Court Rules CFPB Unconstitutional and Finds CFPB Improperly Applied Mortgage Lending and Reinsurance Laws

October 25, 2016 Advisory

In PHH Corporation v. Consumer Financial Protection Bureau, no. 15-1177 (D.C. Cir. Oct. 11, 2016), the Court of Appeals for the D.C. Circuit recently held that the organizational structure of the Consumer Financial Protection Bureau (CFPB) is unconstitutional. The appellate court concluded that the CFPB's structure—as an independent agency with a single director—did not contain sufficient checks to satisfy basic separation of powers concerns. The Court, however, declined a request to find the CFPB to be unconstitutional as a whole. Instead, it struck the portion of the CFPB's enabling legislation that made its director removable only for cause, effectively converting the CFPB from an independent agency to an executive agency.

While this constitutionality holding certainly makes for good academic discussion and could have a large impact down the line if future presidents decide to have an active role in shaping CFPB policy, the decision's impact on the CFPB's current operations are negligible. Rather, the practical impact of the decision comes from the second part of the Court's opinion, where the D.C. Circuit vacated a $109 million order against the defendant.

The case arose from PHH, a mortgage lender and its affiliated reinsurer, appealing the CFPB's $109 million order against it that was based on the CFPB's determination that PHH had violated Section 8 of the Real Estate Settlement Procedure Act (RESPA). A little context: insurers who write mortgage insurance often procure reinsurance for that risk. Sometimes, the mortgage lender, or a company it is affiliated with, underwrites that very reinsurance cover. Section 8 of RESPA prohibits mortgage lenders from giving kickbacks to mortgage insurers in exchange for buying reinsurance from the lenders.

Before Congress created the CFPB in 2010, the Department of Housing and Urban Development had interpreted Section 8 to allow mortgage lenders to refer borrowers to mortgage insurers whose reinsurance coverage they provided as long as the lenders did not give the mortgage insurers any kickback if the borrower purchased mortgage insurance through the insurer.

Nevertheless, in a "newly minted" interpretation of Section 8, the CFPB determined that such captive reinsurance arrangements are prohibited and that PHH had violated Section 8 for that reason. Remarkably, the CFPB also retroactively applied this new interpretation of Section 8 against PHH, ordering it to disgorge $109 million in profits, even though the arrangement at issue occurred before the CFPB issued its new interpretation of Section 8. The CFPB also concluded that no statute of limitations applied to its administrative order, allowing it to punish PHH for conduct occurring outside of the three-year limitations period set in RESPA. The CFPB's position was that although RESPA contains a three-year limitations period, the Dodd-Frank Act, the statutory mandate for the CFPB, does not have a limitation period.

The Court of Appeals soundly rejected the CFPB's interpretation of Section 8, its retroactive application of that interpretation, and its statute of limitations argument.

First, the Court held that Section 8 does not prohibit captive reinsurance agreements as long as there is no kickback from the mortgage insurer to the lender/reinsurer, reasoning that it is Congress's decision, not the CFPB's, to outlaw such arrangements and that Section 8 does not contain such a limitation on its face.

The Court next refused to accept the CFPB's retroactive application of the "complete about-face" concerning captive reinsurance agreements, concluding that applying the new interpretation ex post facto ran afoul of due process by "contraven[ing] the bedrock due process principle that the people should have fair notice of what conduct is prohibited."

Finally, the Court dispatched the CFPB's statute of limitations argument. The Court concluded that ignoring the limitations periods in the statutes the CFPB is authorized to enforce, and instead applying Dodd-Frank, which does not impose a statute of limitations for administrative proceedings, would be absurd and illogical. As the Court pointed out, it could theoretically lead to CFPB actions to enforce 19 different consumer protection statutes, with the ability to levy civil penalties, for activities taking place over a 100 year period or longer.

Considering the issues raised in this case, the CFPB will likely seek to have the Supreme Court review the D.C. Circuit's decision. While it remains uncertain whether the constitutional aspects of the D.C. Circuit's decision will have any impact on the day-to-day operations of the CFPB, this opinion allows mortgage insurers and lenders to continue (or bring back) captive reinsurance arrangements. Moreover, this ruling is likely to embolden parties who believe that the CFPB has taken overly aggressive positions against them, and may well result in Congress revisiting the broad authority it granted to the CFPB under Dodd-Frank.