Components of the U.S. Federal Reserve System recently prevailed in two lawsuits in which both plaintiffs – Custodia Bank and PayServices Bank – alleged the defendants were required to grant the plaintiffs’ master account requests and wrongfully denied them master accounts.  Both the United States District Court for the District of Wyoming and the United States District Court for the District of Idaho rejected these claims and instead ruled as a matter of law that the respective regional Federal Reserve Banks had discretion to deny the plaintiffs’ requests for a master account. 

Putting aside very extreme instances, these recent decisions further confirm that the Federal Reserve System appears to have near unfettered discretion in determining which banks can receive a master account.  Although these court rulings turn primarily on statutory interpretation issues and broad legal principles, these rulings will have particular practical consequences for financial institutions looking to serve niche industries – such as cryptocurrency and cannabis – which regulators perceive as presenting higher risks in regard to anti-money laundering, sanctions, safety and soundness and other regulatory concerns.

Master Accounts

As explained in our previous blog post related to Custodia Bank, Inc.’s (“Custodia”) lawsuit against the Board of Governors of the Federal Reserve System (the “Fed”) and the Federal Reserve Bank of Kansas City (“FRBKC”), a master account allows a financial institution to operate in the normal course as a custodial bank in the U.S., and gives deposit institutions access to the Fed’s services, including its electronic payments system.  Therefore, having a Fed master account is critical to any depository institution looking to operate in the U.S. financial system.  Although Custodia had accessed the Fed system through a correspondent bank with a master account, a correspondent bank account relationship involves certain costs and risks – the primary risk being that the correspondent bank will simply terminate the correspondent bank account relationship.

Custodia Bank Case

The United States District Court for the District of Wyoming (the “Wyoming Court”) issued its order on March 29, 2024.  The Wyoming Court dismissed Custodia’s claim against the Fed for Administrative Procedures Act (“APA”) violations for lack of federal jurisdiction.  It also granted FRBKC summary judgment on Custodia’s cause of action against FRBKC seeking a writ of mandamus compelling FRBKC to grant Custodia a master account. 

In its amended complaint, Custodia — a state-chartered special purpose depository institution (“SPDI”) under Wyoming law intended to facilitate cryptocurrency banking that is generally prohibited from extending loans — alleged that the Fed and FRBKC improperly denied Custodia’s application for a master account with the Fed.  Most importantly, Custodia argued that the defendants did not have discretion to deny Custodia’s master account application.  Notably, Custodia did not challenge the reasons underlying the master account denial.

Master Account Claim

The Wyoming Court held that FRBKC had discretion to deny Custodia’s master account request.  The parties do not dispute that Custodia was eligible to obtain a master account.  What the parties disagree on is whether FRBKC must grant Custodia a master account because it was eligible for one.  The Wyoming Court answered no to that question and held whether to grant a master account is discretionary.  Just because a depository institution is eligible to receive a master account does not mean it must receive a master account as a matter of statutory entitlement.

The Wyoming Court rejected Custodia’s claim that 12 U.S.C. § 248a requires that all legally-eligible depository institutions receive a master account.  The Wyoming Court reasoned, amongst other things, that § 248a’s language itself does not mandate that Federal Reserve Banks grant a master account to every eligibly institution that requests one.  Section 248a is also directed towards the Fed, not the Federal Reserve Banks, and instructs the Fed to create a non-discriminatory pricing schedule.  Additionally, the Wyoming Court pointed to § 248a(c)(2), which states:

All Federal Reserve bank services covered by the fee schedule shall be available to nonmember depository institutions and such services shall be priced at the same fee schedule applicable to member banks, except that nonmembers shall be subject to any other terms, including a requirement of balances sufficient for clearing purposes, that the Board may determine are applicable to member banks.

12 U.S.C. § 248a(c)(2) (emphasis added).  By including “all” before “Federal Reserve services” but not before “nonmember depository institutions,” Congress signaled it intended to treat the two differently.  It did not intend to signal that all Federal Reserve bank services be available to all nonmember depository institutions. 

Additionally, the Wyoming Court reasoned that this reading is consistent with the text of 12 U.S.C. § 342, which states a Federal Reserve Bank may receive deposits from member banks and nonmember depository institutions.  The Wyoming Court agreed with the Southern District of New York’s conclusion, as discussed in this blog post, that § 342 “makes clear that Federal reserve banks are authorized to maintain Master Accounts, but are not required to do so.”  Banco San Juan Internacional, Inc. v. Fed. Reserve Bank of New York, No. 23-CV-6414 (JGK), 2023 WL 7111182, at *7 (S.D.N.Y. Oct. 27, 2023).  The Wyoming Court also pointed out that if Custodia’s position mandating that master accounts be created for eligible parties were correct, “it would effectively mean that depository institution chartered under the laws of a state, regardless of how soundly crafted, is entitled to a master account allowing it direct access to the federal financial system.”

The APA Claim

The Wyoming Court also dismissed Custodia’s APA claim, which it brought only against the Fed, because it determined that Custodia was not challenging a “final agency action.”  The APA grants federal courts the authority to review an agency’s final agency action.  Custodia alleged that the Fed took a final agency action when it sent an email (the “no-concerns email”) to FRBKC stating that it had reviewed FRBKC’s pre-decisional analysis of Custodia’s request for a master account and had no concerns with FRBKC’s intent to deny Custodia’s master account application.

The Wyoming Court held the no-concerns email was not a final agency action under the APA for two reasons: (i) the no-concerns email was not “the whole or a part of an agency rule, order, license, sanction, relief, or the equivalent or denial thereof or failure to act as enumerated in the definition of “agency action,” and (ii) the no-concerns email was only the Fed’s implementation decision pursuant to a broader agency plan. 

Regarding the latter point, the Wyoming Court noted that the no-concerns email pointed to the Guidelines for Evaluating Account and Services Requests that the Fed announced in August 15, 2022, and also to S-letter 2667, which is a policy the Fed enacted that requires Federal Reserve Banks to consult with the Fed staff on certain requests for master accounts.  Therefore, the no-concerns email implemented the plans set forth in the Guidelines and S-letter 2667 and was not a final agency action.  Custodia had not challenged either the Guidelines or S-letter 2667.

PayServices Bank Case

The United States District Court for the District of Idaho (the “Idaho Court”) issued its order on March 30, 2024, just one day after the Custodia decision.  The Idaho Court granted the Federal Reserve Bank of San Francisco’s (“FRBSF”) motion to dismiss PayServices Bank’s (“PayServices”) complaint.  Similar to Custodia, PayServices — a private Idaho depository institution focused on facilitating trade commodities by providing payment processing to foreign merchants, buyers and governments — alleged FRBSF unlawfully denied its application for a master account.  Like Custodia, PayServices argued that the defendant did not have discretion to deny PayServices’s master account application.  Unlike Custodia, PayServices disagreed with FRBSF’s justification for denying its master account request.

FRBSF moved to dismiss PayServices’s complaint, alleging (i) each claim must be dismissed because FRBSF had discretion to deny PayServices a master account, (ii) each claim must alternatively be dismissed because FRBSF is not a federal agency, (iii) the APA claim must alternatively be dismissed because FRBSF’s decisions to deny PayServices a master account was not arbitrary and capricious, and (iv) the Due Process claim must alternatively be dismissed because PayServices did not allege it was denied procedural protections. 

First, consistent with the Wyoming Court’s ruling the day before, the Idaho Court held FRBSF had discretion to deny PayServices’s master account request.  PayServices similarly argued that § 248a(c)(2) requires that it receive a master account.  In response, FRBSF argued that § 248a(c)(2) neither entitles PayServices to a master account nor imposes any duties on Federal Reserve Banks relating to master accounts.  FRBSF put forth the same argument that FRBKC asserted — 12 U.S.C. § 342 provides Federal Reserve Banks with discretion to grant or deny master accounts.  The Idaho Court agreed with FRBSF on this point for essentially the same reasons that the Wyoming Court agreed with FRBKC.

Second, the Idaho Court held FRBSF is not a federal government agency and therefore each of PayServices’s claims — its APA, Mandamus Act, and Due Process claims — must be alternatively dismissed.  Both parties agreed that to qualify as an agency under the aforementioned theories, an entity must exercise substantial independent authority on the government’s behalf.  The Idaho Court likened Federal Reserve Banks to “private corporations, owned by their member commercial banks.”  While the Fed, a federal agency, has policy oversight over the Federal Reserve Banks, it does not follow that Federal Reserve Banks are thus converted into federal agencies.  The Idaho Court pointed to the fact that Federal Reserve Banks are controlled by their own board of directors.  

Third, the Idaho Court held that FRBSF’s decision to deny PayServices’s master account request was not arbitrary and capricious.  PayServices alleged FRBSF’s denial of its master account request was arbitrary and capricious because FRBSF was required to grant the request.  As the Idaho Court discussed earlier in its opinion, and as explained above, § 342 and not § 248(a)(c) governs master account requests, and FRBSF was not required to grant the request.  The Idaho Court also noted that “while PayServices allege[d] that FRBSF denied its maser account request using the Board of Governors’ August 2022 Guidelines . . . , it d[id] not plead any facts showing that FRBSF’s decision was inconsistent with them.” 

Lastly, the Idaho Court held there were no alleged denials of procedural protections.  Because PayServices did not have a legitimate claim of entitlement to a master account, its allegation that it had a property interest in the master account and that FRBSF’s denial of such an account violated its right to procedural due process was without merit.  Further, PayServices’s claim to a master account was not a fundamental right under the U.S. Constitution and thus its substantive due process claim was without merit.  

The Idaho Court agreed with FRBSF’s argument that even if PayServices’s claim to a master account were a protected property interest, PayServices was not denied any procedural protections and so its Due Process claim should be dismissed.  PayServices had two opportunities to meet with FRBSF, was allowed to submit written evidence, and was sent a written decision explaining the basis for FRBSF’s decision to deny the request.  The Idaho court agreed these protections were enough to satisfy the Due Process clause.

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