Preemption of State Mortgage Banking Regulations for Operating Subsidiaries of National Banks
July 11, 2007
On April 17, 2007, the United States Supreme Court ruled that federal regulation of national banks under the National Bank Act excludes Michigan regulators’ authority to register, license and supervise an operating subsidiary of a national bank that conducts mortgage bank activities. In a 5-to-3 decision, the Court held that such an operating subsidiary is regulated exclusively within the purview of the Office of the Comptroller of the Currency (OCC) and not subject to the licensing, reporting and visitation requirements of the state regulators. Watters v. Wachovia Bank, N.A., 550 U.S. ___ (2007). Prior to becoming a wholly-owned subsidiary of Wachovia Bank, Wachovia Mortgage Company had been a mortgage bank regulated by the Michigan Office of Insurance and Financial Services (OIFS). Once it became an operating subsidiary of Wachovia Bank, Wachovia Mortgage surrendered its state mortgage lending registration, stating that as an operating subsidiary of a national bank, it was no longer subject to the Michigan regulatory scheme governing mortgage banks.
The Court rejected the OIFS Commissioner’s contention that the OCC’s power over an operating subsidiary was not exclusive and adopted the arguments embraced by lower courts that the National Bank Act grant of powers to bank operating subsidiaries to conduct activities “incidental” to banking, subjects both national banks and their operating subsidiaries to the visitation powers of the OCC exclusive of any interference by state banking authorities. The OCC regulations define “Visitorial powers” to include (i) the examination of a bank, (ii) the inspection of a bank’s books and records, (iii) the regulation and supervision of activities authorized or permitted pursuant to federal banking law, and (iv) the enforcement compliance with applicable federal or state laws concerning those activities.
The Court reasoned that the OCC’s authority over a national bank even when conducted through operating subsidiaries, are “subject to the terms and conditions that govern the conduct of such activities by national banks” and that such supervisory authority is exclusive. The substantive regulation of the OCC under the Banking Act is focused not on the corporate structure of the bank and whether activities are conducted through a bank division or operating subsidiary, but rather on regulating the power itself. Whether the bank opts to conduct activities within an operating subsidiary of the bank is an internal organization question, and it is “not material that functions qualifying or within ‘the business of banking’ was to be carried out not by the bank itself, but by an operating subsidiary.” In either case the National Bank Act subjects the activity to OCC supervision and authority and part of such authority is protecting such activities from “significant interference by state bank regulators.”
Distinction Between Operating Subsidiaries and Other Bank Affiliates
The Court distinguished between (1) operating subsidiaries such as Wachovia Mortgage Company that engage in activities that could be conducted by national banks themselves, and (2) other bank affiliates, including financial subsidiaries authorized under the Gramm-Leach-Bliley Act that may engage in broader financial activities beyond those that can be conducted by national banks. The Supreme Court acknowledged that affiliates such as those conducting insurance activities and others authorized by the Gramm-Leach-Bliley Act would need to be licensed by state regulators.
No Deference Analysis Necessary
In resisting the Michigan regulator’s arguments that the Supreme Court should not defer to the OCC regulation and interpretation of the National Bank Act, the Court stated that deference to the OCC was not the issue in this case. The OCC’s regulation merely affirmed what the National Bank Act already conveyed:
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.
Rejection of Michigan’s Constitutional Arguments
The Court similarly rejected the Michigan regulator’s assertion that the Tenth Amendment to the Constitution reserved to the states power to regulate mortgage banking activity, reasoning that the Tenth Amendment only reserves to the states powers not delegated to Congress. National bank regulation “is a prerogative of Congress under the Commerce and Necessary and Proper Clauses” and thus was not covered by the Tenth Amendment.
What’s the Point?
In addition to vindicating the OCC’s general power to regulate national bank operating subsidiaries, Watters offers a clear path for bank holding companies to structure their mortgage activities in an operating subsidiary so as to avoid the state licensing schemes imposed on mortgage banks. Partly in response to what many perceive as a crisis in subprime
lending, several states have expanded their regulation over mortgage brokers
and mortgage bank licensees. Bank companies can avoid much of this
variegated and sometimes idiosyncratic regulation by reorganizing their
mortgage banking operations and conducting them through an operating
subsidiary of a national bank.
For more information, e-mail John R. Mussman at
john.mussman@hklaw.com or call toll-free, 1-888-688-8500.
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