Anyone interested in charters from the Office of the Comptroller of the Currency should be following Lusnak vs. Bank of America, 883 F.3d 1185 (9th Cir. 2018), which is being appealed from the Ninth Circuit to the United States Supreme Court. OCC charters are of course a hot topic—now that the OCC is accepting applications from FinTech companies for national bank charters, the power of federal regulators to excuse federally chartered entities from compliance with state regulations may be more important than ever. After all, the key benefit offered by a national bank charter for many FinTech companies is exemption from state-level money transmission licensing and regulation… in theory.
In reality, many state-vs-federal constitutional questions remain unanswered. Federal courts are still defining the extent of the power of federal financial regulators to exempt federally regulated institutions from state laws. The Supreme Court could help clarify these important issues in the next year or two if it grants the recent request to consider Lusnak.
Lusnak itself does not involve any cutting-edge issues relating to fintech or money transmission. Instead, Lusnak presents the question of whether a national banking association must comply with California laws requiring mortgage servicers to pay borrowers at least 2% annual interest earned on funds escrowed by borrowers with servicers for payment of things like yearly taxes and insurance premiums. See Cal. Civ. Code § 2954.8(a). This California law is broadly written, applying to all financial institutions that originate or hold residential California mortgages, which ostensibly includes national banks. Id.
The United States Congress, on the other hand, has declared that a state consumer finance law does not apply if the law “prevents or significantly interferes with the exercise by the national bank of its powers.” 12 U.S.C. § 25b(b)(1)(B). Although this particular law was only enacted in 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, it codified the Supreme Court’s 1996 ruling that states may regulate national banks if “doing so does not prevent or significantly interfere with the national bank’s exercise of its powers.” Barnett Bank of Marion Cty., N. A. v. Nelson, 517 U.S. 25 (1996). As discussed further below, the interplay between the state law pre-emption standards enacted in Dodd-Frank by Congress and the standards defined by courts over the years are at the heart of this appeal.
In Lusnak, the federal district judge dismissed the borrower’s lawsuit, holding that California’s escrow-interest laws do not apply to a national bank under federal banking laws. On appeal, the Ninth Circuit reversed and ruled against the bank, noting that “minor interference” with banking powers “is not enough” and that instead emphasized the law must be “unduly burdensome.” The Ninth Circuit did indicate that in other cases, defendants could put on evidence about the burdens imposed by the state regulations at issue. But here, the court decided without evidence that the California interest-escrow law was not unduly burdensome for the following reasons:
- for mortgage escrows mandated by federal law, Congress has ordered national banks to pay the same interest required by state law for mortgage-related escrows, 12 U.S.C. § 1639d(g)(3); and
- the 2% interest rate mandated by California law was not “punitively high,” in the view of the court.
The bank’s request for re-hearing by the entire circuit was denied in May, and the bank has now asked the Supreme Court to take the case.
As noted in the petition for certiorari, Lusnak seemingly contradicts a long line of cases exempting national banks from compliance with state consumer finance laws, such as:
- laws prohibiting banks from using the word “saving” in ads, Franklin National Bank of Franklin Square v. New York, 347 U.S. 373 (1954);
- laws regulating check-cashing fees, Wells Fargo Bank of Tex. N.A. v. James, 321 F.3d 488 (5th Cir. 2003) & Baptista v. JPMorgan Chase Bank, N.A., 640 F.3d 1194 (11th Cir. 2011);
- laws regulating fees on stored value gift cards, SPGGC, LLC v. Ayotte, 488 F.3d 525, 532-33 (1st Cir. 2007); and
- laws requiring disclosures on convenience checks, Parks v. MBNA Am. Bank, N.A., 54 Cal. 4th 376 (2012).
Supreme Court cases such as Marquette Nat. Bank v. First of Omaha Svc. Corp., 439 U.S. 299 (1978) and Smiley v. Citibank (South Dakota), N. A., 517 U.S. 735 (1996), holding that national banks are not subject to state usury laws limiting interest rates and late charges, respectively, could be added to this list, although these base pre-emption of state usury laws upon specific federal statutes regarding interest rates charged by national banks rather than the broader statutes allowing banks to conduct other business.
If the Supreme Court does accept the Lusnak appeal, it could help clarify when national banking laws pre-empt state laws. The Lusnak litigation itself has made this issue more important. As the petition for review notes, at least a dozen other states have similar escrow-interest laws, and a number of class actions have been filed against national banks who did not pay interest on escrow in reliance on federal pre-emption.
Lusnak raises other interesting questions regarding the topic of federal bank regulation and federal pre-emption of state law:
(1) Can the OCC issue binding regulations exempting national banks from interest-on-escrow laws? The OCC currently states a “national bank may make real estate loans … without regard to state law limitations concerning… escrow accounts, impound accounts, and similar accounts.” 12 CFR 34.4(a)(6). Although the applicability of this language to mortgage servicing has been questioned, as discussed below, other courts have concluded that this provision does exempt national banks from interest-on-escrow laws. Lusnak takes a very different approach.
In Lusnak, the Ninth Circuit barely even reaches this regulation because it finds that the “OCC’s conclusions are entitled to little, if any, deference” under the Skidmore standard for deference. The Skidmore standard was first identified in Skidmore v. Swift & Co., 323 U.S. 134 (1944), which held that courts could “properly resort for guidance” to regulatory interpretations of certain laws, but that such administrative interpretations are “not controlling upon courts.” According to the Ninth Circuit in Lusnak, Dodd-Frank mandated Skidmore judicial deference to OCC state-law pre-emption determinations, stating that in reviewing such determinations, courts shall assess the validity of such determinations, depending upon the thoroughness evident in the consideration of the agency, the validity of the reasoning of the agency, the consistency with other valid determinations made by the agency, and other factors which the court finds persuasive and relevant to its decision. 12 U.S.C. § 25b(b)(5)(A).
As noted by the bank in its pleadings in Lusnak, the Second Circuit had reached the opposite conclusion prior to Dodd-Frank, finding that courts “must defer to the [OCC’s] regulations if they reflect a reasonable construction of the statutory scheme.” Wachovia Bank, N.A. v. Burke, 414 F.3d 305, 321 (2d Cir. 2005). This decision applied the Chevron standard of judicial deference to administrative interpretations, under which “a court may not substitute its own construction of a statutory provision for a reasonable interpretation made by the administrator of an agency.” Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). The Supreme Court itself applied Chevron deference to OCC pre-emption determinations prior to Dodd-Frank in agreeing with the OCC that late charges constituted “interest” for the purpose of the federal laws permitting national banks to charge “interest” above state-law usury caps. Smiley v. Citibank (South Dakota), N. A., 517 U.S. 735 (1996).
As Justice Antonin Scalia, the author of Smiley, would later write, Skidmore deference should be “feared by litigants who want to know what to expect” because under Skidmore “protracted confusion” results about which regulations are valid and which are not. United States v. Mead Corp., 533 U.S. 218 (2001) (Scalia, J. dissenting). By applying Skidmore deference to OCC pre-emption determinations, Lusnak renders such OCC determinations all but meaningless and deprives national banks and their customers of certainty, and nationwide uniformity, on these important matters.
(2) Could Congress expand the powers of the OCC to make binding pre-emption determinations? Should the Supreme Court decide to apply Skidmore deference under Dodd-Frank, Congress could also simply specify that 12 U.S.C. § 25b(b)(5)(A) requires Chevron deference to OCC pre-emption determinations. Further, as the Ninth Circuit noted in Lusnak, Congress has at times provided other federal financial regulators with more extensive powers to determine that their regulated institutions are exempt from state laws, and such delegations of authority have generally been upheld by federal courts. For instance, in Flagg v. Yonkers Savings & Loan Association, 396 F.3d 178 (2d Cir. 2005), the Second Circuit ruled that the now-disbanded Office of Thrift Supervision had an “extremely broad grant of power” to regulate any operations of Federal savings association, and indicated that this permitted the OTS to pre-empt all state laws relating to escrow accounts unless such decisions are or arbitrary and capriciousness and therefore wholly unjustifiable. While the National Banking Act currently seems to confer less expansive authority to the OCC, Congress could change that as well.
(3) Should the OCC change its regulations? Although not at issue in Lusnak, another federal judge recently noted that the OCC’s current regulations on pre-emption of state law for residential mortgage lending could be interpreted narrowly. In Althaus v. Cenlar Agency, Inc., No. 17-445 (JRT/DTS), 2017 U.S. Dist. LEXIS 167475, (D. Minn. Oct. 10, 2017), the defendant federal savings bank was sued for violating Minnesota’s broad statutory requirement that mortgage servicers make timely tax payments from escrows. As in Lusnak, the defendant bank argued that 12 CFR 34.4(a) pre-empts these Minnesota laws. The district court found that “34.4(a)’s express preemption appears to apply only to national banks ‘mak[ing]’ loans.” Id. at *13. Continuing, the court stated, “[i]f the OCC intended to expressly preempt state laws with regard to other national bank activities, it could have used broader language as in § 34.3 (‘make, arrange, purchase or sell’) or § 34.4(b) (mentioning ‘the real estate lending powers of national banks’).” Id. at 13-14. Given the multiple briefs filed by the OCC as friend-of-the-court in Lusnak, it would be ironic if the Supreme Court decides to apply Chevron deference to the OCC’s regulations but agrees with the federal judge in Althaus that the OCC’s existing regulations pre-empting state laws in “making” loans do not apply to servicing those loans.
(4) Could Congress expand the ability to create non-bank federally chartered entities exempt from state and local regulation? Because the formation of corporations and other entities is traditionally a state matter rather than a federal matter, federal courts have not defined what limits exist on the ability of the federal government to charter business entities and then exempt those entities from the state and local regulations. After all, the first part of the famous 1819 Supreme Court decision McCulloch v. Maryland, 17 U.S. (1819) concluded that the “necessary and proper” clause allowed Congress to charter a banking corporation as a power incidental to its enumerated powers, but did not identify which underlying enumerated powers permitted this activity. Congress currently has the expansive enumerated power under the Commerce Clause to regulate any activities “that substantially affect interstate commerce,” United States v. Lopez, 514 U.S. 549, 559 (1995), so it might be considered constitutional for Congress to charter national corporations and then excuse those corporations from compliance with various state and local regulations. While most federal corporate charters, including an OCC national bank charter, carry their own heavy regulatory burdens at this time, a day when general federal corporate charters are standard (and costly 50-state legal surveys and licensing projects are rare) may not be beyond imagination.