Watters, Linda (Commissioner, Michigan Office of Insurance & Financial Services) v. Wachovia Bank, N.A., et al. (04/17/2007)

Questions presented: (1) Is the interpretation of the Comptroller of the Currency that 12 CFR 7.4006 preempts Michigan's laws regarding mortgage lending, as applied to state-chartered nonbank operating subsidiaries, entitled to judicial deference under Chevron USA, Inc. v. Natural Resources Defense Council? (2) Does 12 CFR 7.4006, by equating a state-chartered nonbank operating subsidiary with a national bank for the purposes of federal preemption of state regulation, violate the 10th Amendment to the Constitution?

BY HILARY OSWALD, MEDILL NEWS SERVICE

At first blush, Watters v. Wachovia Bank, N.A., seems to be a case full of esoteric banking laws and jargon-heavy references to obscure federal agencies. At its heart, however, is a question as old as the Bill of Rights: Where does federal regulation end and a state's jurisdiction begin?

For nearly 200 years, the United States has had a dual banking system. Banks are either chartered and regulated by states, or they are chartered and regulated by the federal government.

Seems simple.

But Watters v. Wachovia Bank shows how complex the system can be when a federal regulatory agency goes toe-to-toe with a state agency in the battle for authority over a state-chartered banking corporation.

On Jan. 1, 2003, Wachovia Mortgage became a wholly-owned operating subsidiary of Wachovia Bank, a national bank. Chartered by the state, an operating subsidiary is a separate corporation from the national bank, but under federal law, it can engage in the same business practices, including mortgage lending.

On April 3, 2003, after making mortgage loans in Michigan for nearly six years, Wachovia Mortgage notified the Michigan Office of Financial and Insurance Services (OFIS) that it would continue to issue mortgages without registering with the OFIS, thereby violating Michigan's laws.

Its logic: As an operating subsidiary of a national bank, it no longer had to follow state banking regulations because it was regulated by the Office of the Comptroller of the Currency (OCC), the federal agency that oversees national banks.

In response, Linda Watters, the Commissioner of the Michigan OFIS, informed Wachovia Mortgage that it could no longer make loans in Michigan. Wachovia Bank and Wachovia Mortgage filed suit against Watters, seeking a declaration that the OCC regulations preempt (or take precedence over) Michigan laws.

The central legal question is whether the OCC, through the National Bank Act, has the authority to promulgate federal regulations that attempt to preempt state law.

The OCC administers the National Bank Act, which authorizes national banks to exercise "all such incidental powers as shall be necessary to carry on the business of banking."

The National Bank Act also specifies that "no national bank shall be subject to any visitorial powers except as authorized by federal law, vested in the courts or such as shall be exercised by Congress." In this instance, visitorial powers are powers to regulate and examine banks' activities.

The Michigan laws at issue permit the state to investigate a consumer complaint if federal regulators do not investigate the complaint. It also imposes fees and various standards on the banks and requires they register with the state.

By promulgating its regulations, the OCC has determined that the creation of subsidiaries falls into the category of "incidental powers," so Michigan cannot examine or regulate Wachovia Mortgage's lending activities.

The question then becomes: What role should federal administrative agencies like the OCC play in resolving the tension between state and federal regulations?

The lower courts answered that question by examining the case in light of the 1984 Supreme Court decision in Chevron U.S.A. Inc. v. National Resources Defense Council, Inc.

In Chevron, the decision created a two-pronged test to determine when courts must defer to a federal agency's interpretation of a statute it administers.

Step one: If Congress has clearly spoken on the precise question and its intent is unambiguous, the courts must defer to that interpretation of the law.

Step two: If the meaning of the statute is unclear or if Congress is silent on the issue, courts must give deference to the agency's interpretation of the law, if the interpretation is based on a "reasonable construction" of the statute.

The U.S. District Court for the Western District of Michigan at Lansing issued summary judgment in favor of Wachovia. It concluded that Congress had not spoken on the precise question in this case, so it used the second prong of the Chevron test and decided the OCC's interpretation was reasonable.

The district court also considered whether the federal regulation interferes with rights guaranteed to the states under the 10th Amendment. It ruled that Congress has the authority to regulate national banks under the Commerce Clause. The 10th Amendment allocates only the rights and powers to the states that are not spelled out as federal powers.

The 6th Circuit Court of Appeals affirmed.

In a decision filed Dec. 19, 2005, the court rejected Michigan's argument that the OCC's regulation inappropriately expanded the definition of "national bank" to include the operating subsidiary. Instead, it concluded that a national bank's "incidental powers" include the power to conduct business through an operating subsidiary.

"The regulations…simply reflect the eminently reasonable conclusion that when a bank chooses to utilize the authority it is granted under federal law, it ought not be hindered by conflicting state regulations," the 6th Circuit concluded.

In its petition for writ of certiorari to the Supreme Court, Watters argued that the lower courts should not have applied the Chevron test. It contends the preemption of state laws is so extraordinary, it should be reserved for "the expertise of the courts." The precedent for its argument comes the 10th Circuit's 1991 ruling in Colorado Public Utilities Commission v. Harmon.

On June 19, 2006, the Supreme Court accepted review in the case. Justice Clarence Thomas took no part in that consideration.

Watters has inspired plenty of debate among industry experts and legal scholars.

Because the usual reasons for granting a petition seem to be absent, many industry experts wonder why the Supreme Court agreed to hear the case.

For example, the three federal appeals courts - the 2nd, 6th and 9th circuits - to rule on operating subsidiaries have upheld the validity of the OCC rules.

John Gorman, general counsel for the Conference of State Bank Supervisors, suspects that the Court wants to clarify when Chevron applies.

"[The Court] could have denied cert and made a statement," he said.

Furthermore, the Court declined to hear a very similar case out of Connecticut: Burke v. Wachovia Bank. The major difference between the cases is that Watters asks the justices to consider the role of the 10th Amendment.

Legal scholars also wonder how broadly the Supreme Court will write its opinion. It could limit its decision to the realm of national banks and their operating subsidiaries.

Or, it could answer the broader question of whether federal agencies should get preemption deference, that is, the authority to determine when their statutes trump state laws.

"If Chevron does apply, it gives [federal] agencies a certain degree of authority to expand the scope of their powers," said Kathryn Watts, visiting assistant professor at the School of Law at Northwestern University.

On April 17, 2007, a divided Court ruled 5-3 that state regulators have no authority over the business conducted by national banks.

"We have repeatedly made clear that federal control shields national banking from unduly burdensome and duplicative state regulation," Justice Ruth Bader Ginsburg wrote in the majority opinion, which was joined by Justices Samuel Alito, Stephen Breyer, Anthony Kennedy and David Souter.

Ginsburg noted that a state cannot subject a national bank to its "visitorial" controls, and said the same rule applies to its subsidiaries.

"Just as duplicative state inspection and supervision would significantly burden mortgage lending by national banks, so too those state controls would interfere with that same activity when conducted by a national bank's operating subsidiary," Ginsburg wrote.

But Justice John Paul Stevens, writing for the three dissenters, said Congress did not give the OCC the authority to preempt state law.

"Although the dual banking system's main virtue is its divergent treatment of national and state banks, Congress has consistently recognized that state law must usually govern the activities of both national and state banks for the dual banking system to operate effectively," Stevens wrote in a dissent, which was joined by Chief Justice John Roberts and Justice Antonin Scalia.

Justice Clarence Thomas recused himself from the case because his son and daughter-in-law work for Wachovia Bank.