On October 11, 2016, the U.S. Court of Appeals for the District of Columbia Circuit ruled that the Consumer Financial Protection Bureau’s (CFPB) structure was unconstitutional, but that the violation was easily remedied by severing the part of the statute that created the CFPB that permitted its Director to be removed only for cause. Instead, the Director now will serve at the will of the President of the United States, who can remove the Director at any time.
The CFPB’s existence and authority over 19 consumer financial laws arose out of the 2010 major financial services regulatory reform law, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). As a result of Dodd-Frank, statutory authority from a number of agencies that enforced various consumer protections relating to financial services was transferred to the CFPB.
The case began in 2014, when the CFPB began an administrative enforcement action against home mortgage lender PHH Corporation (PHH) relating to mortgage reinsurance provided by PHH’s subsidiary Atrium Insurance. Persons obtaining a mortgage to purchase a home may be required to obtain mortgage insurance to cover part of the lender’s losses if the borrower defaults on the mortgage. Mortgage insurers then may obtain mortgage reinsurance to spread some of the risk of borrower defaults. PHH often referred borrowers to mortgage insurers that in turn used the PHH subsidiary for mortgage reinsurance. This was known as a captive reinsurance arrangement, a not uncommon arrangement at the time.
The federal Real Estate Settlement Procedures Act (RESPA) prohibits kickbacks or referral fees in connection with real estate settlement services, but the law contains a safe harbor for payments for bona fide compensation for services actually performed. The Department of Housing and Urban Development (HUD), the agency that enforced RESPA pre-CFPB, in 1997 had issued written guidance (later incorporated into a regulation), relied on by the mortgage industry, that captive reinsurance arrangements were permissible under RESPA as long as the mortgage insurer paid no more than reasonable market value for the reinsurance.
PHH thus could refer customers to whom it was lending money to mortgage insurers who obtained reinsurance from Atrium, provided that the mortgage insurers paid PHH’s reinsurance subsidiary no more than the reasonable market value for the reinsurance. If the mortgage insurer paid more than reasonable market value (presumably in appreciation for PHH referring its customer to the mortgage insurer in the first place), that excess could constitute an illegal kickback or referral fee. Actions to enforce the prohibition could be brought within three years of the date of the violation.
The CFPB challenged PHH’s use of a captive reinsurer, finding that (i) RESPA barred captive reinsurance arrangements, (ii) all of PHH’s captive reinsurer dealings since 2008 violated RESPA, and (iii) the three-year statute of limitations did not apply to the CFPB. The CFPB ordered PHH to pay $109 million in disgorgement of the captive reinsurance fees and enjoined PHH from entering into future captive reinsurance arrangements. PHH appealed directly to the U.S. Court of Appeals for the District of Columbia Circuit, claiming that the CFPB was not only wrong on the law, but its structure also violated Article II the U.S. Constitution, which deals with the Executive Branch of the U.S. government.
The 2-1 majority 101 page opinion, authored by Judge Brett Kavanaugh, found that federal agencies in the United States are one of two types. The first type is an executive agency, such as the U.S. Department of Justice, which is headed by an individual that can be removed at will by the President. The second type of federal agency is an independent agency, which is governed by a multi-member commission or board, such as the Federal Reserve Board, and whose members can only be removed for cause by the President. The CFPB’s structure, of a lone Director who could only be removed for cause by the President, violated the U.S. Constitution by concentrating too much unchecked power in the hands of one individual. Judge Kavanaugh described the CFPB Director as “in essence, … the President of Consumer Finance” because of his broad unilateral power to exercise executive authority over the CFPB.
Although PHH had asked the court to shut down the CFPB entirely, the court, citing Supreme Court precedent, agreed that the structure of the CFPB was unconstitutional yet chose a narrower remedy of making the CFPB’s Director subject to removal at the will of the President. With the severing of the firing-for-cause provision from the rest of the statute setting up the CFPB, the CFPB now will operate as an executive agency similar to other U.S. executive agencies headed by a single person:
The President is a check on and accountable for the actions of those executive agencies, and the President now will be a check on and accountable for the actions of the CFPB as well.
With respect to RESPA, the majority ruled in PHH’s favor, finding that the original HUD interpretation was a correct interpretation of the law, and that captive reinsurance arrangements are permissible, as long as the amount paid by the mortgage insurer for the reinsurance does not exceed the reasonable market value of the insurance. The court ruled that the CFPB could not discard the HUD interpretation and then impose its incorrect interpretation of law retroactively on PHH going back to 2008, stating:
When 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.
The court vacated the CFPB’s order and remanded the matter back to the CFPB for further proceedings in accordance with the court’s opinion, finding moreover that the three year statute of limitations on bringing enforcement proceedings was indeed applicable. “On remand, the CFPB may determine, among other things whether, consistent with the applicable three-year statute of limitations, the relevant mortgage insurers paid more than reasonable market value to Atrium.”