For CFPB, Parsing Which Rules Stay, and Which May Go

Richard Cordray's recess appointment to the Consumer Financial Protection Bureau may ultimately be invalidated, but legal experts say several recent mortgage regulations approved on his watch may still be upheld.

But questions remain whether other rules that apply primarily to nonbanks, such as payday lenders and credit reporting agencies will hold up because, absent a permanent director, the CFPB would have no authority to create or enforce them, attorneys and industry consultants say.

The uncertainty stems from a court ruling Friday that invalidated President Obama's appointments of three new members to the National Labor Relations Board while the Senate was on its winter break. On that day, Jan. 4, 2012, Obama also named Cordray the director if the CFPB, and many Washington insiders expect that Republicans who opposed Cordray's nomination in the first place will use the NLRB ruling to challenge his appointment.

Apart from whether Cordray's appointment would stick – most experts believe that will ultimately be decided by the Supreme Court – there are real questions about whether the myriad rules the CFPB has written in the last year would remain valid. Of particular concern are rules relating to mortgage lending, servicing, and loan officer compensation, all of which were released in the last two weeks.

Several lawyers say the recent mortgage rules will not be overturned even if it turns out that Cordray's recess appointment was unconstitutional. Ray Natter, a partner at the law firm Barnett Sivon & Natter, says it is unlikely that a court would invalidate the so-called qualified mortgage rule, which would essentially ban lenders from making the riskiest loans, out of "fear of the chaos that would result."

Moreover, even if the court were to void the existing qualified mortgage rule, the Treasury secretary could step in and assert the authority to issue a new rule because, under the Dodd-Frank Act, it has the authority to carry out certain CFPB functions.

"In this situation, the court would have discretion to fashion remedies that it feels are appropriate including looking at the public good and fairness," Natter says. "The fact that voiding the final QM regulation may cause significant disruption in the mortgage markets will weigh in favor of maintaining the validity of the final QM rule."

Some analysts think the Treasury secretary could step in as acting director of the CFPB and re-propose all the bureau's prior rules, essentially creating a new rule-writing process. But starting from scratch could create more uncertainty and cause nonbanks in particular to drastically curtail their lending, according to David Stevens, the president and chief executive of the Mortgage Bankers Association.

"The last thing the industry needs right now is a new round of uncertainty," says Stevens. "Cordray has proven himself to be an effective director and they have put out rule-makings that the industry is working to implement, and if they were suddenly overturned and the industry found itself in non-compliance, it could cause severe repercussions."

Still, Treasury's CFPB authority only goes so far; under Dodd-Frank, it has limited jurisdiction over non-depository institutions. If Cordray is determined to be only the bureau's acting director, then the bureau would not have authority over certain areas including: prohibiting unfair, deceptive or abusive acts; prescribing rules and model disclosure forms; and supervising non-depository institutions.

Andrew J. Pincus, a partner with Mayer Brown LLP who represents the U.S. Chamber of Commerce, says the Obama administration now faces a conundrum.

"If we're now in the world where there's no CFPB director, and the power is vested in the Treasury secretary, there's a strong argument that the rules would be invalid because they were signed by Cordray," Pincus says. "They could have the Treasury secretary go back and sign them, but the Treasury secretary only has the power to exercise authority over banks."

Alan Kaplinsky, a partner with Ballard Spahr, says the NLRB ruling could potentially roll back the clock to Jan. 3, 2012, when the CFPB was operating under an acting director and, as a result, the bureau could not issue any new rules against nonbanks.

"There will be doubt over the things the CFPB can do with respect to nonbanks," Kaplinsky says.

Others say whatever happens, the CFPB's past rules are unlikely to be invalidated by any court.

"Even if the Supreme Court rules that the appointment was unconstitutional, it does not mean that everything Cordray did as CFPB director is illegal," wrote Jaret Seiberg, at Gugghenheim Securities, in a research note. "The courts have the ability to rule that prior decisions remain in effect because Cordray was acting in good faith. So the Qualified Mortgage rule, the servicing rule and enforcement actions are likely to stand regardless of the outcome."