DC Circuit Issues Landmark Decision Holding the CFPB's Structure Unconstitutional: What Happens Next?

In a groundbreaking decision on October 11, 2016, the D.C. Circuit held the structure of the Consumer Financial Protection Board (CFPB) unconstitutional. Citing the "CFPB's concentration of enormous power in a single, unaccountable, unchecked Director," which "not only departs from settled historical practice, but also poses a far greater risk of arbitrary decision making and abuse of power, and a far greater threat to individual liberty" than any previously established regulatory agency, the court held that provisions of the Dodd-Frank Act that removed the CFPB from oversight authority were beyond Congress' constitutional powers to legislate. The court stopped short of ordering the shutdown of the CFPB, ruling, however, that a narrower remedy in which the Director of the CFPB must be held accountable to the President – and the President held accountable for the CFPB's acts – would allow sufficient oversight to allow for continued operations of the Bureau. 

In severing the Dodd-Frank provisions that exempted the CFPB Director from Presidential oversight, the court reasoned that the result would follow the model of Executive Departments, like the Departments of Justice and Treasury. But this analogy is misplaced. Since the President has appointed the CFPB Director, it is improbable that the Director will be removed by the President. There is another check on the power of all Executive Branch agencies and independent agencies, and that is the power of the purse. All other government entities are subject to the appropriations of Congress. Through the power of appropriations, Congress can provide an important check on the power of government entities. 

The CFPB, however, has never been subject to the Congressional appropriations process as it obtains all the funds it needs from a draw on the Federal Reserve. At least the actions of the Chairman of the Federal Reserve are not unilateral and are the result of deliberations of the entire board. There is no board or commission in the CFPB's structure  to reign in any actions of its Director. A change of that nature would require Congressional action.

The 2-1 decision also struck down, on constitutional grounds, specific actions the CFPB had taken against PHH with respect to an enforcement action under the Real Estate Settlement Procedures Act (RESPA): The Court found that the Bureau incorrectly interpreted Section 8 of RESPA, the Bureau departed from long-standing prior interpretations of RESPA and applied a new, retroactive interpretation that deprived PHH of its Constitutional due process rights and that the CFPB was bound by the three-year RESPA statute of limitations. Each of these holdings is significant because it highlights serious questions regarding the CFPB's theories, not only in the PHH case but in prior actions and amicus briefs filed by the Bureau.

In the current matter, PHH established a wholly owned subsidiary known as Atrium Insurance Corporation (Atrium) which provided reinsurance to the mortgage insurers that insure mortgages generated by PHH. In return, PHH referred borrowers to mortgage insurers that used Atrium for reinsurance. The "captive arrangement" was very common in the industry. Mortgage insurers did not pay any more than reasonable market value to Atrium for the reinsurance. Section of 8(a) of RESPA prohibits any kind of kickback or referral fees between entities. However, section 8(c) carves out several exceptions and safe harbors that permit the "payment to any person of a bona fide salary or compensation… for services actually performed." So as long as a person was a salaried employee or was hired to perform the service, the payment of a fee was proper. The Department of Housing and Urban Development (HUD) previously concluded that 8(c) permitted the use of captive reinsurance arrangements as long as the mortgage insurer paid no more than reasonable market value for the reinsurance. The CFPB thought otherwise, disagreed with HUD's interpretation, and brought an action against PHH. Furthermore, the CFPB applied this new interpretation retroactively against PHH, notwithstanding PHH's reliance on the HUD interpretation.

This is not the first time the CPFB has used novel interpretations of longstanding law against financial institutions and covered persons. In CFPB v. Frederick J. Hanna & Associates, P.C. ("Hanna"). ___WL, ___, 2015 U.S. DIST LEXIS 52515, Case No 1:14-cv-2211-AT, (Jul 14, 2015, N.D. Ga.), the CFPB brought an action against a Georgia law firm under the Fair Debt Collection Practices Act ("FDCPA") which is subject to a one year statute of limitations. The Bureau argued that the time limitation did not apply to it, stating "quod nullum tempus occurrit regi" or "time does not run against the King." The District Court of Georgia somewhat sided with the  Bureau by declining to rule on the issue so as to "consider further judicial developments that may be of assistance." In the matter of Dwolla, Inc., the CFPB brought an enforcement action against a company that operates an online payment system, alleging that it violated 12 U.S.C. § 5531 of the Consumer Financial Protection Act (CFPA) which prohibits unfair, deceptive or abusive acts or practices (UDAAP). Even though there was no finding that any security breach occurred or that any consumer data was compromised, the Consent Order made a  controversial conclusion that  Dwolla's actions "were likely to mislead a reasonable consumer into believing that Dwolla had incorporated reasonable and appropriate data-security practices when it had not" and that Dwolla's "representations were material because they were likely to affect a consumer's choice or conduct regarding whether to become a member of Dwolla's network." Finally, the numerous disparate impact/redlining cases (Ally Financial, Hudson City, 5th  Third Bank) are further evidence of the Bureau's attempt to push forward novel interpretations of the Equal Credit Opportunity Act (ECOA) to achieve its result.

The dissenter, Judge Henderson, concurred with the court's decisions striking down and remanding the enforcement action, but would have avoided the issue of the CFPB's structural constitutionality. 

Today's D.C. Circuit decision may provide the financial services industry some comfort to challenge the Bureau or force the Bureau to be more thoughtful in its approach, but  many consent orders are already in place, and stipulations of judgment in civil actions brought by the Bureau have been entered by agreement of all parties. It is difficult to know what impact the court's ruling will have on pending rulemakings on payday lending and those in the pipeline on arbitration and debt collection practices. In the near term, it seems likely that the Bureau will seek rehearing from the full D.C. Circuit, given the signal importance of the decision. And there is little question that these developments will re-invigorate the calls to reform the CFPB, with strong views on all sides of the issue.

Clark Hill's Consumer Financial Services Regulatory & Compliance Practice Group is a national leader in the field of consumer financial services law, providing strategic legal counsel to clients in all areas of consumer finance. We provide counsel, consultation and litigation services to financial institutions, law firms and debt buyers throughout the country. Our group can help you navigate this rapidly evolving regulatory environment. Our exceptional team of lawyers and government and regulatory advisors has extensive experience in – and an in-depth understanding of – the laws and regulations governing consumer financial products and services. We can assist you in developing and implementing compliance programs, as well as defending consumer litigation and regulatory enforcement actions.