A divided panel of the U.S. Court of Appeals for the District of Columbia Circuit ruled October 11, 2016, that the current structure of the Consumer Financial Protection Bureau (CFPB) is unconstitutional. The court concluded that an independent agency such as the CFPB cannot have a single director who is beyond the supervision of the President. The court called the CFPB Director “the single most powerful official in the entire U.S. government, other than the President,” in terms of unilateral power.

Although other independent agencies governed by multi-member commissions are permissibly structured, as are executive agencies headed by individuals who report to the President, the CFPB’s novel single-director structure who may be removed only for cause violates the Constitution. Rather than find that the CFPB could no longer operate because of this constitutional problem, however, the court ruled that the agency could operate but that the director now reports to the President, who can now remove the director at will.

The court also unanimously rejected: (1) the CFPB’s interpretation of the permissibility of captive reinsurance arrangements under the Real Estate Settlement Procedures Act (RESPA); (2) the CFPB’s attempted retroactive application of its interpretation; and (3) the CFPB’s argument that under the Dodd-Frank Act of 2010, there is no statute of limitations for any CFPB administrative actions. The last of these rulings may ultimately prove, in the long run, to be the most significant setback for the CFPB’s regulatory agenda.

The case may embolden regulated parties to litigate with the CFPB, at least until the constitutional question is more definitively settled.

Separation of Powers Refresher

In a lengthy opinion, the court reviewed the fundamentals of the Framers’ intended separation of powers and tracked the development of this principle through two centuries of caselaw. In 1926, for example, the U.S. Supreme Court recognized the President’s Article II authority to supervise, direct, and remove at will subordinate officers in executive agencies in Myers v. United States, 272 U.S. 52. Nine years later, the Supreme Court created an exception to Myers by permitting Congress to create independent agencies that exercise executive power. Humphrey’s Executor v. United States, 295 U.S. 602 (1935). Independent agencies, such as the Securities and Exchange Commission and National Labor Relations Board, differ from executive agencies because independent agency heads are removable by the President only for cause, not at will, and therefore the President does not supervise or direct them.

As the D.C. Circuit explained on Tuesday, “[t]he independent agencies collectively constitute, in effect, a headless fourth branch of the U.S. Government.” The court cautioned, “Because of their massive power and the absence of Presidential supervision and direction, independent agencies pose a significant threat to individual liberty and to the constitutional system of separation of powers and checks and balances.”

To check the power of independent agencies, they historically have been headed by a multi-member commission as opposed to an individual director, which, in theory, reduces the risk of arbitrary decisionmaking. Congress, however, in passing the Dodd-Frank Act, created the CFPB and its novel structure. Although originally proposed to be governed by a multi-member commission, various compromises led to its establishment with only a single director.

Single-Director Structure Is Unconstitutional for Independent Agency

The court concluded that the “vast power over the U.S. economy” held by the CFPB is problematic given that it lacks the critical check of a multi-member governing structure. Although PHH argued that the CFPB’s unconstitutional structure should prevent it from continued operation, the court chose a narrower remedy and severed the Dodd-Frank Act’s for-cause provision from the remainder of the statute. That is, the CFPB may continue to operate but the President now may remove the director at will, and may supervise the director. The director of the CFPB is now akin to the heads of executive agencies in terms of relationship to the President.

CFPB’s Specific Statutory Interpretations Rejected

The controversy originated in a CFPB enforcement action brought against PHH, Inc., a mortgage lender, that resulted in imposition of $109 million in penalties. PHH sought to vacate the order on grounds that included a challenge, under Article II of the Constitution, to the CFPB’s status as an independent agency headed by a single director.

PHH also raised specific challenges to the CFPB’s statutory rulings in the order levied against PHH. The court unanimously agreed that the CFPB incorrectly interpreted Section 8 of RESPA to bar all captive reinsurance arrangements. In such arrangements, a mortgage lender such as PHH refers borrowers to a mortgage insurer, which then buys reinsurance from a mortgage reinsurer affiliated with the referring mortgage lender. In the PHH case, the mortgage reinsurer was a wholly-owned subsidiary of PHH. The court concluded that these arrangements are permissible as long as the relevant mortgage insurers pays no more than reasonable market value to the affiliated reinsurer.

The court also agreed with PHH that the CFPB departed from the Department of Housing and Urban Development’s consistent prior interpretations of these arrangements. Specifically, the court rejected the CFPB’s attempts to retroactively apply its new interpretation against PHH. According to the court, the CFPB’s attempted retroactive application “violated bedrock principles of due process.”

The court also rejected the CFPB’s argument that Dodd-Frank imposes no statute of limitations for any CFPB administrative actions to enforce any consumer protection laws. The court concluded that the Dodd-Frank Act incorporates the respective statutes of limitation contained in the underlying statutes enforced by the CFPB and thus RESPA’s three-year statute of limitations was applicable.

Judge Henderson joined in the majority’s opinion in rejecting the CFPB’s statutory rulings but dissented from the majority’s constitutional analysis because she believed that the court could have decided the case without reaching the constitutional question.

The court remanded the case for the CFPB to determine whether the mortgage insurers in the PHH captive arrangement paid no more than reasonable market value for reinsurance from PHH’s wholly-owned mortgage reinsurer.

The CFPB may file a petition for panel rehearing or petition for rehearing en banc within 45 days.