OCC Provides Guidance on Preemption Issues

The OCC issued two final rules strongly declaring that national banks and their operating subsidiaries may operate nearly free from state law restrictions. The two rules amplify and strengthen existing OCC interpretations regarding the extent to which Federal laws, the National Bank Act in particular, preempt state laws purporting to regulate the activities of national banks and their operating subsidiaries (the "Preemption Rule") and preclude state regulators from exercising "visitorial" or examination powers over these entities except in limited circumstances (the "Visitorial Powers Rule"). The OCC explained that it is taking these actions to eliminate "excessively costly, and unnecessary, regulatory burdens" imposed by "an overlay of state and local standards and requirements on top of the Federal standards to which national banks are already subject" and to ensure that national banks may operate under "uniform, consistent, and predictable standards" that enhance their business and ability to meet the needs of their customers. The two rules become effective February 12, 2004.

The Preemption Rule defines a wide area in which national banks and their operating subsidiaries may engage in real estate and other lending, deposit taking, and other activities without limitation by state law or regulators. Although the OCC declined to state - as the OTS has done with respect to operations of federal savings associations - that it intends to "occupy the field" of national bank regulation, the Preemption Rule is the strongest statement yet from that agency asserting that national banks are not subject to most state law requirements. An existing OCC regulation provides that national bank operating subsidiaries are subject to state law only to the same extent as a national bank. Therefore, operating subsidiaries will benefit derivatively from this rulemaking.

The Preemption Rule provides that a national bank may engage in deposit taking, lending and other activities, without regard to state laws concerning, among other matters:

• Licensing, registration (except service of process), and reporting;

• Ability of creditors to obtain private mortgage insurance or other credit related insurance or risk mitigants;

• Loan-to-value ratios;

• Interest (however, Federal law sets the maximum interest at the usury rate applicable in the state where the bank is located or maintains a branch);

• Terms of credit, including repayment schedule, amortization, and minimum payments;

• Terms and circumstances in which a loan may be accelerated;

• The aggregate amount that may be loaned;

• Escrow accounts;

• Access to and use of credit reports;

• Disclosure and advertising;

• Processing, origination, servicing and sale of mortgage loans;

• Abandoned and dormant accounts; and

• Funds availability.

As is currently the case, under the Preemption Rule national banks will remain subject to state contract, tort, criminal, debt collection, property, taxation and zoning laws, as well as to state laws that the OCC determines to be only incidental to the operations of the national bank.

The Visitorial Powers Rule complements the Preemption Rule by clarifying Section 484 of the National Bank Act and existing OCC precedent concerning the extremely limited degree to which state regulators may examine national banks and enforce state laws with respect to national banks. Under the Visitorial Powers Rule, only the OCC may exercise visitorial powers with respect to the content and conduct of activities authorized by national banks under Federal law. The only exceptions to this rule are those specifically provided by Federal law, such as the ability of state regulators to examine bank records for compliance with applicable unclaimed property or escheat laws and the ability of Federal and state regulators to "functionally regulate" certain securities and insurance activities, as provided in the Gramm-Leach-Bliley Act. Federal law permits visitorial powers "as are vested in the courts of justice." However, the OCC has clarified in the Visitorial Powers Rule its position that this exception does not grant state authorities any right to inspect, direct, regulate, or compel compliance by a national bank with respect to any law. Rather, under the Visitorial Powers Rule, the OCC confirms its existing position that only the OCC may enforce state or other laws against national banks, and only to the extent such laws are applicable to national banks. As was the case under the Preemption Rule, the OCC has confirmed that the Visitorial Powers Rule will apply to operating subsidiaries through existing OCC regulations provided that an operating subsidiary of a national bank is subject to state laws only to the same extent as its parent bank.

Although existing OCC precedent mostly protects n ational banks from the operation of state laws, the Preemption Rule is expected to enhance the OCC’s ability to determine the extent to which new state requirements apply to national banks. Presently, each time a state enacts a new requirement, it is often necessary to seek OCC clarification that the new requirement conflicts with Federal law and is, thus, preempted. Federal law requires the OCC to seek public comment before issuing an interpretive letter or ruling preempting a state consumer protection law, unless the OCC or the Federal courts have already determined that Federal law preempts another law raising similar issues in the past. A principal benefit that the Preemption Rule thus appears to offer is that the OCC may not be required to conduct a notice and comment process each time it considers a new preemption issue. Though the OCC does not explicitly address this issue in the explanatory release accompanying its Preemption Rule, the OCC will presumably take the position in the future that it does not need to go through a notice and comment procedure to determine that state laws inconsistent with its regulation are preempted because the Preemption Rule itself was already subject to this process.

Lastly, though not directly related to preemption, the rules also contain provisions precluding national banks from engaging in predatory lending, which the OCC defines as consumer lending based predominantly on the bank’s realization of the foreclosure or liquidation value of collateral securing the loan, without regard to the borrower’s ability to repay the loan. This standard does not prevent a national bank from making legitimate, collateral based loans, such as a reverse mortgage, provided the borrower understands that it is likely or expected that the collateral will be used to repay the debt.

The Department of Labor (the "DOL") has issued a prohibited transaction class exemption under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), covering the release of claims and extensions of credit by ERISA plans in connection with the settlement of litigation (the "Class Exemption"). The Class Exemption, labeled PTCE 2003-39, was issued on December 31, 2003, and is effective retroactive to January 1, 1975. The Class Exemption covers situations where an ERISA plan exchanges or releases its claims in exchange for cash (or certain other forms of consideration) from one or more parties in interest in connection with the settlement of litigation or threatened litigation. The Class Exemption also covers the resulting extension of credit by a plan to the party in interest in connection with such a settlement when the consideration is to be paid in installments. The Class Exemption only applies to genuine controversies where the terms and conditions of the settlement are authorized and negotiated by an independent fiduciary, after taking into consideration the likelihood of recovery, the costs and risks of litigation, and the value o f the claims foregone. In the case of settlements entered into after January 30, 2004 that do not involve class action litigation, the plan must receive advice from an independent attorney that a genuine controversy exists. In the case of all settlements entered into after January 30, 2004, the terms and conditions of the settlement must be described in a written settlement agreement or consent decree. In the case of class action litigation, the DOL has provided that the independent fiduciary need not negotiate the terms and conditions of the settlement. Such terms and conditions must, however, be taken into account by the independent fiduciary in deciding whether to participate in the settlement. In all cases, the settlement can be no less favorable to the plan than to similarly-situated persons participating in the settlement that are not plans. The DOL also clarified that the Class Exemption does not cover transactions described in PTCE 76-1 relating to delinquent employer contributions to multiemployer and multiple employer collectively-bargained plans.

The FRB, FDIC, FinCEN, NCUA, OCC, OTS and the Department of the Treasury (the "Agencies") jointly issued interpretative guidance in the form of frequently asked questions ("FAQs") regarding the application of the Customer Information Program ("CIP") requirements (the "CIP Rule") under Section 326 of the USA PATRIOT Act (the "PATRIOT Act"). A lthough the FAQs expressly apply only to CIP requirements for banks, savings associations, credit unions and certain non-federally regulated banks, they may be useful in addressing similar issues that arise in the investment company and broker-dealer contexts. The FAQs contain 29 questions and answers and cover, among other topics, (a) who is considered a new customer, e.g., when a Financial Institution ("FI") receives assets from a pension plan administrator who is removing a former employee from the plan, (b) whether the CIP Rule applies to an FI’s foreign subsidiaries, (c) when one FI may rely on another to perform elements of its CIP, (d) how an FI may demonstrate a "reasonable belief" that it knows the true identity of a customer with an existing account and (e) how customer identity is properly verified, e.g., in the case of sole proprietorships and partnerships. Among the interpretations provided by the Agencies are that the CIP Rule does not apply to any part of an FI located outside of the U.S., but FIs are encouraged to implement an effective CIP throughout their operations to the extent the CIP does not conflict with local law. An individual with power-of-attorney is the "customer" if an account is opened for a person who lacks legal capacity, but if the account is opened for a competent person, the latter is the "customer" and the person holding the power-of-attorney is merely an agent. A customer that has had an account with an FI but closed the account will nevertheless be treated as a new customer subject to the CIP requirements when opening a new account. Each time a certificate of deposit is rolled over or a loan is renewed a new "account" is established, but if the FI has a reasonable belief that it knows the holder’s true identify it need not perform its CIP procedures unless a new customer is added to the loan or deposit account relationship. Moreover, a person that has an existing account with a bank affiliate is not deemed to have an existing account with the bank. Finally, the FAQ clarifies that the reliance provisions of the CIP rule do not require that the FI being relied upon perform the procedures in the relying FI’s CIP; the FI being relied upon must only perform the elements of a CIP required by the CIP Rule.

NASD Notice to Members 03-77 (the "NTM") proposed amendments to NASD Rule 2210 (governing communications with the public) and NASD Rule 2211 (governing institutional sales material and correspondence) that would require communications with the public, institutional sales material or correspondence, that include fund performance information permitted by Rule 482 under the Securities Act of 1933 and Rule 34b-1 under the Investment Company Act of 1940 to disclose: (a) standardized information required by Rule 482 and Rule 34b-1, (b) the fund’s maximum sales load and (3) the fund’s annual operating expenses. This information would have to appear in a prominent text box in a type size as least as large as that used to present non-standardized performance information. Among other topics, the NTM solicits comment on (a) possible alternatives to the proposed disclosure, (b) whether other information should be presented and (c) whether additional information should be required in fund advertisements that do not include performance information, e.g., whether advertisements that refer to a fund as "no-load" or part of a "no-load" family of funds should be required to include fund expense information. Comments on the proposal must be received by January 23, 2004.

The FRB issued a supervisory letter (the "Letter," SR-03-22) in which the FRB describes enhancements to its bank holding company ("BHC") supervision program regarding FRB assessments of the level and trend of compliance risk at BHCs. The Letter describes the initial phase of implementation of this enhanced supervision, which will involve an initial emphasis on large complex banking organizations and some large banking organizations (collectively "Large BHCs"). The FRB stated that it will use examiners with appropriate consumer compliance experience to implement the program and will ask them to assess a Large BHC’s level of compliance risk as high, moderate or low (taking into account the risk mitigation effects of internal control and review processes). Subsequently, the examiners will assess the direction (increasing, stable or decreasing) of consumer compliance risk at the Large BHC and analyze "how that risk impacts reputational, operational, legal or other risks considered in the risk analysis process." The risk assessment will include an evaluation of corporate governance and management reporting systems with regard to consumer compliance risk. Examiners will also be asked to evaluate the adequacy of a Large BHC’s consumer compliance audit program and how and whether the Large BHC proactively follows-up on audit findings and takes appropriate corrective action. The FRB states in the Letter that, generally, Large BHCs will be notified of potential consumer compliance weaknesses as part of the ongoing supervisory process and will be asked to correct deficiencies. The FRB also notes that it iscontinuing its policy of not conducting consumer compliance examinations of nonbank subsidiaries of BHCs unless the examination is needed to address a significant compliance issue that could cause widespread violations or consumer harm.

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