At the end of March, components of the US Federal Reserve System ("FRS" or the "Fed") prevailed in two lawsuits brought by depository institutions seeking master accounts.1 These decisions have significant implications for the Fed's authority and discretion to grant or deny master account requests, as well as for the legal rights and remedies of applicants. In this Legal Update, we summarize the facts and holdings of these cases and provide some analysis and recommendations for depository institutions that are interested in obtaining or maintaining a master account with the Fed.
BACKGROUND
The FRS is the central banking system of the United States, responsible for conducting monetary policy, supervising and regulating certain types of financial institutions, and providing payment services to the public and the government.2 The FRS consists of the Board of Governors (the "Board"), 12 regional Federal Reserve Banks ("FRBs"), and the Federal Open Market Committee.3
Pursuant to the Federal Reserve Act, the regional FRBs provide financial services to depository institutions, including banks, credit unions, and savings and loans, much like those that institutions provide for their customers.4 These services include collecting checks, electronically transferring funds, and distributing and receiving cash and coin.5 To settle transactions with an FRB, an institution may open a master account with the FRB or rely on another institution's master account on a correspondent basis.6 In all cases, an FRB must approve an institution's request to have access to services, including with respect to opening/using a master account.7
CUSTODIA BANK CASE
Custodia Bank is a Wyoming-chartered special-purpose depository institution ("SPDI"), a type of depository institution established under Wyoming law intended to facilitate crypto-asset custody and related services. Custodia Bank applied for a master account with the FRB of Kansas City ("FRBKC") in October 2020. The application was denied in January 2023. Custodia Bank contended that FRBKC was statutorily required to grant the master account request and that the Board had interfered with FRBKC's decision-making process to force FRBKC to improperly deny the master account.8 Custodia Bank sued the Board and FRBKC to compel them to issue it a master account.
Custodia Bank brought one cause of action against the Board for violation of the Administrative Procedures Act ("APA"), alleging that the Board's actions were arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law. Custodia Bank asked the court to compel the Board to issue it a master account. The Board opposed Custodia Bank's motion for judgment as a matter of law on this claim, arguing that it had not taken any final agency action that was reviewable under the APA. Custodia Bank brought a separate cause of action against FRBKC asking the court to compel FRBKC to issue it a master account, arguing that FRBKC was statutorily required to grant Custodia a master account, and FRBKC made a cross-motion for summary judgment on the basis that it maintained the discretion to deny Custodia Bank's application.
In Custodia Bank, Inc. v. Federal Reserve Board of Governors and Federal Reserve Bank of Kansas City, the US District Court for the District of Wyoming dismissed the plaintiff's complaint against the Board and granted summary judgment in favor of FRBKC, finding that FRBKC had discretion to deny the master account request and that the plaintiff had no viable legal claims against either defendant.
The court found that Board had not taken a final agency action with respect to Custodia Bank's application to FRBKC. It based this finding on an assessment of an email from the Board to FRBKC expressing no concerns with the FRBKC's proposed denial of Custodia Bank's application for a master account, which Custodia Bank had identified as a final agency action compelling FRBKC to deny its application. The court concluded that the email itself was not an agency action under the APA and that, further, the email was only the Board's implementation of a broader agency plan that had been previously implemented in, among other things, the Board's adoption of its Guidelines for Evaluating Account and Services Requests (the "Master Account Guidelines").
The court also found that FRBKC had discretion to deny the master account request, relying on an analysis of various statutory provisions imposing rights and obligations on the Board and the various FRBs with respect to master accounts.9 Custodia Bank had asserted that 12 U.S.C. § 248a—enacted in 1980 as part of the Depository Institutions Deregulation and Monetary Control Act ("DIDMCA") and requiring the FRB to establish a uniform fee schedule for services to be provided by FRBs and stating that "[a]ll Federal Reserve bank services covered by the fee schedule shall be available to nonmember depository institutions"—eliminated the FRBs discretion to deny access to covered services (which are provided through a master account) to nonmember institutions such as Custodia Bank. The court, disagreeing with a non-controlling concurring opinion in Fourth Corner Credit Union v. FRB Kansas City, concluded that the statutory language of § 248a did not affect the existing discretion that FRBs had to deny master accounts prior to the enactment of the DIDMCA.10 The court concluded that legislative action subsequent to the Fourth Corner decision—requiring the Board to create and maintain a public database of master accounts and applications, including applications "approved, rejected, pending or withdrawn"11 —confirmed the FRBs' discretion to "reject" applications. Further, the court noted that policy considerations support discretion by the FRBs, as state banking regulators are not tasked with protecting the interests of the national financial system or national monetary policy, which are implicated by access to a master account.
Therefore, the court dismissed Custodia Bank's complaint with respect to the Board and granted summary judgment in favor of FRBKC on March 29, 2024.
PAYSERVICES BANK CASE
PayServices Bank is a private Idaho depository institution that focuses on facilitating the trading of physical commodities. It applied for a master account with the FRB of San Francisco ("FRBSF") on August 10, 2022. FRBSF denied the application on May 31, 2023, citing the Master Account Guidelines and the risks associated with PayServices' business model.12 PayServices disagreed with the denial, asserting a legal entitlement to a master account under federal law and sued FRBSF to compel it to open a master account for PayServices.
PayServices brought three claims against FRBSF: (1) under the APA, alleging that FRBSF's decision was arbitrary and capricious; (2) under the Mandamus Act, seeking a court order to compel FRBSF to grant the master account; and (3) under the Due Process Clause of the Fifth Amendment, claiming that FRBSF deprived PayServices of a protected property interest without due process of law. The court noted that the success of each of these claims depended on the existence of a nondiscretionary duty to make a master account available to PayServices through which it can access FRB services.
In PayServices Bank v. Federal Reserve Bank of San Francisco, the US District Court for the District of Idaho dismissed the plaintiff's complaint for declaratory and injunctive relief, finding that the defendant had discretion to deny the master account request and that the plaintiff had no viable legal claims against the defendant.
The court granted FRBSF's motion to dismiss as well as related motions to strike and for leave to file a notice of supplemental authority. The court ruled that FRBSF had discretion to deny the master account request based on 12 U.S.C. § 342, which states that FRBs "may receive from any of its member banks ... deposits of current funds in lawful money, national-bank notes, Federal reserve notes, or checks, and drafts, payable upon presentation, or other items, and also, for collection, maturing notes and bills." The court interpreted the word "may" as conferring discretion on the FRBs and rejected PayServices' argument that the word "may" should be read as "shall" or "must."
The court also found that FRBSF is not an agency of the federal government, and therefore, PayServices' claims under the APA, Mandamus Act, and Due Process Clause could not stand. The court relied on the Ninth Circuit's decision in Lewis v. United States, which held that FRBs are not an instrumentality of the federal government for purposes of the Federal Tort Claims Act.
Finally, the court found that even if FRBSF was an agency of the federal government, it had not acted in a manner that was inconsistent with the statute or Master Account Guidelines. Further, it had not denied PayServices its right to procedural and substantive due process under the Constitution.
Therefore, the court dismissed PayServices' complaint with prejudice on March 30, 2024, and entered judgment in favor of FRBSF.
TAKEAWAYS
While not binding on other courts, the Custodia Bank and PayServices cases add support for the conclusion that FRBs retain discretion in their decisions whether to open or maintain a master account for eligible institutions. For eligible institutions, particularly those with non-traditional charter types or business models, these decisions confirm the importance of considering the Board's Master Account Guidelines when developing the institution's application to the relevant FRB for a master account. These decisions do not, however, further address the ongoing debate as to which institutions are eligible to be considered for a master account and only reinforce the potential for FRBs to exercise discretion through potentially opaque decisions on individual applications.
Footnotes
2. Fed. Reserve Bd. of Govs., The Fed Explained, at 1 (Aug. 2021).
3. Id. at 2.
4. See generally FRB Services, About Federal Reserve Bank Services (2024).
5. FRB services do not include transactions conducted as part of FRS's open market operations or administration of FRBs' discount window.
6. See FRB Services, Operating Circular 1, § 2.1 (Sept. 1, 2023).
7. E.g., Fourth Corner Credit Union v. FRB Kansas City, 861 F.3d 1052 (10th Cir. 2017); TNB USA Inc. v. FRB New York, 2020 WL 1445806 (S.D.N.Y. Mar. 25, 2020).
8. Custodia Bank also had applied to the Board to become a member of the FRS. This application also was denied, but Custodia Bank did not challenge that denial.
9. The court noted that even if the Board controlled FRBKC's decision to deny the application, which is a matter of fact, not law, the outcome would be the same.
10. Among other reasons, the court noted that Congress was highly unlikely to "hide elephants in mouseholes," by adopting "implicit terms in a statute directed at a different entity [i.e., the Board, not the FRBs]."
11. See 12 U.S.C. § 248c.
12. See our discussion of the Master Account Guidelines.
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