Q1. What is the purpose of this article?
A1. I explain that a recent appeals court decision that has to do with the governance of the Consumer Financial Protection Bureau (CFPB) has little if any relevance to Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) equity investors. Fannie Mae and Freddie Mac are together known as the government sponsored enterprises or GSEs.
As I have explained in a number of previous articles, the litigation of interest to GSE equity investors has to do with the 3rd Amendment to the Senior Preferred Stock Purchase Agreements (SPSPAs). In a formal sense, there are separate SPSPAs between U.S. Treasury (Treasury) and Fannie Mae and between Treasury and Freddie Mac. However, the Federal Housing Finance Agency (FHFA) acts as regulator and conservator of the GSEs. Therefore, the SPSPAs are really agreements between Treasury and the FHFA.
I continue to recommend that investors do their own due diligence with respect to the investment prospects of the GSE equity securities.
Q2. Are you familiar with the PHH Corporation, et al. Court of Appeals (D.C.) decision by a three-judge panel with respect to the constitutionality of the governance structure of the CFPB?
A2. Yes, I am familiar with this decision. It is my understanding that the panel chose to reject statutory provisions that provide for an independent director of the CFPB, which meant that the CFPB director served a five-year term and could only be removed for cause, such as "inefficiency, neglect of duty or malfeasance." It is my understanding that the court was concerned that there was a single director, rather than a multi-member "commission" structure, similar to the U.S. Federal Energy Regulatory Commission (FERC) or the Federal Communications Commission (FCC). Thus, the decision states that:
Because the CFPB is an independent agency headed by a single Director and not by a multi-member commission, the Director of the CFPB possesses more unilateral authority - that is, authority to take action on one's own, subject to no check - than any single commissioner or board member in any other independent agency in the U.S. Government. Indeed, as we will explain, the Director enjoys more unilateral authority than any other officer in any of the three branches of the U.S. Government, other than the President.
As I will explain below, it can readily be seen that the Director of the CFPB is subject to meaningful checks on his or her unilateral authority. Thus, the Director of the CFPB does not enjoy more unilateral authority than anyone in the U.S. government other than the POTUS.
I would characterize this as an ideologically-based decision by the three-judge panel. The opinion was written by Circuit Judge Kavanaugh, who was appointed by G.W. Bush and who was approved by the Senate following a contentious Senate battle. Senior Circuit Judge Randolph, who was appointed by G.H.W. Bush, joined this opinion. Circuit Judge Henderson, who was appointed by G.H.W. Bush, joins as to Parts I, IV, and V of this decision.
It is my understanding that this Circuit Court panel found that it was better to have what I would call a "politicized" CFPB rather than to have a single independent director of the CFPB. This is despite the numerous safeguards that provide an assurance that the CFPB director cannot act in an arbitrary and unilateral manner.
Q3. Is this CFPB decision subject to en banc review and/or review by SCOTUS?
A3. Yes, it could be subject to en banc review by a majority of the 11 D.C. Circuit Judges (this excludes the seven Senior Judges). Note that seven of the Circuit Judges were appointed by Bill Clinton or Obama, while four of the Circuit Judges were appointed by G.H.W. Bush or G.W. Bush. Note also that Chief Judge Garland has not been participating in recent months, pending consideration of his nomination to SCOTUS.
This CFPB decision could also be subject to review by SCOTUS.
Q4. Please describe the checks on the CFPB Director's independence.
A4. I would note the following.
First, the CFPB's decisions are subject to review by the courts.
Second, the CFPB is required to follow the Administrative Procedures Act of 1946.
Third, the CFPB Director can be removed for cause, such as "inefficiency, neglect of duty or malfeasance."
Fourth, decisions by the CFPB are subject to veto by a vote of a 2/3rds of the voting members of the Financial Stability Oversight Council (FSOC). It is my understanding that the FSOC "consists of 10 voting members and 5 nonvoting members and brings together the expertise of federal financial regulators, state regulators, and an independent insurance expert appointed by the President." The FSOC's 10 voting members include:
1. the Secretary of the Treasury, who serves as the Chairperson of the Council,
2. the Chairman of the Board of Governors of the Federal Reserve System,
3. the Comptroller of the Currency (OCC),
4. the Director of the Bureau of Consumer Financial Protection (CFPB),
5. the Chairman of the Securities and Exchange Commission (SEC),
6. the Chairperson of the Federal Deposit Insurance Corporation (FDIC),
7. the Chairperson of the Commodity Futures Trading Commission (CFTC),
8. the Director of the Federal Housing Finance Agency (FHFA),
9. the Chairman of the National Credit Union Administration (NCUA), and
10. an independent member with insurance expertise who is appointed by the President and confirmed by the Senate for a six-year term.
The nonvoting members, who serve in an advisory capacity, are:
- the Director of the Office of Financial Research,
- the Director of the Federal Insurance Office,
- a state insurance commissioner designated by the state insurance commissioners,
- a state banking supervisor designated by the state banking supervisors, and
- a state securities commissioner (or officer performing like functions) designated by the state securities commissioners.
Q5. Given that the FSOC can veto a decision of the CFPB director, is a multi-member CFPB commission necessary?
A5. No. A multi-member commission structure is used at the FERC, the FCC, and many state public utility commissions, but the primary oversight of these regulatory agencies is the courts, the legislature, and the law. Thus, these agencies must follow their statutes (including the Administrative Procedures Act of 1946, or APA of 1946), subject to scrutiny by the courts and the legislature.
The CFPB is different. Its decisions are subject to veto by the FSOC. Given that this is the case it should not matter that the CFPB director is considered an independent regulator, appointed to a five-year term. Ample checks on the CFPB director's discretion are in place.
Q6. Do you think that this decision is relevant to the FHFA at the present time?
A6. No. With respect to FHFA and the independence of Director Watt, a comparable issue is not currently before any court.
Note that the issue of whether FHFA is subject to oversight by the courts is an item of dispute in the appeal of Judge Lamberth's decision.
Note also that HERA of 2008 specifically states that:
''(7) AGENCY NOT SUBJECT TO ANY OTHER FEDERAL AGENCY.-When acting as conservator or receiver, the Agency shall not be subject to the direction or supervision of any other agency of the United States or any State in the exercise of the rights, powers, and privileges of the Agency."
Moreover, there is a Federal Housing Finance Oversight Board (FHFOB) that provides some degree of oversight of the FHFA while ensuring that the Director of the FHFA retains his independence. HERA of 2008 specifies that:
''(NYSE:A) IN GENERAL.-There is established the Federal Housing Finance Oversight Board, which shall advise the Director with respect to overall strategies and policies in carrying out the duties of the Director under this title.
(NYSE:B) LIMITATIONS.-The Board may not exercise any executive authority, and the Director may not delegate to the Board any of the functions, powers, or duties of the Director.
(NYSE:C) COMPOSITION.-The Board shall be comprised of 4 members, of whom-
(1) 1 member shall be the Secretary of the Treasury;
(2) 1 member shall be the Secretary of Housing and Urban Development;
(3) 1 member shall be the Chairman of the Securities and Exchange Commission; and
(4) 1 member shall be the Director, who shall serve as the Chairperson of the Board.
(1) IN GENERAL.-The Board shall meet upon notice by the Director, but in no event shall the Board meet less frequently than once every 3 months.
(2) SPECIAL MEETINGS.-Either the Secretary of the Treasury, the Secretary of Housing and Urban Development, or the Chairman of the Securities and Exchange Commission may, upon giving written notice to the Director, require a special meeting of the Board.
Q7. Are both CFPB and FHFA required to follow the APA of 1946?
A7. Yes. However, I have argued in previous articles that FHFA doesn't follow even the most basic requirements of the APA of 1946.
Q8. What issues are currently before the appeals court with respect to the GSEs.
A8. It is my understanding that six basic issues are currently before the appeals court, D.C. Circuit, with respect to the GSEs.
(1) Whether FHFA exceeded its statutory authority by failing to preserve and conserve assets.
(2) Whether FHFA was acting under the direction/supervision of Treasury.
(3) Whether Treasury exceeded its authority by exceeding the sunset provision.
(4) Whether there was a breach of contract with respect to the GSE dividends (i.e., the senior preferred stock dividends are paid in cash but no preferred dividends are paid to non-governmental GSE preferred holders).
(5) Whether there was a breach of the implied covenant of good faith and fair dealing.
(6) Whether there was a breach of fiduciary duty.
Note that these six topics were mentioned in a recent Investors Unite conference call with GSE investors.
Q9. Do you have any further comments at this time?
A9. No, I do not.
Disclosure: I am/we are long AN INVESTOR IN GSE PREFERRED STOCKS, SUCH AS FNMAS, AND FMCKJ, AMONG OTHERS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not an attorney. I am a consulting economist on matters related to public utility regulation.
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