U.S. District Courts in Connecticut and New Hampshire Uphold Preemptive Powers of Federal Thrift and Banking Regulators
October 19, 2006
John R. Mussman- Chicago
Two U.S. district courts – in Connecticut and New Hampshire – have ruled that federal regulatory authority over federally chartered financial institutions preempted state regulatory action, even over unaffiliated third party contractors conducting activities on behalf of federally regulated financial institutions. In State Farm Bank v. Burke, No. 3:05-cv-00808-JBA, slip op. (D. Conn. June 21, 2006) (“State Farm Bank”), the U.S. District Court of Connecticut reasoned that the “exclusive and plenary power” of the federal Office of Thrift Supervision’s (OTS) regulators was exclusive and preempted the Connecticut Banking Commissioner’s power to require independent contractors to be licensed to conduct deposit-related and other services relating to loan products on behalf of State Farm Bank, FSB, a federal savings association (State Farm). Just over one month later, in SPGGC, LLC v. Kelly A. Ayotte, Attorney General No. 04-cv-420-SM, slip. op. (D. N.H. Aug. 1, 2006) (“SPGGC”), the U.S. District Court of New Hampshire issued a declaratory judgment that a shopping center operator, Simon, could sell prepaid stored value cards issued by a national bank and a federally chartered thrift without complying with New Hampshire’s Consumer Protection Act. The New Hampshire court found that regulations issued by the Comptroller of the Currency and the OTS preempted Connecticut’s restriction on fees and charges assessed on gift cards issued by national banks and federally regulated thrifts, even though the cards were marketed through third-party contractors unaffiliated with the banks. Both courts found that the federal regulators’ authority over the financial institutions included exclusive authority over programs operated through third-party contractors and that such federal authority preempted the application of state law.
State Farm Bank
In State Farm Bank, the court reviewed the control that State Farm exercised over the third-party contractor’s activities. The arrangement State Farm established with its agents permitted them “to perform marketing, solicitation, and customer service activities related to [State Farm] deposit and loan products and services and other authorized banking powers.” Each agent acted exclusively on behalf of State Farm, was required to receive training in State Farm’s products and in compliance with applicable law, and was subject to close oversight by State Farm, including board and audit committee reviews.
The court determined that in the Home Owners’ Loan Act, 12 U.S.C. § 1461 et seq., Congress created a “broad grant of regulatory authority to OTS to provide for the organization, incorporation, examination, operation, and regulation of federal savings associations generally, and coupled with case law, concluded that the regulatory control of the OTS over federal savings association is ‘so pervasive as to leave no room for state regulatory control.’” Under federal statute, the OTS possesses “the authority ... to regulate and examine the performance of such [independent] agents ‘to the same extent as if [their] services were being performed by the savings association on its own premises.’” Under this statutory authority, the OTS had concluded that a thrift “should not be hamstrung in the exercise of its authorized powers merely because it chooses to market its products and services using agents whose activities the association closely monitors and controls” – that the OTS’ authority was exclusive, a determination that the U.S. district court determined was clearly within the OTS’ regulatory purview.
SPGGC
Unlike the thrift’s agents in State Farm Bank, Simon’s sale of stored value gift cards in SPGGC was not exclusively for one financial institution. Simon marketed gift cards for two different issuers: (1) a national bank; and (2) a federally chartered thrift. For both cards, however, the financial institution, rather than Simon, received the fees charged for the card and Simon was compensated through a sales-based commission. Those aspects of gift card relationship with the consumer that were the focus of New Hampshire’s Consumer Protection Act were governed by a contract between the financial institution and the consumer, could not be modified and were not controlled by Simon.
The activities concerning gift cards were covered by the regulations governing national banks and federally chartered thrifts. In SPGGC, like State Farm Bank, the court not only considered the broad, exclusive authority granted by Congress over banks and thrifts to use unaffiliated agents, but also determined that the activity the state sought to regulate through the agent was a product line of the financial institution subject to federal regulatory supervision.
What’s the Point?
Both State Farm Bank and SPGGC affirm that federally chartered financial institutions can act through independent contractors or agents without fear of regulation by state regulatory agencies. Two caveats: (1) the activity must be one that the financial institution itself could conduct under federal statute and regulation; and (2) the bank or thrift must exercise adequate control over the arrangement — either by maintaining control over the third-party contractor or over the product itself. Of course, such control must include an assurance that the agent is ultimately under the OTS’ regulatory authority.
State Farm Bank and SPGGC represent a growing body of case law supporting the federal regulators’ preemption of state law in their supervision of thrift activities. This judicial support for preemption is important in light of federal regulators’ issuance of the following legal opinions preempting state law:
• In June 2006, the OTS issued a legal opinion preempting state licensing laws governing stored value cards.
• In July 2006, the OTS issued its legal opinion granting a second-tier mortgage operating subsidiary the same preemption of state licensing, registration and lending law, and upholding its use of the most favored interest rate doctrine available to the federally chartered thrift itself.
Thus, the OTS appears to be moving to expand its preemption of state law at the same time that many courts are upholding such expanded preemptive authority.
For more information, e-mail John Mussman at john.mussman@hklaw.com or call toll free, 1-888-688-8500.