Prudential Financial has a fight on its hands that could alter the course of government regulation of large nonbank companies.
The insurance giant entered uncharted legal territory earlier this week when it appealed the government’s decision to subject the firm to stricter supervision. There is no precedent for the challenge because Prudential is one of the first companies that regulators have designated as a systemically important financial institution, or SIFI, a label that would place it under the purview of the Federal Reserve.
While analysts agree that the challenge will be an uphill battle, they say the outcome could have significant bearing on how regulators proceed with future designations. Any decision will be closely watched by Wall Street, since the designation signals a major shift in the oversight of a broad swath of big companies that play in financial markets.
“This is something to watch with fascination,” said Donald Lamson, a banking attorney at Shearman & Sterling. “There may come a point in the proceedings where the parties agree on a designation where the terms would be less onerous than what Prudential fears.”
At issue is the unknown, but potentially damaging, ramifications of being designated by the Financial Stability Oversight Council, the new interagency panel of regulators tasked with policing systemic risk. The label comes with higher capital requirements and other restrictions that could eat into a firm’s profitability.
Treasury Secretary Jack Lew, who heads the council, has said enhanced oversight of firms whose failure could threaten the financial system is essential to protecting taxpayers and promoting economic stability. But Prudential argues that it is not the kind of behemoth company that could destabilize the financial markets.
“We will continue to work closely with regulators to demonstrate our belief that the company does not meet the requirements of the SIFI designation,” the company said in a statement Tuesday. “We have faith in the integrity of the FSOC’s review process, which provides for the ability to contest the proposed designation.”
Prudential has requested a closed-door hearing before the FSOC, which has until August to schedule the meeting. After that, the council will make a final decision within 60 days.
Treasury spokeswoman Suzanne Elio said the FSOC is not at liberty to discuss the designations until the process is completed, but she insisted that the council did not enter into its decision lightly.
“The council has developed a robust process for evaluating whether a nonbank financial company should be subject to Board of Governors supervision and to enhanced prudential standards,” Elio said in an e-mail.
Just a handful of companies have acknowledged that they were named by the FSOC. American International Group and GE Capital said the council notified them last month that they would be designated. Neither company has chosen to challenge the decision.
“We have strong capital and liquidity positions and we are already supervised by the Fed. Accordingly, we have decided not to appeal or ask for a hearing,” said Russell Wilkerson, a spokesman for GE Capital. “We have been and will be prepared to meet the requirements for SIFIs.”
Prudential indicated last month that it might appeal FSOC’s decision. The company has asked the council not to apply banking rules to life insurance firms that have different operating models. Insurers have argued that their businesses are not systemically risky and questioned whether they are paying for the sins of one company: AIG.
The insurance giant cast a pall over its industry when it received $182 billion in government aid to save it from near collapse in 2008. Although it was AIG’s derivatives operation that crippled the company, the insurer’s entire business came under intense public scrutiny to the chagrin of others in the industry.
Attorneys and others following the process doubt that Prudential has much of a chance of getting the FSOC to reverse course. This case marks the first real test of the council’s legal powers and it’s unlikely to roll over easily, analysts say.
It has also taken the council nearly three years since the passage of Dodd-Frank, the reform law that created the FSOC, to determine which nonbank firms should be subject to additional oversight. The three-step process of examination was so lengthy and detailed that it may be difficult for Prudential to make its case at this point, said Isaac Boltansky, a financial analyst at Compass Point.
If the FSOC rejects Prudential’s challenge, the insurer could file a separate lawsuit to block the designation. Corporations have not historically been successful in suing regulators because the courts tend to pay deference to federal agencies, said banking attorney Daniel Meade at Hogan Lovells.
“When an agency is properly exercising its authority to interpret a federal law . . . the courts tend to defer to the agency,” he said. Whether the lawsuit is successful, Meade said it could shine light on the rather opaque designation process, as other companies would be able to access documents from the case.
Officials at Prudential declined to discuss whether the company is considering taking a judicial route.
Even if Prudential loses its bid this time, it can try again because the council will review designations annually, said Margaret Tahyar, a partner at the law firm Davis Polk. “It may not be about winning this battle,” she said. “It may be about winning the war.”
Annual review, however, means that Prudential could be named again at any time, said Lamson of Shearman & Sterling. “The government could change the criteria or rely on different metrics to assert there is a need for designation.”