Here We Go Again: Fifth Circuit Rules CFPB Funding Mechanism Is Unconstitutional, Strikes Down Payday Loan Rule
On October 19, 2022, a three-judge panel of the United States Court of Appeals for the Fifth Circuit ruled that the Consumer Financial Protection Bureau (CFPB) funding mechanism violated the Appropriations Clause of the Constitution and , therefore, rescinded the 2017 CFPB payday loan rule. In the case Community Financial Services of America c. Consumer Financial Protection Bureau(“Community financial”), the court ruled that the independent funding of the CFPB through the Federal Reserve is constitutionally invalid, and further that the payday loan rule was only made possible by this unconstitutional source of funding and should be struck down. While the CFPB will almost certainly request a rehearing bench or appeal to the Supreme Court, the ruling calls into question the validity of all rule-making and enforcement activities undertaken by the CFPB since its inception.
Since the establishment of the CFPB, many parties have challenged its structure as unconstitutional. In the case of Seila Law, LLC v. Consumer Financial Protection Bureau, the Supreme Court ruled that the structure of an agency headed by a single director who can only be removed by the president “for cause” violated the separation of powers clause. Notably, however, the Court found this provision to be severable and, therefore, simply invalidated the “for cause” requirement of the Dodd-Frank Act, essentially amending Dodd-Frank to allow the removal of the CFPB director to the President’s discretion. Rather than invalidating the action taken by the CFPB in Seila Lawthe Court sent this case back to the court of first instance to assess the impact on the civil enforcement proceedings.
In Community financial plaintiffs sued the Bureau in 2018 on behalf of payday lenders and access to credit businesses, seeking an order rescinding the 2017 payday loan rule (“the rule”), alleging that the rule violated the authority statute of the CFPB and, among other arguments, that the regulator violated the constitutional separation of powers. The rule, which regulates payday, vehicle title and other types of consumer loans, was proposed in 2016 under director Richard Cordray, became final in 2017 and effective in 2018. The rule prohibits generally what the Bureau considers to be unfair and abusive practices. in the underwriting, payment and collection of these loans. Plaintiffs specifically took issue with sections related to limitations on a lender’s ability to obtain loan repayments through pre-authorized account access. See 12 CFR § 1041.8. Essentially, the rule prohibits any further attempts to withdraw payments from accounts after two consecutive withdrawal attempts have failed due to lack of sufficient funds.
While the case was pending, under Acting Director Mick Mulvaney, the CFPB issued a new notice and comment period to consider revisions to the rule. The District Court of Community financial issued a hold while this process was in progress. Eventually, under the leadership of Kathy Kraninger, the CFPB issued a new proposed rule repealing the underwriting portions of the rule but leaving the payment provisions intact. Moreover, following the Supreme Court ruling in Seila Law, Director Kraninger finalized the revised rule and issued a “ratification” of the rule. The district court then lifted the stay and the parties filed respective motions for summary judgment. The district court granted summary judgment for the CFPB, ruling that (1) segregation of the Director of Revocation did not nullify the rule ab-initio(2) the Director’s ratification of the rule was a remedy for any constitutional harm suffered by the plaintiffs, (3) the rule was within the authority of the CFPB and was not arbitrary or capricious, (4) the mechanism of CFPB’s funding did not violate the Appropriations Clause, and (5) the CFPB’s action did not violate the non-delegation doctrine.
The Fifth Circuit decision
On appeal, the Fifth Circuit essentially sided with the CFPB on all but one issue, albeit crucial in terms of impact. The Court held that the CFPB acted within its authority in promulgating the rule and that the CFPB did not act arbitrarily or capriciously in promulgating the rule. Moreover, the court held that the plaintiffs had failed to demonstrate that the isolation of the director of revocation at the time the rule was enacted had created concrete harm for the plaintiffs and, therefore, had not even need to consider whether Director Kraninger’s ratification had cured that harm. . The Court further ruled that the rule did not violate the doctrine of non-delegation, as the wording of the Dodd-Frank statute creating the CFPB set forth an “intelligible principle” to guide the CFPB’s discretion, namely “to put in implement and, where appropriate, consistently enforce the Federal Consumer Finance Act with the goal of ensuring that all consumers have access to markets for consumer financial products and services and that markets for consumer financial products and services are fair, transparent and competitive” and to protect against “abusive acts or practices” in relation to consumer credit.
However, on the question of whether the CFPB’s financing structure violates the appropriations clause, the Court ruled in favor of the plaintiffs. The Court pointed out that the CFPB, unlike most other federal agencies, is not subject to annual appropriations from Congress. Instead, the CFPB is funded by the Federal Reserve, with the only restriction being that the director submit an amount deemed “reasonably necessary to discharge” his or her duties, and that the amount not exceed 12% of operating expenses. Federal Reserve totals. . The Court further noted that the Federal Reserve is himself outside of the appropriation process through bank appraisals, and that all funds transferred or acquired by the CFPB be kept in a fund under the sole control of the CFPB Director, further isolating it from the oversight of the CFPB. Congress. The Court concluded that these multiple levels of isolation from the credit allocation process amounted to “an off-the-books credit card ringing.”[un]appropriate funds”” and that Congress “violated the separation of powers embodied in the appropriations clause” by approving such a funding structure.
The Court went on to hold that the plaintiffs easily demonstrated direct harm as a result of this constitutional issue, “because the funding used by the Bureau to enact the payday loan rule was drawn entirely from the unconstitutional funding scheme of the agency”. Plaintiffs were found to be entitled to “a rewind of [the Bureau’s] action.” The Court entered judgment for the plaintiffs on this claim, striking down the rule.
The CFPB can either ask for a new hearing bench before the full Fifth Circuit or ask the Supreme Court to certiorari. A bench the ruling may not be worth reviewing, as the Fifth Circuit is not seen as supportive of the CFPB’s position. The Bureau has approximately 50 days to act. The decision of the Fifth Circuit Committee can be put on hold as the case progresses without any immediate impact on CFPB operations. But the decision has wide and deep implications for the future of the agency.
For example, if this decision is upheld on bench review, by the Supreme Court, or is approved by other courts, it could have an impact on the entire rule-making and enforcement activities that the CFPB has undertaken since its inception, given that potentially all of these actions could be challenged as being funded by an unconstitutional mechanism. Likewise, it would create a funding crisis for the Office, as neither the bench Neither the Fifth Circuit nor the Supreme Court would be able to provide an alternative funding mechanism for the Bureau, pushing the “fix” to what could well be a divided or Republican-controlled Congress.
Meanwhile, financial services firms will continue to articulate such arguments in response to CFPB administrative proceedings, civil investigation requests and even enforcement proceedings, all of which rely on a source of funding that a court circuit appeal has now been ruled unconstitutional. Although litigants need to show that the unconstitutional funding mechanism caused them specific harm, the Fifth Circuit’s decision “makes[es] this showing  simple” by holding that “the funding used by the Bureau to enact the payday loan rule was drawn entirely from the agency’s unconstitutional funding scheme, [and therefore] there is a linear connection between the invalidating provision (the Bureau’s funding mechanism) and the impugned action (the enactment of the rule).
A similar logic would appear to apply to all regulations promulgated by the CFPB since its inception, including but not limited to mortgage servicing rules, repayment capacity rules and qualifying mortgages, the built-in mortgage disclosure rule and the recent debt collection. Rules. But financial services firms can argue that even CFPB enforcement activities under laws and regulations that were not promulgated by the CFPB are unconstitutional, since the CFPB cannot undertake such enforcement activity. only through a constitutionally inadmissible source of funding.
Given the current composition of the Supreme Court, the Supreme Court’s previous willingness to declare certain aspects of Dodd-Frank unconstitutional in Seila Law, as well as the strong chance that Congress will pass legislation that would address this problem in an election year or after, this issue may well remain unresolved in the short term. The CFPB should not change its current priorities, agenda and approach to the oversight of consumer financial products and services. Companies must continue to focus on compliance and risk mitigation.