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Does the Fifth Circuit’s decision finding the FHFA is unconstitutionally structured presage a similar fate for the CFPB?

The issue of the CFPB’s constitutionality is currently before the Fifth Circuit in the interlocutory appeal of All American Check Cashing from the district court’s ruling upholding the CFPB’s constitutionality.  As a result, the Fifth Circuit’s decision issued earlier this week which found that the Federal Housing Finance Agency (FHFA) is unconstitutionally structured because it is excessively insulated from Executive Branch oversight could be a preview of how another Fifth Circuit panel might approach the CFPB’s constitutionality.

In addition, the decision will likely influence the approach that the CFPB takes in its brief in All American Check Cashing’s appeal.  All American Check Cashing has already filed its principal brief and the CFPB is seeking a 40-day extension of the date by which it must file its brief (from August 1 to September 10).  In its motion to extend the briefing schedule, the CFPB states that the Fifth Circuit’s opinion “discussed features of the Bureau and compared them to aspects of FHFA’s structure” and thus “many of the arguments discussed by the Court are relevant to the issues in [the All American Check Cashing] case.”  The CFPB is requesting the extension “so that it may evaluate the [Fifth Circuit’s] opinion, and to decide how to address that opinion in the context of the [the All American Check Cashing] case.”  (The motion indicates that All American Check Cashing has no objection to the extension provided it receives a one-week extension for filing its reply brief.)

The FHFA was created by the Housing and Economic Recovery Act of 2008 (HERA) to oversee two of the housing government services enterprises (GSEs).  Like the CFPB, the FHFA was established as an “independent agency” led by a single Director appointed by the President subject to Senate confirmation for a five-year term and who can only be removed by the President “for cause.”  Also like the CFPB, the FHFA is not funded through the regular appropriations process.  Instead, the FHFA is funded through assessments collected from the GSEs.  The FHFA is overseen by the Federal Housing Finance Oversight Board (Board) which is required to testify annually before Congress about the FHFA’s performance and the safety and soundness of the GSEs but cannot exercise any executive authority, or as put succinctly by the Fifth Circuit, “cannot require the FHFA or Director to do much of anything.”

The parties challenging the FHFA’s constitutionality were shareholders of the GSEs who were seeking to invalidate an amendment (Third Amendment) to a preferred stock agreement between the Treasury Department and the FHFA as conservator for the GSEs that required the GSEs to pay quarterly dividends to the Treasury equal to the GSEs’ excess net worth after accounting for prescribed capital reserves.

The Fifth Circuit determined that while the “for cause” removal provision alone was not sufficient to trigger a separation of powers violation, it did trigger a violation when combined with other features of the FHFA, specifically its insulation from the normal appropriations process and the absence of any statutory provision providing for executive branch control over the FHFA’s activities.  The court observed that while two of the Board’s members are Cabinet officials, the Board exercises purely advisory functions.  It determined that the appropriate remedy for the constitutional violation was to sever the for-cause removal provision while “leav[ing] intact the remainder of HERA and the FHFA’s past actions—including the Third Amendment.”

In ruling that the FHFA is unconstitutionally structured, the Fifth Circuit stated that it was “mindful” of the D.C. Circuit’s en banc PHH decision finding the CFPB’s structure to be constitutional but “salient distinctions between the agencies compel a contrary conclusion.”  It observed that, unlike the Board, the Financial Stability Oversight Council (FSOC) can directly control the CFPB’s actions because it holds veto-power over the CFPB’s policies.  The court also commented that the shareholders were not only challenging the for cause removal provision but were challenging the “cumulative effect of Congress’s agency-design decisions.”  (emphasis included)

In its interlocutory appeal to the Fifth Circuit, All American Check Cashing has argued that not only does the CFPB’s single-director-removable-only-for-cause structure, standing alone, make the CFPB’s structure unconstitutional, but that its other features “render it even more clearly unconstitutional when combined with its single unaccountable Director.”  Such other features include the CFPB’s insulation from the regular appropriations process.  As a result, the Fifth Circuit could rely on All American Check Cashing’s “cumulative effect” argument as a basis for disagreeing with the D.C. Circuit’s en banc conclusion in PHH.  Indeed, perhaps with All American Check Cashing’s interlocutory appeal in mind, the Fifth Circuit specifically indicated that its decision was limited to the FHFA’s constitutionality.  The court stated in a footnote:

We do not question Congress’s authority to establish independent agencies, nor do we decide the validity of any agency other than the FHFA….
We leave for another day the question of whether other agencies suffer from similar constitutional infirmities.

Despite the Fifth Circuit’s reliance on the FSOC’s oversight of the CFPB to distinguish the D.C. Circuit’s en banc PHH decision, we are not convinced that the FSOC’s oversight of the CFPB is significantly different from the Board’s oversight of the FHFA.  While the FSOC can veto a CFPB regulation, it can only do so within a short time period by a two-thirds vote and only for reasons of safety and soundness (a very high standard) and not because FSOC members believe the regulation is bad policy.  Indeed, to date the FSOC has not vetoed any CFPB regulation nor has any FSOC member filed a petition to initiate a potential veto vote.  Furthermore, except for its ability to veto a CFPB regulation for safety and soundness reasons, the FSOC has no oversight over CFPB supervisory and enforcement activities.  The FSOC did not consider a veto of the CFPB’s arbitration rule even though the then Acting Comptroller of the Currency took the position that the rule threatened the safety and soundness of the banking system because of the avalanche of class action litigation that the CFPB predicted would result from the rule.  The only check on the CFPB proved to be Congress’ use of the Congressional Review Act to override the arbitration rule.

Should the Fifth Circuit conclude that the CFPB’s structure is unconstitutional, its FHFA decision also suggests that it would rule that the proper remedy is to sever the Consumer Financial Protection Act’s (CFPA) for-cause removal provision.  All American Check Cashing is arguing that the correct remedy is to strike down the CFPA as a whole.

Both the FHFA and the Treasury Department, in their briefs to the Fifth Circuit, sought to avoid the constitutionality issue by arguing that the Third Amendment was entered into by the FHFA’s Acting Director who was removable by the President at will and therefore the shareholders’ harm was not traceable to the for-cause removal restriction.  The FHFA and Treasury Department argued that because HERA, by its plain terms, only restricted the President’s authority to remove the Director but did not restrict the President’s authority to remove an Acting Director, the Acting Director was not subject to the for-cause removal restriction.  The Fifth Circuit rejected this argument stating:

But if the acting Director could be removed at will, the FHFA would be an executive agency—not an independent agency.  There is no indication that Congress sought to revoke the FHFA’s status as an independent agency when it is led by an acting, rather than appointed, Director.  So an acting Director, like an appointed one, is covered by the removal restriction. (footnotes omitted).

The FHFA also argued in the alternative that the FHFA’s structure was constitutional.  In its brief, the FHFA observed that the shareholders were relying on the D.C. Circuit’s vacated panel decision in PHH in arguing that the FHFA’s structure is unconstitutional.  The FHFA stated that “the District Court did not err by agreeing with every other court that has considered the issue that “the reasoning of the panel decision in PHH Corp. [is] unpersuasive even if it had not been vacated.'”

In a supplemental filing, the FHFA notified the Fifth Circuit of the D.C. Circuit’s issuance of its en banc PHH decision rejecting the constitutional challenge to the CFPB’s structure and indicated that the D.C. Circuit’s reasoning closely tracked the FHFA’s arguments in support of its constitutionality.  In addition to defending its constitutionality, the FHFA took the position that if its structure were found to be unconstitutional, the proper remedy would be to strike the for-cause removal provision.

The Fifth Circuit’s rejection of the argument made by the FHFA and the Treasury Department that the shareholders’ constitutionality challenge failed because the Acting Director was removable at will can be expected to influence whether the CFPB will make a similar argument in the All American Check Cashing case.  In opposing All American Check Cashing’s petition to the Fifth Circuit asking it to grant interlocutory review, the CFPB did not directly address the merits of the appellants’ constitutional challenge.  Instead, it claimed that because Acting Director Mulvaney is removable at will by the President and had ratified the CFPB’s decision to bring the lawsuit, any constitutional defect that may have existed with the CFPB’s initiation of the lawsuit was cured and the constitutionality of the for-cause removal provision was no longer relevant to the case.

According to the CFPB, Acting Director Mulvaney is removable at will by the President because the CFPA’s removal provision by its plain terms applies only to “the Director.”  Another Fifth Circuit panel could easily apply the rationale used by the Fifth Circuit in rejecting the FHA’s and Treasury Department’s “plain terms” argument and conclude that the CFPB’s Acting Director also is not removable at will because “there is no indication that Congress sought to revoke the [CFPB’s] status as an independent agency when it is led by an acting, rather than appointed, Director.”

It remains unclear what position the CFPB will take on its constitutionality in the All American Check Cashing case.  However, given that another Fifth Circuit panel now has the Fifth Circuit’s FHFA decision on which it can readily rely to reject an argument by the CFPB that the Acting Director’s ratification makes a ruling on the CFPB’s constitutionality unnecessary, there is now a greater likelihood that the Fifth Circuit will issue a decision that does rule on the CFPB’s  constitutionality.  (In the CFPB’s lawsuit against RD Legal Funding, Judge Preska of the Southern District of New York recently ruled that the CFPB’s single-director-removable-only-for-cause structure is unconstitutional and struck the CFPA (Title X of Dodd-Frank) in its entirety.  The CFPB has not yet indicated whether it plans to appeal Judge Preska’s decision.)

Should any of the parties to the FHFA decision wish to seek a rehearing en banc, they must do so within 45 days after entry of judgment.  The 45-day period applies when one of the parties is a United States agency (here, the FHFA and the Treasury Department) or a current United States officer or employee sued in an official capacity (here, FHFA Director Watt and Treasury Secretary Mnuchin).

 

Copyright © by Ballard Spahr LLP

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About this Author

Kaplinksy, partner, New York, finance
Partner

Alan S. Kaplinsky is Co-Practice Leader of the firm's Consumer Financial Services Group, which has more than 115 lawyers. Mr. Kaplinsky devotes his practice exclusively to counseling financial institutions on bank regulatory and transactional matters, particularly consumer financial services law, and defending financial institutions that have been sued by consumers in individual and class action lawsuits and by government enforcement agencies. Visit Mr. Kaplinsky's profile in Wikipedia.

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