The Financial Stability Oversight Council, or “FSOC” (pronounced “F-Sock”), is among the most important and most underappreciated regulatory bodies in American government. It was conceived in the Dodd-Frank Act as the ultimate regulatory caulking device, filling in the perceived “gaps” in the pre-crisis regulatory edifice that hindsight revealed. The FSOC’s most important gap-filling responsibility is to exercise its “designation” authority, which is set forth in Section 113 of the Dodd-Frank Act. That statute requires the FSOC to identify any otherwise unsupervised financial institution whose financial distress or general mix of activities “could pose a threat to the financial stability of the United States.”
The scope of the FSOC’s statutory charge is breathtakingly wide. Congress provides no further guidance about what “financial stability” refers to, much less what it might mean to “threat[en]” it. Even more strikingly, the grammar is conditional: the predicate “could pose a threat” is lexically cabined only by the metes and bounds of the FSOC’s imagination.
Of course, wide-ranging statutory grants of administrative discretion are ubiquitous in modern government, particularly in so-called “risk regulatory” regimes like the Section 113 designation program. The term “risk regulation” is a contestable moniker, but as used here it describes administrative programs that involve state actors in some meaningful capacity, the primary purpose of which is to regulate present or future conduct in an effort to affect future world states. In this way, risk regulation brings the future into the present by acting upon it. Modern societies make decisions about risks in what German sociologist Ulrich Beck called the “present-future,” and we experience the effects of those decisions in the “future-future.” Beck’s implication is that the future is always and inevitably with us when we make decisions in modern life and government. Crucially, risk regulatory decisions inherently require the exercise of significant discretion on the part of regulators.
To be sure, the problem of administrative discretion is hardly particular to the FSOC, or even risk regulation. It is the central problem of administrative law. Administrative discretion is both necessary and problematic; it is as inevitable as it is deviant. This tension has motivated some FSOC critics to assign the agency epithets ranging from the worn and predictable (e.g., the “Soviet Politburo” or “Star Chamber”) to the more inventive—the “Firing Squad On Capitalism” was former SEC Commissioner Michael Piwowar’s inventive (and, we hope, tongue-in-cheek) contribution.
To respond to these sentiments, the FSOC did what any similarly situated agency would do. As its first regulatory action, it promulgated a notice-and-comment rulemaking that would structure and cabin its discretion in the course of its Section 113 deliberations. That rulemaking culminated in the FSOC’s publication of an “Analytic Framework” that remains in place today. The article I wrote for the Yale Journal on Regulation submits the Analytic Framework to a comprehensive administrative law analysis.
The analysis reveals several problems with the Analytic Framework, some of which are specific to the Section 113 designation program itself, and others of which are generalizable to other financial risk regulatory programs. I want to focus in this blog post on the latter set of problems, which naturally attract a broader audience. (That said, I can’t help but point out briefly one Section 113-specific flaw: namely, that despite all the clamor of the FSOC’s opponents against agency discretion and regulatory overreach, one of the Analytic Framework’s most serious legal infirmities is the inclusion of a filtering device, requested by industry during the rulemaking, that results in significant under-regulation compared to what the statute plainly seems to require).
I want to focus here on two problems that the FSOC’s designation program shares with most financial supervisory programs of the risk-regulatory variety. The article discusses these problems in the context of the designation program, but the problems threaten to destabilize other core pillars of the supervisory system, including capital adequacy, stress testing, and resolution planning (or “living wills”). Importantly, unlike other risk regulators—in, e.g., the environmental, public health, and workplace safety arenas—financial supervisors have yet to develop the institutional and doctrinal forms needed to reconcile the open-ended discretion with the rule of administrative law. In this sense, to study the administrative law of FSOC designations is to undertake a case study for financial supervisory praxis more generally.
The first such problem, which I label the “Causality Conundrum,” refers to a particular type of justificatory demand that administrative law increasingly makes of risk-regulatory agencies. We can think of it as posing the following question: why did the regulator assume that the future would look like that? The problem for the Section 113 program is that the Analytic Framework eschews any formal requirement that the FSOC specify, much less quantify, the predictive judgments embedded in its assessments of how and whether companies might cause disruptions to the financial system. The result is that the Framework makes FSOC designations susceptible to accusations of arbitrariness because it does not require probabilistic specification of the causal channels through which a systemic problem might hypothetically occur. The current—and, in the author’s view, curious—state of administrative law doctrine is such that the FSOC would better insulate its designations from judicial reversal if it required itself to manufacture quantitatively expressed causal scripts, however incomplete and fanciful, linking designated firms to future disaster scenarios.
The third problem, which I label the “Regulatory Costs Dilemma,” addresses the judiciary’s practice, illustrated recently in the 2015 Supreme Court case Michigan v. EPA, of invalidating regulatory actions as “arbitrary and capricious” where the regulator’s decision process does not formally account for the costs incurred by regulated entities in connection with the regulatory action. In each of its designations to date, the FSOC has opted not to take these costs into account—a practice that, if continued, makes the designations vulnerable to this de-legitimating critique.
The Causality Conundrum and the Regulatory Costs Dilemma have already complicated regulatory practice for the FSOC both in the courts (as with MetLife’s successful APA challenge to its designation) and the court of public opinion. However, in taking note of the FSOC’s experience, we also fire a warning shot in the direction of other financial supervisory agencies engaged in the regulation of risk.
Robert F. Weber is an Associate Professor at Georgia State University College of Law. This post is based on an article in the latest print edition of the Yale Journal on Regulation.