On April 17, 2007, the United States Supreme Court upheld the decision of the U.S. Court of Appeals for the Sixth Circuit in Watters v. Wachovia Bank, N.A. that a national bank’s operating subsidiary was shielded by federal law from state oversight.1/ On May 30, 2007, the First Circuit relied on the Watters decision to support a broad preemption of state law governing gift cards.2/ We expect this trend to continue.
In the Watters case, the Supreme Court, in a 5-3 decision, concluded that an operating subsidiary of a national bank may do business under the same terms and conditions as its parent national bank, and a state can no more inspect, require reports from, or otherwise regulate an operating subsidiary than it can a national bank. The majority found it easy to identify a congressional intent to protect national banks (and their operating subsidiaries) from possibly hostile state regulation, but difficult to identify a congressional intent to foster competitive equality between state and national banks. Consumer protection was not a factor. The result may further weaken the arguments of the states in the continuing debate over federal preemption of state banking laws.
Until January 1, 2003, Wachovia Mortgage Company, a North Carolina corporation registered in Michigan to make home mortgage loans, was a wholly owned subsidiary of Wachovia Corporation. On that date, Wachovia Corporation transferred ownership of Wachovia Mortgage to its subsidiary bank, Wachovia Bank, N.A. Shortly afterwards, Wachovia Mortgage surrendered its Michigan mortgage lending license to the Commissioner of the Michigan Office of Insurance and Financial Services. The Commissioner responded by advising Wachovia Mortgage that, effective July 1, 2003, it would no longer be authorized to make mortgage loans in the state. Wachovia Mortgage filed suit in the U.S. District Court for the Western District of Michigan, seeking a declaratory judgment that the Commissioner had no visitorial power over it, and that Michigan’s registration, recordkeeping, reporting, and investigative provisions were preempted by the National Bank Act and the OCC’s regulations. The District Court and the Sixth Circuit agreed.3/ Consensus in the Lower Courts
The Sixth Circuit’s holding that the OCC’s regulation was “eminently reasonable“ and rightly preempted the conflicting Michigan law was in accord with other courts that heard similar challenges to the OCC’s regulation. The U.S. Courts of Appeal for the Second, Fourth, and Ninth Circuits reached essentially the same conclusion that the OCC’s regulation was reasonable in its preemption of Connecticut, Maryland, and California law, respectively.4/
The Supreme Court’s grant of certiorari was somewhat surprising because there was no overt split among the courts that might motivate the Court to hear the case in order to ensure a uniform interpretation of the law. The absence of such a split suggested that some members of the Court were inclined to overturn the preemption decisions based on more fundamental concerns about the role of an administrative agency in refereeing between the states and the federal government.
For the Majority, There Was No Serious Conflict to Resolve
In an opinion written by Justice Ginsburg and joined by Justices Alito, Breyer, Kennedy, and Souter, the Court departed from the reasoning of the lower courts, which upheld the OCC’s exercise of preemptive power in its rulemaking. Instead, the Court focused on the statute. According to the majority, the National Bank Act, adopted in 1864, had been repeatedly interpreted by the Court to provide a broad shield of protection for national banks against state regulation. In briefly quoting or analyzing earlier cases, the Court noted that national banks should be protected from “possible unfriendly State legislation,” and that both the enumerated and incidental powers granted to national banks included a grant of authority that ordinarily preempted “contrary” state law.5/ In a significant footnote, the majority responded to the dissent’s concern to preserve competitive equality between state and national banks by observing that Congress did not pursue this goal consistently throughout the National Bank Act, but only on those occasions when it expressly referenced, and required national banks to observe, state law standards, such as with regard to branching powers under the McFadden Act.6/ The power of national banks to make mortgage loans under the National Bank Act was not limited by reference to the powers of state banks.
Turning specifically to the application of preemptive authority to operating subsidiaries of national banks, the majority found guidance in the Gramm-Leach-Bliley Act of 1999. In that Act, Congress defined a “financial subsidiary” of a national bank as an entity other than a subsidiary that is engaged solely in activities that are permissible for a national bank to perform directly and that performs those activities “subject to the same terms and conditions” as a national bank.7/ By carving out financial subsidiaries in this manner from a larger category of subsidiaries, Congress implicitly recognized operating subsidiaries as a coordinate subset of subsidiaries which were to be treated as the equivalent of national banks in the exercise of their powers. Although the dissent objected that the GLB Act provision in question, which was buried in a definitional clause, was not intended to preempt state law, the majority sidestepped the criticism by explaining that that was not the relevant test. This provision of the GLB Act simply demonstrated “formal recognition” by Congress of the incidental power of national banks to do business through operating subsidiaries on a national bank’s own terms and conditions.8/ Preemption for operating subsidiaries flowed from the unquestioned preemptive authority of national banks themselves. Since the majority concluded that the National Bank Act itself, as amended by the GLB Act, preempted the application of Michigan’s mortgage banking law, it was unnecessary to consider the issue addressed by the lower courts and the dissent as to whether preemptive authority had been granted to and properly exercised by the OCC.
For the Dissent, Competitive Equality and the Role of the States Were Primary Concerns
For Justice Stevens, who wrote the dissent for himself, Chief Justice Roberts, and Justice Scalia, where the majority found the glass half-full regarding federal preemption of state mortgage banking law, he found it half-empty. The dual banking system, while its historical development may have been accidental, had been preserved by the Court over the years by permitting preemption of nondiscriminatory state law only when that law “incapacitated” a national bank or would “forbid” or “impair significantly” its activities. Competitive equality was a consistent policy running through the National Bank Act, rather than an occasional concern as characterized by the majority. The cases relied on by the majority, which expressed such great concern to protect national banks, were inappropriate because they were older cases decided when national banks were instrumentalities of federal monetary policy and not, as they are today, altogether private business ventures. In addition, in view of the fact that Congress initially prohibited mortgage lending by national banks and relaxed that prohibition only gradually over the years, it was inappropriate for the Court to read into the law any intent to provide national banks with a competitive advantage in that area. The indirect reference to operating subsidiaries in the GLB Act might indicate congressional acquiescence in the OCC’s decision to authorize such entities, but it was not a sufficiently clear signal regarding congressional policy on federalism. Absent a signal in 12 U.S.C. § 484(a), which expressly addresses and limits the exercise of state visitorial powers over national banks, that Congress intended that section of law to apply equally to operating subsidiaries, the dissent would not grant preemptive protection to operating subsidiaries. Since the National Bank Act did not support preemption, the dissent found it necessary also to consider whether Congress had delegated preemptive authority to the OCC, and whether the OCC had properly exercised that authority. The answer, in both instances, was no. The statutory authority of banks under 12 U.S.C. § 24 (Seventh) to engage in lines of business that were “incidental” to their core activities, which provided the basis for the OCC to authorize operating subsidiaries, did not include any grant of power to the OCC to preempt the application of state law to those subsidiaries. Even if the OCC had the authority to preempt the application of state law, the dissent asserted that adoption of 12 C.F.R. § 7.4006 overstepped that authority because the OCC did not have the authority to define the scope of federal preemption on a per se basis, especially in view of the delicate political compromises that federalism requires.
Watters v. Wachovia Bank, N.A. Should Encourage Further Growth of Federal Preemption
The willingness of the majority of the Court to find a Congressional intent in the National Bank Act to permit preemption based on inference and negative implications, and its observation that the doctrine of competitive equality plays only a limited role in the National Bank Act, suggests that the role of the states in banking regulation will continue to wane. The OCC should feel encouraged to find grants of powers to national banks and their operating subsidiaries implied throughout the National Bank Act, as well as the ability to preempt state law that interferes significantly (but not necessarily to a crippling extent) with those powers. The short shrift given by both sides of the Court to the role of the states in providing “consumer protection” also suggests that recent efforts by the states to inspect national banks’ loan application data in order to enforce state banking statutes or to impose data privacy standards on national banks and their operating subsidiaries may be adversely affected by this decision.
An example of the possible direction of future cases is SPGCC v. Ayotte, decided May 30, 2007 by the First Circuit Court of Appeals. That court held that the National Bank Act and OCC regulations preempt state consumer protection regulation of gift cards issued by a national bank through a shopping mall acting as the bank’s agent. Relying on Watters, the court stated that permitting the state to regulate the agent would be “too formalistic” an analysis and contrary to the “language and intent” of the National Bank Act. It was more appropriate to focus on the national bank’s exercise of its powers. 9/
The Office of Thrift Supervision, which regulates federal savings associations, may also be encouraged. The broad mandate of the OTS under the Home Owners’ Loan Act is to foster best practices among thrifts, and the OTS has regularly looked to national banks to help to define what best practices are. When the OTS authorized State Farm Bank, a federal savings association, to market its deposit and loan products and services through agents of its affiliated insurance company, it reasoned that the arrangement was substantially similar in terms of both business purpose and oversight to the use of an operating subsidiary for the identical purpose. The federal district court agreed.10/ Watters appears to validate this functional analysis of banking activities and should support the growth of thrift powers as well.
The Court’s decision also has led to some renewed calls for certain legislative or regulatory responses, such as legislation overturning the Court’s decision and limiting the OCC’s ability to preempt certain state laws regarding consumer protection, and revival of “state bank preemption.” In 2005, The FDIC proposed a regulation under which a state bank with multistate branches would be subject only to home state regulation, as a means of providing state banks with a semblance of the unitary supervision that national banks enjoy.11/ This proposal has languished, and raises many unique issues, but state supporters may return to it out of necessity. Such a proposal may improve the operating efficiency and competitiveness of state banks, but it would appear to do so by cannibalizing the state banking agencies, and would do little to enhance state banking regulatory powers in a dual banking system.
If there is any solace for the states in this decision, it may be in the strength of the language of the dissent and the distance between the two sides of the Court. Justice Stevens was the author of Chevron, one of the leading cases on the deference to be granted by the courts to agency rulemaking determinations.12/ Here, he stated that “the most pressing questions” concerned the delegation of authority to preempt to the OCC, and not the statutory questions addressed by the majority, and he argued that the OCC was not authorized to rule, as it had at 12 C.F.R. § 7.4006, on the scope of preemption. That issue remained properly with the courts.13/ Perhaps this will somewhat deter the OCC, or serve as a signal to Congress that it must step in to protect the dual banking system. There have been few calls in Congress for such action since the decision was announced, and there is no reason to expect anything of this nature to advance in the current Congress. But, Congress appears to be the states’ last refuge.