Jan 17, 2024 - Economy

Custodia Bank presents "Exhibit BS" in its lawsuit against the Fed

Illustration of a crumpled dollar bill with binary code over it

Illustration: Sarah Grillo/Axios

A court battle between a novel bank that wants to do business in crypto and the Federal Reserve Board is coming to a head.

Zoom in: The central question in this case is whether a politically motivated Fed intervened in a process conducted by one of the reserve banks it oversees, wrongfully denying Custodia Bank a Fed master account.

The big picture: One major unresolved question that reared its head in 2023 relates to Operation Choke Point 2.0.

  • Crypto is arguing that it is being unfairly shut out from key services like banking, whereas bank regulators have justified their arm's-length stance, citing systemic risk.
  • A win for Custodia may not be a broader win for crypto, but could open the door for other banks that want to do business with the industry.

Catch up fast: The bank first sued in June 2022, saying the Kansas City Fed had taken months to decide on its master account application, though the process was supposed to take days.

  • Now, Custodia is arguing that it was held to different standards and subject to Kafkaesque bureaucratic processes, described as "a ploy to derail Custodia's master account application."
  • In December it filed for summary judgment, publishing evidence surfaced through discovery that would appear to prove that point.
  • See Exhibit BS.

Between the lines: Exhibit BS shows that the Fed Board's line edits, which were made with comments and initials of the Fed staff member who made them, effectively reversed the Kansas City Fed's initially positive assessment.

  • Where the Kansas City Fed previously deemed Custodia Bank's capital "adequate," it was changed to say there was "a lack of a robust capital requirement framework" in its state-chartered bank assessment, Custodia claims.
  • Where Kansas City once saw Custodia's management experience as "impressive" and "extensive," it then described them as showing a "lack of collective depth of relevant banking experience," according to the filing.
  • In one comment, a Fed staffer with the initials KJ said that it would be "important" to highlight the additional risks "that have been illustrated in the recent crypto market meltdown." (Though Custodia's business had nothing to do with FTX's fraud nor the credit collapse of 2022.)
  • The same staffer also suggested referring to an interagency statement in which the OCC, the Fed Board and the FDIC warned of crypto risks to banks, "given that Custodia is proposing issuing a stablecoin."

Of note: A letter written by now-retired bank examiner Katie Cox, who is advising Custodia, outlined 23 complaints and irregularities in how the bank was treated. She wrote:

  • "We urge the Office of the Inspector General to consider whether this approach by the Federal Reserve system to require 'relevant banking experience' might actually be a form of systemic discrimination."

What we're watching: The court's decision on that matter could come by late March, and if it agrees with Custodia, it would order the Fed to grant the bank a master account — an immediate win for Custodia.

  • If the court defers judgment, the case would go to a bench trial in April — that is, a trial without a jury.
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