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U.S. District Judge Janet C. Hall has dealt a blow to state banking regulators in Connecticut and elsewhere, ruling that mortgage-lending subsidiaries of national banks fall outside the power of state banking regulation. In the test case of Wachovia Bank v. John P. Burke, Hall ruled June 1 that the National Bank Act of 1864 leaves the regulation of subsidiary Wachovia Mortgage Corp., a North Carolina corporation, exclusively to the federal Office of the Comptroller of the Currency (OCC). The case is being watched nationally by the banking and mortgage industries. “We will definitely appeal,” Attorney General Richard Blumenthal declared earlier this month. Burke, Connecticut’s banking commissioner, said he was disappointed. The ruling is detrimental to Connecticut consumers, he said. Before 2001, Burke shared oversight of national banks’ mortgage subsidiaries with federal regulators. In 2001, controversial new OCC regulations handed the reins to the feds alone. State banking officials reacted with dismay, contending the feds’ power grab went far beyond Congress’s instructions in the Banking Act. Wachovia began to question its duty to obey both state and federal masters. In December 2002, Wachovia Mortgage surrendered state licenses in Shelton, Waterbury, Bloomfield and New Haven. Burke threatened to charge the company and agents with operating without a state license. In 2003, Wachovia and the mortgage subsidiary sued Burke in federal court, under the federal civil rights statute, seeking emancipation from state regulation. They claimed the Bank Act and the Supremacy Clause preempts state oversight of the mortgage subsidiary. Wachovia Corp., the bank’s holding company, transferred the mortgage company’s stock to Wachovia Bank, and claimed immunity from Connecticut’s regulatory control. As regional mega-banks consolidate nationwide, North Carolina-based Wachovia is taking a lead role in eliminating state oversight of its affiliated companies. It contended in the litigation before Hall a patchwork of state regulation needs to go for business efficiency and to eliminate duplicative, contradictory requirements. In an amicus curiae brief from the OCC, the American Bankers Association, and four other banking industry associations, the banking industry noted the new phenomenon of Internet mortgage origination, and said patchwork state regulation could “well hobble the advancement of this very consumer-friendly electronic medium.” In opposition, 43 state banking officials filed an amicus brief supporting Connecticut’s position, that “the National Bank Act’s preemptive reach extends only to national banks, and Wachovia Mortgage is not a national bank.” Assistant Attorney General Mark F. Kohler, arguing in an October 2003 brief, wrote that the OCC’s new interpretive rule, 12 C.F.R. 7.4006, “represents a naked assault on the traditional authority of states to regulate state-chartered mortgage lenders.” Professor Arthur E. Wilmarth Jr., of George Washington University Law School in Washington, D.C., a national expert on banking law, drafted the brief for the states. “What [Judge Hall] did here is peculiar,” Wilmarth said in an interview. “She acknowledges there’s a statute for national banks and a statute for affiliates. Then she says these [mortgage subsidiaries] are not affiliates, even though, under the plain language of the statute, they clearly are,” he maintained. “Instead she says that the affiliates that Congress was worried about in 1933 were essentially securities affiliates,” after the crash of 1929. Brian C. Fournier, of Meriden’s Hurwitz, Sagarin & Slossberg, also represents the state friends of the court. He said the case has potential to go to the U.S. Supreme Court. “Even before the decision, both sides were contemplating an appeal if they lost,” he said. Eric P. Smith, of New Haven’s Lynch, Traub, Keefe and Errante, is Connecticut counsel for a group of banking associations that backed Wachovia’s stand. “This is a classic case of federal preemption,” he said, praising Hall’s decision as reasonable and sound. Blumenthal counters that the ruling is “very misguided” and “would cripple our enforcement activities against predatory lending abuses and other anti-consumer practices.” Wilmarth noted that banks use corporate subsidiaries to shield the bank from direct risks, such as risky sub-prime loans and predatory lending suits. Blumenthal decried the big banks’ dressing in national garb to avoid state oversight, while simultaneously using state corporation status to avoid court and economic liability. “It’s a pretty blatant, brazen effort,” he said. They want these entities to be part of the national bank when it suits them, and separate when it’s to their advantage,” he said. “They simply can’t have it both ways.” Hall concluded the OCC’s new regulation covered an area in which Congress had been silent, and that the agency’s policy was based on a reasonable interpretation of the act. She agreed with bank arguments that Burke’s threatened enforcement actions would interfere with Wachovia’s authorized powers to form subsidiaries and engage in real estate lending.

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