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Public Hearing on Preemption Petition

Testimony and Written Submission of Cantwell F. Muckenfuss III
Gibson, Dunn & Crutcher LLP
Washington, DC
Federal Deposit Insurance Corporation Public Hearing
May 24, 2005

Good morning. My name is Chuck Muckenfuss. I am here today on behalf of a working group (the "Working Group") of state-chartered commercial banks that are members of The Financial Services Roundtable (the "Roundtable"). Each is among the largest remaining state-chartered banks. Each is grateful to the FDIC for responding to the petition of the Roundtable (the "Petition") seeking parity for state banks in the ability to operate across state lines under a consistent framework of law, regulation and supervision. At stake is the continued vitality of state bank regulation and the structure and dynamics of bank regulation at the federal level that have served our nation so well.

My own background provides a pertinent and, in some respects, unique perspective. I am a partner at Gibson, Dunn & Crutcher LLP where I have practiced in the field of financial regulation for nearly 24 years. More than 31 years ago, I came to the FDIC to work for Director George LeMaistre, a national banker. When Mr. LeMaistre became Chairman in 1977, I became Counsel to the Chairman. In 1978, I became one of three senior deputies to the then Comptroller of the Currency, John Heimann, who had previously served as Commissioner of Banking in the State of New York.

At the outset, the dual banking system seemed unduly complex and remarkably inefficient. I believed that a single federal regulator of banks and bank holding companies would be far superior. My experience in government changed that view.

The reason is quite simple. In a world in which few of us are wise enough and lucky enough to get it right all or even most of the time, the evolution and implementation of public policy are best served by more than one locus of authority and accountability. The public good, like private good, is ill served by monopoly. Diversity works. That is the important insight of federalism and it is the peculiar genius of bank regulation in the United States.

The Roundtable's Petition and the Working Group's testimony reflect the danger to this engine of reform and innovation. Without a comprehensive framework of parity in the ability of state banks to operate interstate under a single uniform framework of law, regulation and supervision, the only viable choice for interstate banks, like those in the Working Group, will be a national charter. That, in short, spells the death of the dual banking system.

Because the Roundtable Petition reflects our work, we request that it be incorporated as part of this testimony. Before responding to each of the questions set forth in the notice of hearing, several key points are worthy of special note.

First of all, it is important to be clear about what is and is not requested in the Petition. The Petition is not requesting a comprehensive federal preemption of state law in the ordinary sense. Rather, it seeks to fully implement an existing federal statutory framework for determining which state law applies when state banks operate across state lines. By providing clarity and certainty, the rules contemplated by the Petition would assure that state banks have parity with national banks in their ability to function under a consistent framework of law, regulation and supervision in their interstate operations.

Second, the principle of parity as a mechanism of maintaining balance in the dual banking system and actions requested by the Petition are neither radical nor path breaking. Congress chose this approach in enacting the McFadden Act, Section 27 of the FDI Act and, finally, the 1997 amendments to the Riegle-Neal Act ("Riegle-Neal II"). The Petition asks the FDIC to fully implement the statutory and policy template enacted by Congress in the 1997 amendments and re-enforced by Section 104 of the Gramm-Leach-Bliley ("GLB") Act ("Section 104"). Because the promise of these acts has not been fulfilled, FDIC action is required. There is a clear need for the FDIC to interpret these existing statutory provisions and to fill statutory gaps through a comprehensive rulemaking implementing these laws.

Third, the FDIC has ample authority to take all of the actions urged in the Petition. Sections 8 and 9 of the FDI Act and well-settled principles of administrative law, fully support the power of the FDIC to implement Riegle-Neal II and Section 104 in a manner that will provide parity to state banks as they conduct business across state lines.

The Petition asks the FDIC to perform exactly the function contemplated for administrative agencies in our system of government. The success of the OCC and the OTS in addressing the need for a seamless scheme of supervision and regulation of interstate banking is illustrative. Certainly, a comprehensive rulemaking is preferable to uncertainty, confusion, litigation and the not so slow death of a robust system of state and federal regulation for state banks of all sizes and strategies. Indeed, the Working Group believes that the scope of the FDIC's very broad authority carries with it a systemic responsibility that requires the requested actions.

Fourth, it is important to underscore that the stakes are far greater than the role of the states in the dual banking system. The direct roles of the Federal Reserve and the FDIC in the regulation of banks are derivative of the federal system of state and national charters. Diversity and choice at the federal level, along with a uniquely successful experience of state-federal cooperation, will be lost if interstate banks -- multinational, regional or community -- must opt for a national charter.

Fifth, the task that we are asking you to undertake is as difficult as it is important. Neither the Petition nor this testimony answer all the questions and concerns that must be addressed. Inherent in the framework embodied in Riegle-Neal II and Section 104 and discussed in the Petition are at least three related challenges that must be addressed:

  • A parity framework must address the possibility that there might be some sort of a "race to the bottom." We believe that the FDIC has several alternatives to assure that this does not occur.
  • A parity framework must provide appropriate resources to assure effective supervision and regulation of state banks and effective and vigorous protection of all customers no matter where they reside. The Working Group believes that these resources are and will be available -- as they have been for more than 30 years -- through partnership between the respective states and the Federal Reserve or the FDIC and through cooperative agreements between and among the states.
  • A parity framework -- like a regime of federal preemption -- must not be, or be perceived as, a device to avoid appropriate and necessary regulation. To put a finer point on the issue: the framework sought by the Working Group must not, for example, be a mechanism to avoid the eradication of predatory practices. In this regard, we support the Roundtable's efforts to obtain federal legislation creating a uniform national standard with respect to predatory lending. We also urge the federal banking agencies to make aggressive use of their considerable authority to advance uniformity at combating these intolerable practices.

In short, the Working Group fully recognizes and appreciates these concerns and others expressed in today's hearing. We are fully committed to working with the FDIC in the process of creating a framework that preserves the dual banking system and fully protects the public interest.

Finally, time is of the essence. The clear statements of the members of Congress closest to this issue in 1997 were eerily, and profoundly, prophetic.* We are now experiencing exactly the dynamic that Riegle-Neal II sought to prevent. This Working Group can testify directly that, absent the clarity and certainty of an implementing rule for state banks operating interstate, we are in the endgame and the result is clear-cut -- a single dominant framework of regulation of interstate banks. Action is required now.

The FDIC Board must carefully consider the undeniable fact that inaction constitutes a choice to ratify the end of the unique American federal system of bank regulation as we have known it for 140 years. It is not the time to sit on the sidelines. The direction from Congress to preserve the dual banking system was clear. Yet the goals of its actions remain unfulfilled. Accordingly, the Working Group challenges those who have not been supportive of the Roundtable's request for an FDIC rulemaking to engage in this discussion in a thoughtful, constructive and positive manner. In our judgment, the failure to do so will have long-term adverse systemic consequences and impose unnecessary costs and burdens on state and national banks, as well as the customers they serve.

The balance of this submission reflects an effort to respond to each of the questions set forth in your notice. The Working Group stands ready to work with the FDIC and all interested parties to address concerns that have been raised in this hearing and in written submissions. We fervently hope the FDIC will continue the important process it has begun with today's hearing.

G-1. Is a preemptive rule in these areas necessary to preserve the dual banking system?
As set forth above, the Working Group believes that implementation of a comprehensive federal framework that assures state banks parity in the ability to operate under a single regime of law, regulation and supervision is absolutely necessary to preserve the dual banking system. As recent conversions reflect and as the experience and analysis of the Working Group confirms, this factor tends to overwhelm all other considerations. Absent rules providing such parity, the state charter is no longer a viable or desirable option for most state banks which choose to operate across state lines – whether they are a transnational, nationwide, regional or community bank.

It is perhaps worthy of note at this point that, although aspects of the requested framework would involve preemption, as when a state law impermissibly discriminates against an out-of-state state bank, what the Petition seeks is not a typical preemptive rule in which federal substantive law trumps state law. Rather, the framework expressly provided in Riegle-Neal II is a federal test for determining which state law (home or host) applies for the interstate activities of state banks – a choice which, under Riegle-Neal II, depends on the applicability of host state law to a national bank.

G-2. What would be the impact on consumers if a preemptive rule were issued in these areas?
We believe that consumers will benefit significantly if the FDIC proceeds with the rulemaking contemplated by the Roundtable Petition.

First and foremost, in the long run, consumers, banking institutions and the financial system will, in our view, be poorly served if state banking departments, the FDIC and the Federal Reserve System are largely irrelevant to the regulation and supervision of interstate banking. As I hope we have made clear, that outcome is certain if action is not taken.

Second, consumers and banking institutions alike will benefit from the clarity, certainty and efficiency when a provider can operate under a uniform and integrated framework of law, regulation and supervision.

Third, and a corollary of the first point, consumers will benefit from diversity. Consumers in a host state will be able to choose among multiple frameworks of consumer protection: that of the OCC, that of the host state or that of the home state (with a federal overlay) if the requested framework is implemented. As this testimony suggests, the failure to implement such a framework will assure there is but a single choice for those who do business with interstate banks – that of the OCC.

Fourth, any regulation adopted by the FDIC should make plain the important cooperative role of the FDIC and the Federal Reserve in the oversight of state banks and the very considerable power and resources that are brought to bear by these agencies. These resources and authority are certainly available to fill any particular gaps in consumer protection and other areas.

And, finally, in particular areas, there may be the necessity for Congressionally enacted uniform national standards. For example, the Roundtable has strongly supported the enactment of such standards in the case of predatory lending. At the same time, the Working Group strongly encourages the banking agencies to explore the development of standards to eradicate predatory practices of all sorts. The concerns expressed in this hearing will provide helpful guidance and development of necessary safeguards which can and should be incorporated in rules promulgated pursuant to the Petition.

G-3. What are the implications of rulemaking in these areas for state banking regulation?
Unless the FDIC responds positively to the Petition and adopts a regime which assures the needed parity rules, state bank regulation will become irrelevant for the vast preponderance of those institutions which operate on an interstate basis. Without these institutions, state banking regulation will largely be the province of those institutions which have no interest in interstate operations and activities. Moreover, across the country, if the asset base of institutions paying fees to support a particular state agency shrinks and state legislators do not provide increased appropriations, a growing number of states may be faced with hard choices and pressure on resources to provide the necessary quality of regulation.

Importantly, this effect is not limited to the states. The role of the Federal Reserve System and the FDIC in bank regulation is dependent on the existence of state banks. Moreover, the population of banks which participate in interstate banking are those of greatest systemic importance. Certainly, elimination of the direct role of the Federal Reserve in the regulation and supervision of these banks would be a radical departure in the functioning of our banking system.

G-4. Would the measures urged by Petitioner achieve competitive balance between federally-chartered and state-chartered financial institutions as advocated by the Petitioner?
The measures sought by the Petitioner, if implemented rigorously, would go a long way to restoring parity between the state and federal charter. It would restore meaningful charter choice for institutions that wish to operate interstate. It should remove the existing, almost hydraulic legal pressures on major interstate banks to operate under a national charter and again provide national banks a meaningful choice whether to remain federal or convert to a state charter. If the rules addressing the matters discussed in the Petition are adopted by the FDIC and provide the scope of parity proposed by the Petition, then the trend of the last decade in favor of the national charter will be reversed. As the Petition reflects, Congress understood well the need for meaningful charter choice in interstate banking as essential for maintaining a competitive balance among national and state banks.

In this regard, it should be highlighted that without the competitive flexibility provided by all the rule provisions sought in the Petition, state banks will continue to be at a distinct competitive disadvantage. State banks must be able to compete on terms of parity with national banks across the country, both in states where they have branches and in all the other states in which they choose to provide product and services without branches, through operating subsidiaries or by direct delivery.

The dual banking system is at an historic crossroads. The FDIC has the opportunity and responsibility to implement the statutory framework that Congress has enacted to maintain parity and fairness. If the FDIC does not implement existing federal statutes to provide parity, the dual banking system as it has existed and functioned for 140 years will wither. What will survive will be a split-level banking system in which only community banks and a few niche institutions will opt for the state charter and regulation at the federal level by the FDIC or Federal Reserve.

G-5. Are there alternative mechanisms available that would achieve the policy goals advocated by the Petitioner?
We do not know of other mechanisms which simultaneously serve the goals of maintaining choice, assuring a nearly seamless web of law, regulation and supervision, and offering the opportunity for effective consumer protection. Rules permitting institutions to have uniform interstate operations can only be effected at the federal level. Multistate state cooperative agreements are highly constructive, but are not truly interstate. In our federal system under the Commerce Clause, interstate rules are necessarily federal rules. Paradoxically, the federal rules sought by the Petition are necessary to preserve the most expansive state role possible in the regulation of banks. That is precisely why Congress has used the parity mechanism in the evolution of banking law.

G-6. Should the issue of competitive parity in interstate operations be left to Congress?
As the Petition reflects, Congress has acted. The result of the FDIC consideration of the Petition will determine whether Congress needs to act further to restore equilibrium and thereby preserve the dual banking system and the FDIC and Federal Reserve's role in it.

The Working Group believes that Congress has provided the FDIC both ample authority and responsibility to implement the needed parity framework. The discussion surrounding this Petition reflects the very poor understanding of what Congress has done and the fact that even statutes of the scope of Riegle-Neal II and Section 104 have not brought about the results Congress intended to achieve. In a system in which wrong business decisions are often punished severely in the financial and competitive marketplaces, as well as possibly in compliance or enforcement orders, regulated financial institutions are loathe to break new ground without regulatory guidance.

That is precisely the reason that the FDIC has an obligation to flesh out the framework which Congress created. And, it is precisely the role of an administrative agency to interpret statutory terms, resolve ambiguities and fill gaps that may exist in legislation, and provide guidance on the application of broadly worded statutes in particular circumstances.

G-7. If the FDIC determines that it has the legal authority to proceed with a preemptive rule, are there reasons why the FDIC should decline to do so? If so, what are they?
The Working Group understands the concerns that have and will be expressed with respect to the Petition and believes that a thoughtful and comprehensive rulemaking will both preserve relevance of the dual banking system to interstate banking and address the expressed concerns. It should be well understood that the concerns will not be addressed at all if the state charter is no longer a vehicle for interstate and consumer banking.

We respectfully submit that the FDIC should carefully consider its responsibilities in light of what Congress did in 1997 and 1999. The politics swirling around the issues of preemption and state consumer protection laws should not obscure the need for FDIC action to implement Congressional policy to preserve the dual banking system.

Moreover, we believe that a rulemaking can and will be successful in addressing concerns raised in the course of these hearings. As stated earlier, we believe that the FDIC and other federal banking agencies have existing statutory authority to address effectively and definitively the concerns regarding the effects and implications of federal preemption for state consumer protection rules. In our national financial services marketplace, all providers should be able to operate under a single seamless set of rules when offering and providing products and services to consumers AND consumers should be able to benefit from uniform and truly effective consumer protection in whatever state they happen to live. The requested rulemaking is the only means that we know to assure that both goals are met. We believe that inaction will assure that neither is met.

G-8. What would be the negative impact, if any, of the FDIC adopting a preemptive regulation as suggested by the Petitioner?
As the answer to G-7 reflects, there will be undeniable negative effects if the FDIC fails to act as requested, and correspondingly we do not believe there should be any negative effects from FDIC implementation of the Petition.

As the foregoing also reflects, we believe that a rulemaking should squarely face concerns that are raised in this hearing. Certainly, for example, any rule must address the possibility that there might be some sort of a "race to the bottom." Our system of notice-and-comment rulemaking serves the very purpose of allowing a federal agency to collect wide-ranging comments about the positive and negative effects of its proposed actions so that it can weigh them and make a reasoned, and reasonable, determination based on the terms and policies of the statutes Congress has adopted. While we believe that adoption of all the Petition's requests would not, and must not, result in any diminution of consumer protections, we believe that the rulemaking process is well suited to identifying any potential negative effects and to addressing those possibilities.

The negative effects of inaction are both clear and substantial. The FDIC Board and the community of interested parties must weigh the consequences of inaction. As this statement reflects, and as the evidence of recent months indicates, the result of inaction will be the demise of the dual banking system at both the state and federal level, and the frustration of clear Congressional policies.

G-9. Do the states have a legitimate interest in how banks conduct business within their borders that would be undermined by the Petitioner's request?
This question is as old as the Republic itself, and since 1787, the answer has been clear. Congress has plenary authority over interstate commerce. While the states retain "police powers" under the Constitution, they must yield to federal laws and rules regarding interstate commerce. Banking and financial services are plainly interstate commerce. See Lewis v. BT Investment Managers, Inc., 447 U.S. 27 (1980).

Under well-established constitutional doctrines concerning the scope of the Commerce Clause, Riegle-Neal I and II, and the GLB Act were enacted under the Commerce Clause and are preemptive. Given the national financial services industry, it makes the most sense for the rules governing interstate banking by both national and state banks to be federal rules that apply seamlessly across state lines.

Moreover, the terms of both Riegle-Neal I and II and the GLB Act reflect careful Congressional consideration of state interests in banking and financial regulation of companies operating within their borders, including the ability of state-chartered banks to operate with parity in interstate commerce. In adopting the rules requested in the Petition, the FDIC would be implementing the balance between state and federal interests struck by Congress in these statutes -- both Congressional determinations of when host state law must yield and provisions stating when state law will be applied. We believe that an FDIC rule could provide a framework of partnership and cooperation among the responsible federal agencies and the respective states which optimally balances those interests within the framework provided by Congress.

G-10. Can state banks be expected to benefit if the FDIC were to preempt state law in the area of interstate banking operations? If so, how?
The Working Group believes the ability to operate on an interstate basis under a single framework of law, regulation and supervision with clarity and certainty are of overwhelming importance to state banks – both competitively and in the ability to serve consumers. These benefits of the requested rule are clear and tangible. As a corollary, state banks will avoid the necessity of the significant cost and disruption of conversion to a national charter in order to be competitive in interstate operations. And, of course, a state bank will benefit from not being compelled to leave a state charter and federal regulator that it has found productive and effective.

And in the long-run all banks and their customers benefit by preserving the dual banking system as a central source of dynamism in our system of bank regulation. The contrast between the evolution of banking and insurance organizations over the last quarter century underscores the efficacy of our dual system of regulation.

G-11. What considerations should the FDIC take into account that either support or challenge the proposition that Congress intended to provide the comprehensive parity envisioned by the Petition?
The Working Group is fully aware that use of the term "branch" in the 1997 amendments to the Riegle-Neal Act might be read as limiting the reach of the "applicable law" regime in that law. Certainly, the agency has the discretion to find that the reach of the provision is so limited. (Even if it adopted this approach, an FDIC rule codifying and amplifying the statute would be highly desirable and would achieve significant benefits.) Similarly, the FDIC could decline to codify Section 104 on the grounds that it does not have express rulemaking authority with respect to Section 104.

At the same time, it is equally clear that Congress has provided the FDIC with ample authority to fully implement the parity framework sought in the Petition. Indeed, the Working Group believes that it is the FDIC's responsibility to do so – both in its administration of the FDI Act and its stewardship of the banking system.

First of all, to fail to generalize fully the "applicable law" rule in the 1997 amendments in the manner requested in the Petition would thwart the purpose of the law so clearly expressed in its legislative history. (See pages 9-14 of the Petition.)

Second, to do so would lead to absurd results, results which we do not believe that Congress intended. This is best seen by considering the result if host state law were applied to an LPO because it is not a branch and because credit decisions and other key aspects of loan transactions are effected in the home state (i.e., the "situs" of the LPO's transactions is the home state). In that case, while home state law would apply to activities conducted in, by or through the branch in the host state, home state law would apply. On the other hand, in the case of the LPO where the key aspects of its loan transactions are effected in its home state, host state law would apply. Congress could not have intended and did not intend this anomalous result.

Third, such results can be avoided through the FDIC's recognition of the relevance of Sections 8 and 9 of the FDI Act and Section 104. As set forth in the Petition, taken together, these provisions provide more than ample authority to implement through rules the applicable law framework contemplated in Riegle-Neal II that provides parity in interstate banking based on the bank's charter law.

This approach is re-enforced by well-settled administrative law principles. Under these principles, agency rules that fill or address a statutory gap generally are afforded considerable deference by courts. See Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 865 (1984). Section 9's "generally conferred authority" makes it apparent "that Congress would expect the agency to be able to speak with the force of law when it addresses ambiguity in the statute or fills a space in the enacted law, even one about which 'Congress did not actually have an intent' as to a particular result." United States v. Mead Corp., 533 U.S. 218, 229 (2001) (quoting Chevron, 467 U.S. at 845). See also National Petroleum Refiners Ass'n, 482 F.2d 672, 681 (D.C. Cir. 1973). ("[T]here is little question that the availability of substantive rule-making gives any agency an invaluable resource-saving flexibility in carrying out its task of regulating parties subject to its statutory mandate.")

In short, the Working Group believes that Congress intended to address the disparity that we are discussing today and when it enacted Riegle-Neal II sought to avoid precisely the phenomenon that is now occurring at such a rapid pace. By making full use of the authority provided by Congress, the FDIC can give full effect to the Riegle-Neal II framework and achieve the goals of Congress which are so clearly and uniformly set forth in statements of the Members most directly responsible for its adoption. These policies were underscored in 1999 in the broader context of the ability of states to adopt laws placing discriminatory requirements on any type of depository institution compared to its competitors. Congress has addressed the full range of issues in the Petition in a comprehensive manner. The FDIC can do likewise in its rules.

G.-12. Is there a need for clarification on what law applies to the interstate operations of state banks?
Absolutely. Discussions with government officials and sophisticated lawyers over the last four years have revealed to me a remarkable lack of understanding of even the clearest aspects of Riegle-Neal II and Section 104. For all parties, clarity and certainty as to applicable law are essential in the conduct of business and the avoidance of expensive litigation and enforcement actions. If Riegle-Neal II and Section 104 were clearly understood and effectively implemented, the disparity we are discussing would not exist.

1-1. What considerations should the FDIC take into account that either support or challenge the proposition that Congress granted the FDIC the authority to make home state law apply to all business conducted by a state bank in a host state in which the bank has a branch, whether conducted directly, or through a branch, a loan production office (an LPO), other office, or OpSub?
In the context of Riegle-Neal, the Roundtable position is the most consistent and logical reading of the statute. Riegle-Neal I authorized the bank to engage in any or all of its permitted activities in the host state once it has a single branch there and to apply its home state law. The only question under Riegle-Neal II is whether Congress intended different law to apply depending on the means used by the bank to conduct its permitted business in the host state or the structure of the transaction (that is, whether use of home state law as the applicable law depends on some actual branch involvement in the bank's transaction).

The legislative history and the stated Congressional purpose to provide parity for state banks must be given great weight. The legislative purpose is clear: Congress was focused on the bank's interstate activities, not the means used by the bank. As Rep. Roukema stated when introducing the bill for vote on the House floor: "The essence of this legislation is to provide parity between state-chartered banks and national banks. . . .This legislation is critical to the survival of the dual banking system. . . . [A] strong state banking system is necessary for the economic well-being of the individual States and for innovation in financial institutions." Chairman D'Amato similarly stated: "The bill is necessary to preserve confidence in a state banking charter for banks with such a charter that wish to operate in more than one state. In addition, it will curtail incentives for unnecessary Federal preemption of State laws. Finally, the bill will restore balance to the dual banking system by ensuring that neither charter operates at an unfair advantage in this new interstate environment. . . ."

By adopting the requested rule, the FDIC will achieve the result Congress intended in 1997 -- parity for state banks in all their interstate operations in a state once it has established the legal basis for transacting business in that host state through the establishment of a branch. All other means for transacting business in a host state -- LPO, OpSub, direct delivery -- must be viewed a lesser, included means compared to the authority to transact business from a full-service host state branch. This approach provides a state bank the ability to operate under a consistent law for all its host state transactions, no matter what particular means the bank may choose to provide the product or service in the host state. This result thus advances both the goals of interstate banking and parity.

Under well-established principles of administrative law discussed in detail in the Petition (pages 6-8), the FDIC has authority to clarify and fill in gaps in statutes it administers. These considerations strongly support the rule sought by the Petition.

1-2. If the FDIC were to adopt a rule as requested, who should determine for each state whether the NBA and OCC rules would preempt host state law for national banks?
The OCC, not the FDIC or a particular state, should determine whether the NBA and OCC rules preempt host state law for national banks.** Under the parity principles governing the requested rulemaking, the home state regulator would follow OCC determinations. If there is any uncertainty about the application of the OCC rules in any case, the rule should allow the home state regulator to approach the OCC directly or through the FDIC, for a definitive determination whether OCC rules would provide preemption for national banks in that instance.

1-3. If the FDIC were to adopt a rule as requested, how should the applicable home state law be determined when the home state statute law is silent?
The rule should provide that if home state statute law is apparently silent, the home state regulator can determine by rule, order, or interpretative statement/letter what is applicable home state law. In general, the home state regulator's written determinations, whether by rule, order, or interpretative statement/letter, should govern, but could be subject to review by the FDIC, upon request of the host state regulator or upon the FDIC's own initiative. The FDIC of course retains authority to adopt general federal rules and guidances addressing practices of state banks and to condition merger or other approvals with respect to CRA or community convenience and needs.

2-1. What considerations should the FDIC take into account that either support or challenge the proposition that an out-of-state, state bank should be able to operate in a state where the bank has no branches under the bank's home state law to the same extent that an out-of-state national bank can operate under the NBA and OCC rules?
During the 1990s, Congress re-examined the fundamental rules governing the delivery of banking and other financial services in interstate commerce, that is, in the largely national marketplace for banking and financial services that had developed in the preceding decades. The Riegle-Neal and GLB legislation confirmed the existence of a robust interstate marketplace for financial services and provided a federal legal framework for the conduct of this interstate commerce.

In Riegle-Neal in 1994, and as re-enforced for state banks in 1997, Congress established a national policy in favor of interstate banking by all banks and provided the same standard for both national and state banks with respect to when they would apply their charter law and when host state law would apply. In 1999, in the GLB Act, Congress went a step further and addressed the extent to which state law could burden or discriminate against depository institutions (and their affiliates) as competitors in the broader financial services marketplace encompassing banking, securities, insurance, and other financial services. These enactments contain provisions that by their terms limit the applicability of state law in interstate commerce involving depository institutions. The considerations that guided Congress in enacting Riegle-Neal and Section 104 provide both the legal and policy considerations for the FDIC to follow in adopting rules under Section 8 and 9 of the FDI Act in response to the Petition.

The GLB Act addressed the entire financial services marketplace and, like Riegle-Neal I and II, adopted broad federal rules to implement the goal of a "level playing field." In Section 104(d) Congress plainly addressed the need for financial services providers, including insured depository institutions, that operate across state lines to do so under uniform rules and not to be subject to individual host state rules or actions that would disadvantage some or all depository institutions vis-à-vis their competitors.

When a state bank seeks to provide products or services outside its home state in a state where it does not have a branch, it is often confronted with requirements or legal risks to which a similarly situated national bank or federal thrift are not subject. For example, many states require licenses to engage in any lending activity in that state, but provide exemptions for banks and nondepository lenders chartered by that state and for national banks and federal thrifts. But an out-of-state state bank often is not granted such an exemption, even though it is also an institution chartered and regulated by a state banking agency and subject to thoroughgoing regulation, supervision, and examination by a federal banking agency under the same framework of federal rules and standards to which home state banks, national banks, and federal thrifts are subject.

As discussed in the Petition and in the response to Question 4-2 below, Section 104(d)(4)(D)(i) provides an express federal law basis for the out-of-state state bank to conclude that the host state licensing requirement is preempted. Nevertheless in absence of rules providing guidance, a state bank faces a difficult practical choice. Its choice is (1) not to get a license, thereby enhancing its competitiveness vis-à-vis its other depository institution competitors that are exempted for the license requirement, but also risking the possibility of a state enforcement action or sanctions under state law for unlicensed lenders (including possible voiding of loans made), which may also have adverse consequences in its next state or federal banking examination or (2) to apply for the license, pay required fees, await any licensing determination, and meet other requirements to which such licensees may be subject.

Faced with the Hobson's choice that this example illustrates, state banks have generally chosen to take the legally less risky course of complying with host state requirements, even though it clearly affects the out-of-state state bank adversely in terms of flexibility, responsiveness and the costs of doing business in that state. These are the very discriminatory burdens addressed in Section 104(d)(4)(D).

The requested rule would implement the terms and policies of Section 104(d) and the parity policies of Riegle-Neal II and address gaps in existing law. Like the parallel OCC rules, the requested rules would reduce legal risk, guide legal compliance by insured banks, and aid the FDIC in making enforcement decisions under Section 8 of the FDI Act. Further, by promoting operating efficiency and competitiveness in interstate banking and by reducing the real costs arising from legal uncertainty and risk, the proposed rule would contribute to the safe and sound operation of state banks. The policy of Section 104 has a goal similar to that of Riegle-Neal II, but plainly addresses a different aspect of the same problem -- discriminatory state laws that disadvantage depository institutions, including state banks, seeking to compete in interstate financial service markets.

Given Section 104(d) and the FDIC's authority to address compliance with law under FDI Act Section 8, the FDIC can exercise its Section 9 authority to adopt a rule consistent with the logic and policy of Riegle-Neal II that will provide state banks greater competitive equality in every state so that no insured state bank will be required to comply with a state law unless a national bank also would be subject to that law.

3-1. What considerations should the FDIC take into account that either support or challenge the proposition that an OpSub should be able to operate under the bank's home state law to the same extent that an OpSub of a national bank can operate under the NBA and OCC rules?
The same considerations set forth in the answers to Questions 1-1 and 2-1 apply to this question, because the law applicable to an office of a state bank OpSub would be the same as for a branch or office of the state bank itself in the same location. If a state bank OpSub is in a state where the bank either has a branch or could have a branch (e.g., where the state bank could branch de novo), then it would be able to apply the bank's home state law under Riegle-Neal II. If the FDIC adopted rules as requested in the Petition with respect to the application of home state law by state banks in non-branching states, then the requested OpSub rule would make it plain that the OpSub would apply home state law to the same extent as the bank. Accordingly, the FDIC should adopt express provisions concerning OpSubs in its rules that parallel the OCC and OTS OpSub rules.

The requirements for a state bank OpSub should be the same as for a national bank OpSub under § 5.34 of the OCC rules, with the added requirement that rules governing the bank under its home state law must permit it to establish a qualifying OpSub.

We note that the definition of "domestic branch" in 12 U.S.C. § 1813(o) currently would permit a state bank to designate an OpSub office as a branch (and thus engage in branching functions, e.g., make loans) if it meets branch requirements, but it would be helpful for the FDIC to make that explicit. Such treatment is consistent with FDIC Advisory Letter 99-5.

The OCC determinations concerning operating subsidiaries are reasonable and have been sustained by the courts. The concept of an operating subsidiary -- a direct subsidiary of a depository institution that can be regulated on precisely the same terms, rules, and conditions as the bank itself because it is limited to activities permitted to the bank itself -- has been well established in federal banking law for many decades. The ability of national bank OpSubs to operate under the same federal preemption as the bank itself has been specifically sustained by the courts. We note that the OCC rules concerning operating subsidiaries were adopted without the existence of any express provision in the National Bank Act , but subsequently were validated by Congress in the GLB Act. An FDIC rule concerning state bank OpSubs as requested would subject them to the same federal rules as apply to the parent bank and would be equally reasonable.

A corollary is that a qualifying state bank OpSub, parallel to a national bank OpSub, would be subject the same level of compliance and consumer protection at both the state and federal levels as a division of the bank itself. Therefore, a state bank Op Sub would be subject to regulation, supervision and examination by the bank's state and federal banking regulators.

3-2. What considerations should the FDIC take into account that either support or challenge the proposition that an OpSub should be deemed equivalent to a division of the bank itself?
The FDIC should take into account precisely the same considerations as the OCC in making this determination. Consistent with the overarching principle of parity, the state bank OpSub must be fully compliant with national bank requirements in order to qualify for treatment under the requested regulation parallel to that of a national bank OpSub.

3-3. If the FDIC were to adopt the requested rule, what requirements should the subsidiary meet in order to be considered an OpSub, e.g., should it be wholly-owned, majority-owned, or just controlled by the bank?
The FDIC should provide that a state bank subsidiary qualifying for treatment as an OpSub under an FDIC rule should meet the same qualifications as a national bank OpSub. Under the OCC rule, a subsidiary qualifies as an OpSub if it engages solely in activities permissible for the national bank and is a corporation, limited liability company, or similar entity and the parent bank either owns more than 50 percent of the voting (or similar type of controlling) interest of the operating subsidiary, or otherwise controls the operating subsidiary and no other party controls more than 50 percent of the voting (or similar type of controlling) interest of the operating subsidiary.

We note that the OCC approach is consistent with FDIC Advisory Letter 99-5, in which the FDIC Legal Division reasoned that the subsidiary in question could be treated as a branch because it was "controlled" by the bank parent. In addition, of course, the bank must have state law authority to establish an OpSub that would meet the federal rule requirements.

4-1. GLBA is not codified as part of the FDI Act, is silent as to rulemaking and applies to all insured depository institutions. What barriers, if any, would there be to the FDIC adopting a regulation or policy statement implementing section 104?
There are no legal barriers to adoption of the requested rule. The FDIC has express authority in Section 8 of the FDI Act to determine whether an insured bank is in violation of "any applicable law," which includes any state law that on its face might appear to apply to an insured depository institution, see, e.g., 12 U.S.C. § 1818(a)(2)(A)(iii), (b)(1). Under Section 9, the FDIC has express general rulemaking authority with respect to "the provisions of this chapter," including Section 8. Inherent in sections 8 and 9 is the authority of the FDIC to adopt rules with respect the law applicable to a depository institution, including the scope of federal preemption that might relieve an institution of the requirement to comply with a state law to which it would otherwise be subject, such as Section 104.

Section 104 by its literal terms provides express preemption of state laws that affect the activities of any "depository institution," as that term is defined in Section 3 of the FDI Act, see 15 U.S.C. § 6801(c)(1), (d)(1), (f)(3), as well as affiliates and persons associated with a depository institution. The question is not whether Section 104 provides broad preemption for all depository institutions operating in interstate commerce, including state banks, but how broad that preemption is in light of the terms and purposes of this provision and in its application in specific contexts. Indeed, as stated in the Petition, the fact that Section 104(d)(4)(D) has not been used by state banks to address the many state laws that impose requirements on out-of-state state banks, but not on their instate or national bank competitors, demonstrates the need for rules.

Section 104 is silent with respect to rulemaking. However, this silence does not deny FDIC authority to address, under its Section 8 and 9 authority, the scope and meaning of the language of Section 104 as applied to "depository institutions." The incorporation of a jurisdictional definition from the FDI Act supports the conclusion that it is consistent with Congressional intent for the FDIC to exercise a role with respect to the interpretation and implementation of Section 104.

Accordingly, the fact that Section 104 is not codified in the FDI Act and is silent with respect to rulemaking presents no barrier at all to the ability of the FDIC to adopt rules interpreting the term and provisions of Section 104 as it applies to "depository institutions." The FDIC's express authority under Sections 8 and 9 provides it full discretion to adopt a rule addressing all the items discussed in the Petition. Moreover, in view of the fact that the FDI Act includes provisions governing all depository institutions, it is also appropriate for the FDIC to take the lead with respect to Section 104.

4-2. What considerations should the FDIC take into account that either support or challenge the proposition that section 104 preempts state law in the manner described by Petitioner?
The preemption relied upon in the Petition flows directly from a literal reading of the statute and the underlying purpose of both Section 104 and the GLB Act more generally. The relative obscurity and apparent complexity of the specific provision in question highlight the overriding need for implementation through FDIC rule.

Section 104 was included in a broad new statute dealing with affiliations among financial providers for the specific purpose of ensuring that states could not impose discriminatory requirements on any depository institution, or affiliate, providing any financial product or service in interstate commerce. As discussed in the Petition, Section 104 addresses the states' ability to affect the terms of competition based upon a competitor's status as a depository institution (or an affiliate of one) in any area of all financial services, including banking. Under clause (4)(D)(i), it denies the states' ability to place (for whatever reason) any type of depository institution competitor at a disadvantage to any other competitor providing the same product or service, without limitation on the charter or lines of business of that competitor. The language adopted by Congress deals globally and broadly with differential treatment by a state of a depository institution compared to its competitors -- all types of competitors under clause (4)(D)(i) ("other persons engaged in the same activity") and nondepository competitors only under clause (4)(D)(ii) ("other persons engaged in the same activity that are not depository institutions or affiliates thereof"). This broad language of clause (4)(D)(i) thus reaches state rules or actions differentiating adversely between out-of-state state banks and instate banks or national banks. The Petition appropriately asks the FDIC to flesh out the meaning of these provisions for insured banks in furtherance of the statutory purpose and in light of the fact that the complex provisions of Section 104(d)(4) are not well understood by banks.

The preemption described in the Petition is stated in the literal terms of Section 104(d). Subsection (d)(1) uses very broad language to provide express preemption to depository institutions: No state "by statute, regulation, order, interpretation, or other action" may "prevent or restrict" a depository institution, or any affiliate, from engaging in any financial activity permitted under the GLB Act, "directly or indirectly, either by itself, or in conjunction with an affiliate, or any other person" (emphases added). Subsection (d)(4) does provide the possibility that a state law or action that would be preempted under the terms of (d)(1) might nevertheless be applicable to a depository institution if it satisfies all of a series of express requirements stated in subsection (d)(4)(D). That is, once the double negative construction is worked through, this provision means that, if a state law, rule, interpretation or action fails to satisfy the requirements of any one of the subparagraphs in (d)(4)(D), it will not escape preemption under subsection (d)(1).

The breadth of the language used in Section 104(d) is consistent with the purposes of the GLB Act to ensure that all depository institutions and their affiliated financial providers could compete across the country with parity. As stated in the 1999 House Banking Committee report on the legislation, the "primary objective of allowing [financial] affiliations is to enhance consumer choice in the financial services marketplace, level the playing field among providers of financial services, and increase competition" (emphasis added). H.R. Rep. No. 106-74, pt 1, at 97 (March 23, 1999). The preemption of state law provided in Section 104 was recognized as essential in light of the "ample evidence that some State statutes -- either on their face or in their application" - had discriminated against banks, particularly with respect to insurance, and thus could prevent banks from operating effectively in the national financial services marketplace. See S. Rep. No. 1105-336, at 8-9 (Sept. 18, 1998); H. Rep. No. 106-74, pt. 1, at 97, 102 (March 23, 1999); H.R. Rep. No. 106-74, pt 3, at 141 (June 15, 1999). As indicated in the Conference Report, the nondiscrimination provisions of Section 104(d) represent the Congressional judgment with respect to the "appropriate balance between Federal and State regulation of the activities . . . allowed under this legislation." Conf. Rep. No. 106-434, at 156-7 (Nov. 2, 1999). Parity of treatment lies at the heart of Section 104.

Comparison with prior versions further demonstrates the intended scope of Section 104(d). The predecessor versions of Section 104 (in H.R. 10, for example) were directed primarily at state laws that had been enacted to prevent banks from having insurance affiliations in that state and to capture the various drafting techniques used to prevent such affiliations. However, in 1999, in the House Commerce Committee mark-up, the scope of Section 104 was dramatically expanded to address much broader issues under the Commerce Clause -- by the inclusion of the Section 104(d)(4) "nondiscrimination" provisions. This expansion was accepted by the Conference Committee.

We believe the FDIC rules should make it plain that Section 104 does by its terms apply to state laws disadvantaging state banks in interstate commerce. Banking is unquestionably among the financial services covered by the GLB Act, and that fact that Congress did not separately consider the various state laws that place state banks at a competitive disadvantage should not be a consideration undercutting the Petition's request. Congress did not consider all the types of state laws that might create disadvantage in the interstate provision of financial services, but plainly adopted very broad statutory language for the purpose of ensuring a level playing field in this area of interstate commerce. It is also important to note that Section 104 preempts state laws that disadvantage one type of competitor and thus does not preempt laws of general applicability to all competitors, such as consumer protection laws.

Congress adopted detailed and complex provisions to specify the appropriate role of state regulation to affect the ability of depository institutions and their affiliates to provide financial services, including banking products and services, across the country. In light of the broad and express legislative purpose, it is appropriate for the FDIC to provide guidance to depository institutions so that they will better understand and be able to apply an admittedly complex statute. Without such practical guidance, it seems likely that the Congressional purpose will fall short of fulfillment.

4-3. What barriers, if any, would there be to the FDIC adopting a regulation or policy statement applicable to all insured depository institutions based on section 104?
As discussed in the response to questions 4-1 and 4-2, Section 104 by its terms provides preemption for "depository institutions" as defined in Section 3 of the FDI Act, a definition encompassing all insured depository institutions. There is accordingly no barrier to an FDIC rule, as suggested in the Petition, that would address the scope and meaning of provisions of Section 104 as applied to all such institutions. We note that many provisions of the FDI Act apply to all insured banks and that the FDIC has previously adopted rules, e.g., Part 362, that apply to all "state-chartered depository institutions," including member banks primarily regulated by the Federal Reserve Board.

4-4. Is it reasonable for the FDIC to read section 104 as having some application to interstate banking operations in general?
Yes, it is reasonable for the FDIC to adopt such an interpretation because interstate banking is part of the interstate commerce expressly addressed in Section 104. It is a particular federal role to prevent states from discriminating against persons from out-of-state engaging in interstate commerce. As set forth above and in the Petition, Section 104(d)(4)(D) provides that a state may not discriminate against an out-of-state bank providing any financial service compared to any competing institution, including a home state or national bank.

The GLB Act, including Section 104, represents an exercise of Congressional authority to regulate interstate commerce engaged in by financial services companies, including depository institutions. The preemption expressed in Section 104(d) lies at the heart of federal interstate commerce regulation by expressly limiting the ability of any state to interfere with, burden, restrict or discriminate against any depository institution, affiliate, or associated person, engaging in financial services activities, including providing banking products and services, in interstate commerce. In adopting Section 104, Congress understood the need in today's national financial services marketplace for competitors to operate on equal terms and the need to remove state impediments. The terms of Section 104 plainly apply to banking, and Congress does not need to have specifically addressed state laws discriminating among banking competitors for the FDIC to reasonably implement Section 104 for the state banks that are the portion of the financial services universe within its authority.

Moreover, the parity principles that are embodied in the McFadden Act, Section 27 and Riegle-Neal, among others, plainly reflect Congressional policy concerning banking and are parallel to those underlying Section 104. These considerations support the requested action.

4-5. The areas of section 104 Petitioner identifies for rulemaking are very discrete but taken together may have a broad impact. What are the overall implications (favorable as well as negative) of adopting the section 104 regulatory guidance suggested by the Petitioner?
The overall implications of the requested FDIC action are consistent with the scope of Congressional action in Section 104 and re-enforce the ability of the FDIC to give full effect to the framework contemplated in Riegle-Neal II. Parity and nondiscrimination in interstate commerce are touchstones of federal banking policy. Moreover, as discussed in the Petition, it is now apparent that the scope and meaning of Section 104 are not well understood and that banks are not benefiting. A rulemaking will be the occasion for definitive interpretation of a complex set of statutory provisions that can be confusing. We believe the scope and meaning of these provisions are clear and that it is precisely the role of an administrative agency to adopt rules "unpacking" dense and complex language and laying out their scope and application.

As discussed above, Congress chose to provide very broad express preemption in Section 104, and used very broad terms. The Petition asks the FDIC to do what expert administrative agencies typically do -- to construe statutory terms in light of the language and purposes of the statute itself, informed by pertinent legislative history. The constructions of the language used in Section 104(d) suggested in the Petition appear faithful to the words used and if adopted by the FDIC would appear to fall comfortably within a standard of administrative reasonableness. The broad effect resulting from a rule expressing such constructions would result from the action of Congress in adopting Section 104(d) in this form, not from the action of the FDIC.

Even though we are aware of state laws and actions that, when applied to an out-of-state state bank, would appear in contravention of Section 104(d), we are aware of no instance in which an affected state bank sought to invoke this preemption. Despite the "level playing field" goal of Section 104(d), it has not had the practical effect of preventing state banks, or their affiliates, from being subject to state laws (such as licensing laws) which are not applied to their banking competitors operating under national charters. All insured depository institutions, whether state or federally chartered, are subject to examination and regulation by a federal banking agency that applies substantively the same rules and standards as the other banking agencies. The "level playing field" approach of Section 104 was built on this foundation and recognizes that the same state-enacted rules should apply, if at all, to all competitors.

The lack of agency guidance concerning the scope and meaning of Section 104(d) to date has thus had an adverse effect on state-chartered depository institutions, which are frequently subject to requirements and burdens imposed by states (other than the bank's chartering home state) that are not imposed on nationally chartered depository institutions, whether by statute, rule, or administrative application. Adoption of the rules sought by the Petition would thus provide relief from present adverse effects and advance the level playing field sought by Congress. It should not negatively affect any depository institution. It also should not have a negative effect on any state, because it would result in the uniform application (or nonapplicability) of state laws to competitors that are similarly situated and already subject to a common framework of federal regulation. Section 104 represents the express application of familiar interstate commerce concepts to banking and financial services. Without FDIC action, Section 104 is likely to be a dead letter.

5-1. Should the FDIC adopt a parallel rule implementing section 27 for state banks similar to 12 C.F.R. 7.4001 and 12 C.F.R. 560.110?
Yes, Section 27 was intended to provide parity, and the adoption of parallel rules would advance parity. Even though the FDIC General Counsel has issued useful and correct opinions addressing these provisions, rules would be more helpful now. In light of the uniform statutory foundation, it is appropriate for state banks to have the benefit of the clarity and assurance that would be provided by a parallel rule. The rules adopted by the OCC and OTS provide useful specific guidance. For example, the OCC and OTS rules each provide a concise definition of the term "interest." The fact that Section 27 has been on the books for many years does not undercut the benefits to be gained by adopting rules; we note that the OCC and OTS rules were adopted many years after enactment of their parallel governing statutes. Moreover, in light of the perceived disparity within the dual banking system, it would be a positive sign for the FDIC to demonstrate its willingness to adopt additional rules providing clarity and support for state banks.

5-2. Should any other issues be addressed by rulemaking to provide state banks competitive equality with national banks regarding section 27? For example, 12 C.F.R. 7.5009 addresses the location under section 85 of national banks operating exclusively through the Internet. Is a similar rule needed for state banks under section 27?
Yes, for the same reasons stated in 5-1. Specifically, in view of the uncertainties and novel issues that arise in connection with electronic banking, it would be useful for the FDIC to adopt rules addressing "location" under Section 27 in an internet banking context, parallel to 12 C.F.R. § 7.5009 (and indeed to solicit comments on other issues arising for state banks in the context of internet banking).

We further note that OCC rule 12 C.F.R. § 7.4006 provides that "[s]tate laws apply to national bank operating subsidiaries to the same extent that those laws apply to the parent national bank." A parallel FDIC rule would be appropriate, for the reasons discussed above in response to questions 3-1 -- 3-3.

5-3. What effect would the exercise of the authority to opt-out of coverage under section 27 have on the rule or rules the Petitioner is requesting?
The requested rule should have no effect, and indeed could not alter the ability of states to opt out under Section 525. The requested rules would address only the scope and operation of Section 27 preemption when it is applicable.

* See pages 10-12 of the Roundtable Petition.

** The Petition could be read as suggesting that it is the state or the FDIC's authority to decide whether a state law is preempted by the OCC. That was not intended.

Last Updated 05/24/2005

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