2550 M Street, NW                                                                                                 Washingt...
MemorandumPage 2institutions. Lawsuits subsequently filed against federal thrift institutions have been dismissed on theba...
MemorandumPage 3standard has not been changed that dramatically. The Act preserves and essentially affirms federalbanking ...
MemorandumPage 4D.       The Standard for Future Preemption ChallengesFor both national banks and federal thrift instituti...
MemorandumPage 5F.      No Continued Applicability of Preemption to Operating SubsidiariesThe Act explicitly overrules a s...
MemorandumPage 6Act) that specifically address the application of state law in relation to that federal law. 25 Except for...
MemorandumPage 7This Memorandum is provided by Patton Boggs LLC for educational and informationalpurposes only and is not ...
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MEMO: Preemption Rules Applicable to Banks and Thrift Institutions After the Dodd-Frank Act


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MEMO: Preemption Rules Applicable to Banks and Thrift Institutions After the Dodd-Frank Act

  1. 1. 2550 M Street, NW Washington, DC 20037 202-457-6000 ____________ Facsimile 202-457-6315MEMORANDUMTo: Clients and FriendsDate: December 2, 2010Subject: Preemption Rules Applicable to Banks and Thrift Institutions After the Dodd-Frank ActI. IntroductionAs has been much publicized, the Dodd-Frank Wall Street Reform and Consumer Protection Act(the “Act”), which was signed into law on July 21, 2010, will have a major impact on the way thatconsumer financial products and services are regulated. Issues related to the preemption of stateconsumer protection laws as applied to national banks and federal thrift institutions, as well as theauthority of states to enforce consumer protection laws generally, are directly addressed by the Act.These provisions were among the most controversial included in the Act. In certain importantrespects, the Act preserves current federal banking preemption laws and codifies Supreme Courtprecedents regarding those laws. However, the Act also changes in significant ways the balancebetween state and federal regulation of consumer financial services.This Memorandum briefly reviews federal bank and thrift institution preemption law prior to theAct and explains the changes (and “clarifications”) to the law as set forth in the Act. In so doing, weidentify areas that banks and thrift institutions will need to address directly in order to deal withsome of the changes brought about by the Act.Perhaps the most significant change to preemption law in the Act is the elimination of the broadextension of preemption that has developed under the National Banking Act (“NBA”) and theHome Owners’ Loan Act (“HOLA”), the primary two laws governing the activities of nationalbanks and federal thrift institutions, respectively, to operating subsidiaries of national banks andthrift institutions. 1 This provision and the ramifications that may result therefrom are discussed inmore detail in Part III, Section F below.II. Existing lawFederal preemption of state law in the banking sector has been greatly expanded over the priortwenty years. For federal thrift institutions, courts have interpreted the HOLA and regulationsissued by the Office of Thrift Supervision (“OTS”) as extending “field preemption” 2 to federal thrift 1 Sections 1044 and 1046 of the Act. 2 Courts will infer an intention to preempt state law if the federal regulatory scheme is so pervasive as to“occupy the field” in that area of the law. Gade v. National Solid Wastes Mgmt. Ass’n. 505 U.S. 88, 98 (1992). In 1982,the Supreme Court ruled in Fidelity Federal Savings and Loan Assn. v. de la Cuesta, 458 US 141 (1982), that the OTSand its predecessor agency, the Federal Home Loan Bank Board, had the authority to issue rules that preempt state lawsfor federal thrift institutions. As a result, the OTS issued a rule in 1996 that “occupied the field” of federal thrift lending ATTORNEY ADVERTISING
  2. 2. MemorandumPage 2institutions. Lawsuits subsequently filed against federal thrift institutions have been dismissed on thebasis of preemption.For national banks, there has been a gradual expansion of preemption from courts, Congress and byinterpretation by the Office of the Comptroller of the Currency (“OCC”) over this period.Practitioners have considered such expansion as tantamount to de facto field preemption fornational banks. The recent trend began following the passage of the Riegle-Neal Interstate Bankingand Branching Efficiency Act in 1994, which allowed national banks to establish branches acrossstate lines. An OCC interpretive letter issued after its passage asserted that Riegle-Neal gave nationalbanks the power to “export” the interest rates of both the state where the bank was headquarteredand the state in which a branch was located. 3 This interpretation allowed banks to take advantage ofthe most favorable interest rates, which has become known as the “most favored lender doctrine.”The doctrine has become one of the hallmarks of federal preemption in the banking sector. Asdiscussed below, this important interpretation has been specifically preserved by the Act. 4In 1996, the Supreme Court in the seminal case of Barnett Bank of Marion, N.A. v. Nelson, FloridaInsurance Commissioner, et. al. 5 invalidated a state insurance law that prohibited national banksfrom selling insurance in small towns in Florida, holding it was preempted by a federal lawpermitting national banks to sell insurance in towns with small populations. The Supreme Courtheld that a state law that “prevents or significantly interferes” with a national bank’s exercise of itspowers is preempted. The Barnett Bank case set a new standard for preemption decisions. As aconsequence and relying on this decision, the OCC began a significant expansion of preemption lawfor national banks.Finally, in 2004, the OCC issued two expansive rules: (i) a preemption regulation providing thatnational banks and their operating subsidiaries were not subject to state laws that “obstruct, impairor condition” a bank’s exercise of its federally authorized powers to make loans or take deposits, 6and (ii) a “visitorial powers” regulation that restricted the authority of states to examine andsupervise national banks, making such examination and supervision the exclusive province of theOCC. 7III. Changes to Existing LawA. OverviewFrom the standpoint of analyzing federal preemption as a result of the Act, the Act divides statelaws essentially into “state consumer financial laws”--as defined, and state laws that are not “stateconsumer financial laws.” By the specific language in the Act, it is intended to “clarify” thepreemption standard for “state consumer finance laws.” As discussed below, the current legalregulation. As a result, federal thrifts were not required to comply with any state laws that regulated lending, except withrespect to subjects identified in the OTS rule and other federal laws. 3 PL 103-328, 108 Stat. 2338 (1994). OCC Interpretive Letter No. 686, September 11, 1995. 4 See III G. “Aspects of Preemption and State Law that Remain Unchanged,” below. 5 517 U.S. 25 (1996). 6 12 CFR § 7.400, 69 Federal Register 1904 (January 13, 2004). 7 12 CFR § 7.407, § 7.409, § 34.4, 69 Federal Register 1904 (January 13, 2004). ATTORNEY ADVERTISING
  3. 3. MemorandumPage 3standard has not been changed that dramatically. The Act preserves and essentially affirms federalbanking preemption laws and precedents already in effect. Significantly, however, the Act does notmodify preemption standards for state laws that are not “state consumer finance laws.” Thus, afterthe preemption provisions of the Act go into effect, 8 every preemption analysis under the NBA andHOLA will focus on whether the provision in question involves a “state consumer financial law.”B. Definition of “State Consumer Financial Law”The Act adds a provision to the NBA which defines a state consumer financial law as “a State lawthat does not directly or indirectly discriminate against national banks and that directly andspecifically regulates the manner, content, or terms and conditions of any financial transaction . . . ,or any account related thereto, with respect to a consumer. 9 ” The Act also incorporates thisdefinition and the related preemption provisions into HOLA. 10 Thus, the state law in question maynot discriminate against national banks, and also must meet several requirements to be a stateconsumer financial law under the NBA or HOLA: (i) it must regulate the manner, content, or termsand conditions of a financial transaction or account; (ii) it must do so “directly and specifically;” and(iii) the financial transaction or account that the law regulates must be “with respect to aconsumer.” 11C. How Future Preemption Determinations Are to be MadeIn a change from current law, the Act provides that courts and the OCC must make preemptiondeterminations on a case-by-case basis with respect to particular state laws, and can no longer relyon blanket preemption determinations like the OCC’s 2004 regulations or the OTS’ broad fieldpreemption. In addition, the standard for judicial review of regulatory determinations will changeunder the Act. Previously, courts accorded a high level of deference to regulatory determinations.Courts generally deferred to an agency’s permissible construction of statutes administered by thatagency. 12 Under the Act, courts must now assess the thoroughness of the OCC’s consideration, thevalidity of the OCC’s reasoning, the consistency with other determinations made by the OCC, andany other factors that the court finds persuasive and relevant to its decision. 13 8 The preemption amendments go into effect on the “designated transfer date,” which is also the date thatmany of the consumer protection enforcement powers of the existing federal agencies are consolidated in the newBureau of Consumer Financial Protection (“Bureau”). The Treasury Secretary is required to fix the designated transferdate within 60 days of the Act becoming law. The date cannot be sooner than six months after the Act becomes law,and (unless the Treasury Secretary submits a report to Congress explaining reasons for a delay) not later than one yearafter the Act becomes law. Sections 1048 and 1062 of the Act. 9 Section 1044 (a) of the Act. 10 The Act amends HOLA to provide, in essence, that HOLA preempts state laws for federal thrifts to thesame extent that the NBA preempts state laws for national banks. Section 1046 of the Act. 11 Section IIIG. “Aspects of Preemption Law that Remain Unchanged,” below, addresses areas of consumerlaw that do not fall within this definition and are therefore outside of the Act’s parameters. 12 Chevron, U.S.A. v. Natural Resources Defense Council, 467 U.S. 837 (1984). 13 Section 1044 (b)(5) of the Act, which uses standards set out by the Supreme Court in Skidmore v. Swift &Co., 323 U.S. 134 (1944). ATTORNEY ADVERTISING
  4. 4. MemorandumPage 4D. The Standard for Future Preemption ChallengesFor both national banks and federal thrift institutions, the standard for determining whether stateconsumer financial laws will be preempted rests on a determination of whether such law: (i)discriminates against national banks; (ii) “prevents or significantly interferes with the exercise by thenational bank of its powers,” as stated in the Barnett Bank case; or (iii) is preempted by anotherfederal law. 14State laws rarely discriminate against national banks. Accordingly, the relevant inquiry will generallybe whether state laws prevent or significantly interferes with a national bank’s powers or whether anexisting federal law covers the subject. Since the Barnett Bank decision was issued, courts haveinterpreted the standard set forth therein to preempt the majority of state laws aimed at regulatingnational banks’ activities. The Act codifies the Barnett Bank standard and national banks willcontinue to rely on this favorable precedent. 15 Courts and the OCC will continue to analyzepreemption questions in light of the Barnett Bank case and subsequent court decisions. However,because the OCC and courts are required by the Act to make preemption decisions on a case-by-case basis, 16 it is likely that significant litigation will ensue, with the focus on whether particular stateconsumer financial laws prevent or significantly interfere with a bank’s powers.E. Enhanced State Scrutiny and InitiativeWhile parties may debate whether and to what extent the Act modifies the current law andregulation with respect to federal preemption, at a minimum the Act will produce increased scrutinyof national banks and federal thrift institutions by states and local authorities. State attorneys generalwill now be authorized to enforce the Act as well as regulations issued by the Bureau. The Actmakes clear that state laws that provide greater consumer protection than federal law are notnecessarily preempted. 17 Also, the Act also upholds a recent Supreme Court decision that allowsstates to sue national banks and federal thrift institutions to enforce non-preempted state laws. 18Therefore, both state attorneys general and state agencies may be more active in enforcementactions.The Act also creates a mechanism for states to impact federal law directly by requiring the Bureau toissue a notice of proposed rulemaking when a majority of states “enact” a “resolution” in support ofthe establishment or modification of a consumer protection regulation. 19 The Act does not statewhat type of state action is required to trigger this obligation. The Bureau is not required to adoptany proposal endorsed by the states, but if it chooses not to adopt a rule based on the stateresolutions, it must explain its decision. 20 14 Section 1044 (b)(1) of the Act. 15 Section 1044 (b)(1)(B) of the Act. 16 Section 1044 (b)(3) of the Act. The OCC is required to consult with the Bureau and take its views intoaccount in rendering a decision. 17 Section 1041 (a)(2). 18 Cuomo v. Clearing House Association, LLC, 129 S. Ct. 2710 (2009). 19 Section 1041 (c)(1) of the Act. 20 Section 1041 (c)(2),(3) of the Act. ATTORNEY ADVERTISING
  5. 5. MemorandumPage 5F. No Continued Applicability of Preemption to Operating SubsidiariesThe Act explicitly overrules a substantial body of case law, including a recent Supreme Courtdecision, 21 in providing that operating subsidiaries and affiliates of national banks and federal thriftinstitutions will now be subject to state law. 22National banks and federal thrift institutions have basically two options for their operatingsubsidiaries. One is to merge the operating subsidiaries into the parent. The other option is to bringthe operating subsidiaries into compliance with state law, which could include obtaining a number ofstate licenses, depending on the specific activities in which the operating subsidiaries engage.Because many states do not provide exemptions from licensing requirements and other lawsregulating financial transactions for subsidiaries or affiliates of depository institutions, the repeal ofpreemption for operating subsidiaries could significantly impact their ability to rely on anyexemptions granted to them by state law.For example, the repeal of preemption for operating subsidiaries does not change the exemption inthe S.A.F.E. Mortgage Licensing Act (the “SAFE Act”) for loan originators employed by banksubsidiaries. 23 Significantly, however, states may go beyond the exemption provided in this law andimpose a licensing requirement on these loan originators. The SAFE Act, which became law in2008, essentially requires every “loan originator” to be licensed under state law (subject to certainexceptions), unless the loan originator is an employee of: (i) a depository institution; (ii) a subsidiaryof a depository institution that is (i) owned and controlled by a depository institution; and (ii)regulated by a federal banking agency; or (iii) an institution regulated by the Farm CreditAdministration. 24Because the SAFE Act does not expressly preempt state laws that require loan originators employedby such subsidiaries to obtain state licenses, the repeal of preemption for operating subsidiaries willpermit states to require employees of operating subsidiaries to obtain state licenses should they sochoose. The model state law to implement the SAFE Act proposed by the Conference of StateBank Supervisors and the American Association of Residential Mortgage Regulators incorporatedthe exemption in the SAFE Act for employees of bank subsidiaries that are registered with theNationwide Mortgage Licensing System and Registry to be established by the federal bankingagencies. Most states adopted this model law without changing this exemption. We will need tomonitor state activity in this area. Although it would be contrary to federal law, in view of the scaleback of federal preemption that has occurred, some states may attempt to remove this exemption inan attempt to license loan originators of bank subsidiaries.G. Aspects of Preemption and State Law that Remains UnchangedThe Act explicitly preserves preemption and other provisions in other federal laws (such as theEqual Credit Opportunity Act, the Truth in Lending Act and the Real Estate Settlement Procedures 21 Watters v. Wachovia Bank, N.A., 550 U.S. 1 (2007). 22 Sections 1044 and 1046 of the Act. 23 12 U.S.C. § 5103 (3)(A)(i) 24 12 U.S.C. § 5103 (3)(A)(i)-(iii) ATTORNEY ADVERTISING
  6. 6. MemorandumPage 6Act) that specifically address the application of state law in relation to that federal law. 25 Except forthe Act’s provisions which relate specifically to preemption for national banks and federal thriftinstitutions, the Act itself cannot be construed to affect the application of any state law, except tothe extent that a state law is “inconsistent” with the Act, 26 and a state law that provides greaterprotection than the Act is not deemed “inconsistent” with the Act. 27Finally, the Act preserves the provisions of the NBA that have been interpreted to provide for the“exportation” of interest rates from the bank’s home state. Specifically, the Act expressly providesthat banks will maintain their ability to charge interest at the rate allowed by the laws of the state inwhich they are located. 28 Under the definition of “interest” in the applicable OCC and OTSregulations, this provision would include not only interest on loans, but other types of feesconnected with the extension of credit, such as late fees, insufficient fund fees, over limit fees,annual fees, cash advance fees, and membership fees.It is also arguable that there are a number of state consumer laws that are not impacted by the Actbecause of the way that “state consumer finance law” is defined, including laws that impose licensingrequirements, 29 laws that regulate unfair or deceptive practices 30 and laws that regulate advertising. 31H. No Retroactive Application to Existing ContractsThe new preemption standards will not apply to any contract entered into by national banks orfederal thrift institutions prior to enactment. The Act and rules to be promulgated by the Bureau donot alter the applicability of OCC or OTS preemption regulations, orders, guidance orinterpretations with respect to any “contracts” entered into by OCC- or OTS-regulated entities andtheir subsidiaries on or prior to the enactment of the Act. 32 This provision should prevent theapplicability of state laws to contracts entered with consumers prior to the Act’s enactment, such ascredit and ATM card agreements, deposit accounts, and similar contracts. However, how the Actwill apply to new extensions of credit made after the enactment of the Act under existing lines ofcredit or credit card accounts is not addressed in the Act. # # # # 25 Section 1041 (b) of the Act. 26 Section 1041 (a)(1) of the Act. 27 Section 1041 (a)(2) 28 Section 1044 (f) of the Act. 29 A requirement that a company obtain a license before engaging in a financial transaction arguably does notregulate the manner, content or terms and conditions of the transaction. 30 Laws that prohibit unfair and deceptive business practices (“UDAP laws”) are frequently used by stateattorneys general and plaintiffs’ attorneys to impose rules on lenders, servicers, and other providers of financial servicesto consumers. To the extent that UDAP laws do not “specifically and directly” regulate financial transactions oraccounts, they would not be considered “state consumer financial laws.” 31 Rules on advertising arguably do not regulate the manner of a financial transaction, nor do they regulate thecontent or terms of a financial transaction. Rather, advertising rules regulate the manner by which a financial institutionmay communicate its products and services to the public. 32 Section 1043 of the Act. ATTORNEY ADVERTISING
  7. 7. MemorandumPage 7This Memorandum is provided by Patton Boggs LLC for educational and informationalpurposes only and is not intended and should not be construed as legal advice. ThisMemorandum is considered advertising under applicable state laws.Please do not hesitate to contact us if you have general questions or if we can be of anyparticular assistance to you. Norman B. Antin Jeffrey D. Haas nantin@pattonboggs.com jhaas@pattonboggs.com (202) 457-6514 (202) 457-5675 ATTORNEY ADVERTISING 5129545