US Appeals Court Declares CFPB Funding Structure Unconstitutional: What’s Next for the Financial Watchdog?

Summary. On October 19, 2022, the United States Court of Appeals for the Fifth Circuit issued its opinion in Community Financial Services Association of America, et al. v. CFPB, et al., in which Plaintiffs challenged the validity of the CFPB’s 2017 Payday Lending Rule on a variety of bases, including that the financial watchdog was unconstitutionally funded. In the 39-page opinion, a three-judge panel ruled that the CFPB’s funding structure violates the Constitution’s Appropriations Clause and separation of powers. Because the funding employed by the CFPB to promulgate the Payday Lending Rule was drawn through the unconstitutional funding structure, the Court ordered the Rule vacated. However, because the decision rests on the general funding structure of the agency, it equates to an existential challenge to the agency and to all of its actions, including the Payday Lending Rule.

Background. The CFPB finalized its Payday Lending Rule in November 2017, which limited various practices regarding covered loans. In April 2018, Plaintiffs sued the CFPB on behalf of payday lenders and credit access businesses, seeking to invalidate the Rule on four theories:

(1) the Rule’s promulgation violated the Administrative Procedures Act;

(2) the Rule was promulgated by a CFPB Director unconstitutionally insulated from presidential removal;

(3)  the CFPB’s rulemaking authority violates the nondelegation doctrine; and

(4)  the CFPB’s funding mechanism violates the Appropriations Clause of the Constitution.

The Fifth Circuit rejected the first three theories, but agreed with the fourth. The Court noted that the constitutionality of the CFPB has been heavily litigated, but the funding issue has not been definitively resolved. 

The Court reasoned that the Appropriations Clause ensures Congress’s exclusive power over the federal purse, and is vital to separation of powers. The Court noted that, while the great majority of executive agencies rely on annual appropriations for funding, the CFPB does not. Rather, the CFPB requests funding each year from the Federal Reserve in an amount determined by the Director, and the Federal Reserve must approve the request, as long as it does not exceed 12% of the Federal Reserve’s “total operating expenses.” Thus, the CFPB (1) determines its own funding needs and (2) receives them directly from the Federal Reserve, which is itself funded outside the appropriations process through bank assessments. This “double insulation” is unique and makes the agency’s structure unconstitutional in the Court’s view. 

The Court noted that, in addition to the CFPB’s funding being “double-insulated” from Congress at the funding stage, Congress has also relinquished its jurisdiction to review CFPB funding on the back end, in multiple ways: (i) the CFPB’s funds are maintained at the Federal Reserve Bank in a fund that is under the control of the Director; (ii) those funds are permanently available, which allows the CFPB to “‘roll over’ the self-determined fund draws ad infinitum;” and (iii) the Act states that the “funds derived from the Federal Reserve System . . . shall not be subject to review by the Committees on Appropriations of the House of Representatives and the Senate.” 

The Court stated: “[t]he Bureau’s perpetual insulation from Congress’s appropriations power, including the express exemption from congressional review of its funding, renders the Bureau no longer dependent and, as a result, no longer accountable to Congress and, ultimately, to the people.” The Court noted that this constitutional problem is even more acute given the CFPB’s authority. Quoting the Supreme Court in Selia Law: the CFPB “acts 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.”

Critics of the ruling have been quick to point out that other government agencies are not covered by the Congress’s appropriations power.  They are correct.  While it is somewhat unclear what distinguishes the constitutionality of the CFPB’s funding from the constitutionality of the funding of these other agencies, it may be the fact that the CFPB’s funding does not come from assessments on the industry (in contrast with, for example, the funding of the FDIC) but rather comes from funds that would normally be remitted by the Federal Reserve to the Treasury Department, which is itself appropriated under federal law.  In other words, because the CFPB’s funding comes at the expense of the Treasury Department’s funding, Congress is forced to appropriate more to the Treasury Department than it would otherwise have to had the CFPB had an alternate funding source.  This fact distinguishes the CFPB’s funding from the funding of other independent agencies (whose budgets have no impact on appropriations) and may be behind the 5^thCircuit’s concerns here.

Having held that the CFPB is unconstitutionally funded, the Court then turned to the appropriate remedy. The Court explained that the remedy hinges on “the distinction between the Bureau’s power to take the challenged action and the funding that would enable the exercise of that power.” Because Congress “plainly (and properly)” authorized the CFPB to promulgate the Payday Lending Rule, it is not per se invalid. Instead, the Plaintiffs must show that the unconstitutional funding provision of the law “inflicted harm.” The Court noted that such showing was easy here, because the CFPB used the unconstitutional funding to promulgate the Rule. Thus, the Court held the Plaintiffs were entitled to “a rewinding of the [the Bureau’s] action.” The Court rendered judgment for the Plaintiffs, vacating the Payday Lending Rule “as the product of the Bureau’s unconstitutional funding scheme.”

What Happens Next? It is widely expected that the agency will seek a rehearing with the full Fifth Circuit (en banc), and if unsuccessful, appeal to the Supreme Court. This is because of the broad ramifications of the decision. While this case is limited to the Payday Lending Rule, the same reasoning (unconstitutional funding) may be used to challenge the validity of essentially every action taken by the CFPB, past, present and future. Likewise, in light of the decision, entities with ongoing dealings with the CFPB, whether through supervisory exams or civil investigative demands, should consider whether the decision has any impact on their matters.