The CFPB Found Unconstitutional…But …

The Consumer Finance Protection Bureau suffered a major blow in Federal Appeals Court yesterday when a three judge panel ruled that parts of its leadership structure are unconstitutional.  This decision was taken as part of mortgage lender’s PHH Corp. appeal of the 2014 $109M financial penalty imposed by the CFPB.

Currently, the CFPB Director, who reports to the President, can only be removed for cause. This ruling changes that, making current Director, Richard Cordray, and those who follow, more accountable to the President for their rulings and decisions.

Not surprisingly, the verdict has drawn sharp responses across the board from opponents and supporters of the CFPB alike.

Theodore Olson, a lawyer representing PHH, told reporters he was “very gratified that the D.C. Circuit has unequivocally and firmly vindicated the conduct of PHH.”

He noted that the decision further vindicated the complaint long-time opponents of the CFPB have made — that it “was created by Congress in a way that violated fundamental separation of powers and is unconstitutional as it has existed prior to this opinion.”

Sen. Elizabeth Warren — one of the guiding figures behind the CFPB — took a somewhat different line on the ruling, firmly noting it was not a defeat for post-financial crisis efforts and banking regulation and reform.

The ruling “will likely be appealed and overturned,” Warren noted. “But even if it stands, the ruling makes a small technical tweak to Dodd-Frank and does not question the legality of any other past, present or future actions of the CFPB.”

The Narrow Ruling — A Rare Win In An Even Rarer Fight

The central issue in the case was a 2014 claim the CFPB made against PHH; specifically that the New Jersey-based mortgage lender pay $109 million for allegedly violating the Real Estate Settlement Procedures Act by accepting kickbacks from mortgage insurers. The CFPB found that PHH referred their customers to insurers with whom they had a financial relationship — regardless of whether or not said insurers were offering consumers the best possible rate.

Then, and now, PHH was not unique in drawing the ire of the agency.

Since its creation, the CFPB has assessed billions in total penalties to a rolodex of major financial players in the U.S. — Bank of America, JP Morgan Chase, Citibank, Wells Fargo and Synchrony Financial. Even ten-figure penalties are not wholly out of the question; two-thirds of the collective $3 billion in penalties issued in 2014 were from a single mortgage lender (Ocwen Financial Corp. and Ocwen Loan Servicing, LLC).

But PHH is unique in that it chose to fight the CFPB’s decision, challenging the CFPB’s ruling that it had engaged in illegal kickbacks that boosted their margins at the expense of homeowners that endured inflated costs for mortgage insurances.

Their first stop was an Administrative Law judge – the one appointed by the CFPB Director — that found the PHH had violated the law. They upheld the CFPB’s findings and imposed a $6.4 million “disgorgement” of ill-gotten financial gains. When the ruling was kicked back to the CFPB, Director Richard Cordray increased the fine by $103 million to a total of $109 million.

After a series of appeals, PHH found itself in front of a three judge panel of U.S. Court of Appeals for the District of Columbia who yesterday found that Director Cordray and the agency made “considerable legal errors in its enforcement action against mortgage lender PHH Corp.”

In their ruling, the D.C. Circuit found that the CFPB adopted a new and flawed interpretation of a real-estate industry law and then wrongly applied that interpretation to their ruling. Moreover, the case also raised an issue as to whether a statute of limitations applied to the CFPB’s enforcement effort. The CFPB’s argument is that Congress didn’t set a time limit for bringing administrative proceedings. The court instead took up a three-year limit applied to enforcement of the alleged kickback violations, a holding that prevents the CFPB from attempting to punish alleged conduct that took place before then.

The appeals court further explicitly pointed out that CFPB’s position on having no statute of limitations was absurd on face.

“The statute of limitations issue will significantly undermine the Bureau’s practice, which is to look back and seek restitution for many years, often before the bureau even existed,” said Andrew Sandler of Buckley Sandler LLP. He added that the court’s ruling against the CFPB on retroactive enforcement of new legal interpretations will “significantly limit its ability to seek damages for past periods of time in certain circumstances.”

And while the institution of reasonable statute of limitations on the CFPB will be a significant limitation – it is potentially not the most significantly limiting part of the ruling.

Those are the questions related to the governance structure of the CFPB itself.

The Bigger Blow

The most attention-grabbing part of the ruling was the Court’s findings that the CFPB violated the Constitution’s separation of powers because its Director isn’t sufficiently answerable to the President. And, unlike other agencies, the CFPB’s funding is pegged to a percent of the Fed’s budget, not Congressional appropriations or outcomes. Further, the Administrative Judges who hear appeals are appointed by the Director, which sets up appeals of the CFPB’s findings to someone appointed by the CFPB.

The decision, written by Judge Brett Kavanaugh, found that the while other similar Executive agencies exist, the Director of the CFPB is a “gross departure” from the traditional manner of setting up independent agencies, which have multiple commissioners or board members who serve as a check on one another.

The panel also found that the current cycle for the CFPB director — a six-year term that can only be terminated for cause — is inappropriate and should instead more closely resemble the structure of other agencies where the President can remove a director at will.

Congress gave the CFPB director “more unilateral authority than any other officer in any of the three branches of the U.S. government, other than the President,” wrote Judge Kavanaugh, a George W. Bush appointee. He said the problem of checks and balances was particularly acute because the CFPB “possesses enormous power over American business, American consumers and the overall U.S. economy.”

However, the Appeals Court ruling stopped short of disbanding the CFPB or suggesting a major overhaul to its operations, including tying its funding to Congressional appropriations.

“The CFPB therefore will continue to operate and to perform its many duties, but will do so as an executive agency akin to other executive agencies headed by a single person, such as the Department of Justice and the Department of the Treasury,” the court said.

So now what?

According to the CFPB’s most recent statement on the subject:

“The bureau is considering options for seeking further review of the court’s decision,” a CFPB spokeswoman said, adding the ruling “will not dampen our efforts or affect our focus on the mission of the agency.”

Most likely, most experts agree, the CFPB will appeal the ruling — probably exercising its option of asking the D.C. Circuit to rehear the case with a full roster of judges participating.

Depending on the outcome there — and how committed the parties are to taking the case to end — the issue could ultimately be appealed to the Supreme Court.

What will be interesting to observe is the degree to which the Court’s verdict throws enough judicial shade on an agency that many believe has too much unfettered power to trigger Congress to press harder to organize it like the other agencies and commissions Judge Kavanaugh referenced in his ruling.

Others say that the battle will rage in the courts for years — with nothing materially changing in the meantime.

Attorney Tom Brown — partner at Paul Hastings, LLP — noted that the ruling, if fully upheld, will likely make some changes possible at the CFPB — though the differences will likely be an issue of degree, not kind.

“In the longer term, however, things could be different.  The ultimate architects of the Bureau wanted it to be insulated from the political branches, including the President, precisely because they did not believe that a politically responsive bureau would vindicate the interests of consumers over industry, “Brown said.  The historical experience of the other expert, independent commissions, provides some support for this view.  Although the FRB, ITC, SEC, FDIC, FCC, NCUA, etc., may have many virtues and do important work, they have not, in the main, had a strong consumer focus.  The Bureau was also designed to be insulated from Congress and the President.  Knowing how controversial the Bureau’s early agenda would be — eliminating arbitration clauses, reigning in payday, etc. — they did not want a single Presidential election to bring it to a halt.  In other words, the flaw identified by the split panel of the D.C. Circuit was, in other words, a feature not a bug,” Brown told PYMNTS.

Either way, the requirement for Presidential accountability won’t likely change Richard Cordray’s life materially between now and the time he leaves his post next year. And depending on who’s elected President and to Congress in less than a month, perhaps not all that much in the long term either.