In a much-anticipated oral argument, the D.C. Circuit considered a wide array of legal issues that could restrict the Consumer Financial Protection Bureau's enforcement authority and its "regulation by enforcement" practices, and may overrule controversial interpretations of the Real Estate Settlement Procedures Act (RESPA) that have in recent years thrown settlement services providers and lenders into a compliance tailspin.

The panel heard the appeal of PHH Corporation, a mortgage lender that the CFPB alleged violated RESPA's prohibition on payment of "kickbacks" or things of value in exchange for referrals through a captive mortgage reinsurance arrangement, where it referred borrowers to mortgage insurance providers and, in return, its affiliate company Atrium reinsured those mortgages. Operating under the long-held belief that such arrangements were carved out of RESPA's prohibition through a safe harbor that allows payments for actual services rendered at fair market value (which was supported by guidance issued by the Department of Housing and Urban Development (HUD), the previous steward of RESPA before the CFPB's formation), PHH found itself the subject of an enforcement action by the CFPB and on the wrong end of a $6 million disgorgement penalty issued by an Administrative Law Judge.

An appeal to the CFPB's Director Richard Cordray not only reaffirmed the CFPB's position that the reinsurance contracts were not protected under the safe harbor, but also increased the penalty to $109 million. Among the reasons for the increase, Director Cordray found that no statute of limitations applied to administrative actions (as opposed to civil actions in federal court) brought by the CFPB under the Consumer Financial Protection Act (CFPA) and that each payment of reinsurance premiums moving forward after closing of the loan constituted a kickback.

On appeal to the D.C. Circuit, PHH challenged these rulings and asserted that the Director's order should be overturned because the make-up of the Bureau is unconstitutional, the Bureau's approach of making law by enforcement action is unfair, and damages should be limited by RESPA's statute of limitations. This set the stage for a contentious oral argument with wide-ranging potential consequences for the agency and the industries it regulates.

"Regulation by Enforcement" Practices Criticized

While the case itself is about RESPA, a theme that permeated the hearing was CFPB's controversial practice of "regulation by enforcement"—where regulated parties may be unaware that the agency views a specific practice as unlawful until they are facing enforcement actions. The panel seemed skeptical of this practice and raised serious questions about its propriety, especially for conduct that historically has been viewed as lawful or even "blessed" informally by regulators. The parties discussed fair notice principles, the effect of prior agency guidance on the CFPB, and the application of the rule of lenity (considering RESPA carries the potential for criminal penalties)—all doctrines and ideas that relate to the ability of the Bureau to advance an interpretation of a statute through adjudication and consent orders.

PHH argued that the company (as well as the industry as a whole) had no notice regarding the CFPB's interpretation of the statute at issue, which it argued cut against years of precedent. Thus, while CFPB could issue a rulemaking changing interpretation of the statute, PHH argued that it was fundamentally unfair to change it covertly and apply a new interpretation for the first time in an enforcement action. PHH argued that this violates the Due Process Clause and doctrine against retroactivity, and that since RESPA contains the potential for criminal liability, the rule of lenity should apply to any ambiguity that may exist.

The Bureau, in response, argued that the agency may interpret ambiguities in the statutes that the CFPB is tasked with enforcing. The Bureau also argued that the HUD letter cited by PHH provided no protection from liability, since it was disclaimed as informal guidance and specific to an individual request. The panel seemed skeptical of CFPB's position and sympathetic to PHH's arguments on due process and fair notice, but it remains to be seen whether the eventual opinion will address these issues broadly, or confine its analysis to the specific facts of the case.

Interestingly, the Bureau's dismissal of informal HUD guidance raises questions regarding whether, and the extent to which, industry participants can rely on the CFPB's own guidance, which typically contains similar disclaimers stating that any guidance is unofficial and nonbinding. CFPB's efforts to support compliance through small entity compliance guides, bulletins, webinars, and other informal means have been praised by an industry tasked with complying with complicated and confusing new regulations. But the CFPB undermines its own efforts by sending a signal that the enforcement office is free to selectively ignore guidance that it deems inconvenient.

Ruling Could Clarify the Scope of RESPA's Safe Harbor

With respect to RESPA, the panel considered arguments from both sides regarding the Section 8(c)(2) safe harbor provision and its viability in circumstances where service contracts are entered into at fair market value between parties that refer business to one another—a practice that for years was viewed as acceptable and within the safe harbor, but has been called into question by the CFPB through enforcement actions. The panel again seemed sympathetic to PHH's position and could reaffirm the safe harbor's availability for reinsurance contracts. Such a ruling also could potentially clarify the applicability of the safe harbor in other contexts, such as marketing services agreements (MSAs), which, like mortgage reinsurance, traditionally were viewed as falling within the safe harbor, but have recently been questioned by the CFPB.

For years, HUD, other regulators, courts, and industry participants interpreted Section 8(c)(2) to allow contracts between parties that may refer one another to customers for settlement service business, so long as any payments made under those agreements were "bona fide," meaning for actual services performed and at fair market value. Indeed, business practices like captive mortgage reinsurance, marketing services agreements, and others were designed specifically around this interpretation and supported by guidance issued by HUD.

When the CFPB took over responsibility for interpreting and enforcing RESPA, this suddenly changed, and (through enforcement, not rulemaking) the CFPB began interpreting the term "bona fide payment" to address not only the relationship between the amount paid and the value of the service, but the CFPB's perceived intent of the parties to the contract. In the CFPB's view, any contract—even a legitimate contract for services at fair market value and not a penny more—could be deemed a "kickback" if the underlying intent in awarding that contract may be to generate referrals. This reading of the statute formed the basis for its complaint against PHH and was the subject of much discussion at oral argument.

The CFPB argued that HUD never expressly sanctioned contracts awarded in this context, but the panel appeared convinced that the term "bona fide" historically had meant no more than the fair market value. The panel seemed to agree with PHH that it was unfair for an agency to effect such a radical departure from previous guidance and understanding through an enforcement action with draconian penalties and no notice to the parties, indicating that such an interpretive change is better accomplished via rulemaking.

Should the panel reverse the CFPB on this issue and solidify the applicability of the Section 8(c)(2) safe harbor, it would be a victory for the industry and would provide much-needed clarification of what is permitted and what is prohibited under RESPA Section 8. The effect of this ruling would reach beyond mortgage reinsurance. It also would help to clarify the permissibility of MSAs between parties to real estate transactions, for lead or contact list purchases, and for various back-end vendor agreements and subcontracts.

Statute of Limitations

Another controversial aspect of Director Cordray's order was the holding that no statute of limitations applies to cases brought in the CFPB's administrative adjudication proceedings. The Bureau's position is based on the language of the CFPA and an interpretation of the term "action" as used in the statute. For its part, PHH has contested the Director's reading and interpretation of the statute, and argued that as a matter of fairness and due process, a statute of limitations (here, RESPA's) must apply in administrative adjudications.

The panel did not focus on the statutory interpretation arguments, but instead questioned the outcome (i.e., whether Congress truly intended for the CFPB to be able to bring enforcement actions in its administrative forum without time limitations). The panel appeared convinced that some limitations period must apply to administrative actions, and questioned whether cases (or the doctrines underlying them) in which courts have "borrowed" statutes of limitations from other laws would be applicable.

Should the panel impose or borrow a statute of limitations, the decision will provide much-needed clarity regarding the potential liability exposure of companies responding to a Notice of Charges in the CFPB's administrative forum, which may also inform prior settlement negotiations.

Constitutionality Questions

Finally, the panel heard arguments regarding the constitutionality of various parts of the Bureau's makeup. PHH argued that several aspects of the CFPB's structure and Director Cordray's appointment, taken as a whole, contravened the separation of powers and general notions of checks and balances. These include the use of a single director who is removable only for cause and lack of congressional appropriations or oversight, coupled with the broad authority delegated to the Bureau through the CFPA.

It is unclear whether the panel will seriously entertain a constitutional ruling on the structure of the Bureau, but the judges expressed some concerns about the agency and the Director's accountability, particularly with respect to removability only for cause. At one point, the panelists suggested that striking the "removal for cause" language from the CFPA could eliminate any constitutional issues that might be found to exist.

The D.C. Circuit's ruling in this case, and any subsequent appeals, play an interesting role in the development of law around the CFPB—both specific to the CFPB's interpretation and use of RESPA, as well as more generally regarding the Bureau's approaches to enforcement and its authority.