Memorandum
MetLife Wins Court Ruling Removing FSOC’s “Too-Big-to-Fail”
Designation
Unsealed Court Opinion Finds That FSOC’s Classification of MetLife as a “SystemicallyImportant Financial Institution” Was Arbitrary and Capricious
April 11, 2016

On March 30, Judge Rosemary Collyer of the U.S. District Court for the District of Columbia invalidated theFinancial Stability Oversight Council’s (“FSOC”) designation of MetLife as a systemically important financial
institution (“SIFI”). 1 Although the court found that MetLife may be deemed “predominantly engaged” in“financial” activities and therefore eligible for designation as a SIFI, the court found “fundamental violationsof administrative law” and a designation process that was “fatally flawed.” In particular, the court
determined that FSOC did not follow its own published standards for SIFI-designation: it did not assess
MetLife’s likelihood of failure, but simply assumed that a failure would occur, and never attempted toquantify or estimate the actual consequences of a failure to the financial system. In addition, FSOC failed toconsider the costs associated with designating MetLife as a SIFI. Accordingly, the court determined that
FSOC’s decision was “arbitrary and capricious,” and granted MetLife’s motion for summary judgment torescind its SIFI designation.
Although the case was determined largely on procedural grounds, it highlights the continuing challenges
regulators face in defining systemic risk on an empirically clear basis.

Background
Section 113 of the Dodd-Frank Act empowers FSOC to designate certain nonbank financial companies assystemically important and therefore subject to supervision by the Federal Reserve. To be eligible fordesignation as a nonbank SIFI, a company must be a “U.S. nonbank financial company,” defined as a U.S.incorporated company that is “predominantly engaged in financial activities.” To be “predominantly
1 MetLife, Inc. v. Financial Stability Oversight Council, C.A. No. 15-0045 (D.D.C. Mar. 30, 2016).

Simpson Thacher & Bartlett LLP

Memorandum – April 11, 2016

2engaged” in financial activities, a company must satisfy either of two tests under Section 102 of the DoddFrank Act. Under the first test, at least 85% of the company’s consolidated annual gross revenues must be“derived” from activities that are “financial in nature.” Under the second test, at least 85% of the company’s
consolidated assets must be “related to activities that are financial in nature.” Eligible companies may bedesignated by FSOC for enhanced supervision under either of two determination standards: (1) whenmaterial financial distress at the company could pose a threat to the financial stability of the United States;or (2) when the very “nature, scope, size, scale, concentration, interconnectedness, or mix” of the company’sactivities could pose the same threat.
In April, 2012, FSOC issued through formal rulemaking a final rule and interpretive guidance related tononbank SIFI determinations. 2 In its final rule, FSOC explained that it would consider a “threat to thefinancial stability of the United States” to exist if a company’s material financial distress would “inflictsignificant damage on the broader economy” through any of three “transmission channels”: Exposure, Asset
Liquidation, or Critical Function or Service.
The final rule detailed six categories that FSOC would consider when assessing whether a company’smaterial financial distress could pose such a threat to the national economy. According to FSOC, the first
three categories—interconnectedness, substitutability and size—“seek to assess the potential for spillovers
from the firm’s distress to the broader financial system or real economy.” The other three categories—
leverage, liquidity risk/maturity mismatch and existing regulatory scrutiny—“seek to assess how vulnerable acompany is to financial distress.”

MetLife’s Designation
On July 16, 2013, FSOC notified MetLife that it was being considered for designation as a nonbank SIFI.
After MetLife conducted multiple meetings with FSOC staff and submitted more than 21,000 pages ofmaterials for evaluation, FSOC voted 9-1 to designate MetLife as a nonbank SIFI on December 18, 2014.
According to its “Explanation of the Basis of Final Determination,” FSOC based its designation on the first
determination standard (i.e., FSOC concluded that material financial distress at MetLife “could pose a threat
to the financial stability of the United States”). Notably, FSOC did not expressly rely on the second
determination standard, that the very nature, scope, size, scale, concentration, interconnectedness, or themix of MetLife’s activities could pose such a threat.
FSOC found that MetLife’s material financial distress would inflict significant damage on the broader
economy through the Exposure and Asset Liquidation transmission channels. With respect to the Exposure
channel, FSOC determined that MetLife’s exposure to creditors, counterparties, investors, or other market
participants is significant enough to materially impair those counterparties and thereby pose a threat to U.S.
financial stability in the event of material financial distress. With respect to the Asset Liquidation channel,
2 See 77 Fed. Reg. 21637 (Apr. 12, 2012).

Simpson Thacher & Bartlett LLP

Memorandum – April 11, 2016

3

FSOC determined that MetLife holds assets that, if liquidated quickly, would cause a fall in asset prices andthereby significantly disrupt trading or funding in key markets or cause significant losses or funding
problems for other firms with similar holdings. FSOC further concluded that MetLife’s existing regulatory
scrutiny would not be able to prevent either threat from being realized, and that MetLife’s complexity wouldhamper its resolution.

MetLife’s Challenge
On January 13, 2015, MetLife submitted a complaint challenging FSOC’s decision to designate MetLife as anonbank SIFI. Among its many arguments against its SIFI designation, MetLife claimed that it was noteligible for designation because it is not “predominantly engaged” in “financial” activities, that FSOC violated
its own regulations in making its designation decision, and that FSOC failed to examine the costs of its
designation decision, focusing exclusively on the presumed benefits instead.
MetLife Eligible for SIFI Designation
As an initial matter, the district court rejected MetLife’s assertion that it was ineligible for designation as anonbank SIFI because it is not “predominantly engaged” in “financial” activities, citing MetLife’s previous
certification to the Federal Reserve when electing to become a financial holding company that “the vast
majority of [its subsidiaries] are engaged in activities that are ‘financial in nature.’” The court further foundno merit in MetLife’s technical arguments that foreign activities cannot qualify as “financial in nature.”“Arbitrary and Capricious” Standard
Although the court found MetLife to be potentially eligible for designation as a nonbank SIFI, the DoddFrank Act allows companies designated as nonbank SIFIs to challenge the merits of such designation incourt. When considering such challenges to SIFI designations, however, courts are expressly limited toreviewing whether the final FSOC determination was “arbitrary and capricious” (a common standard inadministrative law). The standard is highly deferential to administrative agencies such as FSOC; courts
applying the “arbitrary and capricious” standard generally “will not disturb the decision of an agency thathas examined the relevant data and articulated a satisfactory explanation for its action.” 3 Instead, courts
consider only whether the decision was based on a consideration of all relevant factors and whether there
has been a clear error of judgment. However, the standard prohibits an agency from departing from a priorpolicy without explanation or simply disregarding existing rules.
Under this standard, the district court determined that FSOC’s designation of MetLife as a nonbank SIFI wasarbitrary and capricious on two grounds. First, FSOC departed from its prior policy on whether MetLife’svulnerability to financial distress would be considered as a threshold to SIFI designation, and on how a

3 MD Pharm., Inc. v. DEA, 133 F.3d 8, 16 (D.C. Cir. 1998).

Simpson Thacher & Bartlett LLP

Memorandum – April 11, 20164

threat to the financial stability of the United States would be measured, in each case without explanation.
Second, FSOC failed to consider the costs associated with its designation of MetLife.
FSOC’s Departure from Prior Policy without Explanation
The court first determined that FSOC violated its own stated policy by failing to assess MetLife’s
vulnerability to material financial distress before addressing the potential effect of that distress. The FSOC’sown final rule specified that of the six factors it would consider when assessing whether a company’s
material financial distress could pose a threat to U.S. financial stability, three would “seek to assess how
vulnerable a company is to financial distress.” By contrast, the final determination delivered to MetLife did
not include any such vulnerability assessment, claiming instead that all six categories of analysis were meant
only “to assess the potential effects of a company’s material financial distress.” The court found these
positions to be “undeniably inconsistent,” and flatly rejected FSOC’s insistence that it had not changed its
position on whether it must assess vulnerability to financial distress in its designation decisions.
Similarly, the court found that FSOC was inconsistent in its standard for determining whether MetLife’smaterial financial distress would inflict significant damage on the broader economy. In fact, the court
critiqued FSOC for “hardly adher[ing] to any standard when it came to assessing MetLife’s threat to U.S.
financial stability,” relying instead on sweeping assumptions and summarily deeming every possible effect of
MetLife’s distress grave enough to damage the U.S. economy. Even under the deferential standard of review,the court refused to affirm a finding that MetLife’s distress would cause severe impairment of financial
intermediation or of financial market functioning when FSOC refused to perform such an analysis itself.
In its analysis of the Exposure transmission channel, FSOC refused to account for collateral and othermitigating factors. Although FSOC argued that accounting for collateral and other mitigating factors would
only worsen the Asset Liquidation impact, it failed to quantify either impact. Instead, FSOC was content toevaluate interconnectedness but stopped short of calculating what could actually happen if MetLife were tosuffer material financial distress. FSOC’s designation decision assumed MetLife’s distress would inflict“significant damage” on the U.S. economy, but never explained how it would result, in contravention of its
own regulations. Like the FSOC’s reversal on the vulnerability assessment, this change in policy was neither
acknowledged nor explained.
The court acknowledged that the FSOC’s initial interpretation of the Dodd-Frank requirements is “notinstantly carved in stone,” but in the event of a changed position, the FSOC must acknowledge and show
good reasons for such change. With respect to its policy reversals regarding both the vulnerability
assessment impact assessment, FSOC failed to provide any “good reasons” for its change because it statedthat there was no “new policy” to begin with.

Simpson Thacher & Bartlett LLP

Memorandum – April 11, 2016

5

Accordingly, having announced two key interpretations of Dodd-Frank requirements through formal
rulemaking, FSOC was required either to maintain them or to explain its deviation from them. The court
determined that FSOC’s failure to do either was arbitrary and capricious, and sufficient in each case torescind MetLife’s SIFI designation.
FSOC’s Disregard of Cost Considerations
FSOC conceded that it did not consider the costs of designating MetLife a nonbank SIFI, but argued that itneed not undertake such an analysis absent a congressional command. Although the Dodd-Frank Act
requires FSOC to consider “any other risk-related factors that [FSOC] deems appropriate,” FSOC contended
that cost is not necessarily an “appropriate” “risk-related factor” that it must consider.
Citing the recent Supreme Court decision of Michigan v. Environmental Protection Agency, 4 however, thecourt concluded that cost is necessarily an “appropriate” factor for FSOC’s consideration, since “noregulation is ‘appropriate’ if it does significantly more harm than good.”
Turning to the question of whether cost is “risk-related,” the court rejected FSOC’s argument that the onlyrisk that should be considered is whether the company’s distress could pose a threat to the financial stabilityof the U.S. Instead, the court determined that cost must be considered “risk-related” because of its relation
to the risk of MetLife’s distress in the first place. FSOC refused to address MetLife’s contention thatimposing billions of dollars in compliance costs could actually make MetLife more vulnerable to financial
distress, and thus failed to determine whether its designation of MetLife does significantly more harm thangood. This failure, in the court’s view, also rendered the MetLife SIFI designation arbitrary and capricious.

Conclusion
On April 7, the Treasury Department announced that the government would appeal the court’s ruling. If theruling were to stand on appeal, FSOC will most certainly need to revisit the level of rigor with which itconducts its designation analyses going forward. Any such changes to FSOC’s approach may have significant
implications for its ongoing assessment of the asset management industry. In the short-term, it appears thatFSOC has determined that it is more feasible, if not less controversial, for it to focus on asset management
products and services, rather than designations of specific firms. The FSOC held two meetings in Marchalone on the potential risks to U.S. financial stability from asset management products and services. It isparticularly focused on “liquidity and redemption risks and risks associated with the use of leverage by asset
management vehicles,” and it has announced that it “expects to provide a public update on its analysis thisspring.” 5
For MetLife and other nonbank SIFIs, the ultimate implications of an upheld ruling remain unclear.
4 135 S. Ct. 2699 (2015).

5 See Press Release, U.S. Treasury Department (Mar. 21, 2016).

Simpson Thacher & Bartlett LLP

Memorandum – April 11, 2016

6Because the court found that MetLife is eligible to be designated as a nonbank SIFI but found fault only with
FSOC’s determination process, it may be possible for FSOC to revisit MetLife’s SIFI designation following arevamped evaluation (including a vulnerability-to-distress assessment, a quantifiable damage-impact
assessment, and a cost-benefit analysis).
One day after the MetLife order was issued, GE Capital, which was designated a nonbank SIFI in July 2013,
filed a formal request that its SIFI designation be removed. It remains unclear whether Prudential and AIG,
the only other two designated nonbank SIFIs, will similarly challenge their designation in the wake of theMetLife ruling. A Prudential spokesman stated only that company executives “continuously review
developments that impact our company, and we are evaluating what is in the best interests of the company
and our stakeholders.” AIG CEO Peter Hancock has said he is watching the dispute closely, and that thedistrict court’s decision may provide an opportunity for AIG to look for ways to shed its SIFI status.

For further information about this decision, please contact one of the following members of the Firm’s
Financial Institutions Group, including those listed below.

FINANCIAL INSTITUTIONS
Lee Meyerson+1-212-455-3675
lmeyerson@stblaw.com
Mark Chorazak+1-212-455-7613
mchorazak@stblaw.com
Spencer Sloan+1-212-455-7821
spencer.sloan@stblaw.com

The contents of this publication are for informational purposes only. Neither this publication nor the lawyers who authoredit are rendering legal or other professional advice or opinions on specific facts or matters, nor does the distribution of thispublication to any person constitute the establishment of an attorney-client relationship. Simpson Thacher & Bartlett LLP
assumes no liability in connection with the use of this publication. Please contact your relationship partner if we can be ofassistance regarding these important developments. The names and office locations of all of our partners, as well as ourrecent memoranda, can be obtained from our website, www.simpsonthacher.com.

Simpson Thacher & Bartlett LLP

Memorandum – April 11, 2016

7

UNITED STATESEUROPE

SOUTH AMERICANew York
425 Lexington Avenue
New York, NY 10017+1-212-455-2000

LondonCityPoint
One Ropemaker StreetLondon EC2Y 9HUEngland+44-(0)20-7275-6500

São PauloAv. Presidente Juscelino
Kubitschek, 1455
São Paulo, SP 04543-011
Brazil+55-11-3546-1000

Houston
600 Travis Street, Suite 5400
Houston, TX 77002+1-713-821-5650
Los Angeles
1999 Avenue of the Stars
Los Angeles, CA 90067+1-310-407-7500
Palo Alto
2475 Hanover Street
Palo Alto, CA 94304+1-650-251-5000
Washington, D.C.
900 G Street, NW
Washington, D.C. 20001+1-202-636-5500

ASIA
Beijing
3901 China World Tower
1 Jian Guo Men Wai Avenue
Beijing 100004
China+86-10-5965-2999
Hong Kong
ICBC Tower
3 Garden Road, Central
Hong Kong+852-2514-7600
Seoul
25th Floor, West Tower
Mirae Asset Center 1
26 Eulji-ro 5-Gil, Jung-Gu
Seoul 100-210
Korea+82-2-6030-3800
TokyoArk Hills Sengokuyama Mori Tower
9-10, Roppongi 1-Chome
Minato-Ku, Tokyo 106-0032
Japan+81-3-5562-6200

Simpson Thacher & Bartlett LLP