On October 19, 2022, the Fifth Circuit sent shock waves through the financial world, ruling that the Consumer Financial Protection Bureau’s (“CFPB” or the “Bureau”) independent funding structure violates the U.S. Constitution’s Appropriations Clause. Based on this separation-of-powers violation, the court struck down the CFPB’s 2017 Payday Lending Rule (the “Payday Rule”), and through its reasoning called into question literally every action the Bureau has ever taken. Indeed, the court’s reasoning makes it unclear how the CFPB can even keep its lights on, as every ongoing activity of the Bureau requires funding, and that funding has been held constitutionally invalid.
While the decision’s reasoning has these broad potential consequences, it is important to note that it addressed only the Payday Rule. It does not mean that regulated persons can simply ignore prior Bureau guidance and regulations, refuse to participate in examinations, ignore Civil Investigative Demands, or otherwise proceed as if the CFPB has disappeared. It does, however, provide a strong basis for challenging all of these things and more.
We discuss below the decision, its far-reaching implications, and what comes next.
The Decision
In Community Financial Services Association of America v. Consumer Financial Protection Bureau, two trade groups sued the CFPB and its Director, challenging the Bureau’s 2017 Payday Lending Rule on several grounds. That rule was promulgated in 2017 to regulate short-term, small-dollar loans, vehicle title loans, and certain other installment loans. One of the many components of the Rule, the “Payment Provisions,” limited a lender’s ability to obtain loan repayments via preauthorized access. See 12 C.F.R. § 1041.8. Under those provisions, it was deemed “unfair and abusive” for lenders to attempt to withdraw loan payments from consumers’ accounts after two consecutive withdrawal attempts failed due to a lack of sufficient funds, unless they have a new and specific authorization from the consumer. Id. §§ 1041.7, 1041.8(b)(1), (c)(1).
After the district court upheld the Payday Rule on summary judgment, the plaintiffs appealed on four principal grounds: (1) the Rule was outside the Bureau’s authority and violated the Administrative Procedure Act; (2) it was promulgated by a director unconstitutionally insulated from presidential removal; (3) the Bureau’s rulemaking violated the nondelegation doctrine; and (4) the Bureau’s funding mechanism violated the Appropriations Clause. The Fifth Circuit rejected the first three challenges, but held that the Bureau’s funding structure violates the U.S. Constitution’s Appropriations Clause and the separation of powers principles enshrined in it.
Under the Appropriations Clause, Congress has exclusive power over the federal purse. The clause’s language, that “no money shall be drawn from the Treasury, but in Consequences of Appropriations made by Law” is, according to the Fifth Circuit, the “bulwark of the Constitution’s separation of powers.” In finding a constitutional violation, the court keyed in on what it called the Bureau’s “double-insulated” funding structure. Unlike most agencies which depend on annual appropriations for funding, the CFPB simply requests funding from the Federal Reserve in an amount determined by the agency’s director to be reasonably necessary to carry out its functions, subject only to a cap of 12% of the Federal Reserve’s total inflation-adjusted operating expenses. The “double” insulation from the appropriations process stems from the fact that the Federal Reserve also operates outside the appropriations process. Moreover, the Bureau maintains its funds in a separate account, is not required to remit any excess funds back to the Treasury (unlike other agencies), and its use of its funds is not subject to oversight by the Appropriations Committee.
As such, under the Dodd-Frank Act, Congress “did not merely cede direct control over the Bureau’s budget by insulating it from annual or other time limited appropriations. It also ceded indirect control by providing that the Bureau’s self-determined funding be drawn from a source that is itself outside the appropriations process,” a result that is “unprecedented” given the Bureau’s “capacious portfolio of authority.” The court also noted that, following the Supreme Court’s decision in Seila Law, the CFPB’s solitary leader removal at the President’s pleasure represents “the epitome of the unification of purse and sword.” Because the court found that the Bureau could not have issued the Payday Lending Rule but for its unconstitutional funding, it vacated it.
The Bureau’s Next Steps
The Bureau already has dismissed the decision, issuing a statement that “[t]here is nothing novel or unusual about Congress’s decision to fund the CFPB outside of annual spending bills.” It presumably will seek further appellate review by petitioning the Fifth Circuit for rehearing en banc and/or petitioning for Supreme Court review. In another recent decision, Consumer Financial Protection Bureau v. All American Check Cashing Inc., the Fifth Circuit, sitting en banc, allowed a Bureau enforcement action to proceed despite the unconstitutionality of the CFPB’s single-director structure at the time the enforcement action was filed. But in a concurrence filed by Judge Edith Jones, five judges expressed the view that the CFPB’s funding mechanism is unconstitutional. As such, the Bureau may view further review by the Fifth Circuit to be a lost cause and proceed directly to the Supreme Court. Neither the Fifth Circuit nor the Supreme Court is required to grant review, however.
The Decision’s Implications and Where We Go From Here
So what are the implications of this decision? Here are some initial thoughts:
Further (And Perhaps Permanent) Delay of the Payday Rule. At the outset, the court’s holding as to the Payday Rule means that lenders need not comply with it while the Bureau works through the appeal process. Compliance with the Rule was originally set for August 2019. That is of course delayed. And as things stand, the rule may never go into effect.
Continued Challenges to the Bureau’s Regulatory Authority. We should also expect to see continued challenges attacking the Bureau’s authority to issue rules, regulations, and informal guidance. For example, the U.S. Chamber of Commerce and other trade groups recently filed an action against the Bureau in the Eastern District of Texas challenging the agency’s updates to the unfair, deceptive and abusive acts and practices (“UDAAP”) section in the Supervision and Examination Manual. In that lawsuit, the plaintiffs specifically challenged the constitutionality of the Bureau’s funding mechanism. Given the Fifth Circuit’s decision, it is likely that the Chamber will seek to stay implementation of the examination manual’s recent updates, and perhaps move for summary adjudication of the unconstitutional funding issue. Likewise, we could see challenges to other rules and guidance from the Bureau, such as the relatively new Debt Collection Rules.
Enforcement Actions are Vulnerable to Challenge. What is the potential impact on enforcement actions? Under the Fifth Circuit’s logic, all Bureau actions depend on this unconstitutional funding mechanism. The Bureau lacks constitutional funding to prosecute them and, to the extent they rely on Bureau-promulgated rules, the rules themselves are void. As such, all Bureau enforcement actions are vulnerable to challenge. Parties in active litigation or administrative proceedings with the Bureau should review and consider raising similar challenges to the Bureau’s funding mechanism. But to insulate themselves from further challenges, we should also see the Bureau continue to partner with other regulatory and enforcement authorities such as the FTC and state Attorneys General, who are not hampered by the funding issue. What about past enforcement actions that have settled and where companies have paid civil money penalties? While not addressed by the court, it is unlikely these actions are revivable. The Bureau will claim that that any arguments challenging the constitutionality of its funding mechanism, if not raised in the first instance, were waived.
Will Other Courts Agree? While the decision obviously is helpful in cases within the Fifth Circuit, persons seeking to challenge CFPB actions other than the Payday Rule may need to bring those cases in other circuits based on where they reside or are organized. Other courts may reject the Fifth Circuit’s reasoning and find the Bureau’s funding mechanism constitutional for the same reasons expressed by the district court in this case. For this reason, litigation of challenges to CFPB actions based on this theory is likely to take years, with the potential for a circuit split requiring the Supreme Court to decide the issue if it does not do so here.
Furthermore, because many companies have made huge investments in complying with Bureau regulations such as TRID, the financial services industry may be divided on the right approach.
Other Federal Regulators Are in the Crosshairs. We could see similar constitutional challenges to other federal financial regulators such as the OCC. In its opinion, the court noted that several other federal financial regulators are also self-funded and exempt from appropriations. The Federal Reserve, the FDIC, the OCC, the National Credit Union Administration and the Federal Housing Finance Agency all have “uncapped budgetary autonomy,” so they too could face separation-of-powers challenges. On the other hand, the Fifth Circuit attempted to draw a distinction with the Bureau, stating that none of these agencies wield enforcement or regulatory authority in the same expansive and impactful manner as the CFPB. Whether that distinction will prove persuasive remains to be seen, as agencies like the OCC and Federal Reserve also have an outsized regulatory impact on the U.S. economy. However, the CFPB’s unitary leadership structure, directly answerable to the President, may provide a basis for distinguishing these agencies and their funding mechanisms.
How Should Companies Engage with the Bureau and Bureau Regulations? As noted, the Bureau is likely to appeal this decision, and others courts may rule differently on the same issue. While the matter works its way through the courts, companies are advised not to pull back from their compliance obligations. Companies should presume the validity of the rules, regulations and interpretative guidance promulgated by the CFPB. We also believe that companies can continue to rely on various regulatory safe harbors such as the model validation notice for debt collections, or TRID disclosures for TILA/RESPA compliance. Companies that are in early-stage enforcement actions with the Bureau or are facing supervisory examinations should tread carefully and engage competent counsel to help them navigate these issues. Remember, the litigation over the removal of Bureau’s director took years to resolve, and while companies raised arguments concerning the constitutionality of the Bureau’s structure then, the Supreme Court’s decision in Seila Law did not ultimately save anyone. The Fifth Circuit’s decision, while a temporary speedbump for the Bureau, ultimately will not slow down its work or change its policy priorities, at least not in the near term.
Bad News on the Nondelegation Doctrine. While CFPB critics were delighted by the decision on the funding issue, the Fifth Circuit’s opinion also rejected another important argument for challenging the Bureau’s use of its UDAAP authority under the nondelegation doctrine, which limits the extent to which Congress can delegate rulemaking authority to the executive branch. That doctrine recently has been revitalized by the Supreme Court in decisions including West Virginia v. EPA, providing an opportunity to challenge UDAAP rulemaking and “regulation through enforcement.” However, the Fifth Circuit concluded that the Dodd-Frank Act’s definition of “unfairness” provided an “intelligible principle” adequate to guide the CFPB’s use of its rulemaking authority, defeating the application of the nondelegation doctrine. It remains to be seen if Dodd-Frank’s broad definitions of unfairness and abusiveness will support efforts by the CFPB to undertake new rulemakings and other activity in areas like fair lending where Congress in other legislation has clearly defined what behaviors are prohibited and what agency actions are authorized.
What Will Congress Do? Congress plainly has the authority to address the funding issue prospectively by amending the Dodd-Frank Act to subject the Bureau to the appropriations process. But can it save past actions by an unconstitutional agency? We think it likely could ratify existing regulations and guidance by passing legislation adopting them with retroactive effect, given that regulated persons had notice of the rules when they were promulgated. Prior enforcement activity, to the extent it can be invalidated at this point, may be a tougher question. With a deeply divided Congress and many competing priorities, it is unclear how Congress will proceed.
We will continue to monitor developments in this area and keep our clients informed. For more information on the decision and its ramifications, please contact any of the authors or the Manatt professional with whom you work.