The district court's curious reading of the Master Account statute: the case of Custodia vs. the Fed - Guest Post by Finnbar Kiely

This guest post from one of my research assistants highlights some flaws in the district court's reasoning in the case of Custodia's master account

Photo by Jason Dent on Unsplash

Note: In 2024, Custodia Bank lost a motion for summary judgment in its effort to require the Federal Reserve Bank of Kansas City to provide it access to the Fed’s payment and financial services. The Bank argued that a critical 1980 law, explained below, required the Fed to play fairly with banks whether or not they were members of the Federal Reserve System. I agreed and agree with the Bank and was retained by its law firm to offer my expert testimony against the Fed for the denial of its access. I think that denial was erroneous not only as a historical matter (which was the basis of my expertise) but also as a matter of law and policy. The policy is especially important: the Fed is now in the cross-hairs for its efforts to be financial judge, jury, and executioner, shrinking its policy space in ways that may influence monetary policy independence.

In this guest post, my excellent research assistant Finn Kiely took a dive into the the district court’s opinion and finds it unpersuasive. Finn speaks for himself and not for anyone else (including me) but I am delighted to give the blog over to him on this basis. Here’s Finn:

Custodia Bank is a Wyoming-based depository institution, founded in 2020 with the goal of “connect[ing] digital assets with the traditional financial system in a safe and sound way”. It seeks to use its status as a bank to conduct transactions between cryptocurrency and dollars in a more efficient, less risky, and less costly manner. Under America’s dual-banking system, state and federal agencies share responsibility for chartering new depository institutions, and banks can seek either a state or federal charter. Accordingly, Custodia chose to take advantage of Wyoming’s flexible special purpose depository institution (SPDI) charter, allowing it to receive deposits and offer custody services while operating on a full-reserve basis.

The Wyoming State Banking Board voted unanimously to approve Custodia’s business model. However, Custodia soon faced an existential challenge when the Federal Reserve Bank of Kansas City (FRBKC) denied it a master account. A master account allows depository institutions to store large sums of money safely, and, critically for Custodia’s business model, to access Federal Reserve payment, clearing, settlement, and liquidity services. Without a master account, a bank is merely “a kind of storage locker”.

The Fed claims that it has discretion over granting master accounts. Custodia takes a different view, arguing that as a legally-eligible, duly chartered depository institution, it is entitled to a master account. Resolving this dispute hinges largely on Section 248a of the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA), which reads as follows:

All Federal Reserve bank services covered by the fee schedule shall be available to nonmember depository institutions and such services shall be priced at the same fee schedule applicable to [Federal Reserve] member banks.

Custodia claims that this passage means the Fed must provide all eligible depository institutions with access to master accounts and the services they enable. Custodia sued the Federal Reserve Board and the FRBKC, and litigation is ongoing at the appellate level.

The US District Court for the District of Wyoming ruled in favor of the Fed, laying out seven reasons why 248a “does not do the lifting Custodia demands of it”. The seventh and final reason provided is that “important policy considerations” support the Fed’s reading of 248a. This post argues that the court gets these arguments wrong, especially in the context of the history of DIDMCA.

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The court envisions serious negative consequences if the Fed is forced to grant all legally eligible depository institutions with access to a master account, fearing that “one can readily foresee a ‘race to the bottom’ among states and politicians” if state regulators are the “only layer of insulation” in the financial system. As a personal opinion, this perspective is reasonable. However, the court then writes that “the potential negative consequences associated with Custodia's proffered interpretation do not suggest Congress intended the DIDMCA to remove the discretion of Federal Reserve Banks”. The court determines that a certain outcome is wrong, and concludes that Congress would thus not have intended it.

As a matter of statutory interpretation, this reasoning is deeply flawed, especially given that the historical evidence suggests Congress reached a decidedly different conclusion about the merits of the dual-banking system. The legislative history of DIDMCA is filled with references to “open access” and “all depository institutions”, and Professor Julie A. Hill writes that “no evidence exists anywhere in the legislative history that Congress intended for the Reserve Banks to pick and choose which depository institutions would receive access to Federal Reserve payments.” There are convincing arguments that Congress has consistently chosen to preserve the role of state bank regulators as “laboratories of innovation” in the financial system. Inherent to this is that states might grant charters to some institutions that federal regulators would not – in the eyes of Congress this is a feature, not a bug.

The court’s reasoning calls to mind the absurdity canon, which states that when a certain reading of a statute produces a result that is egregiously contrary to social values, Congress must not have intended it. Although not explicitly invoked, its influence is clear: the court uses the supposed negative consequences of a certain outcome to argue Congress would not have intended that outcome, and that the statute should be construed differently.

But the “absurdity” condition does not apply in this case. Not only would making master accounts available to all eligible institutions be fully reasonable, but strong evidence indicates it is the precise outcome Congress intended.

The absurdity canon grants the court broad leeway to determine what outcomes are absurd – and what it even means for an outcome to be absurd. The oft-cited standard of “contrary to perceived social values” is vague, and allows the court immense latitude to substitute its own subjective judgements for congressional decision making. The question of how much discretion the Fed should have over master accounts is nuanced and complex, and there are significant tradeoffs involved. This is the precise role of Congress – to balance tradeoffs, make value judgements, and settle difficult questions.

A better approach, to achieve the court’s stated aim of “giv[ing] effect to the legislative will”, is a more rigorous consideration of legislative history. A criticism from Judge Harold Leventhal is that legislative history amounts to “looking over a crowd and picking out your friends”. However, the absurdity canon, to adopt Judge Leventhal’s analogy, allows judges to ignore the crowd entirely and instead make their own judgements as to what the crowd might have intended. For this reason, the absurdity canon provides an opening for flagrant judicial policymaking.

The absurdity canon has been criticized as “threaten[ing]to upset the balance between legislative and judicial power”, and this case is a superb example. The Wyoming District Court is right that “important policy considerations” are at stake in the Custodia case. But these considerations have already been evaluated and addressed by Congress, and Congress should be the ultimate arbiter of how to balance innovation and stability, how to allocate power between state and federal chartering authorities, how to handle the emergence of crypto-assets – and the other complex questions that the Custodia case has surfaced.