Considering all the dramatic recent events in the financial services industry, a little-noted provision buried deep in the 700-page Housing and Economic Recovery Act threatens to reignite the debate over federal preemption.
As American Banker noted following the Washington Mutual collapse, "Many have raised questions about the OTS' supervisory performance." ["Wamu Vanishes, So May OTS and the Thrift Charter," Sept. 29]. It seems fair to ask whether an agency whose performance — indeed, its viability — is in question should exercise broad powers of preemption shutting states out of the consumer protection business, even when it comes to mortgages marketed by third parties.
As a backdrop to the dispute, since the April 2007 decision in Watters v. Wachovia, several appellate courts have weighed in on whether third-party agents of federal banks and thrifts enjoy the same preemption that the Watters Court applied to national bank operating subsidiaries. Decisions from the First and Second Circuits are implicitly at odds over the issue.
In late August the Court of Appeals for the Sixth Circuit (in the State Farm Bank v. Reardon case) joined the First Circuit in concluding that federal law preempts state laws affecting third-party agents of a federal thrift — in this case, the licensing and registration requirements for independent mortgage broker agents.
Other courts have taken a different view. In June of this year a federal court in West Virginia rejected an argument that third-party agents of national banks are "immune from the scrutiny of state regulators." In that decision, which involved a Capital One Bank dispute with the West Virginia Attorney General's Office, the court concluded that extending preemption protection to third-party corporations not functioning as operating subsidiaries would cause the term "national bank" to mean "national bank" and "any entity that can find a way to graft itself, remora-like, to a national bank."
Every time the definition of "national bank" is broadened, the court warned, "state sovereignty erodes, political accountability dissipates, and a federal agency's role in shaping state policy increases."
Enter the Safe Mortgage Licensing Act, Division A, Title V of the of the Housing and Economic Recovery Act. Among its purposes, Congress said, was the enhancement of consumer protections and antifraud measures. These are laudable enough goals, and they are to be achieved by the establishment of a nationwide mortgage licensing system and registry.
Embedded in the system, though, is an issue of critical importance to the ongoing legal debate about whether third-party agents of federal banks or thrifts are subject to state consumer laws in areas such as licensing and registration. Congress made clear in the act that all residential mortgage brokers are subject to state licensing and registration if they are not "employees" of a depository institution or its regulated subsidiaries.
This would seem to mean that independent mortgage broker agents will be subject to state law.
Not so fast. As with much of Capitol Hill's work, the devil's in the details. The door has apparently been left ajar for the Office of Thrift Supervision and the Office of the Comptroller of the Currency to define the term "employee" in such a way as to snatch away from state oversight a whole class of third-party mortgage brokers even before they were ever subject to it.
Praising as "sensible public policy" a colleague's effort on the House floor to confirm that the OTS and OCC would "have the authority to make an appropriate definition of the term 'employee' of a depository institution," House Financial Services Chairman Barney Frank affirmed that nothing in the act would change the preemptive authority of the OTS and the OCC. "They do obviously have definitional authority under this legislation," he said.
Despite what may appear to be an open invitation to define "independent contractors" as "employees," the OTS' definitional authority must be constrained by plain meaning, common sense, and settled expectations.
Whether workers are classified as "employees" or "independent contractors" is typically defined under state law. And you would be hard-pressed to find state-level examples of "independent contractors" enjoying "full control" of their daily activities and "the right to exercise independent judgment" in marketing — as the State Farm Bank agents do, according to papers filed in the State Farm case — being defined as "employees" of the institution to whom they are contracted.
But if the controversy-buffeted OTS and the OCC flex their "definitional authority" without sensible regard for plain meaning, then states will have to worry not simply about remoras, but every fish in the sea glomming on to federal depository institutions.