Federal Court Rules CFPB Structure Unconstitutional

Practical Law Legal Update w-003-9287 (Approx. 4 pages)

Federal Court Rules CFPB Structure Unconstitutional

by Practical Law Finance

Background

In 2014, the CFPB brought an action against PHH Corporation, a mortgage lender, charging PHH with violation of Section 8 of RESPA for providing certain captive reinsurance arrangements.

When Congress created the CFPB in 2010 under the Dodd-Frank Act, the CFPB was charged with taking over the enforcement of Section 8 from the US Department of Housing and Urban Development (HUD). The CFPB reinterpreted Section 8 and concluded that captive reinsurance arrangements such as the type PHH was engaged in were barred even when the mortgage insurer paid the reinsurer no more than the reasonable market value of the reinsurance. The CFPB applied its new interpretation of Section 8 retroactively to PHH and sanctioned PHH in the amount of $109 million.

In its defense, inter alia, PHH challenged the CFPB's regulatory authority, as well as the constitutionality of its structure, raising a fundamental constitutional objection to the entire CFPB proceeding. PHH argued that, in order to comply with Article II of the US Constitution, the CFPB's director must be removable at will by the President of the United States. In the alternative, PHH argued, the agency required a restructuring with a multi-member commission as opposed to a single director. In the absence of any of the above, PHH advocated dismantling the CFPB and/or invalidating the entirety of the Dodd-Frank Act until Congressed passed new legislation to fix the constitutional flaw.

Outcome

Constitutionality Issue

The first issue (and the one to which the court devoted much of its discussion) the court addressed was the constitutionality of the structure of the CFPB. The court explained that, unlike most independent agencies, the CFPB is headed by a single director, rather than a multi-member commission. This unique structure entrusts the CFPB director with unilateral authority and a wide latitude over "American business, American consumers, and the overall [US] economy."

The court also noted that the CFPB director maintains sole authority when deciding:

What rules to issue.
How and when those rules will be enforced.
Whom they will be enforced against.
What sanctions and penalties will be imposed on violators.

The court noted further that independent agencies that exercise executive power by bringing enforcement actions against private citizens (such as the FCC, SEC, FTC, and NLRB) are generally permissible under Humphrey's Executor v. US (Humphrey's Executor). While these agencies wield substantial power without direct presidential supervision, they are nevertheless kept in check by multiple commissioners. In fact, as the court explained, no independent US regulatory agency prior to the CFPB had ever exercised such substantial executive authority while being headed by a single director.

The court declined to extend Humphrey's Executor to accommodate a single-director independent agency structure, and therefore held that the CFPB is unconstitutionally structured. In its decision, the court found that the CFPB lacks critical checks and balances and is therefore inconsistent with the historical practice under which independent agencies have been organized in the US.

However, the court declined to adopt PHH's proposed remedy of dismantling the CFPB until the passage of new congressional legislation addressing the issue. Instead, the court tweaked the statute to reconstitute the CFPB as, in its view, a constitutionally compliant executive agency. The court stated as follows:

"In light of Congress’s clear textual expression of its intent regarding severability [within Dodd-Frank and its CFPB-related provisions], and because the Dodd-Frank Act and the CFPB may function without the CFPB’s for-cause removal provision, we remedy the constitutional violation here by severing the for-cause removal provision from the statute. As a result, the CFPB will now operate as an executive agency. The President of the United States now has the power to supervise and direct the Director of the CFPB, and may remove the Director at will at any time.”

The court therefore removed certain terms from the Dodd-Frank Act's CFPB origination provision that limited the President's removal power of the CFPB director to for-cause only (12 U.S.C § 5491(c)(3)), replacing them with the power to remove at will. In so doing, the court intended to strengthen the oversight of the CFPB by the executive branch. The court explained that, under similar circumstances, the US Supreme Court had adopted a similar approach of severing certain unconstitutional for-cause statutory provisions, most notably in Free Enterprise Fund v. Public Company Accounting Oversight Board (561 U.S. 447, (2010) (Free Enterprise Fund).

With the narrow remedy in place, the court determined that the CFPB could continue to operate with a single director, albeit under greater executive supervision.

The court went on to address the issues raised by PHH under RESPA.

RESPA Issue

First, the court held that the CFPB had impermissibly departed from consistent prior interpretations of Section 8 of RESPA. Relying on the plain language interpretation of the statute, the court agreed with PHH that Section 8 of RESPA does not bar captive reinsurance arrangements so long as "the amount paid by the mortgage insurer for the reinsurance does not exceed the reasonable market value of the reinsurance."

On this point, the court further rejected the CFPB's retroactive application of its new Section 8 interpretation against PHH, noting that to do so would violate the "bedrock principles" of due process.

Secondly, the court rejected the CFPB's two-part claim that no statute of limitations applied to the case against PHH. The CFPB argued that:

It was broadly authorized to bring enforcement actions under Dodd-Frank.
No statute of limitations existed for any CFPB administrative action for any consumer protection law.

The court instead found that the CFPB was bound by the statute of limitations found in RESPA, to which Dodd-Frank deferred in Section 5563 (12 U.S.C. § 5563(a)(2)). Moreover, the court found no support for the CFPB's second RESPA argument, saying simply that if Congress had intended to restrict the statute of limitations in such a way for administrative proceedings, it would have clearly said so.

The court then remanded the case to the CFPB to consider if PHH violated Section 8 within the three year statute of limitations.

Practical Implications

Since its inception, the CFPB has been politicized and remains emblematic among the financial industry of progressive regulatory overreach (the CFPB is the brainchild of Senator Elizabeth Warren and was sponsored in the House by Rep. Nancy Pelosi and former Rep. Barney Frank).

The PHH pleadings appear to represent a classic case of "throwing it against the wall." In this case, it almost stuck, though even PHH may not have expected the court to seriously entertain its constitutionality challenge to the CFPB's authority. But this court seemed eager to make an example of the controversial agency. As such, this holding has been received as somewhat gratuitous within the legal community.

As a practical matter, however, the CFPB may continue to perform its regulatory function as before.

Update: The CFPB filed an appeal on November 18, 2016.

Federal Court Rules CFPB Structure Unconstitutional | Practical Law