In 2014 a New Jersey mortgage lender called PHH found itself in trouble with the U.S. Consumer Financial Protection Bureau. An administrative judge at the agency ordered the company to disgorge $6.4 million in ill-gotten gains from an insurance-kickback scheme. Later, the CFPB’s director, Richard Cordray, decided that didn’t go far enough. He raised the penalty 17-fold, to $109 million.
Denying any wrongdoing, PHH took its case to the U.S. Court of Appeals for the D.C. Circuit. The result could disrupt the very structure of the CFPB. No decision has yet been made, but in oral arguments on April 12, judges hearing the case raised questions far more consequential than how much, if anything, PHH ought to pay. Although it’s risky to predict a legal result based on comments from the bench, the judges sounded wary of the powers that have been given to the CFPB director.
The agency was created in 2010 by the financial reform law known as Dodd-Frank, which gave the CFPB authority to police credit cards, debt collection, home and payday loans, and other areas where consumers interact with the financial system. Under Cordray’s leadership, the CFPB has imposed billions of dollars in penalties, restitution, and compliance costs on financial giants, including Bank of America, Capital One, Citigroup, and JPMorgan Chase.
The dispute over the CFPB is the latest attempt by business interests to limit the scope of Dodd-Frank. Backed by Wall Street and corporate lobbyists, Republicans in Congress have tried to roll back various provisions of the law. That effort has so far failed, and now the courts have become an alternative venue for the campaign. “The financial industry is using all the tools available to resist the regulation mandated under Dodd-Frank,” says Brian Marshall, policy counsel at Americans for Financial Reform, an advocacy group.
On March 30, in a separate case, a federal trial judge in Washington rejected a major ruling by the Financial Stability Oversight Council, another creation of Dodd-Frank. The FSOC had designated MetLife too big to fail, making the largest U.S. life insurance company subject to heightened regulatory and financial requirements. The court called that decision “arbitrary and capricious.”
If upheld, the ruling favoring MetLife could undermine the council’s authority to designate nonbanks as “systemically important financial institutions” subject to tougher rules because their failure could ignite widespread panic. “This decision leaves one of the largest and most highly interconnected financial companies in the world subject to even less oversight than before the financial crisis,” Treasury Secretary Jacob Lew said in a statement. Lew, Federal Reserve Chair Janet Yellen, and Cordray are three of the council’s 10 voting members.
MetLife said it was “pleased” with the decision. The court embraced the company’s claim that the oversight council hadn’t considered the potential financial effects of its decision on the insurer. That reasoning could open the door for other companies—including American International Group and Prudential Financial—to challenge their designation as systemically important.
The legal battle against Dodd-Frank features some star lawyers. MetLife’s lead attorney, Eugene Scalia, son of late Supreme Court Justice Antonin Scalia, is a partner at the Washington law office of Gibson, Dunn & Crutcher. In recent years, the younger Scalia has brought successful suits eroding Dodd-Frank rules that limited speculative trading in derivatives, let shareholders more easily oust corporate directors, and forced disclosure of payments to foreign governments to facilitate oil and gas projects.
Scalia’s law partner, Ted Olson, a former solicitor general in the George W. Bush administration, argued PHH’s appeal challenging the CFPB. That case began with the agency’s determination that the company had arranged illegal kickbacks when it steered borrowers to mortgage insurers who bought reinsurance from one of its own subsidiaries. PHH contends its conduct was proper and has been standard in the industry for decades.
On appeal, Olson and other lawyers at Gibson Dunn raised a slew of objections, some quite technical. In addition, Olson’s team asserted that the CFPB’s structure violates the constitutional principle of separation of powers, because its sole director, Cordray, can’t be easily ousted by the president and isn’t accountable to Congress. In an unusual arrangement, the CFPB draws its funding from the Federal Reserve System, not the legislative appropriations process. Olson emphasized that the president cannot remove CFPB director Cordray unless he neglects his duties or seriously misbehaves.
Shortly before the oral arguments, the D.C. Circuit panel tipped its hand by specifically instructing lawyers for both sides to address, out of all the issues raised by PHH, the constitutional challenge. With perhaps some hyperbole, Olson told the court: “In summary, this is an unprecedented, unconstitutional agency that has more power than Congress and the president put together.” Rather than object to Olson’s bold claim, the two judges present in the courtroom, Brett Kavanaugh and A. Raymond Randolph, seemed to encourage him at every turn. A third judge, Karen Henderson, will review the arguments via audio recording and participate in the decision. All three were appointed by Republican presidents.
The CFPB’s attorney, Lawrence DeMille-Wagman, contended that the agency’s structure isn’t unique: The Social Security Administration, the Office of Special Counsel, and the Federal Housing Finance Agency are each overseen by a single person. But Kavanaugh seemed to embrace PHH’s argument. “You are concentrating in a single person a huge amount of power, and the president has no authority over that,” he told DeMille-Wagman. “It’s very dangerous in our system to put such huge power in a single person.”
DeMille-Wagman responded that “the president has sufficient control,” because he does have the power to remove a director for cause.
“Really? I don’t understand that,” Kavanaugh replied. The judge pointed out that Cordray’s five-year term ends in 2018, meaning the next president will have to leave him in place for more than a year, even if the two disagree on policy.
That fact, combined with the CFPB’s independence from the congressional appropriations process, “creates a complete lack of accountability, which should be fatal to the agency,” says Sam Kazman, general counsel for the advocacy group Competitive Enterprise Institute. The institute filed a brief supporting PHH and is itself challenging the CFPB’s legitimacy in a separate lawsuit.
If the D.C. Circuit panel finds a constitutional flaw but doesn’t want to take the drastic step of invalidating the CFPB altogether, it could simply throw out the for-cause removal provision and make the director subject to being fired by the president for any reason. The prospect of any restructuring, though, “would be a big step in the wrong direction, entangling the CFPB with politics,” says Marshall of Americans for Financial Reform, which isn’t involved in the case.
The fight over Dodd-Frank’s progeny isn’t likely to end soon. The government has already announced it will appeal its loss in the MetLife case. And whoever wins the CFPB case, the loser is sure to appeal that one, too.
The bottom line: Companies are stepping up their fight in the courts against the 2010 financial reform law. They’ve already notched some victories.