Master Accounts

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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.

Continue Reading  Districts of Wyoming and Idaho Affirm Broad Fed Powers over Master Accounts

The United States District Court for the Southern District of New York (the “Court”) has issued a detailed and complicated Order in the case Banco San Juan Internacional, Inc. v. Fed. Reserve Bank of New York, denying a motion for preliminary injunction by Banco San Juan Internacional, Inc. (“BSJI”), a Puerto Rican bank entity, against the Federal Reserve Bank of New York (the “FRBNY”) and the Board of Governors of the Federal Reserve System (the “Board”).

The case arose out of the FRBNY’s decision to close BSJI’s master account for alleged deficiencies in its anti-money laundering (“AML”) system, which thereby posed systemic risk. The Court held, amongst other rulings, that there is no statutory right to a so-called “master account” with a federal reserve bank.

After the Court filed its Order on October 27, BSJI filed its appeal on October 30, and requested an emergency stay pending appeal and an expedited appeal. On November 9, 2023, the United States Court of Appeals for the Second Circuit referred BSJI’s motion for a stay pending appeal and to expedite to a three-judge motions panel and denied the request for a stay pending appeal.

As we have blogged, and generalizing greatly, having a master account allows financial institutions to operate in the normal course as a custodial bank in the U.S. Having a master account is therefore critical to any institution looking to operate in the U.S. financial system. Accordingly, the FRBNY’s decision, and the Court’s Order, in effect prevent BSJI from operating.

Although some of the background allegations are eye-catching, the Order makes broad legal pronouncements, many of which are not necessarily tied to the alleged facts. The Order therefore emphasizes the significant and unilateral powers of a federal reserve bank, and its discretion to provide or deny master accounts going forward. These powers apply to all financial institutions and require financial institutions to take a serious approach in meeting their AML obligations under the BSA as well as regulator remediation and recommendations regarding the same.  This matter also illustrates how a financial institution can resolve an enforcement action with the Department of Justice, only to find itself still facing an existential threat posed by a regulator for the same underlying activity. 

Continue Reading  SDNY Court Finds Broad Fed Powers Over Master Accounts in Puerto Rican Bank Case Involving AML Concerns

On April 13, the State of Wyoming took the extraordinary step of filing a request for permission to intervene in the ongoing dispute between Custodia Bank, Inc. (“Custodia”) and the Board of Governors of the Federal Reserve System (“the Fed”) and the Federal Reserve Bank of Kansas City.  This dispute involves a complaint (now amended) filed by Custodia – a state-chartered special purpose depository institution (“SPDI”) based in Cheyenne, Wyoming – against the Fed and the Federal Reserve Bank of Kansas City, alleging that the defendants improperly denied Custodia’s application for a “master account” with the Fed. Generalizing greatly, having a master account allows financial institutions to operate in the normal course as a custodial bank in the U.S.  Having a Fed master account is therefore critical to any institution looking to operate in the U.S. financial system.

In a nutshell, Wyoming’s request to intervene critiques the defendants because of their “view of perceived inadequacies in Wyoming’s laws and regulations for SPDIs, [which are] partially responsible” for the denial of Custodia’s master account application.  More specifically, Wyoming accuses the defendants of seeking to treat Wyoming SPDIs in an inequitable manner, thereby “treating state-chartered non-federally regulated banks as second-class banks ineligible to compete with federally-regulated ones.”

This blog post focuses on an important issue referenced seemingly in passing in Wyoming’s request for permission to intervene, which is clearly motivating in part the filing by Wyoming:  on March 24, 2023, the Fed made public its January 27, 2023  Order Denying Application for Membership (the “Order”) by Custodia, which had requested the Fed’s approval under Section 9 of the Federal Reserve Act to become a member of the Federal Reserve System.  According to Wyoming, the Fed’s decision to deny Custodia’s application has the effect of preventing Custodia and other Wyoming SPDIs from ever being able to attain the status of federal regulation.  We focus here on the Order because of its much broader anti-money laundering (“AML”) and sanctions implications for any banks which are contemplating targeted services for the digital asset industry.  The 86-page Order is very detailed, and often also discusses safety and soundness concerns, as well as other issues.

As we discuss, the Order suggests that any bank will have a hard time convincing the Fed that crypto-heavy banking services can comply with the requirements of the Bank Secrecy Act (“BSA”) and U.S. sanctions law.  Likewise, the Fed has expressed its skepticism in the Order that blockchain analytics services, even when applied skillfully and with the best of intentions, actually can satisfy the BSA and U.S. sanctions law due to limitations inherent in crypto transactions relating to knowing with confidence who is actually conducting the transactions.  This same issue was also noted by the recent report by the U.S. Treasury regarding perceived AML and sanctions vulnerabilities in decentralized finance providers.

Continue Reading  State of Wyoming Wades Into Custodia Bank Dispute with Federal Reserve — In Wake of Fed’s Rejection of Bank Due to Crypto-Related AML and OFAC Concerns

Part Two of a Three-Part Series

In the second part of this series, we explore the practical effects of the FinCEN and DOJ guidance documents on industries attempting to serve marijuana related business (“MRBs”). On June 27, 2017, the Tenth Circuit issued an interesting and divided opinion showing us how difficult it can be to square the prohibitions in the federal Controlled Substances Act (“CSA”) and money laundering statutes with state legislation legalizing certain MRB activity and the seemingly permissive nature of the FinCEN and DOJ guidance documents.
Continue Reading  Continued and Unexpected Roadblocks to Serving the Marijuana Industry: Fourth Corner Credit Union v. Federal Reserve Bank