WASHINGTON — A compromise cut late Wednesday by House leaders and Rep. Melissa Bean, D-Ill., on preemption powers for national banks would result in a substantially weaker role for states.

The deal would let the Office of the Comptroller of the Currency keep broad leeway to preempt consumer protection laws — a far cry from the Obama administration's initial effort to eliminate preemption entirely.

It is also likely to make it harder for Senate Banking Committee Chairman Chris Dodd to insist that states be given broad latitude to adopt laws and rules limiting what national banks may do.

"The fact that House Democrats would balk at the bill language bodes very well when the bill goes before the Senate, which tends to be a lot more conservative on these issues," said Jaret Seiberg, a policy analyst at Washington Research Group, a division of Concept Capital.

Andrew Pinkus, a partner in the Mayer Brown law firm, who has testified in favor of federal preemption before the House Financial Services Committee, agreed.

"It's enormously significant," he said. "It tells you that the more that people look at this bill, the idea of getting rid of preemption and subjecting national banks to state laws doesn't make sense. This reaffirms the need for preemption."

Federal preemption of state laws has emerged as a central battleground on the package of financial system reforms. The House began debating the legislation late Wednesday after Bean delayed consideration of the bill until the preemption issue was addressed. A final vote was expected today.

As envisioned by the Obama administration and Democratic leaders, the bill would have created a consumer financial protection agency that would write and enforce rules for banks and nonbank financial companies. The reform plan also would have let states enforce federal and state standards against all institutions — effectively gutting a federal preemption standard that has been in place for more than a century.

Since the bill was introduced in the House in September, however, the banking industry has made several attempts to block the anti-preemption provision. By the time the bill was approved in committee on Oct. 22, House Financial Services Committee Chairman Barney Frank had agreed to a provision that would let the OCC preempt state laws on a case-by-case basis. The industry considered this change insufficient, however, because it did not support deference to the OCC in court and left the agency's preemption powers vague.

The Bean amendment, however, would grant the OCC much more power, allowing it to preempt all similar state standards at once simply by writing a letter or issuing a ruling. It would reaffirm the deference given to the OCC's rulings by the courts.

It would also reduce the threshold required for the OCC to preempt state standards by saying that it could override any law that "prevents, significantly interferes with or materially interferes" with the business of banking.

Banks also could go directly to the courts to preempt a state standard without the OCC's acting at all; the committee's bill did not include this option.

Banking industry representatives continued to argue in public that the Bean amendment could be improved, but privately they acknowledged the standard was far better.

The amendment was only agreed to after Bean and other moderate Democrats prevented House leaders from starting debate on the broader bill, which required a majority vote.

Sources said Bean negotiated with Treasury Deputy Secretary Neal Wolin and House leaders, minus one of the original provision's architects, Rep. Mel Watt, D-N.C., who threatened to take his name off the final amendment and eventually walked away from the negotiations.

Bean persuaded Frank to adopt the bulk of her proposal to broaden preemption and roll it into his manager's amendment. By incorporating it into the base text without requiring a separate vote solely on that provision, the move virtually guaranteed that her preemption language will survive the House vote on overall regulatory reform.

The change angered many states' rights advocates, who had seen the House bill as their best hope to roll back the OCC's sweeping 2004 preemption rules.

"It's a perpetuation of what we've seen as a failed policy, wherein the states have identified problems as they've emerged and the ability to deal with them has been cut off," said John Ryan, an executive vice president at the Conference of State Bank Supervisors. "They are cutting off the most important function of the states in their ability not just to enforce their standards but to develop their own."

But Frank defended accepting Bean's amendment in an interview Thursday, arguing that the industry is overplaying its significance and that it does what he was trying to do during his committee vote — roll back the OCC's 2004 preemption rules.

"I don't think they got much," he said. "I don't think it's a big deal."

He said banks had been seeking "total preemption and they didn't get it."

"I think we are essentially back to where we were in 2004," Frank said. "The point is that only the big banks care about this. The community banks don't care about this; the credit unions don't care about this. It's a big-bank issue. It's JPMorgan Chase and [Citigroup]. … I don't think we gave up anything significant here. I think we clarified."

Though the OCC would not comment, sources said the agency views the Bean amendment as a significant improvement of the bill. Like the industry, however, the agency sees room for improvement and is pushing for stronger visitorial powers and a clarification of the type of federal standard that must be in place in order to preempt a law.

Though the Bean provision would diminish the ability of state attorney general investigations to compel national banks to produce certain records, it would still let the state officials sue national banks and seek monetary damages. The amendment also would let states press for tougher minimum standards. If a majority petitioned the proposed consumer agency to strengthen its standards, the new agency would have to consider it.

Some lawyers are also concerned that the Bean language, though it tries to ensure that the courts give deference to OCC rulings, would require the agency to justify its actions, which would have to be considered valid by the court.

"We're getting better, but we've still got this tortured kind of a process here," said Oliver Ireland, a partner in Morrison & Foerster and a former Fed lawyer. "As a practical matter the administration of this is going to be needlessly burdensome. This is not a return to pre-2004; this is creating a whole new standard or criteria for preemption determinations that wipes out about 130 years of Supreme Court precedent."

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