PHH Corp. v. CFPB: Are Captive Arrangements and Marketing Services Agreements (MSAs) Back in Business?

As many of you have been asking me for my thoughts on the recent decision in the PHH Corp. v. CFPB case by the U.S. Court of Appeals for the D.C. Circuit, I decided to write a brief update to summarize the decision and provide some of my thoughts on what the decision means for the industry, including whether this means captive arrangements and marketing services agreements are back in business.

I. Background

You likely know by now that on January 31, 2018, the U.S. Court of Appeals for the D.C. Circuit issued a decision in PHH Corp. v. CFPB. As you may recall, this case arose because PHH appealed an administrative enforcement action by the CFPB. That enforcement action, which the CFPB initiated against the company in January 2014, alleged violations of RESPA section 8 stemming from a captive reinsurance arrangement that continued through 2013. In June 2015, former CFPB Director Cordray issued a decision in the enforcement action imposing a $109 million judgment. PHH then appealed, asking the court to vacate the CFPB’s decision on the grounds that the CFPB misinterpreted RESPA section 8 and violated due process in applying a new interpretation retroactively, and that the CFPB’s structure is unconstitutional because it has a single Director who is removable only for cause (the Dodd-Frank Act uses the typical causes of “inefficiency, neglect of duty, or malfeasance in office”).

In October 2016, the Court of Appeals issued its opinion by a three-judge panel, finding the CFPB’s structure unconstitutional and the CFPB’s interpretation of RESPA invalid. But in November 2016, the CFPB petitioned the court for a rehearing of the case en banc (i.e., by the full court), which the court granted in February 2017. I wrote about the three-judge panel’s opinion in a previous Client Update on the PHH case, which you can access here:

II. The En Banc Court’s Opinion

The en banc court issued an opinion on both the constitutionality and RESPA issues, both of which could have significant effects on the industry. Regarding the constitutionality issue, the court held in a 7-3 decision that the CFPB’s structure is constitutional, reversing the three-judge panel’s opinion on the issue. Regarding the RESPA issues, the court reinstated the three-judge panel’s opinion, and did not otherwise address these issues in its opinion. Specifically, the court stated that, “[t]he panel opinion, insofar as it related to the interpretation of RESPA and its application to PHH and Atrium in this case, is accordingly reinstated as the decision of the three-judge panel on those questions.” Note that this was essentially a 7-3 decision as well, as three judges issued a concurring opinion that disagreed on the RESPA issue, finding the CFPB’s interpretation of RESPA section 8(c)(2) reasonable.

As described further below (and in my previous Client Update on the case), the D.C. Circuit’s panel opinion held that the CFPB’s interpretation of RESPA section 8 was invalid, finding that captive reinsurance arrangements are permissible under RESPA section 8(c)(2), as long as the reinsurance payments were not in excess of the reasonable market value of the reinsurance. Another important aspect of the panel’s RESPA opinion is the holding that the applicable statute of limitations for the CFPB’s administration actions under RESPA is three years. The panel opinion would have, and now the en banc decision does send the case back to the CFPB to determine whether, in fact, the payments in the arrangement were for the reasonable market value of the reinsurance, satisfying the exemption under section 8(c)(2).

I discuss below the en banc opinion and the panel’s RESPA opinion it reinstates in more detail, and provide some thoughts on its impact on the industry.

III. The Constitutionality Issue

A. CFPB’s Structure is Constitutional

Without getting into the details of constitutional law (please let me know if you’d like to discuss them, as I’d be happy to), the en banc court decided that the CFPB’s structure was constitutional. The decision on the CFPB’s constitutionality means that the CFPB can continue operating as it is currently structured, with a single Director at the helm who is removable only for cause.

This was not a certain outcome. The three-judge panel’s opinion held that the CFPB’s structure was unconstitutional, because the President could only remove the Director “for cause,” which inhibited the President’s ability to exercise executive authority over the single Director of the CFPB. Much of the opinion focused on the threat to individual liberty of a single CFPB Director who is removable only for cause and wields significant power. The panel’s opinion raised concerns that the authorities vested in the CFPB’s single Director, such as the authority to issue subpoenas and impose civil money penalties, could be abused or otherwise harm individuals. The panel also discussed historical precedent, describing the CFPB’s structure as an independent agency with a single Director as a “gross departure from settled historical practice.” In addition, the panel discussed the benefits of a multi-member commission structure over a single agency head for an independent agency. Finding the structure unconstitutional, the panel held that the proper remedy was to “sever” the “for cause” removal provision, which would have allowed the CFPB to continue operating with a Director who is removable without cause (at will) and would not have invalidated the enforcement action against PHH.

But in spite of these significant concerns, the en banc court did not agree with the panel’s opinion, finding the CFPB’s structure constitutional. The court reasoned, in part, that financial regulatory agencies have typically been structured as independent agencies with heads removable only for cause. The court also noted that the Office of the Comptroller of the Currency, a financial regulatory agency, has a single head. However, it is notable that there were multiple dissenting opinions on the constitutionality issue by the en banc court. And notably, one of the dissenting opinions would have invalidated Title X of the Dodd-Frank Act (the statute that created the CFPB), putting the CFPB out of existence, in its entirety and set aside the CFPB’s PHH decisionIt appears that there is some level of disagreement on this issue, and PHH could potentially appeal the decision on the CFPB’s constitutionality, if they are so inclined.

B. What the Decision Means for the Industry

This decision’s immediate effect on the CFPB’s operations and the industry will be minimal. The CFPB is currently headed by Acting Director Mick Mulvaney, who President Trump designated under the Federal Vacancies Reform Act to act as Director after Cordray resigned in November 2017. That statute allows an acting official designated by the President to serve for a limited time period and is not subject to a “for cause” removal provision, and thus, this decision does not appear to have an immediate effect on Acting Director Mulvaney’s ability to serve or protect against his removal.

That being said, this decision could cause the Trump administration to be more careful about who it nominates to be the permanent Director of the CFPB. Based on this decision, whoever becomes the appointed and Senate-confirmed Director will be removable only for “inefficiency, neglect of duty, or malfeasance in office.” Although one of the concurring opinions in the case argued that this “for cause” removal provision under the Dodd-Frank Act allowed removal for “ineffective policy choices,” and as a result only provides a “minimal restriction” on the President’s removal power, an attempt to remove a Director under this provision solely for policy reasons could result in a prolonged legal battle that may be unappealing politically. For this reason, I think that in light of this decision, the Trump administration will strongly weigh whether its choice for Director will adhere to their policy views throughout the five-year term.

In addition, I personally hope that this decision spurs Congress to act on legislation to change the CFPB’s structure to a multi-member board or commission. The panel opinion and en banc court’s dissenting opinions demonstrate that some well-respected judges, as well as others outside of the courts, have found legitimate legal and policy concerns with placing control over decision-making and enforcement for the country’s consumer financial protection laws in a single Director who is removable only “for cause.” In addition to providing for more thoughtful and deliberate decision-making in the agency, placing a commission at the top of the CFPB will also prevent the regulatory pendulum from swinging too wildly when the political party in power changes. The benefits of regulatory stability and certainty to industry cannot be overstated.

IV. The RESPA Issues

Because the en banc court reinstated the panel opinion with respect to the RESPA issues, I briefly summarize below the panel opinion and provide my thoughts on the impact of decision on the industry.

A. Whether RESPA Section 8(c)(2) is an Exemption

As you may recall, Director Cordray’s decision in the CFPB’s enforcement action found that RESPA section 8(c)(2) was not an exemption and thus, PHH violated RESPA section 8(a), even if the payments for reinsurance in the arrangement were reasonably related to the market value. Specifically, Director Cordray stated that, “section 8(c) clarifies section 8(a), providing direction as to how that section should be interpreted, but does not provide a substantive exemption from section 8(a).” He reasoned, in part, that, “reading section 8(c)(2) as an exemption would substantially undermine the protections of section 8,” and that “[i]f section 8(c)(2) permitted compensated referrals, it would “distort the market in ways that the statute as a whole plainly sought to prevent.” Director Cordray reasoned that for section 8(c)(2) to apply, the payment must be “bona fide” and “for services actually performed,” and that “bona fide” in this provision means that the “payment must be solely for the service actually being provided on its own merits, but cannot be a payment that is tied in any way to a referral of business.” Director Cordray essentially found that the term “bona fide” applies to “the purpose of the payment, not to its amount.” The CFPB, defending the enforcement action, argued before the D.C. Circuit that “bona fide” in section 8(c)(2) means that the payment is in “good faith,” i.e., not as a quid pro quo for referrals.

PHH argued that Regulation X, which implements RESPA section 8, treats section 8(c)(2) as an exemption, as it expressly permits payments for services, as long as they are for services actually performed and are reasonably related to the market value of the services.

The panel opinion in the PHH case strongly disagreed with the CFPB’s interpretation of REPSA section 8, describing the issue as “not a close call” and the CFPB’s interpretation as “strained.” The panel opinion held that section 8(c)(2) is an exemption from section 8(a)’s prohibition, rather than an interpretative aid as the CFPB argued, and that section 8(c)(2) permits the captive reinsurance arrangements to the extent the payment does not exceed the reasonable market value. Specifically, the panel opinion stated, “[w]e agree with PHH that Section 8 of the Act allows captive reinsurance arrangements so long as the amount paid by the mortgage insurer for the reinsurance does not exceed the reasonable market value of the reinsurance.”

B. Due Process and HUD’s 1997 Letter

In addition to arguments based on the statutory language, PHH argued that it relied on a prior letter that HUD issued in 1997 specifically addressing captive reinsurance arrangements, in which it stated that such arrangements were permissible under RESPA section 8, as long as the payments were for reinsurance that was actually provided, and were bona fide and not in excess of the value of the reinsurance. Director Cordray had addressed HUD 1997 letter in his decision, finding that the letter “is not in such a form as to be binding on any adjudicator” because it was never published in the Federal Register, and that the letter was “internally inconsistent.”

The panel opinion found that the CFPB’s retroactive application of a change from HUD’s interpretation of section 8(c)(2) to its own interpretation would be a violation of “Rule of Law 101.” Specifically, the panel opinion held that, “even if the CFPB’s new interpretation were consistent with the statute (which it is not), the CFPB violated due process by retroactively applying that new interpretation to PHH’s conduct that occurred before the date of the CFPB’s new interpretation.” The panel stated that the CFPB’s argument that the HUD letter was not binding confused the due process issue of whether the public could rely on an agency pronouncement with the administrative law issue of deference by courts to agency interpretations. The panel opinion stated that to trigger due process protection, “an agency pronouncement about the legality of proposed private conduct need not have been set forth in a rule preceded by notice and comment rulemaking, or the like.”

The panel found that the fact that HUD’s guidance was provided by “top HUD officials” and was given “repeatedly,” was “sufficient” to justify reliance on the guidance for purposes of due process. Notably, the panel stated that it, “do[es] not imply that those two conditions are necessary to justify citizens’ reliance for purposes of the Due Process Clause.”

C. Statute of Limitations

On the issue of the statute of limitations that applies to the CFPB’s administrative enforcement actions under RESPA, the CFPB had originally argued to the three-judge panel that it was not subject to any statute of limitations in its administrative proceedings. In addition, the CFPB argued that RESPA only provides a statute of limitations for court proceedings.

The panel opinion found that the CFPB’s interpretation was “absurd” and “especially alarming,” and held that the CFPB’s administrative actions are subject to the statutes of limitations of the statutes it is enforcing. The panel based this decision on language in the Dodd-Frank Act that states that the CFPB can conduct administrative actions under federal consumer finance laws, “unless such Federal law specifically limits the Bureau from conducting a hearing or adjudication proceeding and only to the extent of such limitation.” The panel held that this provision incorporates the “limits” under specific consumer laws, like RESPA, and that RESPA’s three-year statute of limitations applies to CFPB actions, both administrative and in court, resulting in the CFPB being subject to a three-year statute of limitations for its administrative actions under RESPA.

Notably, the CFPB did not argue that it was not subject to a statute of limitations to the en banc court. The CFPB relented in the oral arguments in the en banc rehearing of the case that it was generally subject a five-year statute of limitations under 28 U.S.C. § 2462.

One issue that was not resolved in the panel or en banc court opinions was whether each reinsurance payment or only the loan closing was a violation of RESPA. Director Cordray’s decision in the CFPB’s administrative enforcement action found, and the CFPB argued in court, that PHH had violated RESPA section 8(a) every time it accepted a reinsurance payment, even if the loan had closed earlier than the date of the payment. But PHH argued that if a violation occurred under section 8(a), it occurred at the time the loan closed.

The panel opinion stated in a footnote that, “we do not here decide whether each alleged above-reasonable-market value payment from the mortgage insurer to the reinsurer triggers a new three-year statute of limitations for that payment. We leave that question for the CFPB on remand and any future court proceedings.” The en banc court did not further address this issue. It remains to be seen if this issue is further litigated if the CFPB decides each payment was a separate violation on remand.

D. What the Decision Means for the Industry

Are Captive Arrangements and MSAs Back in Business?  

The en banc court’s decision on the RESPA issues could have a profound impact on the real estate industry. The decision essentially finds that captive arrangements, marketing services agreements (MSAs), and other arrangements that are designed to fall under the RESPA section 8(c)(2) exemption are permissible, even if they are designed as a quid pro quo for referrals, as long as the payment bears a reasonable relationship to the market value of the services or products that are the subject of the arrangement. As the CFPB offered as an example in oral arguments, under this decision a company purchase paper at wholesale and then require other companies to purchase the paper from it at retail prices to receive referrals. You could say that these captive arrangements and MSAs are back in business, after industry began pulling back on their use when the CFPB began aggressively enforcing against such agreements and issued a compliance bulletin strongly discouraging their use. Many companies have already pulled back on MSAs or other similar arrangement in response to the CFPB, and this decision could represent a significant effect on their business.

Compliance with RESPA section 8 should still be a concern, even though the D.C. Circuit has found such practices permissible under RESPA. First of all, section 8(c)(2) still requires that the services in the arrangement are actually performed, and that the payment is reasonably related to the market value of the services. The court’s opinion sends the case back to the CFPB for a factual determination of whether the reinsurance payments meet this standard. This means that for companies engaging in MSAs or other similar arrangements, obtaining a proper valuation of the services being performed and ensuring those services are actually provided is still a critical step for compliance purposes.

In addition, courts in other circuits could come to a different conclusion. Note that there was a concurring opinion by three judges in the en banc decision that was actually essentially a dissent on the RESPA issue, finding that the CFPB’s interpretation of RESPA, specifically its interpretation of the term “bona fide” in RESPA section 8(c)(2), was reasonable. The CFPB’s interpretation, including its argument regarding the purpose of RESPA being to prevent the type of referral arrangements that the court’s opinion now says are permissible, could be persuasive to courts in other circuits in future litigation. Finally, it would be prudent to review the applicable state laws, as some states have similar prohibitions as RESPA section 8(a) and those states may interpret their laws similarly to the CFPB’s interpretation in the PHH case.

New RESPA Guidance on the Horizon?

In addition, it will be interesting to see if the CFPB revises its October 2015 compliance bulletin regarding marketing services agreements based on this decision, or engages in rulemaking under RESPA to provide more formal guidance regarding section 8(c)(2). Some of the substance of that compliance bulletin conflicts with the court’s opinion.   In addition, as part of its focus on regulatory reform that is signaled in its recently issued Strategic Plan, the CFPB could take revisiting guidance under RESPA section 8 more generally, including updating the policy statements issued by HUD in the 1990s and early 2000s.

Due Process Protections for CFPB Informal Guidance?

With respect to the due process issue, the panel opinion’s discussion regarding due process protections from reliance HUD’s informal guidance may be viewed by some as supporting the industry’s ability to rely on the CFPB’s informal guidance. Most of the CFPB’s new rules have required substantial amounts of informal guidance to clarify significant issues under the rules. While the CFPB has issued very little formal guidance or amendments based on industry requests for clarification, the agency has issued some informal guidance to address industry concerns. In addition, some of that informal guidance has been issued publicly, such as its webinars and compliance guides.

The two factors cited by the court in applying due process protections to the HUD informal guidance were the fact that the guidance was provided by top officials at the agency and that it was repeatedly provided. Much of the CFPB’s informal guidance is issued by CFPB staff and subject to extensive disclaimers warning against reliance. In addition, much of the informal guidance industry relies on is provided in the context of one-on-one telephone calls or presentations at industry events. Further complicating the ability to rely on the CFPB’s informal guidance is the fact that some of the CFPB’s publicly issued informal guidance has had questionable technical accuracy. These facts distinguish much of the CFPB’s informal guidance from the types of guidance the court stated provided due process protections. Another important point is that the panel’s discussion of the due process issues might not be considered by other courts to carry the same weight as the panel’s holding regarding RESPA section 8(c)(2). To the extent that the industry looks to the panel opinion as supporting due process protections for reliance on the CFPB’s informal guidance, caution is warranted.

Statute of Limitations?

Finally, on the issue of the CFPB’s statute of limitations, the decision that the CFPB’s administrative actions are subject to the statute of limitations of the law the agency is enforcing, and the CFPB’s admission that is at least subject to a general five-year statute of limitations will have a significant impact on the CFPB’s future administrative enforcement actions. This includes its enforcement actions under its UDAAP authority, which did not have an explicit statute of limitations. Therefore, the CFPB’s admission of a general five-year statute of limitations is a significant curtailing of its view of its UDAAP authority. In addition, to the extent any pending enforcement actions or investigations look past this five-year mark or the applicable statute of limitations under the law being enforced, this should be an issue raised in those actions.

V. Conclusion

The impact of the PHH case is significant, both with respect to the CFPB’s existence and current structure, and the relationships and potential for referral arrangements between companies in the real estate market. The court’s decision essentially blesses marketing services agreements and other arrangements designed to fall under RESPA section 8(c)(2), even if they are entered into with the understanding that business will be referred between the parties. We may see an increase in the use of these types of agreements based on the court’s decision. But compliance should still be a concern, because the factors under RESPA section 8(c)(2) must still be followed, and state regulators and other courts may come to different conclusions.