Defenders of federal preemption publicly insist the Dodd-Frank Act left things pretty much the way they were. The "Barnett standard," they will tell you, is plenty strong enough to maintain a single set of rules for national banks to follow.

But privately? Those same people concede they are worried, and they should be.

Barbara A. Rehm

First, preemption is losing its biggest institutional champion. It's a safe bet the next comptroller of the currency will not be like the last three. Gene Ludwig, Jerry Hawke and John Dugan all went to the mat to defend (or even expand) preemption, but President Obama is likely to appoint someone who thinks the states should get a bigger say in how best to protect consumers.

In fact the administration sent a clear signal of its intent by not naming Julie Williams as acting comptroller. As the agency's chief legal counsel (and its acting head on two previous occasions) Williams was a key architect of the 2004 rulemaking that extended preemption to national bank operating subsidiaries. The administration didn't want her calling any of the shots, even on an interim basis, so when Dugan's term ended this month it went against tradition and selected the agency's chief of staff, John Walsh, to run the agency until it can get a successor nominated and confirmed by the Senate.

And no matter who the next Comptroller is, one big change has already occurred: under Dodd-Frank preemption no longer covers operating subsidiaries, affiliates or agents of national banks.

That's huge for the large national banks; they run their mortgage businesses from operating subsidiaries, and they no longer are protected from state rules and laws.

These companies are now weighing the cost of pulling those units back into their banks versus registering with all the states where they operate, including obtaining licenses, paying fees and ensuring that the proper disclosures to consumers are made.

What most people think Dodd-Frank did to preemption is this: it reinstated the Barnett standard laid out in a 1996 Supreme Court ruling. That standard said only a state consumer protection law that "prevents or significantly interferes" with a national bank's operations may be preempted.

"Interferes" is not defined.

The law has something called the "designated transfer date," and that's the day when the Office of the Comptroller of the Currency and the Office of Thrift Supervision merge.

The way some experts are reading Dodd-Frank, national banks (and federal thrifts) will lose the protection provided by preemption entirely on the date. (The law gives Treasury Secretary Tim Geithner until Sept. 21 to set the date, which must be between January and December 2011.)

"People who try to tell you that this is not a big deal are either spinning or they are misunderstanding what happened here. This is a huge deal," said Jeremy T. Rosenblum, a partner with the law firm Ballard Spahr in Philadelphia. "Come the designated transfer date the Comptroller's and the OTS's preemption regs go away, at least as to state consumer financial laws."

Dodd-Frank does say that the OCC will have to make its preemption determinations on a case-by-case basis, and if you read the law the way Rosenblum does, that means national banks must comply with every law or rule in the states where they operate or risk being sued.

"This is a country that loves its litigation. It's not a question of waiting for a state to come knocking on the door" to say a rule is not preempted, he said. "There are plaintiffs' attorneys ready, willing and able to bring class actions.

"It's going to be open hunting season on the banking industry."

Even if a national bank persuades the OCC to preempt a state law, that state's attorney general can sue the OCC, and here is where Dodd-Frank made another important change.

The new law instructs judges not to give the OCC the same sort of deference it has received in past lawsuits.

No longer will the OCC be entitled to the generous "Chevron" standard, in which courts largely bow to what federal regulatory agencies decide.

Instead the judge will "assess the validity of such determinations, depending upon the thoroughness evident in the consideration of the agency, the validity of the reasoning of the agency, the consistency with other valid determinations made by the agency, and other factors which the court finds persuasive," according to the law.

The OCC, Dodd-Frank says, also will need "substantial evidence" that "supports the specific finding regarding the preemption."

So what states and what laws are most likely to test preemption?

Most experts expect moves by California, North Carolina, Georgia, New York, New Jersey, Massachusetts, Illinois, Michigan or Maryland.

And the areas most likely to attract challenges are mortgage servicing practices and loan modification efforts, fees and disclosures.

How active the states get will depend in part on how effective the new Consumer Financial Protection Bureau is. The agency, created in Dodd-Frank, has the power to enforce a slew of consumer finance laws. But until it is up and running and effective there remains a void for the states to fill.

Ted Lieu is a member of the California Assembly and chairs its Select Committee on Consumer Financial Protection. He is pleased by the changes Dodd-Frank made on preemption and fully expects Obama's comptroller "will be far less aggressive in using preemption to stop better state laws."

But he says the states, still grappling with the fallout from the mortgage crisis, "will continue to feel compelled to respond to better protect citizens."

Noting Nevada's move last year to require mandatory mediation before a foreclosure, Lieu said, "I authored a similar bill this year in California, but the banking industry defeated it." He vowed to try again.

The tide actually began to turn against preemption before financial reform was passed.

Last summer the Supreme Court handed the Comptroller's Office a rare loss when it decided New York Attorney General Andrew Cuomo could enforce a state fair-lending law against national banks.

Dodd-Frank takes that decision a step further and gives state AGs the power to enforce the federal consumer laws transferred to the CFPB and any rules issued by the bureau as well.

"That's a huge change," said John Ryan, an executive vice president at the Conference of State Bank Supervisors. "It's a very broad grant of authority."

National banks are facing a new reality: the idea that people need protection from powerful companies has trumped the long-held view that the nation benefits from an efficient banking system operating under a single set of standards.

Barb Rehm is American Banker's editor at large. She welcomes feedback to her weekly column at Barbara.Rehm@SourceMedia.com.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.