Rule 100 of Regulation FD provides that if an issuer or a person acting on its behalf discloses material nonpublic information regarding that issuer or its securities to any person listed in paragraph (b)(1) of the rule, the issuer must make public disclosure of the information as required by Rule 101(e).  Public disclosure must be made by furnishing or filing a Form 8-K with the SEC, unless the issuer instead disseminates the information through another method or combination of methods of disclosure reasonably designed to provide broad, non-exclusionary distribution of the information to the public.  The persons described in paragraph (b)(1) include broker-dealers, investment advisers and investment companies, and certain persons associated or affiliated with them, and any person “who is a holder of the issuer’s securities, under circumstances in which it is reasonably foreseeable that the person will purchase or sell the issuer’s securities on the basis of the information.”

Paragraph (b)(2) of Rule 100 contains exemptions for disclosures to certain persons.  Paragraph (b)(2)(i) exempts disclosure to a person that owes a duty of trust or confidence to the issuer, while paragraph (b)(2)(ii) exempts disclosures to a person who expressly agrees to maintain the disclosed information in confidence.  Paragraph (b)(2)(iii), which has been removed by the SEC’s order, exempted disclosures made solely for the purpose of determining or monitoring a credit rating to (A) any nationally recognized statistical rating organization (“NRSRO”) or (B) any credit rating agency that makes its credit ratings publicly available. 

Issuers that wish to disclose material non-public information to credit rating agencies must now determine whether the credit rating agency is a person listed in paragraph (b)(1).  Some credit rating agencies have been registered as investment advisers; indeed, Rule 203A-2(a) under the Investment Advisers Act of 1940 specifically permits any NRSRO to be registered federally (rather than by the states) notwithstanding the amount of its assets under management.  If the credit rating agency is a person listed in paragraph (b)(1), the issuer must either determine whether the agency owes them a duty of trust or confidence or obtain a confidentiality agreement before disclosing material nonpublic information to the agency.  (Credit rating agencies may not agree that they have a duty of trust and confidence sufficient to satisfy the requirements of the exemption.  In its comment letter to the SEC at the time Regulation FD was originally proposed, Moody’s Investors Service, Inc. expressly denied having such a duty, requesting instead a separate exemption under Regulation FD for disclosures to credit rating agencies.)

A.    Current Preemption Standard

There has been a vast expansion of the doctrine of federal preemption of state law in the consumer financial services sector in the last two decades. In its regulations and legal opinions, the Office of Thrift Supervision (OTS) has interpreted the Home Owners’ Loan Act (HOLA) as occupying the entire field of regulation for consumer financial products and services offered by federal savings banks and their operating subsidiaries, and the courts have for the most part agreed. Field preemption has allowed federal savings banks and their operating subsidiaries to offer products and services without regard to state laws purporting to regulate or otherwise affect such products and services, except in very limited circumstances.³

Over the same period, national banks have benefited from a significant expansion of preemption supported both by the OCC and courts. This trend picked up in 1996 when the U.S. Supreme Court in Barnett held that Section 92 of the National Bank Act (NBA), authorizing insurance agent activities for national banks in small towns, preempted Florida insurance laws that would otherwise prohibit a national bank from selling insurance in a small town.⁴ In Barnett, the Court set an important standard for determining preemption for national banks: A state law that “prevents or significantly interferes” with a national bank’s exercise of its powers is preempted.⁵

Barnett provided the OCC with the basis for a broader interpretation of state law preemption under the NBA. In 2004, the OCC issued a preemption regulation providing that national banks and their operating subsidiaries were not subject to state laws that “obstruct, impair or condition” their exercise of federally-authorized powers, including making loans and taking deposits.⁶ The OCC regulations provide illustrative lists of the types of state laws that are preempted, which are virtually identical to those in OTS regulations.⁷

The OCC’s 2004 preemption regulation has led to a six-year run in which national banks and their operating subsidiaries have enjoyed what many consider de facto field preemption.

B.    New Preemption Rules

The new preemption standard goes into effect on July 21, 2011 and will apply to both national banks and federal savings banks. The new standard is essentially the old preemption standard from Barnett with a number of new, important considerations. Before turning to a discussion of the new standard, the scope of its coverage is first explored.

1. Definition of State Consumer Financial Law

The preemption provisions of Dodd-Frank divide state laws into two categories: (1) state consumer financial laws, and (2) state laws that are not state consumer financial laws. Dodd-Frank changes the preemption standard for the former, but not the latter. As a result, every preemption analysis under the NBA and HOLA will soon begin with the threshold question: Is the state law a state consumer financial law?

Dodd-Frank defines state consumer financial law as “a State law that does not directly or indirectly discriminate against national banks and that directly and specifically regulates the manner, content, or terms and conditions of any financial transaction . . . or any account related thereto, with respect to a consumer.”⁸ As a result, aside from the non-discrimination requirement, a state law must have three elements to be a state consumer financial law:

1. the state law must regulate the manner, content, or terms and conditions of a financial transaction or account;
2. the state law must do so “directly and specifically;” and
3. the financial transaction or account regulated by the law must be “with respect to a consumer.”

The qualifications in the first two elements narrow the definition of “state consumer financial law” and provide ammunition for arguments that certain state laws are not state consumer financial laws. For example, an argument can be made that certain state advertising laws are not state consumer financial laws as they regulate the ways in which a bank may communicate about its products and services and do not regulate the manner, content, or terms and conditions of the transaction or account. In addition, an argument can be made that certain state unfair and deceptive acts or practices laws with broad coverage not specific to lenders and other providers of financial products and services are not covered for failure of the “directly and specifically” element.

    2.    New Preemption Standard

Dodd-Frank amends the NBA and HOLA to preempt a state consumer financial law only in three circumstances:

1. “application of a State consumer financial law would have a discriminatory effect on national banks [or federal savings banks], in comparison with the effect of the law on a bank chartered by that State;
2. in accordance with the legal standard for preemption in the decision of the Supreme Court of the United States in [Barnett Bank v. Nelson], the State consumer financial law prevents or significantly interferes with the exercise by the national bank [or federal savings bank] of its powers; or
3. the State consumer financial law is preempted by a provision of Federal law other than this title.”⁹

The third circumstance preserves the preemption provisions in federal laws other than the NBA and HOLA, such as the Truth in Lending Act. And because very few state laws discriminate against national banks and federal savings banks, most preemption analyses will focus on the second circumstance, which adopts the Barnett standard. As a result, the dispositive question will likely be: Does the state consumer financial law prevent or significantly interfere with the exercise of power by a national bank or federal savings bank?

    3.    Consquence

Since 2004, the preemption analyses for national banks have focused on interpreting the OCC’s broad preemption rules. Barnett and court decisions interpreting Barnett were rarely, if ever, considered. Barnett and its progeny also were not considered in preemption analyses for federal savings banks, which, instead, have centered on the OTS’ even broader field preemption rules promulgated in 1996. Because the Barnett standard will soon apply to both national banks and federal savings banks, federally-chartered banks must now become thoroughly familiar with the case law interpreting Barnett.

This body of case law is extensive. Recently, a Shepherd’s report for Barnett identified 62 court decisions that examined or significantly discussed Barnett, and approximately another 188 decisions that cited and involved Barnett apparently to a lesser extent. Although, on balance, the case law is favorable for national banks, by no means have national banks won every case. As a result, lawyers for national banks and federal savings banks must review this case law with an eye towards developing an analytical framework to be used in determining which state consumer financial laws are preempted.

    4.    Grandfathering

Contracts entered into on or before July 21, 2010 are grandfathered so that current preemption standards continue to apply. Dodd-Frank provides that it does not affect any preemption regulations or interpretations issued by the OCC or OTS with respect to contracts entered into on or before the date of enactment of Dodd-Frank (July 21, 2010). This timing formulation raises a question regarding the status of contracts entered into after July 21, 2010, and before the new preemption rules become effective on July 21^st of next year. It appears that the most reasonable view is to also grandfather contracts entered into after July 21, 2010 and before July 21, 2011. 

C.    Operating Subsidiaries and Agents

Dodd-Frank also provides that, as of July 21, 2011, preemption does not extend to operating subsidiaries and agents of national banks and federal savings banks.

In Watters v. Wachovia, the Supreme Court held that the NBA preempted a Michigan law requiring operating subsidiaries of national banks engaged in mortgage lending to register as mortgage lenders.¹⁰ The broad reasoning of the decision strongly suggested that the Supreme Court holding would also extend to other substantive state law limitations, such as, for example, limitations on loan terms and lending practices.¹¹

Dodd-Frank repeals Watters by providing that it does not preempt the application of any state law to subsidiaries or affiliates of a national bank and extends this limitation to subsidiaries and affiliates of federal savings banks.¹² As a result, national banks and federal savings banks have two options for their operating subsidiaries. One is to roll the operating subsidiary up into the parent bank to take advantage of what remains of preemption. The other is to have the operating subsidiary comply with applicable state law.

In 2004, the OTS issued a legal opinion to State Farm Bank (State Farm Letter) concluding that certain exclusive agents of the bank were not subject to state licensing requirements.¹³ The State Farm Letter has been upheld by the courts.¹⁴ The OCC has not issued an analogous legal opinion, but a number of courts have held that the NBA preempts state laws otherwise applicable to agents of national banks in certain circumstances.¹⁵

Dodd-Frank sets aside the State Farm Letter and case law extending preemption to agents of national banks and federal savings banks by adding provisions to the NBA and HOLA which provide that no provision of these statutes will preempt the application of any state law to agents of a national bank or federal savings bank.¹⁶

D.    Interest Exportation

Dodd-Frank preserves interest exportation authority for national banks and federal savings banks. Dodd-Frank provides that none of its provisions affect the authority of a national bank to charge interest at the rate permitted for the most favored lender in the state where the national bank is located.¹⁷ Dodd-Frank amends HOLA to incorporate the preemption provisions inserted in the NBA, which presumably would include this interest exportation preservation provision as well.¹⁸

E.    Action Plan

National banks and federal savings banks relying on federal preemption in their current interstate activities directly or through operating subsidiaries or agents must have an action plan in place to implement Dodd-Frank’s new preemption rules. Any plan should include the following elements:

1. Identify the states in which consumer financial transactions and accounts are offered, and then identify which laws of those states purport to apply to the transactions and accounts offered by national banks or federal savings banks.
2. Determine whether those state laws identified are “state consumer financial laws” as defined by Dodd-Frank.
3. Determine whether the bank is currently complying with each state consumer financial law or taking advantage of federal preemption.
4. If the bank is taking advantage of federal preemption, determine if the state consumer financial law has a discriminatory effect on the bank.
5. If the bank is taking advantage of federal preemption and there is no discriminatory effect, determine if preemption is provided by a provision of a federal law other than the NBA or HOLA.
6. If the bank is taking advantage of federal preemption and there is no discriminatory effect or preemption is not available under a different federal law, then analyze the state consumer financial law under the Barnett prong of the Dodd-Frank preemption standard.
7. If the state law is not preempted under the Barnett standard, products, services and operations must be brought into compliance with the state consumer financial law by July 21, 2011.
8. If operating subsidiaries of the bank are taking advantage of federal preemption, either roll the subsidiary up into the parent bank or bring the subsidiary into compliance with applicable state law. If agents are used to distribute products and services, recognize that agents are no longer sheltered into the bank’s preemption. Conduct due diligence of agents to determine whether or not they are complying with applicable state law by July 21, 2011.

* * *

¹     Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

²      Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25 (1996).

³      See, e.g., 12 C.F.R. §§ 559.3(h)(1), 560.2.

⁴     Barnett Bank, 517 U.S. at 32.

⁵     Id. at 33.

⁶     12 C.F.R §§ 7.4006, 7.4007, 7.4008, 7.4009, 34.4.

⁷     Id.

⁸     Section 1044 of Dodd-Frank.

⁹     Sections 1044 and 1046 of Dodd-Frank. Section 1044 adds the new preemption standard to the NBA by amendment, and Section 1046 amends HOLA to provide that preemption under HOLA is governed by “the laws and legal standards applicable to national banks regarding the preemption of State law.”

¹⁰     Watters v. Wachovia, N.A., 550 U.S. 1 (2007).

¹¹     Watters, 550 U.S. at 20-21.

¹²     Section 1045 of Dodd-Frank; supra, footnote 9.

¹³     OTS Chief Counsel Op. (Oct. 25, 2004) (authority of a federal savings association to perform banking activities through agents without regard to state licensing requirements).

¹⁴     State Farm Bank, F.S.B. v. Burke, 445 F. Supp 2d 207 (D. Conn. 2006); State Farm Bank, F.S.B v. Reardon, 539 F.3d (6^th Cir. 2008).

¹⁵     See, e.g., Pacific Capital bank, N.A. v. Blumenthal, 542 F.3d 341 (2^nd Cir. 2008); SPGGC, LLC v. Ayotte, 488 F.3d 535 (1^st Cir. 2007); SPGGC, LLC v. Blumenthal, 505 F.3d 183 (2^nd Cir. 2007).

¹⁶     Section 1045 of Dodd-Frank; supra, footnote 9.

¹⁷     Section 1044 of Dodd-Frank.

¹⁸     Supra, footnote 9.

Unlike the TAGP, the temporary deposit coverage for noninterest bearing transaction accounts under the Act will apply at all FDIC-insured institutions and will cover only transaction accounts that do not pay interest.  Accordingly, beginning January 1, 2011, low interest NOW accounts and Interest on Lawyer Trust Accounts (“IOLTAs”) currently covered under the TAGP will no longer be eligible for an unlimited deposit insurance.

The Proposed Rule sets forth notice and disclosure requirements for insured depository institutions that are designed to ensure that depositors are aware of and understand the types of accounts that will be covered by the temporary deposit insurance for noninterest bearing transaction accounts.  Insured depository institutions will be required to post a notice in their main office, each branch and, if applicable, on their website; notifying customers currently covered by the TAGP that, beginning January 1, 2011, low-interest checking accounts and IOLTAs no longer will be eligible for unlimited guarantee; and notifying customers individually of any action they take that will affect the deposit insurance coverage of funds held in noninterest-bearing transaction accounts.

The OTS also revised the appendices to New Section 120, incorporating the contents of former Appendix A: Capital Components and Risk-Based Capital, and former Appendix B: Supplementary Information and Issues, with updates into two new appendices: Appendix A, which focuses on the components of capital (Tier 1, Tier 2 and total capital); and Appendix B, which focuses on the calculation of risk weighted assets.  Updates provided in these appendices include, among other things: (i) a discussion on the regulatory capital treatment of TARP and CPP payments; (ii) an updated discussion on the importance of common stockholders equity as the predominant form of Tier 1 capital, and an expanded discussion on the composition of common stockholders’ equity and noncumulative perpetual preferred stock; (iii) an updated discussion of regulatory policy with regard to accounting changes affecting the treatment of on- and off-balance sheet assets; and (iv) a discussion about underwriting and qualifying residential mortgage loans for the fifty percent risk-weight category.

In addition, the OTS retained Appendix C, Prompt Corrective Action Restrictions with no changes and added a new Appendix D addressing frequently asked questions and answers regarding the risk weight treatment of various types of one-to-four family residential mortgage loans.

Ms. Warren has long been rumored to be the top candidate for nomination as CFPB Director; however, concerns had been raised regarding the likelihood that she would be confirmed by the Senate.  As an Assistant to the President and Special Advisor to the Secretary of the Treasury, however, Ms. Warren will not be formally confirmed by the Senate unless she is subsequently nominated to be the CFPB Director by the President.  This is notable because Congress expressly determined that the CFPB should be isolated from political oversight as an autonomous bureau of the FRB headed by an independent Director.  Ms. Warren will be directly accountable to both the President and the Treasury Secretary.

In the role of special advisor, Ms. Warren will not have all of the powers and responsibilities of the CFPB Director, including the rulemaking powers granted to the CFPB Director pursuant to Section 1022(b)(1) of the Act and the requirement to appear before Congress pursuant to Section 1016 of the Act.  Ms. Warren will also be unable to assume the CFPB Director’s position as a member of the Financial Stability Oversight Council.  Pursuant to section 1066 of the Act, the Treasury Secretary acts as the CFPB Director until a Director has been confirmed by the Senate.  On the Act’s transfer date, July 21, 2011, the seat on the FDIC’s Board of Directors currently held by the Director of the OTS will be transferred to the CFPB Director pursuant to Section 336 of the Act; if a CFPB Director has not been confirmed by the Senate by that time the Treasury Secretary will assume that seat on the FDIC Board of Directors.

The Treasury also has set the “designated transfer date” to transfer functions to the CFPB as July 21, 2011.  On this date, certain authorities will transfer from other federal agencies to the CFPB, and the CFPB will be able to exercise certain additional, new authorities under the Act and other laws.  The Act’s new preemption standards for federally-chartered institutions also will take effect on the designated transfer date.  The determination of the designated transfer date sets other deadlines, including setting the target date for publishing final rules that implement the Act’s mortgage reform provisions as January 21, 2013.

• Derivatives
• Clearing and Settlement
• Asset-Backed Securities
• Advisers to Hedge Funds and Other Private Funds
• Whistleblower Program
• Corporate Governance Issues, Including Executive Compensation Disclosure and Related SRO Rules
• Municipal Securities
• Credit Rating Agencies
• Specialized Corporate Disclosure