Consumer Finance Litigation

On Tuesday the D.C. Circuit Court of Appeals issued what is already being touted as a landmark ruling in PHH Corp. v. Consumer Financial Protection Bureau, No. 15-1177, 2016 WL 5898801 (D.C. Cir. Oct. 11, 2016), holding in a 2-1 decision that the structure of the Consumer Financial Protection Bureau (the "CFPB"), and specifically its organization as a "single-Director independent agency" with no meaningful Presidential oversight, violates Article II of the United States Constitution, which in relevant part vests the authority to "take Care that the Laws be faithfully executed" in the President alone. The D.C. Circuit declared that when Congress established the CFPB as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. §§ 5301-5641 (the "Dodd-Frank Act"), it created an "unprecedented" agency structure that, "when measured in terms of unilateral power," made "the Director of the CFPB . . . the single most powerful official in the entire U.S. Government, other than the President." See 2016 WL 5898801, at *2-3, 11-12. As a result, the D.C. Circuit "severed" the "for-cause removal provision" from the statute enacting the CFPB (thereby affording the President the power to remove the Director of the CFPB at will), and in so doing vacated a $109 million fine that the CFPB had imposed on PHH Corporation ("PHH") as a disgorgement penalty arising out of the mortgage lender's "captive reinsurance" practices, which the court found was based in part on a misinterpretation of Section 8 of the Real Estate Settlement Procedures Act, 12 U.S.C. §§ 2601-2617 ("RESPA"). See id. at *4-5, 27-36.

Styled as "a case about executive power and individual liberty," the D.C. Circuit began by emphasizing that the federal government's "executive power to enforce federal law against private citizens . . . is essential to societal order and progress, but simultaneously a grave threat to individual liberty." Id. at *1. Indeed, the court reviewed the fundamental design of the federal government, and reiterated the importance of separating the powers of the executive, legislative, and judicial branches, which serves to "diffus[e] power" and better "secure liberty." Id. (quoting Bowsher v. Synar, 478 U.S. 714, 721 (1986)). Against this backdrop, the D.C. Circuit explained that "independent" agencies - agencies in which "the agency heads are removable by the President only for cause" - "constitute, in effect, a headless fourth branch of the U.S. Government" that have the ability to "exercise enormous power over the economic and social life of the United States." Id. at *1-2. The court warned that "[b]ecause of their massive power and the absence of Presidential supervision and direction, independent agencies pose a significant threat to individual liberty and to the constitutional system of separation of powers and checks and balances." Id. at *2. Nevertheless, the D.C. Circuit reasoned that the risk inherent in these agencies is mitigated by the fact that they "have historically been headed by multiple commissioners, directors, or board members who act as checks on one another." Id.; see also id. at *7-10, 18-20 (describing the background of independent agencies and the safeguards inherent in a multi-member agency head). Stated differently, "the heads of independent agencies, although not accountable to or checked by the President, are at least accountable to and checked by their fellow commissioners or board members." Id. at *2. According to the D.C. Circuit, however, "[t]he CFPB marks a major departure from the settled historical practice requiring multi-member bodies at the helm of independent agencies," as the "massive power [of the CFPB] is lodged in one person - the Director - who is not supervised, directed, or checked by the President or by other directors." Id. at *11, 18.

Unlike traditional "executive agencies" (the heads of which are removable at will and therefore "checked" by the President) and "multi-member independent agencies" (the heads of which "are at least accountable to and checked by their fellow commissioners or board members"), the D.C. Circuit found that the CFPB's lone Director is entirely "unaccountable" and "unchecked," a delegation of power that is "unprecedented in our constitutional history." See id. at *2-3, 12 n.4, 22-23. In particular, the court noted that "[t]he Director alone decides what rules to issue; how to enforce, when to enforce, and against whom to enforce the law; and what sanctions and penalties to impose on violators of the law." Id. at *2. Indeed, in the case at hand, it was the Director alone who was ultimately responsible for the CFPB's interpretation of Section 8 of RESPA, for enforcing that interpretation against PHH, and for imposing the $109 million fine as a sanction for PHH's alleged misconduct. See id. at *2-3. Yet, in addition to this unbridled authority, the court emphasized that the CFPB's Director also "possesses enormous power over American business, American consumers, and the overall U.S. economy." Id. at *4. In fact, as the D.C. Circuit put it, "other than the President, the Director of the CFPB is the single most powerful official in the entire United States Government, at least when measured in terms of unilateral power." Id. at *11. Such "massive, unchecked power," the court explained, was nothing short of "a historical anomaly," and simply too great a threat to "the individual liberty protected by the Constitution's separation of powers." See id. at *12, 26. As such, the D.C. Circuit "conclude[d] that the CFPB is unconstitutionally structured because it is an independent agency headed by a single Director." Id. at *26.

Unsurprisingly, PHH argued that the only appropriate remedy for the CFPB's unconstitutional structure was clear: "strike down the CFPB and prevent its continued operation, if not strike down the entire Dodd-Frank Act." Id. at *27. The D.C. Circuit, however, cautioned that "Supreme Court precedent on severability demands a narrower remedy for the CFPB's constitutional flaw." Id. Specifically, the court reasoned that both the text of the CFPB and Supreme Court precedent dictated nothing more than "severing the for-cause removal provision of the statute," which in turn meant that the CFPB would now "operate as an executive agency." Id. at *27-28. Thus, the President "now has the power to supervise and direct the Director of the CFPB, and may remove the Director at will at any time." Id. at *28. Beyond that, however, the organization and day-to-day procedure of the CFPB was to remain the same, as the D.C. Circuit made clear that its ruling "will not halt the CFPB's ongoing operations," only its single-Director independent agency structure. See id. at *4-5, 28-29.

With the overarching constitutional issue resolved, the court turned its attention to the remaining case-specific issues raised by the appeal - and the $109 million dollar fine ultimately at stake. See id. at *4, 29. According to PHH, the CFPB's order that imposed the fine was improper and should be vacated for three primary reasons: (1) In reaching its decision, the CFPB "incorrectly interpreted Section 8 of [RESPA] to bar so-called captive reinsurance arrangements involving mortgage lenders such as PHH and their affiliated reinsurers," whereby lenders refer borrowers to certain mortgage insurers and, in return, the insurers purchase reinsurance from mortgage reinsurers affiliated with (or owned by) the lenders; (2) The CFPB "departed from the consistent prior interpretations [of Section 8] issued by the Department of Housing and Urban Development, and . . . then retroactively applied its new interpretation of the Act against PHH, thereby violating PHH's due process rights"; and (3) "[m]uch of the alleged misconduct" by PHH underlying the CFPB's decision "occurred outside of [RESPA's] three-year statute of limitations." See id. at *4-5. On all three grounds, the D.C. Circuit agreed.

First, the court agreed that Section 8 of RESPA (codified at 12 U.S.C. § 2607) did not prohibit the "so-called captive reinsurance agreements" that PHH (and other mortgage lenders) had participated in for decades. See id. at *5, 29. Notably, the D.C. Circuit acknowledged that, "[s]tanding alone, Section 8(a) perhaps might have been construed by government enforcement agencies to cast doubt on a mortgage lender's referrals of customers to mortgage insurers who in turn purchased reinsurance from a reinsurer affiliated with the lender" (i.e. captive reinsurance agreements). See id. at *6. After all, RESPA was passed in part to eliminate "kickbacks or referral fees that tend to increase unnecessarily the costs of certain settlement services," see 12 U.S.C. § 2601(b)(2), a practice that Section 8(a) plainly prohibits. See id. § 2607(a); see also PHH Corp., 2016 WL 5898801, at *6. However, the D.C. Circuit pointed out that another provision of RESPA, Section 8(c), "carved out a series of expansive exceptions, qualifications, and safe harbors related to Section 8(a)." See PHH Corp., 2016 WL 5898801, at *6. Of relevance to PHH's captive reinsurance practice was Section 8(c)(2), the court explained, which provides that "[n]othing in this section shall be construed as prohibiting . . . the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or four services actually performed . . . ." Id. (quoting 12 U.S.C. § 2607(c)(2)). Indeed, as the D.C. Circuit viewed it, "[t]he basic statutory question in this case is not a close call" - "Section 8(a) proscribes payments for referrals," but "does not proscribe other transactions between the lender and mortgage insurer," and "Section 8(c) permits captive reinsurance arrangements where mortgage insurers pay no more than reasonable market value for the reinsurance." Id. at *30. Thus, if the relevant mortgage insurers did not pay "more than reasonable market value to the PHH-affiliated reinsurer for reinsurance" (a determination the CFPB had not made), then Section 8(c) of RESPA was simply not implicated. See id. at *5.

Second, the D.C. Circuit also agreed with PHH's contention that "the CFPB violated bedrock due process principles by retroactively applying its new interpretation of the statute against PHH." Id. at *30. In particular, the court reasoned that "[f]or decades," the Department of Housing and Urban Development ("HUD") "explained to mortgage lenders that captive reinsurance arrangements where reasonable market value was paid were entirely permissible under Section 8," and even "adopted a rule, Regulation X, under which captive reinsurance arrangements were permitted so long as the insurer paid reasonable market value for the reinsurance." Id. at *31 (citing 24 C.F.R. § 3500.14(g)). In 2015, however, the CFPB decided upon a new interpretation of Section 8, which "represented a complete about-face from the Federal Government's longstanding prior interpretation" of the statute. Id. at *33-34. The court noted that while "[a]gency change is not a fatal flaw in and of itself," here, the CFPB did far more, as it "retroactively appl[ied] that new interpretation to PHH's conduct that occurred before the date of the CFPB's new interpretation." Id. at *33. According to the court, "[w]hen a government agency officially and expressly tells you that you are legally allowed to do something, but later tells you 'just kidding' and enforces the law retroactively against you and sanctions you for actions you took in reliance on the government's assurances, that amounts to a serious due process violation." Id. at *35. As such, for this additional reason, the D.C. Circuit vacated the CFPB's order, and the $109 million fine associated therewith. Id. at *36.

Third and finally, the court agreed that RESPA's three-year statute of limitations applies to CFPB enforcement actions, including administrative actions to enforce Section 8, and therefore held that to the extent that PHH's alleged misconduct occurred outside of the three-year window, the conduct is not actionable. See id. at *5, 37-41. In so doing, the D.C. Circuit rejected the CFPB's arguments that the Dodd-Frank Act as a whole, and alternatively RESPA in particular, do not impose any statute of limitations "on CFPB enforcement actions brought in an administrative proceeding, as opposed to in court." Id. at *5, 37. Indeed, the court described the language of the statute at issue, 12 U.S.C. § 2614, to be "straightforward," "logical," and "predicable," ruled that it plainly imposes a three-year statute of limitations on CFPB administrative actions, and called the CFPB's contrary position "absurd." See id. at *39-41.

In the end, the long-term impact of the D.C. Circuit's ruling, if any, is far from clear, especially with respect to the day-to-day operations of the CFPB and its (still) lone Director. If upheld, the President would of course have the authority to direct and supervise the Director of the CFPB, and to remove the Director at will prior to the expiration of the Director's five-year term. The substantive effect of this "check," however, is only as meaningful as the extent to which the President exercises it, which for now remains to be seen. As expected, however, Congressional Republicans such as House Financial Services Committee Chairman Jeb Hensarling (R-TX) are lauding the opinion as "vindicat[ing] what House Republicans have said all along, that the CFPB's structure is unconstitutional," and have declared that "[t]his is a good day for democracy, economic freedom, due process and the Constitution." See Press Release, Chairman Jeb Hensarling, Hensarling Statement on CFPB's Unconstitutional Structure (Oct. 11, 2016), http://financialservices.house.gov/news/documentsingle.aspx?DocumentID=401143. In contrast, U.S. Senator Elizabeth Warren (D-Mass.), a staunch supporter of the CFPB and Dodd-Frank as a whole, commented that while the ruling "will likely be appealed and overturned," as it currently stands, the ruling amounts to only "a small, technical tweak to Dodd-Frank," nothing more. See Press Release, Senator Elizabeth Warren, Warren Statement on Ruling on CFPB by Federal Appeals Court (Oct. 11, 2016), https://www.warren.senate.gov/?p=press_release&id=1271.