The Preemption Question

The Office of the Controller of the Currency (OCC) has again succeeded in expanding federal preemption of state banking law. As the bureau of the Department of Treasury charged with regulating national banks, the OCC has long argued for preemption of state banking law in what some have called an effort to make the national bank charter more attractive. The United States Supreme Court has endorsed the OCC’s position in the recent case of Watters v. Wachovia Bank, N.A. In that opinion, the Court held that Wachovia Mortgage Corporation, a real estate lending business and wholly-owned operating subsidiary of Wachovia, is subject to the superintendence of the OCC and not to the regulatory regimes of the several states in which the subsidiary operates. The decision will have a lasting impact on the dual-banking system and should be of interest to both state and national banks. The OCC’s victory is the culmination of years of opinion letters by the agency on the subject of preemption, each letter offering guidance on why various state laws are subject to preemption by federal law. The specific question of whether the OCC has the authority to preempt state law has until now remained unanswered by the Supreme Court, despite dissention on the issue among the circuit courts. The decision in the Watters case, which can be characterized as a clash between federal agency power and states’ rights, concludes that Congress has consistently supported the national banks’ right to avoid registration, inspection, and enforcement in every state in which they do business.

The decision indicates that the OCC, without authorization from Congress, does have the power to conclude that state banking law interferes with federal law and is therefore preempted. Surprisingly, a supreme court that has remained committed to states’ rights in other contexts is supporting the power of federal agencies in the context of banking law. It is unclear whether the Watters decision raises federal agencies to the level of Congress and the courts on the issue of deciding when federal law should prevail over state law. However, the decision, which deals specifically with banking law, will impact all aspects of administrative law, including the paramount question of when courts must defer to a federal agency’s decision-making process.

The Watters Decision

The central question in Watters was whether the State of Michigan had the authority to subject Wachovia Mortgage Corporation to state consumer protection statutes and revoke Wachovia’s authorization to do business in the state for failing to follow those statutes and submit to state supervision. On April 17, 2007, a divided Supreme Court ruled 5 to 3 that state regulators have no authority over the business conducted by national banks.

Justice Ginsberg, writing for the majority, stated that “[w]e have repeatedly made clear that federal control shields national banking from unduly burdensome and duplicative state regulation.” Furthermore, just as a state cannot subject a national bank to its “visitorial” controls, the same rule applies to its subsidiaries. The Court based its ruling on an interpretation of 12 U.S.C. §24 Seventh, which vests in national banks “all such incidental powers as shall be necessary to carry on the business of banking” and has, since 1966, included the incidental authority to do business through its operating subsidiaries.

The dissenters — Justices Stevens, Roberts, and Scalia — were primarily concerned with the fact that, pursuant to the majority opinion, the OCC can now effectively decide what state laws are preempted under 12 U.S.C. §24 Seventh’s “incidental powers” clause. In the dissenters’ view, such an outcome allows an administrative agency to preempt state law at its whim, a concept that the dissent found to be unprecedented. The dissent was especially troubled that the Court “so blithely preempts Michigan laws designed to protect consumers, . . . [which is] a field which the States have traditionally occupied.”

Watters’ Implications

The Watters decision promises to greatly impact both the dual-banking system and state commercial regulation for years to come. Initially, as the dissent warned, this decision “threatens the vitality of most state laws as applied to national banks.” In addition, the decision may well cause remaining independent mortgage companies to seek federal charters to parent them in a bank-holding structure. Any doubt about whether such a step is desirable, at least as far as the regulatory playing field goes, is now eliminated.

Watters will also likely oust a wide variety of commercial actors from state regulation. For instance, in SPGGC, LLC v. Ayotte, the First Circuit relied on Watters to hold that a New Hampshire consumer protection law that regulated gift cards sold by three of the state’s largest shopping malls was preempted by the OCC because the cards were “issued” by Bank of America, a national bank. So, merely by partnering with a national bank to issue gift cards rather than a state-chartered bank, the shopping centers were able to avoid consumer protection statutes as they applied to the gift cards.

Not only has the Watters decision handed the OCC the power to preempt state laws in nearly any manner it chooses under the broad “incidental powers” clause, it has also created a refuge for other commercial entities to avoid state regulations by partnering with national banks or becoming national bank operating subsidiaries. Given the aggressive history of the OCC in these areas, it is likely that the Watters ruling and its progeny will lead to further benefits for national banks and their subsidiaries beyond preemption of consumer protection statutes. Such an outcome, in turn, may further erode the states’ ability to regulate commercial activities in any way related to nationally regulated banks.