WASHINGTON — While the primary selling point of the Office of the Comptroller of the Currency’s fintech charter is an opportunity to avoid state-by-state licensing, it might also provide a workaround to a Dodd-Frank Act provision that eliminated preemption for operating subsidiaries.

Before the passage of the 2010 law, many national banks had set up operating subsidiaries, or consumer-facing companies that are partly owned by the bank, to offer the benefits of preemption to somewhat riskier business lines that could be held at arm's length.

But under Title X of Dodd-Frank, the law struck down preemption privileges for operating subsidiaries, forcing many financial institutions to cut back.

“Banks just started merging them into the bank or simply migrated the business to the bank,” said Scott Cammarn, a partner at Cadwalader. “Few national banks kept op-subs that were customer facing.”

Lauren Saunders, an associate director at the National Consumer Law Center.
The fintech charter “could potentially provide a way for banks to move riskier activity into another entity while still retaining the advantages of bank preemption," said Lauren Saunders, an associate director at the National Consumer Law Center.

But observers said the new fintech charter could effectively bring back operating subsidiaries in all but name, giving banks the opportunity to move a company with a fintech charter under its umbrella and retain preemption rights.

That alarms consumer advocates — many of whom already oppose the fintech charter — who worry it could subvert the purpose of Dodd-Frank.

“The broader point that Congress recognized [was] that preemption in the mortgage area was a problem and one of the contributing causes of the financial crisis,“ said Lauren Saunders, an associate director at the National Consumer Law Center. The fintech charter “could potentially provide a way for banks to move riskier activity into another entity while still retaining the advantages of bank preemption."

Banking attorneys say the situation is a bit more complicated than that.

Operating subsidiaries were supervised by the OCC and, in addition to avoiding state consumer protection laws, they could as a result also export interest rate caps from the business’s original state. Often, those companies were mortgage lenders — an industry that has also signaled an interest in the fintech charter.

State regulators long protested the right of operating subsidiaries to retain preemption powers, but the OCC was ultimately backed up by the Supreme Court in a 2007 ruling, Watters v. Wachovia Bank, which confirmed that the state-licensed mortgage business of a national bank could be regulated by the national bank regulator and overrule state laws.

Observers said trying to use a company with a fintech charter as an operating subsidiary creates some thorny legal issues.

“What if you got one of those national bank charters and make it a subsidiary of your existing bank?” said V. Gerard Comizio, a partner at Fried Frank. “The Dodd-Frank Act provisions that overruled the Watters decision … should not apply to a national bank that is an affiliate or subsidiary of a national bank."

There would also be the question of examinations. An operating subsidiary is examined jointly with its parent. But if it were a bank, it would likely have its own set of examiners.

"You would have the issue of the subsidiary bank being exposed to its own examination regime," said John Beaty, a partner at Venable.

To ensure that the entity benefits fully from the benefits of preemption, banks may opt instead for having an affiliate obtain the fintech charter. This would have the added benefit of avoiding lending limits that exist for operating subsidiaries.

"If you have a bank that is under common ownership with another bank, and the ownership is 80% or [more], then those banks can lend to each other without limits," Beaty said.

Others say banks are likely to prefer holding those business lines inside the bank structure to avoid having to obtain a new charter.

“I'd be surprised if a lot of banks pursued this strategy,” Cammarn said. “The gain is not worth the gamble.”

Yet there is a potential benefit to be had. Before Dodd-Frank, banks saw significant benefits in operating subsidiaries.

“The reason you do an op-sub is, you want to engage in this activity but you want to limit the liability,” said Lawrence Kaplan, a bank attorney of counsel at Paul Hastings. "I just want my left pocket instead of my shirt to do it."

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Lalita Clozel

Lalita Clozel covers fintech regulation, anti-money-laundering, cybersecurity and the Federal Deposit Insurance Corp. in American Banker's Washington bureau.