Federal Preemption of State Consumer Financial Laws: Significant Changes Require Focus Now

The Dodd-Frank Wall Street Reform and Consumer Protection Act dramatically narrows the availability of federal preemption of "state consumer financial laws" for all banks and savings associations, their subsidiaries and agents. Institutions need to take steps now to ensure their operations and products do not violate state law when the new federal preemption rules become effective.
Effective Date: This change is effective (but see caveat below) on the "Designated Transfer Date," which will be 6 to 12 months after July 21, 2010 (subject to extension). Regulations are not necessary.
Preemption Today: Today, national banks, federal savings associations, their subsidiaries and agents, and state chartered banks may disregard compliance with many state laws because federal law preempts the state laws.
For national banks, "state laws that obstruct, impair, or condition a national bank's ability to fully exercise its powers to conduct activities authorized under Federal law," including deposit-taking and lending powers, are preempted. State laws are preempted for both national banks and their operating subsidiaries.
For federal savings associations, federal preemption is even more complete. Federal law occupies the field for most issues, with the exception of certain types of state laws, for both the federal savings association and its operating subsidiaries.
State chartered banks with interstate branches "piggyback" on federal preemption. Their out of state branches are subject to the laws of the host state concerning community reinvestment, consumer protection, fair lending, and establishment of intrastate branches only to the extent those laws are not preempted for out of state national banks with branches in the host state.
Preemption under Dodd-Frank: Sections 1044-1046 of Dodd-Frank narrow preemption of "state consumer financial laws." "State consumer financial laws" are those laws that do not directly or indirectly discriminate against national banks and directly and specifically regulate the manner, content, or terms and conditions of any consumer financial transaction or account. "Consumer" is an individual or someone acting on behalf of an individual. Unless the Bureau of Consumer Financial Protection narrows this definition, the new preemption rules will apply to some business financial transactions and accounts.
Beginning on the Designated Transfer Date, no state laws (not only "state consumer financial laws") are preempted for subsidiaries, affiliates, or agents of national banks or federal savings associations, merely because of their corporate or contractual status as subsidiaries, affiliates, or agents of the banks. Further, "state consumer financial laws" are preempted for national banks -- and, through "piggyback," state chartered banks -- only if the state law:

• has a discriminatory effect on national banks;
  
• is preempted by a specific federal law, but not including the National Bank Act; or
  
• prevents or significantly interferes with the national bank's exercise of its powers under the standard established in Supreme Court's decision in Barnett Bank of Marion County, N.A. v. Nelson, Florida Insurance Commissioner, 517 U.S. 25 (1996).

These new preemption standards also apply to federal savings associations. Federal preemption will no longer "occupy the field" in any area of state law.
A court or the OCC by regulation or order on a case by case basis must determine that a state law prevents or significantly interferes with a national bank's exercise of its powers. The OCC will determine the impact of a particular "state consumer financial law" on a national bank that is subject to that law, or the law of any other state with substantively equivalent terms, based on substantial evidence, on the record, which supports the preemption finding. Courts are directed to look over the OCC's shoulder and assess the validity of the preemption determinations depending on the OCC's thoroughness, the validity of its reasoning, the consistency with other valid preemption determinations, and other factors the court finds persuasive and relevant.
The Barnett standard that the OCC must now use to determine preemption is a very high standard. The existing obstruct, impair, or condition standard is much broader than prevents or significantly interferes. We believe the new standard that must be applied by the OCC, along with the "case by case" determination and court oversight, means the OCC will not aggressively preempt state laws, which means depository institutions will need to comply with many state laws they currently may be disregarding based on federal preemption.
What does this mean for you? Each depository institution (and its subsidiaries and agents) must determine whether it currently relies on federal preemption in connection with its operations and products. Because the new rules for depository institutions only apply to "state consumer financial laws," banks and savings associations must determine what state laws are "state consumer financial laws," and must do so on a state by state basis.
Let's take Maryland for an example of the analysis. For a depository institution operating in Maryland, we believe that Maryland's licensing laws generally are not "state consumer financial laws" because these laws almost exclusively are limited to governing the actions required to be licensed, and licensing does not "directly and specifically regulate the manner, content, or terms and conditions of any financial transaction or account." Even so, there are a few very specific provisions in Maryland's licensing laws (for example, a prohibition against closing a second lien mortgage loan in the borrower's home) that may rise to the level of a "state consumer financial law" and need to be considered.
There are, of course, other Maryland laws that are "consumer financial laws" that depository institutions have traditionally disregarded based on federal preemption, including laws that require:

• A notice to customers when issuing ATM access devices
  
• The month and year a checking account is opened to be printed on checks for new accounts
  
• Depositories to pay at least 3% annual interest on "Christmas," "vacation," and other special purpose accounts
  
• The return of some checks for customers with truncated checking accounts
  
• Interest to be paid on residential mortgage loan escrow accounts
  
• Limits and disclosures related to residential mortgage loan closing costs and attorney fees
  
• Determination and documentation of a residential loan borrower's ability to repay
  
• Election of governing Maryland credit law
  
• A notice of Housing Counseling Programs and Services (beginning January 1, 2011)
  
• Limits on refinancing certain loans at higher rates and charging adjustable rates

Interest that may be charged on loans, including interest rate exportation, survives unaffected by Dodd-Frank's changes to federal preemption. Thus, what constitutes "interest" for purposes of the "most favored lender" interest rate exportation preemption may be an even more important question in light of the Dodd-Frank narrowing of preemption for "state consumer financial laws."
Caveat on Effective Date: Section 1043 preserves the validity of contracts entered into "on or before the date of enactment of this Act," which was July 21, 2010. For those existing "grandfathered" contracts, Dodd-Frank does not affect the applicability of any current regulation, order, guidance, or interpretation issued by the OCC or the OTS. However, the date the preemption provisions are effective is the Designated Transfer Date, which is yet to be determined. This conflict at least raises a question regarding the status of transactions entered into after July 21, 2010 and before the new preemption rules become effective. We believe the only reasonable way to resolve this conflict is to "grandfather" contracts entered into between July 21, 2010 and the Designated Transfer Date. However, in light of the uncertainty raised by this conflict, there is pressure on financial institutions to perform their preemption re-evaluation quickly.
Action Plan: Depository institutions that rely directly or indirectly on federal preemption of "state consumer financial laws" should begin a preemption analysis promptly so that necessary operations and product changes can be made before the Designated Transfer Date.
1. Identify the states in which consumer transactions and accounts are offered, and then identify which laws of those states apply to consumer transactions and accounts.
2. Determine whether those identified state laws are "state consumer financial laws."
3. Determine whether the institution currently is complying with each "state consumer financial law," or is taking advantage of federal preemption. If not taking advantage of federal preemption, the analysis is finished.
4. If the institution is taking advantage of federal preemption, determine if preemption is granted specifically by a particular federal law, and if so, preemption is still available.
5. If the institution is taking advantage of federal preemption and that preemption is not granted specifically by a particular federal law, then the "state consumer financial law" must be analyzed under the Dodd-Frank preemption standard. Assuming the state law will not have a discriminatory effect on national banks, analyze whether the state law prevents or significantly interferes with the institution's exercise of its powers. This is a difficult standard to meet and we caution that federal preemption after the Designated Transfer Date may be very limited.
6. If the state law is not preempted under the new standards, operations and products must be brought into compliance with the "state consumer financial law," at the very latest, by the Designated Transfer Date.
7. If subsidiaries, affiliates, or agents of depository institutions are taking advantage of federal preemption of any state law, operations and products also must be brought into compliance with the state law by the Designated Transfer Date.
Please contact our Dodd-Frank Survival Guide Team to discuss this topic in greater detail.

Copyright 2010 Gordon Feinblatt, LLC. DODD-FRANK SURVIVAL GUIDE is intended for informational purposes only and is not legal advice to any person, entity, or firm. The material included in DODD-FRANK SURVIVAL GUIDE is obtained from a variety of public sources. Portions of the content of this email may contain Attorney Advertising under the rules of some states. Prior results do not guarantee a similar outcome.