MANHATTAN (CN) - Federal rescue efforts that in 2008 kept the country from falling off a fiscal cliff should not be scrutinized under state law, the 2nd Circuit ruled.
Starr International Co., once the principal shareholder of American International Group, argued that actions taken by the Federal Reserve Bank of New York to keep AIG solvent really worked to the detriment of the company and its shareholders.
The company's former head, Maurice "Hank" Greenberg, also once led AIG.
In its 2011 complaint
, Starr alleged that the bank's post-bailout actions amounted to breach of fiduciary duty and aided and abetted AIG's officers in doing the same.
The Federal Reserve Bank's rescue deal for AIG included an $85 billion credit facility in exchange for an 80 percent stake in AIG through common stock to be held in a trust.
It had stepped in with the bailout after the collapse of investment bank Lehman Brothers Holdings in mid-September 2008, and the downgrading of AIG's credit rating, left AIG on the brink of bankruptcy.
In the preceding months, the U.S. financial and credit markets had been sagging under the weight of subprime mortgage delinquencies, and AIG faced increasing liquidity pressure from collateral calls by counterparties on its credit default swaps - a kind of insurance for debt securities.
After the bailout, Starr's lawsuit accused AIG of creating a special vehicle called Maiden Lane III to purchase $62 billion in assets from AIG's credit default swap counterparties at full par value, giving them "backdoor bailouts" to the detriment of the company.
Starr also said AIG was required to issue preferred stock to the trust that would be convertible to the government's 80 percent common stock stake but that other shareholders had no say in approving that provision.
U.S. District Judge Paul Engelmayer dismissed the lawsuit in November 2012, however, after finding that Starr failed to show that the Federal Reserve Bank was a fiduciary to AIG under the law of Delaware, where the company was incorporated.
He said the bank's overarching federal duties pre-empted state law in any case.
A three-judge panel of the federal appeals court affirmed Wednesday, with Judge John M. Walker Jr. noting that, "because of the uniquely federal interests at stake in stabilizing the national economy, state fiduciary-duty law does not apply to FRBNY's rescue activities in this case and that it is preempted and replaced by federal common law."
Indeed, the 12 regional banks in the U.S. Federal Reserve System were created to further national fiscal policy and are recognized by the courts to be "instrumentalities of the federal government," according to the ruling.
As far back as the 1819 decision McCulloch v. Maryland
, the Supreme Court has held that states have no power to tax or otherwise impede a federal instrumentality. More recently, the Supreme Court ruled that in areas of "uniquely federal interests," state law does not apply. Instead, so-called federal common law prevails.
If Delaware fiduciary-duty law were to govern the actions of the Federal Reserve Bank of New York, the bank would be more beholden to AIG than to the national economy, the court found.
"This private duty would present a significant and direct conflict with FRBNY's obligation to act in the public interest as a fiscal agent of the United States and to take action in 'unusual and exigent circumstances' when its failure to act 'would adversely affect the economy,'" Walker wrote, citing provisions of U.S. code.
"Because of the uniquely federal interests at stake in FRBNY's rescue of AIG, at the height of the 2008 financial crisis, which would be compromised by the application of state fiduciary-duty law, we hold that federal common law preempts state fiduciary-duty law and provides the rule of decision."
Judges Debra Ann Livingston and Denny Chin joined Walker in the decision.
David Boies of Boies, Schiller & Flexner in Armonk argued for Starr. Joseph Allerhand of Weil, Gotshal & Manges in Manhattan represented nominal defendant-appellee AIG.
John Kiernan of Debevoise & Plimpton in Manhattan represented the Federal Reserve Bank.
The Wall Street Journal quoted a statement from Boies on Wednesday that says the 2nd Circuit decision addressed only the "narrow issue" of pre-emption and would have no effect on Starr's case
in the U.S. Court of Federal Claims that challenged the bailout on constitutional grounds.