Major financial firms almost never litigate with their regulators. As a result, regulators often take aggressive enforcement positions with little fear of judicial scrutiny. That’s been especially true for the Consumer Financial Protection Bureau (“CFPB”), perhaps the most aggressive agency in the federal government. Major financial institutions have paid billions of dollars in settlements with the CFPB without a court weighing in on the CFPB’s interpretations underlying these actions.        

The lone, notable exception is PHH Corporation (“PHH”), which, after refusing to settle with the CFPB in connection with claims based on mortgage reinsurance, was hit by Director Cordray with a $109 million disgorgement order and an expansive injunction.  Yesterday, on appeal, PHH had its day in court. Based on the oral argument, the U.S. Court of Appeals for the D.C. Circuit appears poised to reject Director Cordray’s decision and also to rule that the concentration of power in a single individual not subject to removal at will by the President violates the Constitution’s separation of powers.  We discuss five key takeaways from the oral argument that are important not only for PHH but potentially for other parties who come before the CFPB and other enforcement agencies.

Background
PHH is not a major Wall Street bank, but is nonetheless a substantial mortgage lender with over a billion-dollar market cap. In January 2014, the CFPB filed a Notice of Charges accusing PHH and four of its affiliates with violating the Real Estate Settlement Procedures Act (“RESPA”) by accepting payments from mortgage insurers to whom a PHH mortgage lender referred mortgage insurance business. The payments were in the form of reinsurance premiums, and were paid to PHH affiliates that are in the business of providing reinsurance. There was no allegation that the payments were outside industry norms, or that the reinsurance was illusory, or that the mortgage insurers charged borrowers above-market rates. The CFPB ultimately ruled, however, that the receipt of such payments violated RESPA because they were part of a referral arrangement—absent payment of reinsurance premiums to PHH affiliates, PHH’s mortgage lender would not refer business to the mortgage insurers. The CFPB brought at least a dozen other RESPA “kickback” cases against firms that, unlike PHH, settled.

The CFPB brought the case administratively, which meant that PHH first had to litigate before an administrative law judge (“ALJ”) and then before the CFPB’s sole Director, Richard Cordray. ALJs rarely rule in favor of respondents, and no one who knows Director Cordray’s background [1] would expect him to take anything other than the most aggressive interpretations of the statutes the agency is charged with enforcing. Not surprisingly, PHH lost before both, with the ALJ ordering PHH to pay $6.4 million in disgorgement and Director Cordray raising that to $109 million. 

Last year, PHH appealed Director Cordray’s decision to the U.S. Court of Appeals for the D.C. Circuit, a court known for carefully scrutinizing agency actions. Yesterday, the D.C. Circuit held oral argument. [2]

The Argument
If the oral argument is an indication of the opinion that the court will eventually issue, the court appears poised to reject Director Cordray’s decision and also to rule that the concentration of power in a single individual not subject to removal at will by the President violates the Constitution’s separation of powers.  The court peppered the CFPB’s counsel not only with questions that suggested great skepticism towards the CFPB’s positions, but with observations that suggested outright rejection of those positions. Our five key takeaways below are based on the court’s comments and questions at oral argument.

1. The Merits. The court appeared unreceptive to Director Cordray’s holding that payments of reinsurance premiums violate RESPA because they involve referrals, even though actual services were provided and the payments were at market rates. RESPA prohibits kickbacks and fee splitting, but the court focused on the language of Section 8(c)(2) of RESPA, which permits “bona fide” payments for “services actually performed.” In response to the CFPB’s argument that payments could not be “bona fide” if they were the product of referrals, the court asked, “Why isn’t the most natural reading of bona fide equivalent to fair market value?” Further, “The reason Congress put bona fide in presumably was to insure that it reflected a real salary, real compensation, which is usually determined by fair market value.” In response to the CFPB’s frequent use of the word “kickback,” the court asked, “If someone is providing a service at fair market value, can that be a kickback?” With respect to the CFPB’s argument that the court’s fair market value interpretation would make other language in Section 8 redundant, the court said, “Congress is often redundant in covering the waterfront and making sure things are either prohibited or exempt when they’re doing things like that. That’s very common.”
2. Fair Notice. The court appeared sympathetic to PHH’s Due Process argument that prior to Director Cordray’s decision, the industry had relied on prior agency interpretations that appeared to permit similar reinsurance arrangements. For example, the court said, “The relevant agencies here had issued definitive statements saying that this activity was legal. And there were repeated statements saying as much.” Further, “The entire industry had the opposite reading [from the CFPB’s], confirmed repeatedly by HUD. Everyone understood what the deal was. If you [the CFPB] want to change it going forward, we can talk about the statutory issue – whether you have authority to do that – but to pull the plug and change it going backwards is very problematic, at least under the Supreme Court’s precedent.” Also, “Correct me if I’m wrong. Everyone was doing this….Do you think they were ‘Oh, it’s blatantly illegal. We’re just going to do it anyway?’ I just don’t think that was going on throughout the industry. They thought, they asked, and maybe they didn’t parse the grammar correctly but there was a widespread understanding, wasn’t it, that this was legal?” With respect to the CFPB’s argument that the guidance on which the industry relied ( a 1997 HUD staff letter) was not a formal rule and that HUD regulations cautioned that informal staff letters do not provide a defense to liability, the court said, “Supreme Court case law on fair notice does not require some formal regulation. It’s as if the police officer says you can cross the street here, and then when you get to the other side the officer gives you a thousand-dollar ticket. That’s what it seems like happened here. You had this blessing to go ahead and then it’s $109 million.”
3. Application of the Rule of Lenity. The rule of lenity holds that in construing an ambiguous statute that authorizes the imposition of criminal penalties, as RESPA and many other consumer protection statutes do, a court should resolve the ambiguity in favor of the defendant. It’s the opposite of the argument that a court should defer to an agency’s interpretation of an ambiguous statute. Contrary to the position of the CFPB, the court appeared sympathetic to applying the rule of lenity. It said, “Footnote 9 of Chevron says that we’re supposed to use all the tools of construction before we go to step 2 [deference]. And the rule of lenity is one of those tools of construction, correct?” Further, “Footnote 9 of Chevron talked about the traditional tools of construction, and the rule of lenity, as Justice Scalia most prominently has said, is foundational.” And further, “The reason for that is that it’s fundamentally unfair, a due process type concern, to interpret ambiguity in a criminal statute or a statute that can be criminally enforced against an individual. It’s foundational to individual liberty that ambiguity is not going to be used against you.”
4. Statute of Limitations. The CFPB argued that RESPA’s 3-year statute of limitations for enforcement actions applies only to actions brought in court rather than actions brought administratively, and that no statute of limitations applied to the administrative proceeding against PHH. The court expressed great skepticism that there could be no statute of limitations. It characterized the CFPB’s theory as “allow[ing] the Director to go back decades and impose major liability on someone for something that happened a long time ago, which we don’t ordinarily see.” It asked, “How do you distinguish the long line of cases that I mentioned dating back to the early 1800s that when there is judicial action by a federal official and the governing statute does not have a statute of limitations the courts borrow either a state statute of limitations or a federal [statute]…The court says that it would be an abomination to have a federal official not bound by a statute to bring an action decades after the event.” After asking the CFPB’s counsel to identify the reasons that statutes of limitations exist, it challenged him to identify why any of those reasons were any less applicable to an administrative rather than a judicial proceeding. The best he could do was acknowledge that all of those reasons applied to both, to which the court asked, “So why would Congress put a statute of limitations only on a judicial proceeding?”
5. Violation of the Separation of Powers. The CFPB argued that the fact that the president can only remove Director Cordray for cause does not violate the Constitution’s separation of powers requirement because the Supreme Court previously upheld a similar arrangement involving the Federal Trade Commission. The D.C. Circuit, however, appeared ready to distinguish that case on the ground that power there was dispersed among members of a multi-member commission rather than concentrated in a single director. In response to the CFPB’s argument that it fell within prior precedent, the court stated, “But they’re commissions. That’s the difference. Historically, independent agencies have been multi-member on the theory that they’re non-partisan or bi-partisan. This is a novel structure—very few precedents that I found….” Further, “The reason for the Commission structure was that this is an exception or difference from the usual control the president has over the executive branch, and that if we’re going to have that kind of structure, we want it to be a group that’s going to be non-partisan or bi-partisan. You can’t have that with a single person. You’re concentrating in a single person a huge amount of power and the president has no authority over that.” Further, “It is very dangerous in our system to put such huge power in a single person.” When counsel for the CFPB pointed to the single-director Social Security Administration, the court stated, “When that was created, President Clinton issued a signing statement saying that there were severe Constitutional problems with that agency.”  On the other hand, the court appeared potentially receptive to the argument that the remedy for the Constitutional violation might be merely to sever the for-cause clause. That was the result in the Supreme Court’s 2010 decision in Free Enterprise Fund v. Public Accounting Oversight Board, in which the Court, after finding that the absence of executive control over the Board violated Article II’s vesting of executive power in the President, held that the Board could continue to function as before but that its members could be removed without cause.

In each of these five areas, the panel’s questions and comments suggested strong disagreement with the CFPB’s positions.  Of course, the panel’s decision will not necessarily be the end of the road for the CFPB, which, if the decision is unfavorable for it, might seek en banc review or file a petition for certiorari in the Supreme Court. But the odds of reversing a D.C. Circuit decision by seeking en banc or Supreme Court review are not high.

Conclusion
Beyond these takeaways, a favorable outcome for PHH would provide a broader lesson to the industry: that it is possible to successfully litigate against the CFPB and other enforcement agencies. It requires, however, a high tolerance for litigation risk and an ability and willingness to devote the resources to take the case through the court of appeals process without certainty as to outcome. In most cases, litigating before the CFPB itself, in which all appeals from administrative actions are decided by its sole Director, is not likely to produce a favorable result.

For the CFPB, a reversal of Director Cordray’s decision in PHH may cause the agency to file contested cases outside the D.C. Circuit.  But it may also cause the agency to consider using its rulemaking authority if it wants to change prior industry guidance, rather than attempting to do so retroactively by issuing aggressive administrative decisions with eye-popping financial consequences.