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National banks won a major victory Tuesday when the Supreme Court ruled that the federal government, not states, has the pre-eminent role in regulating banks’ mortgage business, even if conducted by subsidiaries. By a 5-3 vote in Watters v. Wachovia Bank, the Court found that the National Banking Act pre-empts state regulation of banks — and that the pre-emption extends to their subsidiaries, which the Court said are “equivalent” to the national banks themselves. Banks fought hard for federal regulation under the Office of the Comptroller of the Currency, rather than subjecting themselves to differing — and more aggressive — rules and enforcement at the state level. In the case before the Court, Wachovia Mortgage had been licensed in Michigan, but in January 2003 it notified the state that it had become a wholly owned operating subsidiary of Wachovia Bank, and as such no longer was subject to Michigan’s registration requirements. State banking regulator Linda Watters responded by barring the company from doing business in Michigan. Wachovia went to court to challenge her decision, and the bank won in the lower courts. Justice Ruth Bader Ginsburg, writing for the majority, ruled for Wachovia, stating that “State regulators cannot interfere with the ‘business of banking’ by subjecting OCC-licensed operating subsidiaries to multiple audits and surveillance under rival oversight regimes.” Ginsburg also rejected states’ argument that the Bill of Rights’ Tenth Amendment justified a state role. The amendment, which reserves some powers to the states, does not apply in Ginsburg’s view, because the Constitution assigns banking regulation to the federal government as part of its power over interstate commerce. The decision is a setback for consumers, says Nina Simon, senior attorney for the AARP, the advocacy group for current and future retirees. AARP, along with numerous consumer groups, filed a brief in the case in favor of state regulation. “States have been much more protective of consumer rights in this area,” Simon says. “The decision keeps states out to a greater extent than we would have liked.” Advocates for a greater state role complained that the OCC has a record of “thin and very weak” enforcement, whereas numerous states have taken a more active role in investigating bank practices. The ruling could impact the direction of the growing investigation into the subprime mortgage lending business, Simon added. “These subsidiaries play roles in all these transactions.” American Banking Association President Edward Yingling, while celebrating the decision, said in a press statement released Tuesday it should not be read as a free pass to avoid regulation. “It’s important to note that operating subsidiaries are subject to the full range of federal consumer protection laws that apply to national banks,” Yingling said. “They are also subject to state laws that don’t intrude on federal authority, including a range of state contract, tort, tax, and criminal laws.” Yingling also suggested that there is an upside for consumers in the outcome of the Supreme Court case. “Avoiding a patchwork of duplicative and conflicting federal and state regulation makes it easier for national banks to grant credit to customers across state lines and preserves our industry’s competitive structure,” Yingling said. In an unusual lineup, joining Ginsburg in the majority were Justices Anthony Kennedy, David Souter, Stephen Breyer, and Samuel Alito Jr. Justice John Paul Stevens wrote a stinging dissent, accusing the majority of upsetting the federal-state balance and improperly expanding federal pre-emption doctrine. Chief Justice John Roberts Jr. and Antonin Scalia joined Stevens’ dissent. Without explanation, Justice Clarence Thomas recused in the case, though his financial disclosure forms do not reflect a connection to Wachovia. Tony Mauro can be contacted at [email protected].

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