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CFPB structure ruled unconstitutional

By Holden Lewis · Bankrate.com
Tuesday, October 11, 2016
Posted: 3 pm ET
CFPB structure ruled unconstitutional

Director of the Consumer Financial Protection Bureau Richard Cordray testifies during a hearing before the Senate Banking, Housing and Urban Affairs Committee in April. On Oct. 11, a Federal appeals court slapped down the CFPB and ruled that the bureau is no longer independent. Alex Wong/Getty Images

A Federal appeals court slapped down the Consumer Financial Protection Bureau and ruled that the bureau is no longer independent, and that its director can be fired by the president for any reason.

The ruling by the District of Columbia Court of Appeals gives voters 1 more motive to care about the result of the presidential election, as the next president will have the power to replace -- or keep -- Director Richard Cordray, a liberal who is respected by consumer advocates but is not well-liked by banks.

In an epic smackdown, the appeals court ruled that the bureau violated "anti-retroactivity principles (that) are Rule of Law 101" when it fined PHH Mortgage $109 million for violating anti-kickback rules.

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Reaction to the ruling

Glee was heard across the land from conservatives and business interests.

"This is a good day for democracy, economic freedom, due process and the Constitution," said Jeb Hensarling, chairman of the House Financial Services Committee. "The second-highest court in the land has vindicated what House Republicans have said all along, that the CFPB's structure is unconstitutional."

Joseph Lynyak III, a partner with the law firm Dorsey & Whitney who advises financial institutions, called the ruling a victory for the mortgage industry "by discrediting almost completely the regulatory approach taken by the CFPB."

Consumer advocates were bummed.

Mike Calhoun, president of the Center for Responsible Lending, said the ruling was disappointing, but not surprising, because conservatives have been gunning for the bureau.

"If the 2008 financial crisis showed us anything, it's that consumers need an independent regulator to look after the interests of consumers," Calhoun said, adding, "any efforts to change CFPB's structure would reduce its effectiveness and harm hardworking people across the country."

Lisa Donner, executive director of Americans for Financial Reform, said, "We are hopeful that this erroneous decision will be overturned."

What the case is about

When you make a down payment of less than 20% for a conventional mortgage, you have to get mortgage insurance. And the mortgage insurance company, in turn, buys mortgage reinsurance. This way, the mortgage insurance company is on the hook for modest losses, but for really big losses, it collects claims from the mortgage reinsurance company.

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PHH Mortgage owned a mortgage reinsurance company as a subsidiary. When PHH's customers needed mortgage insurance, PHH sent the business to mortgage insurance companies that bought reinsurance from PHH's subsidiary.

This type of business arrangement has been a common practice for a long time, and regulators were OK with it as long as the reinsurance was sold for a reasonable price. But it was illegal to sell the reinsurance at an inflated price, because that could be considered an illegal kickback under the Real Estate Settlement Procedures Act.

In 2014, the bureau fined PHH Mortgage $109 million for referring borrowers to mortgage insurance companies in exchange for selling reinsurance to those mortgage insurance companies. The bureau said the arrangement was an illegal referral, even if the reinsurance wasn't sold at an inflated price.

PHH disagreed

PHH Mortgage argued that:

  • The bureau misinterpreted the law.
  • The bureau retroactively applied its misinterpretation and violated a 3-year statute of limitations.
  • PHH should be allowed to argue that it didn't overcharge for mortgage reinsurance.

The appeals court agreed with all 3 of PHH's arguments. Among other things, the court said that the bureau acted like a cop who tells you it's OK to cross the street, then hands you a $1,000 ticket for jaywalking. It sent the case back to the bureau to determine whether PHH's reinsurance subsidiary overcharged illegally.

PHH responded: "We are hopeful that the Court's opinion will provide greater certainty to the entire mortgage industry regarding the industry's reliance on long-standing regulation as to how to conduct business consistent with RESPA." The company said it will continue to present evidence that it has complied with anti-kickback rules.

The bureau has the option of asking the full appeals court -- instead of a 3-judge panel -- to review the case, or appealing the ruling to the Supreme Court.

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Restructuring, sort of

PHH argued that the Consumer Financial Protection Bureau was structured illegally because it's an independent agency headed by 1 person instead of by multiple commissioners or board members. Conservatives have been advancing this argument for years, and the D.C. Appeals Court ruled 2-1 that the bureau indeed was structured in an unconstitutional way.

The bureau was set up as an independent agency, meaning that the president could fire the bureau's director only for "inefficiency, neglect of duty, or malfeasance in office." The president couldn't fire the director for having bad judgment. The appeals court ruled that the bureau no longer is an independent agency, but an executive agency whose director serves at the discretion of the president.

"The CFPB therefore will continue to operate and to perform its many duties, but will do so as an executive agency akin to other executive agencies headed by a single person, such as the Department of Justice or the Department of the Treasury," the court ruled.

This still leaves open the question of whether all the bureau's past actions -- including billions of dollars of penalties collected -- are void, Lynyak said.

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