Cheat Sheet: What CFPB Constitutionality Ruling Means for Lenders

Be careful what you wish for.

That's the lesson for banks and other financial institutions that have long sought to win a check against the Consumer Financial Protection Bureau's power after the U.S. Court of Appeals ruled Tuesday that its structure is unconstitutional.

Far from a victory for the industry, the court's solution — allowing the president to dismiss a CFPB director for any reason — arguably makes the situation worse by putting the CFPB directly under the control of the White House. As a result, the CFPB is effectively no longer an independent agency.

"That's the worst thing that can happen to the banking industry and consumers," said Richard Hunt, president of the Consumer Bankers Association, which has lobbied for changes to the agency's structure. "It leads to a whipsaw effect every four years. We need certainty and stability."

But the ramifications for the decision go far beyond just the CFPB's independence, and may have consequences for other federal agencies with a similar structure. It may also hamper the CFPB's ability to pursue certain cases and retroactively apply new rules.

Following are four takeaways from the ruling:

The court's decision regarding Respa may be an even bigger deal

Most of the reaction to Tuesday's ruling has focused on court's ruling to strike language from the Dodd-Frank Act that only allowed the CFPB director to be removed "for cause."

But the decision also invalidated the CFPB's $109 million fine levied against New Jersey-based nonbank mortgage lender PHH Mortgage due to alleged violations of the Real Estate Settlement Procedures Act.

In pursuing PHH, the CFPB provided a novel interpretation of Section 8 of that law, effectively outlawing the practice of steering customers to preferred mortgage insurance providers in exchange for having those providers purchase reinsurance from captive firms of the mortgage originator.

CFPB determined that its interpretation applied retroactively against PHH and further said that its administrative actions were not subject to the usual three-year statute of limitations governing judicial actions. The court disagreed with the CFPB, saying that it would only be a violation of Respa if the mortgage insurance offered by the preferred clients was more expensive than what borrowers might find elsewhere.

"This court has just said to the CFPB that they are concerned about the way they make decisions, that they're not a multimember agency, and that they badly misinterpreted the statute, and applied the decision retroactively," said Jon Eisenberg, partner with K&L Gates. "All of that is of far more practical significance than whether Cordray is removed for cause."

Jaret Seiberg, managing director of Cowen Group, said the court's decision limits PHH's exposure substantially, and sets some meaningful restrictions on how Respa will be applied going forward.

"If the market value was unreasonable, then there could still be a Respa violation," Sieberg said in a note to clients. "To us, this sharply limits PHH's legal risk in the case, even if the agency concludes it underpaid for the reinsurance."

The ruling calls into question the constitutionality of the OCC and FHFA:

In the court's ruling, Judge Brett Kavanaugh argued that the CFPB has a unique set-up unlike that of any other federal agency. He concluded that an agency could be independent of the administration only if it had a commission-structure or some other limitations on its power, arguing that the CFPB director was more powerful than any other government official absent the president.

Yet the CFPB shares a similar structure with two other federal regulators: the Office of the Comptroller of the Currency and the Federal Housing Finance Agency.

The OCC is run by a single director that can be dismissed by the president upon notification of the Senate while the FHFA director, like the CFPB's, can only be dismissed for cause.

In his ruling, Kavanaugh acknowledged that the FHFA faced similar issues, though the order does not directly affect the agency. "That agency is a contemporary of the CFPB and merely raises the same question we confront here," he wrote.

Kavanaugh dismissed comparisons to the OCC, however, insisting that notification of the Senate was not a big hurdle for the president.

"The comptroller is removable at will by the president," he wrote.

Still, that's not necessarily clear — and could become a point of contention for others seeking legal action against the OCC or FHFA.

"This ruling lacks judicial precedent and it feels like a case of judicial activism on the right," said Aaron Klein, an economist with the Brookings Institution. "The ruling, if applied, opens up a can of worms on other, well-established regulatory structures like the OCC, the FHFA, and the Federal Reserve regional banks."

The outcome of a likely appeal is unclear

The CFPB has not said whether it intends to appeal the D.C. Circuit's ruling, but observers said there is little doubt that it will.

The first option would be to ask for a broader review by other judges of the entire D.C. Circuit — known as and en banc review — to revisit the ruling. If that appeal is rejected, or if it is granted but the ruling is upheld, the CFPB can then ask the Supreme Court to review the case.

Whether it will receive en banc review is uncertain, though there are signs that it might. Judge Karen Henderson dissented from the majority in the three-member panel ruling, arguing that the court erred in making a judgment on the CFPB's constitutionality when it could have dispensed with the case by simply vacating the CFPB's $109 million fine and striking down its interpretation of Respa. Dissents on rulings tend to increase chances for en banc review.

Alan Kaplinsky, head of the consumer protection group at Ballard Spahr, said very few en banc petitions are ever granted. The fact that this is a high-profile case raises those odds, but since the judges issued a relatively narrow ruling relative to the relief that was sought might make other judges on the court less willing to take it up.

The court "applied a very narrow remedy," said Kaplinsky. "It just excised from the statute a couple of words. So it may be that the other judges on the court look at this opinion, and say, 'We don't see anything wrong with this opinion.'"

Andrew L. Sandler, the chairman and executive partner at BuckleySandler, said that the CFPB has to appeal the case because the decision creates an opening for other attorneys to pursue the agency in court. Though the Court of Appeals did not strike down the entire CFPB, plaintiffs might attempt to win a similar case in another jurisdiction that would be more amenable to taking such an action.

"The court sought to apply an elegant solution to create stability," Sandler said. "However, lawyers will be looking for ways to argue that prior acts of the bureau should be deemed invalid because the bureau was operating on an unconstitutional basis."

Seiberg said the probability of the case going before the Supreme Court depends almost entirely on whether Hillary Clinton or Donald Trump wins the White House, given that the victor of the presidential election will pick a potentially pivotal vote on the high court.

"Whether the justices take the case, in our view, will depend upon who fills the seat vacated by the death of Justice [Antonin] Scalia," Seiberg said. "If Democrats control that nomination, the odds favor the court taking the case while a Republican nominee could tilt the justices against accepting the appeal."

The ruling will strengthen calls for a bipartisan commission

The ruling may accelerate calls to turn the CFPB into a five-member commission, a move that would satisfy the court's definition of an independent agency.

Industry representatives have long sought such a change, noting that the five-member structure was originally suggested by the CFPB's founder, Sen. Elizabeth Warren, D-Mass., and the Obama administration. (Both the administration and Warren now oppose a commission structure.)

"Because the court proposed a fix allows the bureau to continue operating, but that doesn't mean the original idea — floated by Sen. Warren, by the administration and the original House bill — is a bad one," said Jason Oxman, the head of the Electronic Transactions Association. "A five member commission results in more reasoned and balanced decision-making."

The CBA's Hunt agreed. "I don't know why the Democrats are so stubborn not to create a commission," he said. "That doesn't mean the banks are going to win. We are going to lose 3-2 most of the time...If you are a Democrat or Republican, you should want stability."

Rep. Randy Neugebauer, R-Texas, argued Tuesday that the ruling proved the need for a bill he authored which would turn the CFPB into a five-member commission.

"I am concerned that the court's remedy was to further politicize the CFPB by making it an executive branch agency with Director [Richard] Cordray answering to the president," he said in a statement. "We have seen with other federal agencies that a five-person bipartisan commission works to de-politicize the regulatory process. The court agreed there is too much power invested in an unaccountable, single director. Now we need to change the CFPB structure to benefit American consumers."

Joseph Rodriguez, partner with David Wright Tremaine, said Democrats might now be more willing to consider a structural change as part of a deal.

"Unless the election swings heavily toward a [Republican] Congress, it'll probably be tough sledding for such a standalone bill, but as part of a larger compromise on other issues I could really see the commission getting legs," Rodriguez said. "Especially when you consider that since now the Director can be removed at will, it introduces the prospect of extreme volatility in consumer finance regulation, and a commission could be viewed as necessary to prevent that."

Tim Jenkins, a partner at Nossaman, said that the ruling "improves the chances of that option being considered by the next Congress.

"There are lots of Democrats who would say privately right now that they are open to discussions, particularly around the composition" of the CFPB, Jenkins said. "There are Democrats currently in Congress who believe a panel is a better approach than a single commissioner."

But in a statement issued Tuesday, Warren blasted the ruling, and reiterated her opposition to structural changes.

"The CFPB has been, and will remain, highly accountable to both Congress and the president, and continued Republican efforts to transform the agency's structure or funding should be seen for what they are: attempts fostered by big banks to cripple an agency that has already forced them to return over $11 billion to customers who have been cheated," she said.

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