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Dual Insulation? The Fifth Circuit's Factual Misunderstanding of CFPB Funding

posted by Adam Levitin

I know I’m carrying around some extra weight.  But I don’t think it’s quite double insulation.  That sounds like something you need if you’re going on a polar expedition or are really concerned about the heating bill.  But the concept of "dual insulation" plays a big role in the Fifth Circuit’s decision in Community Financial Services Association of America, Ltd. v. CFPB, which held the CFPB’s funding mechanism to be unconstitutional because it is not an annual appropriation from Treasury.   

In this post, I’ll discuss some of the background on the case, the poorly understood nature of the CFPB’s funding (factual mistakes about which loomed large in the Fifth Circuit’s decision), and the challenge the Fifth Circuit faced in trying to differentiate the CFPB’s funding from that of a host of other federal regulatory agencies (that’s where dual insulation comes in).

Before getting to the double insulation, a bit of background on the case. The case is at core a challenge by a payday lending trade association (that’s what “Community Financial Services” means—even Victor Klemperer would have been impressed) to the remaining stub of the CFPB’s Payday Rule. The CFPB repealed the most significant part of the rule, an ability-to-repay requirement, but left in place a prohibition on payday lenders making more than two unsuccessful draws on a bank account without consumer consent.

The payday trade association was unsuccessful in its challenge to the rule, but prevailed on what was truly a throw-away point in its briefs, namely the claim that CFPB’s funding is unconstitutional. By throw-away point, I mean that the appellant spent all of 368 words in its opening brief on the issue and 70 words in its reply brief. The CFPB also barely touched the issue, with a mere 370 words in its brief.  While the point was more extensively briefed in a previous Fifth Circuit case, where the court, en banc, declined to rule on the issue, it was barely on the radar screen in this case.

Despite this grossly inadequate briefing of the constitutional issue, the Fifth Circuit panel, after shooting down all of the administrative law challenges to the Payday Rule, then turned to the CFPB’s funding with all of the righteousness it could muster. The Fifth Circuit found the CFPB’s funding mechanism to be repugnant to the constitution because it violated the separation of powers principle articulated by the Appropriations clause.  Therefore, the Fifth Circuit concluded that the rule was invalid because it must have been made using the improper funding.

How the CFPB Is Funded

The CFPB is not funded through annual appropriations by Congress. Instead, the CFPB gets to draw annually on the Federal Reserve System an amount up to 12% of the Fed’s 2009 operating budget, inflation-adjusted.  The Federal Reserve System (other than the CFPB) consists of 12 regional private regional Reserve Banks and the Board of Governors, a federal regulatory agency.

No part of the Federal Reserve System is funded through Congressional appropriations. Because the regional Reserve Banks are private entities, they are, of course, self-funded, rather than funded from Treasury. The Board of Governors is itself funded almost entirely (98.4%) with a Congressionally authorized perpetual assessment on the regional Reserve Banks, just like the CFPB. To the extent that the individual Reserve Banks run a surplus (after paying their assessments and capped dividends to their members), they are required to remit the extra funds to Treasury. Given that Congress does not control the expenses of the Reserve Banks or even the Board in any meaningful way, there is no guaranty that any particular Reserve Bank will ever run a surplus.

The Supposed Problem with CFPB Funding

The problem with the assessment arrangement in the eyes of the Fifth Circuit is that it is inconsistent with the separate of powers principle as articulated by the Appropriations clause.  The Appropriations clause provides that “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law.” 

Now, literally, there is no Appropriations clause violation in the case of the CFPB, because the CFPB does not draw funding from Treasury. Instead, it draws from an account at the Federal Reserve Board that is funded through the assessment on the regional Reserve Banks, just as the Board itself is funded through an assessment on the regional Reserve Banks.  Indeed, the Federal Reserve System’s audited financials list under “Operating Expenses” a category called “Assessments”.  There are two entries under that category:  “Board of Governors operating expenses and currency costs” and “Bureau of Consumer Financial Protection.”

 The Fifth Circuit did not engage with the textual limitation of the Appropriations clause. Instead, it used it as a launching point for a separation of powers argument that centers on the idea that the “purse” and the “sword” should never be in the same hands, meaning that executive agencies should not be self-funding because there would not be adequate legislative controls on them. 

Conceptually, this separation of powers argument is sloppy. Annual appropriations requires affirmative legislation each year, which as a constitutional matter takes a simple majority vote in both Houses. Why is that a different level of Congressional control than a bill that revokes self-funding or otherwise directs the agency to do or refrain from doing something? Both bills require the same votes as a constitutional matter (internal Congressional procedures are irrelevant from a constitutional perspective). It’s hard to see how Congress loses any control over a federal agency from a constitutional standpoint by not having annual appropriations. To be sure, as a practical matter, there are differences, but let’s not pretend that those practical differences are constitutionally significant. The Framers certainly weren’t aware of them, and they’re basically political science/institutional behavior insights. And if we’re going to care about this sort of practical political effect in determining this case, then we ought to be considering it in every case.

The Problem of Differentiating Other Federal Regulatory Agencies.

The bigger problem for the Fifth Circuit, however, is that the CFPB is not unique in being a self-funding executive agency. The Federal Reserve Board is also self-funding through the very same mechanism. So too is the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Federal Housing Finance Agency, the National Credit Union Administration, the Farm Credit Administration, the Farm Credit Insurance Corporation, the Bureau of Engraving and Printing, the Public Company Accounting Oversight Board, and Federal Prison Industries, Inc. All of these entities are able to exercise rulemaking and enforcement authority, within their regulatory bailiwick, just like the CFPB. 

The challenge, then, for the Fifth Circuit, was to somehow differentiate the CFPB from these other agencies for which it has no particular animus.  The Fifth Circuit needed to find a way to smack down the CFPB without threatening the constitutionality of a host of other federal agencies.  To that end, the Fifth Circuit came up with two lines of argument. First, it claimed that these other agencies have a “narrower” mission than the CFPB. And second, it claimed that the CFPB’s funding mechanism was in fact different because it has “dual insulation.”  Both of these claims are wrong.

Differentiation #1:  Breadth of Mission

Let’s start with the breadth of mission. As an initial matter, it isn’t clear what yardstick one uses to measure the breadth of mission.  Is it the number of entities regulated or what they are regulated for or some combination or something else?  Breadth of mission just isn’t a meaningful concept here, much less one that has any constitutional significance. 

Even accepting that breadth of mission matters, however, it’s hard to claim that the CFPB obviously has broader authority than some of the other entities. The CFPB has regulatory authority over the much (but not all) of the consumer finance industry, but compare that with the Federal Reserve Board, which is tasked with ensuring price stability and full employment in the economy through regulation of monetary policy, and also regulates all bank holding companies, all financial holding companies, and all Federal Reserve member banks, as well operates the nation’s wire transfer, check, and ACH systems.  In the pursuit of those ends, the Federal Reserve Board has rulemaking, enforcement, and adjudicative powers, just like the CFPB. Heck, the Fed even has its own police force! Other regulators, like FDIC or OCC or NCUA, regulate a narrower set of entities than the CFPB, but they regulate those entities more broadly, not just for compliance with consumer financial laws, but for “safety and soundness” throughout their operations. 

And then if we take the Fifth Circuit’s breadth of mission distinction seriously, it has a bizarre implication, namely that a separation of powers violation is ok, just as long as it isn’t too big. Is there now a constitutional doctrine of de minimus violations?  Where exactly is the threshold? If the CFPB regulated only payday lenders, would self-funding be ok?  What if it also regulated debt collectors?  And credit reporting agencies?  The Fifth Circuit’s logic compels this silly exercise. This is not how the Constitution works.

Differentiation #2:  Dual Insulation

The Fifth Circuit’s other attempt to differentiate the CFPB is through its claim that the CFPB’s funding is unique because there is “dual insulation” from Congressional control. First, the CFPB’s funding is itself outside of appropriations, and second, it comes from the Fed, which is itself outside of appropriations. 

What are we to make of this mental mush?  If the problem that the funding unappropriated, that’s a binary issue. It’s appropriated or it’s not, and if it’s not, then the source is irrelevant. It’s not as if the “dual insulation” actually makes it any harder for Congress to control the CFPB. All it takes is a simple majority Congressional vote to change the CFPB’s funding. There’s no increase in the separation of powers issue based on the source of the CFPB’s funds if they are not appropriated.  The only “insulation” that matters is the first level.

The claim that the funding is from the Fed is irrelevant to the issue of Congressional control.  It’s also factually wrong. The Fifth Circuit seems to think that the CFPB is funded by the Federal Reserve Board. It isn’t. It’s funded by the Federal Reserve System. Technically, the CFPB draws on an account held at the Board, but the Board is just acting as agent for the System. The CFPB’s funding statute specifies that the Board is to transfer to the CFPB a cut of the earnings of the System. As the Board itself has virtually no revenue other than its own assessments on the System, the CFPB’s funding is just an assessment on the private Reserve Banks. The CFPB’s funding mechanism is exactly the same as the Federal Reserve Board’s funding mechanism.  And as an assessment on private entities, it works just like the funding of the FDIC, the OCC, the NCUA, etc. The only difference is that Congress placed a cap on the CFPB’s assessment, meaning that Congress exercises more control over the CFPB’s budget than it does over those of the other self-funded agencies. 

The Fifth Circuit might have spared itself from this embarrassment if it had requested supplemental briefing on the funding issue rather than shooting from the hip based on a few paragraphs of briefing.

Curiously, the dual insulation point was never raised in the briefing in Community Financial Services. So where did the Fifth Circuit get the argument from?  It comes from another case challenging CFPB constitutionality. The dual insulation point was a major line of argument for the appellant in a prior Fifth Circuit case, All American Check Cashing v. CFPB.  In All American Check Cashing, the appellant payday lender made the dual insulation claim in an attempt to fit the argument into the paradigm of Free Enterprise Fund v. PCAOB, a case in which the Supreme Court had held that two levels of insulation from Presidential removal was unconstitutional:

Like the dual-insulation from presidential removal invalidated in Free Enterprise Fund, the CFPB funds itself by requisitioning hundreds of millions of dollars from the Federal Reserve’s budget, which itself is independently funded by fees assessed upon the Federal Reserve banks. 12 U.S.C. § 243.  This “added layer of [budgetary] makes a difference. Free Enter. Fund, 561 U.S. at 495.

This was frankly a bad argument, but poor Ted Olson at Gibson Dunn must be peeved that he lost his case only to see his argument lifted by the Fifth Circuit without attribution to hand a win to the Jones Day team in Community Financial Services.

The dual insulation argument is both meaningless from a separation of powers standpoint and factually wrong.  But even if we were to credit the dual insulation argument, it is not clear what purchase it has in terms of outcomes. Does anyone think the Fifth Circuit would have ruled differently if the CFPB were funded through a direct assessment on businesses engaged in consumer finance? It’s silly to pretend that the dual insulation matters. 

A Minor, but Annoying Point that Just Shows How Much the Fifth Circuit Had It in for the CFPB

The Fifth Circuit invalidated the Payday Rule because it concluded that the Rule must have been funded with unappropriated funds. But there was no evidence supporting that conclusion; the Fifth Circuit thought the source of the funding was "fairly apparent." Perhaps. The problem is that while the assessment on the Federal Reserve System is currently the CFPB’s only funding stream (aside from restricted use collections of Civil Monetary Penalties), the CFPB did have an additional revenue of $200 million annually in appropriated funds for each of its first five years. To properly conclude that the Payday Rule was funded with the unappropriated funds requires some sort of tracing methodology. That sort of grubby commercial law precision isn't the sort of thing with which imperious courts of appeal tend to dirty their hands. But it's hard to read the opinion to conclude anything other than the Fifth Circuit was out for blood and wasn’t going to let factual accuracy, inadequate briefing, or this sort of evidentiary issue get in its way.

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