In a significant ruling with broad financial services repercussions, the U.S. Court of Appeals for the Fifth Circuit, sitting en banc, has ruled that the Federal Housing Finance Agency (FHFA), the conservator for both Fannie Mae and Freddie Mac, is unconstitutionally structured because its director may be removed solely for cause. The court therefore severed that provision from the law. Because this provision is substantially similar to the statutory structure for the Consumer Financial Protection Bureau (CFPB), it is now highly probable that the same court will likewise find the CFPB structure unconstitutional.
What happened
In 2008, during the subprime meltdown, Congress passed the Housing and Recovery Act (HERA), which established the FHFA and authorized it to, among other things, serve as conservator or receiver for Fannie Mae and Freddie Mac “for the purpose of reorganizing, rehabilitating, or winding up the[ir] affairs.” HERA created FHFA as an independent agency, and provided that its director may be removed by the President solely for cause.
Collins v. Mnuchin is one of numerous shareholder challenges to a 2012 agreement between the FHFA (as conservator) and the Treasury Department under which Treasury provided billions of taxpayer dollars in capital but Fannie and Freddie were required to pay Treasury quarterly dividends equal to their entire net worth. This exchange is known as the “net worth sweep.” The result left investors with sharp losses.
In July 2018, a three-judge panel of the Fifth Circuit concluded that the FHFA was not constitutionally structured but that the “net worth sweep” deal was proper. Plaintiffs sought en banc review (that is, review by the entire Fifth Circuit panel).
On review, the en banc decision largely affirms the three-judge panel. That said, the decision is a complex one because it includes two separate majority rulings and multiple dissents. Read together, the decision has the effect of reinstating the three-judge panel’s conclusion that the remedy for such constitutional violation is to sever the “for-cause” removal provision.
While the CFPB repercussions are obvious, they might not compel the same result. On the side of unconstitutionality, the CFPB, just like the FHFA, has a single director who may be removed solely for cause, and it is not subject to congressional appropriations because it receives its funding directly from the Federal Reserve.
In March 2019, the Fifth Circuit heard oral argument in All American Check Cashing, a case challenging the CFPB’s constitutionality. The plaintiff there took an interlocutory appeal of a district court’s ruling upholding the CFPB’s constitutionality. In Collins, however, the court did take pains to distinguish the FHFA structure from that of the CFPB. The court noted it was “mindful” of the PHH Mortgage v. CFPB decision of the D.C. Circuit that upheld CFPB constitutionality, but “salient distinctions between the agencies compel a contrary conclusion.” For example, the Financial Stability Oversight Council may control CFPB regulatory conduct due to its ostensible veto authority, although that authority is extraordinarily limited and requires a supermajority vote. In contrast, the Federal Housing Finance Oversight Board that oversees the FHFA possesses mere “advisory” authority. So there are important differences that might cause the Fifth Circuit to reach a different result, and the ultimate outcome may very well rest on the Fifth Circuit panel’s willingness to reject PHH Mortgage.
To read the en banc ruling, click here.
Why it matters
The Fifth Circuit’s ruling has important implications for the FHFA, which serves the all-important role of conservator of Fannie and Freddie. But, of significant interest to those who follow the CFPB, a Fifth Circuit ruling that deems the CFPB unconstitutional would likely lead to a review by the Supreme Court to resolve the circuit split. Stay tuned.