Shortly after the Supreme Court issued its 7-2 opinion in CFSA v. CFPB, holding that the funding mechanism for the CFPB created in the Dodd-Frank Act (a capped amount each year from the “combined earnings of the Federal Reserve System”) is Constitutional, several scholars, one practitioner (me) and legislators began to focus on a different statutory and constitutional infirmity —namely, the fact that since September 2022, the Federal Reserve System had no combined earnings out of which it could lawfully fund the CFPB. The articles, op-eds and other prior developments are chronicled in our blog, Consumer Finance Monitor, and are available here, here, here, here, here, here, here, and here.

On July 9, Bruce Johnson of Potomac Global Partners (formerly Deputy Director of the CFPB) published a very thoughtful article which strongly supports the position that the CFPB is being unlawfully funded. The title of his article is: “Examining the New Debate on CFPB Funding.”

Mr. Johnson’s lead and strongest argument is as follows:

“Dodd-Frank Section 155(c)

It may be useful to examine the entirety of the Dodd-Frank Act in discerning the meaning of Section 1017(a) – the section that creates the funding mechanism. For instance, Title I of the Act created a new agency known as the Office of Financial Research (OFR). The purpose of the OFR is to collect data, perform research, and create systemic risk diagnostic tools to support the activities of the Financial Stability Oversight Council (FSOC), another body also created by Title I of Dodd-Frank. Section 155 of Dodd-Frank, now codified at 12 U.S.C. 5345, establishes funding for the OFR. Interestingly, this section created a two-phase funding process. A permanent funding mechanism, which began 12 July 2012 and remains in effect today, funds the OFR through assessments of large banks and non-bank financial institutions designated by the FSOC for supervision by the Fed. However, there was also an interim funding mechanism in effect between 21 July 2010 and 20 July 2012. This interim funding, provided by Section 155(c) of the Act, states:

‘During the 2-year period following the date of enactment of this Act, the Board of Governors shall provide to the Office an amount sufficient to cover the expenses of the Office.’

Both Section 155(c) and Section 1017(a) of Dodd-Frank obligate the Board of Governors to provide amounts to a new agency created by the Act. However, Congress did not specify a source from which amounts must be drawn for transfer to the OFR; it simply instructed the Board of Governors to transfer to the OFR whatever amount was necessary to cover its expenses. Congress’s silence in this regard arguably left the Board of Governors with the discretion to determine how to effectuate transfers to the OFR. But this is not the case with the CFPB’s funding, where Congress both specified the amounts to be transferred (i.e., the quarterly amount requested by the Director, subject to an annual statutory maximum) and instructed the Board of Governors to draw the amounts from a particular source (i.e., “from the combined earnings of the Federal Reserve System”).

Scholars and practitioners might therefore consider whether Congress’s decision to require a funding source for the CFPB – but not for the OFR – supports or undermines the broader construction of “combined earnings.” For instance, if Congress had intended that any revenues (such as interest income on Treasuries) would be a sufficient source of funds for transfer to the CFPB, Congress presumably could have remained silent as to the funding source, as it did with the OFR. But does such a construction render the funding source requirement in Section 1017(a) of Dodd-Frank surplusage? Perhaps reading Sections 155(c) and 1017(a) in pari material can assist in evaluating whether Congress meant something more specific than “any revenues” when it chose to designate the “combined earnings of the Federal Reserve System” as the source of funds for transfer by the Board of Governors to the CFPB.”

Mr. Johnson’s other arguments relate to: (1) the fact that the Federal Reserve Board has no statutory authority to assess the Federal Reserve Banks in order to satisfy the funding requests of the CFPB; and (2) the Fed’s accounting treatment of funds paid to the CFPB as “above-the-line operating expenses” which, he asserts, is inconsistent with Dodd-Frank.

Mr. Johnson concludes:

“Given the foregoing, there is a question whether the Board of Governors has the statutory authority to fund CFPB transfers through assessments on the Reserve Banks, and thereby account for the resulting assessments as above-the-line operating expenses, or whether the amounts transferred to the CFPB should be accounted for as below-the-line remittances deducted from earnings. The answer to this question may bear materially on whether the Board of Governors can lawfully honor CFPB funds transfer requests that it receives in circumstances where, as has been the case since November 2022, the Federal Reserve System has no net earnings. It may also bear on whether the financial statements issued by the Board of Governors since 2010 are free from misstatements and present fairly, in all material respects, the financial position of the Board of Governors and Reserve Banks and the results of their operations and changes in capital.

Scholars and practitioners will surely continue to debate this question. However, to resolve legal uncertainty, the Federal Reserve Board of Governors should publicly identify the statutory authority supporting its present CFPB funding and accounting practices.”

It’s not clear to me what the relevance of this is to the more fundamental point of whether the transfers are permissible under Dodd-Frank at all, which is a matter of what Dodd-Frank permits and requires, not how the Fed accounts for the payments. I’m not a CPA and I’m in no position to opine on whether the Fed’s accounting treatment is right or wrong.

Mr. Johnson’s article will not be the end of this debate. This is not an issue which should be taken lightly or swept under the rug. Just as it was necessary for the courts to resolve the other Constitutional issue in the CFSA case, there is an urgent need for the courts to resolve this “new” issue. All stakeholders, including the Fed, Treasury, CFPB, companies subject to the regulatory, supervisory and/or enforcement jurisdiction of the CFPB, and consumers need a definitive answer, Major public policy issues (and potential criminal culpability) are at stake.

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