Supreme Court’s surprise ruling further erodes federal preemption

Exclusive analysis for FinReg21 by Darrell Delamaide

Perhaps the most surprising thing about the Supreme Court’s surprise decision abridging federal preemption in banking regulation was that conservative Justice Antonin Scalia sided with the liberal wing of the court in the 5-4 decision and wrote the majority opinion.

For 140 years, nationally chartered banks have been able to use federal preemption to shield themselves from prosecution by state attorneys general seeking to enforce their states’ consumer protection laws.

But last week [June 29], the Supreme Court handed down its decision in Cuomo v. Clearing House Association LLC, with Scalia parsing federal preemption so that states retained “prosecutorial” rights, as distinguished from “visitorial” rights of routine bank examinations, which are preempted.

The decision further eroded a preemption principle already damaged by another court decision this year. In March, Wyeth v. Levine ruled 6-3 that drug makers could not rely on federal regulation to protect them from lawsuits under state consumer protection laws.

The new ruling follows an April 2007 decision in Watters v. Wachovia Bank, N.A. The court affirmed 5-3 that operating subsidiaries of national banks are protected by federal preemption in their lending activities with regard to visitorial rights, while leaving open the question which state laws can be enforced.

The principle faces a further challenge in the draft legislation released last week [June 30] to create a Consumer Financial Protection Agency. The administration proposal expressly grants states the freedom to prosecute if their consumer protection laws are stricter than rules adopted by the new agency – there is no federal preemption in this regard.

The Cuomo v. Clearing House Association case dates back to the time when Eliot Spitzer was attorney general in New York. After successfully tackling trading abuses in mutual funds and research fraud at Wall Street securities firms, Spitzer wanted to go after banks he thought were discriminating against minorities by charging them more for loans.

But Spitzer ran into opposition from the Office of the Comptroller of the Currency, the main federal bank regulator, and the banks, represented by the Clearing House Association, who argued that the state attorney general had no right to information about the loans because of federal preemption.

The lower courts sided with the OCC and the banks. Spitzer in the meantime had his revolving door experience in the New York governor’s mansion and his successor as attorney general, Andrew Cuomo, took over the suit.

The Supreme Court decision leaves much of preemption intact. States do not have visitorial rights to just come in and look at a bank’s books. Nor can they even issue an “executive subpoena” to get the information. Rather, they have to go to court and get a subpoena if they feel a bank is violating state consumer protection laws with their lending practices.

Still, the decision was a substantial setback for the industry.

“We’re disappointed that the Supreme Court has decided to question the OCC’s role as the exclusive regulator for national banks,” Edward Yingling, chief executive of the American Bankers Association, said in a statement. “This decision, which invalidates the OCC’s interpretation reflected in its regulation, changes over 140 years of settled law.”

Yingling went on to warn that the ruling will make it difficult for banks to serve consumers in “today’s hi-tech, mobile society” because they will face a patchwork of duplicative and conflicting federal and state regulation and enforcement actions.

The industry likes federal preemption because it means they can deal with a single regulator at the federal level and not have to gear up for compliance with a different mix of restrictions in each of the 50 states.

For this reason, national insurance companies have long lobbied for a federal insurance charter and federal regulator to free them from the obligations of meeting individual state requirements.

The states have argued the local regulation of the insurance industry is necessary to ensure that companies have sufficient backing to meet claims.

Consumer advocates welcomed the court’s decision.

"As the court clearly recognized, this is a time when more – not less – enforcement of fair lending laws is essential,” said John Payton, president of the NAACP Legal Defense Fund. “Civil rights always benefit when both states and the federal government work aggressively to curb discrimination.”

And Spitzer himself, who always argued that this was a law enforcement issue and not a regulatory issue, welcomed the ruling.

“This is a big win for law enforcement and for those who believe that banks need to have an appropriate level of scrutiny,” he said.

Scalia’s lining up with the liberal justices on this issue is a reminder that conservative does not always mean pro-business. Scalia, considered by some to be the most conservative justice on the court, tipped his hand during the oral arguments in April.

A recap of the proceedings on Scotusblog said that Scalia remained unconvinced by arguments from the U.S. deputy solicitor general Malcolm Stewart, representing the OCC, that the wording of the National Bank Act implied exclusivity of enforcement.

“Indeed, Justice Scalia argued repeatedly with the respondents over their definition of ‘enforcement preemption,’” blogger David Schwartz wrote.

Already then, according to this observer, the issues being considered and the course of the debate evidenced “an intriguing and unusual line-up of justices,” with Scalia siding more often with the liberal judges.

While the tenor of questioning in the oral arguments can sometimes be misleading, in this case they accurately foreshadowed the final decision.