The New York State Department of Financial Services (“DFS”) has achieved a big win for state-based regulation of nonbank companies, in a lawsuit against the Office of the Comptroller of the Currency (“OCC”). The case involves the OCC’s two-year effort to grant special-purpose national bank charters to financial technology companies, and thereby preempt state law. In a decision last week, the Southern District of New York handed a win to the states in this national dispute over the proper boundaries of state and federal regulation of non-depository financial services companies.[1]
The National Bank Act
The federal and state governments historically have engaged in a power struggle in regulating the banking industry. Alexander Hamilton and Thomas Jefferson famously fought over the respective roles of the federal and state governments, with Hamilton advocating for a strong central government, and Jefferson desiring to preserve the powers of the states. In 1863, following the Civil War, Congress enacted the National Currency Act, establishing both a national currency and the Federal Reserve banking system. Under what is now called the National Bank Act, the United States operates under a “dual banking” system, pursuant to which banks have the choice of obtaining a charter either from the federal government or the states. In our banking system, whether the bank is chartered by the OCC or a state banking department, the Federal Deposit Insurance Corporation (“FDIC”) insures the deposits up to $250,000 per account holder. This FDIC insurance is integral to the dual banking system, providing protection to consumers in the event of bank losses.[2]
New York’s Banking Department also has a long history, having been formed in 1851. In 2011, the Banking Department combined with New York’s Insurance Department to form the New York State Department of Financial Services (“DFS”), which is responsible for the regulation, supervision and enforcement of laws with respect to New York’s financial services industry. DFS charters significant financial institutions, including large and small wholesale and community banks, numerous branches of foreign banks, and nondepository institutions, including all insurance companies doing business in New York as well as money transmitters, licensed lenders, check cashers and cryptocurrency firms. In total, DFS supervises institutions with assets in excess of $7 trillion.[3]
The Licensing and Supervision of Non-Depository Companies
The dispute in Vullo v. OCC involves the licensing of non-depository companies, meaning firms that engage in certain activities that banks also conduct, but which do not accept or hold “deposits” from customers. The legal issue in the case centers around the meaning of the phrase “business of banking” under the National Bank Act. Specifically, under the National Bank Act, for a bank to receive a national charter, the OCC must determine that the institution “is lawfully entitled to commence the business of banking,” and the grant of the charter entitles the institution to conduct:
all such incidental powers as shall be necessary to carry on the business of banking; by discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; by receiving deposits; by buying and selling exchange, coin, and bullion; by loaning money on personal security; and by obtaining, issuing, and circulating notes.[4]
Once chartered by the OCC, the National Bank Act provides that the states are preempted from in any way interfering with the regulation of the chartered bank, and many state laws – such as usury limits – do not apply to the federally chartered bank. This principle even extends to an attorney general’s ability to conduct certain inquiries of a national bank.[5]
On the other hand, the states and not the federal government historically have licensed non-depository companies that engage in financial services businesses. Insurance is the leading example of financial services companies that are almost exclusively regulated by the states. But state banking laws also provide for the supervision and regulation of other nonbanks, including money transmitters, licensed lenders, premium finance companies, mortgage lenders and servicers, check cashers and, most recently, crypto-currency firms. DFS, and its predecessor the Banking Department, has regulated these nonbank, non-depository firms for decades – as have the banking departments in all other states. The federal government has never regulated these types of companies, many of which utilize financial technology for their businesses.
Background to the OCC’s Fintech Charter Decision
The OCC first began considering the chartering of non-depository “fintech” companies in March 2016. At that time, the OCC published a “white paper” setting forth its proposed new “OCC fintech charter,” which would allow nonbanks to obtain a federal bank charter under the National Bank Act, and thereby preempt the states from licensing and enforcing laws against the companies so chartered. In December 2016, the OCC published another white paper, which asked “whether it would be appropriate for the OCC to consider granting a special purpose national bank charter to a fintech company,” which thereby would be immune to state law and visitorial authority “in the same way and to the same extent” as “a full-service national bank.”[6] In a statement at the time, when I was DFS Superintendent, I stated:
DFS opposes any effort to federalize what states have been doing – and doing well – for over a century…. State regulators, like DFS, are best positioned to continue to protect consumers and ensure that dynamic service providers like fintech firms will continue to flourish within an appropriately tailored regulatory regime. History has demonstrated that the states, not the federal government, have the requisite knowledge and experience to effectively regulate non-depository financial service providers and guard against predatory and abusive practices.[7]
In a comment letter, I set forth several reasons that the OCC’s proposal was problematic, including that it is not authorized by the National Bank Act, would create regulatory uncertainty, would encourage “too big to fail” institutions, would undermine important consumer protections enforced by the states, and would stifle innovation and small businesses in order to benefit large companies.[8]
The Conference of State Bank Supervisors (”CSBS”) similarly opposed the OCC’s proposed fintech charter. And, notably, the Independent Community Bankers of America raised similar concerns in its comment letter, stating:
ICBA does not believe that the OCC has the necessary authority for establishing a special purpose national bank charter that engages exclusively in non-depository core banking functions…. [T]here is no explicit authority under the National Bank Act to charter a fintech company as a special purpose bank…. Congress needs to consider all the policy implications of a fintech charter, including the scope of such a charter and how the business of banking should be defined under federal law.[9]
In March 2017, the OCC released a draft supplement to the Comptroller’s Licensing Manual, stating its position that granting charters to fintech companies that would not take deposits was within its authority. DFS again expressed disagreement with this view, asserting that the OCC lacks the legal authority under the National Bank Act “to seek to charter nonbank financial institutions and thereby create an uneven playing field for state banking institutions in derogation of state sovereignty.”[10]
In April 2017, CSBS filed a lawsuit against the OCC in the District Court of the District of Columbia, challenging the OCC’s fintech charter decision.[11] On behalf of DFS, I filed suit in the Southern District of New York. The OCC responded to both suits by arguing that the issue was not “ripe” for resolution, and that the plaintiffs lacked standing to sue. In particular, the OCC represented in court that it had not yet determined whether to proceed with the fintech charter. As a result of this position, both courts dismissed the cases without prejudice, without reaching the merits. In the Southern District of New York suit, Judge Naomi Buchwald dismissed the case in light of the OCC’s assertions that “the OCC has not yet determined whether it will issue SPNB charters to fintech companies, nor has it received or reviewed any applications for any such charter.”[12]
In July 2018, Comptroller Otting made clear his position to proceed with the fintech charter, announcing that the OCC would begin to accept and review applications for such charters.[13] As a result, in September 2018, DFS sued again, and the CSBS followed with its suit in October 2018. In the complaint and legal briefing, the states explained the substantial injury that would result from the preemption of the states’ licensing of non-depository companies as well as the enforcement of state consumer protection laws. In response, the OCC again argued that the cases were not ripe for resolution, this time focusing on the fact that the OCC has not yet “granted” an application – a matter exclusively within the OCC’s own discretion.
The Court’s Decision
In a 57-page decision issued on May 2, 2019, Judge Victor Marrero of the Southern District of New York agreed with DFS’s position. The Court first rejected the OCC’s standing and ripeness challenges, noting that “national banks avoid application of many state laws and regulatory systems because of the blanket preemption” and that a “key feature of the dual banking system is that, with certain exceptions, any entity that is not a deposit-receiving bank – including non-depository fintech companies – is left largely to the prerogative of the states to regulate.”[14] The court noted that the “threats to New York’s sovereignty are so clear that OCC does not even mention, let alone contest, the state’s interests.”[15] Accordingly, the Court found “DFS’s claims both constitutionally and prudentially ripe for adjudication.”
Judge Marrero next considered the OCC’s argument that the DFS suit was untimely, on the ground that the OCC’s fintech charter is based on a 2003 regulation, triggering a six-year statute of limitations. The Court rejected the argument, noting that “DFS rightly points out that OCC’s position on timeliness is somewhat in tension with its argument about ripeness.”[16] The Court further noted that after adoption of the regulation, the “OCC concededly has never chartered a national bank that has taken deposits.”[17] The Court concluded that the OCC had not met its burden on its affirmative defense, although it stated that the OCC may re-raise the timeliness defense later in the proceedings.[18]
Turning to the merits, the Court concluded that “the term ‘business of banking,’ as used in the [National Bank Act], unambiguously requires receiving deposits as an aspect of the business.” In reaching this conclusion, the Court discussed the 1863 definition of “banking”, which included the receipt of deposits. More critically, the Court surveyed the broader context, noting the many provisions of the statute that relate to a national bank’s deposit-receiving powers.
Significantly, the Court noted that, in drafting the National Bank Act, Congress relied heavily on New York’s banking laws, which included the premise that the “business of banking” has always included the power to engage in deposit-receiving.[19] Notably:
Indeed, the Court is not aware of OCC ever having chartered a non-depository entity as a national bank on the strength of the NBA’s “business of banking” clause. Rather, on the two occasions that OCC began issuing national bank charters to a type of non-depository institution, Congress first amended the NBA explicitly to authorize OCC to do so.
Id. at 44. Those two circumstances were amendments to the statute to allow OCC to charter “trust banks” in 1978 and to charter non-depository “bankers’ banks” in 1982. In each such instance, Congress acted to amend the statute, rather than, as here, the executive agency seeking to do so without Congressional authorization. Id. at 44-45.
The Court expressed concern that the OCC’s fintech charter would be the first time the agency asserted the power to charter non-depository institutions – based on a 2003 regulation enacted 140 years after the statutory language, which decision impacts the “proper balance of federal and state functions and powers in our dual system of government and dual-banking structure.” Id. at 46. The Court stated:
Such dramatic disruption of federal-state relationships in the banking industry occasioned by a federal regulatory agency lends weight to the argument that it represents exercise of authority that exceed what Congress may have contemplated in passing the NBA.
Id. at 46-47. Accordingly, the Court concluded that it is “unambiguous that receiving deposits is an indispensable part of the ‘business of banking’ as used by Congress” in the National Bank Act, and that “only depository institutions are eligible to receive national bank charters from OCC.” Id. at 52-53. As a result, the Court held that DFS stated a claim against the OCC.[20]
In sum, this decision highlights the significance of the longstanding battle between the federal government and the states in banking regulation and enforcement. There is no doubt that the states historically have licensed and regulated non-depository companies, and that the OCC has not done so. In this particular circumstance, the OCC might have thought that it could win this turf battle by using the term “fintech” to argue that the dual banking system should apply to firms employing financial technology. Judge Marrero did not accept this approach, relying instead on the National Bank Act’s actual language and the impact that the OCC’s reading would have on the states. As the Court implied, regardless of the use of technology, the National Bank Act does not authorize the exercise of new regulatory powers by executive agency fiat. Whether a company uses technology or not, the fact of taking deposits has been the essence of the business of banking for 150 years, and preemption occurs only after Congress has determined it by statute. Following this decision, the OCC might consider withdrawing its fintech charter, and either ask Congress to legislate on the issue or maintain the current state-federal balance. Should the OCC choose to proceed instead with litigation, this issue likely will reach two Courts of Appeal and possibly the U.S. Supreme Court. I vote for the states.
Footnotes
[1] Vullo v. OCC, No. 18 Civ. 8377 (VM), Decision and Order (May 2, 2019).
[2] See 12 U.S.C. sections 222 and 1815.
[3] Id. at 2.
[4] 12 U.S.C. section 24 (Seventh).
[5] See Cuomo v. Clearinghouse Ass’n, 557 U.S. 519 (2009).
[6] Exploring Special Purpose National Bank Charters for Fintech Companies (PDF: 133 KB).
[7] Statement by DFS Superintendent Maria T. Vullo Regarding the OCC Special Purpose National Bank Charters for Fintech Companies, Press Release (December 2, 2016).
[8] Letter to Comptroller Thomas J. Curry, Re: Exploring Special Purpose National Bank Charters for Fintech Companies, Maria T. Vullo (January 17, 2017) (PDF: 657 KB).
[9] Letter to Comptroller Thomas J. Curry, Re: Exploring Special Purpose National Bank Charters for Fintech Companies, Christopher Cole and James Kendrick (January 17, 2017) (PDF: 233 KB).
[10] Letter to Comptroller Thomas J. Curry, Re: Comptroller’s Licensing Manual Draft Supplement: Evaluating Charter Applications From Financial Technology Companies, Maria T. Vullo (April 14, 2017) (PDF: 8.36 MB).
[11] CSBS Files Complaint Against Comptroller of the Currency (April 26, 2017).
[12] Vullo v. OCC, No. 17 Civ. 3574, 2017 WL 6512245 (S.D.N.Y. Dec. 12, 2017), at *5.
[13] Office of the Comptroller of the Currency, Press Release, OCC Begins Accepting National Bank Charter Applications From Financial Technology Companies (July 31, 2018).
[14] Vullo v. OCC, at 21-22.
[15] Id. at 24.
[16] Id. at 29.
[17] Id. at 31.
[18] Id. at 32. Although the Court’s decision on the meaning of the “business of banking” is a legal decision, the Court ordered the parties to confer on a scheduling order for dispositive motions or trial, following no more than sixty days for discovery.
[19] Id. at 43.
[20] DFS also asserted a Tenth Amendment claim, based on the argument that any powers not given to Congress are reserved for the states. The Court dismissed the Tenth Amendment claim because it found that a “claim that turns on whether Congress articulated its choice” does not implicate the Tenth Amendment, though noting in a footnote that the Court “is not unmoved by the potentially vast effect that OCC’s proposed course of action could have on the dual banking system and the banlance of state and federal power. The court finds that these concerns are more properly cognizable as a basis to find DFS has standing and as a consideration that undermines the proposition that the NBA is fairly read to indicate that Congress has, in fact, taken the momentous step of broadly authorizing OCC to charter non-depository national banks.” Id. at 56 n. 14.
Maria T. Vullo is a senior fellow at NYU School of Law’s Program on Corporate Compliance and Enforcement, and is former Superintendent of the Department of Financial Services.
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