Court Ruling Could Undo Many CFPB Actions

A ruling by a federal appeals court last week could render the recess appointment of Richard Cordray to head the Consumer Financial Protection Bureau unconstitutional, and it could also invalidate recent rulings by the National Labor Relations Board.

If Cordray's appointment is voided, it doesn't just mean that the director would have to go through the formal process of getting confirmed by the U.S. Senate, it could unravel a year's worth of rulemaking, including settlements with credit card providers worth hundreds of millions, and other actions by the new agency, which opened in 2011, established by the Dodd-Frank Act.

Even though Cordray has headed the CFPB since last January, he has done so as a recess appointment by the President, executed under the pretense that Congress had adjourned at the time. Republicans, however, have argued that Congress was in fact still in pro forma session, meaning it was not technically gavelled to a break, and therefore his appointment, as well as three individuals named to the NLRB, were unconstitutional.

On Jan. 25, a three-judge panel of the D.C. Circuit Court of Appeals rendered a unanimous decision favorable to the plaintiff in the case of Noel Canning v. National Labor Relations Board. The crux of the case is that the plaintiff, a Pepsi bottler, questioned the authority of the NLRB on the grounds that three members, also named as recess appointments by President Obama, were invalid and should not count toward a needed quorum. The decision throws into question NLRB decisions made since Jan. 4, 2012, invalidating, for example, recent rules that protect the privacy of employee social media accounts.

With the Canning ruling (expected to be challenged all the way to the Supreme Court), it is likely that Cordray's appointment will also be vulnerable, as is any CFPB rulemaking, guidance, and enforcement actions made through his authority.

“It is hard to see how the logic of that case doesn't apply to the CFPB,” says Oliver Ireland, an attorney with the law firm Morrison & Foerster who focuses on financial services and bank regulatory issues.

If the ruling stands and is applied to the similar circumstances of the CFPB, it could invalidate many of the agency's official actions. “If the Cordray appointment is void, then so too is every supervisory action and every new regulation promulgated by the CFPB arising out of newly created Bureau powers,” says Richard Gottlieb, a member of the senior management team for law firm Dykema Gossett and chair of its national Consumer Financial Services practice. “The CFPB's world has been turned upside down.” 

“There's not much question that if it is determined that the director of the CFPB was not properly appointed then certainly all the rulemaking applicable to non-banks will be invalid,” agrees Michael Halloran, a partner with the law firm Pillsbury Winthrop Shaw Pittman who previously served as general counsel for Bank of America and deputy chief of staff at the Securities and Exchange Commission. “There are plenty of non-banks—credit card issuers, mortgage originators and servicers, and pay-day-loan businesses—that are subject to the CFPB and its regulations only because Cordray was appointed. If his appointment is invalid than those non-bank regulations are invalid.”

A statement offered by the CFPB downplayed the matter. "The Bureau is not a party in the case decided today, and the court's ruling has no direct effect on the Bureau," a spokesman said. "Going forward, we will continue our essential work to protect American consumers."

A similar view was expressed by NLRB Chairman Mark Gaston Pearce. “The Board respectfully disagrees with today's decision and believes that the President's position in the matter will ultimately be upheld,” he said. “It should be noted that this order applies to only one specific case, Noel Canning, and that similar questions have been raised in more than a dozen cases pending in other courts of appeals. In the meantime, the Board has important work to do."

The significant attention placed on the CFPB's non-bank regulations is due to the way the it was created. Mandated by Dodd-Frank, its powers came in three varieties. There were powers transferred to it by statute from other agencies. Then, there are rules and guidance flowing directly through its director. A third level of regulations can be made independent of the director and, if needed, validated by the Secretary of the Treasury.

As the CFPB's proposed power structure was scrutinized by members of Congress, a Jan. 10, 2011 letter by the inspectors general of the Treasury Department and Federal Reserve addressed what the Bureau could and could not do if a director was not confirmed by the Senate prior to the “designated transfer date” of July 21, 2011.

“If the Cordray appointment is void, then so too is every supervisory action and every new regulation promulgated by the CFPB arising out of newly created Bureau powers.”

—Richard Gottlieb,

Member,

Dykema Gossett

Lacking a formal director, “the Bureau may continue to operate under the [Secretary of the Treasury's] authority” and has the authority to “conduct examinations (for federal consumer financial law purposes) of banks, savings associations, and credit unions with total assets in excess of $10 billion,” they said. It could also continue to enact rules, issue guidelines, and conduct studies for activities handed over to it by another agency, the letter explained.

Among the activities forbidden without a director confirmed by Congress: supervising non-depository institutions through rulemaking and examinations.

Although, the recent ruling is specific to the NRLB, it will no doubt be leveraged against the CFPB, which is already facing legal challenges to its constitutionality.

On June 21, the State National Bank of Big Spring, Texas; the Competitive Enterprise Institute; and the 60 Plus Association filed a lawsuit in U.S. District Court for the District of Columbia charging that legislative aspects of the CFPB's creation were unconstitutional and that Cordray's recess appointment should be dismissed. Other arguments waged are that the CFPB has too much independence (because Congress cannot set its budget), that the President cannot remove the CFPB director except in special circumstances, and that courts are expected to give CFPB decisions extra deference. These challenges will now be decided in light of the NRLB decision.

Nevertheless, Andrew Sandler, chairman and executive partner of the law firm BuckleySandler, says that although the NLRB decision “does suggest some level of uncertainty as to the validity of the Cordray appointment” his firm is “advising clients to continue cooperating with CFPB.”

“I really don't think it is in anybody's best interest to void everything that has happened at the Bureau since its inception,” Ireland says. “Certain things could be done by the Secretary of the Treasury in a transition period, but then what happens? There needs to be some process to resolve those issues assuming a case would go against the bureau and the legitimacy of the director.”

TREASURY & FEDERAL RESERVE RESPONSE

Below is a selection from a joint response by the Department of the Treasury and the Federal Reserve System to a Congressional request for information regarding the CFPB:

The interim authority specified in section 1066 of the Dodd-Frank Act does not fully terminate on the designated transfer date. Sections 1066(a) and 1066(b) identify two different expirations for Treasury's authority. The Secretary's authority under section 1066(a) terminates when a Director is confirmed by the Senate, rather than on the designated transfer date. Section 1066(a) states, “The Secretary is authorized to perform the functions of the Bureau under this subtitle until the Director of the Bureau is confirmed by the Senate ...”

If the Bureau does not have a Senate-confirmed Director by the designated transfer date, the Bureau may continue to operate under the Secretary's section 1066(a) authority. Specifically, until a Director is confirmed, section 1066(a) grants the Secretary the authority to carry out the functions of the Bureau found under subtitle F of title X.3 On the designated transfer date, subtitle F grants the Bureau the authority to:

Prescribe rules, issue orders, and produce guidance related to the federal consumer financial laws that were, prior to the designated transfer date, within the authority of the Board, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, and the National Credit Union Administration;

Conduct examinations (for federal consumer financial law purposes) of banks, savings associations, and credit unions with total assets in excess of $10 billion, and any affiliates thereof;

Prescribe rules, issue guidelines, and conduct a study or issue a report (with certain limitations) under the enumerated consumer laws that were previously within the authority of the Federal Trade Commission (FTC) prior to the designated transfer date;

Conduct all consumer protection functions relating to the Real Estate Settlement Procedures Act of 1974, the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, and the Interstate Land Sales Full Disclosure Act that were previously within the authority of the Secretary of the Department of Housing and Urban Development prior to the designated transfer date;

Enforce all orders, resolutions, determinations, agreements, and rulings that have been issued, made, prescribed, or allowed to become effective prior to the designated transfer date by any transferor agency or by a court of competent jurisdiction, in the performance of consumer financial protection functions that are transferred to the Bureau, with respect to a bank, savings association, or credit union with total assets in excess of $10 billion, and any affiliates thereof; and

In the absence of a Senate-confirmed Director, the text of section 1066(a) authorizes the Secretary to perform these transferred functions. The Secretary's authority to carry out these transferred functions terminates when a director is confirmed by the Senate.

If there is no Senate-confirmed Director by the designated transfer date, in general, the Secretary is not permitted to exercise the Bureau's authority to:

Prohibit unfair, deceptive, or abusive acts or practices under subtitle C in connection with consumer financial products and services;

Prescribe rules and require model disclosure forms under subtitle C to ensure that the features of a consumer financial product or service are fairly, accurately, and effectively disclosed both initially and over the term of the product or service;

Prescribe rules under section 1022 relating to, among other things, the filing of limited reports to the Bureau for the purpose of determining whether a non-depository institution should be supervised by the Bureau;

Supervise non-depository institutions under section 1024, including the authority to (a) prescribe rules defining the scope of non-depository institutions subject to the Bureau's supervision, (b) prescribe rules establishing recordkeeping requirements that the Bureau determines are needed to facilitate non-depository supervision, and (c) conduct examinations of non-depository institutions.

Sources: Treasury Department; Federal Reserve.

In the meantime there are many questions still to be answered, he adds. “If I am a non-bank institution that is going to be examined by the Bureau, what do I do? Is this exam legitimate? Can the Bureau protect my confidential information?”

“There is another big problem,” Halloran says, explaining that the Dodd-Frank Act makes it clear that the director of the CFPB must be approved by the Senate. “One thing I've never understood is how the Obama administration gets around the statute,” he says. “The statute says what it says, and you've got to deal with it.”

Unintended Consequences

If Cordray's appointment is invalidated it could set in motion a series of actions, some of them not so favorable to non-bank financial companies. According to Halloran, the CFPB had a Jan. 21 Congressional deadline to issue a variety of rules on mortgage origination and servicing that go into effect in 2014. The statute said that if the Bureau didn't meet the deadline, the rules set forth in the statue—among them Ability-to-Repay and Qualified Mortgage regulations—would go into effect by themselves, in accordance with the language of the original legislation.

“When a suit is brought and won against the CFPB, you will have a giant problem, because [lacking the authority of a director] the statute goes into effect,” Halloran says. “The mortgage industry has got to figure out a way to go back and fix all their mortgages to comply with the statute, because the CFPB varied from the statute in many ways. Everybody was getting ready over the next 12 months to fix their mortgage forms to comply with the new rules; now they are going to have to develop another set of forms to comply with the statute in the absence of the rules.”

Gottlieb says that courts have ruled favorably in the past on de facto officers, those who, after being appointed were determined to have not been legal. The problem for the CFPB is the fact that a constitutional issue is at play and knowing that could invalidate any “good faith” anticipation that Cordray's tenure is permissible under that doctrine.

“This is not a situation where someone made a mistake and appointed the wrong person, or didn't have the authority to do so,” he says. “It is a constitutional issue on whether a president has the right to do a recess appointment when there is no recess.”

Gottlieb, however, expects the CFPB to operate as though it is business as usual, at least until a court specifically strips Cordray's legal standing. “What is the CFPB going to do? Nothing,” he says. “They will continue to do exactly what they want to do until told otherwise by a court. They are not going to shut anything down.”

Last week, President Barack Obama officially nominated Cordray as director of the Consumer Financial Protection Bureau. At the very least, the NLRB decision will surely complicate Cordray's new nomination and upcoming confirmation hearings. The timing of that nomination, Gottlieb says, is certainly suspicious.

“I don't believe in coincidence,” he says. “I think that probably the court gave a heads up that it was going to issue a ruling and they wanted to get the appointment in place in advance of that ruling. It is very peculiar timing.”