As it enters its fourth year of operation, the Consumer Financial Protection Bureau (CFPB) continues to flex its muscle in new and sometimes startling ways. The latest advance for the CFPB was unveiled in the decision of Director Richard Cordray (Director) in the case In the Matter of PHH Corp., et al. In that administrative proceeding, the Director heard and decided the appeals, by both the CFPB enforcement division and PHH Corporation, of an adverse decision by an administrative law judge (ALJ) ordering a $6.4 million disgorgement penalty and injunctive relief against PHH. The enforcement action alleged that PHH violated provisions of the Real Estate Settlement Procedures Act (RESPA) which prohibit kickbacks in the form of compensated referrals of settlement services.
On June 4, 2015, the Director surprised many with his decision, which sided almost uniformly with the CFPB and increased the $6.4 million dollar penalty initially awarded to a whopping $109 million dollars. Many are still struggling to grasp the full implications of the decision.
In his ruling, the Director held that the CFPB was not bound by RESPA’s statute of limitations when proceeding administratively and that the concept of disgorgement under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) reached gross revenues not delimited by costs or losses incurred through the challenged practices. The Director also made clear that his agency would not be bound by interpretations issued by the Department of Housing and Urban Development (HUD) which historically enforced RESPA. After a brief discussion of the factual background, we will examine the decision’s myriad legal ramifications and what insight it provides for future CFPB enforcement proceedings and administrative appeals.
On January 29, 2014, the CFPB issued a notice of charges alleging that PHH created a kickback scheme, whereby PHH referred mortgage insurance business to mortgage insurers in exchange for mortgage reinsurance contracts which those insurers entered into with PHH’s wholly-owned subsidiary, Atrium Insurance Corporation.
A trial was conducted before a CFPB ALJ. The ALJ found that when a mortgage insurer entered into a reinsurance contract with Atrium, it generally began to receive substantial mortgage insurance business from PHH, and that on the occasions when those reinsurance contracts were terminated, referrals from PHH dropped off precipitously. The ALJ found that this relationship had all the hallmarks of a prohibited kickback under Section 8(a) of RESPA.
One of PHH’s principal defenses was that its practices were in line with a 1997 guidance letter issued by HUD on captive reinsurance and Section 8(c)(2) of RESPA. The ALJ agreed that these authorities provided a defense if PHH established that its reinsurance involved a real transfer of risk and that the price the mortgage insurers paid did not exceed the value of the reinsurance services provided. However, the ALJ determined that there was limited actual risk transfer and a lack of commensurability between price and the value of the services performed, and found that PHH failed to prove a defense under Section 8(c)(2).
PHH also invoked RESPA’s three-year statute of limitations on “actions” to enforce RESPA as a defense. RESPA provided a three-year statute of limitations on HUD's “actions” to enforce RESPA and required HUD to bring its enforcement actions in court. Since PHH shuttered its mortgage reinsurance business in 2009, much of its alleged offending conduct was outside of HUD's reach. However, Dodd-Frank, which created the CFPB and reapportioned HUD’s enforcement authority for RESPA to the CFPB, is written differently. It allows the CFPB to bring enforcement actions as administrative proceedings. Dodd Frank also provided for a three-year statute of limitations period, but it applied only to “actions brought by the Bureau.” 12 U.S.C. 5564(g). The ALJ held that this statute of limitations did not apply to CFPB administrative enforcement actions, by construing the term “actions” to mean court actions, and not administrative proceedings. The semantic distinction between judicial “actions” and administrative “proceedings” finds support in the applicable case law, including BP America Production Co. v. Burton, 549 U.S. 84, 91 (2006).
To avoid constitutional retroactivity issues, the ALJ held that the CFPB could not retroactively revive claims which had become time-barred in the hands of HUD prior to the creation of the CFPB. He permitted the CFPB to pursue only those claims which accrued within the three-year limitations period before the CFPB was created, making July 21, 2008, the applicable start date for the CFPB’s RESPA look-back period. Critically, the ALJ held that the cause of action under RESPA accrued when the loans closed and the contract for mortgage insurance was impermissibly referred. For those claims which accrued after the CFPB was created, the CFPB would not be subject to any statute of limitations.
PHH initially had some success defending the CFPB’s request for large civil penalties. The ALJ, however, permitted disgorgement, over PHH’s objection, of the premiums received by the reinsurer Atrium for loans which closed within three years of the CFPB’s creation. These amounts were offset against the amount of payments made by Atrium on such reinsurance polices, which came to a net total of $6.4 million dollars in penalties. Both the CFPB and PHH appealed. The Director’s June 4, 2015, decision is the result.
The Decision: Important Take-Aways
Appealing CFPB Administrative Enforcement Actions Carries Considerable Risk
While all appeals carry risk, the risk to industry members seems particularly acute in the context of appealing CFPB administrative enforcement actions. The end result in this case says it all – PHH’s initial penalty of $6.4 million was increased to an astounding $109 million dollars as a result of the Director’s decision. Two factors unique to appealing CFPB administrative enforcement actions offer at least a partial explanation for the divergence of the outcomes reached by the ALJ and the Director.
1. De Novo Review
In his decision, the Director not only reviewed the ALJ’s findings of law de novo, but also gave no deference to the ALJ’s findings of fact. As a result, the ALJ’s ruling offered little protection on appeal. In this case, both PHH and the CFPB appealed the ALJ’s decision to the Director. Thus, given the standard of review and the nature of cross-appeals, the Director essentially had tabula rosa to rule as he saw fit.
This standard of review will figure prominently in future appeals of CFPB enforcement actions. It makes the ALJ’s decision largely superfluous on review, as the Director is free to adopt those findings with which he agrees and discard those with which he does not. Thus, an appellant’s chances in an appeal of the ALJ’s decision depend almost entirely on how the issues on appeal comport with the Director’s perspective as a jurist.
2. The Director’s Perspective of His Role as an Appellate Decision-Maker
The decision offers some insight into the Director’s personal perspective of his role as an appellate decision-maker. The Director obviously wears two hats: that of the director of the agency regulating the financial services industry and prosecuting enforcement actions, and that of the initial appellate decision-maker on cases administratively prosecuted by the CFPB enforcement team. Judging from the Director’s first decision in his appellate capacity, it seems safe to say his perspective is highly receptive to the advocacy presented by his enforcement team. In the Director’s decision, scarcely a single issue is resolved in PHH’s favor. The Director’s decision is dismissive of regulatory guidance issued by his predecessors at HUD, which guidance federal courts had already adopted. Thus, the expectation going into any appeal before the Director should be tempered by an understanding that the Director may come to the case inclined to resolve most issues in favor of his enforcement team.
The Director’s decision is now on appeal to the United States Court of Appeal for the District of Columbia Circuit. How the D.C. Circuit rules will certainly be important as it has the potential to either embolden the Director further or temper his future rulings.
RESPA May Prohibit More Than You Thought
The Director’s decision is also noteworthy for its aggressive legal interpretation of several provisions within RESPA. Many of the Director’s interpretations seem at odds with the way the industry, HUD, and federal courts historically interpreted RESPA.
1. Incentivizing Referrals is Actionable Under RESPA
The Director found that a “referral is an action directed to a person that affects the selection of a mortgage service paid for by any person.” (Emphasis added.) This interpretation ignores the limitation found in RESPA that requires the person influenced to be “such person” that pays for the settlement service. See 12 C.F.R. § 1024.14(f). Nonetheless, the Director’s holding that “indirect influence” of settlement service providers is actionable, if it stands, is sure to finds its way into future CFPB enforcement actions and civil class actions. In light of this holding, the industry would do well to take a fresh look at all practices in light of the Director’s interpretation. One can imagine the Director making a similar finding with respect to many different types of servicer marketing or co-marketing relationships if the evidence suggests referrals are part of the reason for such relationships.
2. Section 8(c)(2) is Not the Protection it Used to Be
Many, including the ALJ, HUD, and numerous federal courts, interpreted Section 8(c)(2) as meaning that payments made at market prices for services actually performed were outside the scope of RESPA’s prohibition on kickbacks. The Director, however, disagreed, stating that, “I interpret Section 8(c)(2) to clarify the application of Section 8(a), not as a substantive exemption to liability.” The future relevance of Section 8(c)(2) is now in doubt. Rather than clarifying Section 8(a), under the Director’s interpretation, Section 8(c)(2) seems to introduce ambiguity. Regardless, the Director expressly rejected PHH’s argument that these provisions were sufficiently ambiguous to support application of the rule of lenity, which requires the resolution of ambiguities in criminal statutes in favor of defendants. Thus, if there is any perceptible connection between referrals and payments of any kind for settlement services, including market rates for services actually performed, there is a risk that a violation of RESPA will be inferred by the CFPB.
3. Aggressive Disgorgement Penalties May be Available
What makes the evisceration of Section 8(c)(2) all the more concerning is the sizable disgorgement penalty awarded by the Director. While PHH argued strenuously that disgorgement was unavailable because Congress did not include it in RESPA’s remedial scheme, both the ALJ and the Director construed Dodd-Frank, specifically 15 U.S.C. 5565(a)(2)(D), as authorizing disgorgement. On top of that, the Director’s multiplication of the ALJ’s already sizable $6.4 million dollar penalty into a $109 million dollar award is particularly disconcerting. The size of the disgorgement penalty grew under the Director’s interpretation for two reasons.
First, the Director found that “PHH violated RESPA every time it accepted a reinsurance payment,” not simply each time an individual loan transaction closed and mortgage insurance business was referred. That finding is contrary to established case law regarding the accrual of causes of action under RESPA including Snow v. First American Title, 332 F.2d 356 (5th Cir. 2003). By expanding the scope of the penalty to include every premium PHH collected from July 21, 2008, onward, including premiums collected on loans which were originated before the CFPB ever existed, the Director dramatically increased the size of the penalty assessed against PHH.
Second, the Director based the disgorgement amount on gross revenue from premiums ceded, not profits. Thus, even though there is no dispute that Atrium did not realize a profit during certain years at issue, the Director did not offset the size of the disgorgement penalty by any amounts Atrium paid on mortgage reinsurance claims. Instead, the Director used the gross amount of premiums ceded to Atrium to calculate the size of the penalty. The CFPB is sure to request revenue-based calculations, as opposed to profit-based ones, when it seeks disgorgement in future enforcement proceedings.
Enforcement will be Different under the CFPB
One thing is abundantly clear from the Director’s decision – the CFPB has no intention to maintain business as usual. Instead, the CFPB has demonstrated a willingness to radically depart from the way HUD interpreted and enforced RESPA.
1. No Statute of Limitations to CFPB Administrative Enforcement of RESPA
The Director’s holding on the statute of limitations, if it stands, will completely remake how RESPA is enforced going forward. Previously, RESPA provided a three-year statute of limitations on “actions” brought by HUD to enforce RESPA. HUD was limited to proceeding in court and had no jurisdiction to proceed administratively. Thus, HUD was entirely bound by this three-year statute of limitations for enforcing RESPA. By contrast, Dodd-Frank, which created the CFPB and reapportioned HUD’s RESPA enforcement authority to the CFPB, is written differently. It permits the CFPB to bring enforcement actions either through court actions or administrative proceedings. Dodd Frank also provides a three-year statute of limitations for the CFPB, which is applicable to “actions brought by the Bureau.” See 12 U.S.C. 5564(g). The ALJ held this statute of limitations does not apply to CFPB administrative enforcement proceedings, construing the term “actions” to mean civil actions, and not administrative proceedings. The Director affirmed this portion of the ALJ’s recommended decision.
Only constitutional prohibitions on retroactivity created any limitations whatsoever on the scope of the CFPB’s look-back period. Thus, the Director held that while the CFPB could not revive claims that became time-barred under HUD (and retroactively re-criminalize the conduct), it could pursue all claims which accrued within the three-year limitations period applicable to HUD. Furthermore, the Director determined that there is no limitation for administrative enforcement for those claims which accrued after the CFPB was created. Thus, PHH was held liable for all conduct from July 21, 2008, forward.
Granted, in this case, the time period for assessing liability was only a few years longer than the limitations period previously applicable to HUD. However, this look-back period will now extend indefinitely. Twenty years from now, the industry will be faced with the intimidating prospect of an approximately 25-year look-back period, and with a virtually unbounded disgorgement penalty to boot. It is difficult to fathom the logic in support of an inconsistent three-year limitations period for judicial enforcement, and none at all for administrative enforcement. If this ruling stands on appeal, a Congressional amendment is needed to address this issue.
2. HUD Guidance of Limited Precedential Value with CFPB
Another troubling aspect of the opinion was the short shrift the Director gave to previous guidance HUD provided the industry on the issue of captive reinsurance. The Director found that “[t]o the extent that the letter is inconsistent with my textual and structural interpretation of section 8(c)(2), I reject it.” While the Director is certainly not the first regulator to depart from the interpretations of his predecessors, HUD’s 1997 letter of guidance appeared consistent with the text and purpose of RESPA. The issue was by no means black and white, but that was of course why the industry sought HUD’s guidance. PHH and other industry members operating mortgage insurance and reinsurance businesses relied upon this guidance. HUD’s interpretation was accepted by the ALJ and several federal courts. See, e.g., McCarn v. HSBC USA, Inc., 2012 WL 7018363 (E.D. Cal. 2012) (citing the 1997 HUD letter of guidance in evaluating when captive reinsurance arrangements are permissible under RESPA); Kay v. Wells Fargo & Co., 247 F.R.D. 572 (N.D. Cal. 2007) (while not directly citing the 1997 HUD letter of guidance, both parties, as well as the court, agreed that the “substantiality of risk transfer” was a “crucial liability issue”). Nonetheless, the CFPB and the Director have made a radical departure on the issue and penalized PHH mightily for it. It should be anticipated that the CFPB may disregard other HUD guidance letters in future enforcement efforts.
3. Enforcement Actions are Supplanting Notice and Comment Rule-Making
Traditionally, the government communicated its regulatory priorities and statutory interpretations through a notice and comment rule-making process. This allowed the industry to participate meaningfully in the regulatory process and plan ahead for sea changes in the regulatory environment. While the CFPB also utilizes notice and comment rule-making, it has increasingly resorted to enforcement actions to communicate its priorities and statutory interpretations. Since many of these enforcement actions settle, enforcement has proven a poor medium for such communications.
Since the enactment of Dodd-Frank, the focus of litigation activity in the consumer financial services area has shifted slowly from courts around the country to the administrative arena in our nation’s capital. The proliferation of enforcement proceedings which are opaque and emerge into public view through consent orders only serves to convey the impression that traditional methods of case law development – hardening concepts through the crucible of the adversary process and the percolation of decisions through the district and circuit courts – is on the wane. Instead, the contours of interpretative rules emerge in the form of consent orders, reflecting broad acquiescence to the CFPB’s legal positions, are often explained for the first time, if at all, in a consent decree.
One would hope that the process of developing substantive case law through the adversary process might still be available in administrative prosecutions such as the one at issue in this case. However, an observer must wonder whether the risk of a substantial multiplier of an initial award resulting from the litigant’s exercise of its rights to challenge an ALJ award will discourage litigants from making such challenges in the future. As for future court actions, one can predict that the CFPB will continue to gravitate to the friendly environs of its own hearing rooms, rather than less hospitable courts, where its reach is unobstructed by limitations periods and where its own Director, who presumably sets policy for the CPFB’s Enforcement Division, also decides the merits of that policy as the first line of appellate review.
Conclusion – Stay Tuned
There is much to learn from the Director’s decision and PHH’s experience. And more is sure to come. The Director and the CFPB face other legal challenges. One of particular note is a constitutional challenge to certain aspects of the CFPB’s operation and structure, including the Director’s lone position on top, which recently survived CFPB’s motion to dismiss based on standing and ripeness in State National Bank of Big Spring, et al. v. Jacob J. Lew, et al., Nos. 13-5247, 13-5248, 2015 WL 4489885 (D.C. Cir. July 24, 2015). If that case were successful in establishing that the CFPB is an independent agency which must be headed by a board, and not just a single director, it would cast much doubt on the validity of the Director’s work, including the enforceability of past decisions rendered in his appellate capacity.
For its part, PHH has already appealed the Director’s decision to the United States Court of Appeal for the District of Columbia Circuit on the grounds that it is “arbitrary, capricious, and an abuse of discretion within the meaning of the Administrative Procedure Act.” PHH has also adopted several of the constitutionality arguments put forward by State National Bank regarding the concentration of power in CFPB and the Director’s position. Already, PHH has won a minor victory in the appeal by securing from the D.C. Circuit a stay on enforcement of the Director’s mammoth disgorgement penalty and injunctive relief. Whichever way it rules, the DC Circuit’s decision will no doubt be interesting reading, as the first ever appeal of a CFPB enforcement action marches towards its conclusion.