Regulatory Preemption: Are Federal Agencies Usurping Congressional and State Authority?

Written Statement of the
North American Securities Administrators Association, Inc.
U.S. Senate Committee on the Judiciary

September 12, 2007

The North American Securities Administrators Association, Inc. (“NASAA”), is the nonprofit association of state, provincial, and territorial securities regulators in the United States, Canada, and Mexico.   The members of NASAA include the state agencies that are responsible for regulating securities transactions under state law.    Their fundamental mission is protecting consumers who purchase securities or investment advice, and their jurisdiction extends to a wide variety of issuers and intermediaries—many of them securities affiliates of banks—who offer and sell securities to the public.

NASAA believes that the trend toward preemption of state regulatory authority over the past fifteen years has exposed the public to a heightened risk of abuse at the hands of unscrupulous bankers, brokers, advisers, and insurance agents.  Today’s hearing is focusing on regulatory preemption and two recent regulatory actions are of particular concern to NASAA: Rule 7.4006 promulgated by the Office of the Comptroller (OCC), 12 C.F.R. § 7.4006, and the opinion letter issued by the Office of Thrift Supervision (OTS) on October 25, 2004.

Office of Comptroller of the Currency
In rule 7.4006, the OCC rule substantially amended the National Bank Act and insulated hundreds of state-chartered operating subsidiaries of national banks across the country from regulation under state banking laws.  A single federal agency in Washington, acting without a Congressional mandate, has thus determined that state banking laws enacted to protect consumers do not apply to national bank subsidiaries.

Congress did not intend such a result.  Although the National Bank Act restricts the power of states to regulate national banks, it imposes no restraints on the states’ authority over operating subsidiaries of national banks.  Congress has never expressly forbidden states from regulating bank operating subsidiaries, nor has it occupied the field of banking regulation to the exclusion of all state authority.  Moreover, the application of state consumer protection laws to national bank operating subsidiaries does not significantly interfere with the operation of national banks or their affiliates and thus does not conflict with federal law.

Regrettably, the federal courts have repeatedly upheld the validity of rule 7.4006—a trend that bodes ill for consumers.  See, e.g., Watters v. Wachovia Bank, N.A., 127 S. Ct. 1559 (2007).  The most immediate harm flowing from rule 7.4006 is that it shields operating subsidiaries of national banks from the application of state banking laws that provide consumers with significant protections against abusive lending practices, particularly in the area of mortgage loans.  NASAA harbors an additional concern: As the worlds of banking, insurance, and securities increasingly intersect, NASAA and its members fear that the OCC may seek to encroach further upon state regulatory jurisdiction, not only in banking, but potentially in the areas of insurance and securities as well.  National banks have already invoked the OCC’s visitorial powers rule to impede investigations by state securities regulators relating to the securities activities of banks and their subsidiaries, even though such investigations are unquestionably permitted under the Gramm-Leach-Bliley Act (GLBA).

In short, OCC Rule 7.4006 constitutes an impermissible attempt by a regulatory agency to expand the preemptive scope of a federal statute in derogation of Congressional intent.  The result is less consumer protection.  Consumers are best served when regulators at the federal and state level work together to ensure not only the safety and soundness of the banking system, but also the fair and equitable treatment of banking customers.

Office of Thrift Supervision
In an opinion letter issued on October 25, 2004, the OTS concluded that state licensing and registration requirements do not apply to independent contractor agents who market deposit and loan products on behalf of State Farm Bank, a federal savings association (State Farm).  The letter claims that these agents are exempt not only from state banking laws but also from state securities laws requiring the licensure of those who sell securities.  This interpretation applies to agents selling all types of certificates of deposits (CDs) on behalf of State Farm, regardless of whether or not those products are fully insured by the FDIC and regardless of how complex or risky they may be.  The OTS opinion letter is particularly troubling since it preempted an important body of state law without first being subject to the public comment and hearing process.

Once again, a federal banking agency exceeded Congressional authority.  The Home Owner’s Loan Act, under which the OTC operates, nowhere expressly or impliedly preempts the application of state law to State Farm’s agents marketing CDs.  Furthermore, although federal case law holds that conventional CD products do not constitute securities, the issue is far from settled with respect to unconventional CDs that pose heightened risks because of their inherent features or the way in which they are marketed.

Early indications are that the federal judiciary will side with the OTC.  See State Farm Bank, F.S.B. v. Burke, 445 F. Supp. 2d 207 (D. Conn. 2006).  Thus, as in the case of OCC rule 7.4006, it appears the only way to ensure that American investors and consumers are adequately protected from abusive practices in the financial services arena is for Congress to reign in these banking agencies and clearly delineate the appropriate role for state regulation.

Because of the potential risk to investors, states securities regulators should retain the right to require independent sales agents acting on behalf of State Farm or similar banking associations to become licensed with their state securities regulator in order to sell CD’s.  State licensing requirements add a significant layer of protection by screening out agents who are unfit by reason of training, education, or disciplinary history to market securities.

Where Congress has left room for the application of state law to financial institutions, federal regulatory agencies should not be permitted to “preempt” Congress’s judgment.  The public needs the protections that state law offers.  From NASAA’s standpoint, this approach is especially important in the area of securities regulation.  In keeping with the modern regulatory approach known as functional regulation, state securities regulators assert their jurisdiction based principally upon the nature of the financial activity involved, not the nature of the entity engaged in that activity.  Accordingly, with certain exceptions, bank entities offering securities to the public are subject to state securities regulation, along with more traditional broker-dealers and their registered representatives.  Congress intended states to exercise this regulatory authority for the benefit of our nation’s investors and consumers.

September 12, 2007

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