Could Dodd-Frank be unconstitutional?

February 15, 2013

A growing number of states are making the case that President Obama's Wall Street reform is unconstitutional. Eight states have just signed onto a lawsuit claiming that broad swaths of Dodd-Frank are illegal, joining three states and three private groups.

Legal experts say the case against Dodd-Frank is premature, and much of it is unlikely to hold up in court. But some believe that at least one part of the lawsuit points to legitimate constitutional problems that could be raised in court further down the road.

(JONATHAN ERNST/REUTERS )
(Jonathan Ernst -- Reuters )

The lawsuit was originally filed in June by a small Texas bank, State National Bank of Big Spring, and two conservative advocacy groups, the Competitive Enterprise Institute and the 60 Plus Association. The suit claims that major parts of Dodd-Frank violate the Constitution's separation of powers, including the new Consumer Finance Protection Bureau; a new council with the discretion to determine which non-bank financial firms are "too big to fail" and subject to additional regulation; and the government's new "Orderly Liquidation Authority" to force failing financial companies to dissolve "with little or no advance warning," according to the lawsuit.

Alabama, Georgia, Kansas, Montana, Nebraska, Ohio, Texas, and West Virginia have now joined Oklahoma, South Carolina, and Michigan in the lawsuit. Their attorneys general argue that the OLA, in particular, violates states' property rights because of the investments that states have made in financial firms that could be dissolved by the federal government.

"Under this law, unelected federal bureaucrats can unilaterally liquidate financial institutions in which the state invests taxpayer dollars. The State of Texas could be denied basic due process rights and taxpayers’ dollars could recklessly be put at risk," Texas AG Greg Abbott said in a statement.

Legal experts believe that much of the lawsuit is unlikely to have much standing in court. "Sure, Dodd-Frank is a mess; sure, the statute is unwieldy and inefficient; sure, the statute takes power away from citizens and states and transfers it to the federal government. However, it’s not unconstitutional or otherwise illegal for Congress to pass a bad law. And this is what Dodd-Frank is," says Jonathan Macey, a professor at Yale Law School.

Kenneth Klee, a law professor at UCLA, points out that the states' major argument in the lawsuit — that Dodd-Frank violates states' rights under the new bankruptcy provision — doesn't hold up. "States don't have rights on bankruptcy law — Congress could prescribe anything at any time. There's no vested property interest there," he explains.

However, some legal experts also believe there are parts of the lawsuit that raise serious constitutional problems, particularly regarding Dodd-Frank's new authority to put failing financial firms into government receivership — under extreme time pressure.

"Basically, a receiver is to be appointed by a federal district judge in the DC District court in a confidential proceeding that can last no longer than 24 hours. This deprives a variety of stakeholders of any notice or opportunity to be heard, raising due process problems," says Columbia University law professor Thomas Merrill. "It also forces the district judge to make a decision under a deadline that it too short to give adequate consideration to the issues, which raises separation of powers questions regarded interference with the judicial process."

Klee similarly believes that the law's liquidation authority and other "Too Big to Fail" provisions are constitutionally problematic. "The separation of powers and federalism concerns are quite serious," he says, pointing to the same concern about the right to due process when a failing financial firm is forced into government receivership under such a restrained time frame.

However, even those who believe there are major constitutional problems with Dodd-Frank believe the lawsuit is premature and say it's unlikely to move through the courts until the government actually uses its new authority to force a failing financial institution to dissolve. "I have difficulty seeing how anyone has standing to raise them before there is any prospect that Title II is about to be applied," concludes Merrill.

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