Dodd-Frank’s Day in Court

Three States Join Lawsuit Against Dodd-Frank

Chris Dodd, Barney Frank / AP
September 24, 2012

Three states have joined a lawsuit challenging the constitutionality of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

On Sept. 20, South Carolina, Michigan, and Oklahoma joined a lawsuit challenging the legality of the financial reform act. Their complaint argues that the "Orderly Liquidation Authority" granted to the Treasury Secretary under Title II of the act "violates the separation of powers."

In a conference call with reporters on Friday, Scott Pruitt, Oklahoma’s attorney general, said legislators used the 2008 financial crisis "to concentrate power in Washington, DC."

He argued that the bill is incompatible with the U.S. constitutional system and its framework of checks and balances.

The lawsuit, he said, is about the "fundamental concept of making sure that our Constitutional framework is upheld."

The act gives the treasury secretary the power to liquidate financial institutions "with little or no advance warning, under cover of mandatory secrecy, and without either useful statutory guidance or meaningful legislative, executive, or judicial oversight," the filed complaint states.

Each state has pension funds in institutions regulated by the act, the complaint states, which are exposed to harm if the treasury secretary liquidates a bank. Each state is "ultimately liable" for the pension funds, so if the pension funds lose value because of actions permitted under Title II, the states could be forced to absorb the losses.

The states also argue that Title II violates the Due Process clause of the Fifth Amendment and the requirement in Article One of the Constitution that bankruptcy laws be "uniform."

Alan Wilson, attorney general for South Carolina, said during the conference call that under Dodd-Frank states lose the constitutional protections they enjoyed under prior bankruptcy law.

Adam White, an attorney with Boyden Gray & Associates, told the Washington Free Beacon that before Dodd-Frank there was a substantial body of bankruptcy law and tradition that made bankruptcy proceedings transparent.

After Dodd-Frank, however, "states will not have any of the protections of bankruptcy law that they had before," he said.

Bankruptcy law "has turned into a black box" under Dodd-Frank, said Boyden Gray during the conference call.

The states’ allegations of harm due to losses in pension value are hypothetical, which could open them to charges of bringing a premature suit.

However, White said, the "states are injured right now because on the face of the law, Dodd-Frank has removed the rights they used to have" under bankruptcy law. This loss of rights means they have standing under Article 2, Section 2 of the Constitution, which restricts the Court’s jurisdiction to actual "cases" and "controversies."

Further, White said, the states have no choice but to bring their constitutional claims before any financial institutions are liquidated. Because Dodd-Frank restricts judicial review so severely, he said, there has to be a "pre-liquidation challenge or there’s no challenge at all."

Both Oklahoma Attorney General Scott Pruitt and South Carolina Attorney General Alan Wilson asserted that, while Title II of Dodd-Frank is called the "Orderly Liquidation Authority," this part of the law actually would introduce instability into the financial system.

"We must challenge Dodd-Frank to protect Oklahoma taxpayers and our financial stability. The law puts at risk the pension contributions and tax dollars that the people have entrusted us to protect," Pruitt said in a statement.

Wilson echoed Pruitt’s sentiments in a statement: "These new regulations do not stabilize the nation's economy, they create greater uncertainty. As a result, States cannot allow our taxpayers, our investments or the Constitution to be subject to such financial risk."

Pruitt also criticized "too big to fail banks," saying "I think it enshrines" them in America’s financial system. Wilson pointed out that while proponents of the law argue that it protects the financial industry, the law says nothing about Fannie Mae and Freddie Mac, which have been widely criticized for contributing to the banking collapse in 2008.

"It just consolidates power in Washington, DC," Wilson said.

Gregory Jacobs, a lawyer on the conference call from the firm O’Melveny & Myers, pointed out that Dodd-Frank gives big banks with the "too big to fail" designation an unfair advantage over smaller banks. Research shows, he said, that these big banks have a "cost of capital" advantage over smaller banks.

Pruitt said that the too-big-to-fail label constitutes a "tacit endorsement" by the government.

One of the original plaintiffs in the lawsuit is State National Bank of Big Spring, in Big Spring, Texas. State National Bank, along with the 60 Plus Association and the Competitive Enterprise Institute, filed the original lawsuit challenging the law in June.

It is unclear whether other states will join South Carolina, Michigan, and Oklahoma in this lawsuit, although Wilson said that among other states, "there is great interest and support in what we are doing."

The Department of the Treasury did not respond to requests for comment.