Texas Federal District Court Invalidates CFPB Exam Manual Changes Which Opined that Discrimination is a UDAAP Violation

As we predicted long ago, on Friday, September 8, 2023, the Federal District Court for the Eastern District of Texas vacated the changes made in March 2022 to the CFPB’s Exam Manual. On that date, the CFPB purported to use its authority to prohibit unfair, deceptive, or abusive acts or practices (UDAAPs) to target discriminatory conduct, even where fair lending laws may not apply. 

Specifically, the CFPB directed its examiners to apply the “unfairness” standard under the Consumer Financial Protection Act (CFPA) to conduct considered to be discriminatory, whether or not it is covered by the Equal Credit Opportunity Act (ECOA)(such as in connection with denying access to a checking account). Under the CFPA, an act or practice is “unfair” if (1) it causes or is likely to cause substantial injury to consumers, (2) the injury is not reasonably avoidable by consumers, and (3) the injury is not outweighed by countervailing benefits to consumers or competition. In its press release, the CFPB stated:

“The CFPB will examine for discrimination in all consumer finance markets, including credit, servicing, collections, consumer reporting, payments, remittances, and deposits. CFPB examiners will require supervised companies to show their processes for assessing risks and discriminatory outcomes, including documentation of customer demographics and the impact of products and fees on different demographic groups. CFPB examiners will look at how companies test and monitor their decision-making processes for unfair discrimination, as well as discrimination under ECOA.”

The CFPB’s blog post about the manual update provided an indication of some of the practices the CFPB would scrutinize using an “unfairness” analysis. As an example of a discriminatory practice that “fall[s] squarely within our mandate to address and eliminate unfair practices,” the blog post identifies “the widespread and growing reliance on machine learning models throughout the financial industry and their potential for perpetuating biased outcomes,” and specifically mentions “certain targeted advertising and marketing, based on machine learning models, [that] can harm consumers and undermine competition.” Observing that “[c]onsumer advocates, investigative journalists, and scholars have shown how data harvesting and consumer surveillance fuel complex algorithms that can target highly specific demographics of consumers to exploit perceived vulnerabilities and strengthen structural inequities,” the CFPB indicated that it would “be closely examining companies’ reliance on automated decision-making models and any potential discriminatory outcomes.”

After an unsuccessful attempt to convince the CFPB to withdraw its changes to the Exam Manual, the United States Chamber of Commerce and other trade associations filed a lawsuit against the CFPB in Federal District Court for the Eastern District of Texas seeking, among other things, a declaration that the Exam Manual changes are unlawful. The plaintiffs claimed that the manual update should be set aside because it violates the Administrative Procedure Act (APA) for the following reasons:

1. The update exceeds the CFPB’s statutory authority in the Dodd-Frank Act. The CFPB cannot regulate discrimination under its UDAAP authority because Congress did not give the CFPB authority to enforce anti-discrimination principles except in specific circumstances. The CFPB’s statutory authorities consistently treat “unfairness” and “discrimination” as distinct concepts. (To demonstrate the compliance burdens resulting from the update, the plaintiffs allege that the CFPB has provided no guidance for regulated entities on what might constitute unfair discrimination or actionable disparate impacts for purposes of UDAAP. As examples of issues creating confusion, the plaintiffs allege that the CFPB has not identified what are protected classes or characteristics or what activities are not discrimination (such as those identified in the ECOA), and has not explained how regulated entities should conduct the sorts of assessments that the CFPB appears to be contemplating given existing prohibitions on the collection of customer demographic information.)

2. The update is “arbitrary and capricious” because the CFPB’s interpretation of “unfairness” contradicts the historical use and understanding of the term. The plaintiffs allege that the FTC’s unfairness authority does not extend to discrimination and that Congress borrowed the FTC Act’s unfairness definition for purposes of defining the CFPB’s UDAAP authority. They also allege that the CFPB’s contemplated use of disparate impact liability when pursuing UDAAP claims flouts congressional intent and U.S. Supreme Court authority.

3. The update violates the APA’s notice-and-comment requirement because it is a legislative rule that imposes new substantive obligations on regulated entities.

In addition to claiming that the Exam Manual update should be set aside due to the alleged APA violations, the plaintiffs allege that the update should be set aside because the CFPB’s funding structure violates the Appropriations Clause of the U.S. Constitution. (Pursuant to Dodd-Frank, the CFPB receives its funding through requests made by the CFPB Director to the Federal Reserve, subject to a cap equal to 12% of the Federal Reserve’s budget, rather than through the Congressional appropriations process.) As support for their unconstitutionality claim, the plaintiffs cite the concurring opinion of Judge Edith Jones in the Fifth Circuit’s en banc May 2022 decision in All American Check Cashing in which Judge Jones concluded that the CFPB’s funding mechanism is unconstitutional. (While the case was pending, the Fifth Circuit issued a unanimous opinion in a case entitled CFSA et al v. CFPB in which it agreed with Judge Jones’s concurring opinion mentioned above and held that the CFPB’s funding mechanism is unconstitutional and that its payday lending rule is invalid.)

The plaintiffs in the Chamber case subsequently filed a motion for summary judgmentwhich was met with a dispositive motion by the CFPB. Initially, the Court rejected all of the CFPB’s arguments, including that the plaintiffs lacked standing to bring the lawsuit, that the CFPB was immune from the lawsuit as a sovereign and that venue was improper in the Eastern District of Texas. While the CFPB conceded that the plaintiffs motion based on the CFSA case should be granted, it argued that the Court should not reach or decide any of the other arguments made by the plaintiffs in support of invalidating the Exam Manual changes. The Court disagreed and, instead, in a well-written opinion, explained why the Exam Manual changes were contrary to the UDAAP statutory authority. The Court had no need to, and did not, reach or decide the other two APA issues raised by the plaintiffs

The Court first dealt with two preliminary interpretive issues. First, it concluded that no Chevron deference should be given to the CFPB’s revisions to its Exam Manual. Because the CFPB did not request judicial deference, the Court concluded that the CFPB waived this potential argument. Second, the Court observed that “‘the words of a statute must be read in their context and with a view to their place in the overall statutory scheme.’ That inquiry is ‘shaped, at least in some measure, by the nature of the question presented’—here, whether Congress meant to confer the power the agency asserts. Even if an agency’s ‘regulatory assertions had a colorable textual basis,’ a court must consider ‘common sense as to the manner’ in which Congress would likely delegate the power claimed in light of the law’s history, the breadth of the regulatory assertion, and the economic and political significance of the assertion.” [Footnotes omitted]

Based on these principles, the District Court relied upon the “major questions doctrine.” The major questions doctrine is a principle which states that courts will presume that Congress does not delegate to executive agencies issues of major political or economic significance. The “major questions doctrine” is derived from the Supreme Court opinion in FDA v. Brown & Williamson Tobacco Corp. (2000): “[W]e must be guided to a degree by common sense as to the manner in which Congress is likely to delegate a policy decision of such economic and political magnitude to an administrative agency.” It was relied upon in a recent Supreme Court opinion in State of West VA v. Environmental Protection Agency where the Court “recognize[d] that sweeping grants of regulatory authority are rarely accomplished through ‘vague terms’ or ‘subtle device[s].’ Courts must ‘presume that Congress intends to make major policy decisions itself, not leave those decisions to agencies.’ If that major questions canon applies, ‘something more than a merely plausible textual basis for the agency action is necessary. The agency instead must point to clear congressional authorization for the power it claims.” The doctrine was also relied upon in Biden v. Nebraska where the Court likewise recognized that “the economic and political significance [of the agency’s forgiveness of federal student loans] is staggering by any measure” and that “the basic and consequential tradeoffs” that are necessarily part of the action “are ones that Congress likely would have intended for itself.”

The Court had no difficulty identifying the “major question” here. “The choice whether the CFPB has authority to police the financial-services industry for discrimination against any group that the agency deems protected, of for lack of introspection about statistical disparities concerning any such group, is a question of major economic and political significance.” The economic impact was demonstrated by the substantial sums of money (“millions of dollars per year”) spent by companies on compliance. The political implications included the impact on state and federal powers, since the CFPB would be overriding state decisions on discrimination issues, as well as the “profound” implications regarding the scope of federal power with regard to protected classes, prohibited outcomes, and defenses to claims of misconduct.

Against that backdrop, the Court found nothing in the Dodd-Frank Act to support the CFPB’s position. The Court agreed with the plaintiffs that discrimination and unfairness are treated as distinct concepts in the Act, noting, for example, the creation of a CFPB office devoted to “fair, equitable and nondiscriminatory access to credit” which references the Equal Credit Opportunity Act but makes no mention of unfairness and the statutory definition of unfairness which fails to mention discrimination. Looking to the text, structure of the Dodd-Frank Act, and the historical gloss on unfairness, the Court held that “the Dodd-Frank Act’s language authorizing the CFPB to regulate unfair acts or practices is not the sort of ‘exceedingly clear language’ that the major questions doctrine demands ….”

After concluding that the Exam Manual changes exceeded the CFPB’s UDAAP statutory authority, the Court vacated the changes to the Exam Manual. Curiously, the Court also granted an injunction against the CFPB preventing it from enforcing the changes in the Exam Manual against only members of the plaintiff trade associations.

Here are our observations and takeaways: 

1. We were surprised that the CFPB didn’t appear to argue that the case ought to be just stayed pending the outcome of the Supreme Court opinion in CFPB v. CFSA since many courts had done precisely that with respect to pending enforcement actions by the CFPB. While we expect that the trade associations would have opposed a stay since they were very anxious to obtain a ruling on the merits, the Court might very well have “kicked the can down the road.”

2. The Court may have created some unnecessary confusion by issuing an injunction precluding the CFPB from enforcing the Exam Manual changes only against the plaintiffs and their members after it had previously vacated the Exam Manual changes in their entirety as to everyone effected by those changes. Once it vacated the Exam Manual changes, why did the Court decide to even bother with issuing injunctive relief? Once it decided to grant this additional and seemingly superfluous remedy, why did it confer the benefits only on the plaintiffs and their members? We assume that it did so to insure that the CFPB does not seek to bring any supervisory action or enforcement action against the plaintiffs under the now discredited theory that it can assert that allegedly discriminatory practices are unfair. However, by sowing this confusion, trade associations other than the plaintiffs may feel it necessary to seek to intervene in the lawsuit and seek their own injunctive relief to benefit their own members or they may feel it necessary to bring a separate suit seeking the same injunctive relief. That is, of course, precisely what has recently happened in the lawsuit brought by the American Bankers Association and Texas Bankers Association challenging the legality of the final rule recently promulgated under Section 1071 of Dodd-Frank dealing with mandatory data collection with respect to small business loans. See here, here, here, here, here, here, here, here, & here for our blogs about the multiple interventions and preliminary injunction motions that the 1071 case has spawned. We don’t expect that to happen in this case since we very much doubt that the CFPB would investigate or bring an enforcement action against a company that is not covered by the injunction unless the CFPB is hoping to create a split in authority by suing in another Circuit, like the Second Circuit which has held that the CFPB’s funding is constitutional.

3. We were surprised that the CFPB waived its argument that the Court should give judicial deference to the changes to the Exam Manual based on the Chevron case even thougha case is pending before the Supreme Court which might overrule Chevron. Under the Chevron judicial deference doctrine, a court must validate an agency’s interpretation of a regulation if the statutory authority is ambiguous and the regulation is reasonable. (Perhaps the CFPB took this approach because it did not want to concede that the changes to the Exam Manual constituted a “rule” under the APA. However, the Court found against the CFPB on this issue.)

4. While the Court did not directly rule on whether Section 5 of the FTC Act (which, like the CFPA, proscribes unfair and deceptive acts and practices) also encompasses discrimination claims, the Court certainly cast aspersions on the FTC’s conclusion that it does. Perhaps, the FTC will keep its powder dry for the time being in pursuing this theory.

5. The big question is whether the CFPB will appeal to the Fifth Circuit. If the District Court had not vacated the changes to the Exam Manual, we don’t think the CFPB would appeal since its odds of prevailing in the Fifth Circuit (the home of CFSA v. CFPB and the most conservative Circuit Court in the country) would be very slim. An appeal could result in a Fifth Circuit opinion affirming the District Court on the merits and that, of course, would be much worse for them than this District Court opinion.

6. The District Court opinion will have some impact on the anticipated lawsuit in the District Court in Texas against the CFPB challenging a final credit card late fee regulation based on the binding Fifth Circuit opinion in CFSA v. CFPB, but the more significant aspect of the opinion predicated on the “major questions doctrine” will not apply. That’s because the credit card late fee regulation is contemplated by the CARD Act and is not a creature of UDAAP.

7. The highly anticipated “open banking” regulation is also not a creature of UDAAP but instead is authorized by a separate express provision in Dodd-Frank.

8. This opinion will naturally result in the industry scrutinizing other pronouncements by the CFPB based on UDAAP as statutory authority. One obvious target is likely to be a Circular published in 2022 by the CFPB where it concluded that data security breaches resulting from a company’s negligence or malfeasance could be a UDAAP violation.

9. We do not think that there is any reasonable possibility of Congress enacting legislation which would define UDAAP to encompass discrimination.

10. While this case dealt with the “unfairness” prong of UDAAP and not the “abusive” prong of UDAAP, we would expect the industry to scrutinize any past or future explications of what the CFPB deems to be abusive to ensure that it passes muster under the “major questions doctrine.”