Election Eve: What Will Be the Consequences for the CFPB?

One day before the presidential election, the outcome still seems up in the air.  So does control of the Senate. This week, I’ll assess what the possible outcomes could mean for federal regulation of consumer finance by the Consumer Financial Protection Bureau.

Who leads the Bureau in 2017 is not genuinely at stake. A President Clinton would presumably not ask or expect Director Cordray to resign. The Bureau and his work leading it are part of President Obama’s legacy, and a part that is particularly valuable to the more left-leaning parts of the Democratic coalition. A President Trump might want to replace the Director before the end of his five-year term (in July 2018), but I suspect he would not succeed. The Dodd-Frank Act says the Director is entitled to complete his term, absent “inefficiency, neglect of duty, or malfeasance in office.”

A panel of the D.C. Circuit recently held that provision unconstitutional (in PHH v. Consumer Financial Protection Bureau) and declared that the Director can be removed at will. However, the Bureau can be expected to seek en banc rehearing of that decision, especially if Trump wins the election. (The Bureau would be able to represent itself in the D.C. Circuit, even without the approval of the Department of Justice.) The en banc court would include 12 judges (in the event of a Trump election, Chief Judge Garland would presumably return to hearing cases; and Judge Randolph, though senior, was on the panel), of which the Bureau could expect 7 to disagree with the panel. A Supreme Court featuring a new Justice appointed by a President Trump might eventually decide the removal limitation is unconstitutional. Nevertheless, that decision would be unlikely to arrive before spring 2018, shortly before the Director’s term will expire anyway. A President Trump might try to force the issue by demanding the Director’s nomination; but if the Director resists, as he well might, the resulting litigation would not be any faster than the PHH case.

So, unless something tempts Director Cordray to leave, we can expect him to stay through his term regardless who wins the presidential election. What about executive orders that a new President might issue? That, too, would be a contest of wills. A major premise of the PHH opinion was that if the Dodd-Frank Act restricts the President’s ability to remove the Director, then the President also cannot bind him to comply with executive orders. While I find that premise dubious, it would give the Director justification for not complying with a new President’s executive orders while the constitutional issue remains pending in court.

The outcome of the congressional elections could be more significant, although in more subtle ways. Suppose that 2017 sees a President Trump and a Republican-controlled House and Senate. The Republican majorities would probably push legislation to disable or weaken the Bureau; the leading Republicans on the relevant congressional committees have long been unfriendly to the Bureau.

An outright repeal of the Consumer Financial Protection Act or abolition of the Bureau would be unlikely to succeed, so long as the filibuster remains as a tool for opposing legislation. But more subtle changes—and I include some fairly impactful amendments in that category—could be feasible. Many Republicans have long wanted to replace the Director with a multi-member Commission, or to eliminate the Bureau’s automatic funding mechanism so that the agency would be fully subject to the annual appropriations process. Consider a few other possibilities that would be even more subtle:

Congress could amend 44 U.S.C. § 3502 to reclassify the Bureau as an executive agency rather than an independent regulatory agency.

It could amend § 1013 of the Consumer Financial Protection Act to eliminate the Bureau-specific compensation scheme and put Bureau staff on the ordinary GS pay schedule. That would mean a substantial pay cut for many employees and could affect retention and hiring.

It could alter the Bureau’s litigating authority so that the Bureau must always get DOJ approval before representing itself. (Currently, the Bureau only has to consult with DOJ, and it only needs DOJ acquiescence to represent itself at the Supreme Court.)

It could limit the Bureau’s supervisory authority, for example by limiting the topics on which the Bureau can examine a company.

It could eliminate the Civil Penalty Fund and redirect the proceeds from civil penalties to the Treasury.

Because these smaller changes would be less politically salient than wholesale alteration of the Bureau would be, a Democratic filibuster would be harder to maintain. Trade groups and lobbyists pushing a smaller change would put pressure on Democratic Senators to support the amendment. And for many possible amendments a Democratic Senator might be able to construct a decent rationalization. How many, and which, of these smaller amendments avoid filibuster will depend on politics between Senators and industry donors; and on politics within the Democratic caucus, including how firmly each Senator is willing to stand by the Director.

That kind of environment will inevitably have an effect on the Bureau’s regulatory activities. Imagine the agency’s operating under the persistent threat that five or six Democratic Senators might conclude that the political cost of protecting the Bureau from a given legislative amendment is too high. That might motivate the Director to trim his sails a bit. Consider the PHH case: Declaring unlawful an industry-wide practice in which the Department of Housing and Urban Development had acquiesced for 15 years, the Director then overruled an administrative law judge to increase the company’s liability from $6 million to $109 million, while also taking the position (remarkable even if it were correct) that he was subject to no statute of limitations. Regardless what one thinks about the merits, this was an aggressive case. Would the Director have decided the same way if five or six Senators were the only thing protecting the Bureau from, say, losing its litigation authority? In a way, the world of a Trump presidency and a Republican Senate would be reminiscent of the Bureau’s early years. Back then, the Director needed Senate confirmation to ensure his authority. Early Bureau enforcement activity and rulemakings—including the major mortgage rulemakings of January 2013—came against this backdrop of needing to find enough senatorial support to overcome a filibuster.

That said, the environment of 2017 after a Republican victory tomorrow would obviously be quite different from 2013. It seems impossible to predict what a President Trump would actually do. If, for example, he tries to compel the Director to resign, that clash would consume some of the Bureau’s resources and the Director’s attention, and might even embolden the Bureau to accelerate aggressive enforcement or rulemaking activity. The politics of the fight might dominate any discussion of legislation, and stiffen the resistance of Democratic Senators to any change in the Bureau’s statute. The Director might try to generate more eye-catching cases and rules to magnify the stakes of the battle.

In short, while a Clinton victory would probably mean business as usual at the Bureau, a Trump victory could go a couple of ways. It could, if a Trump Administration chose its battles carefully, motivate the Bureau to be more cautious and modest. Or it could lead to a period of substantial turmoil in consumer finance—as in so much else.

Payday Proposal: What is Abusive?

The Dodd-Frank Act prohibits “abusive” acts and practices in the offering or provision of consumer financial products and services. That prohibition was new in federal law in 2010, and it engendered significant uncertainty about what would mark an act or practice as abusive. The Act identified four different types of potentially abusive conduct, each with elements set forth in the statute. But for each type, the statutory elements used some open-ended terms, like “unreasonable,” which the Consumer Financial Protection Bureau was left to elaborate. In particular, three of the four descriptions of abusive conduct in the Dodd-Frank Act involve “tak[ing] unreasonable advantage of” some characteristic that exposes consumers to potential harm (such as a lack of understanding of material risks). What qualifies as taking unreasonable advantage?

Bureau enforcement actions have shed at best a dim light on how the Bureau understands and applies these concepts, in part because there has been little occasion for actual briefing on abusiveness claims in the Bureau’s enforcement complaints. In the proposed rule on payday lending, the Bureau explained an abusiveness theory in a rulemaking for the first time. Nobody should realistically expect the Bureau to lay out a definition or a bright-line rule, and indeed this proposed rule did not. But how much leeway courts give the Bureau to determine what is “unreasonable advantage” will probably depend on the clarity and rigor of its reasoning when it makes those determinations.

As background, the payday proposal addresses two types of loans that the rule would define: covered short-term loans and covered longer-term loans. Subject to certain exceptions, a loan on which repayment is due within 45 days would be a covered short-term loan. A loan of longer than 45 days would be a covered longer-term loan if it has an interest rate over 36% and the lender either takes a vehicle title as collateral or “obtains a leveraged payment mechanism,” such as a right to make automated withdrawals from a bank account. For either type of covered loan, the proposed rule would determine that it is an unfair and an abusive practice to make a loan without reasonably determining that the borrower will have the ability to repay the loan. The rule would specify various ways a lender should make an ability-to-repay determination, and it would provide a number of exceptions. The exceptions are important and complicated, and the proposed rule would have a number of other features. But as indicated above, this post focuses on the proposed determination that lending without reasonable underwriting is an abusive practice. IIn addition, I’ll discuss only short-term loans, for the sake of brevity and because that will be enough to illustrate the point.

The Bureau would find that lending without underwriting “takes unreasonable advantage” of borrowers’ lack of understanding of material risks. The Bureau says payday borrowers don’t understand the risk that a first short-term loan will grow into a multi-loan sequence with much higher borrowing costs (and risks of default). Second, the Bureau would find that making covered loans without underwriting takes unreasonable advantage of borrowers’ inability to protect their interests. The proposal suggests that payday borrowers are unable to protect themselves from the risks just mentioned, because they borrow at times when they need cash immediately and don’t have the time, resources, or opportunity to find other sources.

The Bureau acknowledges that a lender can take some amount of advantage of a borrower. As the statute says, conduct is abusive only if it takes “unreasonable” advantage. In principle, a business could take advantage of consumers’ misunderstanding of risks, or inability to protect their interests, without being abusive, so long as the advantage doesn’t cross the line to being unreasonable. What leads the Bureau to think the accused practice is unreasonable here is a combination of “[s]everal interrelated considerations.” The Bureau observes that lending without regard to the borrower’s ability to repay is different from how lenders operate traditionally and in (says the Bureau) “virtually every other credit market.” Meanwhile, the proposal states, short-term lenders’ business model depends on consumers’ being unable to repay their loans, because customer acquisition costs are high enough that single short-term loans, paid in full, would not be profitable. “Also relevant” is the fact that payday borrowers generally have “moderate incomes, little or no savings,” and poor access to other credit. Finally, the proposal says that lenders do things that “further exacerbate the risks and costs” for consumers, such as using marketing techniques to push consumers to treat the loans as short-term credit, facilitating rollover into new loans, and not encouraging borrowers to pay down principal gradually as they reborrow.

The proposal doesn’t explain why these four considerations make the accused practice abusive. However, only the fourth seems potentially robust as a contribution to a decision that the practice takes unreasonable advantage. Strikingly, that is the one most tenuously related to the definition that the Bureau has actually proposed for an abusive practice.

The first two observations, about lenders’ business model, must stand or fall together. Failure to assess a borrower’s ability to repay, on its own, might be different from many other credit markets. (But perhaps not all. Microfinance famously relies on alternative models of loan decisionmaking.) Novelty and difference might be suspicious, but it would seem like a dangerous use of the law to make them indicators of unreasonableness. Moreover, in general it is hard to see how not assessing borrowers’ ability to repay would enable a lender to take any advantage of borrowers’ vulnerability to the risk of not repaying. As the proposal notes, a borrower’s failure to repay is, in most credit markets, bad for the lender. The critical difference here is that, according to the proposal, lenders don’t assess ability to repay because they would actually rather borrowers don’t repay immediately, but rather reborrow and support the business model.

This situation is to be assessed against the statutory criterion: that the practices “takes unreasonable advantage of” consumers’ inability to protect themselves. Consider the latter. There is evidently a population of consumers who need credit in urgent circumstances and who, for various reasons, have little choice about where to get it. Providing that credit will involve some cost. Charging the borrowers that cost, plus profit, might well amount to taking advantage of their inability to protect themselves. Still, as the Bureau acknowledges, only taking unreasonable advantage is abusive. Perhaps charging too much would be unreasonable. But the proposal does not go that way. Rather, it argues that the structure itself—imposing a hefty finance charge over a series of short-term loans and therefore not wanting the borrower to pay the first loan back in full—is an unreasonable way to collect the money. Why that should be so is not obvious, and the proposal does not say.

The Bureau’s third consideration is that payday borrowers tend to be particularly vulnerable. That vulnerability is certainly relevant to the question whether they are unable to protect their interests. And therefore it might be something a lender would try to take advantage of. But unless the Bureau means to suggest that for some vulnerabilities, any advantage a business might take would be unreasonable, the fact that many payday borrowers have an inability to protect their interests does not weigh in either direction on whether a particular business model is unreasonable.

That leaves us with the fourth consideration, the observation that payday lenders do marketing to push consumers to focus on the short-term—and thus underestimate the full costs and risks of the loans. That consideration does sound more like unreasonableness, and it is consistent with claims of abusiveness the Bureau has made in a few enforcement actions. Roughly speaking, the idea would be that payday lenders have partly caused or contributed to consumers’ vulnerability—the lack of understanding of the risks, and the inability to protect themselves—by using marketing techniques that obscure the risks and encourage consumers to underestimate them. Perhaps it might be acceptable to take advantage of preexisting consumer misapprehensions; but, in this line of thought, a practice becomes abusive when it profits from consumer misunderstanding that the lender has enhanced in service of its business.

To my eyes, that looks like a potentially quite viable theory of an abusive practice. However, it would not be the practice that the Bureau’s proposal identifies! Under the proposed rule, every covered short-term loan made without reasonably assessing the borrower’s ability to repay the loan would be abusive—regardless whether the lender had done anything to foster consumer misunderstanding. Conversely, a lender might obfuscate the costs of its loans by every means possible, which is the sort of conduct that led to the Bureau’s fourth consideration. Such a lender might achieve great success in inducing borrowers to take high-cost loans. But as long as it had assessed their ability to repay, it would not be liable for the abusive practice this proposal discusses.

All this might seem theoretical, because if the Bureau issues a rule that looks like the proposal, it will still have the unfairness determination, and the rule might look almost exactly the same even if a court struck the abusiveness finding. It is actually quite important. As a practical matter, a defendant facing potential liability will care a great deal whether lending without underwriting is only unfair, or is unfair and abusive. In the second situation, the same course of conduct might lead to multiple sets of civil penalties.

More significantly, though, the proposal’s discussion of “unreasonable advantage” is important for what it reveals about the Bureau’s approach to abusiveness. I suggest that the agency is still so awed by its new abusiveness authority that it is reluctant to use it as a real policymaking tool. Since the enactment of the Dodd-Frank Act, the power to find conduct abusive—even if it was not unfair or deceptive—has been a sword of possibly broad sweep that the Bureau could wield in its regulatory mission. As the discussion above indicates, the payday proposal contains material that might have supported a specific, precise finding about a relatively narrowly defined abusive practice. But adopting that finding, especially alongside the sweeping unfairness determination, might have brought “abusive” down to earth. Instead, the Bureau proposed to make an equally sweeping abusiveness determination, at the cost of providing a fairly vague and thinly explained rationale for the finding.

Courts may accept this, or they may develop a narrower understanding of “unreasonable advantage” on their own. The Bureau has taken a gamble on the scope of the prohibition on abusive practices.

Payday Lending: Will the Proposal Alone Be Fatal?

Like many people, I am still digesting the Bureau’s proposed rule on payday lending.  It’s been three months, I know; but it’s a complicated proposal with a lot of moving parts.

One feature has become clear, though, and that is the simplicity with which the proposed rule would identify an unfair practice. For all that the rule would set up various off-ramps, exceptions, and safe harbors, it would begin with this statement: It is an unfair practice for a lender to make a loan, if it is among certain types, without reasonably determining that the borrower will have the ability to repay the loan. That simple statement on its own could be quite dangerous for the industry, even if the Bureau makes much more generous exceptions in the final rule, or even if it doesn’t finalize the rule.

The Bureau has been studying short-term, small-dollar loans for at least a few years. Its primary concern appears to be that—as the Bureau describes it—lenders market their loans as short-term debt, while fully expecting and indeed relying on borrowers not to be able to repay in the short run, so that they refinance repeatedly and end up paying astronomical amounts of interest. To prevent that behavior, the Bureau proposes to determine that it is an unfair (and an abusive) practice to make a covered loan without making a reasonable determination of ability to repay. (The proposal would cover two defined sets of loans, which it calls “covered short-term loans” and “covered longer-term loans.” For purposes of this discussion, we can set aside the scope of those definitions, and the differences between them.) The proposal would specify in further detail how to conduct an acceptable underwriting process, and it would also set up alternative lending models that a company could pursue instead of doing traditional underwriting. For example, a lender could make short-term loans without underwriting if (among other conditions) the loans were designed to prevent borrowers from refinancing more than two times, and the lender made certain disclosures.

Perhaps the underwriting model the Bureau sets forth would be workable for some small-dollar lenders, and perhaps the alternative models would work for others. (Or perhaps not, as the comment record for the rulemaking suggests.) But because of the way the proposal is structured, those features may not matter much as a practical matter. Given the authority that the Bureau claims in the proposal to prescribe a broad range of measures so long as they “have a reasonable relation” to an unfair practice, the Bureau had some latitude about what to identify as the unfair practice and how to connect its other provisions to that determination. What the Bureau has proposed is the broadest possible description of the unfair practice: lending “without reasonably determining that the consumer will have the ability to repay the loan.” Much of what the Bureau could have framed as ancillary regulations “reasonably related” to an unfairness determination is presented, in the proposal, as exceptions from what would otherwise be an absolute prohibition.

Why does this matter? The Bureau is not the only locus of enforcement regarding unfair practices. States can enforce the Consumer Financial Protection Act, including its prohibition on unfair practices. Of course the Bureau could make clear that a lender using its alternative models is exempt from the statutory prohibition on unfair practices, as well as the regulatory requirements of the Bureau’s putative rule. But states, and in many states consumers, can also enforce state laws prohibiting unfair practices. In many states, the unfair practices law is essentially identical to the one governing the Bureau; many others borrow from federal law, in that an act that is wrongful under federal law can be an unfair practice under state law.

So let us suppose the Bureau issues a rule like what it has proposed. A lender opts to use the alternative lending models the Bureau makes available. Doing so would protect the lender from liability under the Consumer Financial Protection Act. But a consumer plaintiff—or a class of consumer plaintiffs—could still sue under state law, charging that the failure to do reasonable underwriting is an unfair practice. Such a plaintiff would point out that the Bureau has determined it is unfair to issue a covered loan without making a reasonable determination of ability to repay. That the Bureau offers the alternative lending models as an exemption from the federal prohibition on unfair practices, the plaintiff would continue, does not immunize the lender’s misconduct under state law.

The problems do not stop there. Suppose a different lender performed underwriting compliant with the rule’s specifications on how to make ability-to-repay assessments. That lender might like to think compliance would protect it from unfair-practices liability. But the Bureau’s proposal doesn’t include those underwriting specifications in the definition of the unfair practice. It identifies the unlawful practice as not “reasonably determining that the consumer will have the ability to repay.” What is “reasonable,” and what is “ability to repay”? The proposed rule would elaborate on those concepts only for use in the Bureau’s ancillary regulations related to the unfair practice. In a lawsuit under state law based on the premise that not reasonably determining ability to repay is an unfair practice, the parties would have to litigate what kind of determination is reasonable, and what counts as ability to repay.

Perhaps most difficult of all, a state-law plaintiff would not have to wait for the Bureau’s final rule. So far as one can tell from the proposed rule, the criteria for determining by rule that a practice is unfair are exactly the same as those for finding it unfair in any other proceeding. If the Bureau finds the identified practice unfair, it has always been unfair (or at least since section 1031 of the Dodd-Frank Act took effect)–and it is unfair already. A plaintiff could sue a small-dollar lender for that unfair practice now, both for ongoing business and for past lending stretching as far back as the applicable statute of limitations will allow. The plaintiff would of course need to prove that doing small-dollar lending without reasonable underwriting is an unfair practice. While the Bureau’s proposed rule would not be as powerful an aid as a final rule conclusively determining the point for purposes of the Dodd-Frank Act, it is still a great help. A court or a jury might place substantial weight on the assessment in the Bureau’s proposal, preliminary though it is.

Note also that the alternative lending models will not even be protection from the federal violation unless and until the Bureau issues a final rule granting those exemptions. Until that time, lenders could even be vulnerable to aggressive state-based enforcement of the federal prohibition on unfair practices.

These issues might ultimately be hypothetical, if the rule as proposed would destroy the small-dollar lending industry anyway. However, the Bureau seems to think small-dollar lending will continue, albeit in different forms and with lower volume. The current proposal, because it doesn’t take careful account of state law, may make that outcome less likely.

The PHH Case, Part II: Retroactivity and Liability Exposure Continued

In my last post, I talked about the possibility that enforcement by the Bureau is a change in law that shouldn’t have retroactive effect. That is to say, conduct that predated the change in law shouldn’t be subject to it. The last post assumed that July 21, 2011, was the date of the change; so according to this retroactivity theory, conduct earlier than that date wouldn’t incur liability to the Bureau. (As I also noted, the same conduct might expose a person to enforcement from other corners. For example, the Department of Housing and Urban Development could, on July 22, 2011, have sued PHH on the same theory the Bureau eventually used. No guessing here how that suit would have turned out.)

In this post I’ll talk about an even later date: July 16, 2013. As seasoned Bureau-watchers know, that was when the Senate confirmed Director Cordray. While a confirmation of the agency head would be important for any agency, it was particularly significant for the Bureau because of the staged way in which the agency came into existence and assumed its powers. The Bureau existed as of July 21, 2010, when the Dodd-Frank Act was enacted. For the first year of its existence, it engaged only in managerial operations: hiring employees, preparing budgets, negotiating service contracts, etc. The substantive regulatory provisions of the Consumer Financial Protection Act became effective on a date chosen by the Treasury Secretary, which the statute called the “designated transfer date.” That ended up being July 21, 2011. Also on that date, a range of pre-existing regulatory functions already being performed by other agencies transferred to the Bureau. But there was no Director yet. Under section 1066 of the Act, the Treasury Secretary exercised the Bureau’s authorities “under this subtitle” until the Senate confirmed a Director.

“This subtitle,” the one to which section 1066 refers, is subtitle F. That subtitle describes the transfer of pre-existing functions; it does not encompass the Bureau’s new authorities. There are various ways to read section 1066. One could take it to mean that the Treasury Secretary would be acting “under this subtitle,” but exercising all the Bureau’s authorities. Or one could accept that “under this subtitle” modifies “authorities,” so that the Treasury Secretary could only exercise subtitle F authorities. I’m not sure I agree with that second reading. But the Inspectors General of the Treasury Department and of the Federal Reserve adopted it, and the Bureau has not to my knowledge disagreed. (On April 22 this year an administrative law judge opined that under section 1066 the Treasury Secretary was able to exercise all the Bureau’s administrative enforcement authority. However, the reasoning seems dubious, and it seems unlikely the Director would adopt it. The opinion observes, correctly, that section 1061(a) defines “consumer financial protection function” to include “all authority to . . . issue orders” under “any Federal consumer financial law.” But section 1061(a) doesn’t actually confer any authority; the only powers that section 1061 actually provides are those consumer financial protection functions that already existed at predecessor agencies.)

So it seems reasonable to assume that under the prevailing view of section 1066, the Bureau was unable to exercise the new authorities created by the Consumer Financial Protection Act until it passed the section 1066 trigger. One could also debate when that happened, but for illustrating the ideas in this post I’ll assume the trigger is exactly what section 1066 purports to say: Senate confirmation.

So, on July 15, 2013, the Bureau could sue to enforce RESPA section 8—that was a transferred authority under subtitle F—but it couldn’t enforce through an administrative proceeding. HUD never had the option of administrative proceedings, and the Bureau’s ability to use them comes from subtitle E. In the last post, I identified two ways in which Bureau enforcement could constitute new law that shouldn’t operate retroactively. First, the Bureau is a new plaintiff with priorities and incentives different from its predecessor agencies. Second, and really more importantly, the Director as an adjudicator is different from a court. Following through that idea from the last post, if the Bureau commenced an administrative enforcement proceeding on July 17, 2013, that proceeding oughtn’t to cover conduct from before July 16. (At this point it might be worth repeating a caveat from the last post. There are arguments on either side of this issue, and I don’t know how it would really come out.)

Defendants and respondents in Bureau enforcement cases have been quite alert to the significance of section 1066. But many of the arguments have not quite hit the point straight on, in part because they are excessively constitutionalized. Respondents and defendants have argued, for example, that the Bureau didn’t have standing under Article III until it had a Senate-confirmed Director; or that the Appointments Clause precluded the Bureau from exercising new authority until the Senate confirmed an agency head. Arguments like these are a bit discomforting, because it’s not uncommon for this or that agency in the federal government to be run by someone filling a vacant seat on an acting basis. If some aspect of the Constitution would preclude the Bureau from doing some of its work while it lacked a Senate-confirmed head, wouldn’t the same argument block other agencies too? As a constitutional matter there wouldn’t seem to be anything different about the Bureau just because it was new.

As a matter of statutory interpretation, by contrast, the newness of the Bureau was perhaps quite important. Congress chose to phase in the new agency in several steps, beginning (as explained above) with the first in which the Bureau existed but had no regulatory authority at all. It would be within the prerogative of the legislature, I’d think, to set things up so that for some time the Bureau could only exercise the existing authorities, and then eventually could (among other things) enforce all federal consumer financial laws by administrative order. The question is simply one of statutory interpretation: Is that in fact how the Dodd-Frank Act works?

To answer that question, how to read section 1066 is obviously quite important. Set against that, the fact that various subtitles besides subtitle F were “effective” as of the designated transfer date in 2011 seems less significant. To be sure, various provisions in subtitle C made certain conduct unlawful as of that date. And it would be odd to interpret the Dodd-Frank Act to immunize that conduct unless and until the Bureau received a Senate-confirmed Director. But it didn’t; under section 1042 states were able to sue immediately on the transfer date; and they could obtain remedies provided by section 1055 (in subtitle E, the general enforcement subtitle). The fact that the section 1066 trigger depended on administrative action (nominating a Director) also doesn’t seem too important. After all, the Consumer Financial Protection Act made the effective date of many of its provisions depend on administrative action, namely the Treasury Secretary’s choice of the designated transfer date.

The Director did eventually ratify the Bureau’s pre-confirmation actions. But that also doesn’t necessarily resolve the issue. The prerequisites for a ratification are generally that the person had the authority for the act at the time of ratification, and would have had the authority had she been in place when the act originally occurred. One purpose for these requirements seems to be to protect individual rights; “[t]he intervening rights of third persons cannot be defeated by [a] ratification.”  One would think the rules for ratification would also protect against retroactivity.  If Bureau administrative enforcement of a given law is indeed a change that shouldn’t apply retroactively, it’s not clear that the Director could simply ratify administrative proceedings from before his confirmation.

The bottom line of the arguments here would be: For many federal consumer financial laws, the Consumer Financial Protection Act did not permit the Bureau to engage in administrative enforcement until it had a Senate-confirmed Director; when that point came, the Director became a potential decisionmaker for administrative enforcement proceedings; that change in decisionmaker is a substantial change in law that should not apply to conduct from before the confirmation. So if the Bureau wants to impose liability for conduct before July 16, 2013, it needs to sue in court.

In the PHH case, that conclusion would have erased all but perhaps $2 million of the $109 million in disgorgement that the Director ordered. We can expect respondents to take serious effort to make some version of this argument work.

The PHH Case, Part I: Retroactivity and Liability Exposure

A little over a year ago, the Bureau determined that PHH Corporation had violated section 8 of the Real Estate Settlement Procedures Act, the prohibition on payments for referrals, and ordered PHH to disgorge just over $109 million. The D.C. Circuit heard arguments on PHH’s challenge to that order on April 4. The case has proved to be a major confrontation, raising the oft-repeated questions about the Bureau’s constitutionality in an appeals court that seems likely to decide them and contesting the Bureau’s interpretation of section 8 in some fundamental ways. Much has been written about the case; but in this and the next couple posts, I’d like to focus on a few aspects that have attracted less attention but could still be quite significant. Assuming the D.C. Circuit doesn’t eliminate the Bureau—and, given how the Supreme Court dealt with the last major separation-of-powers challenge to an agency’s structure, that assumption seems fair—these other issues will continue to be important even if the Bureau loses the PHH case.

The first topic is the temporal scope of liability. This is particularly significant because the Bureau evidently believes many of its administrative adjudications are not subject to a statute of limitations. This point is worth stressing because it is not limited to the kinds of claims PHH faced. The Bureau’s theory was that RESPA’s statute of limitations applies to “actions,” and “action” refers to a court case rather than an administrative proceeding. The Bureau is authorized to bring administrative enforcement proceedings for any of the laws it enforces (except to the extent other laws specifically limit that authority)–TILA, the FDCPA, Regulation O, and all the rest. Many of those laws state limit periods for “actions” just like RESPA does.  Presumably in cases under those laws the Bureau would take the same position it did here, that an administrative enforcement proceeding is not subject to the time limit.

If the Bureau prevails in this view—and that is at least a substantial possibility—it will be important for any entity facing Bureau enforcement to understand what other time limits there could be on liability.

The Director’s decision in the PHH case recognized one such limit. An administrative proceeding without a statute of limitations became possible only thanks to subtitle E of the Dodd-Frank Act, which became effective on July 21, 2011. By July 20, 2011, PHH’s potential RESPA liability for payments on July 20, 2008, or before had elapsed. For the Bureau to revive that liability would have amounted to a retroactive application of the law under which the Bureau (according to the Director’s decision) enjoys no statute of limitations for administrative adjudications. Retroactive operation is disfavored, so he imposed liability only back to July 21, 2008.

But one could argue for later dates, even if the Bureau is right that its administrative adjudication faces no statute of limitations. In this post I’ll discuss an argument for July 21, 2011, as the limit on PHH’s liability to the Bureau. (In a later post I’ll discuss July 16, 2013, as a possible limit.) This timing issue can be quite significant. While the public materials in the PHH case don’t reveal the detailed time series of its payments, it’s possible to estimate that if liability went back only to July 21, 2011, PHH would only have had to disgorge about $40 million. Much less than the $109 million the Bureau ordered. It is worth thinking about timing issues beyond the statute of limitations itself!

Why July 21, 2011? This involves that same issue of retroactivity. The Supreme Court has said that in general a statute does not operate retroactively unless it is clear Congress intended it to do so. The Bureau seems to take for granted that when it comes to Bureau enforcement, the Dodd-Frank Act should not have retroactive effect. I’ll take that for granted too. That’s why the Director did not impose liability for payments before July 21, 2008; doing so would have been a retroactive effect. But what about the payments between that date and July 2011? Would it be retroactive for the Bureau to require disgorgement of those?

The Director seems to have assumed, in passing, that it would not. The clue to this is one line in the decision that notes it is not a retroactive effect for a statute to modify procedural rules, “including changes to the forum which charges are prosecuted.” But it may not be so simple. Before the Dodd-Frank Act, the Department of Housing and Urban Development could enforce RESPA section 8 by suing in court. Now the Consumer Financial Protection Bureau can enforce it by having its enforcement office file charges before an administrative law judge and then seek an order from the Director. There are at least a few ways in which this is more than just a procedural change.

A “change in forum,” one imagines, is just a move from one court to another. The old court and the new court would apply the same decision rules, and the outcome ought, in the main, to be the same regardless of the change in forum. A change that can “affect substantive entitlement to relief” would arguably be more than just a change in forum. Moving from courts to administrative adjudication could have that kind of effect. For example, the Director of the Bureau might well have a statutory interpretation different from what a court would reach. A court’s task in statutory interpretation is to find a single best reading, even if the statute is ambiguous. By contrast, if a statute is ambiguous an agency might legitimately inject its policy preferences to choose an interpretation that is not the best one a court would reach but is still permissible.  So an agency as decisionmaker on statutory issues is different from a court.

On questions of remedy as well, an agency may be different. A court deciding whether to grant disgorgement is exercising its equitable discretion, subject to the standards applicable to that sort of authority. An agency head deciding whether to order disgorgement will presumably also take account of various policy matters—the value of deterrence, the significance of the issue to a broader industry or economy, the conduct of the respondent during the investigation, and much more—that would not be as relevant to a court. I’m not suggesting it would be improper for an agency to think about such things. But the fact that it might can make it a substantially different kind of forum from a court.

Besides allowing a new adjudicator, the Dodd-Frank Act also changed the complaining party. A change in plaintiff can be quite significant. For example, in Hughes Aircraft Co. v. United States, the Supreme Court held “permitting actions by an expanded universe of plaintiffs with different motives” would “essentially create[] a new cause of action, not just an increased likelihood that an existing cause of action will be pursued.” In that case the expanded plaintiffs were private qui tam relators who, under the prior law, would not have been able to bring the claims at issue. Adding private plaintiffs seeking financial gain is obviously not the same as changing from HUD to the Bureau. Still, the Bureau is not quite the same. Its policy mandates are not necessarily the same, and its enforcement priorities may be different. Moreover, the Bureau does have a financial interest different from HUD’s, because the Bureau can impose civil penalties that go into the Bureau’s Civil Penalty Fund rather than into the general fund at Treasury.  (True, the Bureau would not be able to impose those penalties on pre-enactment conduct, regardless how the broader retroactivity argument that I’m discussing plays out. But in a case where conduct spans the pre-enactment and post-enactment periods, the availability of civil penalties might encourage the Bureau to bring a case, even if it couldn’t obtain those periods for the pre-enactment conduct.)

These issues are complicated, and there are arguments to make both ways. I’ve only offered one side here just to sketch the ideas. The bottom line of the argument might be that the Bureau cannot obtain relief for RESPA violations predating July 21, 2011; or at least that it can attack such conduct only by suing in court. Would this be a windfall for RESPA violators? Not exactly. The Dodd-Frank Act left in place HUD’s authority to enforce section 8 by suing in court, with a three-year statute of limitations, just as it did before July 2011.

The Bureau’s Arbitration Proposal: Giving substantive effect to class actions?

On May 24, the Consumer Financial Protection Bureau published its proposal to restrict the use of arbitration agreements in a broad range of consumer financial products and services. “Predispute” arbitration agreements—typically entered as part of general product agreements—have been a topic of interest at the Bureau for some time, as it carried out research on how they are used. Section 1028 of the Dodd-Frank Act, which directed the Bureau to do those studies, empowers the Bureau to prohibit predispute arbitration agreements (with respect to consumer financial products and services) or restrict their use.

The Bureau does not propose to prohibit arbitration agreements entirely. Instead, it is focused on how arbitration agreements affect class actions. According to the Bureau’s proposal, class actions are an important mechanism for securing companies’ compliance with consumer financial law, especially because in many cases the damages available to a given individual consumer would be too small to warrant individual litigation. So the Bureau’s proposed rule would prohibit a company from using a predispute arbitration agreement to avoid a class action in court. If a company and its product are covered by the rule (a complicated question for another time), the company would not be allowed to “rely in any way on a pre-dispute arbitration agreement . . . with respect to any aspect of a class action.”  “Class action,” for these purposes, would mean not only certified class actions (those in which the court has ruled that the case can proceed on a class basis), but also cases in which the plaintiffs seek class status but the courts have not yet decided. In future agreements entered after the rule is effective, companies would also have to include a clause promising not to use the agreement to stop a class action in court.

The Bureau’s proposal includes an extensive discussion of the legal authorities on which the rule would rely. But one important discussion seems to be missing: Does the Bureau actually have the authority to privilege class actions in this way?

Class actions in federal court are, of course, a feature of federal judicial procedure—in particular Rule 23 of the Federal Rules of Civil Procedure. The federal courts establish procedure under the Rules Enabling Act, which says federal procedural rules cannot “abridge, enlarge, or modify any substantive right.”  The Supreme Court has repeatedly warned that Rule 23 must be interpreted carefully to avoid overstepping that bound.

The Bureau’s proposed rule would mean that when a plaintiff in federal court is a representative of a certified class, the defendant cannot assert a predispute arbitration agreement to compel the plaintiff to arbitrate claims that are “related” to the class action. (The arguments would be about the same for pre-certification cases, in which plaintiffs ask for class treatment but no decision has been made. For simplicity I’ll just discuss certified cases.) Notably, the Bureau’s proposal would not otherwise call consumer arbitration agreements into question. Absent a class action, the defendant would be free to enforce the arbitration agreement. But it would be unable to do so in a class action.

It seems likely to me that the federal courts could not properly establish a prohibition like that on their own. Of course the Federal Arbitration Act would preclude them from limiting the use of arbitration clauses. But the Rules Enabling Act on its own would also be an obstacle. Whether to arbitrate or litigate is a key question about a case that, as far as the federal rules are concerned, should not depend on whether the case proceeds on a class basis. Perhaps one could say arbitration is not a “substantive right”—what the Rules Enabling Act says federal procedural rules cannot affect. But the Supreme Court has interpreted that category broadly with respect to Rule 23. For example, the Court recently observed (although in dictum) that “evidence cannot be deemed improper merely because the claim is brought on behalf of a class.”  (That statement actually seems to go a bit far. The Rules Enabling Act is also the basis for the Federal Rules of Evidence, the very nature of which is to determine which evidence is proper or improper for a case in federal court.) Moreover, the promise to arbitrate is a contractual obligation; it would be hard to justify treating that obligation as inferior to other contractual promises with respect to the Rules Enabling Act.

So, can the Bureau achieve by regulation the result that the Rules Enabling Act would preclude for courts themselves? That is the question that the Bureau should contemplate.

It would be tempting to say there is no issue because, in the Bureau’s scheme, Rule 23 would not be affecting substantive rights; the Bureau’s regulation, and behind it section 1028, would be doing the work. But that answer only begs the question. Does section 1028 indeed authorize the Bureau to prescribe different outcomes for consumer class actions? It doesn’t say so explicitly. It allows the Bureau to restrict the use of arbitration agreements, but the Bureau and the courts will need to interpret that authority in light of other relevant law, such as the Rules Enabling Act. The Rules Enabling Act articulates a preference that the substantive rights of the parties to a case shouldn’t depend on whether they litigate in federal or state court. One could argue that a later statute, addressing an unrelated area, should not be read to permit exactly that outcome.

As an aside, note that although the Bureau’s proposed rule would also apply to state class actions, the enforceability of an arbitration clause could still depend on the difference between state and federal court. State class actions can be different from, and more limited than, federal class actions. For example, Mississippi has no class actions at all, and Virginia only on a few limited topics; South Carolina doesn’t allow class actions for monetary relief below a threshold of $100 per class member. South Carolina seems to rule out exactly the sorts of small-dollar class actions that the Bureau says it wants to protect!

Some hypotheticals might help illustrate why it is not self-evident that section 1028 would permit the Bureau’s proposed rule. The Bureau can identify and prohibit unfair, deceptive, or abusive acts or practices (“UDAAP”). Could the Bureau declare that a defendant in a class action about marketing of financial products is not allowed to introduce evidence of its communications with individual consumers? Assume for the moment that such a rule could be justified, on its own terms, under the UDAAP standards. Would UDAAP authority permit the Bureau to, in effect, revise the evidence rules for class actions?

As another example, under the Fair Debt Collection Practices Act (“FDCPA”) the Bureau can generally regulate “the collection of debts by debt collectors.”  Sometimes when a consumer complains that a debt collector is trying to collect an incorrect amount, it turns out that the collector has already obtained (perhaps by default) a state-court judgment for that amount. In that situation, a federal court will often refuse to entertain the consumer’s claim under the FDCPA, on the ground that the Rooker-Feldman doctrine precludes a lower federal court from questioning a state-court judgment.  Could the Bureau overcome that obstacle by issuing a rule stating that a state-court judgment does not conclusively show that a debt collector is claiming the right amount?

I raise these questions here, but I don’t mean to be suggesting an answer. These are interesting issues of statutory interpretation, and the best approach presumably depends on the details. (The Bureau’s proposal cites a few existing regulations from other agencies that restrict the use of arbitration agreements. But so far as I can tell, among those examples only the SEC’s involved a comparable preference for class actions; and that rulemaking did not consider the issue. Moreover, the SEC was only approving a rule issued by FINRA, a private industry self-regulatory body, rather than imposing the restriction itself. That fact might make the analysis different.) With respect to the Bureau’s arbitration proposal, there are surely arguments to be made that the Bureau does have the authority to privilege class actions against arbitration. And it might not be surprising if historical materials associated with the enactment of the Dodd-Frank Act reveal that section 1028 was meant to permit exactly that sort of restriction. My point here is simply to observe that this is an important and non-trivial issue, one that the Bureau and anybody interested in the Bureau’s arbitration proposal should think about.