Fifth Circuit Rules CFPB's Self-Funding Mechanism Is Unconstitutional

The Consumer Financial Protection Bureau (CFPB) has once again faced constitutional challenges. On Oct. 19, 2022, the U.S. Court of Appeals for the Fifth Circuit held that the agency's "unique" self-funding scheme is unconstitutional. Because the funding employed by the CFPB was found unconstitutional, the Fifth Circuit vacated the agency's Payday Lending Rule (Payment Provisions) relating to a lender's ability to obtain loan repayments though preauthorized account access.

CFPB Background

The CFPB is an independent regulatory agency housed within the Federal Reserve System. Congress established the CFPB through the Dodd-Frank Act and created the agency to promote financial stability and reorganize the financial regulatory system in response to the 2008 financial crisis and the Great Recession. Its goal is consumer protection in the financial sector, and this jurisdiction extends to all entities within the financial services industry, including banks, credit unions, securities firms, payday lenders and debt collectors. The CFPB's regulatory power runs the gamut, from rulemaking and supervision to enforcement. Indeed, the Fifth Circuit noted its "capacious portfolio of authority" as acting "as a mini legislature, prosecutor, and court, responsible for creating substantive rules for a wide swath of industries, prosecuting violations, and levying knee-buckling penalties against private citizens."

In order to both maintain independence and insulate the CFPB from political pressures, Congress enacted two structural provisions for the agency. First, the Dodd-Frank Act required that the CFPB's single director could be removed only by the President of the United States for cause. Second, Congress allowed the CFPB to be funded independently through the Federal Reserve, rather than the congressional appropriations process. Both of these features are fairly unique among federal agencies. Therefore, both of these features have been challenged in the courts in recent years.

In 2020, the U.S. Supreme Court addressed the CFPB's leadership structure in Seila Law LLC v. CFPB, where the Court held that allowing the sole director of the CFPB to be removed for cause only was a violation of the separation of powers. The Court thus held that the CFPB's director must be an at-will employee of the President.

Payday Lending Rule and the Fifth Circuit's Decision

In turn, the Fifth Circuit recently addressed the constitutionality of the CFPB's self-funding mechanism in CFSA et al. v. CFPB. The lawsuit was filed by the Consumer Financial Services Association of America (CFSA) and another trade group in connection with the CFPB's Payday Lending Rule.

The Payday Lending Rule was promulgated to regulate payday, vehicle title and other high-cost installment loans. In a nutshell, this rule prohibited lenders from attempting to withdraw payments for loans from consumers' bank accounts after two failed consecutive withdrawal attempts. As with all rules promulgated by the CFPB, the Payday Lending Rule emerged out of the CFPB's self-funding mechanism.

The rule had two major components. One was the "Underwriting Provisions," which prohibited lenders from making covered loans "without reasonably determining that consumers have the ability to repay the loans according to their terms." That provision, however, was repealed, and not part of the Fifth Circuit's ruling. The other is the "Payment Provisions," which limits a lender's ability to obtain loan repayments through preauthorized account access.

While most agencies receive their funding through the congressional appropriations process, the CFPB receives its funding from the Federal Reserve, which the Fifth Circuit noted "is unique across the myriad independent executive agencies across the federal government." Each year, the CFPB requests from the Federal Reserve an amount "reasonably necessary to carry out the Bureau's functions," not to exceed 12 percent of the Federal Reserve's total operating expenses. In turn, the Federal Reserve receives its funding through bank assessments. The result is that the CFPB's self-funding is doubly insulated — and completely outside congressional control. The trade groups took issue with this funding scheme before the Fifth Circuit.

The trade groups challenged the Payday Lending Rule on several grounds: that it violated both the Administrative Procedure Act (APA) and the Constitution's Appropriations Clause and separation of powers doctrine.

Under the APA, a court must set aside agency actions that are "arbitrary, capricious, or in excess of statutory jurisdiction." The Fifth Circuit concluded that the Payday Lending Rule passed muster under the APA, as the CFPB had a reasonable basis to conclude that its rule sought to quell an unfair practice to consumers — preventing repeated fees as a result of excessive withdrawal attempts on accounts that owe covered loans.

However, the Fifth Circuit ruled that the CFPB's funding structure violated the Constitution's Appropriations Clause and separation of powers doctrine. The Fifth Circuit found that, under the Appropriations Clause, Congress has exclusive power over federal monies and that any power granted to another branch or agency must be limited by congressional control over the funds. This restriction was intended as a limit on the Executive branch (including agencies), in accordance with the separation of powers doctrine. At the core of the court's analysis is its instruction that the Appropriations Clause's purpose is to ensure Congress's "exclusive power over the federal purse."

Turning to the funding structure of the CFPB, the Fifth Circuit found that Congress improperly and unconstitutionally ceded control over the CFPB's budget by allowing it to self-fund directly from the Federal Reserve. This funding structure, the Fifth Circuit found, rendered the CFPB no longer accountable to Congress and the people.

As a result, the Fifth Circuit vacated the Payday Lending Rule as a product of the Bureau's unconstitutional funding scheme. As the Court noted, "without its unconstitutional funding, the Bureau lacked any other means to promulgate the rule. Plaintiffs were thus harmed by the Bureau's improper use of unappropriated funds to engage in the rulemaking at issue."

This analysis has obvious implications for other rules promulgated by the Bureau.

The Takeaway

The Fifth Circuit's ruling potentially calls into question every single rule, guidance and order that the CFPB has issued — as they all trace their origins to the CFPB's unconstitutional self-funding structure. Given the potential implications of this ruling, the CFPB will likely seek to overturn it either by petitioning the Fifth Circuit for en banc review or petitioning for a writ of certiorari in the Supreme Court.

In addition, this decision may have implications for other agencies that are similarly funded outside the congressional appropriations process, such as the Federal Reserve, Federal Deposit Insurance Corp. (FDIC), Office of the Comptroller of the Currency (OCC), National Credit Union Administration (NCUA) and Federal Housing Finance Agency (FHFA).

How We Can Help

Holland & Knight's Consumer Protection Defense and Compliance Team includes a robust CFPB and Federal Trade Commission practice, with experienced attorneys who are recognized as thought leaders in the field. The firm has represented dozens of companies and individuals in federal and state investigations concerning advertising, marketing practices, privacy and data security, consumer credit, telemarketing and debt collection, saving clients from significant financial loss, public scrutiny, and having to make changes to their core business operations.

For more information or questions about the specific impact of court rulings on the CFPB, contact the authors.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.