The right of the federal banking oversight system to preempt any attempts by the various states' to regulate federally chartered financial systems has been discussed several times in these pages over the last month. That discussion centered on a nationwide system to allow the states to more efficiently license mortgage companies and agents.

That system, sponsored by the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (ASRMR) while in its infancy, has already been accepted by the majority of state mortgage regulators. The National Association of Mortgage Brokers (NAMB), however, has objected to implementation of the system on the grounds that it did not cover all mortgage lenders, specifically those under federal oversight and thus unfairly targeted only a portion of the mortgage system. CSBS countered that currently 70 percent of originators are licensed or otherwise regulated by the various states, that states are precluded by federal law from regulatory activities relating to any federally chartered bank, thrift, or credit union.



Effectively the licensing system was being condemned for something over which it had no control.

Now the U.S. Supreme Court has come down squarely on the side of preemption as it applies to subsidiaries of federally regulated banks.

In the case of Watters v. Wachovia Bank, N.A., the Court ruled five to three (with Justice Thomas taking no part in the review) to affirm a lower court's decision that Wachovia Mortgage Corporation, a wholly owned subsidiary of Wachovia Bank, N.A. was not subject to regulation by the Michigan Office of Insurance and Financial Services (OIFS) headed by Linda A. Watters, Commissioner.

Justice Ginsburg, writing for the majority which also consisted of Justices Kennedy, Alito, Souter, and Breyer, stated that Michigan expressly excludes both state and national banks from regulation by OIFS but requires that mortgage brokers, lenders and servicers that are subsidiaries of national banks register with OIFS, pay an annual operating fee, file an annual report, and open its books and records to inspection by OIFS examiners. Wachovia Mortgage was registered with the state from 1997 until 2003 at which time it became a wholly owned operating subsidiary of the North Carolina-based bank and subsequently informed the state that it was surrendering its mortgage lending registration because of its subsidiary status. Commissioner Watters responded with a letter advising the mortgage company that it would no longer be authorized to conduct mortgage lending activities in Michigan.

The bank and the mortgage company filed suit against Watters seeking declaratory and injunctive relief prohibiting her from enforcing Michigan's registration prescriptions against Wachovia Mortgage and from "interfering with OCC's exclusive visitorial authority." The District Court in which the suit was brought found for Wachovia and this decision was upheld by the Court of Appeals for the Sixth Circuit.

Ginsburg wrote that the business activities of national banks are controlled by the National Bank Act (NBA) and actual regulations arising from the Act are promulgated by the Office of the Comptroller of the Currency (OCC) which is charged by Congress with authority to audit the bank's books and records, "largely to the exclusion of other governmental entities, state or federal." Furthermore, she wrote, it is uncontested that Wachovia's real estate (lending) business, if conducted by the bank itself, would be subject to OCC's regulation to the exclusion of state registration and that Michigan's own rules were written so as not to apply to the bank's themselves. Watters had argued that "the State's regulatory regime survives preemption with respect to [...] operating subsidiaries" because such subsidiaries are separately chartered under some State's law. She characterized them simply as "affiliates" of national banks.

In response Ginsburg said, "Nearly two hundred years ago, in McCulloch v. Maryland, this Court held federal law supreme over state law with respect to national banking. In the years since the NBA's enactment, we have repeatedly made clear that federal control shields national banking from unduly burdensome and duplicative state regulation." However, federally chartered banks are subject to state laws if such laws don't conflict with the NBA. For example, states can govern usury, contracts, and transfer of property ...but states can exercise no control over national banks except in so far as Congress may permit. "Anything beyond this is an abuse, because it is an usurpation of power which a single State cannot give."

The NBA authorizes national banks to engage in mortgage lending, subject to OCC regulation. "Beyond genuine dispute, state law may not significantly burden a national bank's own exercise of its real estate lending power, just as it may not curtail or hinder a national bank's efficient exercise of any other power..."

And Ginsburg continues, since 1966, OCC has recognized the "incidental" authority of national banks to do business through operating subsidiaries and in 1999 Congress defined and regulated such subsidiaries. At the same time Congress distinguished operating subsidiaries from "affiliates" with the former being those that can conduct activities that are permissible for a national bank to engage in directly either as part of, or incidental, to the business of banking."

Ginsburg said that Watters did not dispute that national banks were authorized to use an operating subsidiary to conduct activities under the same authorization, terms, and conditions that apply to the parent bank itself, but at the same time sought to impose state regulation on these subsidiaries over and above regulation by OCC. "But just as duplicative state examination, supervision, and regulation would significantly burden mortgage lending when engaged in by national banks, so too would those state controls interfere with that same activity when engaged in by an operating subsidiary."

Justice Steven's dissent, written on behalf of Justices Scalia, and Chief Justice Roberts can be read in its entirety here.

CSBS President Neil Milner issued a press release shortly after the decision was handed down which stated the extreme disappointment of the Conference with the Watters v. Wachovia case. "We see it," he said, "as a setback for financial consumers and state efforts to battle predatory lending, abusive mortgage lending practices, and mortgage fraud. (It) does irreparable harm to the states' historical role in advancing consumer protection and ability to respond to local issues.

"Now that the Court has decided the matter, it is incumbent on all financial regulatory agencies - state and federal - to work together toward achieving the common goal of consumer protection."