WASHINGTON — The provision in the Dodd-Frank banking reform law that gives the federal government the power to liquidate big financial institutions may be unconstitutional because it violates the banks’ due process rights, a leading legal scholar told a House subcommittee Tuesday.
Also known as the “orderly liquidation authority,” the provision gives the federal government authority to summarily liquidate a big financial institution that is on the verge of going under. The Federal Deposit Insurance Corporation then becomes receiver of the failed bank’s assets.
Once the treasury secretary mandates the liquidation of a financial institution, the company is afforded just 24 hours to convince the court that a reversal of that decision is warranted.
The initial goal of the provision was to avoid bailouts like the one that saved American International Group Inc. in 2008, ensuring that taxpayers were not culpable for the massive losses that “too big to fail” financial institutions were engendering. Instead, creditors and shareholders would bear responsibility.
But the constitutionality of the judicial review process is now being called into question.
Thomas Merrill, a professor at Columbia Law School in New York City, told the Oversight and Investigations subcommittee of the House Financial Services committee that providing stakeholders with no notice of an impending liquidation is a “super due-process breach” where rights are “vaporized.”
Merrill questioned how a company, in efforts to stave off liquidation, could prove conclusively that its assets were greater than its debts in just one day.
“The statute makes a mistake in trying to push judicial review into this extremely truncated 24-hour review,” he said.
Another factor clouding the law’s constitutionality is that company officials are required to remain silent if their financial institution is being considered for liquidation.
“The [statute] makes it a federal crime to recklessly disclose that a proceeding is taking place,” Merrill said. “They cannot leak this to The New York Times or The Washington Post without being carted off to jail.”
“Potentially there will be due process violations and all kinds of shareholders will have incentives to raise their concerns,” he said.
Subcommittee Chairman Rep. Patrick McHenry, R-N.C., said Merrill’s testimony shows that the Dodd-Frank banking reform law only “pretends to end too-big-to-fail.”
But some Democrats on the subcommittee disputed the criticisms of the provision.
“You can challenge any legislation on its constitutionality, but the question is, will you prevail,” said Rep. Al Green, the top Democrat on the subcommittee.
“We must move forward with Dodd-Frank. We must bring certainty to the market that it richly deserves.”