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Designation of MetLife overturned based on lack of cost-benefit analysis, failure to follow guidance

In a33-page decision, a federaldistrict court judge said that while MetLifeInc. made many arguments against its designation as a systemically importantfinancial institution, it was a federal body's "unacknowledged departure fromits guidance and express refusal to consider cost" that triggered her decisionto overturn the company's designation.

JudgeRosemary Collyer of theU.S. District Court for the District of Columbia ruled in a decision issued that the Financial StabilityOversight Council's designation of MetLife was arbitrary and capricious. The textof her decision was unsealed April 7 with no redactions.

Collyerwrote that the designation should be rescinded on two grounds, both administrativerather than on the argument of whether MetLife is indeed systemically risky.

First,the FSOC made critical departures from certain standards it adopted in its own guidance,without explanation or recognition, she ruled.

"Thatalone renders FSOC's determination process fatally flawed," Collyer wrote.

She explainedthat FSOC guidance calls for applying analytical categories to assess a companybefore it became distressed, and that another group assess the impact of such distresson financial stability. But, in the FSOC's "Final Determination" for MetLife,it posited that all six categories were meant "to assess the potential effectsof a company's material financial distress," not its vulnerabilities to suchdistress, she said.

The judgesaid that the FSOC's own guidance must refer both to the risk of destabilizing themarket and to the risk of distress in the first place.

Secondly,the FSOC purposefully omitted any consideration of the cost of MetLife's SIFI designation,she wrote. Collyer said that the FSOC assumed benefits without consideration ofcosts. She pointed out that the SIFI regulator, the U.S. Federal Reserve Board,at the time of MetLife's designation, had no capital standards in place and doesnot even now. These "enhanced prudential standards" for insurance SIFIsremain under development at the Fed, whose officials have repeatedly said they willtake the time to get the rules done right.

The FSOCargued that the only relevant cost is that of designation itself, not of these futureprudential standards, the judge noted.

Moreover,the FSOC never responded to MetLife's allegation or its argument that imposing billionsof dollars in cost could actually make MetLife more vulnerable to distress, shestated. Because the FSOC refused to consider cost as part of its calculus, it isimpossible to know whether its designation does significantly more harm than good,Collyer wrote, citing legal precedents.

The lackof any cost-benefit analysis is "arbitrary and capricious" under SupremeCourt precedent, the judge concluded.

The judgealso noted that the FSOC relied only on its first determination standard in designatingMetLife, not the second one. The first assumes "material financial distress"at a company that could pose a threat to the financial stability of the U.S. Thesecond determination standard deals with the mix of the company's various activities.FSOC independent insurance expert Roy Woodall has noted this omission in his dissentsof the MetLifeand Prudential Financial Inc.SIFI designations, favoring the approach that analyzes companies' potentially riskyactivities.

The FSOChas since shifted its analysis and is taking this activities-based approach in itsreview of the financial stability of U.S. asset managers, and policy-watchers notethat this activities-based model will be used internationally, at the G-20 FinancialStability Board, and possibly for shadow banking elsewhere.The FSBexpects to develop activities-based policy recommendations by spring 2016, accordingto a Dechert LLP report.

The courtdid affirm the FSOC's conclusion that MetLife is eligible for designation, rejectingone of MetLife's arguments.

"Weremain pleased with the U.S. District Court's decision," MetLife spokesmanChris Stern said.

A Treasury Department spokesperson formally announcedthe administration's decision to appeal the ruling late on April 7, hours afterTreasury Secretary Jack Lew issued a lengthy statement condemning the court decision.The Department of Justice will make the filing. Treasury did not offer a timetablefor the appeal.

"Thisdecision leaves one of the largest and most highly interconnected financial companiesin the world subject to even less oversight than before the financial crisis,"Lew said in his statement.

"Weintend to continue defending vigorously the process and the integrity of FSOC'swork, and I am confident that we will prevail," Lew said after the decisionhad been unsealed.

Lew arguedthat it is the FSOC's duty to address the risks associated with very low probabilityevents, citing the unanticipated failures of AmericanInternational Group Inc. and Lehman Brothers.

"Ifthe Council only responds to risks after they are likely to threaten financial stability,we will pave the way for the next crisis," Lew argued. The Treasury secretaryalso dismissed Collyer's cost-benefit analysis argument.

Thereexists no requirement from Congress that the FSOC conduct a cost-benefit analysisbecause it "would impair the Council's ability to address the risks of a futurefinancial crisis that could severely damage the financial system and the U.S. economy,"Lew stated.

Sen.Sherrod Brown, D-Ohio, ranking member of the Senate Committee on Banking, Housingand Urban Affairs, also raised the specter of the two iconic financial crisis companiesin a statement after the court unsealed the decision.

"Wecannot forget that massive non-bank institutions like AIG and Lehman Brothers werecentral to the last financial crisis, and Wall Street Reform was created to protecteveryday working people from once again paying the price when 'too-big-to-fail'institutions go unchecked," Brown stated.