The U.S. Supreme Court’s decision in Mayo Found. For Medical Educ. & Research v. U.S. (131 S. Ct. 704) (Mayo) appears to have prescribed greater judicial deference to federal agency regulatory guidance. In Mayo, the Supreme Court held that courts should use the Chevron standard when assessing the validity of an agency’s regulatory interpretations. The Chevron standard provides federal agencies broad discretion and latitude in the interpretation of their regulations, only scrutinizing such interpretations if the promulgating statute is silent on a matter and the agency rule is arbitrary and capricious in substance. The Mayo decision may have a significant impact on many upcoming federal agency rulemakings, including those mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Courts may interpret the Mayo decision as a mandate that all federal regulators, including federal banking agencies, shall be afforded more latitude and deference in the rulemaking process, likely rendering challenges to new rules more difficult. Moreover, federal regulators may be emboldened to enact rules once considered outside their authority and jurisdiction. Therefore, interested parties may want to consider what, if any, regulations they believe should be modified, streamlined, expanded, or repealed, and actively participate in the rulemaking process to ensure their interests are considered before a final rulemaking is published.

Mayo Decision: Expansion of Deference Provided to Federal Agency Interpretations of Regulations

The Mayo decision appears to strengthen the rulemaking powers of federal agencies. To provide context to the Mayo decision, it is important to understand the Department of Treasury (Treasury Department)’s rulemaking mandate. In general the Treasury Department promulgates two types of regulations: 1) “legislative” regulations that are issued pursuant to the Internal Revenue Code of 1986 (IRC); and 2) “interpretative” regulations issued pursuant to a provision of the IRC providing the Treasury Department authority to issue any necessary rules and regulations to implement and enforce provisions of the IRC. Most Treasury Department regulations are considered interpretive in nature.

In Mayo, the petitioner medical clinic claimed that their medical residents satisfied the definition of students under the IRC, and therefore were exempt from Federal Insurance Contribution Act (FICA) taxes. After a notice and comment period, the Treasury Department issued interpretative regulations explicitly stating that medical residents who performed full-time services were not students for purposes of the FICA exemption. The petitioners brought action against the Treasury Department, claiming that its interpretation was impermissible under the IRC. The Supreme Court in Mayo unanimously sided with the Treasury Department and determined that the Treasury Department’s interpretative regulation finding that medical residents were more akin to actual employees rather than students was appropriate and therefore medical residents would not be exempt from FICA taxes.

The Supreme Court in Mayo stated that the Chevron standard, which provides substantial deference to federal agencies’ interpretative rules and permits such interpretations so long as the regulation is a permissible construction of the statute, is the appropriate framework to determine the full-time employee rule. The Supreme Court’s unanimous decision in Mayo was also unequivocal. The court stated that an agency should receive substantial deference in its interpretations and shall only be scrutinized if the interpretation is unreasonable. Before Mayo, the court of appeals were split in their application of Chevron and its predecessor case, National Muffler Dealers Ass’n., Inc. v. United States (National Muffler), to determine the validity of agency interpretive rules. By applying the Chevron standard in Mayo, the Supreme Court seemed to implicitly undermine the standard used in National Muffler. National Muffler used a multi-factor test analysis in determining the validity of regulation, which in practice provides less deference to a federal agency’s regulatory interpretation. Thus, the Mayo decision could be read to provide substantial deference to both Treasury regulatory interpretations and, importantly, other federal agency regulatory interpretations, in context of agency guidance.

Executive Order 13536: Improving Regulation and Regulatory Review

One week after the Supreme Court’s decision in Mayo, President Barack Obama issued Executive Order 13563: Improving Regulation and Regulatory Review (the Executive Order). The major objectives of the Executive Order include allowing public participation in the regulatory process, as well as promoting predictability and reducing uncertainty in the regulatory process. In the context of public participation, the Executive Order stated that each federal agency shall afford the public a meaningful opportunity to comment via the Internet on any proposed regulation, with a comment period that should generally be at least 60 days.

This mandate is particularly relevant in the context of the Mayo decision. As discussed, the Mayo decision appears to provide federal regulatory agencies broad latitude and deference when it comes to a court’s evaluation of the permissibility of a regulation or its interpretation. A heavy burden is placed on a party affected by a particular regulation to seek judicial review or to overturn an agency interpretation of a regulation.

In the wake of the recent passage of the Dodd-Frank Act, various federal banking and securities agencies are releasing a significant number of rules to implement and interpret the legislation. Given both the Executive Order’s promotion of participation of affected parties in the rulemaking process as well as the Mayo decision’s increased deference to federal agencies in the promulgation and interpretation of their regulations, it would be prudent for affected parties to fully participate in any upcoming rulemakings in connection with the Dodd-Frank Act. If affected parties do not participate in the notice and comment period of a proposed rulemaking, to both critique a rulemaking as well as provide commentary on the appropriate way for an agency to regulate or interpret a certain section of the Dodd-Frank Act, the stakeholder may not have another opportunity and substantive arguments may not be recognized by the judiciary once a regulation or interpretation is finalized by the agency.

Federal Agencies Already Appear Emboldened Post-Mayo

In the federal banking context, Federal Deposit Insurance Corporation (FDIC) Chairman Sheila Bair recently indicated, at a American Bar Association Government Relations Summit, that the FDIC plans to promulgate more interpretative guidance to prevent industry excesses. Chairman Bair also stated at the summit that the FDIC plans to issue more interpretative regulations in the near future because the banking industry needs to get past the rhetoric that implies that, when it comes to financial services, the best regulation is always less regulation.

In the context of the Dodd-Frank Act, federal banking agencies have already begun the process of promulgating interpretive guidance. For example, Title III of the Dodd-Frank Act transfers supervisory functions, including interpretative rulemaking related to savings and loans holding companies (SLHCs), from the abolished Office of Thrift Supervision (OTS) to the Federal Reserve. Specifically, the Federal Reserve recently provided a Notice of Intent to Apply Certain Supervisory Guidance to SLHCs. In the notice of intent, the Federal Reserve stated its intention to issue formal guidance interpreting the appropriate standards of capitalization, liquidity, and risk management for SLHCs with principles of safety and soundness that are consistent with the Federal Reserve’s established approach regarding bank holding company supervision. Some of these new standards promulgated in the guidance may not be appropriate for the SLHCs and may be unduly burdensome. Once the interpretative rulemaking process is complete, however, it is likely that the Federal Reserve would receive significant deference from the courts in their interpretations in this context.

Also, in the context of legislative rulemakings in connection with the Dodd-Frank Act, the FDIC recently announced a newly proposed rulemaking on Credit Risk Retention. The proposed rule attempts to implement Section 941 of the Dodd-Frank Act, which requires issuers of securitized loans to retain a 5 percent interest in the risk of loss of such loans. The Dodd-Frank Act provides an exemption to this rule for certain types of lower-risk products. However, Chairman Bair stated in the notice of proposed rulemaking’s press release that she believes this exemption should be narrowly drawn and that properly aligned economic incentives are the best check against lax underwriting standards.

Chairman Bair’s recent suggestion that interpretative guidance and regulations are necessary to improve the stability of the banking sector; the FDIC’s notice of intent to provide interpretative guidance on appropriate levels of capital, liquidity and risk management for SLHCs; and the FDIC’s announcement that they plan to narrowly draft exemptions to the newly proposed risk redemption requirements for securitized loan issuers are additional examples of federal banking agencies arguably pushing the boundaries when promulgating regulations. This interpretative guidance and these legislative rulemakings suggest that stakeholders need to participate in the notice and comment period of such rulemakings if they believe such regulations should be modified, streamlined, expanded or repealed.

Again, the Mayo decision indicates that it may be extremely difficult for an affected party to overturn an agency regulation or interpretation of a regulation in court. The court in Mayo specifically noted that the regulations in question in the case were issued only after notice and comment procedures, a consideration the Supreme Court identified in their precedents as a significant sign that a rule merits greater deference. Therefore, the notice and comment period may provide affected parties their only legitimate opportunity to provide substantive input and to influence a rulemaking.