By Travis P. Nelson
Picture this: The country is in the midst of a nationwide financial crisis characterized by widespread foreclosures. A period of economic expansion and prosperity, fueled by imprudent financiers operating in a market that encouraged speculation and risky lending, has suddenly come to an end. Moreover, an attorney representing a state government is in federal court arguing that the federal status of a bank does not prevent the host state from enforcing otherwise generally applicable state law against a federally chartered institution.
Sound familiar? The War of 1812 had recently ended, market speculators were rampant, underwriting was far from safe and sound, and the Panic of 1819 had hit. The case, of course, was McCulloch v. Maryland, and the federally chartered bank at issue was the Second Bank of the United States. Although the country is in a different kind of war, and the nature of the market disruption has changed, the debate over the role of state action against federally-chartered banking institutions continues.
In Clearing House Association v. Cuomo, New York recently hosted one of the latest rounds in the debate between the Office of the Comptroller of the Currency (OCC) and state regulators. In this case, the Manhattan-based U.S. Court of Appeals for the Second Circuit (having jurisdiction over New York, Connecticut and Vermont), held that Attorney General Andrew Cuomo lacked the authority to obtain bank records in connection with an investigation of alleged racial discrimination in residential real estate lending.
What made this case interesting, versus other attempts by state regulators to interfere with the OCC’s supervisory powers, is that the attorney general argued that the exercise of state power would not conflict with federal banking power, but would rather supplement federal enforcement of federal civil rights laws. Unlike other cases where the state was attempting to apply a substantive law that was plainly contradictory to federal law, or where state enforcement conflicted with federal supervision, here Attorney General Cuomo argued that his power to enforce civil rights laws was permissible under the federal Fair Housing Act, and therefore not preempted by the National Bank Act (NBA). The court rejected the attorney general’s argument, finding that the OCC retained exclusive power to supervise the lending activities of national banks.
Preemption of Agents
Whereas in 2007 the U.S. Supreme Court, in Watters v. Wachovia, brought finality to the question of whether states may regulate operating subsidiaries of national banks, holding that operating subsidiaries are subject to the exclusive supervision of the OCC, in PGGC v. Ayotte, the Boston-based U.S. Court of Appeals for the First Circuit (which includes Maine, Massachusetts, Rhode Island and Puerto Rico) addressed the next round of the preemption debate: Do states have the power to regulate the activities of third-party agents acting on behalf of national banks? The Ayotte court looked to the NBA language permitting national banks to use “duly authorized officers or agents” in the exercise of their incidental powers.
Further, in rejecting the state’s argument that the OCC preemption regulation at issue was irrelevant, as it covered banks and not third-parties, the Ayotte court followed the guidance of Justice Ruth Bader Ginsburg in Watters, stating “this analysis is too formalistic: the question here is not whom the New Hampshire statute regulates, but rather, against what activity it regulates.” In applying both the NBA and the Home Owners Loan Act (HOLA) governing federal savings associations, the Ayotte court held that national banks and federal savings associations may exercise their preemptive powers through agents free of state law restrictions. In other words, at least in the First Circuit, if a state law restriction would be preempted as applied to a national bank or federal savings association, then that law would be preempted as applied to agents of those institutions insofar as such agents are performing activities on behalf of their federally chartered principals.
In October 2007, the Manhattan-based Second Circuit issued its decision in SPGGC v. Blumenthal, involving two provisions of Connecticut law that prohibited a bank from issuing gift cards that (1) imposed inactivity or dormancy fees and (2) contained an expiration date. The gift cards were issued by Bank of America, a national bank and member of the Visa system. The gift cards in question included a dormancy fee, imposed on the unused balance after six months, and a one-year expiration date. The Connecticut attorney general charged that SPGGC had violated the Connecticut Gift Card Law, and informed SPGGC that it intended to bring an enforcement action to curtail the offending practices. SPGGC filed suit in federal court seeking a declaratory judgment and injunctive relief on the basis that the NBA preempted Connecticut’s Gift Card Law and that SPGGC was acting as an agent of a national bank in this instance and therefore is entitled to the NBA’s protections.
The lower court dismissed SPGGC’s complaint, ruling that the NBA did not preempt the provisions of the Gift Card Law in question. On appeal, the Second Circuit agreed with the lower court’s ruling that the Gift Card Law could prohibit the imposition of dormancy and inactivity fees collected by SPGGC because those fee restrictions only affected SPGGC, and not the national bank.
On the expiration date matter, the Second Circuit took a different view. Because Visa required member banks, including Bank of America, to set expiration dates on their products, the state law prohibition on them would interfere with a national bank’s ability to exercise its powers under the NBA to issue gift cards. As such, state interference with the expiration date provisions of the gift card product was preempted. Unlike Ayotte, in which the First Circuit held that Watters v. Wachovia is equally as applicable to national bank agents as it is to operating subsidiaries, the Second Circuit in Blumenthal took the view that Watters is limited to operating subsidiaries: “[W]e believe that it would be a mistake to read Watters so broadly as to obscure the unique role assigned to operating subsidiaries in the context of national banking regulation.”
Even though the Second Circuit took a narrower view of Watters than the First Circuit did, it acknowledged that under the right circumstances, NBA preemption of state law could be available to an agent. The Blumenthal court distinguished its holding from that in Ayotte on the facts, focusing on the degree of agency and the extent to which the fees were determined by the national bank versus the non-bank third party. The lesson of both Ayotte and Blumenthal is that the less discretion a bank allows its agent in the performance of bank-related activities, the more likely state interference will be preempted.
A federal district court in Ohio, in State Farm Bank, F.S.B. v. Reardon, reached an alternate result to Ayotte and Blumenthal, holding instead that exclusive agents of a federal savings association are subject to state mortgage broker laws, notwithstanding the assertion of preemption by the Office of Thrift Supervision (OTS). In response to the attempts by John Reardon, superintendent of the Ohio Division of Financial Institutions, to enforce state law against the exclusive agents of State Farm, the company argued that application of Ohio law to exclusive agents of a federal savings association is preempted by HOLA and implementing regulations promulgated by the OTS. These regulations were evidenced by an OTS chief counsel opinion letter addressing the precise State Farm activities at issue. The court rejected State Farm’s argument that the Ohio law is preempted. Under the facts and circumstances before the court, the court did acknowledge that the OTS might very well have preemptive authority in this matter, but even if it did, the exercise of such authority had not yet been properly established by the agency. The court rejected the validity of the OTS chief counsel opinion letter, holding that the letter attempted to change the law and the agency’s existing policy but was not the product of notice-and-comment rulemaking under the Administrative Procedures Act, and therefore was not entitled to deference. The court determined that the underlying statute and regulations provide no support for the proposition that non-employee third-party exclusive agents are exempt from state regulations.
Most observers of the trends in preemption might have thought that under the above-quoted language from Ayotte that the Ohio court, even if it viewed the OTS State Farm Opinion Letter as flatly over-reaching, would have undertaken an analysis like the Ayotte court and found a statutory basis for preemption. Instead, the Ohio court viewed the Watters holding as applying only to banks and their operating subsidiaries, and that absent a controlling regulation, there was no legal basis for preempting application of state law to agents. There are definite problems with this decision, for example, that it acknowledges the possibility that the OTS could promulgate a preemption regulation, while such practice is at least called into question by Watters, and that it declines to address application of Ayotte.
What to Expect
In the end, thus far the federal courts that have addressed the issue of whether agents of national banks and federal savings associations are entitled to preemption to the same extent as their federally chartered principals have been in general agreement to the extent that they all seem to agree that given the right attendant circumstances, such preemption would be available. As between the First and Second Circuits, the distinction is in the discretion that the federally chartered institution must retain – the First Circuit does not dwell on the degree of discretion, whereas the Second Circuit looks for discretion to be primarily retained in the principal. The even more complex question, which will have to wait for another day, is how such agent preemption principles apply to the interstate activities of state-chartered banks.s
Travis P. Nelson (email@example.com) is an attorney in the financial services group of the New Jersey office of Pepper Hamilton LLP. He is a former enforcement counsel with the OCC and regularly represents financial institutions in regulatory compliance, enforcement and class action litigation.