Board of Governors of Federal Reserve System v. First Lincolnwood Corporation – Oral Argument – October 11, 1978

Media for Board of Governors of Federal Reserve System v. First Lincolnwood Corporation

Audio Transcription for Opinion Announcement – December 11, 1978 in Board of Governors of Federal Reserve System v. First Lincolnwood Corporation

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Warren E. Burger:

The case is submitted.

We’ll hear arguments next in 832, Board of Governors of the Federal Reserve against First Lincolnwood.

Mr. Shapiro, I think you may proceed when you’re ready.

Stephen M. Shapiro:

Mr. Chief Justice and may it please the Court.

This case is here on the Federal Reserve Board’s petition for certiorari to the United States Court of Appeals for the Seventh Circuit.

The Seventh Circuit set aside an order of the Board which it denied respondent permission to become a bank holding company under the Bank Holding Company Act of 1956.

This case presents the question whether the Board may deny a bank holding company application where the proposed bank subsidiary is undercapitalized and where the proposed holding company would be so encumbered by debt that the bank would remain undercapitalized for a period of at least 12 years.

Warren E. Burger:

You mean by that question is whether they have the authority to do it or whether they have the discretion to do it?

Stephen M. Shapiro:

Whether they have the statutory authority to deny the application and we’re here today to contend that the Board may indeed deny such an application unless it entails the capital deficiency’s remedy.

Respondent is an Illinois corporation.

William J. Brennan, Jr.:

Do I correctly understand that the undercapitalization is conceded here?

Stephen M. Shapiro:

That’s correct.

In respondent’s brief, the point is made that the capital ratios were low that is recognized in Seventh Circuit opinion and indeed it’s recognized in all of the other submissions from the Comptroller and from the Federal Reserve Bank and from the Board’s staff.

Respondent is an Illinois corporation which plan to acquire 80% of the voting stock, the First National Bank of Lincolnwood.

It stated in its application that it would assume not only the stock but also a debt in the sum of $3.7 million.

Respondent also planned to cause the bank to issue an additional million dollars in debt securities after formation of the holding company and an additional million dollars in equity after the holding company was formed.

The application was initially reviewed by the Chicago Federal Reserve Bank.

The Reserve Bank recommended approval of the application despite its recognition that the capital level in the bank was below the Board’s current guidelines and would remain below those guidelines during the 12-year period needed to retire the debt.

The Reserve Bank believed however that the competence of management and possible improved earnings were positive factors which outweigh the low capitalization factor and in the brief letter, the Comptroller of the currency joined in that affirmative recommendation.

When the application was received by the Board in Washington, it was reviewed initially by the Board’s Division of Research and Statistics and then again by its Division of Banking Regulation and Supervision, both of which recommended denial.

They pointed out again that the bank was seriously undercapitalized at present.

The ratio of capital to assets was 5% when it should have been at least 8%.

That meant that the bank needed an additional $2.5 million in equity capital to meet the Board’s minimum standards.

Byron R. White:

But denying the application wasn’t going to give it that additional capital though, was it?

Stephen M. Shapiro:

That’s quite correct but the insistence in this category of cases, the capital be replenished as a prerequisite to getting the desired change and status is the motivation that makes applicants come up with the additional equity capital.

William H. Rehnquist:

In other words, the Board kind of has the red light and says, “Unless you meet — unless the bank meets particular qualifications which we would not independently enforce if you’re holding company application, we will deny leave for formation of the holding company.”

Stephen M. Shapiro:

The light is red until the Board examines the financial resources of the parent and the subsidiary and has to find that each is adequate under the Board’s current standards and in this case, it found a serious deficiency in the bank and it found that the holding company by extracting dividends from the bank would keep the bank would keep the bank in that undercapitalized state for a period of at least 12 years.

William H. Rehnquist:

Well, wouldn’t the dividends be extracted by the present owners if there is no holding company?

Stephen M. Shapiro:

That’s correct.

That is quite true.

William H. Rehnquist:

So, what good does it do to deny the application?

Stephen M. Shapiro:

By insisting on replenishing of capital in this kind of case where there’s a serious deficiency, the Board has obtained an injection of badly needed capital in some 400 separate cases and an injection of some $2 billion in badly needed equity in the banking system.

That’s the good that’s done and that’s what at stake with this application approval power.

The power has been used effectively and successfully to augment the capital base in the nation’s banks.

Potter Stewart:

It discharges the price, in other words, for somebody who wants to form a single bank holding company and get the tax advantages of that, he has to pay the price by improving the capitalization of the bank.

Stephen M. Shapiro:

That’s correct.

There is a test that has to be passed.

Potter Stewart:

Even though the capitalization of the bank was unchanged — would be unchanged absent Board action, whether or not it was owned as before by individual owners or owned thereafter by a holding company.

Stephen M. Shapiro:

That’s precisely the point and this procedure is identical to the procedure under the Federal Reserve Act which Congress stated was the model to be applied here.

When an applicant seeks membership in the Federal Reserve System, it doesn’t matter whether the change in status would cause a worsening of its condition.

It hardly ever will.

It’s inconceivable that it would.

The question though in this context is whether minimal standards are met and if they’re not met, the applicant is told to go back, improve the situation and come back at a later date for a Board approval and that’s the approach that’s been applied consistently under the holding company.

Potter Stewart:

Mr. Shapiro, having interrupted you, may I ask you this which doesn’t seem to be very clear from my reading of the briefs at least.

Do the individual owners, if this should become a holding company, do the individual owners remain guarantors of the debt?

Stephen M. Shapiro:

Yes, they are.

They are indeed guarantors, secondarily liable.

Potter Stewart:

So — so, if that’s true, the situation remains as before from the point of view of the stability of that indebtedness and —

Stephen M. Shapiro:

The situation —

Potter Stewart:

And any advantage of the holding company however is light as in that advantage then, isn’t it?

Stephen M. Shapiro:

That’s correct.

The situation remains in the state of serious undercapitalization.

There’s no improvement over a 12-year period and that’s the crux of our different —

Potter Stewart:

No improvement in the capitalization of the bank and there wouldn’t have been, had there been no holding company.

Stephen M. Shapiro:

That’s correct and that’s why at this juncture, the Board insists, there now be an improvement to remedy —

Potter Stewart:

As a price — as a price for this people getting the tax advantage of forming of one bank holding company, what do you get —

Stephen M. Shapiro:

It’s not a price, it’s the statutory criteria.

Our financial resources —

Potter Stewart:

It’s a condition.

Stephen M. Shapiro:

Correct.

John Paul Stevens:

Mr. Shapiro, if I understand you correctly, if the holding company were a multi-million dollar concern, just all cash and no-risk business in it, no multiple bank situation, you would nevertheless and if the advantage at the results of the formation of holding company would be totally to the benefit of the bank because they get the tax deduction, they don’t now get.

You would nevertheless disapprove the application unless they poured additional capital into the bank.

Stephen M. Shapiro:

That’s correct.

Until the 8% standard has been satisfied, the subsidiary’s condition is seriously deficient and that has to be remedy as a prerequisite for approval.

That’s quite correct.

Warren E. Burger:

Is there not some value to the guarantees resulting from the Holding Company Act, from a holding company status?

Stephen M. Shapiro:

There certainly is very significant advantage in having the holding company status.

The holding company for one thing is in the position to issue debt securities without the restrictions under regulation cue that apply to individual banks with the holding company based additional business activities can be entered into.

There are numerous benefits in addition to the tax advantage.

Byron R. White:

In most banks, almost.

Potter Stewart:

But not in Illinois.

Stephen M. Shapiro:

But not in Illinois, that’s correct.

Illinois has limits on branch banking.

One facility within 15,000 yards, the second facility within two miles and that’s it but in many states, of course, where there are limits on branching, you can get around those limits by setting up a holding company with multi-bank subsidiaries.

Oklahoma and Texas are clear examples of that situation.

Potter Stewart:

But if your answer is accurate that the original owners here remain as guarantors of the indebtedness then there is the advantage of now there being two sets of debtors instead of just one.

Stephen M. Shapiro:

Well, the holding company.

Potter Stewart:

The holding company is now added as an additional debtor.

Stephen M. Shapiro:

But —

Potter Stewart:

And the original debtors remain debtors, correct?

Stephen M. Shapiro:

The holding company under this application would remain simply a shell.

It would have no additional working assets —

Potter Stewart:

It assumed the indebtedness, doesn’t it?

Stephen M. Shapiro:

That’s correct.

It assumes the indebtedness.

Potter Stewart:

So there’s an additional debtor?

Stephen M. Shapiro:

And would have no income other than the dividends paid from the bank which would otherwise be otherwise be paid to these guarantors that you referred to so it wouldn’t be —

John Paul Stevens:

Otherwise, it would be paid to Uncle Sam in half, wouldn’t they?

A lot of those — the dividends for the most part you’re talking about are the product of the tax saving?

Stephen M. Shapiro:

That’s correct.

Stephen M. Shapiro:

In the first year, the saving would be roughly a $130,000.00 diminishing every year down to —

John Paul Stevens:

The Government’s position is that its better to have that money go to the Government really.

Stephen M. Shapiro:

Well, the Government’s position is that if this new valuable status is sought, it is incumbent upon the parties seeking this new advantage to shoulder the responsibility of maintaining adequate capital in the bank, that’s the Government’s position in Mitchell.

John Paul Stevens:

And your position is based entirely on the statutory language that the Board shall take in to consideration the financial and managerial resources of future prospects of the company or companies in the banks concerned.

Stephen M. Shapiro:

And its based on the long history that we cite on the brief, one pertinent portion of that is the analysis or the analogy to the practice under the Federal Reserve Act where an applicant can’t obtain membership in the system unless its capital as adequate relative to assets and relative to liabilities in the judgment of the Court.

John Paul Stevens:

No, there of course you’re talking about membership in the system of banks all of which affect one another in their operation; we don’t have any consideration like that here, do you?

Stephen M. Shapiro:

There is a certainly economic differences but Congress said that they are inconsequential and that the same pattern is applicable under the Holding Company Act.

John Paul Stevens:

Does the Government still concede as it did, at least Judge Fairchild have quoted you in the Court of Appeals to saying that in any economic analysis of this, the formation of the new company can only be beneficial to the bank can’t cause any harm.

Stephen M. Shapiro:

I think that that concession has been estrange a bit but we do agree that a hundred and $130,000.00 benefit is better than no one $130,000.00 benefit and that’s a positive factor.

John Paul Stevens:

And you can’t point to any harm other than the failure to do something you wanted to do.

Stephen M. Shapiro:

We can point to possible harm and the Board did that in its opinion.

It pointed out that there could be a weakening of the banks financial condition and what it meant by that was what the staff had indicated in its projections of the condition of the bank for a 12-year period.

Capital ratios could decline slightly to a 4.8% starting at 5.2% but that was based on a number of assumptions and it was caused by a number of factors.

John Paul Stevens:

All of which would have applied if there’ve been no bank holding company involved here?

Stephen M. Shapiro:

Well, some of which would not have applied.

The issuance of the million dollars in debt securities was a new step and that gives rise to new debt service requirements of a hundred thousand dollars every year, that was a new element but we do not say that there’s any assurance that this bank subsidiary would be worse of 12-years hence, it’s a possibility and there are other possible dangers that result from the affiliation of a bank and a leverage holding company.

The Beverly Hills National Bank case is a vivid example.

In that case, the holding company issued commercial paper, debt – short-term debt securities and it was unable to meet its obligations on that commercial paper.

Only $2 million in debt and that caused the run on the bank.

John Paul Stevens:

Yes, but that was a situation —

Stephen M. Shapiro:

Even though the bank was sold.

John Paul Stevens:

— in which they did not maintain the 80% necessary to take advantage of the tax advantage which is the whole purpose of this transaction, isn’t it?

Stephen M. Shapiro:

I’d — I have never seen that fact referred to Your Honor that there was less than 80% control in the Beverly Hills National Bank case.

I believe that there was 80% control.

John Paul Stevens:

Oh, I’m sorry I’m confused.

Stephen M. Shapiro:

The difficulty was that that the holding company couldn’t meet a relatively small obligation on its debt securities and even though the bank resounds, this caused the panic among depositors.

$30 million in deposits were withdrawn in three days.

This is a possible difficulty that results from the combination of a highly leverage holding company with large amounts of debt outstanding and the possibility of not being able to meet its obligations.

This is a danger imposed on the bank that wouldn’t otherwise exist.

We’re not saying that will happen.

Stephen M. Shapiro:

The Board made no finding that it necessarily would result but that’s the sort of danger that the Board takes into account when it talks about possible weakening which it referred to in its opinion.

Warren E. Burger:

What criteria do you suggest were taken into account by the Federal Reserve Bank of Chicago in recommending approval of this application?

Stephen M. Shapiro:

The Reserve Bank in Chicago recognized the low capitalization problem and recognized its persistence but it felt that there was a strong management in this bank and that the management had done a lot of good for the bank which we don’t dispute and that this management shouldn’t be faulted for taking over the bank at the time of difficulty and a sop if you will should be thrown to them and that possible improved earnings could reduce the string on the capital but the Board simply disagreed concluding that the low capitalization factor was such a serious problem that steps had to be taken out.

That persuasion and suggestion and urging of improvement wasn’t enough and that the Board had to insist upon application of its 8% rule.

Warren E. Burger:

And what about the Comptroller’s view of this?

Stephen M. Shapiro:

The Comptroller originally recommended against the transaction on the ground that the bank’s capital was too low.

Later, he changed his mind on the theory that the injection of million dollars of debt and the million dollars in equity would be some improvement in the situation and indeed it would initially capital in the bank would be raised somewhat but it would still be $1.5 million short and that’s the objection of the Board.

Even with this injection of capital it’s not close to the standard that it should be.

William H. Rehnquist:

What sanctions are available on the part of any federal agency for the bank’s failure to meet the standard you’re referring to apart from the application for a holding company?

Stephen M. Shapiro:

Apart from denial of the holding company, it is in theory possible that the Comptroller could commence a cease and desist proceeding involving a trial —

William H. Rehnquist:

He didn’t do it here?

Stephen M. Shapiro:

He didn’t do it here.

He has relied extensively on moral persuasion and urging for improvement and the reason for that is obvious.

This trial procedure is a highly cumbersome and time-consuming proceeding that may end up nowhere.

By that I mean that if there’s an order to cease and desist from being under capitalized and market conditions are such that stock can’t be sold, there may be no way to comply with the order.

William H. Rehnquist:

So the holding company is kind of a goody that’s held out in exchange for giving up this rather extended proceeding that would be necessary if the bank didn’t want a holding company?

Stephen M. Shapiro:

If the Board or the Comptroller had to conduct trial and an appeal in the judicial enforcement proceeding every time that they needed to correct the capital deficiency in some 400 cases of the Board alone, they’d be doing nothing else but conducting these kinds of trial, it would be totally infeasible.

William H. Rehnquist:

Well, in the criminal law area this has been outlawed for years, I suppose you realize that they’re making someone give up a right to jury trial in that sort of a thing like the case right behind you is not too different from that.

Granted this is of — this is the area of civil or right in criminal but don’t you have any hesitation about advancing that argument?

Stephen M. Shapiro:

I don’t because no right here is being given up.

There is no right to holding company status unless and until its determined that the resources of the bank and the holding company are adequate in the judgment of the Board and what that means is that this 8% test has to be met and its perfectly common in this industry for a bank that seeks the changing status to have to pass the test in financial soundness and until it does that, the application’s approval is withheld.

That’s a common procedure under the Federal Reserve Act, Under The Federal Deposit Insurance Company Act —

William H. Rehnquist:

Those Acts specifically authorize that sort of test, don’t they?

Stephen M. Shapiro:

And this Act, the legislative history makes very clear, incorporates these same standards.

Congress said that the very same considerations that are used under the Federal Reserve Act and under the FDIC Act should be applied under the Bank Holding Company.

William H. Rehnquist:

They didn’t say it say it in this Act?

Stephen M. Shapiro:

They said it in the House Report that a company that — and they used the term financial resource and what after all is a resource.

The literal definition of that term means something set aside in extra additional support, that’s the dictionary definition of the word resource and that’s just what capital is in the banking system.

It’s a cushion, something extra, something set aside as insurance against poor earnings, against bad loans, against unexpected demands from depositors rather creditors.

So resource adequacy is what we’re talking about and we’re talking about capital adequacy.

Stephen M. Shapiro:

I think the statute literally read supports us directly.

This history that I referred to keying the statute to the Federal Reserve Act supports us directly and the whole history before that under the 1933 Act supports us directly where Congress expressly said that the holding company should be a source of strength to an undercapitalized subsidiary and that if capital was inadequate at the application stage, that’s a ground for denial.

That’s been the pattern since 1933 and for that reason we think that not only the history but the literal text is four square behind us.

We would expect respondent to point to something in the history that suggest that the Boards inference is incorrect about its own statutory authority but respondent hasn’t done that I think that that’s a testimony to the support of nature of this history.

John Paul Stevens:

Mr. Shapiro, I just want to clear one thing up in my mind.

You mentioned that if you had to get a cease and desist order in under capitalization situations, it should be engaged in almost constant litigation because I gather from that and is this a correct inference that the problem of banks not complying with your 8% rule is a very common problem, a lot of banks don’t comply with it, is that right?

Stephen M. Shapiro:

Since 1970, 400 applications have been held to be deficient under the standard under holding company —

John Paul Stevens:

400?

Stephen M. Shapiro:

— act alone and that’s just one agency as scrutinizing capital in banks and in each of this cases the Boards insisted on —

John Paul Stevens:

You mean the 400 applications in which the acquired banks capitalization didn’t meet the 8% test and that was the reason for denial?

Stephen M. Shapiro:

That’s correct and the denial was combined with an improvement at the later stage resulting in a replenishing of the needed capital and Board’s testimony before the Senate in 1976 was that this has resulted in the injection of some $2 billion in additional capital and so we’re talking about a recurrent problem that’s dealt with, we think economically under the statutory provision.

John Paul Stevens:

Well if there — if there are 400 banks that this was a problem and that it were subject to application, I presume there must have been a lot of other banks that weren’t involved in proposed transaction that also were deficient in capital, is that right?

Stephen M. Shapiro:

That’s correct and the —

John Paul Stevens:

So that — that maybe it’s almost a characteristic of the banking industry that they don’t satisfy this particular criteria?

Stephen M. Shapiro:

Well, we know that that isn’t true because the Board has made statistical analysis of banks within different peer groups and within this peer group which is a size criterion, the average nationally is 9% and so the Board’s 8% standard is somewhat lower than the national average.

It’s a problem in many cases but on the average, the banks do better than the Board’s standards but that’s not to say that it isn’t a recurrent problem that has to be dealt with in an economical way under the Board’s supervisory powers.

John Paul Stevens:

And is it a flat rule of the Board that no one bank holding company will be permitted to be organized if the bank to be acquired has a capital ratio of less than 8%?

Stephen M. Shapiro:

I am informed that it is as close to a flat rule as it could possibly be, I believe that it is.

John Paul Stevens:

Is the rule contained in a written regulation anywhere?

Stephen M. Shapiro:

It’s contained in the uniform system of bank classification which is in the bank examiner’s manual which has been in existence since 1969.

It’s referred to from time to time in Board opinions, its contained in the banking treatises that bankers rely on and it’s constantly the subject of discussion between bankers and bank examiners when there’s a case of under capitalization.

John Paul Stevens:

And they basically what they do?

They never allow any change in status or anything to the bank unless it will make a change to comply with this standard?

Stephen M. Shapiro:

Well, a bank that was below the 8% standard wouldn’t get into the Federal Reserve System until it improved.

The holding company that sought to acquire would not get holding company status until it was improved and FDIC insurance wouldn’t be had until the capital deficiency was improved.

It’s a very serious matter, its one of the prerequisites of banking.

John Paul Stevens:

Would the bank lose their FDIC insurance when they get below this amount?

Stephen M. Shapiro:

Pardon me?

John Paul Stevens:

Will the bank lose its FDIC insurance coverage if its capital ratio falls below this percentage?

Stephen M. Shapiro:

That is such a draconian sanction that it’s never been done.

John Paul Stevens:

It just won’t grant new insurance to a bank that doesn’t comply?

Stephen M. Shapiro:

Well, if this bank were denied its FDIC insurance, it would mean that it would go under receivership.

It’s a national bank and it has to have it and so methods other than the ultimate weapon are used and one weapon of course is just urging from the regulatory authorities to improve but that’s proven to be inadequate and this case has proven to be inadequate.

The Comptroller urged this bank repeatedly that its capital funds picture should be replenished and restructured to a fully acceptable level and that the Board of Director should take immediate steps to achieve that end.

The Comptroller understands in 73 —

John Paul Stevens:

But of course in the denial or the application has not achieve the end, I gather.

Stephen M. Shapiro:

Not —

John Paul Stevens:

Still as under the —

Stephen M. Shapiro:

Not to the state because it’s still in litigation and of course they hope for success which would —

John Paul Stevens:

Even if the FDIC wins the litigation then its objective will not be achieved?

Stephen M. Shapiro:

Well, we hope that it will be achieved through the offer of new equity securities by the bank, by finding new ventures at the holding company level, or by retaining the earnings for a period of time in the bank, any of these steps could be employed to replenish the capital base and if that occurs and it should occur within a reasonable period of time, then this respondent is free to return to the Board to get a fresh appraisal of its application.

We’re not being obstructive.

We’re not standing in the way.

When this improvement takes place, we’ll give the application — a first consideration and we welcome that return from respondent.

This is not the death knell to the formation of the holding company I would stress.

I will also stress that the Board’s interpretation of this law which has been in existence since the early 60’s and has been applied again and again in denials of holding company applications which have been published.

This interpretation has been in existence.

During the period of time when Congress amended the law, it amended it in 1966, it amended it again in 1970 and it didn’t express even the slightest disagreement with the Board’s policies and under this Board decision, this Court’s decisions when Congress amends the law without disagreeing with a visible and obvious policy of this sort that amounts to ratification by Congress of the agency’s interpretation and this Court has said repeatedly that the greatest discretion is owing to an administrative agency’s interpretation of its own enabling statute and that argument applies a fortiori we say when there have been two amendments of the law without any hint of disagreement.

And of course this policy of strong capitalization has been at the base of the congressional concerned in this area since 1913.

Potter Stewart:

Mr. Shapiro, has any other Court — considered this question in any Court other than the Court of Appeals of the Seventh Circuit?

Stephen M. Shapiro:

No Your Honor, no other Courts has and you’ll notice that the Seventh Circuit relies upon general reasoning rather than the citation of any precedent and that’s because there is no case law in this area.

We have to turn to the statute, its literal text and its history had —

Potter Stewart:

One more question, who wrote the opinion for the panel?

Stephen M. Shapiro:

It was senior —

Potter Stewart:

September 7, 1976, it doesn’t —

Stephen M. Shapiro:

Senior Judge Hastings wrote the panel decision and Judge Fairchild who had dissented in the original case wrote the decision for the en banc court.

Potter Stewart:

Doesn’t appear who the author was of the panel of —

Stephen M. Shapiro:

I notice that myself Your Honor with some embarrassment but those are the authors of the opinions.

Potter Stewart:

Just go on.

Thank you.

Stephen M. Shapiro:

Respondent asserts that because a capital deficiency already exists here that there is no rational ground for us to stand on the way.

That were being arbitrary and capricious because the milk has already been spilled, the damage is done they say and there’s no reason to make a fuss but we say that the situation should be improved and that new powers, a new status should not be conferred until that improvement takes place and I don’t think there’s anything arbitrary or capricious about that.

The old maxim about greater rights, pre-supposing, greater responsibilities we think applies fully in this case.

Warren E. Burger:

Now, where — how do you relate that specifically to the statute, that doctrine?

Stephen M. Shapiro:

Under the statute the Board is directed to consider an every case financial resources and the legislative history says that these considerations of financial soundness and managerial soundness, the so-called banking factors are the basis for granting or denying and if the applicant has not shown sufficient responsibility to raise capital to minimally adequate levels, then the statute we say authorizes a flat denial and tell the applicant improves the condition of the bank and meets minimum Board standards.

Mr. Chief Justice, I see that the white light is on and I would request your leave to reserve the remainder of my time to reply.

Warren E. Burger:

Very well.

Mr. Collins.

George B. Collins:

May it please your — may it please the Chief Judge in this Honorable Court.

The transaction here involved does not change anything except for the better.

The Federal Reserve Bank of Chicago wrote an analysis of this transaction which was quite full and which pointed out that the — I think their exact language was that the bank would be severely prejudice or severely hindered if the transaction were not allowed.

The reason for that is that by this transaction, by the formation of this holding company, the bank will or the entity consisting of the bank and its owners will benefit by $130,000.00 per year.

Right now, the amount would be a $160,000.00 a year because it’s based upon the current average interest rate.

Now, if the Court please that is a large benefit and that is why the bank sought holding company status.

In Illinois, having a bank holding company, a one bank holding company is of no particular great benefit from a business point of view.

You can’t open branch banks with it.

You can’t have multiple holding company banks.

You can’t do anything with it except really do what the voting trust does now.

Now, the bank has a voting trust right now where the four men who were involved belong to this voting trust and that voting trust does exactly what the holding company will do which is sit there and vote every year at the time of election of directors and receive a dividend and use the dividend to pay interest on the loan which exists.

Now, in this transaction, there is absolutely nothing new created by the transaction, there is only a reshaping in form from a voting trust to a holding company which will perform precisely the same function as the voting trust.

So there —

Lewis F. Powell, Jr.:

Mr. Collins, I take it you’re not defending the judgment below on the theory espouse by the Seventh Circuit however?

George B. Collins:

I am Your Honor.

Lewis F. Powell, Jr.:

You are not.

George B. Collins:

That — I am, I do.

I do contend that Judge Fairchild wrote correctly.

I contend that Judge Fairchild wrote correctly when he said that in order to strike down a transaction or to deny a transaction, there must be something about that transaction which in some manner causes some detriment to some banking factor.

The Board denies this Your Honor on the basis of a policy decision, a basic economic policy decision and I think in that respect, I differ very much with counsel.

Counsel puts that to Your Honor here today that the Board has the right under their reading of the statute to decide basic economic policy to fix an 8% rate which they affix no place in any written regulation.

They have not one piece of paper, not one thing that’s published as a regulation that I know of says 8%.

George B. Collins:

They have the right to say that and then to deny on the basic —

Potter Stewart:

They have the power to say that?

George B. Collins:

Well, they might have the power to make such a regulation.

Potter Stewart:

And that’s the argument.

They probably have the right?

George B. Collins:

But they surely haven’t made such a regulation.

The — I don’t know that they have the power.

Potter Stewart:

Well now, you say they don’t?

George B. Collins:

Well, it would seem to me to be this that they have the power —

Potter Stewart:

It doesn’t.

George B. Collins:

— only to relate it to the specific transaction.

Is this transaction a good one or a bad one?

Now, if Your Honor please, the Board has many powers, the power over money policy United States which does not involve hearings, it does not involve a record.

They meet once a week and decide if we’re going to be richer or poorer whatever they decide.

But that is not what this is.

This is supposed to be a judicial type decision where you take a record in a case and decide yes or no.

William H. Rehnquist:

Certainly, the Board could have a general rule though by which it treats a number of applications?

George B. Collins:

If they do, it does not appear from their opinions.

They simply say that in this instance, we think there would be a strain on the bank’s — on the bank’s capital or that in this instance there would be no strain.

You can’t read their opinions and come a way with any understanding of any policy other than that, sometimes they say it will cause its strain and sometimes they say it won’t.

It is — they’re not written like judicial opinions.

One of them is here and many are cited in the brief.

They are not judicial opinions.

They don’t appear to be even.

They don’t really go with precedent.

They simply say that this is a strain and that’s not.

In this instance, I would suggest that the primary regulation of a bank is sue the Comptroller of Currency.

And I think it important that the Court understand that banks are heavily regulated by a most responsible and competent regulatory authority.

There are basically three, the FDIC, the Comptroller of Currency and the state banking authority.

In this instance it’s a Comptroller because it’s a national bank and a member of the Federal Reserve System I would add.

Warren E. Burger:

Well, do you take the position that the Board had no authority to deal — make this decision at all?

George B. Collins:

No, no sir, not — please don’t put me on that, no sir.

They had authority to decide the case.

Warren E. Burger:

Well, you said the Comptroller of the Currency had that authority?

George B. Collins:

No, they had the authority to decide the case but this is how it is suppose to work according to the statute.

The bank applies or the holding company applies.

The Comptroller is then asked to pass judgment upon it before the FRB does.

The Comptroller — if the Comptroller says no because the banking factors are adverse, then you get an evidentiary hearing before the Federal Reserve Board or some delegate thereof.

If the Comptroller says yes on banking factors, then you still have the competitive factors, the antitrust factors that must then be decided and the Board can then decide the case on the antitrust and competitive factors and review the Comptroller on the so-called banking factors.

Now, as Congress wrote and as it would appear to me to have been intended to be written and as Chairman Burns said when it was — when the 1971 Bank Holding Company Act was passed, the Federal Reserve Board does not pretend to want to regulate what goes on inside a bank and Mr. Burns said that — Governor Burns said that.

He said, “We don’t want to regulate banks, that’s up to the Comptroller.”

Now, the Comptroller has plenary powers over banks.

They have vast and enormous powers.

It’s not some involved court thing.

One of the cases cited in the Government’s reply brief here.

The Malone case I believe gives an example of the breadth of that power.

They can go on a bank and say you’re closed and you are.

It’s really very little you can do about it.

You go to a hearing later.

So the Comptroller has very full powers to do as he wishes with the bank and he has the primary responsibility and in this instance, the Comptroller exercise a very basic primary responsibility and said, after there was a change, go ahead.

The ironic thing is that the change the Comptroller proposed, the Federal Reserve Board didn’t like.

They said, one of the items in the record here says that the Federal Reserve Board regards it as less — less favorable that the changes that the Comptroller required is making the proposition less favorable.

So you have the situation where you have essentially two regulatory bodies having input into one decision.

But its suppose to be a judicial —

Lewis F. Powell, Jr.:

Mr. Collins.

George B. Collins:

Pardon me.

Lewis F. Powell, Jr.:

May interrupt you just a minute?

George B. Collins:

Yes, sir.

Lewis F. Powell, Jr.:

The difficulty with your argument you are now making as I perceive it is that the Comptroller has authority only to make a recommendation to the Federal Reserve Board with respect to the formation of a holding company.

The Congress made the choice of putting the decision making authority in the Federal Reserve Board with respect to a holding company.

George B. Collins:

Very much so.

Lewis F. Powell, Jr.:

The Comptroller can only — can only make a recommendation.

George B. Collins:

May I respond on that point Your Honor?

Lewis F. Powell, Jr.:

Please do.

George B. Collins:

The Comptroller has the — has the duty to respond to the application.

He may respond yes or no.

If he responds yes, then it is decided by the Federal Reserve Board without any hearing.

They simply take the papers, the documents that are presented.

If the Comptrollers says no, then the Federal Reserve Board is obliged to grant a hearing.

My point is that some status is given by that statutory scheme to the Comptrollers acquiescence or non-acquiescence and the Comptroller remains in all events the primary regulatory authority over the bank and the Federal Reserve Board does not pretend according to its chairman at one point to govern what goes on inside a bank or to concern itself with the day to day capitalization of the bank.

Now, —

Lewis F. Powell, Jr.:

Well, that’s true but Section 3 imposes obligation on the Board to consider the financial —

George B. Collins:

Correct.

Lewis F. Powell, Jr.:

— condition not only of the bank but of the holding company?

George B. Collins:

Correct.

Lewis F. Powell, Jr.:

And the future prospects of both?

George B. Collins:

Well, —

Lewis F. Powell, Jr.:

So show that your —

George B. Collins:

There are ways —

Lewis F. Powell, Jr.:

— on the Comptroller seems to me to be perhaps misplaced to some extent.

George B. Collins:

Well, if Your Honor thinks so then certainly misplaced but —

Lewis F. Powell, Jr.:

Well, it’s relevant — it’s relevant —

George B. Collins:

But the point that —

Lewis F. Powell, Jr.:

— but I’m talking about the ultimate responsibility.

George B. Collins:

But the point that I would make is that the decision that they’re to make is suppose to be a judicial decision and not an economic decision.

That the Federal Reserve Board —

Lewis F. Powell, Jr.:

Well, what authority do you have for that?

George B. Collins:

Well, that it’s a statute.

That it impose an obligation to decide the competitive factors.

That it comes out of the Bank Merger Act.

George B. Collins:

It’s taken whole right out of the Bank Merger Act.

The legislative history to which counsel adverts just doesn’t exist for this statute except through the Bank Merger Act.

Are you arguing that financial condition of a bank is a judicial decision rather than —

Lewis F. Powell, Jr.:

No, sir.

George B. Collins:

— an economic or banking decision.

Lewis F. Powell, Jr.:

I’m arguing — I am — well, no, I think its up to the Comptroller whether or not a bank should open tomorrow morning and he makes that decision everyday as to every bank in America and I don’t know that that’s a judicial decision unless there was a case of gross abuse and I don’t know that there’s ever been such a case but I think that and my point to Your Honor is that the decision of whether to allow or to withhold the privilege of a bank holding company is one which is accorded or not accorded in accordance with judicial principles and not as part of the money policy of the Federal Reserve Board.

Potter Stewart:

Oh!

Except, except Mr. Collins, maybe I’m simply repeating the concern expressed by my brother Powell but the statute enacted by Congress clearly provides that in every case, that is in every application to become a bank holding company, the Board shall take into consideration the financial and managerial resources of the banks concerned.

George B. Collins:

Correct.

Potter Stewart:

It imposes a statutory duty upon the Board to —

George B. Collins:

I have — I have no —

Potter Stewart:

In every case to take those —

George B. Collins:

Right.

Potter Stewart:

— concerns into consideration.

George B. Collins:

And I have no quarrel with that because to me, what that means is that you view this case in this record and if there’s anything about this transaction which harms anyone of those considerations or does not even or you could even say does not benefit the situation upon this considerations that it is entirely proper for the Board to take that into consideration.

Potter Stewart:

Or has to in every case?

George B. Collins:

Well, certainly.

Potter Stewart:

That’s the rule of Congress.

George B. Collins:

Well, certainly but the point is that in this case, they are denying this status, I suggest as part of their basic monetary policy of the United States and not because of anything good, better and different about this case.

Now, I think that’s a difference between the open market committee or the money type actions of the Board and this particular item.

Potter Stewart:

Well, the Board simply says we took into consideration the financial resources of the bank concerned.

George B. Collins:

Well, that’s what they in their opinion —

Potter Stewart:

At which was Congress directed us to do in every case.

George B. Collins:

The most that can be said is that they claim in their opinion which is in the petition.

They take the position that because the owner of this bank, the holding company will owe money which already owed and has been owed for three, four years now.

Because the old money that the holding company could — that this debt could prevent the holding company from resolving any unforeseen problems that may arise at the bank, that the language right out of their opinion at 26 (a) of the petition for certiorari.

Now, if it is the point of the Seventh Circuit opinion and I believe it to be correct, I hope it is, that they have to see something wrong with this transaction, with this particular transaction some way in which this transaction is harmed by a holding company status before they can deny the benefit of a $160,000 a year tax saving to this ownership entity now.

The ownership entity exists right now and right now it owes $3.7 million.

If there’s a holding company, they still owe it — they still owe it personally because they have to guarantee the note as the lender would require and does require.

So nothing changes except that there’s a $160,000.00 benefit per year that goes towards reducing that debt.

George B. Collins:

That’s $160,000.00, it doesn’t — its not created now.

So essentially, what is done here by the Federal Reserve Board is they are saying that the tax laws of the United States may — you may not have the benefit of this tax law because you didn’t do something else that we want you to do which in our monetary policy, we believe you should do.

Now, their monetary policy is not really written because it changes so much.

There is evidence in a book that the Government cites called —

Thurgood Marshall:

Do you think they should ignore “monetary policy?”

George B. Collins:

Well, I would hope —

Thurgood Marshall:

How could they?

George B. Collins:

Well, I think that —

Thurgood Marshall:

In one grant you say that that’s their job.

George B. Collins:

Well, let me —

Thurgood Marshall:

And then your next grant you say, but they shouldn’t do it when it comes up against my bank.

George B. Collins:

I think that’s the difference between this Court in any judicial body and an administrative body and I’ll agree with Your Honor that they’ll have a hard time doing that but I think they have the obligation when they have a judicial decision to make which this is.

Thurgood Marshall:

Where in the legislative history did you get any of this?

George B. Collins:

The legislative history if I may, the legislative history is that this is a judicial type decision and a judicial type decision means you got to be fair to both sides and act equally among all parties and that’s what a judicial decision is.

Thurgood Marshall:

Well, I should assume that any administrative body is obliged to do that whether it’s judiciary or anything else.

George B. Collins:

But in an open market money committee meeting at the Federal Reserve Board, there’s no plaintiff and no defendant and they simply decide on the basis of some administrative rule what they’re doing.

Thurgood Marshall:

Well, what’s wrong with what was done here?

George B. Collins:

What was done here, what is wrong is done here —

Thurgood Marshall:

What you wanted, do you take the rules says that once the Comptroller meets and decides in favor of the bank that all the Federal Reserve Board does is rob his time?

George B. Collins:

Not at all.

The obligation —

Thurgood Marshall:

What if — what is different from that on the other —

George B. Collins:

Alright, the obligation of the Federal Reserve Board is they could definitely I think overrule the — suppose the Comptroller had a bank that was in a failing condition and he said well, start a holding company and that’ll pull it out.

I think they definitely have a function here but they have to exercise it in a judicial and not economic manner.

It’s been documented that the Federal Reserves —

Thurgood Marshall:

Listen, it’s a Federal Reserve Board, it’s not the Federal Reserve Court.

George B. Collins:

Well, it is in this instance — when they’re exposed to make a judicial decision and decide between parties on the basis of a record, they’re suppose to do it so fairly and I think that that’s different from their general administrative responsibility over the money systems.

Warren E. Burger:

When you say between the parties, who are those parties?

George B. Collins:

Parties would be the applicant and the respondent which should be the staff of the Federal Reserve Board which shows to go against this.

They made a submission against it —

Warren E. Burger:

That’s not a party situation in the normal context of —

George B. Collins:

Well, not in — in the administrative law context, I think it might be considered that the Federal Reserve Board of Chicago strongly recommended this and the strongest of term, they said it was the bank would suffer severe detriment if it were not granted.

The people at staff here, of course we don’t know that as it goes through, you only learn that when you get the record but the staff here said no, they didn’t like it because it was in conflict with the current posture was their words.

The current posture of the Board, the current policy of the Board and so they said this doesn’t comply with our current policy.

Alright, then the Board has to decide what’s right and what’s wrong and I think that when they decide that, they’re deciding between two contentions.

Lewis F. Powell, Jr.:

Mr. Collins, I’m having little difficulty following you when you talk about the Board’s decision in this case being based on the Federal Reserve Board’s monetary policy, is that referred to by the Board in its decision?

George B. Collins:

No it is not.

I based that upon an analysis in a book that the Government cites called Heller, a guidebook to holding company law.

Its — I believe page 128 to 130 of that book which I just read yesterday and which says plainly that up until 1974, they were very liberal with the formation of this holding companies and they intended to approve them.

Then, in 1974 when there was economic difficulty in the country, they decided that they will change their policy and attempt to get more money into the banking system by refusing the holding companies and by making the banks come up with more money in order to start them.

Now, Mr. Shapiro this morning, my good friend here argues that their right because they have the right to require more money simply as part of their general governance of the American economic system but —

Lewis F. Powell, Jr.:

That’s not really what the Board said in this case though.

George B. Collins:

No, it is not.

It is — it was the observation of their author of that book that whatever they said in their opinions, what they do is they decide things on the basis of policy.

Now, the Internal Board Report which is the staff report to the Board which is in the appendix uses the words current posture.

Counsel argues here today forcibly that it is policy that causes them to do this and if they have the right to deny this tax advantage because of policy that banks should have more capital.

William H. Rehnquist:

Well, anytime you’re adjudicating a case involving a particular applicant like your client here, you make the adjudication on individual factual determinations but then you apply policy to them, don’t you whether its legislation or rule making or what?

George B. Collins:

Well, my point is that should be at least some kind of written policy that someone can know and for them to simply to deny it on the basis of a record when in fact on the facts of the particular case nothing but benefit flows from it.

I think that there — I think that’s just plain arbitrary wrong and capricious because when the problem will be on its way to being solve if they will grant the holding company status which in Illinois means nothing as far as other business are concern.

If they were but granted, then we’re a $160,000.00 a year towards solving every problem that there is.

If they deny it, we aren’t.

Warren E. Burger:

But suppose the Federal Reserve Board and looking down the road is their business includes that anything that will encourage speculation and bank stocks at a particular time is bad for the whole monetary system, then do you say they cannot take that policy into account?

George B. Collins:

Well, if they — if that policy were applied to this case, they would grant the holding company because when four people own stock that’s tied up for many years that is not readily salable because its closely held and where they have to keep the 80% block together to qualify for the tax consideration, then in this case it wouldn’t — the application of such a policy would leave them in an arbitrary and capricious position.

What — I don’t know what the deciders of great questions consider.

I have never decided anything.

But to me, if they have a record before them, they should decide their case on the basis of the record before them and upon the harm or good to be done out of that transaction.

Warren E. Burger:

Just for this one transaction and this mean —

George B. Collins:

I would think so.

You so judge if a man does an armed robbery, you judge the one transaction; you don’t convict him because of a general policy on that.

Warren E. Burger:

Well, but the Federal Reserve Board has got to somewhat different function, has it not?

George B. Collins:

Well, I think in this instance, the way the statute and the procedure is written.

I think they have the duty of deciding any two antitrust questions and I think you could consider this part as part of the antitrust consideration or you can consider separately.

Now, in the Third National Bank case which was written and decided in this Court 11 years ago, the same language out of the Bank Merger Act was held to apply it to the specific transaction as viewed through antitrust or an antitrust prospective.

So this language has been precisely interpreted in that statute as having to do only with the antitrust considerations of the case and having to do only with that specific circumstance and not otherwise.

Now, —

Lewis F. Powell, Jr.:

Mr. Collins?

George B. Collins:

Yes.

Lewis F. Powell, Jr.:

I’ve read a few of these opinions over the years and uniformly the Federal Reserve Board and also the courts treat about three basic elements in analyzing this request.

The competitive factors are one, the antitrust division.

Second guess is the Board on those, then the banking factors are second package of things but the Boards and Courts look at.

And finally, the Board looks at the convenience of the community whether or not the community will be better served, the convenience and needs of the community.

So I don’t quite understand how you can say that all the Board is concerned with is the competitive factor.

George B. Collins:

I was pointing out if Your Honor please that the same language in the Bank Merger Act, it has exactly the same language.

Lewis F. Powell, Jr.:

Yes, that’s right.

George B. Collins:

Has been so interpreted by this Court.

Lewis F. Powell, Jr.:

Oh really?

George B. Collins:

I agree that the Federal Reserve Board certainly looks at it as Your Honor describes.

Lewis F. Powell, Jr.:

Yes.

George B. Collins:

But the Bank Merger Act was not so construed in the Third National Bank case from which where this involved banks at National Tennessee.

It just — was done differently and I want to bring up one other point.

In the legislative history argument, they go back to statutes — to a statute passed in 1933 which would appear to require the holder of bank stock if a corporation to have certain financial standing.

Well, if Your Honors please, that was because in the 1930’s, there was a law that said that bank stockholders were personally liable on their bank stock to the extent to the par value of that stock in case the bank fail.

Now, there was such a law once upon a time.

It was — its Section 64 of the National Banking Act and in 64 (a) repeals that as to bank stock acquired after some day back in the 1940’s and it is no longer the law.

Now, there was once a very real and precise reasoning — reason for requiring the owner of bank stock to have a certain financial status.

Now, the Board here tries to make that old law back into the law by saying that the owner of bank stock if it’s a corporation should have a lot of money so that if there is trouble at the bank they can come up with the money and that’s what they say in the opinion in this case, that they want the applicant, the holding company to have money to come up with.

If the — if that isn’t the law anymore, the owner of bank stock can own nothing except that bank stock if he’s an individual, he can be as poor as can be and its not against the law to own bank stock no matter how poor you are in other matters.

You can only own that stock and you can owe on it to a 100% of its worth and you can still lawfully own it.

I think that the legislative history that counsel cites is undercut by the fact that in the initial writing of the laws on this subject, there was then existent, this law requiring that you make up any loss in a bank if you’re a stock holder to the extent of the par value of that.

If the Court please, we contend that the Seventh Circuit was right that if it doesn’t make any difference, it shouldn’t make any difference.

George B. Collins:

If this transaction does not harm anyone and that it is a correct transaction and I thank you all.

Warren E. Burger:

Very well, Mr. Collins.

Mr. Shapiro, you have three minutes, do you have anything further?

Stephen M. Shapiro:

Mr. Chief Justice and may it please the Court.

I would differ with Mr. Collins with great deference on the question of monetary policy.

This case has nothing to do with monetary policy in simple terms.

Monetary policy is concerned with the level of money in the general economy and it’s regulated through open market transactions, reserve requirements and through the interest rate of the discount window of the —

Warren E. Burger:

How would you say — how would you say that relates it all to the desirability or undesirability of speculation and bank stocks at any particular period?

Are there some nexus there?

Stephen M. Shapiro:

I believe that that’s a separate question, Your Honor.

The point I’d like to make if I may is that this case is dealing not with money supply with the safety of banks.

It’s not concerned with aggregate demand of the economy but with the cushion of equity in the banking system and Mr. Collins referred to Mrs. Heller’s treaties, I think if the Court reviews that, it will make very clear that the policy that we’re talking about here is the capital cushion for bank safety.

In 1974, that became an issue because banks were failing.

There were several large failures including the Franklin National Bank and the Board decided that at this point in time that the strict capital standards were essential to the safety of the banking system.

The argument was made that the Board’s opinion was too cursory.

I’ll refer the Court briefly to Camp versus Pitts, 411 U.S. 138.

This is a case we haven’t cited but it deals with the adequacy of banking agency’s opinion and denying an application.

The opinion is about three years old of this Court, 411 U.S. 138.

And I would say in closing that the Comptroller does not have the final word here as this Court said in the Whitney National Bank case, Congress had no intention to give the Comptroller a veto over the Federal Reserve Board under the Federal Bank Holding Company Act.

And we think this case should be viewed from that perspective because the statute is explicit, that the Board makes this decision and the Comptroller merely advises.

Thank you very much.

Warren E. Burger:

Thank you gentlemen.

The case is submitted.

We’ll hear arguments next in —