Sixth Circuit Rules Ohio Mortgage Broker Act Preempted by Office of Thrift Supervision - For Now

The 6th Circuit U.S. Court of Appeals ruled on August 22, 2008 that a federally-chartered thrift is preempted from the requirement that its Ohio-based exclusive agents comply with the licensing and registration requirements of Ohio Mortgage Broker Act (the “Act”)...

in order to serve as mortgage lending and banking agents. ¹

State Farm Bank, F.S.B. is a federally-chartered thrift regulated by the federal Office of Thrift Supervision (OTS). State Farm Bank offers financial products and services, including first and second mortgages and home equity lines of credit. In 2004, in order to capitalize on the booming mortgage loan and home financing market, it developed a business plan to use the exclusive insurance agents of its parent, State Farm Mutual Automobile Insurance Company, to market its mortgage products to the public. The agents would provide information about the Bank’s mortgage loan products to their customers and would assist them in completing the loan applications. They would not, however, participate in the evaluation of the loan applications, the underwriting criteria, or make lending decisions, or close the loans. The Bank made sure the agents complied with applicable federal laws and regulations by requiring them to complete prescribed in house education and training programs as part of their exclusive agency agreement with the Bank. The training programs were reviewed by the OTS during the course of its examination of the Bank and its agents, consistent with its regulatory oversight powers.

In order to successfully launch the business plan, however, it needed to be sure its agents would not have the additional burden of licensing and registration under the Ohio Mortgage Broker Act, since the activities that were contemplated are of the type subject to the Act. The Bank relied upon the OTS’ preemption regulations to avoid the need to subject its agents to registration, licensure, and oversight by the State of Ohio. So the Bank requested the OTS to issue an opinion on the issue, and the OTS complied by issuing a formal opinion on October 25, 2004 that stated that the Act’s mortgage broker licensing and related requirements were preempted with respect to the Bank’s independent contractor agents.

The Bank provided the Ohio Superintendent of Banks with a copy of the OTS Opinion. What the Bank didn’t count on, however, was the refusal by the Superintendent to exempt the Bank and its agents from compliance with the Act, notwithstanding the OTS Opinion.

The Superintendent argued that the OTS preemption regulations did not expressly preempt state laws that govern the conduct of third-party agents who perform lending and banking activities on behalf of a federal thrift. State Farm filed suit in federal court against the State of Ohio, and the trial court sided with the State. In its opinion, the court reasoned that state regulation of a federal thrift, its employees, and subsidiaries who engage in lending and banking activities could be distinguished from state regulation of exclusive agents of a federal thrift who engage in the same activities. State Farm appealed, and the 6th Circuit reversed the district court, holding that the district court had taken too narrow an approach to the issue of federal preemption.

The appellate court reviewed the OTS preemption regulations ², which permit federal savings associations to extend credit as authorized by federal law “without regard to state laws purporting to regulate or otherwise affect their credit activities.” The Court noted that the OTS had provided a list of thirteen, non-exclusive, examples of the types of state laws preempted by the regulations, as well as a list of the types of state laws that the regulations do not preempt provided they only incidentally affect the banking and lending activities of a federal savings association. It first addressed the Superintendent’s argument that the preemption regulations were not relevant since the activities at issue were being performed by the Bank’s exclusive agents and not by the Bank. He relied upon the fact that the regulation refers exclusively to the activities of the federal thrift, and did not specifically say that it preempted state laws to which a federal savings association’s agents were subject. The Court rejected this argument, stating that “… it is the activity being regulated rather than the actor who is being regulated that matters.” ³

Continuing its analysis, the Court looked at whether the Act fell within the categories of state laws subject to preemption by the OTS regulations, and found that the Act’s licensing and certification requirements fall within the category of laws referenced in the regulation. Since the Act requires the licensing and registration of mortgage brokers, and affects the processing and origination of mortgages (activities which are specifically listed in the regulation) the Court found that the Act was subject to preemption. Here, the Superintendent had argued that the Act did not prevent or significantly interfere with the ability of the Bank to exercise its mortgage lending power, and that the Bank had made the choice to conduct its mortgage lending business. It could avoid incurring damages by simply restructuring its business plan. The Court was not persuaded by this line of reasoning, stating that by advancing it the Superintendent “does more harm than good to his position.” ⁴

The Court concluded that the Superintendent’s position placed the Bank in the untenable position of having to either change its structure or forgo mortgage lending in the state of Ohio. Such a result would frustrate the purpose of the federal law authorizing the creation of savings associations ^5, because it indirectly prohibits the Bank from exercising the federally-granted powers.

State Farm’s victory will likely be temporary, however. In a footnote to the opinion, the Court recognized that its ruling may very well be superseded by the recently enacted Housing and Economic Recovery Act of 2008 (HERA). This law will establish a nationwide licensing and registration system for all loan originators, including mortgage brokers and loan officers. All loan originators at FDIC-insured banks will have to be registered through the nationwide system, and all other loan originators will be required to be licensed by the State or through a HUD-backup system if a state does not establish a licensing system. Within 12 months, the states are required to develop mortgage broker licensing requirements consistent with the minimum standards including educational requirements, background checks, and testing. When Ohio passes a law to comply with HERA, such a law will very likely subject a bank’s exclusive agents to state regulation and will not be eligible for the OTS’ federal preemption. ⁶

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1 State Farm Bank, FSB et. al. v. Reardon, Case No. 07-4260 (6th Cir. Ct. App., August 22, 2008).
² 12 CFR §§545.2 and 560.2.
³ State Farm, p .9.
⁴ Id., p. 11.
⁵ Home Owners Loan Act, 12 USC §1461, et. seq.
⁶ State Farm, p. 2.