Per the Fifth Circuit Court of Appeals: the Consumer Financial Protection Bureau’s (CFPB) funding structure is unconstitutional, and the 2017 Payday Lending Rule, which was a direct result of this unconstitutional funding mechanism, must be vacated.
Does this mean that the CFPB itself is unconstitutional? What does this mean in the long run for the CFPB? And what does this bombshell decision mean for the ARM industry?
To assess where we are headed, here are three things you need to know about the October 19, 2022 Opinion in Community Financial Services Association of America v. CFPB (Case No. 21-50826, 5th Cir. 2022):
1. The Court said the CFPB’s funding structure was unconstitutional. Does that mean that the CFPB itself is unconstitutional?
The Community Financial Services Association of America (CFSA) argued that the CFPB’s “vague and sweeping” rulemaking authority is too broad without guiding principles and therefore violates the Constitution’s separation of powers. The Court disagreed. Instead, it held that though the boundaries set for the CFPB’s rule-making authority are broad, they exist and are delineated. Further, because Congress’s grant of rulemaking authority to the CFPB was accompanied by a specific purpose, objectives, and definitions to guide its discretion, granting authority to the CFPB passes muster and is sufficient.
That said, though the CFPB has the authority to make rules, the Court held its funding structure was unconstitutional. Under the Appropriations Clause of the constitution, as part of our system of checks and balances, congress has the “power over the purse.” Most other executive agencies rely on annual appropriations for funding. The CFPB, however, is not required to rely on appropriations. Instead, it simply requests an amount from the Federal Reserve that the CFPB director determines is reasonably necessary to carry out the CFPB’s business. So long as that request doesn’t exceed 12% of the Federal Reserve's total operating expenses, the request must be granted. According to the Fifth Circuit, this “double insulation from congress’s purse strings,” is unconstitutional.
Regarding the severity of the unconstitutional funding mechanism of the CFPB, the Court referenced an Alexander Hamilton quote and minced no words, stating, “ An expansive executive agency insulated (no, double-insulated) from Congress’s purse strings, expressly exempt from budgetary review, and headed by a single Director removable at the President’s pleasure is the epitome of the unification of the purse and the sword in the executive—an abomination the Framers warned 'would destroy that division of powers on which political liberty is founded.'”
2. If the CFPB was funded improperly does that mean every CFPB rule is invalidated?
No, again. This decision doesn't mean that every rule the CFPB has created since its inception is automatically invalidated. The Court explicitly stated that though it held the funding structure of the CFPB is unconstitutional, CFSA was not entitled to a compulsory invalidation of the Payday Lending Rule.
Instead, the Court explained that to vacate the Rule, CFSA must show that the unconstitutional funding provision inflicted harm. That said, the Court found that in this case, the inflicted harm was straightforward because a CFPB report shows that it spent over nine million dollars for “research, markets & regulations” during the fiscal quarter in which the rule was issued. Since the CFPB lacked any other means to promulgate the rule without its unconstitutional funding, CFSA showed sufficient harm, and the Rule was vacated.
3. So, what does this mean for the CFPB's Payday Lending Rule? If the Bureau were properly funded, would the rule have survived?
The Court did not say the Payday Lending Rule was unconstitutional or that the CFPB lacked authority to create it.
The Consumer Financial Protection Act (Act) grants the CFPB the power to make rules prohibiting “unfair, deceptive, or abusive” acts or practices in connection with consumer financial products or services. There are specific definitions in the Act that govern when an act or practice may be deemed “unfair” or “abusive.” Under the Act, an act or practice meets the definition of “unfair” if the CFPB has a reasonable basis to conclude that (1) the act or practice causes or is likely to cause substantial injury to customers; (2) is not reasonably avoidable by consumers; and (3) is not outweighed by the countervailing benefits to consumers or competition.
As explained in more detail here, the Payday Lending Rule regulates payday, vehicle title, and high-cost installment loans. Its provisions include a prohibition on attempting to debit an account again after two unsuccessful attempts. Though the CFSA did not dispute that consumers may experience injuries after failed payment attempts, they argued that lenders are not the cause of those injuries since the consumer's bank decides whether to charge a fee or close the account. Since the lenders are not imposing the charge for withdrawal attempts, the CFSA argued that attempting to withdraw funds multiple times does not meet the definition of “unfair”, and therefore, the CFPB lacks the authority to regulate this practice.
The Court disagreed with the CFSA. It concluded that the definition of “unfair” was satisfied because consumers would not be harmed without the repeated initiation of unsuccessful attempted withdrawals. Though insufficient funds charges come from a third party (namely the consumer’s financial institution), the role played by lenders in bringing about the harm cannot be erased. The court also rejected CFSA’s arguments that consumers could reasonably avoid charges if they would fund their accounts properly or choose not to utilize these financial products.
You can read the full opinion here.
Thoughts from the Legal Advisory Board
Joann Needleman, Member, Clark Hill, PLC - "As much as industry did not like the CFPB, I do not think, after a decade, it was ever about its existence, but how it went about regulating the consumer financial services marketplace. Financial service regulators are nothing new. It was the breadth of power and unaccountability that was a concern. Because of its unaccountability it lost its credibility. It was also about its attitude that the only way to protect consumers was by taking a totalitarian approach. Nobody ever believed that it was an “independent” agency and this was certainly true during the prior Administration when you saw how Congress reacted when they did not have “their” person at the CFPB. Since its inception, the CFPB has been a political football and the financial services industry simply cannot operate in that type of environment. Going forward I hope changes to the CFPB will bring more collaboration, more opportunities for consensus building and more measured approaches so that consumers can reap the true benefits of the CFPB’s work. The time has come to bring a commission to the CFPB."
Brit Suttel, Shareholder, Barron &Newburger, P.C. - "I think the ruling is fascinating and the industry will certainly feel ripple effects. I think right now the focus continues to be on the 5th Circuit because that is the only circuit where the ruling has precedential effect. The holding will likely be a focus in the case that was filed against the CFPB by various trade organizations regarding the UDAAP examination update regarding fair lending and discrimination. I also think it is very likely that this will end up in the Supreme Court."
Stefanie Jackman, Partner, Troutman Pepper - "An appeal is very likely. Many think that the Fifth Circuit went further than necessary with its remedy. If the Supreme Court agrees that the funding process is unconstitutional but agrees that unwinding a decade plus of activity is not feasible, the easiest solution for the Court may be to simply strike the language in Dodd-Frank exempting the CFPB from the appropriations process. That should default to it being funded through appropriations and also would be consistent with Chief Justice Roberts' position that the Court should not legislate or rewrite the law."
John Bedard, Bedard Law Group, P.C.- "I am so pleased to see Courts finally listening to arguments about the [un]constituionality of the CFPB. Hopefully, this decision will cause other courts throughout the country to think twice before cavalierly dismissing constitutional challenges to the CFPB."
Only time will tell what the long-term effects of this case will be. The CFPB did not put a “closed for business” sign on its door when the opinion came out. Its also important to note that had the CFPB been properly funded, the Payday Lender Rule would have survived. With that in mind, it would not be wise to unravel compliance procedures or assume the CFPB will disappear anytime soon. However, this case may be the catalyst of some changes at the CFPB and certainly gives those inside and outside of the Fifth Circuit Court of Appeals reason to move to dismiss CFPB actions.