The PHH Case—PHH Corporation et.al. v Consumer Financial Protection Bureau—is extremely important not just for its judgment that the CFPB is structured unconstitutionally, but as a window into how the Bureau operates and how it can abuse its enormous power. (That ruling has been set aside and the case is currently being reheard.)
The case revolves around an interpretation of Section 8 of the Real Estate Settlement Procedures Act of 1974, which bans “kickbacks” in real estate settlements, with a statute of limitations of 3 years. Responsibility for regulating RESPA and the title insurance industry lay with the Department of Housing and Urban Development until the Dodd-Frank Act transferred it to the CFPB.
In such settlements, mortgage borrowers with less than a 20 percent down payment are usually required to take out mortgage insurance to protect the lender from potential losses until at least 20 percent of the principal has been repaid. This insurance was usually provided by a third party, until PHH, a mortgage loan originator, invented the concept of a captive reinsurance firm—a reinsurer that is a subsidiary of the lender.
That raised the question of whether fees paid to the captive reinsurance firm represented a “kickback” on the part of the lender. Both the Office of the Comptroller of the Currency and HUD were asked this question during the Clinton administration, and both issued guidance letters that suggested that captive reinsurers could avoid liability under RESPA if certain conditions were met (such as that the fees were genuinely compensatory, representing purely the value of services received). This is an extremely complicated issue. A layman’s guide to it can be found here.
With increased scrutiny surrounding mortgage issues around the time of the financial crisis, HUD initiated investigations into whether some title insurance companies were violating RESPA provisions, seemingly contradicting its earlier guidance. In the meantime, reinsurance ceased to be profitable for many firms, and PHH ceased using it in 2009.
Upon its creation, the CFPB began to use its wider regulatory power beyond the title insurance industry to investigate lenders as well for potential RESPA violations. In 2013, the CFPB ordered four mortgage insurers to pay $15.4 million in penalties, stating: “In exchange for kickbacks, these mortgage insurers received lucrative business referrals from lenders. These types of kickbacks were a common practice in the years leading up to the financial crisis.”
In 2014, after its attempt to impose a $100 million settlement failed, the CFPB brought charges against PHH, alleging it had paid kickbacks to its reinsurers and that the insurance provided was little more than a “sham.” The CFPB alleged that these practices endured from 1994 until 2009 and that customers paid for these fees at a level up to 40 percent of their premiums, pushing up the cost of mortgages. The charges were brought not before a district court, as was usually the case with RESPA violations, but before the CFPB’s own administrative law judge—thanks to a power granted to the CFPB by Dodd-Frank. It did so because administrative proceedings under Dodd-Frank are not subject to RESPA’s statute of limitations.
In its response, PHH noted that RESPA has a three-year statute of limitations, that its insurance paid out $156 million of claims over the years and was not therefore a sham, and that its insurance practices adhered both to the guidance and approval from HUD and to case law. In his judgment, the CFPB’s administrative law judge found PHH guilty of RESPA violations from 2008, the earliest date allowed to be penalized under RESPA’s statute of limitations, and ordered disgorgement of $6.4 million in “ill-gotten gains.”
Both PHH and the CFPB moved to appeal. Remarkably, any appeal from a CFPB administrative procedure is to the CFPB director alone. In essence, CFPB Director Cordray appealed the findings of a semi-independent judge to himself.
In its appeal, the Bureau asserted that continuing violations meant that the statute of limitations was not an issue, that PHH should therefore disgorge $493 million representing its alleged illegal payments from 1995 to 2009, and that it should pay a daily penalty amounting to a total of “at least” $256 million.
In June 2015, Cordray affirmed the administrative law judge’s finding against PHH “though on somewhat different grounds.” He found that no statute of limitations applied (and if it did, said it would only apply to Article III court actions), dismissed the idea that the HUD interpretation provided any protection, and increased the disgorgement to $109 million.
PHH appealed the decision to the D.C. Circuit. It appealed on the merits of the case, and alleged that the CFPB was itself unconstitutional. On October 11, the court found in favor of PHH.
In its most significant finding, the court held that the Bureau’s structure, with a single director only removable “for cause,” was unconstitutional.
The court noted that the Constitution vests the execution of the laws in the person of the president and that this requires accountability of junior officers to him. The Supreme Court, in Myers v. United States (1926), “therefore recognized the President’s Article II authority to supervise, direct, and remove at will subordinate officers in the Executive Branch.” [Emphasis added] However, in Humphrey’s Executor v. United States, 295 U.S. 602 (1935), the Supreme Court provided an exception to that in the case of “independent agencies,” thereby creating what the Court in this case called, “a headless fourth branch of the U.S. Government.” These agencies are generally multimember commissions.
The court found that the CFPB did not qualify as constitutional under the Humphrey’s Executor exception because: “In the absence of Presidential control, the multimember structure of independent agencies acts as a critical substitute check on the excesses of any individual independent agency head—a check that helps … protect individual liberty.” It noted that multi-member commissions provide for better deliberation and their structure “helps to avoid arbitrary decision-making,” and mitigate the risk of regulatory capture (where a regulated industry calls the shots for the regulators).
In so doing, the court called attention to the Supreme Court’s opinion in Free Enterprise Fund v. Public Company Accounting Oversight Board (2010), which noted: “Perhaps the most telling indication of the severe constitutional problem with the Public Company Accounting Oversight Board, another agency set up by Dodd-Frank, is the lack of historical precedent for this entity.” The court further wrote:
In this case, the single-director structure of the CFPB represents a gross departure from settled historical practice. Never before has an independent agency exercising substantial executive authority been headed by just one person.
Accordingly, the judgment found:
To remedy the constitutional flaw, we follow the Supreme Court’s precedents, including Free Enterprise Fund, and simply sever the statute’s unconstitutional for-cause provision from the remainder of the statute. Here, that targeted remedy will not affect the ongoing operations of the CFPB. With the for-cause provision severed, the President now will have the power to remove the Director at will, and to supervise and direct the Director.
The case is not only important for this finding. It is also important because the court found in favor of PHH in the other complaints. Specifically, it found that:
- Section 8 of RESPA allows for captive reinsurance along the lines set out by HUD (the court said that this was “not a close call”) and that the CFPB was not entitled to Chevron deference in its interpretation of the law;
- In departing from HUD’s consistent prior interpretations and retroactively applying its new interpretation against PHH, the Bureau violated PHH’s due process rights; and
- The statute of limitations in RESPA applied both to court and administrative proceedings.
In discussing retroactivity, the court said that “this was Rule of Law 101,” indicating its opinion that the CFPB had acted outside the rule of law. In fact, in responding to the CFPB’s argument that the HUD interpretation did not give mortgage lenders any assurance that they were acting legally, the court said it found:
This particular CFPB argument deeply unsettling in a Nation built on the Rule of Law. When a government agency officially and expressly tells you that you are legally allowed to do something, but later tells you “just kidding” and enforces the law retroactively against you and sanctions you for actions you took in reliance on the government’s assurances, that amounts to a serious due process violation. The rule of law constrains the governors as well as the governed.
While the question of the CFPB’s constitutionality divided the court (a dissent was filed on that part of the ruling), the court was unanimous in regards to the Bureau’s behavior in the other matters. Therefore, it is unlikely that the rehearing will result in a different decision on the CFPB’s actions against PHH. The facts stand as a sharp example of the CFPB’s ability to abuse its enormous power.