencies in This Context?
Much of the discussion in the master account controversies of the past few years has focused on the question of whether Reserve Banks are required by law to grant master accounts to any institution that is eligible for one.
But even assuming for the sake of argument that a Reserve Bank is required to grant master accounts to all who are eligible, there is another hurdle a bank might need to overcome: if a Reserve Bank refuses to follow the law, can a federal court force the Reserve Bank to comply?
There is a difference of opinion on this question between the federal courts, but at least a few courts have suggested the answer to this question might actually be no. The situation is basically this:
PayServices sued the FRBSF under the Administrative Procedure Act and the Mandamus Act.3
The APA provides for review of “agency action,” while the Mandamus Act allows federal district courts to compel action by “an officer or employee of the United States or any agency thereof.”
In front of the district court the FRBSF argued that it was not an agency in this context. Therefore, FRBSF contended that even if the court found that the FRBSF does not have discretion when acting on master account requests, PayServices’s claims must still be dismissed.
After ruling for FRBSF on its main argument that the statutory scheme gives Reserve Banks discretion, the district court for good measure went on to also rule in favor of FRBSF on its alternative argument.
The court wrote that although “Federal Reserve Banks are integral components of the Federal Reserve System, such that it can legitimately be argued that they are federal instrumentalities” they at the same time are “more accurately described as private corporations, owned by their member commercial banks” and thus “are not agencies of the federal government in this setting.”4
Given this alternative holding from the district court, Judge Smith opened his questioning for PayServices’s attorney, Jade. A. Craig, by asking for PayServices’s “best argument that the Reserve Bank is a federal agency.”
Mr. Craig responded that the FRBSF in the master account context “exercises independent authority and decision making power based on the authority to receive applications for master accounts and approve those applications without direct review or oversight from the Federal Reserve System Board of Governors.”
When it was Jonathan Youngwood’s turn to argue on behalf of the FRBSF, Judge Smith’s first question likewise focused on the agency issue, as did a follow-up question that led to this exchange:
Judge Smith: What role does the fact that the Reserve Bank is privately owned, at least a majority, play in this analysis?
Mr. Youngwood: I think it would be a stunning thing, frankly, to find that a privately owned institution where six of the nine directors are elected by the stockholders, that somehow that entity is an agency, particularly for the purposes here.
Neither Judge Tymkovich nor Judge Bumatay seemed entirely comfortable with the implications of this response, and a short while later there was this exchange:
Judge Tymkovich: So we have a non federal agency, a private corporation, essentially, that has a discretionary gate keeping role for access to the national banking system, and there's no judicial review of that circumstance? Whatever discretion is exercised, there's no review of decisions that are made in denying master account status?
Mr. Youngwood: For a variety of reasons, in this case, there is no opportunity for judicial review that is correct.
Judge Tymkovich: What if the bank's decision denies a master account because they don't like the ethnicity of the bank shareholders or the applicant shareholders? You know where I'm going. There’s an impermissible factor, and it's, you know, we just have to trust them?
Mr. Youngwood: No, I don't think that is the answer, Your Honor. I think there's Congressional oversight. And I think one of the reasons –
Judge Tymkovich: But no judicial review?
Mr. Youngwood: Not unless Congress finds a way to give you judicial review. But I think the Congressional oversight shouldn't be overlooked. And in fact, if you look at the 2022 amendments –
Judge Bumatay: You really are asserting that the bank can discriminate based off of race and that there's no judicial review of that?
Mr. Youngwood: Your Honor, there may be other avenues if somebody discriminates over race, but it's not going to be an APA type review. I mean, there's plenty of obviously, issues, potential race or gender or other discrimination in the world that involve entities that are not agencies, and there may be ways to get judicial review, in contractual relations and other —
Judge Smith: Title VII, Title IX, whatever.
Mr. Youngwood: Yes, there are other laws Congress passes.
An Argument for Discretion
Early in the questioning of Mr. Craig, Judge Tymkovich offered what may be the best policy argument for Reserve Bank discretion in making master account decisions:
Judge Smith: So now that gets back to what I understood you to say before that basically, PayServices has a per se right, that the Reserve Bank has no discretion whatsoever in denying the master account. Is that correct?
Mr. Craig: Yes, Your Honor. And I'd like to explain that, because I do understand the hesitancy around limiting the Reserve Bank’s authority, particularly as an arm of the government.
Judge Tymkovich: Especially if we have a risky business model coming in. You know, we've had as recently as 2008 a financial crisis in this country. Doesn't the Reserve Bank have some role in the system to make sure that these novel institutions, new business models that inject risk into the system are adequately policed? And for some of them, it may be a rejection of a master account, because that can allow risk into the state and national banking system.
A little later on, Judge Tymkovich also questioned whether it really can be the case that Reserve Banks are required to grant accounts to all who are eligible “no matter how outlandish the business model of the applicant is.” Similarly in a question to Mr. Youngwood toward the end of the argument, Judge Tymkovich reiterated his “concern … about the ability of the Federal Reserve System to control risk and avoid injecting undue risk into the system.”
Mr. Craig responded to these and similar points by arguing that though Reserve Banks must grant master accounts to those who are eligible, the Reserve Banks may address concerns like the ones Judge Tymkovich raised by using their statutory authority to impose reasonable restrictions on the use of the account.
The Dual Banking System
Mr. Craig in his argument sought to orient PayServices’s claims in the context of the “Supreme Court's continued affirmance time and again of the nation's dual banking system.” In this Mr. Craig may have found at least one receptive member of the panel in Judge Bumatay, as this exchange illustrates:
Judge Bumatay: So the reason why the Fed bank said that they rejected your bank here is it has unproven risk management, an unproven risk management framework. Does Idaho analyze the risk management framework when deciding to grant approval to the bank?
Mr. Craig: Yes, it does, Your Honor. So the PayServices bank incorporators submitted a large amount of information, including a Bank Secrecy Act/anti-money laundering policy and its own compliance manuals.
Judge Bumatay: So in essence, here, the Fed bank overruled Idaho's decision on whether or not there's an appropriate risk management framework?
Mr. Craig: Exactly. It did.
Judge Bumatay: What gives them authority to overrule state banking decisions?
Mr. Craig: They don't have the authority under the Federal Reserve Act to overrule the decisions of state chartered banks and the guidelines framework that they've developed in August, that they developed in August of 2020, essentially redlines state chartered banks out of access to master accounts. It sets up a three tiered system that appears nowhere in the Federal Reserve Act.
Judge Bumatay: So under the authority they claim now they could just say, we're not going to accept any banks from Idaho, right?
Mr. Craig: That's correct.
Mr. Youngwood during his argument sought to frame the issue differently, arguing that this case should not be thought of as the Reserve Bank telling states what they can or cannot do, but rather should be viewed as the Reserve Bank carefully considering its own obligations to safeguard the banking system.
Mr. Youngwood: Your Honor, there are state systems and there are federal systems. And I am not saying that the state of Idaho, the state of Wyoming, the state of New York, any state, can't charter a bank. What we're saying is, if they want access to a master account, which is an important thing, then there are guidelines. We are not stopping them from getting a correspondent bank relationship. So they could take that charter that Idaho gives them, and if another bank, and there are something like 9000 with master accounts, wants to enter into a contractual relationship with them, a commercial arrangement, they can get access. So this is not my client saying we are telling Idaho, or any state what to do. It's saying, once you've done something, we get to decide under the guidelines whether you have direct access.
The Toomey Amendment
In December 2022, then-Senator Toomey secured the inclusion in the National Defense Authorization Act of an amendment to the Federal Reserve Act. The amendment, now in the law at 12 USC 248c, requires the Federal Reserve Board to maintain an online searchable master account database, including information on those entities that have applied for master accounts and whether the request was “approved, rejected, pending, or withdrawn.”
In recent master account litigation, the Federal Reserve Board and the Reserve Banks have argued that Section 248c’s reference to “rejected” master account requests reflects a Congressional confirmation of the authority of Reserve Banks to deny master account requests from eligible institutions. Senator Toomey has since said that this “wildly mischaracterize[s]” what his amendment was meant to do, but the Federal Reserve’s argument has proved convincing to at least a few courts.
It appeared to hold some weight with the Ninth Circuit panel as well, based on questions from Judge Smith and Judge Bumatay. Judge Smith at one point asked Mr. Craig, “Doesn't 248c show that the Reserve Bank can reject master account requests?” while Judge Bumatay later in the argument told Mr. Youngwood that he thought Section 248c provided the FRBSF with its “strongest textual argument.”
Mr. Craig’s argument in response to Judge Smith’s question was effectively that the Reserve Bank can reject a master account request if the institution is ineligible in the first place or if the institution has violated state or federal law. PayServices believes it is these denials that Congress meant to capture in the database required by Section 248c. Otherwise, Reserve Banks must grant accounts to all who are eligible.
When asked later on to respond to that argument, Mr. Youngwood argued that PayServices’s construction of Section 248c would read into the statute a limit on reasons for rejection that is not actually there.
Judge Bacharach’s Concurrence
In 2017 the Tenth Circuit considered a lawsuit brought by Fourth Corner Credit Union against the Federal Reserve Bank of Kansas City. The Tenth Circuit’s decision in that case took the form of a very short per curiam opinion, accompanied by a concurring opinion from each judge on the panel.
One of the concurring Fourth Corner opinions, from Judge Bacharach, takes the view that under the relevant statutes all eligible depository institutions are entitled by law to master accounts. Judge Bacharach’s concurring opinion, though not controlling in the Tenth Circuit or elsewhere, has understandably been seized upon by PayServices and other banks seeking master accounts.
This set up a kind of funny situation during last week’s argument, given that Judge Tymkovich, normally a Tenth Circuit judge, was also sitting on this Ninth Circuit panel. Judge Tymkovich observed to Mr. Youngwood, good naturedly:
Judge Tymkovich: I am from the 10th Circuit, and I'm fond of Judge Bacharach’s work, and I guess I’d appreciate your kind of taking him on and explaining why, well, he got it wrong in his concurrence.
For its part, the Tenth Circuit next month will have the opportunity to again consider the master account issue, as it is scheduled to hear Custodia Bank’s lawsuit against the Federal Reserve Bank of Kansas City. The panel for the Tenth Circuit argument has not yet been determined.
October 2024 Cease and Desist Order
In the course of his argument, Mr. Youngwood drew the court’s attention to an October 2024 cease and desist order issued by Idaho against PayServices Bank. Mr. Youngwood did not get into these details, but the order presents the following facts:
On August 3, 2022, PayServices received conditional approval from the Idaho Department of Finance to receive an Idaho bank charter and engage in the business of banking.
A month later, the Department granted PayServices a waiver to allow the company to use the word bank in its name while PayServices worked to satisfy Idaho’s conditions for full approval.5
Idaho’s grant of conditional approval to PayServices was initially scheduled to expire on August 3, 2023.
PayServices did not meet Idaho’s requirements to secure full approval by that date, but Idaho allowed PayServices to resubmit an updated application and, after receiving that updated application, extended the approval deadline until October 15, 2024.
When PayServices still could not meet Idaho’s conditions for grant of a bank charter by the extended October 15, 2024 deadline, the Department on October 16 terminated the conditional approval.
Also on October 16, “the Department rescinded its September 12, 2022 waiver allowing PayServices to use the word ‘bank’ in its name.”
That same day, “an executive of PayServices corresponded with the Department and stated that PayServices Bank rejected the Department’s recission and refused to stop using ‘PayServices Bank’ and ‘bank’.”
It was not completely clear from the oral argument what effect, if any, the FRBSF believes this order (which PayServices is appealing) should have on the Ninth Circuit’s decision in this case.6
“I do agree with you that ducks are birds, sir.”
Finally, to conclude on a lighter note with what might be an obvious point: this post has included a number of quotes from Judges Tymkovich, Smith and Bumatay, but you should be careful about reading too much into any one of those quotes in trying to predict the outcome of this case. Sometimes federal judges just say stuff, as this exchange from the argument demonstrates.
Mr. Youngwood: The statute [12 USC 248a(c)(2)] reads “All Federal Reserve bank services covered by the fee schedule shall be available to nonmember depository institutions…” It’s significant that the all is in one place and not the other.
Judge Bumatay: Why?
Mr. Youngwood: Because the “all” means all services. The nonmember depository institutions without the word all doesn’t mean that every nonmember depository institution has to have it or that everyone who is applicable, which is I think how they are trying to make this read.
Judge Bumatay: I don’t know if that’s true linguistically. I mean, you say, “All ducks are birds.” If you just said “Ducks are birds” … they mean the same thing.
Mr. Youngwood: I guess I respectfully disagree with you on that.
Judge Bumatay: Oh really? Hmm.
Mr. Youngwood: I don’t –
Judge Bumatay: You agree that ducks are birds?
Mr. Youngwood: I do agree with you that ducks are birds, sir.
Judge Bumatay: And that all ducks are birds?
Mr. Youngwood: I –
Judge Bumatay: Those two sentences mean the same thing.
Mr. Youngwood: I am not – not my specialty, I suspect that’s correct. But I do think perhaps –
Judge Bumatay: They mean the same thing, you have to concede that.
Mr. Youngwood: Respectfully your honor, I don’t think so. There could be, if you have 20 species of things that people call ducks, and whatever way scientists – not my field – categorize them, 10 of them would be in the category of birds and 10 of them would be in some other category, it would still be true to say ducks are birds.
Judge Smith: The birds of a feather flock together?
Quick Hits
Moving away from master accounts, this post wraps up with a few notes on other recent developments I thought were interesting, including a Kansas bank attempting to use Jarkesy to stop an FDIC enforcement action, some worries from FSOC about large credit unions, and a relatively harsh (but perhaps not very important) inspector general report about the CFPB.
Kansas Bank Sues to Stop AML-Related Enforcement Action
The Supreme Court’s Jarkesy decision earlier this year holds that when the SEC seeks civil money penalties against someone who is alleged to have committed securities fraud the Constitution requires that the SEC do so in federal court, rather than bringing the case before its own in-house judges.
The federal banking regulators have their own in-house administrative process for adjudicating enforcement actions brought against banks and individual bankers. Is that process constitutionally suspect too? We don’t yet have a definitive answer. A few months ago there was a challenge brought in the District of Columbia, but that attempt to wield Jarkesy against the FDIC was ultimately rejected on procedural grounds, and the individual in question later settled with the agency. Elsewhere, two challenges remain pending before the Fifth Circuit.
The cases mentioned above all feature attempts by individual bankers or institution-affiliated parties to push back against agency proceedings against them. But just before Thanksgiving a case was filed in federal court in Kansas that, to the best of my knowledge, represents the first post-Jarkesy challenge brought by a bank itself.
The case involves a small Kansas institution called CBW Bank which, as Jason Mikula at Fintech Business Weekly wrote earlier this year, was a pioneer of the banking-as-a-service business model.
According to CBW’s motion for a preliminary injunction, the FDIC during an exam in 2019 identified BSA and AML-related issues in the bank’s correspondent banking and money services businesses. This part of CBW’s story was already publicly known, or at least could have been guessed, given that the bank in August 2020 was subject to a public FDIC enforcement action signaling these sorts of issues.
What is new and in the public domain for the first time, however, is CBW’s claim that the FDIC did not stop there. According to the motion, the FDIC has for some time also been pursuing a civil money penalty against CBW arising out of the same events at issue in the 2019 exam.
[T]he FDIC continues to pursue a penalty assessment against the Bank in connection with a supervisory visit in 2019. […]
On November 18, 2022, CBW received a 15-day notice regarding the FDIC’s consideration of potential civil monetary penalties. The parties engaged in good faith settlement negotiations after CBW responded to the notice. CBW’s counsel was informed on November 18, 2024, however, that the FDIC plans on November 19, 2024 to issue a notice assessing civil monetary penalties under Section 8(i)(2)(H) of the Bank Secrecy Act. At that time, CBW’s counsel was informed by the FDIC that unless CBW agreed to the settlement the FDIC proposed the FDIC would initiate litigation. CBW did not accept the proposed settlement, and on November 19, 2024, the FDIC served CBW with a notice of hearing.
CBW’s motion does not specify the exact money penalty the FDIC is seeking, but the bank asserts that the amount is “unreasonable and unprecedented for a bank of this size, complexity, and supervisory history.”
Prior to Jarkesy, this sort of enforcement action, if not settled by consent, would have proceeded in-house before an administrative law judge. Now, CBW argues that the FDIC cannot proceed in-house and asks the court to enjoin the agency from doing so.
So far we only have CBW’s side of the story.7 The bank and the FDIC recently agreed on a briefing schedule for the case, and a response from the FDIC is expected by December 20.
FSOC Annual Report Warns About Credit Union Resolution
Yesterday the Financial Stability Oversight Council released its 2024 annual report. The headline risks flagged by FSOC are consistent what you would probably expect from following the news and the public statements of FSOC’s principals.
Similarly, most of the Council’s specific recommendations with respect to banks and other depository institutions (pp. 58-59) are all in line with actions some or all of the federal banking regulators had already proposed to take. FSOC thinks it would be helpful, for example, if the federal banking agencies would “complete the Basel III reforms,” and in addition “finalize a proposal to improve the resilience and resolvability of certain large banking organizations by requiring them to maintain outstanding long-term debt…” Regulators are also “encourage[d] . .. jointly to implement section 956 of the Dodd-Frank Act regarding incentive compensation practices.”
The substance of all of these recommendations was included in more or less the same form in last year’s report.
There was one depository institution-related recommendation in the 2024 report, however, that jumped out to me as new (emphasis added throughout).
The Council encourages the NCUA to continue efforts to mitigate the risk of a significant credit union failure. If the NCUA is unprepared for significant failures, including of the largest credit unions or highly interconnected credit unions, or third-party service providers, then the SIF may be unable to withstand the resulting losses. The Council encourages the NCUA to explore the drivers of and preventative measures around large institution failures and strengthen supervisory policies and procedures that reduce the likelihood of such a failure occurring. The Council also advises the NCUA to closely examine procedures for failed institution resolution, identify deficiencies and implement strategies to mitigate loss and risk to the SIF.
Just to avoid giving the wrong impression, I think the absolute wrong way to read this is as signaling that the FSOC is concerned about the imminent failure of any significant credit union. But given how large (and how quickly) some credit unions have grown, you can see why FSOC thinks it makes sense for NCUA to start exploring these sorts of questions.
Inspector General Report Criticizes CFPB’s Process for Transitioning Banks to CFPB Supervision
With respect to federal consumer financial law, the Dodd-Frank Act gives the CFPB supervisory authority over insured banks and credit unions with $10 billion or more in total assets. Firms below that size are supervised with respect to federal consumer financial law by their prudential regulator.
An inspector general report released on Thursday offered several criticisms of how the CFPB approaches this transition in supervision.
From 2017 through 2023, 90 depository institutions crossed the $10 billion threshold and transitioned to the CFPB's oversight.
We found that the CFPB did not timely or effectively complete most of the transitions we reviewed, in some cases taking over a year to complete key onboarding steps. It also took varying approaches to coordinating with the prudential regulators. We attribute these issues to the CFPB not having established a program for onboarding depository institutions that transition to its oversight.
The CFPB in its response to the report (pp. 16-17) says it has fixed or will fix the underlying concerns, and to be honest it is not clear to me exactly how material in the first place the issues the OIG found actually were to the CFPB’s ability to supervise transitioning firms. One can also raise the standard questions with these sorts of OIG reports about sample sizes, representativeness of interviewees, etc.
But even with all those caveats, some of the OIG’s findings are pretty rough for the CFPB in depicting what was apparently a pretty disorganized approach.
For example, one issue you’d want to think about when transitioning consumer-related supervision from one regulator to another is how to deal with problems identified by the old regulator but not yet corrected by the bank at the time it moved over to CFPB supervision. At least as portrayed by the OIG, the CFPB’s regional supervisory offices responsible for managing transitions weren’t sure or had conflicting views about the answer to this question (emphasis added).
[I]nterviewees from the regional offices did not have a shared understanding of the CFPB’s role in following up on preexisting MRAs and enforcement actions for transitioning institutions. Multiple interviewees stated that the prudential regulator is responsible for following up on preexisting MRAs and enforcement actions, one interviewee indicated that the CFPB is responsible, and yet another was unsure.
During the onboarding process, regional office conversations with the prudential regulators varied, as did the documentation received from those regulators. For example, four of the eight depository institutions we tested transitioned with preexisting MRAs, but the regional office for only one of the four institutions indicated discussing this topic with the prudential regulator. In addition, we identified an instance in which a regional office did not request any prior examination reports or documentation from the prudential regulator.
In a different section of the report, the OIG criticizes the CFPB - based on a sample of eight transitioning banks - for the agency’s failure to “complete most of those transitions timely or effectively.” The CFPB also, according to the OIG, struggled to document when exactly it had completed certain onboarding steps, timely or otherwise.
[Office of Supervisory Examinations] had difficulty locating, and in some cases could not locate, documentation showing the completion dates for key onboarding steps. We noted that for three of the eight depository institutions, OSE could not provide completion dates for some of the key onboarding steps. Additionally, OSE could not provide documentation to support certain dates for key onboarding steps for six of the eight depository institutions.
In response to these and other findings the CFPB’s Director of the Division of Supervision states that “since the beginning of 2024 the CFPB has worked on developing its onboarding program and consulted with the OIG while drafting the policy.”
Judge Tymkovich serves on the Tenth Circuit but is sitting on this panel by designation.
The quotes included in this post come from my manual transcription of the relevant portions of the argument. Any errors in the transcription are the fault of this blog, and not the fault of the judges or lawyers.
PayServices also brought a due process claim under the Fifth Amendment.
The district court did not distinguish between the APA and the Mandamus Act for purposes of its analysis.
In general, the banking laws of Idaho prohibit a company from doing business in Idaho while using “bank” or similar words in its name unless the company is actually a bank or has been granted a waiver to allow it to use those words. This is the relevant Idaho code section if you want the nuances.
In fact, when Mr. Youngwood brought this up Judge Bumatay quickly asked if it actually supported PayServices’s argument more than it did the FRBSF’s, in the sense that it demonstrates that state regulators (and not only the Reserve Banks) are “doing this type of review that you're doing, that they're looking for risk management issues.”
And even then, one suspects it might only be part of the story. The timeline as laid out in CBW’s motion - 2019 exam, 2020 consent order (not actually mentioned in the motion), 2022 15-day notice, 2024 notice of charges - doesn’t totally make sense on its own.