Here We Go Again: Fifth Circuit Rules The CFPB’s funding mechanism is unconstitutional and overturns the Payday Lending Rule
On October 19, 2022, a three-judge panel of the United States Court of Appeals for the Fifth Circuit ruled that the funding mechanism for the Consumer Financial Protection Bureau (CFPB) violated the Constitution’s appropriation clause and thus overturned the 2017 Payday Loan Rule of the CFPB. In the event of Community Financial Services of America v Consumer Financial Protection Bureau(“Community finances’), the court ruled that the CFPB’s independent funding from the Federal Reserve was unconstitutional and that the Payday Lending Rule was made possible by that unconstitutional funding source and should be repealed. While the CFPB will almost certainly be aiming for a repeat en banc or appealing to the Supreme Court, the ruling calls into question the validity of all rulemaking and enforcement activities that the CFPB has undertaken since its inception.
Since the CFPB’s inception, numerous parties have challenged its structure as unconstitutional. In case of Seila Law, LLC v Consumer Financial Protection Bureau, the Supreme Court ruled that the structure of a single director-led agency, which can only be removed by the president “for cause” violates the separation of powers clause. More specifically, however, the court found that provision was severable and accordingly simply invalidated the “cause of cause” requirement in the Dodd-Frank Act, essentially changing Dodd-Frank to allow the CFPB director to be at the discretion of the President can be dismissed. Instead of those from the CFPB in Seila lawthe court remanded this case to the trial court to assess the implications for the civil enforcement process.
in the Community finances Plaintiffs sued the Bureau in 2018 on behalf of payday lenders and credit access firms, seeking an order repealing the 2017 Payday Credit Rule (“the Rule”), alleging that the Rule violated the statutory authority of the CFPB and, aside from other arguments that the regulatory authority violated the constitution’s separation of powers. The rule, which governs payday, vehicle title, and other types of consumer loans, was proposed under Director Richard Cordray in 2016, became final in 2017, and went into effect in 2018. The rule generally prohibits what the Bureau considers to be unfair and abusive practices in the underwriting, payment and collection of such loans. In particular, the plaintiffs challenged sections relating to limitations on a lender’s ability to obtain loan repayments through pre-authorized account access. See 12 CFR §1041.8. In essence, the rule prohibits any further attempts to withdraw payments from accounts after two consecutive withdrawal attempts have failed due to insufficient funds.
While the case was pending, the CFPB, under Acting Director Mick Mulvaney, issued a new notice and comment period to consider revisions to the rule. The district court in Community finances granted a stay during these proceedings. Eventually, the CFPB, under Director Kathy Kraninger, enacted a new rule proposal that eliminated the insurance-related portions of the rule but left the payment provisions intact. In addition, after the judgment of the Supreme Court in Seila lawDirector Kraninger finalized the revised rule and issued a “ratification” of the rule. The district court then reversed the stay and the parties filed appropriate motions for summary judgment. The district court entered summary judgment for the CFPB, ruling that (1) the director’s deportation did not invalidate the rule from the beginning(2) the Director’s ratification of the rule resolved every constitutional violation plaintiffs suffered, (3) the rule was within the authority of the CFPB and was not arbitrary or capricious, (4) the CFPB’s funding mechanism did not violate the Appropriations Clause and (5) the action of the CFPB did not violate the doctrine of non-delegation.
The judgment of the fifth federal court
On appeal, the Fifth Circuit sided with the CFPB on essentially all but one, albeit crucial, issue of impact. The court ruled that the CFPB acted within its authority in making the rule and that the CFPB did not act arbitrarily or unpredictably in making the rule. In addition, the court ruled that the plaintiffs did not show that the director’s deportation at the time the rule was promulgated caused the plaintiffs specific harm and, consequently, they did not even need to consider whether director Kraninger’s ratification had cured that harm . The court also ruled that the rule did not violate the non-delegation doctrine because the wording of the Dodd-Frank Act creating the CFPB established an “understandable principle” that guided the CFPB’s discretionary powers to “rigorously enforce implementation and, where appropriate, consumer finance laws, to ensure 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 “unlawful, unfair, deceptive, or abusive acts or practices” in the related to consumer finance.
However, the court ruled in favor of the plaintiffs as to whether the CFPB’s funding structure violated the Appropriations Clause. The court emphasized that unlike most other federal agencies, the CFPB is not subject to annual Congressional appropriations. Rather, the CFPB is funded by the Federal Reserve, with the only restriction being that the director submit an amount that is deemed “reasonably necessary” to perform his duties and that the amount does not exceed 12% of the Federal Reserve’s total operating expenses . The court further emphasized that the Federal Reserve is even outside of the fund allocation process through bank appraisals and that all monies transferred to or acquired by the CFPB be held in a fund under the exclusive control of the Director of the CFPB, further isolating them from Congressional oversight. The court found that this multiple foreclosure of the appropriation process “is tantamount to an unscheduled charge card that rings.”[un]Adequate Funds” and that Congress “violated the separation of powers embodied in the Appropriations Clause” in approving such a funding structure.
The court further ruled that the plaintiffs could easily have demonstrated direct harm from this constitutional issue “because the funds used by the bureau to promulgate the payday loan rule were drawn entirely from the agency’s unconstitutional funding system.” The plaintiffs were entitled to “a reversal of [the Bureau’s] Action.” The court ruled on that claim for the plaintiffs and cleaned up the rule.
The CFPB can either request a rehearing en banc before the full Fifth Circuit or the Supreme Court certiorari. A en banc The decision may not be worth considering as the Fifth Circuit is not perceived to be positive about the CFPB’s position. The Bureau has about 50 days to act. The Fifth Court Panel’s decision may be stayed if the case advances without immediate impact on the CFPB’s operations. But the ruling has far-reaching and far-reaching implications for the agency’s future.
For example, if that decision is upheld en banc reviewed by the Supreme Court or endorsed by other courts, this could have implications for the whole of legislation and Enforcement actions taken by the CFPB since its inception, as potentially all such actions could be challenged as being funded through an unconstitutional mechanism. Likewise, it would create a funding crisis for the Bureau since neither the en banc Neither the Fifth Circuit nor the Supreme Court would be able to provide a replacement funding mechanism for the Bureau and advance the “solution” to a potentially divided or Republican-controlled Congress.
In the meantime, financial services firms will continue to make such arguments in response to the CFPB’s administrative actions, civil investigation requests, and even enforcement actions, all of which rely on a funding source that an appeals court has now ruled unconstitutional. Although litigants would have to prove that the unconstitutional funding mechanism caused them specific harm, the Fifth Circuit’s ruling is “make[es] this shows  straight forward,” noting that “the funds used by the Bureau to promulgate the payday loan rule were drawn entirely from the agency’s unconstitutional funding system, [and therefore] There is a linear relationship between the weak provision (the Bureau’s funding mechanism) and the contested action (rule promulgation).”
Similar logic appears to apply to all of the rules made by the CFPB since its inception, including but not limited to the Mortgage Servicing Rules, the Ability to Repay and Qualified Mortgage Rules, the Integrated Mortgage Loan Disclosures Rule and the most recent Debt collection rules. But financial services firms may argue that even CFPB enforcement actions under laws and regulations not enacted by the CFPB are unconstitutional because the CFPB can only conduct such enforcement actions through a constitutionally prohibited funding source.
Given the current composition of the Supreme Court, the Supreme Court’s prior willingness to declare aspects of Dodd-Frank unconstitutional is in Seila law, coupled with the high probability that Congress would pass legislation that would address this issue in an election year or after, this issue could remain unresolved in the short term. The CFPB is not expected to change its current priorities, agenda and approach to oversight of consumer financial products and services. Organizations should continue to focus on compliance and risk mitigation.