Overview: On February 27, 2023 the U.S. Supreme Court agreed to hear a case that may determine whether the Consumer Financial Protection Bureau (“CFPB” or “Bureau”) will continue to exist. The root of the issue is whether the Bureau’s funding mechanism violates the Constitution. In addition to deciding the fate of the Bureau, the case will have implications for whether the Bureau’s past actions should be vacated or dismissed as well.
The Bureau’s Funding Mechanism
Under the Dodd-Frank Act, the CFPB was created as an independent regulatory agency within the broad ambit of the Federal Reserve System. Similar to some other independent financial regulatory agencies—such as the Federal Reserve System itself, the Federal Deposit Insurance Corporation (“FDIC”), and the Office of the Comptroller of the Currency (“OCC”)—the CFPB does not derive its operating budget from congressional appropriations. However, where the FDIC and OCC collect assessments that are paid by the financial institutions they regulate, the CFPB draws its funds from the Federal Reserve System. The Bureau submits an annual budget to the Federal Reserve Board and, so long as the budget request does not exceed 12% of the Federal Reserve’s total operating expenses, the Federal Reserve Board must grant the request. And because the Federal Reserve is also outside the congressional appropriations process, the U.S. Court of Appeals for the Fifth Circuit has observed that the Bureau is therefore “double insulated” from Congress’s control of federal spending in a way that is unique among federal agencies.
Constitutional Challenges
In 2018, the CFPB faced one of its first significant tests. PHH Corporation and several of its affiliates and subsidiaries (collectively “PHH”) challenged an administrative ruling handed down by the Bureau relating to PHH’s mortgage insurance and reinsurance transactions under the Real Estate Settlement Procedures Act (“RESPA”). In 2014, the Bureau brought its administrative action, which culminated in a hearing before an administrative law judge (“ALJ”) borrowed by the Bureau from the SEC. The ALJ wrote a Recommended Decision concluding that PHH violated RESPA and recommending a disgorgement of $6.4 million. However, CFPB Director Richard Cordray overruled the ALJ’s recommendation and instead imposed a disgorgement order of more than $109 million. PHH appealed the decision to the U.S. Court of Appeals for the D.C. Circuit, which was heard by a three-judge panel that included Judge Brett Kavanaugh. In October 2016, the panel ruled against the Bureau. Judge Kavanaugh’s opinion was particularly critical toward the Bureau. However, rather than focusing on the funding of the agency, the D.C. Circuit panel struck down the provisions of the Dodd-Frank Act that prohibited removal of the Bureau’s Director without cause. The Bureau appealed to the full D.C. Circuit Court, requesting an en banc decision. The en banc Court then overturned the panel decision, upholding both the Bureau’s decision in the PHH case and the constitutionality of the Bureau itself. Because the Bureau—under a new Director—later dismissed the case against PHH, no further appeal to the Supreme Court was necessary.
In the course of examining whether the removal provisions of the Dodd-Frank Act violated the Constitution, the D.C. Circuit Court also analyzed the Bureau’s funding. In particular, the Court noted that the independence of financial regulators has significant historical precedent and remains “a prominent pattern today.” The Court compared the Bureau to the Federal Reserve System, the FTC, and the CFTC. Because “insulation from political concerns” is “advantageous in cases where it is desirable for agencies to make decisions that are unpopular in the short run but beneficial in the long run,” the Court found that history, tradition, and precedent “show that Congress may appropriately give some limited independence to certain financial regulators.” The Court opined that the CFPB’s independent funding provisions in the Dodd-Frank Act are constitutionally valid.
In 2019, the Supreme Court overturned some of the PHH case’s conclusions when it invalidated the provision of the Dodd-Frank Act that prohibited removal of the Bureau’s Director without cause in Seila Law v. CFPB. But the Seila Law decision was narrow, stopping short of vacating any actions previously taken by the Bureau or addressing the Bureau’s funding.
Beginning in 2018, a collection of trade groups sued the Bureau seeking invalidation of its Payday Lending Rule, adopted in 2017, based on several constitutional challenges. The U.S. District Court for the Western District of Texas dismissed the challenges, but on appeal, the Fifth Circuit ruled against the Bureau specifically with respect to the Bureau’s funding mechanism. Essentially, the Fifth Circuit found that the Constitution not only grants exclusive budgetary power to Congress but also that Congress may not delegate away that responsibility through legislation. According to the Fifth Circuit, Congress’s power of the purse is an essential check against the powers of the other branches of government and therefore fundamentally may not be abdicated. In its opinion, the court noted that “without its unconstitutional funding, the Bureau lacked any other means to promulgate the [Payday Lending Rule].” This opinion thus called into question all actions the Bureau has taken using its unconstitutionally obtained funding.
What Comes Next
The Bureau has petitioned the Supreme Court for a prompt review of the Fifth Circuit decision for three “compelling reasons:”
- The Fifth Circuit has held that an Act of Congress violates the Constitution but the decision contradicts the D.C. Circuit’s decision in the PHH case with respect to the CFPB’s funding mechanism.
- The cloud cast by the Fifth Circuit decision has “immense legal and practical significance.” Specifically, according to the CFPB, defendants in several Bureau enforcement cases have now sought dismissal pursuant to the Fifth Circuit decision and new challenges to the Bureau’s other rules and actions are expected to multiply as time goes on. Additionally, the uncertainty caused by the circuit court split will frustrate the Bureau’s work administering and enforcing consumer financial protection laws.
- The possibility that all of the Bureau’s past actions can now be called into question on constitutional grounds raises serious concerns for the entire financial services industry, and the potential voiding of Bureau interpretations and precedent creates massive regulatory uncertainty for the industry.
Arguably, until and unless the Supreme Court stays the Fifth Circuit decision, the Bureau cannot operate in the states within the Fifth Circuit (Mississippi, Louisiana, and Texas). This would have serious unintended consequences as financial institutions could be subject to Bureau oversight in some states but not others. Upholding the Fifth Circuit’s decision could also have ramifications for the other federal financial regulatory agencies that are funded outside the congressional appropriations process.
It should also be noted that the Supreme Court had the chance to eliminate the Bureau’s structure previously, in the Seila Law case, but chose not to. However, the Court’s makeup has become even more conservative since that time. Senator Elizabeth Warren, the primary architect of the CFPB, issued a statement in response to the Court announcing the case: “Despite years of desperate attacks from Republicans and corporate lobbyists, the constitutionality of the CFPB and its funding structure have been upheld time and time again. If the Supreme Court follows more than a century of law and historical precedent, it will strike down the Fifth Circuit’s decision before it throws our financial markets and economy into chaos.”
One possible solution would be for Congress to amend the Bureau’s empowering statute to change its funding structure. The Supreme Court could even remand the case to Congress to do just that. At that point, most aspects of the Bureau’s makeup would likely become bargaining points for the two political parties. Given the current divided composition of Congress, lawmakers reaching agreement on a revised structure for the CFPB seems highly unlikely.
Outlook: The Supreme Court is not expected to hear arguments in the case until next term, so a decision is not likely to be issued until 2024. All parties involved in the consumer financial services sector will be watching the case closely as it will have a significant impact on every area regulated by the Bureau.
______________________________________________________________________________________________________________________
AUTHOR INFORMATION:
Craig Saperstein, a member of Nacha’s Government Relations Advisory Group, is a partner in the Public Policy practice of Pillsbury Winthrop Shaw Pittman LLP in Washington, D.C. In this capacity, he provides legal analysis for clients on legislative and regulatory developments and lobbies congressional and Executive Branch officials on behalf of companies in the payments industry. Deborah Thoren-Peden is a partner and member of the Financial Institutions Team at Pillsbury Winthrop Shaw Pittman LLP. She provides advice to financial institutions, bank and non-bank, and financial services companies. Daniel Wood is a Counsel and member of the Financial Services Regulatory Team. He provides analysis for financial institutions, technology companies, and clients that offer consumer financial products. Brian Montgomery is a Senior Counsel and member of the Financial Services Regulatory Team. He provides analysis for financial institutions, technology companies, and clients that offer consumer financial products. The information contained in this update does not constitute legal advice and no attorney-client relationship is formed based upon the provision thereof.