Fifth Circuit Holds CFPB Funding Structure is Unconstitutional, Invalidates Payday Lending Rule

A three-judge panel of the United States Fifth Circuit Court of Appeals held that the CFPB’s funding structure is unconstitutional. The CFPB must now consider whether to appeal to the Supreme Court, seek en banc review (by all of the Fifth Circuit judges), or let the ruling stand (which does not dissolve the CFPB). If the CFPB chooses to let the ruling stand, then the CFPB’s Payday Lending Rule is invalidated.

CFPB’s Unique Funding Mechanism

As most readers are likely aware, the CFPB is insulated by statute from the ordinary congressional appropriations process by intentional congressional design. For most federal agencies, Congress periodically reviews and approves of their budgets and, while it rarely happens, theoretically Congress may withhold funding if it is displeased with the agencies’ substantive policies. The CFPB’s funding mechanism, by contrast, “is unique across the myriad independent executive agencies across the federal government” in that CFPB “simply requests” from the Federal Reserve “an amount ‘determined by the [CFPB Director] to be reasonably necessary to carry out the’ agency’s functions.” Opinion at 4.  The Federal Reserve must provide the requested amount so long as it does not exceed 12% of the Federal Reserve’s operating expenses, but CFPB in its early days exceeded even that cap with the Federal Reserve’s assent. And, as the court noted, the Federal Reserve funding process is itself insulated from the ordinary congressional appropriations process, deriving its revenue from interest owned on securities and fees paid by bank members. The CFPB’s annual budget is around $600 million annually.

The CFPB’s funding was insulated from Congress in this way by express design of the early mastermind of the concept of a CFPB, then law professor and now Senator Elizabeth Warren (D-Massachusetts), who, along with consumer advocates, argued that CFPB might face too much lobbying pressure from a pro-industry Congress to effectively regulate financial institutions if it were subject to ordinary congressional appropriations processes.

In the last major challenge to the CFPB’s funding structure, the Court of Appeals for the D.C. Circuit upheld the funding structure, but with little discussion (citing the Federal Reserve and OCC as financial regulators with budgets independent of most Congressional oversight, at p. 40-41).

What the Ruling Means for Now—Payday Lending Rule Invalidated

The case before the Fifth Circuit panel was brought by a Texas financial industry trade group seeking to invalidate the CFPB’s 2017 Payday Lending Rule which regulated short-term loans and was always substantively controversial. The trade group raised four main arguments:

• the Payday Lending Rule is unconstitutional because the CFPB Director is insulated from being removed by the President (the same issue presented in Seila Law LLC v. CFPB, 140 S. Ct. 2183, 2200 (2020),
• the Payday Lending Rule exceeded CFPB’s authority to regulate “unfair” practices for both substantive and procedural reasons,
• the CFPB’s wide rulemaking powers violate the non-delegation doctrine, and
• the Payday Lending Rule is unconstitutional because it was enacted by the CFPB under the above-described funding mechanisms.

The district court sided with the CFPB on all fronts, but the Fifth Circuit reversed as to the last point, invalidating the Payday Lending Rule and holding that the CFPB’s funding mechanism is unconstitutional.

All three of the judges on the panel were appointed by President Trump. The ruling follows an opinion authored by well-known conservative Fifth Circuit Judge Edith Jones in May 2022 reaching the same conclusion concerning the CFPB’s insulated funding.

But it would be inaccurate to call this a nakedly partisan ruling. The panel sided with the CFPB as to the role of CFPB Director in light of Seila Law, in which the Supreme Court effectively amended the Dodd-Frank Act to require the CFPB Director to be removable at the pleasure of the President but did not invalidate any CFPB actions taken prior to the ruling. The panel also sided with the CFPB as to the Payday Lending Rule’s substance, finding that CFPB acted within its authority to regulate unfair conduct and did not act arbitrarily or capriciously in enacting the Rule. The panel also rejected the trade group’s non-delegation argument. And as remedy, the panel arguably could have reached the conclusion that all of the CFPB’s activities since its inception have been invalid, but instead limited its ruling only to the Payday Lending Rule, the regulation at issue in the case before it.

Why is the CFPB’s Insulated Funding Mechanism Ruled Unconstitutional?

The panel held that the CFPB’s insulation from congressional appropriations impermissibly granted the executive branch both “the sword,” i.e., the ability to use state power to coerce compliance with laws, and also “the purse,” i.e., the funding necessary to wield that sword. Such unity of authority, the panel noted, was opposed even at the Founding (citing Federalist No. 48, authored by James Madison).

In an earlier ruling, Judge Edith Jones, frequently on the short list for Supreme Court nominations in Republican presidencies, had made the case at length that the Constitution requires Congressional oversight of the purse strings. Specifically, Article I, Sec. 9, Clause 7, states: “No money shall be drawn from the Treasury but in Consequence of Appropriations made by Law.”

So is the CFPB Structure Unconstitutional? What Comes Next?

We will closely monitor what comes next. The CFPB can continue operating even without appealing the ruling because the Fifth Circuit only invalidated the rule in the case before it, that being the Payday Lending Rule. And even on that score, the court held open the possibility that litigants in other cases may be unable to show a requisite nexus of harm between the CFPB’s funding structure and a particular challenged regulation. In other words, not every regulation will be invalidated if challenged, but the record made that easy here, according to the panel, because of the trade group’s proof that the CFPB spent over $9MM on market research outside of normal overhead to support the drafting of the Payday Lending Rule.

Financial services providers should assume the CFPB is here to stay for now, however, as the ruling has no immediate effect outside the short term loan industry, and most analysts think that whatever the Supreme Court might eventually do will take months or even years to develop.