The PHH Decision—A Suggested Analysis for Covered Institutions

A recent federal appeals court ruling in favor of mortgage company PHH Corp. has created a level of uncertainty regarding the Consumer Financial Protection Bureau and all of its enforcement actions taken in the past five years. This article analyzes the PHH decision, offers suggestions for consumer financial companies subject to the CFPB's jurisdiction to consider, and provides alternative approaches the CFPB's management might consider on a go-forward basis.

Joseph T. Lynyak III

By Joseph T. Lynyak III

Joseph T. Lynyak III is a Partner in Dorsey & Whitney LLP's Finance & Restructuring Group and a member of the Banking Industry Group. He practices in both the firm's Washington, D.C., and Southern California offices.

For the first time since the New Deal, the constitutionality of a federal agency was directly addressed by the courts. On Oct. 11, a three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit) found that the Consumer Financial Protection Bureau (CFPB) was structured in a manner that violates the constitutional prerogative of the president to hire and fire agency heads without cause. In addition, the D.C. Circuit soundly criticized several administrative actions taken by the CFPB against PHH Mortgage Company (PHH), and reversed those actions, including the imposition of a $109 million dollar disgorgement order assessed against PHH.

Notwithstanding a litany of adverse decisions it made against the CFPB, the D.C. Circuit restored the constitutional validity of the CFPB prospectively by rewriting the CFPB's enabling statute to permit the president to fire the director of the CFPB without cause.

This unique decision has created a level of uncertainty regarding the CFPB and all of its aggressive enforcement actions taken in the past five years. For example, since its inception, the CFPB has collected over $11 billion in civil money penalties (CMPs) from persons and institutions it has targeted. It has entered into consent agreements based upon statutes of limitation (SOL) that now may be viewed as having expired. Further, the deliberative process by which the CFPB has adopted controversial new interpretative legal positions that effectively reversed decades of administrative law may now be under scrutiny. Finally, and perhaps most importantly, the public policy debate regarding the advisability of restructuring the governance structure of the CFPB to create a commission is now reopened.

This article analyzes the PHH decision and its component parts, and offers suggestions for consumer financial companies subject to the CFPB's jurisdiction to consider, and provides alternative approaches the CFPB's management might consider on a go-forward basis.

Background of the PHH Case and the D.C. Circuit's Decision

In 2014, the CFPB initiated an administrative action against PHH in which it alleged that PHH was violating Section 8 of RESPA for establishing a reinsurance affiliate and collecting premiums for accounts for which the reinsurance agency held an interest. Importantly, PHH defended its actions based upon a Department of Housing and Urban Development (HUD) interpretative letter (which was relied upon by the mortgage industry for over 19 years) that authorized the practice being complained of by the CFPB. (Among other things, that HUD guidance required that a reinsurance affiliate assume actual credit risk exposure, and specified several procedures necessary to make use of the safe harbor created by the HUD interpretative letter.)

In the administrative proceeding, the CFPB disagreed that PHH's reinsurance affiliate complied with RESPA's requirement that it only receive fees for the risk assumed. In addition, it rejected the reliance placed by PHH on compliance with the HUD letter, and in statements belying fundamental hubris, indicated that a regulated entity could not rely upon any reasonable administrative guidance except that which is formally included in agency regulations.

In the administrative enforcement action, the CFPB fined PHH approximately $6.5 million as an appropriate disgorgement remedy, which PHH appealed to the director of the CFPB. In the appeal, PHH argued that: (a) PHH was entitled to rely upon the HUD letter; (b) the CFPB's newly minted interpretation of Section 8 of RESPA was never announced to the public and hence violated PHH's due process rights by retroactively applying a completely new interpretation of RESPA without adequate public notice; and (c) the CFPB exceeded the applicable statute of limitations relating to the alleged RESPA violations.

In a ham-handed response (and, to some observers, retaliatory), the director confirmed the administrative hearing determination and increased the disgorgement amount from approximately $6.5 million to $109 million. Among other things, the director took the legal position that when it uses its enforcement authority, the CFPB was not subject to a SOL (arguably allowing it to look backward in time to the establishment of the U.S. government). Finally, in a statement that smacks of noblesse oblige, the director elected not to impose CMPs on PHH in addition to the increased disgorgement order.

PHH appealed the director's affirmation of the administrative hearing, which was heard by the D.C. Circuit in early 2016. In defense of its position, PHH forcefully challenged the constitutionality of the CFPB's structure based upon basic principles embodied in the U.S. Constitution relating to the separation of powers. According to PHH, in order to pass constitutional muster, an agency deemed to be an “independent” agency must be governed by a commission rather than by a single individual. In the case of the CFPB, the enabling legislation for the CFPB limited the president's power to fire the CFPB's director only “for cause,” rather than pursuant to the permissible extent of the executive's authority.

In addition to its constitutional arguments, PHH repeated the arguments it had made in its administrative appeal to the Director of the CFPB that: (i) the CFPB's novel interpretation of RESPA was incorrect as a matter of law ( i.e., the statute at issue, Section 8 of RESPA, was clear); (ii) the CFPB had denied PHH due process by not providing any advance notice of its new interpretative position; and (iii) the CFPB was subject to an applicable stature of limitation (which in this instance was three years).

A final decision was issued on Oct. 11, 2016, by the D.C. Circuit. The decision was extremely critical of the CFPB, and the D.C. Circuit ruled in favor of PHH on all of the legal positions it raised.

On the substantive legal issues, the D.C. Circuit made three findings. First, it held that Section 8(c) of RESPA clearly authorized the creation of the reinsurance subsidiary by PHH, provided that reasonable value was paid to the reinsurance subsidiary for the actual risk assumed. The court rejected the CFPB's view that Section 8(c)(2) of RESPA did not create an exception to the prohibition on referrals as contained in Section 8(a). Rather, the D.C. Circuit adopted the long-standing interpretation of Section 8(c) that provided an exception to the referral prohibition so long as actual services were provided and the payment received was commensurate with the services. Second, the court held that the refusal to provide advance notice of its controversial interpretative positon on RESPA was a violation of due process and thereby negated the $109 million dollar civil money penalty assessed against PHH. Third, the D.C. Circuit dismissed as clearly erroneous the position that the CFPB was not subject to a statute of limitation, and held that the CFPB's administrative enforcement action was subject to RESPA's three-year SOL.

Before making these findings, however, the D.C. Circuit concluded that it had to address the constitutionality of the CFPB's structure. After analyzing somewhat arcane case law, the D.C. Circuit found that the limits placed on the president's authority by the CFPB's enabling statute to only authorize the dismissal of the Director for cause created an infirmity in the CFPB's structure that failed constitutional muster. Rather than leaving the Administration with an agency that was defective on a go-forward basis, however, the D.C. Circuit took it upon itself to rewrite the CFPB's enabling statute and thereby corrected the CFPB's constitutional defect prospectively.

Considerations for Affected Consumer Financial Service Parties

Besides being a comprehensive criticism of the overall conduct of the CFPB, many companies are now considering the implications of the PHH decision. Assuming that the CFPB elects not to appeal (a path that we would advise if asked), we offer several observations for companies affected by previous agency actions:

Recoupment of Civil Money Penalties Paid

Many companies and individuals have paid significant CMPs to the CFPB that now arguably may be void or voidable because the status of the CFPB as an unconstitutionally structured agency completely negated its ability to take enforcement action against a party forced into settlement by the CFPB's enforcement staff.

The question arises, therefore, what might be a remedy for a company that previously settled with the CFPB? First, while it might be possible to merely seek an administrative remedy before the CFPB, a more likely avenue might be to seek to recover previously paid CMPs in the federal Court of Claims pursuant to that court's authority to hear contract claims involving the federal government pursuant to the Tucker Act. Because the CFPB arguably falsely claimed it was a validly existing independent agency and was authorized to enter into a contract of settlement with a counterparty, the Court of Claims might look favorably on such an action and treat consent order as contract claims within its jurisdiction.

Second, the grounds upon which a potentially defective order may have been entered should be reviewed—specifically the terms of an enforcement order as it relates to the applicable SOL. If an enforcement order and alleged violations relates to a time period that currently now exceeds the applicable SOL, the remedial measures might now be beyond the CFPB's ability to relitigate the same. Importantly, in reference to the past payment of CMPs assessed by the CFPB, an evaluation whether alleged violations exceed a SOL if computed today would constitute a basis for seeking reimbursement of previously paid CMPs.

Amendment to Non-Monetary Enforcement Orders and Provisions

In addition to the possible recoupment of improperly paid CMPs paid, there are literally dozens of enforcement actions issued by the CFPB that now may be defective. While in many cases remedial measures previously ordered by the CFPB may have been salutary in effect by requiring companies to adopt improvements to their compliance management systems, the implications of the possible defective nature of any such orders should be considered. This is because the failure to comply with the terms of a consent order with the CFPB can itself constitute a stand-along separate violation that enables the CFPB to take further enforcement action. Clarifying that an order is no longer valid (at least in regard to further enforcement action) might be in the proper circumstances strategically appropriate.

In the minimum, the status of an existing consent order creates the possibility of renegotiating terms and conditions originally agreed to by a company—including remedial measures deemed onerous or impractical.

The CFPB's Reaction to the PHH Decision

The D.C. Circuit was undeniably critical of the CFPB's conduct in connection with its dealings with PHH, and the opinion contains not only harsh criticism of the agency but also reasonable suggestions for improving future agency conduct. We offer the following as possible lessons to be learned by the CFPB:

Quantitative Considerations

In terms of its deliberative processes, the D.C. Circuit opinion suggests that the CFPB might consider several changes when implementing its statutory mission.

First, the CFPB should reconsider its interpretative approach to consumer regulation. A review of its rulemakings leads one to the conclusion that regulations are frequently written by a committee and the complexity of its final rules is oftentimes overwhelming. For example, the newly minted Truth in Lending Act-RESPA Integrated Disclosure (TRID) rules are now being reexamined by the CFPB, yet in its proposed changes critically important corrections suggested by mortgage lenders addressing error correction procedures have been ignored. Generally, the CFPB might elect in the future to concentrate on producing regulatory guidance that establishes bright-line tests to be followed by the industry, rather than complex and poorly written regulations.

Second, the CFPB should cease its practice of refusing to provide clear guidance to regulated companies, and engage in real constructive dialogue with industry participants. This failure may be due in part to the staff composition at the CFPB that favors aggressive enforcement versus focused and balanced regulation and supervision. In any event, a commission form of governance would significantly assist by bringing to the table qualified experts whose expertise extends beyond formerly acting in the capacities of attorneys general and prosecutors.

Third, structurally, the CFPB's enforcement division should be placed under the direct supervision of the legal division of the CFPB. Anecdotally, the current organizational of the CFPB encourages aggressive enforcement behavior without reasonable policy balancing outside of the enforcement silo that currently exists. For example, the CFPB has taken extreme positions regarding its computation of the number of consumer violations that occur, as well as the possible exposure to a company when targeted in an enforcement action. In the case of PHH, the CFPB deemed RESPA to be violated each time the reinsurance affiliate received a premium payment—which meant that PHH was arguably exposed to an astonishingly high potential CPM. The potential for abusive enforcement in light of the CFPB's exceptional range of penalty alternatives argues strongly for the imposition of legal oversight of the CFPB's enforcement mechanisms based upon sound policy.

Qualitative Considerations

A significant portion of the D.C. Circuit's opinion addresses the value of a commission form of governance, including how a commission might assist the achievement of public policy goals. The D.C. Circuit is the most experienced federal court when viewing the administrative functions of the federal government, and is most likely to review CFPB conduct in the future. The PHH decision should, therefore, be viewed as an admonition to the CFPB compelling it to conform to the broad historical parameters of federal agency administrative law. While the D.C. Circuit has indicated its willingness to forgive the CFPB if it “walks the line” in the future, the PHH decision clearly demonstrates that future actions that exceed administrative norms will be viewed in an extremely skeptical manner by the courts.

Whether the CFPB elects to moderate its administrative behavior could reveal itself in its continued emphasis on relying upon alleged UDAAP violations without providing the industry with clear guidance. Similarly, the CFPB might begin to minimize its regulation of the consumer financial services industry through enforcement action by providing the clarity that can be achieved through the administrative rulemaking process.

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