Constitutional Challenge to Dodd-Frank Grows Ranks

Eight states join constitutional lawsuit against 2010 financial reform act
Barney Frank, Chirstopher Dodd / AP

Barney Frank, Chirstopher Dodd / AP

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Eight more states have joined a lawsuit against part of the Dodd-Frank financial reform act, arguing that the act undermines their financial stability.

A judge for the United States District Court for the District of Columbia Tuesday accepted the plaintiffs’ motion to amend the complaint to include the eight new states. The new states are Alabama, Georgia, Kansas, Montana, Nebraska, Ohio, Texas, and West Virginia. They join Michigan, Oklahoma, and South Carolina, which launched the suit in September 2012.

“Dodd-Frank … gives the federal government the power to pick winners and losers, putting the state of Georgia’s financial assets at risk,” said Georgia’s Attorney General Samuel Olens in a statement. The states filed to join the lawsuit last week.

Dodd-Frank came as a response to the financial collapse in 2008; the law seeks to prevent a similar collapse from reoccurring by regulating the financial sector.

The states are challenging Title II of Dodd-Frank, which sets up the “Orderly Liquidation Authority” (OLA). The OLA gives the treasury secretary the power to break up financial institutions the government determines pose a systemic risk to America’s financial stability.

The states argue in the amended complaint that the Orderly Liquidation Authority blurs the separation of powers set up in the Constitution, allows the government to seize property without “due process of law,” and violates the Constitution’s stipulation that bankruptcy laws be “uniform.”

The states argue the OLA could hurt them if it is ever invoked to dissolve an institution in which they have a financial stake, as it “exposes those creditors to the risk that their credit holdings could be arbitrarily and discriminatorily extinguished in a Title II liquidation, and without notice or input.”

Peter Wallison, a financial policy expert at the American Enterprise Institute, highlighted two problems with the OLA.

“This law seems to override bankruptcy laws” and to strip the states of their traditional rights under bankruptcy law, he said.

Wallison said it is possible a state could be “left behind” when the government takes over and restructures a financial institution, leaving the state’s liabilities unpaid and forcing the state to absorb the losses itself. Traditional bankruptcy law requires these liabilities to be protected when a company goes through bankruptcy.

Wallison also said the law severely restricts the appeal process for the treasury secretary’s decision. Affected individuals have only one day to appeal the secretary’s decision to invoke the OLA and break up a financial institution, he said.

Sam Kazman, the general counsel for the Competitive Enterprise Institute, said the OLA sets up a situation for many states similar to the situation Indiana faced in the 2009 bailout of Chrysler. Indiana, whose pension funds held a stake in Chrysler, was treated differently from other creditors and ultimately lost $6 million when the company was restructured, Kazman said.

“I see the possibility of that being repeated here on a much broader scale,” he said.

Michigan, Oklahoma, and South Carolina joined an existing lawsuit brought by several private plaintiffs, including the Competitive Enterprise Institute and the State National Bank of Big Spring, Texas. The original plaintiffs brought their suit on June 21, 2012.

The private plaintiffs argued in the original complaint that three aspects of Dodd-Frank are illegal.

They argued the bill grants the Consumer Financial Protection Bureau power too broadly, violating the Constitution’s separation of powers, and that the bill gives the Financial Stability Oversight Council unconstitutional power arbitrarily to declare banks “systemically important”—effectively too big to fail. This hurts smaller banks.

The suit also argued that Obama unconstitutionally appointed Richard Cordray to head the CFPB.

Securities and Exchange commissioner Daniel Gallagher said last month the SEC was only a third of the way through the regulations the law requires.

He had specific criticisms of Dodd-Frank as well: The bill failed to address some important aspects of the financial industry and was filled with a “grab bag of wish list items.”

“It’s a perfect example of not letting a good crisis go to waste,” Gallagher said about the law.

The judge’s ruling Tuesday sets the schedule for a series of replies to the motion from each side. The government’s final submission to the court is due April 9.

The Department of the Treasury did not return a request for comment.