Credit Risk Management Controls

QUESTION 

Our regulator has said we have numerous defects in our credit risk practices for loan underwriting. This came as a shock to us since we have a low foreclosure rate. Nevertheless, the examiner says we have no control process for a self-assessment. 

To satisfy the regulator, we must put together a self-assessment policy and procedure to handle credit risk underwriting. We don’t know where to start. 

If we knew the control areas of credit risk management that the examiner wants us to self-assess, we could draft a self-assessment process. So, we’re writing you for some feedback. Thank you for these weekly newsletters! 

What are some controls involving credit risk underwriting practices? 

ANSWER 

You bring up an important distinction that many companies do not consider. There is a difference between risk assessments generally and the correlative control areas subject to review. The control areas are the framework on which the risk assessments are built. But you must outline those areas, or the self-assessment is an aimless set of procedures with limited value to management. 

To begin, you should define the regulatory risk. For instance, you could define the self-assessment’s purpose as evaluating the underwriting practices for new loans in residential real estate. Keep in mind that your assessment would consider the guidelines provided by investors and state and federal agencies. 

You must assess your risks and adjust your approach to make informed underwriting decisions and manage credit risks throughout the life of the loans, if applicable. I will provide a few control areas that should be the bases on which the self-assessment is established. My suggestions are by no means to be viewed as comprehensive. In fact, I am only touching on the ‘tip of the iceberg’ in self-assessments involving credit risk management. 

The goal is to elucidate a credit risk management process that covers steps for conducting a thorough credit risk management evaluation to determine what you need to do to update your institution’s credit risk controls and reduce your underwriting risks. 

Suggested Control Areas for Credit Risk Management 

·       Management controls, including prudence, separation of duties, quality, and capital 

·       Administration and Business line practices 

·       Credit approval process for loan types, terms, and conditions 

·       Follow-up measures related to a borrower’s performance, default exposures, and servicing reports 

·       System support to assist with credit analysis 

·       Substandard borrowers and the administrative system needed to manage these loan transactions 

·       Collateral and guarantees 

·       Loan policy controls, including Board of Directors approvals, periodic reevaluations, violations noted, and policy audits 

·       Loan review controls, including independence requirements, periodic adjustments, approvals, and reporting requirements 

·       Controls over past due and charge-off loans, including Watch lists, review categories, evaluation of reasons, and follow-up measures 

·       Controls over real estate owned (REO), including ownership rights, records, holding periods, and the sales process 

·       Foreclosed property controls, including status reports, property maintenance, and the sale decisions 

·       Loan accounting controls, including the accuracy of records, the adjustment process, exception management, quality controls, and the reporting process

·       Compliance with certain specified regulations, acts, and practices 

In building you self-assessment, make sure your findings are useable in one or both types of compliance assessments: on-site and remote. Both on-site and remote reviews may consist of the following activities (among others): notification, scheduling, self-assessments, documentation submission, interviews, file reviews, and reporting.

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director
Lenders Compliance Group

Reverse Mortgage Discrimination

QUESTION

Earlier this year, our federal regulator alleged that we were discriminating on reverse mortgages based on age. At this point, we are still trying to satisfy their requirements to remedy this issue.

Frankly, I don’t see how a HECM can be a focus of age discrimination since we originate them only for homeowners who are 62 or older. Senior citizens are usually people who are 62 or older.

Also, the regulator told us that our reverse mortgage advertisements had fair lending issues. Those concerns are all resolved now. But I need some clarification about the fair lending implications.

How does fair lending impact reverse mortgages?

And what types of advertisements can cause fair lending violations?

ANSWER

Fair lending compliance certainly applies to reverse mortgages. Just like traditional mortgages, reverse mortgages are subject to federal laws governing mortgage lending, including TILA, RESPA, and fair lending laws such as the Equal Credit Opportunity Act (ECOA). These laws and their respective implementing regulations set forth important protections for all mortgage borrowers, including reverse mortgage borrowers.

But, many protections are not tailored to the unique needs of reverse mortgage consumers. ECOA and its implementing regulation, Regulation B, set forth rules prohibiting discrimination by a creditor based on age (or race, color, religion, national origin, sex, or marital status) with respect to any aspect of a credit transaction. ECOA covers both intentional discrimination (i.e., disparate treatment) and also facially neutral practices that have a disparate impact on a prohibited basis, including age.

Regulation B also prohibits creditors from making statements to applicants or prospective applicants discouraging – on a prohibited basis – a reasonable person from making or pursuing an application.

Reverse mortgages are available only to consumers 62 years of age and older. Generally, the amount a consumer can borrow is partly a function of the consumer’s age. This is permissible under Regulation B. However, fair lending concerns can still arise in the reverse mortgage context. For example, if a lender that offers a range of lending products, including reverse mortgages, were to discourage creditworthy applicants over age 62 from applying for alternatives to a reverse mortgage, the lender could risk violating Regulation B.

State regulators have taken enforcement actions to combat unfair and deceptive marketing of reverse mortgages. Many administrative actions have centered not only on individuals and entities that make unfair or deceptive statements about reverse mortgages but also on those that misrepresent their ability and qualifications to offer reverse mortgages to consumers.

Many reverse mortgage lenders are also subject to UDAAP enforcement actions by the CFPB.[i] Some reverse mortgage lenders may also be subject to enforcement actions by the FTC.[ii]

Reverse mortgage advertisements are often a minefield of fair lending violations. Often, the violative ads confuse the consumer. Other ads tend to cause consumers to misunderstand one or more important features of the loans and the loans’ potential risks.

Here are a few of the fair lending issues we have found in our advertising compliance reviews. Keep in mind that these consumer reactions are in some way caused by the texts, various features, and delivery methods of the advertisements.

·       Advertisements caused consumers to believe that the government provided reverse mortgages and that repayment would not be required, giving the impression that reverse mortgages are not loans. 

·       Some ads caused consumers to mistakenly believed that money received through a reverse mortgage represented home equity they had accrued over time and that there was no reason they would have to pay it back. 

·       Many ads either did not include interest rates or put them in the fine print, leading to consumers finding it difficult to understand that reverse mortgages are loans with fees and compounding interest like other loans. 

·       Certain advertisements were confusing due to being incomplete and inaccurate, such as ads implying or stating that borrowers cannot lose their homes or do not have to make monthly payments. 

·       Many ads claimed that reverse mortgage proceeds were "tax free," thus leading consumers to believe they would not have to pay property taxes. 

·       The bogus claim of "tax free" money was used in ads by giving the impression that reverse mortgages are a government-run program or benefit. 

·       Advertisements using language or images referenced the Department of Housing and Urban Development (HUD) or the Federal Housing Authority (FHA), signaling that the government was funding and operating a reverse mortgage program for senior citizens. 

·       Some advertisements created a false perception by stating or implying that the main benefit of a reverse mortgage was that consumers could remain in their homes "as long as they want" based on ads that said, "the title and deed remain in their name." This implied that having a reverse mortgage meant they could never lose their home. This is false because while reverse mortgage borrowers retain the title and deed, the loans are secured by a lien, and borrowers can, in fact, lose their homes. Reverse mortgage borrowers are responsible for several requirements, including paying property taxes, homeowner's insurance, and property maintenance. Failing to meet these requirements can trigger a loan default that results in foreclosure. 

·       Advertisements hid various terms and conditions in the "fine print." Indeed, in some cases, it is likely that consumers could not even read the ridiculously small fine print in the printed ads, and, for the most part, no consumers could read the fine print used in television ads. Ads that included information about borrower requirements typically did so in the fine print. Fine print generally addressed tax and insurance requirements, property maintenance and residency requirements, repayment terms, and other important loan details. 

·       Advertisements caused consumers to misunderstand the government's role because the ads stated that the loans were "government insured" or a "government-backed program." A few advertisements went so far as to use text and graphics, such as eagles and government seals, to imply that reverse mortgages are affiliated with or offered by the federal government. 

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director 

Lenders Compliance Group

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[i] Dodd-Frank Act § 1031

[ii] 15 USC § 45

Servicer refutes being a Creditor

QUESTION 

We are servicing a loan portfolio of $2 billion. All we do is service loans belonging to lenders. We do not originate loans. 

Last week, we got a lawyer's letter that says we are a creditor. She represents the borrowers on a loan we service. She claims that we are responsible for errors in the escrow analysis. 

Our outside counsel tells us she doesn't have a case. He says we're not creditors. But he won't go into the details with us. I am the Compliance Manager. I may not be a lawyer, but I think I am entitled to an explanation. Hopefully, you can provide some feedback that we are not getting from our own lawyer. 

Is a servicer a creditor? 

ANSWER 

Let's start with a brief definition of the term "creditor." 

For purposes of our discussion here, the term "creditor" means a person who regularly extends credit that is subject to a finance charge or payable by a written agreement in more than four installments (not counting a down payment) and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when no note or contract exists. 

In general, TILA imposes liability only on creditors for violations of its provisions. 

Some exceptions include the requirement that servicers provide notices of transfer or assignment of mortgage loans, certain obligations of loan originators,[i] and liability of assignees for violations apparent on the face of a disclosure statement, except when the assignment was involuntary.[ii] 

So, typically, a borrower who sues a defendant for violating TILA must tie the violation to the creditor (or, in the exceptions just mentioned, the servicer, loan originator, or assignee). 

A federal district court in Maryland recently addressed this requirement succinctly in Ayres v. PHH Mortgage Corp.[iii] 

In 1991, Ayres financed the purchase of a home by borrowing $72,660 from Market Street Mortgage Corporation. Ocwen became the loan servicer in 2011, and PHH took over servicing in 2019. Successive lawsuits followed, and Ayres entered into a loan modification agreement at some point. 

What made me think of this lawsuit is that, like your situation, disputes arose regarding the escrow account maintained in connection with the loan. 

In 2021, Ayres sued Ocwen, PHH, and the trustee for the securitization trust that held Ayres's loan, alleging that the defendants had engaged in misconduct related to the loan modification and overcharged the escrow account. 

Among other claims, Ayres alleged violations of the Home Ownership and Equity Protection Act (HOEPA, part of TILA) and Regulation Z. Importantly, Ayres alleged in her complaint that the trustee was the owner of the loan. 

The defendants moved to dismiss the HOEPA claim because: 

(1) they were not "creditors" under TILA;

(2) TILA, HOEPA, and Regulation Z do not apply to loan modifications;

(3) the loan modification was not a high-cost mortgage loan under TILA;

(4) the loan was not negatively amortized; and

(5) nothing in an existing consent order prohibited the loan modification. 

Ayres responded that: 

(1) the defendants were "creditors;"

(2) HOEPA applies to loan modifications;

(3) the mortgage loan under the modification agreement was a high-cost mortgage loan;

(4) the loan was negatively amortized; and

(5) Ocwen was not licensed under an applicable Maryland statute and, therefore, could not enter into the loan modification. 

The court dismissed the complaint because Ayres failed to allege that Ocwen had been involved with the origination of the loan or was the party to whom the loan was initially payable. Instead, Ayres simply alleged that Ocwen was the loan's servicer and that someone else was the owner or assignee. 

Thus, Ayres failed to state a claim because none of the defendants was a "creditor" within the meaning of TILA, which, by extension, disposed of the need to address items (2) through (5).

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] See 15 U.S.C. §1639b regarding duty of care and the prohibition of steering incentives.

[ii] 15 U.S.C. §1641(a)

[iii] Ayres v. PHH Mortgage Corp., 2022 U.S. Dist. (D. Md. Sept. 19, 2022)

Quality Control: Independence and Oversight

QUESTION 

I am the compliance manager at a lender in the Midwest. We downsized our Quality Control department recently due to market conditions. However, we still have a quality control manager and two other QC employees. Frankly, we may outsource all the quality control soon. 

I am interested in keeping stability in QC, whether we keep or outsource it. To do that, I need to know two things: (1) how to maintain QC independence and (2) what kind of audit will provide oversight of the QC department and functions. 

We have solved the second item since we are using your firm for the QC Tune-up. But I still don't know how to determine if our QC department is truly independent. Last year, our regulator told us that our QC department was not operating independently. We expect them back soon for another examination, and I'm sure this will come up again. 

How should we maintain QC independence? 

And, what are some audit features for overseeing the QC department? 

ANSWER 

Our QC Tune-up reviews of post-closing frequently find that the Quality Control department and functions are not independent of the originations and production lines. I will add that the same is the case for prefunding, as the prefunding process sometimes doesn't operate independently of production. 

We've even encountered situations where the head of underwriting is also involved in managing QC. That's about as big a violation of independence as imaginable! I have a business card from somebody that says she's the "VP / Underwriting and Quality Control." Regulators go ballistic when they come upon such inappropriate situations. And investors, such as Fannie, forbid it. 

If you're serious about preserving the integrity of the QC process, all your post-closing QC employees (including those related to establishing, monitoring, and enforcing procedures) must be independent of the production, underwriting, and closing departments. Furthermore, the reporting lines should not be blurred and must reflect the independence of the audit QC process at all levels. 

Prefunding QC process must operate independently of the lender's production department. If, for some reason, that is not possible, prefunding QC must nevertheless be done by individuals without involvement in reviewing the subject loan's processing and underwriting decision. 

Here's the point: the wall between QC and the production, underwriting, and closing departments ensures that the QC staff is not influenced to alter QC results. Obviously, it is critical that QC auditing is conducted without bias or compromising the quality control findings resulting from internal influences or conflicts of interest. 

Thank you for retaining us for the QC Tune-up. By using the QC Tune-up, you are acting responsibly to determine the strengths and weaknesses of the QC department and its functions. If others want information about the QC Tune-up, please contact us here. 

You may have a written QC plan, but how are you ensuring that the QC program operates according to the requirements set forth therein or whether the QC department's activities are verifiably independent, without influence by parties with a vested interest in QC results? Most investors demand an effective QC program. Indeed, if you check your investor PSAs and supporting documents, you'll likely find that it is a breach of your contractual obligations with them if you do not have an effective QC department. 

To monitor the QC department, four factors should be considered.

 

1.   Oversight procedures should be independent of all key functions of the loan manufacturing process. This ensures that the reviews provide an objective and unbiased evaluation.

 

2.   Reporting lines should reflect the independence of the audit process at all levels, thereby ascertaining that QC activities are performed in an unbiased manner.

 

3.   The audit function must not share any reporting lines with functional areas under review.

 

4.   The oversight function must report directly to senior management and/or the Board of Directors. Reports derived from the procedures should recommend remedies, if needed, to ensure risk management, internal control, and governance objectives. 

If remediation is needed, I recommend drafting an action plan. The plan should be continually updated, as appropriate, with remediation initiatives and changes to policies and procedures. Also, ratify an audit or oversight review schedule that contains areas subject to review and the timeframe required to fulfill the review process. Be sure the scope of the review is clearly defined. 

QC oversight is so important and mission-critical that most of our clients have us conduct a QCTune-up every twelve months. Over twelve months, many testing protocols can change, statutes and investor guidelines vary, approval authorities and personnel change, ongoing change management is updated, and loan level documentation may be revised, all of which affect the effectiveness of the QC department.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

Servicing Quality Control: Why’s and Wherefore’s

QUESTION 

I am the Chief Compliance Officer of a mid-size mortgage lender. I started here about three months ago. We are Fannie and Freddie approved and subservice our loans. However, I have discovered some serious lapses in compliance involving our subservicing oversight. 

Last week, I was shocked to find out that we have never done loan servicing quality control. To make matters worse, we have never done an annual review of the servicer. When I discussed this with the CEO, he blew me off. He doesn’t want to do loan servicing QC. As to the annual review, he only wants to do the bare minimum. 

He reads your weekly newsletter and quotes you all the time. I do too. But I have to get through to him somehow about the urgency of doing loan servicing QC. We are scheduled for our Fannie MORA review soon, and I know this may be an issue. I thought you would be willing to write an article about this requirement. 

I spoke to your firm’s representative to get a proposal for loan servicing QC, the most pressing issue. She sent me the proposal and other materials. But I can’t get anything done until the CEO authorizes this compliance service. I hope the CEO reads your response. I will show it to him! 

What is the importance of doing loan servicing quality control? 

ANSWER 

Loan servicing quality control is not an option. My sense of your CEO’s reaction is that he views it as an optional rather than a mandatory compliance requirement. If he wants to talk, ask him to contact me. Your investors, such as Fannie and Freddie, will demand servicing QC as a condition of their relationship with your firm. 

Think about it! You are entrusting the precious product of your loan originations into the hands of another company to conduct loan servicing; however, for whatever reason, you are not implementing ongoing, loan level, quality control of the servicing activities nor checking on the subservicer annually to ensure there are no risk-related issues that could affect the safety and soundness of your financial institution. Doesn’t make much sense, does it? 

My impression from your inquiry is that you also do not have a Loan Servicing Quality Control Plan (“Plan”). That, too, is a requirement. Just as you have a quality control plan for loan originations, if you are subservicing you must have a quality control plan for servicing through a subservicer. 

Loan servicing QC covers Fannie Mae, Freddie Mac, HUD/FHA, VA, Ginnie Mae, USDA, CFPB, many investors, and state (statutory) mandates. In most cases, your firm is still liable for the actions of your subservicer. For example, Freddie mandates implementing a written quality control program for servicing its mortgages. Subject to audit, Freddie will review and require changes to the Plan. Servicers must have written policies and procedures documenting their Plan’s requirements and consistently monitor compliance with these policies and procedures as part of a prudent risk management framework.[i] 

Need compliance support for loan servicing quality control? Contact us HERE. 

Consider the areas subject to loan servicing quality control reviews conducted for HUD/FHA loans. Except for particular factors associated with certain loans (i.e., FHA, VA), the servicing QC review, which should be conducted monthly, would include, but not be limited to, a per file selection audit of:[ii] 

·       ARM adjustments, conversions, and disclosures;

·       Assumption processing;

·       Bankruptcy procedures;

·       Claims, and claims without conveyance of title;

·       Collections and defaults;

·       Continuity of contact with the borrower;

·       Customer service;

·       Deficiency judgments;

·       Document retention;

·       Early intervention;

·       Early payment defaults (i.e., FHA);

·       Error resolution;

·       Escrow administration;

·       Fees and charges;

·       Flood monitoring;

·       Force-placed insurance;

·       Foreclosure processing;

·       Handling of prepayments;

·       Hazard insurance;

·       HECM disbursement reporting;

·       Information requests;

·       Loss Mitigation efforts;

·       Maintenance of records.

·       MIP billings;

·       New loan boarding;

·       New loans, servicing transfers, acquisitions;

·       Paid-in-full mortgages;

·       Payment processing;

·       Payoffs, demands, and satisfaction;

·       Periodic billing;

·       Pre-foreclosure;

·       REOs;

·       Reporting under the Single Family Default Monitoring System (SFDMS);

·       Section 235 (FHA) recertifications;

·       Servicing delinquent accounts; and,

·       Trustee Sales. 

Federal, state, and agency statutes and requirements apply to mortgage lending, servicing (and foreclosure). Loan level reviews such as foreclosure, loss mitigation, ARM adjustments, and servicing transfers are reviewed to ensure compliance with regulatory requirements. Actually, we have counted at least twenty-six essential loan servicing functions. We target these functions. They are called Areas of Inquiry or AOI. Sampling is usually random, which allows the file selection to show the implementation of the Life Events applicable to the file in particular and the servicing portfolio in general. Our audits are done by credentialed auditors, compliance professionals with expertise in servicing compliance. Although there are automated auditing platforms, we know from experience that there is no replacement for a hands-on review of documents subject to audit. 

Let’s zero in on your Fannie Mae Seller/Servicer arrangement.[iii] It appears you are a Master Servicer.

Collecting a Debt from a Susceptible Consumer

QUESTION 

Our compliance department received a complaint from a borrower about being harassed. She is overdue in her payments, her escrow is going negative, and we have tried to get her to respond to letters and calls. Our attorney is now involved in replying to her. 

But it is very frustrating when we try to contact the borrower in every way, and then she accuses us of harassment. The main threat she has is that we intimidated her and used threatening language. I doubt it. 

We have received debt collection training and know what we’re doing, what to say and what not to say. Nevertheless, this complaint happened! 

Maybe you can provide guidance by discussing the prohibitions against harassment to collect a debt. 

What are some prohibitions regarding harassment in debt collection? 

ANSWER 

Over the years, we have handled disputes like the one you describe. Indeed, generally, your situation is rather common, though each case is reflective of particular facts. 

Some of the abusive acts my firm has encountered in connection with collecting a debt are:

 

·  using threat or use of violence or other criminal means to harm a person;

·  using obscene or profane language;

·  advertising for a debt to coerce payment of a debt;

·  repeatedly contacting a debtor with an obvious intent to annoy, abuse, or harass  them; and,

·  placing calls without any meaningful disclosure of the caller’s identity. 

And, believe it or not, we’ve encountered an attempt to collect a debt by publishing a list of consumers who allegedly refuse to pay debts! 

Proverbs (22:7) says, “the borrower is servant to the lender.” But such harassing and abusive acts are morbidly extreme and straight-out violations of the Fair Debt Collection Practices Act (FDCPA).  

The FDCPA aims to protect consumers from harassment or abuse concerning debt collections.[i] There are five specific types of prohibited conduct that constitute harassment or abuse. I’ll list them below. 

Before listing them, I will note the following provision in the FDCPA: 

“… a debt collection may not engage in any conduct the natural consequence of which is to harass, oppress, or abuse any person in connection with the collection of a debt.”[ii]

[Emphasis added.] 

You might think this is subjective, but you would be wrong. The purpose of the provision, as stated by Congress in the Senate report regarding the consideration of the FDCPA, is to “enable the courts, where appropriate, to proscribe other improper conduct which is not specifically addressed.”[iii]

Thus, a debt collector may be liable even if its actions do not fall under the five prohibitions. If you want to wind up in court, be my guest. There’s a huge body of case law that will get you focused real quickly. 

Alternatively, seek competent, professional guidance to ascertain if your plans to collect a debt are potentially liable, especially if they seem to fall outside the five specific prohibitions. 

Here are the five examples of conduct – and note the word “examples,” meaning these are not meant to be exclusively comprehensive – that fall under the prohibition:[iv]

 

1.  Threatening to contact third parties;

2.  Communicating unnecessarily with third parties when the consumer can be reached directly;

3.  Using intimidating or insulting language;

4.  Repeated and frequent personal contact with the consumer; or

5.  Continuing to collect after multiple notices of bankruptcy discharge.

The terms “harass,” “oppress,” and “abuse” are not defined under FDCPA, and so are given their plain meaning. Note the phrase quoted above – “the natural consequence of which is to harass, oppress, or abuse” – uses all three terms. Therefore, a standard is used to determine the issue, and whether or not the consumer actually believes they are being harassed, oppressed, or abused is not relevant. 

The term for a standard that courts often use is the “susceptible consumer” standard. That standard is not “subjective” and can be applied objectively. Under the “susceptible consumer” standard, courts look to a consumer who is “relatively more susceptible to harassment, oppression, or abuse” based on their circumstances.[v] 

A final point: the FDCPA applies to the harassment or abuse of not only consumers but also “any person” in connection with debt collection. Thus, a debt collector may be liable for the natural consequences of its actions on family members, friends, or others. 

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director 

Lenders Compliance Group

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[i] 15 USC § 1692d

[ii] Idem

[iii] Senate Report # 382, 95^th Congress, First Session 4 at 4 (1977)

[iv] FTC Staff Commentary on FDCPA § 806

[v] Jeter v Credit Bureau, Inc., 760 F.2d 1168, 1179 (11^th Circuit 1985) 

Snollygosters and Throttlebottoms

QUESTION 

I have been reading about the CFPB coming under attacks as being unconstitutional. If it is found to be unconstitutional, we are concerned about everything it has done all these years, such as whether we are going to still be required to follow all its rules and regulations. 

It seems to me the politicians who created the CFPB should have thought of its constitutionality before setting it up in the first place. We send them to Congress, they create the CFPB, and then it is found to be unconstitutional years later. I think that could affect the whole shebang of policies my company put in place for years at a huge expense. 

I'm no lawyer but most of these Congress critters are lawyers. They should know how to write a constitutional law. I am frustrated. I am concerned about CFPB enforcement, too. Especially at this time, I do not have the money to reset our policies to pre-CFPB conditions if the CFPB's authority is destroyed. 

I have read your articles for years. I know you can explain what is going on. 

What are the implications of the CFPB being considered unconstitutional? 

ANSWER 

I have received many questions along the lines of your inquiry. Quit paying so much attention to snollygosters who prey on your fears. Fear gets people fired up, which is the point of it all. Then they get all charged up, go out to vote, and, lo and behold, they elect the fearmongering throttlebottoms who proceed to screw up the machinery with anfractuous, circuitous, serpentine, and tortuous crepitations of impending apocalypse. 

Let's dispense with the realm of signs, portents, and omens. 

So, first and foremost, take a deep breath. The CFPB's rules are not going anywhere for now. However, there are some litigation challenges along the way that will need to be vetted. 

A few weeks ago, on October 19, 2022, three judges in the Fifth Circuit Court of Appeals ruled that the funding mechanism of the Consumer Financial Protection Bureau (CFPB) is unconstitutional.[i] Specifically, the court found it was a violation of the Appropriations Clause[ii] of the Constitution for the CFPB to receive funds upon the CFPB Director's request to the Federal Reserve instead of through Congressional appropriations. 

The instant case involves a challenge to the validity of the payment provisions of the CFPB's 2017 Payday Lending Rule ("Rule"). Under the Rule, lenders are prohibited from making payment transfers from consumer accounts after two consecutive failed attempts due to insufficient funds unless the consumer authorizes such attempts. 

The district court granted summary judgment in favor of the CFPB. But, on appeal, the plaintiffs challenged the CFPB's promulgation of the Rule, alleging that the Rule was promulgated by a Director who could not be removed, which means the Director is "insulated" from removal. (I'll come back to the implications of the Director being "insulated" momentarily.) The plaintiffs further alleged that the CFPB's rulemaking itself is violative of the non-delegation doctrine and that the CFPB's means of receiving funds violates the Appropriations Clause. 

The non-delegation doctrine stems from the Constitution's vesting clause and separation of powers. The doctrine is an interpretation derived from Article I, Section I of the Constitution that declares all legislative power granted by the Constitution is vested in the Congress, the legislative branch. Thus, it's a principle in administrative law that holds Congress cannot delegate its legislative powers to other entities, such as delegating its power to administrative agencies or private organizations. 

The court said that the way the CFPB receives funds allows the CFPB to have a "double insulation" from the Congressional appropriation power: the CFPB Director's requesting funds from the Federal Reserve, which the Director deems "to be reasonably necessary," violates Congress's appropriations power. 

Furthermore, the court reasoned that the Federal Reserve itself falls outside of Congress's appropriations power because it receives funds from bank assets not subject to review by the House or Senate Committee on Appropriations. 

Therefore, the court found that Congress's authorization of the CFPB to promulgate the Rule was not unconstitutional, but the CFPB improperly used unappropriated funds to engage in the rulemaking process. In its reasoning, the court clarified that the CFPB lacked the ability to exercise the power to promulgate the Rule through constitutionally appropriated funds. 

In my view, this ruling will not have much or any impact on the structure of the CFPB. The court's ruling focuses on how the CFPB receives its funding and its violation of the Appropriations Clause. I think it's unlikely that this case will have any effect on the CFPB's enforcement powers as a regulatory agency. 

That word "unlikely" is doing a lot of work there. I happen to think the CFPB's funding mechanism is constitutional under the Appropriations Clause; in fact, the CFPB must ask Congress for any money it receives out of the Treasury, which goes for several other federal agencies operating similarly, including the FDIC. 

The court must recognize the potentially devastating consequences that could result from interfering with the funding practices of all independently funded government agencies. We know this because the court specifically limited its reasoning to the CFPB. It did this juridical prestidigitation by claiming that the CFPB's authority is unlike those of other federal regulators and that its funding independence "goes a significant step further." How it goes a "significant step further" is somewhat of a mystery. 

I fail to see the difference. And if there is a difference, the court does not bother to explain why those differences are constitutionally significant, as far as I can tell. 

As the Constitutional Accountability Center has stated:

"Despite the court's attempt to carve out a special rule for the CFPB, its reasoning would seemingly apply to the host of other financial regulators that are independently funded, including the Federal Reserve Board, which supervises and regulates numerous banking institutions."[iii]

So, the court has put the CFPB and many similarly funded agencies into a reductio ad absurdum conundrum since it now calls into question the rules, guidance, and orders that the CFPB and the other agencies have issued, inasmuch as they are similarly funded like the CFPB. For instance, agencies similarly funded outside the congressional appropriations process are the Federal Reserve, Federal Deposit Insurance Corp (FDIC), Office of the Comptroller of the Currency (OCC), National Credit Union Administration (NCUA), and Federal Housing Finance Agency (FHFA). 

The ruling attempts a surgical clip but winds up taking a machete to many agencies. 

Indeed, the CFPB has already stated that the Fifth Circuit's decision is "neither controlling nor correct" and "mistaken." The CFPB has stated, "there is nothing novel or unusual about Congress's decision to fund the CFPB outside of annual spending bills."[iv] 

This past Monday, November 14^th, the CFPB petitioned for a writ of certiorari to the U. S. Supreme Court, saying that the Fifth Circuit’s decision "threatens to inflict immense legal and practical harms on the CFPB, consumers, and the nation’s financial sector.”[v] 

The CFPB should now request a stay from the Fifth Circuit pending the Supreme Court decision, or, if denied by the Fifth Circuit, it should ask for a stay from the Supreme Court. If the CFPB doesn’t get a stay, it is not unreasonable to conclude that the Fifth Circuit’s decision could impede the CFPB’s litigating of current cases while also potentially impacting past enforcement actions and rulemaking.[vi]

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director

Lenders Compliance Group

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[i] Community Financial Services Association of America, Limited; Consumer Service Alliance of Texas v Consumer Financial Protection Bureau; Rohit Chopra, in his official capacity as Director, Consumer Financial Protection Bureau, United States Court of Appeals for the Fifth Circuit, Case 21-50826

[ii] Article I, Section 9, Clause 7, U. S. Constitution: “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time.”

[iii] As Wrong as It is Dangerous: The Fifth Circuit’s Decision Holding the CFPB Funding Structure Unconstitutional, Constitutional Accountability Center, https://www.theusconstitution.org/blog/blog-as-wrong-as-it-is-dangerous-the-fifth-circuits-decision-holding-the-cfpb-funding-structure-unconstitutional

[iv] Appeals court finds CFPB funding unconstitutional, Katy O'Donnell, October 19, 2022, statement to Politico from CFPB spokesperson Sam Gilford. https://www.politico.com/news/2022/10/19/appeals-court-cfpb-unconstitutional-00062626

[v] Consumer Financial Protection Bureau, Et Al, v Community Financial Services Association of America, Limited, Et Al, Petition for a Write of Certiorari, November 14, 2022, section Reasons for Granting the Petition, p. 10

[vi] Ibid. Reasons for Granting the Petition, Section B. The Decision Below Warrants Review, And The Court Should Hear The Case This Term, p. 28