D.C. Circuit Upholds CFPB’s Constitutionality: Why the PHH Case Underscores the Importance of Internal Agency Discipline

D.C. Circuit en banc opinion

On January 31, the U.S. Court of Appeals for the D.C. Circuit issued a plurality opinion en banc that confirmed the constitutionality of the Consumer Financial Protection Bureau’s (“CFPB”) governance by a sole Director, while reinstating the decision below that struck down the CFPB’s $109 million disgorgement demand in the underlying dispute.

This case, PHH Corporation v. CFPB, No. 15-1177, _ F.3d _ (D.C. Cir. Jan. 31, 2018), is remarkable not only for its outcome, but also because the Court was highly fragmented in reaching this decision. In fact, out of ten circuit judges who participated in the decision, only one judge did not write or join a separate opinion. Even the judge who wrote the plurality opinion, Circuit Judge Cornelia Pillard, joined a concurrence.

Key facts in the underlying dispute

The case arose from the CFPB’s imposition of penalties and a disgorgement demand on a mortgage lender (PHH) and its captive reinsurer under the Real Estate Settlement Procedures Act (“RESPA”). The CFPB contended that this statute prohibits situations in which mortgage lenders refer higher-risk borrowers to a designated reinsurer, who then pays a portion of the reinsurance premium as an alleged kickback to the original lender. Under RESPA, mortgage lenders may not receive kickbacks or referral fees for settlement services (12 U.S.C. §§ 2601-2617).

The administrative law judge initially recommended a $6.4 million disgorgement, which represented the amount of reinsurance premiums that did not appear to be reasonably related to the reinsurance service.

The CFPB Director at the time, Richard Cordray (appointed by President Barack Obama) determined that a much greater disgorgement amount under RESPA was warranted. The Director interpreted the statute to prohibit all reinsurance premium payments where there was not open competition for the reinsurance service. The Director also interpreted the statute of limitations (“SOL”) as applicable only to district court proceedings, and, incredibly, held that no SOL applied at all to administrative proceedings. Accordingly, the Director sought to disgorge all payments that PHH and the reinsurer received, despite the fact that some portion of the premiums actually were “bona fide” payments related to the reinsurance service.

The D.C. Circuit’s three-judge panel decision

Faced with this expansive interpretation of the CFPB’s disgorgement power and high demand, PHH sought judicial review in the D.C. Circuit. In October 2016, a three-judge panel held that RESPA did not prohibit the reinsurance premium amounts that were reasonably related to the reinsurance service. This decision was based on Section 8(c)(2) of RESPA, which contains an exception for kickbacks if the payment constitutes a “bona fide” payment for services. The panel also held that the SOL applied to administrative proceedings, and vacated the Director’s high disgorgement demand.

A majority of the panel went further, and held that the CFPB’s single-Director leadership structure was unconstitutional because the doctrine of separation of powers could not permit an independent agency to have a sole Director whom the President cannot remove without cause. We previously wrote about the three-judge panel decision here. To cure the constitutional defect, the three-judge panel altered the CFPB’s enabling statute (without an act of Congress) to make the role of the Director more accountable to the President, by making the Director removable at will—as opposed to “for cause,” which we discuss further below. The CFPB sought en banc review from the D.C. Circuit.

The en banc court’s decision and rationale

Upon rehearing en banc, the D.C. Circuit issued its decision late last month. In the order, the Court declined to consider the RESPA question and accordingly reinstated the three-judge panel’s decision as to RESPA issues. The Court stated explicitly that its January 31 order was limited only to the constitutional question, upheld the constitutionality of the CFPB, and reversed the three-judge panel’s judgment with respect to the CFPB’s leadership structure.

The plurality opinion traced the history of the presidential power to appoint and remove heads of independent agencies, which Congress may limit by requiring removal for cause. Although other independent agencies with consumer protection functions typically have multiple commissioners to maintain political balance in their leadership, Congress had designed in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“the Dodd-Frank Act”) a leadership structure involving a sole Director position for the CFPB. The D.C. Circuit focused on the fact that Congress had included a “for-cause” provision, which allowed the President to remove the Director only for “inefficiency, neglect of duty, or malfeasance in office” (i.e., “removal for cause”).

To assess the CFPB in light of prior precedent, the Court employed a two-step rationale. First, the Court examined how Congress had “embraced and relied on [the for-cause removal clause] in designing independent agencies” ever since 1935, when the Supreme Court approved Congress’s method of ensuring agency independence through the use of such a clause. Noting earlier precedents that upheld similar arrangements, the plurality opinion found that the Constitution allowed Congress to create a sole Director position that is removable only “for cause.”

Second, the Court explained that this limitation on removal was constitutionally permissible, so long as the circumstances did not suggest additional, undue restrictions against the President’s ability to exercise that removal power. Because there were no undue limitations on the President’s power as to the CFPB, the Dodd-Frank Act’s structure did not unconstitutionally limit the President’s executive authority under Article II. Therefore, the Court held that the sole Director structure, as originally written in the Dodd-Frank Act, was constitutional.

Additionally, among other key issues, the Court also addressed the CFPB’s funding source—a topic of longstanding interest, given that since 2011, Senate Republicans have proposed that the CFPB should not be funded by the Federal Reserve System (which was also written into the Dodd-Frank Act), and instead be subjected to the Congressional appropriations process. In the opinion, the Court held that “Congress can, consistent with the Appropriations Clause, create governmental institutions” that are funded outside “the ordinary appropriations process,” and that the CFPB’s source of funds “has no constitutionally salient effect on the President’s power.”

The three dissenting opinions, however, questioned the constitutionality of the CFPB’s structure. They viewed the fact that the Director was only removable for cause to be problematic, in that concentrating expansive regulatory power in one individual while simultaneously insulating that person from political accountability could create a threat to liberty.

Interplay between the PHH decision and the pending D.C. Circuit appeal in English v. Trump et al.

As a matter of constitutional law, the PHH case sheds light on potential future ramifications for industry as it relates to another, pending CFPB case. Namely, the plurality opinion foreshadows an interesting, potential outcome regarding the case, English v. Trump, et al.

In that case, the plaintiff (the CFPB’s Deputy Director, Leandra English) sued the President and John Michael “Mick” Mulvaney, challenging the President’s appointment of Mulvaney to the position of CFPB Director as inconsistent with federal law. The English case is on expedited appeal before the D.C. Circuit—the same court that decided PHH about two weeks ago.

Interestingly, an argument presented by an amicus brief in support of Mulvaney’s appointment is another constitutional argument: that a restriction on the President’s power to appoint and remove officers would infringe the power of the executive branch and run afoul of Article II of the Constitution. As the amicus brief points out, the court should approve President Trump’s appointment of Mulvaney or else sanction a violation of Article II.

Although the English case and the PHH case relate to different provisions in the Dodd-Frank Act, both cases involve constitutional issues. The plurality opinion in PHH signals what the court may find persuasive as it approaches the constitutional issue in English. The following aspects of the PHH case are noteworthy:

  • In PHH, the plurality opinion specifically analyzed Article II. The Court cited section 3 of Article II, noting that the inquiry before it was to “determine whether the means of independence, as deployed at [the CFPB], impedes the President’s ability under Article II of the Constitution to ‘take Care that the Laws be faithfully executed.’” However, it appears that the plurality opinion’s reasoning was consistent with the overall separation of powers established by the Constitution. Namely, the Court ruled in a manner that harmonized the checks and balances between Article III (the power of the courts) and Article I (the power to make laws vested in Congress).
  • The PHH Court noted that PHH’s criticism of the CFPB’s statutorily-created structure was based on its assertion that “independent agencies with a single leader are constitutionally defective,” while independent agencies headed by a multi-member commission are not defective. The Court held that this “distinction finds no footing in precedent, historical practice, constitutional principle, or the logic of presidential removal power.” The Court went on to explain: “PHH seeks no mere course correction; its theory, uncabined by any principled distinction between this case and Supreme Court precedent sustaining independent agencies, leads much further afield.” Accordingly, the Court concluded that the decision of Congress to grant the CFPB’s Director “protection against removal except for ‘inefficiency, neglect of duty, or malfeasance in office’” had “no constitutional defect,” and overturned the three-judge panel’s decision to rewrite the statute to alter the Dodd-Frank Act’s provisions establishing the CFPB’s structure.
  • At bottom, the Court resisted judicial activism. The PHH Court grappled with separation of powers, respecting the obligation of courts to interpret the laws as written by Congress, as opposed to making new legislation through the courts by—for instance—altering cherry-picked statutory language without an act of Congress. A better court-fashioned remedy, if the CFPB’s structure is unconstitutional, would be—as Circuit Judge Karen Henderson wrote in her dissenting opinion—to “invalidate [the CFPB’s enabling statute] in its entirety and let Congress decided whether to resuscitate—and if so, how to restructure—the CFPB.”

While one could justifiably argue that the CFPB’s enabling statute gave birth to an independent agency that functions with too much power concentrated in one person, the plurality opinion and Judge Henderson’s dissenting opinion presented options, either of which are arguably faithful to the separation of powers between Article III and Article I. Just because Congress wrote a law that is bad policy does not make it permissible for the court to sever the language it finds unconstitutional.

Because the same court is deciding the English case, the Court may be inclined, as the plurality opinion was in PHH, to respect the need for a balance of powers between Articles I and III, hew closely to the statutory provisions written by Congress that are at issue in that case (i.e., the Federal Vacancies Reform Act and the Dodd-Frank Act), and decline to rewrite statutory language for the sake of maximizing the scope of the President’s Article II powers.

A look behind the PHH decision: three key takeaways for future CFPB activities

Moving forward, the decision also puts the spotlight on three important issues for those interested in the CFPB’s activities.

Issue One: The decision brings into focus—at a practical level—the issue of whether and when a transition of CFPB leadership under a new administration might alleviate industry concerns. Some media reports have suggested that a director who opposes regulation is more favorable for industry. Maybe, but there are countervailing concerns when the issue is viewed more broadly.

Arguably, market participants and regulators are both better off if each engages with the other in a way that fosters predictability and clarity. This is especially true in the consumer space, where compliance lookbacks and systems implementations depend on significant lead time, cross-functional coordination, and substantial investments—given the volume of customers served by such businesses. As a result, the predictability of regulations and enforcement expectations is a critical ingredient for sound business planning. Absent a steady hand at the helm, even a director who means well may inadvertently cause abrupt policy changes that undermine predictability.

As an example, when President Trump appointed Mick Mulvaney as the CFPB’s new Director, observers anticipated a decrease in the issuance of new regulations. However, one such regulation hanging in the balance was actually an amendment, at the industry’s request, to update the previously-issued prepaid rule. The amendment was crafted by the CFPB before Mulvaney’s appointment, and agreed upon by the CFPB and industry in principle, with formal implementation left for a later day. Because of an impending implementation deadline of April 1, 2018, however, in the months leading up to the deadline, the CFPB’s leadership transition created uncertainty as to whether corporations should assume the Cordray-negotiated amendment would stick, or whether corporations will be deemed out of compliance on April 1. Ultimately, the previously-negotiated amendment was finally issued. Although the Mulvaney-led CFPB agreed to release the amendment crafted by the Cordray-led CFPB, with a modified effective date of April 1, 2019, this example demonstrates that the changing of the guard brings with it a risk of course reversal that is at odds with the goal of predictability.

Issue Two: The Court’s order calls into question another key issue: should Congress amend the statute to make the CFPB headed by a commission instead of a director? A commission and staggered terms could aid consistency by ensuring overlapping staff and advisors to the commissioners, despite consequences of elections. However, short of a legislative fix to the Dodd-Frank Act, there can be no commission at the CFPB. At the moment, it is unlikely that Congress can pass substantial reform to the structure of the CFPB. It is important to consider the PHH decision against that backdrop.

The Court’s decision reveals difficult predicaments that are exacerbated when coupled with the absence of a near-term, legislative fix to the CFPB. The CFPB’s architecture, as approved by the D.C. Circuit, foreshadows the continued potential for significant swings in policy at the CFPB in the long term. As opposed to the pursuit of substantive policy goals (whatever that may be, e.g., to foster business growth, protect consumers, or increase government transparency), these changes may stem from the mundane, added administrative burdens from transitions during political change, which can be anathema to predictability and efficiency.

Issue Three: The decision underscores why now, more than ever (given issues 1 and 2), there must be robust corporate governance mechanisms beneath CFPB leadership. Without the moderating influence of other appointees from different administrations, and (now thanks to the PHH Court) protected from removal except for cause, the CFPB Director may continue to exercise the significant authority and discretion of that office to advance the political priorities of an incoming (or, because of the five-year term, an outgoing!) administration. For example, once the Director’s term ends, a new administration may take the CFPB in the opposite direction by appointing its own Director. This could ensure a perpetuation of pendulum swings in enforcement and regulatory priorities every five years. Such an outcome is problematic for the work of regulating markets, and hurts progressives and conservatives alike.

Therefore, under the current leadership structure, the sole guardian against volatility in regulatory policies may really be the CFPB’s own internal corporate governance structures and personnel. Such internal checks and balances ought to be designed at the outset to allow an agency to regulate entities in a manner divorced from political ideology. This is a new opportunity for the CFPB as it undergoes its first leadership transition.

Whether it will seize the opportunity, only time will tell.

J.H. Jennifer Lee

J.H. Jennifer Lee

Jenny represents large and regional banks, card issuers, mortgage bankers or mortgage insurance companies, online lenders, Fin Tech firms, private equity firms with consumer-facing specialty finance strategies, or any “covered person” delineated in the Bureau’s statute, title X of the Dodd-Frank Act. As a lawyer who worked inside the Consumer Financial Protection Bureau (Bureau) Office of Enforcement for several years beginning with the Bureau’s founding, Jenny possesses unique experience that she draws upon to provide clients with defense strategies for enforcement by or litigation with the Bureau....

T. Augustine Lo

T. Augustine Lo

Associate, Litigation
Columbia Center
701 Fifth Avenue, Suite 6100
Seattle, Washington 98104-7043
+1 (206) 903-8721
lo.augustine@dorsey.com

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