Federal Law vs. State Law: Effects on the Economy

Former President Donald J. Trump’s administration had frequent clashes between the federal government and the states, in which he claimed maximum power for the executive branch but at other times deferred to the states in matters typically regarded as the responsibility of a national government.

Some of the conflicts were set off by the COVID-19 pandemic, in which President Trump threatened to preempt governors’ and local officials’ shelter-in-place orders that shut down schools and businesses to prevent contagion of the novel coronavirus. For example, in June 2020, the U.S. Department of Justice attempted to file a brief, supporting plaintiffs who challenged Hawaii’s COVID-19 14-day quarantine for out-of-state visitors, only to be rebuffed by a Trump-appointed federal district court judge.

In April 2020, Trump tweeted that whether to “open up the states” and restart the economy was “the decision of the President,” not of state governors. He claimed to have “total” authority on the matter until the assertion was shot down by researchers and legal experts. He then backed down, leaving decisions about reopening to state governors while making certain that they understood his wishes for a quick start and implying that he could use federal funding as a lever.

The former president and states also clashed over the federal stockpile of personal protective equipment to battle the pandemic, including whether states should have had access to it and where the responsibility lied for equipping hospitals with ventilators.

States vs. the Federal Government—Who Has the Power?

Depending upon the situation, Trump often strayed from conservative Federalist views, based on interpretation of the 10th Amendment, that the lion’s share of powers rightly belongs to the states, with limited powers for the national government. The amendment states that “powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

Enumerated powers reserved for the federal government under the U.S. Constitution include national defense, foreign policy, international trade, immigration, interstate trade and patents, and the ability to coin money. Concurrent powers with the states include taxation, creating lower courts, and the right to build roads. Police powers and matters of health and safety are generally left to the states and localities.

But during the Trump administration, more and more states—especially those led by Democrats— challenged federal regulatory changes in consumer protections for banking and financial services and the Affordable Care Act (ACA). States also took the lead in enacting data privacy and cybersecurity laws and litigating some antitrust matters, particularly with respect to communications technology.

In terms of investor and consumer protections, New York, California, and other states passed laws and regulations that increased consumer protections for financial services and emerging financial technologies (fintech). The states acted since they believed the federal government was slow to enact new rules and weakened existing protections.

States moved first to regulate data privacy and cybersecurity of financial services—which in Europe and elsewhere has been achieved at the national and European Union (E.U.) level. And they pushed to enforce antitrust laws against technology companies where they believed the federal government wasn’t taking strong enough action against consolidation, particularly in the mobile communications industry (such as the T-Mobile and Sprint merger).

States also took action ahead of the Federal Trade Commission (FTC) and federal Consumer Financial Protection Bureau (CFPB) to sue Equifax on behalf of consumers for a massive 2017 data breach that affected more than 147 million consumers.

The following is a look at five conflicts between the states and the federal government over regulatory matters of concern to consumers and investors.

1.  Financial Technology (Fintech) Regulation

Financial technology companies—including money transmitters, online and app-driven mobile consumer-lending platforms, and virtual currency licensees—are not covered by a single federal regulatory framework. Companies may be required to submit to licensing at the federal and at state levels.

“Banking and mortgage banking always have had a dual regulatory environment,” says Scott Samlin, a partner in the consumer financial services group of the law firm Blank Rome in New York City, where he focuses on compliance and advisory work for financial services companies. “Typically, the federal government sets a floor, not a ceiling, and encourages the states if they provide greater protections to consumers. Typically, the states take the lead, and courts have typically ruled in favor of states and against the OCC [U.S. Office of the Comptroller of the Currency] unless there is a direct conflict with federal law, such that the state law is preempted under the supremacy clause.”

Some fintechs, particularly money transmitters, have sought federal regulation, arguing that many different state regulators are impeding the advancement of the industry, particularly with respect to foreign competitors.

In July 2018, the OCC announced that it would start accepting applications for a special-purpose bank charter it had introduced in 2016 for fintech companies that take deposits, lend money, or pay checks and would be held to the same standards as national banks. But some states argued that state regulators are better equipped to protect consumers. New York—arguably the next most powerful regulator of banks and insurance companies in the U.S. after the federal government—along with other states, filed lawsuits that delayed the implementation of the OCC special bank charter.

On Dec. 19, 2019, the OCC filed an appeal of a federal court ruling in the Southern District of New York that agreed with New York’s Department of Financial Services (NYDFS) claim that the OCC lacked authority to grant fintech charters to nondepository institutions. 

However, despite siding with the NYDFS overall, the federal court dismissed the DFS’s 10th Amendment claim, saying that the state’s claim “did not trigger the 10th Amendment because it related only to whether Congress had clearly chosen to preempt state chartering authority, rather than whether Congress had exceeded its enumerated powers,” according to an article by Dawn Causey, general counsel at the American Bankers Association et al, in the October ABA Banking Journal.

“The legal battle simmering in New York is the latest iteration of the pushmi-pullyu battle of wills in the dual banking system,” the article concludes.

“These tensions are most certainly going to continue,” Samlin says, “as long as there is a perception that the federal government is not being proactive in terms of adopting regulations in new areas like fintech and in enforcement of existing regulations.”

2. Cybersecurity and Data Privacy Regulation

Despite calls for a federal data privacy regulation corresponding to the EU’s General Directive on Privacy Regulation, or GDPR, the United States does not have a comprehensive national data privacy law or a comprehensive federal cybersecurity law.

Instead, the U.S. has a patchwork of federal laws, including the Health Insurance Portability and Accountability (HIPAA) Privacy Rule and Security Rule; Gramm-Leach-Bliley Act (Financial Modernization Act of 1999); the Fair Credit Reporting Act (FCRA) of 1986; the Electronic Communications Privacy Act of 1986 and the Federal Trade Commission Act to regulate various aspects of data privacy and cybersecurity under various agencies at the national level.

States’ laws

In the absence of a comprehensive federal law—which has been talked about for years but was not advanced during the Trump administration—states, including New York and California, have enacted their own respective cybersecurity and data privacy laws that have broad reach because they apply to businesses operating in their populous and influential states. These cybersecurity laws govern the collection, transmission, and use of sensitive personal data, including Social Security numbers and financial information, and include requirements for data breach notification.

The New York State DFS Cybersecurity Regulation took effect in March 2017. In 2018, California enacted legislation regulating the cybersecurity of the Internet of Things (IoT). The even more far-reaching California Consumer Privacy Act of 2018 took effect on Jan. 1, 2020, and closely resembles the European GDPR.

In turn, the National Association of Insurance Commissioners (NAIC) crafted its model cybersecurity law after the NYDFS cybersecurity regulation.

Federal Regulation

In December 2019, the federal government’s first widely applicable cybersecurity regulation was approved in a U.S. Securities and Exchange Commission (SEC) rule change requiring that members of the National Securities Clearing Corporation (NSCC) (and organizations applying for membership) confirm that they have a cybersecurity program. Organizations reporting trade data also can be required to submit a cybersecurity confirmation effective as of Dec. 9, 2019, when the rule was approved by the SEC.

“When considered with the SEC’s Statement and Guidance on Public Company Cybersecurity Disclosures, there is a clear movement towards regulation of cybersecurity at the federal level,” wrote Richard Borden and Joshua Mooney, attorneys with the law firm White and Williams, in a recent client alert.

Mooney, who is chair of the cyber law and data protection group at the firm, said in an email, however, that in this instance, the federal and state rules are not in conflict.

“The NSCC rule and DFS cyber regs are complementary and are not at cross-purposes…In fact, the NSCC certification, which requires a company, as part of its certification process, to attest to a third-party assessment or internal audit of the company’s cyber program, will instead accept certification under the DFS cyber regulations as satisfaction of this assessment requirement,” Mooney said.

3. Federal vs. State Fiduciary Rules for Financial Advisors

Under the Obama administration, the Department of Labor (DOL) drafted new regulations for certain financial advisors requiring them to meet a fiduciary standard, which legally mandates that they put clients’ best interests first. It is a higher accountability standard than the previous suitability standard, which requires a recommendation only to be appropriate for the customer.

But in February 2017, shortly after taking office, President Trump issued a memorandum attempting to delay the rule’s implementation by 180 days in order to study the potential impact of the new regulations.

A year later, in March 2018, in a lawsuit brought by the U.S. Chamber of Commerce and the Financial Services Institute as well as other parties, the Fifth U.S. Circuit Court of Appeals in New Orleans vacated the Obama administration’s fiduciary rule in a two-to-one decision.

States Step in with Fiduciary Standards

Since then, some states have stepped in to introduce their own fiduciary standards for retirement investment advisors. New York, Massachusetts, Nevada, and New Jersey are among the states that have imposed—or are considering imposing—their own laws or regulations requiring a fiduciary standard for certain financial advisors.

A state court upheld NYDFS Amended Rule 187 requiring broker-dealers, agents, and insurance brokers selling annuities and life insurance to state residents to do so in the “best interest” of their clients, effective Aug. 1, 2019, for annuities and Feb. 1, 2020, for life insurance. The rule was opposed by the National Association of Insurance and Financial Advisors among other groups and was supported by consumer groups.

In a July 2018 news release, then-NYDFS Commissioner Maria Villa said, “The regulation will fill in regulatory gaps to protect New York consumers from the elimination of the federal Department of Labor’s Conflict of Interest Rule, which the Trump administration failed to protect on appeal after a ruling from the U.S. Fifth Circuit Court of Appeals, and also supplements existing consumer protections that already exist in New York, including setting reasonable limits on compensation and compensation transparency for the sale of a life insurance or annuity product in New York State.”

4. Antitrust Regulations

New York, California, and Massachusetts emerged as some of the most active states in utilizing state and federal laws prohibiting unfair competition and restraint of trade under the Trump administration.

Last year, New York State Attorney General Letitia James and California AG Xavier Becerra joined forces with more than a dozen other state attorneys general to try to halt the proposed merger of mobile service providers T-Mobile, a subsidiary of Deutsche Telekom AG, with Sprint Corp.

The complaint was filed in federal district court in Manhattan by those states, as well as Colorado, Connecticut, the District of Columbia, Maryland, Michigan, Mississippi, Virginia, and Wisconsin (and later, by several other states), alleging that the merger of two of the world’s largest wireless companies would deprive consumers—especially low-income consumers—of the benefits of competition and drive up prices for cellphone services.

FCC Commissioner Ajit Pai had argued the deal would not be anticompetitive and would enhance the development of 5G technology. And T-Mobile and Sprint had already received approval from the U.S. Department of Justice and the Federal Communications Commission, after the companies agreed to sell off Sprint’s prepaid phone business and Boost mobile, and sell Spectrum to Dish Network Corp.

A federal judge in Manhattan ruled in favor of the $26 billion merger, and the deal was consummated in April 2020.

However, actions against other companies were taken. In October 2020, the U.S. Department of Justice and state attorneys general brought antitrust charges against Alphabet, Inc., the parent of Google, over its online advertising business.

Apple Inc. fell under scrutiny by authorities over its app store. Also, the European Commission opened an antitrust investigation to determine if Apple’s conduct in connection with Apple Pay violated EU competition rules. 

5. Marijuana Banking Regulation

Conflicts between federal narcotics and anti-money-laundering laws and state laws allowing the production and sale of marijuana for medicinal and recreational purposes have created a banking crisis for the fledgling industry in the United States. The marijuana industry considers this conflict to be one of the major obstacles to the growth and development nationally of the legal marijuana industry.^

While President Trump campaigned in 2016 in favor of leaving marijuana legalization to the states, his administration took actions at the federal level that conflicted with state laws.

In 2018, then-Attorney General Jeff Sessions rescinded an Obama-era policy that discouraged federal authorities from prosecuting marijuana activities that are legal in the states. Sessions said that federal prosecutors would have discretion as to what actions to take when state rules conflict with federal drug laws. The rescission dismayed government officials in the eight states that had legalized recreational use, as well as industry proponents and conservative Republican members of Congress.

Legislation designed to ease banking restrictions on the legal marijuana industry in the states was introduced in Congress and passed with bipartisan support in the U.S. House of Representatives. But the Secure and Fair Enforcement (SAFE) Banking Act failed to come to a vote in the Republican-led U.S. Senate.

President Trump’s fiscal year 2021 budget also removed a rider that prevented the U.S. Justice Department from using federal funds to interfere with state medical marijuana laws, though the rider had been approved every year since 2014.

Stepping in again to fill a void in federal regulation, the New York Department of Financial Services stated in July 2018 that it “will not impose regulatory actions” on any New York State-chartered bank or credit union for opening an account or starting a new banking relationship with a medical marijuana–related business that complies with federal and state laws.

But when President Trump signed a funding bill in December, he attached a statement indicating that he believed the federal government could enforce federal drug laws against individuals who comply with state medical marijuana laws.

And in March of 2020, at a House Appropriations Financial Services and General Government Subcommittee Hearing, the then-Treasury Secretary Steven Mnuchin said that he would not take administrative action to protect banks servicing marijuana businesses from being penalized by federal regulators. Mnuchin told the committee that it was up to Congress to enact legislation to resolve the problem.

“Congress can act to preempt anything that is left to the states. It is only generally left to state power when Congress doesn’t act. But in our legislative environment, it isn’t that easy to get legislation passed,” says Samlin, of the law firm Blank Rome.

The Bottom Line

Looking ahead, even with the Biden-Harris administration, consumers and investors probably can expect more of the same state and federal conflicts. It remains uncertain whether legislators in Congress will be able to work together to resolve these issues.