Supreme Court Case May Have Big Impact on CFPB

WASHINGTON — The Supreme Court is set to hear at least two cases this fall that may have a dramatic impact on the lending business and the legality of certain new regulations.

Just a week after the high court said it would decide a case that might upend regulators' use of "disparate impact" theory to pursue fair-lending cases, the Supreme Court said Monday it would also hear a case that calls into question President Obama's recess appointments to the National Labor Relations Board.

Although the case does not directly involve Richard Cordray, the director of the Consumer Financial Protection Bureau, his recess appointment was made the same day as the NLRB appointments, and any Supreme Court decision is likely to eventually determine the legality of his tenure.

Ironically, however, any decision probably won't affect Cordray directly. Cordray's appointment will expire at yearend, while the Supreme Court is unlikely to issue a ruling until 2014.

Still, even with Cordray gone, the ruling is almost certain to affect parts of the mortgage rules and other regulations promulgated during his time in office, potentially invalidating their applicability to nonbanks.

"There's a lot riding on the U.S. Supreme Court case," said Jim Martin, a partner at Reed Smith Martin. "It's going to be a mess if those recess appointments are invalidated."

At issue are the CFPB's legal powers under the Dodd-Frank Act. The 2010 financial reform law created the agency and said it inherited existing regulatory authority to write new rules that cover all banks. The law also gave the CFPB authority to regulate nonbanks such as debt collectors and payday lenders, but in a drafting error, it said the nonbank authorities were not valid until a Senate-confirmed director of the agency was in place.

The Obama administration has argued that its recess appointment of Cordray in January of last year meets the Dodd-Frank law's requirements and the agency has promulgated rules since then as if they apply equally to banks and nonbanks.

But if the Supreme Court invalidates the NLRB appointments, a legal challenge to Cordray's appointment is likely to quickly follow. Assuming that challenge is also successful given the fact that it parallels the NLRB decision, any rules released by CFPB may no longer apply to nonbanks. It also would no longer have authority to examine or take enforcement actions against nonbanks.

In such a case, the CFPB "can still police and enforce existing consumer finance law" on nonbank entities, said Isaac Boltansky, a policy analyst at Compass Point Research & Trading. "They just wouldn't have authority to have boots on the ground."

Many observers think the Supreme Court is likely to rule the recess appointments unconstitutional, pointing to lower courts that ruled the Senate was technically in session at the time (The Obama administration argues these "pro forma" sessions didn't really count.)

"There's better than a 50-50 chance that the Supreme Court will conclude that NLRB appointees were invalid," said Alan Kaplinsky, who heads the consumer financial services group at Ballard Spahr. "The logic of the D.C Circuit Court's decision seemed pretty sound and the third circuit agreed with the D.C. Circuit that a president can only make recess appointments during an intersession recess."

To be sure, a political deal could nullify any impact to the CFPB before the Supreme Court rules. Senate Republicans have refused to confirm Cordray until structural changes are made at the agency. If Democrats and Republicans agreed to a deal, Senate confirmation of Cordray would likely put to rest any concerns about the agency's regulations and supervision to date. Still, a deal is now seen as unlikely and it's unclear if either side wants a compromise.

"One would think logically that it might get all the parties to sit down and negotiate a political compromise but I don't think that's going to happen until the Supreme Court issues its opinion," Kaplinsky said.

If the Supreme Court upholds the lower courts' rulings, conservative groups will likely seek to invalidate actions that Cordray took in using his statutory authority as a director.

Such a ruling may work against banks, where the CFPB's legal authority is clear, because they eliminate any level playing field between banks and their nonbank competitors.

But observers said it's not a simple either-or proposition. The Supreme Court could hold that any decisions the NLRB made with its disputed commissioners were valid, even if the appointments themselves weren't. Such logic would put CFPB's existing rules on solid footing.

Alternatively, the high court ruling could potentially undermine enforcement actions the CFPB has already taken.

"When you start to unpack this thing it gets very, very complicated," Martin said. "You're not just talking about the retroactive affirmation of a rule; you're also talking about the validity of actual decisions that were made against a company and the company's response. If the CFPB has to start over, it is hard to predict where it will end up."

Though it's difficult to determine who will lead the CFPB next year, most sources said there will likely be some limiting of powers regardless of the Supreme Court's decision. If Cordray's recess expires before a Supreme Court ruling, Kaplinsky said it's highly unlikely that Obama will use another recess appointment because it would appear he was "thumbing his nose" at the court. It's also unlikely that the Senate will confirm or appoint someone before then.

The more likely case is that the CFPB will go back to how it operated before Cordray was appointed, when the secretary of the Treasury selected an acting head. At the time in late 2011, it was Raj Date. However, sources say that structure also limits the CFPB from taking actions that statutorily require an official director.

If an acting director is appointed by the Treasury secretary, "the CFPB's powers would be greatly reduced," Kaplinsky said. "It would not be the full panoply of powers that a lawfully appointed director could exercise."

A representative of the CFPB declined to comment. Kaplinsky said he expected the Supreme Court to make a decision in the first quarter next year.

In the meantime, Republicans and conservative groups will likely continue to use the Supreme Court's decision to hear the NLRB case as leverage in their efforts to restructure the CFPB or invalidate parts of the Dodd-Frank Act. But Democrats do not appear willing to give on the issue.

"So-called reforms to the CFPB's structure represent nothing more than solutions in search of problems," said Sen. Sherrod Brown, D-Ohio, in a press release on Monday. "It's time to put consumers first and confirm Rich Cordray."