Why Elizabeth Warren's Consumer Watchdog Could Be In Danger

• A federal court heard oral arguments in a mortgage lender's challenge to a Consumer Financial Protection Bureau fine.

• The judges present seemed open to ruling the entire agency unconstitutional.

• An unfavorable ruling would be the biggest legal setback yet for the CFPB, but it is liable to be overturned on appeal.

WASHINGTON -- Federal judges were receptive on Tuesday to the idea that the Consumer Financial Protection Bureau is unconstitutional in its current form, suggesting they are likely to deal the agency its greatest legal setback yet.

The consumer watchdog, conceived of by Sen. Elizabeth Warren (D-Mass.), was included in the 2010 Dodd-Frank financial reform law over financial industry objections -- and it has been a thorn in the industry's side ever since.

The issue of the agency’s constitutionality arose in oral arguments before a panel of judges on the U.S. Court of Appeals for the D.C. Circuit, where the CFPB is defending a $109 million fine it levied against PHH Corporation. The agency accuses the mortgage lender of orchestrating a massive kickback scheme.

Circuit Judges Brett Kavanaugh and Raymond Randolph were present for the oral arguments. Karen Henderson, the third member of the tribunal charged with deciding the case, could not attend. All three judges are Republican appointees.

At the heart of the hearing was whether the design of the CFPB, which is headed by a single individual who can only be dismissed for very specific reasons, violates the Constitution's separation of powers because it is unaccountable to the political branches.

PHH’s attorneys, led by Theodore Olson, one of the most prominent litigators in the country, claim that the limits on the president’s ability to remove the CFPB director deprive the executive branch of real power over the agency, and that its funding from the Federal Reserve also keeps it out of Congress’ reach.

The result, Olson argued on Tuesday, is an agency so unaccountable to the public, it approaches “the very definition of tyranny.”

“In summary, this is an unprecedented, unconstitutional agency that has more power than Congress and the president put together,” Olson concluded.

The CFPB’s legal team countered in legal filings and oral arguments that the Constitution does not specify how Congress can or cannot construct the leadership structure of a federal agency. 

Lawrence DeMille-Wagman, the CFPB’s senior litigation counsel, observed that “Congress has made agencies headed by a wide variety of constructions.”

DeMille-Wagman went on to cite the Social Security Administration, the Office of Special Counsel and the Federal Housing Finance Administration as examples of federal agencies headed by one person with similar employment protections as the CFPB director.

DeMille-Wagman also argued that PHH was trying to have it both ways by complaining that CFPB’s power is concentrated in the hands of its director Richard Cordray, but also bemoaning Cordray’s “Hydra-headed authority,” implying diffuse authority.

“The bureau is headed by one director, Richard Cordray. I saw him last week; he is not Hydra-headed,” DeMille-Wagman quipped, eliciting chuckles.

Kavanaugh, in particular, was not buying DeMille-Wagman’s argument. He claimed that the few agencies with comparable power where the president has limited control, like the Federal Trade Commission, have a multi-member leadership structure, precluding power from being concentrated in the hands of just one individual.

Kavanaugh implied that in light of the CFPB's single-leader structure, the president should have the power to remove the agency's director for policy reasons rather than the narrow performance criteria allowed under current law.

“You already said that the next president, [or] this president, if they don’t agree with the direction of the agency -- it’s being too lenient, they think it should push harder; it’s being too aggressive, they think it should be more prudent -- you’re saying the president can’t change for that reason?” Kavanaugh asked.

Brian Marshall, policy counsel for Americans for Financial Reform, a progressive group supportive of the CFPB’s arguments, contends that if PHH’s concern is really that the president lacks sufficient authority over a federal agency, a multi-member structure should be even more problematic.

“To get control of the Federal Trade Commission, a president would have to remove three commissioners -- and that is virtually impossible,” he said.

Should the appeals court find the structure of the CFPB unconstitutional, it theoretically could just strike down the language of the law limiting the president’s power to fire the CFPB director, rather than rule the entire agency unconstitutional. That is what DeMille-Wagman offered as CFPB’s preferred legal “remedy” should the court rule against them.

A decision against the CFPB could nonetheless embolden other financial institutions to challenge it. Lower federal courts ruled against two previous cases challenging the CFPB's constitutionality. 

Defining A Kickback Scheme

If the judges were to find the entire CFPB unconstitutional, as they hinted they might, then the agency's penalty against PHH would be irrelevant. There would be no need for the court to address the legal intricacies of the mortgage giant’s defense of its practices.

But the federal judges indicated that if they decide to pursue a narrower ruling, they might also be sympathetic to PHH’s case.

PHH admits that it referred its borrowers to mortgage insurers in exchange for the insurers' agreement to purchase reinsurance sold by one of PHH's subsidiaries. A significant percentage of the insurance premiums homeowners paid to those insurers went right back to PHH in the form of reinsurance payments.

The CFPB argues that the transactions were a violation of the Real Estate Settlement Procedures Act, which prohibits “kickbacks,” or unearned fees, for real estate-related referrals.

The agency's $109 million fine would have PHH surrender to the Treasury what is just a portion of the profits the company made from the "kickbacks," according to CFPB filing papers. 

PHH maintains that the profits it received as a result of the referrals were permissible, since they fall under RESPA's exception for “bona fide salary or compensation ... for services actually performed.”

The judges seemed to find PHH’s argument compelling, repeatedly asking DeMille-Wagman to demonstrate that profit from the referrals did not count as a legitimate payment for PHH’s services.

What Happens Next

Observers of the federal judiciary say it is anyone’s guess when the court will rule in the case.

“Anywhere from a few weeks to a year would not be unusual for a circuit court case,” said Julie Nepveu, senior attorney for AARP Foundation Litigation and author of an amicus brief for the CFPB.

Once a decision is handed down, the losing side can appeal to the full appeals court, composed of all the judges active in the circuit, or head straight to the Supreme Court, should the latter accept a petition to hear the case. A party can also appeal to the Supreme Court after the full federal appeals court rules against it.

Merrick Garland, President Barack Obama 's nominee for the Supreme Court vacancy, is the chief judge of the U.S. Court of Appeals for the D.C. Circuit. He is likely not to participate in a full rehearing of the case, given his recent nomination.