WASHINGTON — Senate Banking Committee Chairman Chris Dodd's latest regulatory reform bill was expected to clear up how state consumer protection laws will be applied to national banks.
It did the opposite.
The Senate bill would explicitly return to the so-called "Barnett" standard that existed before the preemption rules issued by the Office of the Comptroller of the Currency in 2004. But the bill also contains language that OCC officials warned would make preemption more complex and burdensome.
For instance, the OCC said, it would be harder for a national bank to ignore a state law it believes interferes with its business and easier for state attorneys general to file class actions against federally chartered banks.
"We had hoped in the Senate the bill would correct and address some of those concerns and in fact lead more toward a place where we have strong uniform standards," Comptroller John Dugan said Wednesday. "Unfortunately, it seems to be a step backward from what the House bill had done."
The issue is also crucial to state regulators, who see federal regulatory reform as a chance to revisit an issue on which they have lost in the courts. They argue that the best way to protect consumers is to let states enact and enforce their own laws against all banks, regardless of charter.
Preemption "is one of the most important consumer protection issues and in my opinion even more important than where the CFPA should be housed," said New York Banking Superintendent Richard Neiman, referring to the proposed Consumer Financial Protection Agency.
The Obama administration unveiled a regulatory reform plan last June that would have eliminated preemption, allowing states to write and enforce their own laws against national and state banks. The House passed a reg reform bill in December and took a slightly different tack, but Dodd's initial bill, introduced last November, echoed the president's draft.
Both the House and Senate bills would try to restore the so-called Barnett standard, named for a 1996 Supreme Court decision, Barnett Bank v. Nelson, which allowed the OCC to preempt state laws on a case-by-case basis. The Senate version would explicitly refer to that court case in defining preemption standards, but the House bill uses its own language that national banks and the OCC have warned do not adequately reflect the Barnett standard.
The OCC also argues that additional requirements in the Senate bill could upend the preemption process. Chief among them is a provision that says the OCC or a court must make a "determination" that a state law is preempted before a national bank could ignore that law. Under current rules, a national bank can decide a state law is preempted and opt not to follow it, pending review by the regulator or a court.
The Senate bill, however, would not let a bank do that without an affirmative decision from the OCC or a court — a process that could take months or even years. The OCC also would have to consult with the proposed new consumer protection regulator before issuing any preemption ruling and review its decisions every five years.
"The standard that has to be evoked for federal preemption and uniform standards has gotten higher and harder to invoke, which is not a good thing," Dugan said.
It is not even clear whether, once the OCC preempts a particular state law, this decision would suffice to cover a similar law in a different state, observers said. The bill says the OCC can preempt a state law that is "substantially equivalent" but is unclear about what this means.
"The bill requires the OCC to act on a case-by-case basis," said Ray Natter, a partner in Barnett Sivon & Natter PC. "If a preemption determination is based on reasons that would apply to a lot of state laws, you shouldn't have to adjudicate every similar law enacted by the states. You should be able to rely on the precedent and the explanation for the decision. Otherwise, you are bogging the agency and the courts with needless litigation."
The end result is that, though preemption would still exist, it would be harder and more costly to invoke.
"It's going to be a higher hurdle," said Gil Schwartz, a partner in Schwartz & Ballen LLP. "I think national banks will still be able to rely significantly on the ability to preempt state laws. It's just that the process will become more cumbersome."
Banking industry representatives are also concerned that both the House and Senate bills would overturn the 2007 Watters v. Wachovia Supreme Court decision, which said that operating subsidiaries of national banks enjoy the same preemption rights as their parents.
Instead, the bill would force subsidiaries and affiliates to comply with state consumer law regardless of whether it applies to national banks.
"It's significant because the comptroller was willing to go to the Supreme Court to make clear [that preemption] applies to subsidiaries," said Schwartz. "If subsidiaries are subject to state law, then it would require significant restructuring by some national banks who have put their mortgage companies in the subsidiary."
Like the House bill, the Senate version would expand state attorney general powers against national banks. The House bill would let an attorney general enforce both state and federal consumer laws against national banks, and the Senate bill would also let attorneys general bring civil actions against national banks.
"On one hand the Senate bill supports the Barnett standard, but on the other hand it undermines it," said Scott Talbott, a senior vice president of government affairs of the Financial Services Roundtable.
But Jane Azia, the director of consumer protection in the New York Banking Department, defended the expansion, saying it is needed to beef up consumer protection. "It allows states to act proactively and aggressively to enforce their own laws in their states," she said.
For their part, state regulators are satisfied to restore the Barnett standard but prefer the House version, which says a state law must "significantly" interfere with the business of banking before it can be preempted. The Barnett court case is couched in similar language but adds tests that have made it easier for the OCC to persuade courts that a law is preempted.
"The OCC has always interpreted Barnett to give it more flexibility to applying preemption," said Neiman, the New York regulator. "That's why utilizing the specific language of the House bill really reflects what the holding of Barnett should be."
Banking industry representatives said that much of the fight can turn on just a few legislative words and that is why Congress should drop any change in preemption standards.
"One of the problems in this area [is], very small changes in language can make a big difference and, if it isn't just dropped, there will be confusion about the issue for years as everything is relitigated," said Ed Yingling, the American Bankers Association CEO.
But Yingling said he remains hopeful the Senate will ultimately drop the issue.
"At one point in … negotiations, it was widely reported there would be no preemption provision, which would mean the status quo would be maintained," he said. "We still hope that would be [the] final result."
