As the joint conference committee of the House and Senate begins the reconciliation process to produce a final version of financial reform legislation, Congress needs to pay attention to one of the most critical issues involved in responding to future fiscal crises: how to properly constrain the treasury secretary’s determination that, because of the national interest, a financial company should be terminated. Both the House and Senate bills grant the secretary the authority to initiate a Federal Deposit Insurance Corp. (FDIC)-supervised liquidation of a financial company whose failure poses systemic risk (so-called “resolution authority”) and would subject that determination to judicial review. Although including a judicial review procedure is imperative, its mere provision is insufficient. A properly designed procedure must be sufficiently robust so as to ensure the legitimacy of government intervention. Improperly exercised resolution authority would bring the demise of a financial company that otherwise could have sought renewed life through, for example, bankruptcy reorganization. Worse yet, an expansive assertion of executive power would go unchecked.
The Senate bill does not propose an effective judicial review system and thus does not sufficiently limit executive power. The House version provides a better alternative, although it too could be improved. If the committee follows through on Sen. Christopher Dodd (D-Conn.)’s call “to take the best parts of both bills and marry them together,” the resulting judicial review provision will adequately restrain resolution authority, yet still allow for an effective governmental response. Three questions are at the core of this issue: What aspects of the secretary’s determination are subject to review? Who reviews the determination? When does the review occur?
Under the Senate bill, the scope of judicial review is inexplicably limited to a simple factual question: whether the secretary properly determined that the firm to be liquidated “is in default or in danger of default.” The default determination, however, is only one of six criteria that must be satisfied if the secretary is to exercise resolution authority. The other criteria relate to matters more closely connected to the concepts of systemic risk and the need for government intervention — for example, findings by the secretary that the company’s failure would have “serious adverse effects” on the nation’s financial stability and that “no viable private sector alternative is available to prevent the default of the financial company.” The House bill, on the other hand, subjects to judicial scrutiny all the criteria that would trigger the secretary’s decision to dismantle a financial company.
It is troubling that the Senate bill insulates five of the six criteria from judicial review, especially since the sole criterion for which review would exist — default — will substantially turn on questions of fact, such as whether the company is insolvent or illiquid. By limiting judicial review to a fact-checking function, the bill fails to incorporate a sufficient restraint on the executive branch. Perhaps the decision to pull the plug on a financial company is the quintessential political question on which judges should not opine. But if that’s true, Congress should make that policy choice transparent by simply not providing for judicial review. On the other hand, if judicial review is appropriate, then it ought to be true substantive review, akin to that set forth in the House bill, and not merely the veneer of judicial examination.
The Senate bill also makes a poor choice of decision-maker in its proposal to establish an Orderly Liquidation Authority Panel (OLAP) within the U.S. Bankruptcy Court for the District of Delaware. OLAP would consist of three judges from the Delaware bankruptcy court. The quality of the review of resolution authority will not improve, however, with a judge who has experience with the intricacies of the Bankruptcy Code. A generalist judge can effectively assess the fact-based metrics that both bills use to define default, such as the capitalization, solvency or liquidity of the company. Likewise, a generalist judge is well-situated to review the other findings underlying a systemic-risk determination.
Moreover, selection of all OLAP judges from the Delaware bankruptcy court unnecessarily constrains the choice of judges. This is of special concern with the District of Delaware, which only has one permanently authorized bankruptcy judgeship. The possibility of the temporary judgeships expiring could prevent OLAP from being constituted (a problem that would be solved with enactment of the proposed Bankruptcy Judgeship Act of 2010, currently pending in the Senate).
Finally, the OLAP forum choice is troublesome. It does not make sense to vest so much power in the Delaware bankruptcy court. After all, the outcome of judicial review is likely to have substantial nationwide implications. Indeed, were it otherwise, the proposed resolution authority would be rather unnecessary.
The House bill removes these concerns by channeling initial judicial review to the federal district courts — either to the district court for the judicial district in which the financial company’s home office is located or to the U.S. District Court for the District of Columbia. The proposal not only selects a generalist judge to review the secretary’s systemic-risk determination, it has the added benefit of geographic variation in the choice of decision-maker.
As for the timing of judicial review, the House bill misses the mark in allowing for it only after the FDIC has been appointed as receiver of the financial company that will be liquidated. If it turns out that the secretary made the wrong call, judicial review would provide little solace to a company in dire economic straits seeking to rehabilitate itself. A receiver appointment could frighten off potential investors and lenders, thus guaranteeing the company’s demise. An attempt to unscramble the egg through removal of the receiver would be meaningless in the scheme of things. The Senate bill, on the other hand, hits the right note by requiring the secretary to petition the judiciary for approval authorizing the appointment of a receiver. And, by requiring judicial review of the secretary’s determination on a highly expedited basis, the Senate bill is mindful of preserving the secretary’s need to act nimbly under exigent circumstances.
The questions we have identified go beyond economic or legal consequence. They implicate how Congress chooses to rely on the judiciary to constrain and legitimate executive power. Financial reform legislation ought to provide for a relevant and robust judicial role.
Jonathan R. Nash is professor of law at Emory University School of Law; Rafael Pardo is associate professor of law at Seattle University School of Law and will join the faculty at the University of Washington School of Law in June. They have co-authored an empirical study of the bankruptcy appellate system.