CFPB Director Richard Cordray's novel interpretation of the Real Estate Settlement Procedures Act is at the heart of a mortgage servicer's case against the agency.
CFPB Director Richard Cordray's novel interpretation of the Real Estate Settlement Procedures Act is at the heart of a mortgage servicer's case against the agency. Rick Reinhard

A federal appeals court has set the stage for yet another legal showdown over the Consumer Financial Protection Bureau's structure in a major test of the bureau's authority.

The U.S. Court of Appeals for the D.C. Circuit will hear oral arguments Tuesday about the single-director structure of the CFPB. The closely watched case, PHH v. CFPB, is widely expected to be appealed to the Supreme Court, even though a ruling is not likely until the end of the year.

In questions last week, two judges focused on constitutional issues raised by PHH Corp., a New Jersey mortgage lender that appealed a $109 million judgment last year by CFPB Director Richard Cordray. The agency's director had overturned an administrative law judge's $6.4 million fine alleging PHH illegally accepted kickbacks from mortgage insurers to whom it had referred customers, arguing it did not take into account the extent of the damage done to consumers by the firm.

As part of PHH's suit, it argued that the CFPB's single-director structure violates the Constitution's separation of powers doctrine by limiting the president's "removal authority." Under the statute creating the agency, the CFPB director can only be removed "for cause," setting up a possible constitutional conflict.

Lawyers will parse the roughly 15 minutes or so of oral arguments Tuesday to glean how the three-judge panel might rule. In a case with a wide range of possible outcomes, experts are focused on four major issues:

Constitutional Questions About the Authority of a Single Director

While the judges' questions offered some insight into the court's thinking, several lawyers cautioned not to read too much into them.

Both parties must be prepared to answer: what other independent agencies have been headed by a single person, and what remedies are appropriate if the CFPB's structure is found to be unconstitutional. The judges also asked if removing the provision allowing the director to be removed only "for cause" would be an appropriate remedy and how that would affect the legality of Cordray's actions.

"It's the big million-dollar threshold question," said Lucy Morris, a partner at Hudson Cook and a former deputy enforcement director at the CFPB. "Either it was illegal because the CFPB is unconstitutional – or not. They are trying to address the big question first."

She said it was unlikely that the D.C. Circuit would try to "rewrite what Congress wrote."

"Constitutional questions are the most important, but I wouldn't necessarily assume that the result would be negative for the bureau," Morris said. "Other courts have looked at the constitutionality of the bureau and so far no one has ruled that any actions or decisions by the director or the bureau have been unconstitutional."

Still, the constitutional questions took some lawyers by surprise. Last year, courts ruled against two companies, Morgen Drexen and ITT Educational Services, that also had both challenged the CFPB's structure on similar grounds as PHH.

"I can't believe at the end of the day that they'll get rid of this agency," said Jeff Naimon, a partner at BuckleySandler. "I'm assuming we're still going to have a world with the CFPB."

Others expressed doubt that the court would go full-throttle and invalidate all past CFPB activity, including other enforcement actions and rules. A cynical interpretation, one lawyer suggested, is that the court could strike the "for cause" clause and clear the way for a Republican president to fire Cordray on his first day in office.

Still, the case has constitutional weight given that PHH hired prominent attorney and former U.S. Solicitor General Ted Olson alongside lawyers with expertise on the Real Estate Settlement Procedures Act, which is at the core of the case.

The CFPB's Novel Interpretation of Respa

The primary goal of Respa is to eliminate kickbacks or referral fees that tend to increase the cost to consumers of certain settlement services. Section 8(a) of Respa bans any fee, kickback or "thing of value," in exchange for a referral.

But for at least two decades, the real estate industry has relied on an exemption in Respa that provided a safe harbor and expressly allowed the payment of fees under certain conditions. The clash between two provisions in Respa is at the heart of the case.

"We have a CFPB that taken positions on Respa that are starkly in contract to the prior positions on Respa that everyone relied on," Naimon said.

The case began in 2014 when the CFPB alleged that PHH originated loans and then referred borrowers to "captive" mortgage insurers, who then purchased "reinsurance" from PHH subsidiaries in exchange for customer referrals. The CFPB charged that PHH took reinsurance fees as kickbacks, resulting in higher insurance premiums for borrowers.

The bureau alleged that PHH received up to 40% of the premiums that borrowers paid to mortgage insurers, resulting in hundreds of millions of dollars in kickbacks.

But PHH argued that its conduct fell within the safe harbor of section 8(c)(2) of Respa because payments represented "bona fide … compensation ... for services actually performed."

A federal appeals court has set the stage for yet another legal showdown over the Consumer Financial Protection Bureau's structure in a major test of the bureau's authority.

The U.S. Court of Appeals for the D.C. Circuit will hear oral arguments Tuesday about the single-director structure of the CFPB. The closely watched case, PHH v. CFPB, is widely expected to be appealed to the Supreme Court, even though a ruling is not likely until the end of the year.

In questions last week, two judges focused on constitutional issues raised by PHH Corp., a New Jersey mortgage lender that appealed a $109 million judgment last year by CFPB Director Richard Cordray. The agency's director had overturned an administrative law judge's $6.4 million fine alleging PHH illegally accepted kickbacks from mortgage insurers to whom it had referred customers, arguing it did not take into account the extent of the damage done to consumers by the firm.

As part of PHH's suit, it argued that the CFPB's single-director structure violates the Constitution's separation of powers doctrine by limiting the president's "removal authority." Under the statute creating the agency, the CFPB director can only be removed "for cause," setting up a possible constitutional conflict.

Lawyers will parse the roughly 15 minutes or so of oral arguments Tuesday to glean how the three-judge panel might rule. In a case with a wide range of possible outcomes, experts are focused on four major issues:

Constitutional Questions About the Authority of a Single Director

While the judges' questions offered some insight into the court's thinking, several lawyers cautioned not to read too much into them.

Both parties must be prepared to answer: what other independent agencies have been headed by a single person, and what remedies are appropriate if the CFPB's structure is found to be unconstitutional. The judges also asked if removing the provision allowing the director to be removed only "for cause" would be an appropriate remedy and how that would affect the legality of Cordray's actions.

"It's the big million-dollar threshold question," said Lucy Morris, a partner at Hudson Cook and a former deputy enforcement director at the CFPB. "Either it was illegal because the CFPB is unconstitutional – or not. They are trying to address the big question first."

She said it was unlikely that the D.C. Circuit would try to "rewrite what Congress wrote."

"Constitutional questions are the most important, but I wouldn't necessarily assume that the result would be negative for the bureau," Morris said. "Other courts have looked at the constitutionality of the bureau and so far no one has ruled that any actions or decisions by the director or the bureau have been unconstitutional."

Still, the constitutional questions took some lawyers by surprise. Last year, courts ruled against two companies, Morgen Drexen and ITT Educational Services, that also had both challenged the CFPB's structure on similar grounds as PHH.

"I can't believe at the end of the day that they'll get rid of this agency," said Jeff Naimon, a partner at BuckleySandler. "I'm assuming we're still going to have a world with the CFPB."

Others expressed doubt that the court would go full-throttle and invalidate all past CFPB activity, including other enforcement actions and rules. A cynical interpretation, one lawyer suggested, is that the court could strike the "for cause" clause and clear the way for a Republican president to fire Cordray on his first day in office.

Still, the case has constitutional weight given that PHH hired prominent attorney and former U.S. Solicitor General Ted Olson alongside lawyers with expertise on the Real Estate Settlement Procedures Act, which is at the core of the case.

The CFPB's Novel Interpretation of Respa

The primary goal of Respa is to eliminate kickbacks or referral fees that tend to increase the cost to consumers of certain settlement services. Section 8(a) of Respa bans any fee, kickback or "thing of value," in exchange for a referral.

But for at least two decades, the real estate industry has relied on an exemption in Respa that provided a safe harbor and expressly allowed the payment of fees under certain conditions. The clash between two provisions in Respa is at the heart of the case.

"We have a CFPB that taken positions on Respa that are starkly in contract to the prior positions on Respa that everyone relied on," Naimon said.

The case began in 2014 when the CFPB alleged that PHH originated loans and then referred borrowers to "captive" mortgage insurers, who then purchased "reinsurance" from PHH subsidiaries in exchange for customer referrals. The CFPB charged that PHH took reinsurance fees as kickbacks, resulting in higher insurance premiums for borrowers.

The bureau alleged that PHH received up to 40% of the premiums that borrowers paid to mortgage insurers, resulting in hundreds of millions of dollars in kickbacks.

But PHH argued that its conduct fell within the safe harbor of section 8(c)(2) of Respa because payments represented "bona fide … compensation ... for services actually performed."

Phillip Schulman, a partner at Mayer Brown, said Cordray adopted a "new and stark interpretation" of Respa that essentially guts the safe harbor and prohibits a payment tied in any way to a referral.

"Everyone operated on the assumption that 8(c)(2) was an exemption but [Cordray] said that if there is any referral going on, then you can't use 8(c)(2) to shield yourself from that referral," Schulman said. "I would have to believe the 8(c)(2) issue is the core and the potential focus" of the court.

Cordray also dismissed PHH's defense that the Department of Housing and Urban Development had approved the safe harbor exemption in a 1997 letter by former Assistant Secretary for Housing Nicholas Retsinas. The letter was not published in Federal Register and so was not "a rule, regulation or interpretation," the CFPB claimed.

Lawyers hope to at least get a resolution to the battle over Respa's provisions.

"I hope to see a ruling on Respa,” Naimon said. "If they uphold it, we'll at least know what the law is."

The Scope of the CFPB's Statute of Limitations

Another concern in the case is whether the agency's statute of limitations extends beyond the date of the bureau's enforcement authority, which began July 21, 2011.

The CFPB has argued that because PHH's appeal went through an administrative law judge, and not a court proceeding, no statute of limitations applies.

Without any statute of limitations, industry experts believe the bureau could challenge an array practices going back many years, which would increase the potential liability for civil or criminal penalties.

"RESPA's three-year statute of limitations does not apply here because the bureau's enforcement authority comes not from RESPA but from Dodd-Frank, which imposes no limit on the bureau's administrative proceedings," the CFPB said in its brief in the case.

In a footnote, the CFPB said its authority was modeled after federal banking agencies and no statute of limitations applies "when banking agencies use administrative proceedings to challenge violations of the laws they enforce."

Moreover, RespaA is just one of 19 statutes the CFPB enforces, according to the U.S. Chamber of Commerce. If the court upholds Cordray's view that there is no statute of limitations, the agency could bring far more penalties against companies for past conduct, lawyers said.

The Amount of Damages

One of the most galling aspects of the case for many in the industry was Cordray's decision to expand the scope of the allegations and increase the disgorgement amount to $109 million from $6.4 million.

The administrative law judge had recommended that PHH disgorge all reinsurance premiums that its subsidiary had received on loans that had closed on or after July 21, 2008.

But Cordray alleged that PHH was liable each time a mortgage insurer forwarded a premium payment to its subsidiary, significantly raising the damages.

Several lawyers agreed that the case would ultimately move beyond the D.C. Circuit.

"No matter which way they rule, this won't end the litigation," Morris said. "If the CFPB wins, I imagine PHH would appeal. If PHH wins, the CFPB would appeal. So the next step on this would be the Supreme Court."

While constitutional issues will get the most notice, some cautioned that the conflict raised by Cordray's interpretation of Respa is likely to be central to the ultimate ruling.

"Until we know which issues the court is going to focus on and how they are going to come out, there is this limbo that everyone, including the CFPB, is waiting to see the outcome," Schulman said.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.