Fifth Circuit Panel Rules CFPB Funding Mechanism Is Unconstitutional

With the dark cloud over the Consumer Financial Protection Bureau (CFPB) that was the constitutional challenge to the for-cause limit on removal of its Director having mostly lifted, a new and more ominous cloud has descended in the form of another constitutional challenge.

On October 19, a unanimous three-judge panel of the U.S. Court of Appeals for the Fifth Circuit ruled that the CFPB’s funding mechanism violates the U.S. Constitution’s Appropriations Clause and the separation of powers principles on which it is based.

Pursuant to the Dodd-Frank Act, the CFPB receives its funding through requests made by the CFPB Director to the Federal Reserve, subject to a cap equal to 12 percent of the Federal Reserve’s budget, rather than through the congressional appropriations process.

The ruling was issued in Community Financial Services Association of America, Limited v. Consumer Financial Protection Bureau, a lawsuit brought by the CFSA and another trade group challenging the payment provisions in the CFPB’s 2017 final payday/auto title/high-rate installment loan rule (Rule). (Under former Director Kraninger, the CFPB rescinded the Rule’s ability to repay provisions but ratified its payment provisions.)

The district court granted summary judgment for the CFPB, rejecting all of the trade groups’ claims, including their arguments that the Consumer Financial Protection Act’s restriction on the CFPB Director’s removal (which the U.S. Supreme Court ruled was unconstitutional in Seila Law) rendered the Rule void ab initio and that the Rule was invalid because the CFPB’s funding mechanism violates the Appropriations Clause.

Prior to oral argument in the trade groups’ Fifth Circuit appeal, the en banc Fifth Circuit ruled in CFPB v. All American Check Cashing that the CFPB’s enforcement action against All American could proceed despite the removal provision’s unconstitutionality at the time the enforcement action was filed.

The en banc Fifth Circuit did not reach All American’s alternative argument that the CFPB’s funding mechanism contravened the Constitution’s separation of powers and instead left that issue open for the district court to consider on remand. However, in a concurring opinion in which four other Fifth Circuit judges joined, Judge Edith Jones agreed with All American’s argument that the CFPB’s funding mechanism was unconstitutional and concluded that the proper remedy was for the enforcement action to be dismissed. The trade groups submitted the concurring opinion as supplemental authority to the Fifth Circuit panel hearing their appeal and argued that the panel should adopt the reasoning of the concurring opinion and invalidate the Rule.

The Fifth Circuit panel first rejected the trade groups’ arguments that the Rule’s payment provisions were invalid because (1) they were promulgated by a CFPB Director who was unconstitutionally insulated from removal by the President, (2) they were promulgated in violation of the Administrative Procedure Act because the Rule exceeded the Bureau’s UDAAP authority and was arbitrary and capricious, and (3) the CFPB’s rulemaking authority represents an unconstitutional delegation of legislative power to the CFPB by Congress because there is no intelligible principle behind the CFPB’s broad rulemaking authority.

Turning to the trade groups’ Appropriations Clause argument, the Fifth Circuit panel first referenced the “magisterial separate opinion” written by Judge Jones in All American and announced that they reached the same conclusion as Judge Jones “that the Bureau’s funding mechanism contravenes the Constitution’s separation of powers.” Based on its review of the Appropriation Clause’s history, the panel established the critical role that the Clause is intended to play in the separation of powers by ensuring Congress’s exclusive power over the federal purse. With that backdrop, the panel examined the CFPB’s funding mechanism. Observing that the CFPB receives its funding directly from the Federal Reserve which itself is funded outside of the appropriations process, the panel stated:

So Congress did not merely cede direct control over the Bureau’s budget by insulating it from annual or other time limited appropriations. It also ceded indirect control by providing that the Bureau’s self-determined funding be drawn from a source that is itself outside the appropriations process–a double insulation from Congress’s purse strings that is ‘unprecedented’ across the government….Whatever the line between a constitutionally and unconstitutionally funded agency may be, this unprecedented arrangement crosses it (emphasis included).

The panel rejected the CFPB’s argument that its funding mechanism satisfied the Appropriations Clause because that mechanism was created by Congress and could be altered by Congress. According to the panel, a law alone did not satisfy the Appropriation Clause’s command that “No money shall be drawn from the Treasury, but in Consequence of Appropriations made by law” (emphasis added). In the panel’s view, to satisfy the Clause, “an appropriation is required.”

Having concluded that the CFPB’s funding mechanism “cannot be reconciled with the Appropriations Clause and the clause’s underpinning, the constitutional separation of powers,” the panel turned to the question of remedy. The panel drew a distinction between the CFPB’s power to take an action and having the lawful money necessary to take that action. Based on the Supreme Court’s decision in Collins (which held that the restriction on the FHFA Director’s removal was unconstitutional), the panel found that because the violation did not remove the CFPB’s power to promulgate the Rule, the trade groups had to show harm resulting from the Appropriations Clause violation. However, it considered “making that showing [to be] straightforward in this case” because without the unconstitutional funding, the CFPB “lacked any other means to promulgate the rule.” According to the panel, the trade groups “were thus harmed by the Bureau’s improper use of unappropriated funds to engage in the rulemaking at issue.”

The panel reversed the district court’s grant of summary judgment in favor of the Bureau on the Appropriations Clause issue, and vacated the Rule “as the product of the Bureau’s unconstitutional funding scheme.”

Given the decision’s enormous potential implications, we expect the CFPB to seek to overturn the ruling by either petitioning the Fifth Circuit for a rehearing en banc or proceeding directly to the Supreme Court with a certiorari petition.

The CFPB would appear to face daunting odds in obtaining a rehearing en banc. For a petition for rehearing en banc to be granted, a majority of the active Fifth Circuit judges must vote in favor of a rehearing. The Fifth Circuit currently has 16 active judges. (There is one vacancy and President Biden’s nominee to fill the vacancy is awaiting a confirmation vote in the Senate.) Of the 16 active judges, 12 are nominees of Republican Presidents (including five nominated by President Trump). In addition to the three Republican-appointed active judges on the panel who ruled for the trade groups, four other Republican-appointed active judges have indicated they agree the CFPB’s funding mechanism is unconstitutional by joining in the concurrence in All American. Assuming these seven active judges would vote against a rehearing en banc, a rehearing en banc could only be granted if nine of the remaining active judges were to vote in favor of a rehearing. Since only four of the nine remaining judges are Democratic appointees, even assuming all four Democratic nominees were to vote in favor of a rehearing, a rehearing en banc would require all five Republican nominees to vote in favor of a rehearing. Assuming the CFPB engages in a similar “head counting,” it might decide not to seek a rehearing en banc and instead file a certiorari petition with the Supreme Court and ask the Fifth Circuit to stay its mandate while the petition is pending.

Perhaps foremost among the decision’s enormous implications is its potential impact on all rules and guidance that the CFPB has issued as well as on any other actions the CFPB has taken based on its UDAAP or other authority, both ultimately if the decision becomes final in its present form and during the pendency of the rehearing/certiorari petition process. Those actions include existing enforcement orders, particularly ones with ongoing reporting and related requirements. At present, the Fifth Circuit’s decision is only binding on federal district courts in Texas, Louisiana, and Mississippi. However, because it is an appellate court ruling, it might be given weight by district courts outside of the Fifth Circuit considering challenges to CFPB enforcement actions and other CFPB activity based on an alleged Appropriations Clause violation.

The decision, if it becomes final in its present form, would appear to mean that for the CFPB to survive, it will have to become subject to the congressional appropriations process. Such a change would carry vast political implications that are likely to impact how the CFPB approaches its mission. 

Beyond its potential implications for the CFPB, the decision also has potential implications for other federal agencies that are funded outside of the congressional appropriations process. In addition to the Federal Reserve, the OCC, FDIC, NCUA, and FHFA are not funded through appropriations.

While the panel observed that “[t]he Bureau’s perpetual self-directed, double-insulated funding structure goes a significant step further than that enjoyed by the other agencies” and that none of these agencies have enforcement or regulatory authority “remotely comparable” to that of the CFPB, the panel did not provide clear guidance on what “the line between a constitutionally and unconstitutionally funded agency may be.”  Thus, the decision creates the potential for these other agencies to face Appropriations Clause challenges to actions they take.

Consumer financial services providers face an increasingly complex regulatory landscape. Innovative new technologies have emerged to deliver products and services and the roles of federal and state regulators are evolving. Our nationally recognized Consumer Financial Services Group helps clients chart a course to achieve their business objectives in these times of change and challenge. Please call us for more information.

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