The PHH Case Part III: Fair Notice

This is the third in the series of posts about the PHH case. To review, the Consumer Financial Protection Bureau determined that PHH had violated section 8 of the Real Estate Settlement Procedures Act by means of a practice in which PHH referred mortgage insurance business only to companies that then bought reinsurance from a PHH subsidiary. The Bureau ordered PHH to disgorge $109 million in payments, apparently all the reinsurance payments received in this practice between mid-2008 and the Bureau’s order. In the last two posts I discussed the possibility that PHH shouldn’t be liable for payments before July 2011 or perhaps even July 2013.

Today’s post is about a different issue, although one that also involves temporal limits on liability. PHH has argued that the practice the Bureau criticized was widespread in the industry, and that industry participants generally thought it was lawful based on certain guidance documents from the Department of Housing and Urban Development. (HUD was the Bureau’s predecessor in enforcing RESPA.) Even if the Bureau now decides the insurance-reinsurance arrangements are improper, PHH says, it’s not fair to make PHH pay for what it did when the practice was regarded as acceptable.

As I noted in my first post, PHH’s challenge to the Bureau’s order is pending with the D.C. Circuit. The panel hearing arguments seemed sympathetic to PHH’s argument, and it wouldn’t be surprising if the court relieves PHH of its liability on this basis. The question for this post is, what happens the next time, in the next industry? The “fair notice” argument may grow less effective over time.

PHH’s argument derives from a principle that a person shouldn’t be penalized unless the person had “fair notice of the conduct” that is “prohibit[ed] or require[d].” This is an old idea, but the Supreme Court has given it renewed vigor in recent years. In FCC v. Fox Television Stations, the FCC changed its policy about indecency standards. Under the new policy, it imposed penalties for several broadcasts that had predated the policy. The networks argued that the broadcasts were not indecent under the prior policy, so it was unfair to penalize them. The Court, focusing on the complicated history of FCC indecency enforcement in the area, noted that the networks had lacked “fair notice” that their broadcasts would be considered improper. The regulatory change was too “abrupt.” In Christopher v. SmithKline Beecham, the Department of Labor filed an amicus brief interpreting its Fair Labor Standards Act regulations to make the position of “pharmaceutical detailer” a non-exempt position. (Thus, FLSA wage regulations would apply for pharmaceutical detailers.) But the industry had treated detailers as exempt salespersons for decades, without objection from DOL. The Court refused to defer to DOL because DOL’s position would entail “massive liability . . . for conduct that occurred well before that interpretation was announced.” Coming after decades of DOL’s evident acquiescence in the industry practice, the opinion says, “the potential for unfair surprise is acute.”

Some language in the SmithKline Beecham opinion almost suggests that an administrative agency should never order a respondent to be liable on the basis of an interpretation announced for the first time in the same proceeding. But it would probably be a mistake to read that language too broadly, because another longstanding principle is that an agency can make its policy decisions on a case-by-case basis, even if that means applying new policies to prior conduct. Even since SmithKline Beecham—and even in cases imposing serious consequences for past conduct—courts have reiterated that an agency has discretion whether to announce new principles via adjudication or rulemaking. Besides, it would go a bit far to insist that an agency must spell out an interpretation in unmistakably clear language before it can hold people to it. The concept is “fair notice,” not knock-down-the-door notice. Or, as FCC v. Fox put it, “a person of ordinary intelligence” should have “fair notice of what is prohibited.”

What irritated the Court in FCC v. Fox and SmithKline Beecham was clearly a sense that the agencies involved had reversed course from positions that the regulated parties had relied on. Each agency had given those companies some reason to think their conduct was lawful, and no hint to the contrary until the adjudications that imposed liability.

Suppose instead an agency announced that it was seriously reconsidering its past position and didn’t know what the decision would be; or had disavowed a past interpretation and said the issue was open for future adjudications. Could the agency then announce a new interpretation (assuming it were reasonable) and enforce it in the same adjudication? Maybe yes, maybe no. At any rate the Bureau may, in the PHH case, have made a disavowal of this sort.

Recall that PHH argued it had relied on past HUD guidance. PHH says its case is like SmithKline Beecham and FCC v. Fox because the Bureau reversed the HUD interpretation. Of course, the Bureau is not HUD. And, given the circumstances of the Bureau’s founding as an agency meant to improve on the regulation of consumer finance that went before, it would not be surprising to see it disagree with at least some of its predecessor agencies’ policies. But, as PHH points out, the Bureau said in 2011 that, pending any further action, it would apply “the official commentary, guidance, and policy statements” of its predecessor agencies.

The Bureau also said it would “give due consideration to the application” of “other written guidance” from predecessor agencies, depending on factors including the persuasiveness of the guidance. Presumably, by contrast the statement about “official” guidance, this sentence meant the Bureau would not necessarily apply other guidance documents. Still, before the Director’s PHH decision, one might have wondered whether the Bureau really would depart significantly from its predecessors’ “other” guidance without engaging in some process. One might also have wondered what would distinguish “official” from “other” guidance, because the Bureau’s statement didn’t say. That ambiguity itself might have provided some reassurance; had the Bureau intended to depart abruptly from some category of prior guidance, one imagines, it would have demarcated that category more clearly.

The PHH decision goes some way to disabusing us of these notions. PHH principally cited a 1997 letter from HUD staff, responding to industry inquiries about the lawfulness of “affiliated-reinsurance arrangements.” The Director’s decision criticizes the 1997 letter as internally inconsistent, but at bottom it acknowledges that on the key point—that if the value of payments is no greater than the value of the reinsurance there is no section 8 violation—he simply disagrees. Evidently the Bureau is quite ready to reverse the guidance of one of its predecessors.

Moreover, the PHH decision provides a significant clarification about the difference between “official” and “other” guidance. The 1997 letter was not “official” guidance because it wasn’t published in the Federal Register and therefore didn’t rank as a “regulation, rule, or interpretation of the Secretary” under HUD’s RESPA regulations at the time. The agencies implementing many other federal consumer financial laws had similar concepts in their regulations. So, for those laws, only the formal published interpretations might be official guidance. Anything else, evidently, is “other” guidance. Taking the PHH decision together with the Bureau’s 2011 statement, the Bureau seems to have indicated that a large swath of the guidance its predecessors provided is truly open to reversal.

That may or may not be enough to provide the “fair notice” that FCC v. Fox speaks of. Still, it seems to me it has become riskier to rely on pre-Bureau guidance. PHH may prevail in its “fair notice” argument. After PHH, future respondents might not fare as well.