An appeals court ruling that the Consumer Financial Protection Bureau’s funding structure is unconstitutional raises the stakes in a long battle over the agency, potentially setting the stage for a test the Supreme Court sidestepped only two years ago when it declined to find the entire agency unconstitutional.

A three-judge panel of the 5th U.S. Circuit Court of Appeals last week vacated a 2017 CFPB payday lending rule, saying the agency’s funding is unconstitutional because it draws money from the Federal Reserve, insulating it from congressional oversight. 

The decision is not only expected to make it harder for the CFPB to enforce rules, at least temporarily, but it also opens up the prospect of widespread disruption in a regulated area of the economy and potentially a need for Congress to step in and resolve the funding issue.

“We’re going to immediately start to see a spillover effect for companies that don’t want to comply with regulations, for companies that don’t want to deal with CFPB law enforcement investigations,” said Christopher Peterson, a University of Utah law school professor and former CFPB official. “They can point to this decision in the 5th Circuit to start dragging their feet to slow down investigations.”

The decision will be binding in the 5th Circuit’s jurisdiction, covering Louisiana, Texas and Mississippi, and will be “highly persuasive” in other circuits until there’s a competing case to contradict it, he said.

A Supreme Court sequel

Peterson and other legal experts said the CFPB is expected to ask for a stay to the ruling and for a review by the full 5th Circuit. Such an en banc review could affirm, soften or reverse the decision reached by the three judges. Anything less than a full reversal increases the likelihood that the case will go to the Supreme Court.

“There is nothing novel or unusual about Congress’ decision to fund the CFPB outside of annual spending bills,” Sam Gilford, a CFPB spokesperson said, without commenting on an appeal. Gilford added that other federal financial regulators and the Federal Reserve System are funded that way and that the CFPB would continue to enforce the laws and protect consumers.

The Supreme Court only two years ago curtailed the independence of the CFPB, finding the director’s insulation from presidential control violated the Constitution, but it took no issue with its funding structure. The 5th Circuit panel’s decision, however, ups the ante by posing a question the high court didn’t directly address in 2020.

“The only constitutional defect we have identified in the CFPB’s structure is the Director’s insulation from removal,” Chief Justice John G. Roberts Jr. wrote for the majority in a 5-4 decision in a case known as Seila Law v. CFPB. In the 2010 law that established the CFPB, Congress said the president could fire the director only for cause.

Roberts, joined by conservative Justices Samuel A. Alito Jr. and Brett M. Kavanaugh, wrote that it was unconstitutional to give the director so much independence but didn’t declare agency rules unconstitutional. And they rejected Seila Law’s request to dissolve the CFPB if they found the director’s insulation from presidential authority to be unconstitutional. 

“We think it clear that Congress would prefer that we use a scalpel rather than a bulldozer in curing the constitutional defect we identify today,” Roberts said. The solution was to bring the director under presidential oversight rather than eliminate the agency. 

Seila Law had challenged a CFPB demand for documents in its investigation of the California law firm. The case touched on the agency’s funding, but only to support the argument that the director wielded too much power without answering to the president or Congress.

The 5th Circuit panel has put the CFPB funding at the heart of the matter. The arrival in late 2020 of conservative Justice Amy Coney Barrett to replace progressive Ruth Bader Ginsburg on the Supreme Court and the court’s June decision curtailing the EPA’s ability to regulate carbon emissions are adding to uncertainty about the court’s view of the administrative state.

“Ten years ago, I would have said, no chance, but today, with that EPA case, with the abortion decision, hey, you know, who knows?” Peterson said. “There is a very realistic possibility that the Supreme Court could get five votes to agree that the funding mechanism is unconstitutional.” 

Peterson was a special adviser in the CFPB’s Office of the Director from 2015 to 2016 and senior counsel in its Office of Enforcement from 2012 to 2014. 

Kathleen Engel, a law professor at Suffolk University in Boston, said the potential consequences would give the high court pause despite conservatives’ dislike of the CFPB.

“The majority is hostile to the broad authority of the CFPB, but the consequences of striking down CFPB regs are so extreme at a time when the country is in economic turmoil,” she said in an interview. “This would just have tremendous consequences.”

Bill Hulse, vice president of the U.S. Chamber of Commerce Center for Capital Markets Competitiveness, said the Supreme Court would likely find the agency’s funding source unconstitutional. The chamber is part of a separate lawsuit challenging a change to the agency’s examination manuals that also argues the CFPB funding violates the Constitution’s appropriations clause.  

“I don’t think the CFPB is necessarily going to get a whole different answer from the Supreme Court than they have from the 5th Circuit,” Hulse said in an interview. “The Supreme Court has been interested in addressing overreach by the administrative state.”

In the 2020 case, Justices Clarence Thomas and Neil M. Gorsuch issued an opinion that at least illustrated how much could be in play. Thomas, who wrote the opinion, said the director’s insulation from presidential control was unconstitutional and that the court should therefore reject the CFPB’s action, in that case a demand for Seila Law documents. The two were in the 5-4 majority over the director’s independence but wanted to also throw out the agency’s demand for documents.

Legislative resolution

“What does the 5th Circuit’s decision mean for the agency’s actions to date in general? The other part of that question, too, is what’s it mean for the agency’s actions going forward?” Hulse said. “It seems likely that the Supreme Court would find a potential remedy being that the agency should be subject to appropriations. It does leave open the question, however, what it means for the agency’s actions the last 10 or so years.”

The chamber advocates subjecting the CFPB to the appropriations process. CFPB supporters warn doing so would undermine its independence.

Most federal banking regulators are funded by fees on the businesses they regulate, sitting outside the appropriations process, including the Fed, Federal Deposit Insurance Corporation and others. Some financial regulators, including the Securities and Exchange Commission, are funded through appropriations, although the money is provided to the SEC by industry fees, not taxpayer dollars. 

The CFPB is unusual in that it draws its funding from another agency, the Fed, rather than through appropriations or fees. 

Peterson said the 5th Circuit’s vacating of a rule because the funding is unconstitutional could call into question the legitimacy of all of the CFPB’s rules. 

“Everything from mortgage loans to checking, savings accounts, to college student loan collection, credit reports, identity theft protections, all are organized by regulations that the Bureau has issued,” Peterson said. Congress could lessen the potential fallout with legislation that puts CFPB actions into statute, he said. 

“You may want Congress to pass a law that ratifies all the work that the bureau has done so far in order to stop this cloud of uncertainty over whether or not all the agency’s work is tainted by unconstitutionality,” he said. Altering the agency’s funding structure to levy and rely on industry fees like other banking regulators could also sidestep the reasoning laid out by the 5th Circuit decisions, Peterson said.

Hulse said Congress could resolve the issue before it even gets to the high court by passing legislation putting the CFPB into the appropriations process. Rep. Andy Barr, R-Ky., has introduced such a measure. The proposal is likely a nonstarter for Democrats, who say it would hobble the agency and subject it to political whims.

“There’s nothing stopping them theoretically from passing a bill in the lame duck,” Hulse said.  “This doesn’t have to get to the Supreme Court.”