States vs. the Feds: A Fragile Truce

In policing money pros, a tug-of-war over who's in charge

New York Attorney General Eliot Spitzer isn't the only state official at odds with Washington these days. Spitzer recently upstaged the Securities & Exchange Commission with a headline-grabbing $40 million settlement with a hedge fund for improper trading of mutual-fund shares. But turf fights are raging all along the financial-policy front. The states insist they have the right to impose their own, stiffer rules on national financial institutions to protect consumers' privacy, curb predatory lending, and police brokerage firms. The feds' response? Back off -- that's our job.

Chalk up the tug-of-war in part to a backlash against what's popularly seen as the feds' frequent ineptness as enforcers. With rising complaints about privacy abuses, deceptive lending practices, and other rip-offs, states are moving into the vacuum created by Washington's inattention "to the ways that the changing financial-services market is harming consumers," says Travis Plunkett, legislative director for the Consumer Federation of America.

Spitzer's attacks on Wall Street are inspiring other state enforcers to take on big corporate icons on behalf of consumers. And the public perception that the states are cracking down on shady practices more aggressively than the feds is turning up the heat on Washington. Banks and brokerage firms that operate nationally are up in arms about the prospect of a patchwork of rules. But the uniform standards they support are generally less rigorous than what state officials and consumer advocates say is needed to deter abuses.

The outcome of these battles would be clearer if Congress could make up its mind where it stands. While conservatives on Capitol Hill traditionally favor states' rights, Congress has been sympathetic to pleas from financial-services firms -- among the biggest campaign contributors -- for one set of national rules. So the feds are squashing states' efforts to force national banks to follow local predatory lending laws. But the states have a real shot at enforcing their own rules on issues where Washington has left the door open to local solutions.

Privacy is where states may have the most running room. A new California law lets consumers block banks, credit-card companies, and other institutions from sharing their personal financial information. The law clashes with provisions of the Fair Credit Reporting Act that override state curbs on sharing customer data by companies under the same corporate umbrella. The provisions expire on Jan. 1, but the House on Sept. 10 voted 392-30 to make them permanent. A rival Senate bill would let consumers block solicitations from affiliated companies, but still allow them to share data. "That's only half a loaf," complains Democratic California State Senator Jackie Speier, sponsor of her state's law.

If the federal act's provisions are renewed, the courts could overturn part of the California law. But that law will still impose curbs on data-sharing with outside firms that are stricter than the federal code. Alarmed, financial firms are beating the drum for a national privacy standard. But to get one, they'll probably have to give consumers more protections than federal law does now.

On the investment-fraud beat, state securities regulators are looking to patrol more territory. They have been able to stall a congressional proposal to bar them from imposing their own rules on brokerage firms that violate securities laws. State securities cops also have agreed to a truce with the SEC over policing Wall Street. In a show of cooperation on Sept. 16, Spitzer and SEC Enforcement Div. Director Stephen M. Cutler jointly announced charges against a Bank of America (BAC ) broker in connection with the mutual-funds case. Still, such teamwork could easily break down, given SEC Chairman William H. Donaldson's insistence on his agency's role as the markets' rule-setter -- and the AGs' penchant for publicity.

The states aren't making much headway, though, in imposing their own laws on national banks. With some lenders targeting low-income borrowers for high-rate mortgages, states such as Georgia and North Carolina are adopting laws against predatory lending. But in July, the federal Office of the Comptroller of the Currency said Georgia's law -- barring fat fees, prepayment penalties, and other abusive loan terms -- doesn't apply to national banks, which the OCC oversees. The state backed off on applying the law to these banks. "No matter how beneficial the purpose, constitutionally, states don't have the power to regulate the activities of federally created financial institutions," says Comptroller of the Currency John D. Hawke Jr. States know these laws can be preempted but pass them anyway because it's politically popular, he says. Besides, Hawke insists, the real culprits are not national banks but mortgage brokers and finance companies, which the law still covers.

Turf battles over financial policy are nothing new. The states and the feds have sparred since the days of Alexander Hamilton. At a time of nonstop revelations of shady practices by financial giants, the current fight could last a few more rounds yet.

By Amy Borrus, with Mike McNamee, in Washington

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