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Supreme Court Decision Update - Watters v. Wachovia Bank

wachovia.jpgThe first of today’s three 40+ page Supreme Court opinions comes in Watters v. Wachovia Bank (PDF of the opinion). This case is about how much authority states have to regulate national banks’ mortgage lending business, specifically when that business is handled by a subsidiary company.

QuizLaw Analysis: Banking, mortgages and federal/state preemption. It’s exciting as it sounds. And the quick answer is that states have very little authority to regulate national banks’ lending operations, regardless of whether those operations are handled by the bank itself or by a subsidiary. The most interesting thing about this opinion is, frankly, that the dissent comes in at 24 pages, seven pages longer than the 17 page majority opinion.

So we’re talking banks? Yup. Specifically, we’re talking Wachovia Bank and Wachovia Mortgage Corporation. Wachovia Bank is a national banking association which has been chartered by the Office of the Comptroller of the Currency.

The Office of the Who and the What-Now? So there’s the National Bank Act (the “NBA”), which covers the business activities of all national banks. And the Office of the Comptroller of the Currency (the “OCC”) is in charge of overseeing these banks and how they deal with their customers, making sure the banks comply with the NBA and any rules and regulations promulgated by the OCC itself. Among other things, the NBA authorizes federal banks to do real estate lending. For the purpose of this case, it’s also important to recognize that bans are authorized to exercise “such incidental powers as shall be necessary to carry on the business of banking.” These powers include the permission/ability to set-up a subsidiary entity to do activities which the bank itself is authorized to do.

Gotcha. We can go back to Wachovia now. Right, so Wachovia Bank is an OCC chartered bank. Wachovia Mortgage Corporation, meanwhile, is a company that just does mortgage lending and related services in, among other places, Michigan. From 1997 through 2003, Wachovia Mortgage complied with Michigan mortgage lending laws. See, Michigan laws say that national banks are exempt from the state’s mortgage lending regulations, but that other subsidiaries, brokers, lenders, etc. are not. Those entities must register with the state’s Office of Insurance and Financial Services (the OIFS) and comply with other requirements (pay annual fees, file annual reports, etc.). So Wachovia Mortgage did all this through 2003.

However, in the beginning of 2003 , Wachovia Mortgage became a wholly owned subsidiary of Wachovia Bank. Shortly thereafter, Wachovia Mortgage surrendered its registration and stopped playing along with Michigan law, because it was now the subsidiary of a national OCC bank. The OIFS Commissioner responded by saying that Wachovia Mortgage couldn’t do mortgage lending in Michigan anymore. So the Wachovia entities sued, arguing that the NBA and the OCC regulations take precedence over Michigan’s lending laws, preempting them.

The key to understanding all of this is that everyone agrees “that Wachovia’s real estate business, if conducted by the national bank itself, would be subject to OCC’s superintendence, to the exclusion of state registration requirements and visitorial authority.” So the question is whether Wachovia’s subsidiary (Wachovia Mortgage) is also subject to the OCC in a way that state law is preempted.

What happened in the lower courts? As it matters to the substance of this decision, the District Court granted summary judgment to the banks. Relying on a 1984 Supreme decision, the District Court “deferred to the Comptroller’s determination that an operating subsidiary is subject to state regulation only to the extent that the parent bank would be if it performed the same functions.” The Court also rejected an argument made by the OIFS Commissioner that the Tenth Amendment prohibited this outcome. On appeal, the Sixth Circuit, affirmed the District Court, and that was that.

So who’s got the majority on this one? That would be Justice Ginsburg, with a 5-3 majority. She’s joined by Justices Kennedy, Souter, Breyer and Alito. Justice Stevens dissented, joined by Chief Justice Johnny and the Scalia. Justice Thomas didn’t have anything to do with the case.

And what’s Ginsburg have to say for herself? She begins by citing an old law school staple, the 1819 case of McCulloch v. Maryland where “this Court held federal law supreme over state law with respect to national banking.” She then says that, since the 1864 enactment of the NBA, the Supremes have repeatedly made it clear “that federal control shields national banking from unduly burdensome and duplicative state regulation.” So states can regulate national banks when its laws and regulations don’t “prevent or significantly interfere with” the bank’s exercise of powers. But if there is such prevention or interference, “the State’s regulations must give way.”

And this applies to mortgage lending? Sure does. The NBA specifically authorizes national banks to do mortgage lending, so states can enforce laws that would “significantly burden a national bank’s own exercise of its real estate lending power.” In fact, Ginsburg says that the NBA specifically gives exclusive authority and control to the OCC. This is why the Michigan laws correctly exempt national banks from the state requirements - it’s “not simply a matter of the Michigan Legislature’s grace, [citation], [f]or, as the parties recognize, the NBA would have preemptive force, i.e., it would spare a national bank from state controls of the kind here involved.” If not for this ban, national banks would have to register in every state in which they do business, and be subject to inspection and enforcement in each of those states. And Congress recognized this, which is why it said that banks were only subject to the visitorial powers (i.e., allowing a supervising officer to visit the business and examine operations) of federal agencies.

Ok, but what about when it’s a subsidiary doing the lending? Right. The Michigan OIFS Commissioner argues that this preemption only applies to national banks themselves, not their subsidiaries. The Commish says these subsidiaries are “affiliates” of the national banks and are, therefore, “also subject to multistate control.” However, it has long been understood that national banks can do business through subsidiaries as part of their “incidental” authority under the NBA and as authorized by the OCC. As such, the OCC already licenses and oversees subsidiaries like Wachovia Mortgage. The OCC therefore treats national banks and their subsidiaries as “a single economic enterprise.”

The OIFS Commish doesn’t dispute that banks can do business through operating subsidiaries. Instead, she says that states can also regulate the subsidiaries in addition to whatever regulations the OCC has. But, Ginsburg points out, “just as duplicative state examination, supervision, and regulation would significantly burden mortgage lending when engaged in by national banks, [citation], so too would those state controls interfere with that same activity when engaged in by an operating subsidiary. Ginsburg goes on to note that the Supremes have never said that “the preemptive reach of the NBA extends only to a national bank itself.” Instead, previous decisions have focused on a national bank’s powers, rather than corporate structure. And, whenever operating subsidiaries have come up, the Supremes have treated them “as equivalent to national banks with respect to powers exercised under federal law.” Security against interference from state regulation is an important aspect of the banking business which national banks do, and this should apply regardless of whether it’s the bank itself or a subsidiary doing the business.

The OIFS Commissioner says that Congress should’ve explicitly said that the NBA ban on state inspection rights applies to subsidiaries as well as the banks themselves, particularly since another section specifically talks about “affiliates.” But Ginsburg says this argument is bunk for two reasons. First, the use of operating subsidiaries wasn’t even authorized until 1966, so it makes no sense to look at the intent when the NBA laws were originally enacted in 1864 and 1933. Second, there’s an important distinction here. As already mentioned, affiliates may do things which the bank itself isn’t authorized to do under the NBA, whereas operating subsidiaries can only do what the banks themselves can do. So the two should not be looked at as being one in the same.

So is that it? Almost. Ginsburg wraps things up by noting that the OCC regulations say that: “Unless otherwise provided by Federal law or OCC regulation, State laws apply to national bank operating subsidiaries to the same extent that those laws apply to the parent national bank.” The OIFS Commish says that the OCC lacked the authority to promulgate this regulation because preemption is an issue for the courts to decide. But Ginsburg says that doesn’t matter because this regulation simply clarifies what’s already in the NBA itself - namely, that:

A national bank has the power to engage in real estate lending through an operating subsidiary, subject to the same terms and conditions that govern the national bank itself; that power cannot be significantly impaired or impeded by state law.

What about that Tenth Amendment business? Ginsburg says the Tenth doesn’t come into play here:

As we have previously explained, “[i]f a power is delegated to Congress in the Constitution, the Tenth Amendment expressly disclaims any reservation of that power to the States.” [citation] Regulation of national bank operations is a prerogative of Congress under the Commerce and Necessary and Proper Clauses. [citation] The Tenth Amendment, therefore, is not implicated here.

Seems simple enough - so why does the dissent feel the need to talk even longer about all this? As mentioned above, Justice Stevens wrote a lengthy 24 page dissent, joined by Chief Justice Johnny and the Scalia. Basically, Stevens says that there is no federal law specifically immunizing subsidiaries from state regulation, and Congress hasn’t explicitly authorized any federal agency to preempt state law. So he thinks that Ginsburg “endorses an agency’s incorrect determination that the laws of a sovereign State must yield to federal power,” causing an improper shift in the federal-state balance.

Of course, he says all this in considerably more detail through 24 pages, and you can read them all for yourself if you’re interested. It’s worth pointing out, however, that Stevens notes that, in his view, “the most pressing questions in this case are whether Congress has delegated to the Comptroller of the Currency the authority to preemption the laws of a sovereign State as they apply to operating subsidiaries, and if so, whether that authority was properly exercised here.” And he says “no” in response to both of these questions, and scolds the Court for not answering them directly and simply concluding that preemption is a “necessary consequence.”