AIG American International Group Inc

By Ryan Tracy and Leslie Scism 

WASHINGTON -- A judge invoked broad legal grounds to rescind federal oversight of MetLife Inc., calling into question the process the Obama administration has used to bring other large insurers under the Federal Reserve's thumb.

U.S. District Judge Rosemary Collyer, who last week overturned regulators' determination that distress at MetLife could put the economy at risk, Thursday unsealed her written opinion in the case. She took regulators to task for an "unreasonable" decision that didn't consider potential costs and relied on a process that was "fatally flawed."

The administration is expected to appeal the ruling in the coming weeks, but hasn't said explicitly that it will do so. One administration official said Thursday he believes an appeal is likely.

"We intend to continue defending vigorously the process and the integrity of [the Financial Stability Oversight Council's] work, and I am confident that we will prevail," said U.S. Treasury Secretary Jacob Lew, who heads the oversight council, in a statement Thursday. "This decision leaves one of the largest and most highly interconnected financial companies in the world subject to even less oversight than before the financial crisis."

The findings by Judge Collyer amount to a broadside against one of the core overhauls the Obama administration and Congress enacted in response to the 2008 financial crisis, when financial institutions that fell outside federal oversight put the economy at risk. Her opinion contradicts some of the top federal financial regulators and sets up a legal battle that will determine whether they continue to supervise some of the largest U.S. insurance companies.

In the 33-page document, Judge Collyer blasted the FSOC's process for tagging MetLife as "systemically important financial institutions" under the 2010 Dodd-Frank law, implicitly also criticizing a similar process that was used to tag MetLife's two biggest rivals -- American International Group Inc. and Prudential Financial Inc. -- as SIFIs. The oversight council includes the heads of the Federal Reserve, Securities and Exchange Commission, and other regulators.

AIG and Prudential declined to comment Thursday, but people familiar with the matter have said the firms are expected to review the MetLife case and consider their own legal challenges.

MetLife, which received the SIFI label by a 9-1 vote of the council in December 2014, is the only firm to challenge regulators' decision in court so far. But it is possible AIG and Prudential could follow with their own lawsuits if MetLife is ultimately successful, undoing one of the Obama administration's key post-financial crisis regulatory accomplishments.

"We remain pleased with the U.S. District Court's decision," a spokesman for MetLife said.

By faulting the oversight council's process rather than its overall findings, Judge Collyer may have left the door open for the group to redo its work and once again subject MetLife to federal oversight.

"We believe the court has left the door open for the Financial Stability Oversight Council to redesignate MetLife as a systemically important financial institution, though the process may be more time-consuming and complicated," Guggenheim Securities analyst Jaret Seiberg wrote in a note to clients Thursday.

Mr. Seiberg also said that MetLife is undertaking a separate initiative to shed some assets in a way that could make the company appear less worrisome to regulators in the future.

Dodd-Frank gives regulators the authority to designate firms as SIFIs if their failure or activities could threaten financial stability. The SIFI label comes with tougher oversight from the Fed, including annual stress tests and limits on borrowing that are expected to go beyond those applied to other insurance companies, which are primarily regulated by the states.

In designating MetLife, regulators outlined a range of risks associated with the firm and described how, if the firm got in trouble, stress could spread quickly to other parts of the economy.

Judge Collyer said those findings included assumptions that weren't backed up by analysis of potential losses at MetLife and its counterparties.

"Every possible effect of MetLife's imminent insolvency was summarily deemed grave enough to damage the economy," she wrote.

Mr. Lew's statement said "the financial crisis showed direct and predictable counterparty losses are not often the means by which the failure of a financial company could destabilize markets and threaten the U.S. economy."

The judge also faulted regulators for process fouls.

In April 2012, the council issued a final rule interpreting its authority under Dodd Frank. She said that document made promises that the oversight council later abandoned without explanation, violating administrative law and rendering its decision arbitrary and capricious. Specifically, she said the FSOC had promised to assess MetLife's vulnerability to financial distress, but didn't do so, and that it changed its definition of what it means to threaten the financial stability of the U.S.

The oversight council has argued it didn't depart from its initial promises and was required to assess only the impact of MetLife's failure, not the likelihood of it.

Judge Collyer also invoked a June 2015 Supreme Court decision on regulatory cost-benefit analysis, known as Michigan v. Environmental Protection Agency. The decision, written by the late Justice Antonin Scalia -- whose son Eugene is a partner at Gibson, Dunn & Crutcher LLP representing MetLife -- found the EPA acted unreasonably when it didn't consider cost in making a regulatory decision.

"Because FSOC refused to consider costs as part of its calculus, it is impossible to know whether its designation 'does significantly more harm than good,'" Judge Collyer wrote, quoting the Michigan decision.

Mr. Lew said Congress chose not to require the FSOC to conduct a formal cost-benefit analysis "for good reasons" because doing so would impair regulators' ability to address risk. He said crises are difficult to predict, but their damage can be far-reaching.

University of Michigan law professor Michael Barr, who was an architect of the Dodd-Frank law during a stint at the Treasury Department, said he thinks the decision will be overturned on appeal.

"I think the judge fundamentally misunderstands what the FSOC is required to do.... I think the judge is wrong."

Write to Ryan Tracy at ryan.tracy@wsj.com

(END) Dow Jones Newswires

April 07, 2016 15:06 ET (19:06 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.