Federal Reserve tries to repair damage from AIG bailout case in new brief

December 15, 2015

(Reuters) – The Federal Reserve Bank of New York is not a fan of U.S. Court of Federal Claims Judge Thomas Wheeler, who ruled in June that the Treasury Department’s $87 billion bailout of AIG violated the Fifth Amendment rights of AIG shareholders.

The judge, you’ll recall, found that when the government insisted on taking an equity stake in AIG as part of the 2008 rescue, it exceeded its authority under the Federal Reserve Act. And according to Wheeler, lawyers within the Federal Reserve, as well as outside counsel from Davis Polk & Wardwell, deliberately structured the AIG loan package to avoid prohibitions on taking equity and to give the Fed ongoing control of AIG. Wheeler ended up awarding no damages to AIG shareholder Starr International – the financial services company controlled by onetime AIG chief Maurice Greenberg – because the judge said shareholders would have been wiped out had it not been for the bailout. But an amicus brief the Fed filed Monday shows just how much Wheeler’s opinion stung.

Both Starr and the government have appealed Wheeler’s decision to the Federal Circuit U.S. Court of Appeals – Starr and its lawyers at Boies Schiller & Flexner to reverse the no-damages finding and the Justice Department to protect its emergency rescue powers. Their briefs add hundreds more pages to the vast record in this case, in which both sides have recited their favorite pieces of evidence ad nauseum.

The Fed’s amicus brief is something different. Judge Wheeler’s opinion depicted the institution as sneaky and sophistic, asserting legal justifications for actions Fed lawyers knew to be illegal. The Fed’s new filing aims to correct what it considers “misrepresentations” in Judge Wheeler’s version of “the historical record of an important event in the Nation’s financial history.” This brief, in other words, wants to hammer out whatever dents Judge Wheeler put in the reputation of the Fed and its lawyers.

The judge’s most damning conclusion was that Thomas Baxter, general counsel of the New York Fed and Scott Alvarez, general counsel of the Fed’s board of governors, knew the Federal Reserve Act barred the government from taking equity in AIG yet figured out a way around the prohibition. The Fed brief said Wheeler was wrong on both assertions.

Both Baxter and Alvarez, the brief said, were on record well before the AIG takeover advising the Federal Reserve that the government had authority to demand stock from a corporation receiving an emergency loan. In a March 2008 memo, written six months before the AIG loan, Baxter opined that the Federal Reserve Act did not empower the government to rescue a failing company by purchasing its stock but did allow the Fed to insist upon an equity stake as a bailout condition. (Baxter’s staff reiterated that position in June.) Alvarez, meanwhile, emphasized in a memo to the board of governors that the Fed has broad discretion under the law’s bailout provision.

The government did create a trust to hold its AIG shares, the Fed brief said, but that wasn’t – as Judge Wheeler contended – to get around a prohibition on the Fed taking equity in a bailout. Baxter and Alvarez were confident the government could demand equity in a bailout but not entirely sure the Fed could hold onto the shares in the long term. The trust, according to the brief, “eliminated the need to resolve the open legal question about FRBNY’s ‘holding’ the equity.”

Judge Wheeler was also wrong, according to the brief, when he depicted the trust as a vehicle for the Fed secretly to cut out AIG shareholders and gain control of the company. Baxter came up with the idea of a trust based on his involvement with the shutdown of the Bank of Credit and Commerce International in the 1990s, the brief said, “not engaging in circumvention.”

The trust mechanism, according to the Fed, was “a useful and appropriate device to place control of stock in the hands of trustees better suited to cast shareholder votes than Federal Reserve officials.” It also seemed preferable, the brief said, “to avoid having FRBNY retain any economic interest in these shares, so that there would be no appearance of conflict of interest or unfair competitive advantage for AIG.”

When the judge cited excerpts from memos and emails suggesting Baxter and Alvarez had a shadier rationale for the trust, the Fed brief said, he was either quoting unofficial draft documents or ignoring contrary testimony and documents. “The trial court went out of its way to discuss – and, in multiple instances, misstate – the views of Federal Reserve lawyers,” according to the Fed. “The court asserted that (Baxter and Alvarez) believed FRBNY’s obtaining and holding AIG equity would be beyond its legal authority. The record established otherwise.”

There’s lots more in the brief, of course, including a defense of the AIG trustees “disparaged” in Judge Wheeler’s opinion and proclamations of the government’s paramount interest in undoing a decision that could restrict the Fed’s discretion in structuring bailout deals. Mostly, though, the filing seems like an institution standing by lawyers who have served it with loyalty.

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