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From Banking and Finance Law Daily, January 30, 2014

Application of Delaware fiduciary duty laws to New York Fed’s AIG bailout was preempted

By Richard A. Roth, J.D.

Federal common law preempted the application of Delaware state fiduciary duty laws to the Federal Reserve Bank of New York’s actions when it bailed out American International Group in 2008, the U.S. Court of Appeals for the Second Circuit has decided. Applying the state laws to the federal reserve bank’s actions would interfere with the bank’s ability to protect federal interests in stabilizing the national economy, the court said (Starr International Company, Inc., Federal Reserve Bank of New York, Jan. 29, 2013, Walker, Circuit Judge).

Shareholder’s claims. According to the complaint by Starr International Company, Inc., the company was AIG’s principal shareholder in 2008 when AIG warned the federal government that liquidity problems might force it to file for bankruptcy. To prevent that, the New York Fed offered to create an $85 billion credit facility at an initial interest rate of 14.5 percent. As part of the arrangement, AIG was to give the federal government an 80 percent interest in AIG common stock that would be placed in trust.

Due to statute of limitations issues, the court said, Starr could not challenge the terms of the initial bailout; however, it did complain about two subsequent financial transactions:

  • the creation of the Maiden Lane III special vehicle, funded by AIG and the New York Fed, to buy $62 billion in assets from AIG credit default counterparties at par value; and

  • the conversion of AIG preferred stock held by the trust to common stock.

Starr asserted that the New York Fed had a fiduciary duty to AIG and breached that duty by participating in these transactions.

The U.S. District Court for the Southern District of New York dismissed Starr’s suit. According to the district court, Starr failed to show that the New York Fed was AIG’s fiduciary under Delaware laws and, even if the bank was a fiduciary, the state laws were preempted. The appellate court reviewed only the preemption ruling.

Basis for preemption. The application of state laws to areas of “uniquely federal interests” is preempted, the court began. The New York Fed’s bailout of AIG at the height of the financial crisis presented such a federal interest, and that interest would be compromised by the application of Delaware laws on fiduciary duties.

The New York Fed is a fiscal agent of the United States that is an instrumentality of the federal government, the court said. While the bank has shareholders, it is not operated for those shareholders’ profit; instead, the New York Fed, like all of the federal reserve banks, is operated to further the federal government’s fiscal policies.

According to the New York Fed, its AIG bailout was completely authorized by federal law. The Federal Reserve Act gives it both the authority to make emergency loans (12 U.S.C. §343, as in effect in 2008) and the incidental powers to engage in the business of banking (12 U.S.C. §341). On the other hand, Starr asserted that the bailout activities exceeded the New York Fed’s powers.

Scope of preemption. The court decided that it did not matter whether the New York Fed had, in fact, gone too far. Preemption is not limited in its scope to the lawful operation of a federal instrumentality. The states simply have no authority to control the activities of a federal instrumentality in any manner, the court concluded.

If Delaware laws were permitted to make the New York Fed a fiduciary of AIG, the bank would be required to protect AIG’s interests and act in the best interests of AIG’s shareholders, the court pointed out. This would directly conflict with the bank’s obligation to act in the public interest as a fiscal agent of the federal government. Such a direct conflict required the preemption of the state laws.

Background on Starr International Company. Starr’s board chairman and managing director is Maurice Raymond “Hank” Greenberg, who was chairman and CEO of AIG until 2005. Greenberg has been highly critical of the New York Fed’s treatment of AIG, claiming that it inappropriately benefitted foreign credit default counterparties at the expense of AIG shareholders. A separate suit by Starr raising constitutional claims against the federal government is pending in the U.S. Court of Federal Claims.

The case is No. 12-5022-cv.

Attorneys: David Boies (Boies, Schiller & Flexner LLP) for Starr International Company, Inc. John S. Kiernan (Debevoise & Plimpton LLP) for Federal Reserve Bank of New York. Joseph S. Allerhand (Weil, Gotshal & Manges LLP) for American International Group, Inc.

Companies: American International Group, Inc.; Starr International Company, Inc

MainStory: TopStory FederalReserveSystem FinancialStability Preemption ConnecticutNews NewYorkNews VermontNews

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