CQ WEEKLY – IN FOCUS
Oct. 13, 2012 – 12:22 p.m.
Dodd-Frank Fight Shifts to Courts
By Ben Weyl, CQ Staff
In his first debate with President Obama, Republican Mitt Romney pledged to repeal the Dodd-Frank financial overhaul if he won the election. It’s a surefire applause line among the GOP faithful, who believe that the 2010 statute and its resulting mountain of regulations created a monstrous federal intrusion into the banking system, one that is weighing down the economy and costing the nation jobs.
Still, Romney would have difficulty fulfilling that promise if he became president. In the past two years, Republicans in Congress have tried several times to knock down Dodd-Frank, aiming at the entire law and also at some of the pieces that created new regulatory structures around the financial industry. Democrats have guarded the law aggressively, repelling even minor changes for fear that they would lead to the scaling-back of the law. They will guard it just as zealously if the GOP gains control of the Senate.
There’s no guarantee, however, that Dodd-Frank will remain the law of the land. As has been the case with Obama’s health care law, the most serious challenges are likely to come in the courts. In fact, Dodd-Frank’s opponents in the financial and broader business worlds have had some success: Two judges have struck down regulations to implement the law.
The gravest threat to Dodd-Frank may come from a lawsuit that challenges the constitutionality of its fundamental components. The architects of the law dismiss the challenge, but some legal scholars say that parts of the suit may have merit.
Filed in June by a Texas bank and two conservative advocacy groups, the lawsuit claims that the Consumer Financial Protection Bureau (CFPB) and the Financial Stability Oversight Council (FSOC), both established under Dodd-Frank, violate the Constitution’s separation of powers doctrine because they grant federal agencies power but don’t require congressional or court oversight.
Last month, three state attorneys general, all Republicans, joined the challenge; they argue that the authority the regulators were given to dissolve failing firms breaches both the separation of powers and the right to due process.
The growing legal assault is reminiscent of the Affordable Care Act challenge, which ended up in the Supreme Court; in this instance, the fate of the country’s largest financial regulatory law in generations may be decided by the high court.
Many Democrats had scoffed at the idea that the health care overhaul was unconstitutional and might be overturned by the courts. The challenge was, they said, a legally baseless attack from critics of the law who had lost on the legislative battlefield.
That sentiment can now be heard among many backers of Dodd-Frank.
“It’s totally political,” Rep.
C. Boyden Gray, an attorney for the plaintiffs, obviously disagrees. “Only time will tell whether it’s legally baseless,” he says.
Dodd-Frank Fight Shifts to Courts
Gray, who was President George Bush’s White House counsel (1989-93), has been beating the drum against Dodd-Frank for two years. He has set out his case in the opinion pages of The Washington Times, The Washington Post and The Wall Street Journal. And he co-wrote a paper, published in November 2010 by the conservative legal group the Federalist Society, that laid most of the foundation for the lawsuit’s claims. Gray says he was drawn to the suit after reading Dodd-Frank.
“It was worse than anything on this general area of separation of powers, and accountability — worse than anything I had ever seen, worse than anything on the books,” he says. “It involves all three branches of government being precluded from oversight functions, and it’s unique in its own accountability.”
The statute, written in response to the 2008 financial crisis, was an attempt to prevent such events — the Lehman Brothers failure, the $700 billion federal bailout for Wall Street, the collapse of the subprime mortgage market — from recurring. The financial industry and congressional Republicans vigorously opposed the legislation, but Obama and a Democratic Congress ultimately enacted the law in July 2010.
The largest rewrite of the country’s regulatory regime since the Great Depression, it provided federal regulators with a host of new powers — powers that legislators and the financial industry are now trying to roll back.
But Republican lawmakers have not taken direct aim at Dodd-Frank, as they did with the health care overhaul. Whereas the GOP House has passed dozens of measures to repeal all or part of the health care law, lawmakers have generally tiptoed around this financial regulatory law because it is so popular with the public. Bills to repeal Dodd-Frank fully have been introduced in the House and the Senate but have gone nowhere. The House last year passed one major piece of legislation to weaken the law — a bill to restructure the consumer protection bureau — but that measure was effectively dead in the Senate, thanks to Democratic opposition. Even if Republicans win control of the Senate, a minority of Democrats may be able to fend off major threats to Dodd-Frank through the filibuster, making the courts the most likely arena in which opponents will attack the law.
In June 2012, the State National Bank of Big Spring, Texas — a town of 27,000 near Midland in West Texas — along with the Competitive Enterprise Institute, a think tank focused on free markets, and the 60 Plus Association, a conservative advocacy group that represents seniors, filed suit against the law in the U.S. District Court for the District of Columbia.
One part of the challenge centers on the CFPB, a watchdog created to help borrowers who seek credit cards and mortgages and to prevent the sorts of shady lending practices that fueled the 2008 financial crisis.
The plaintiffs argue the law provides limitless power to the bureau without meaningful checks; for example, the agency has the authority to prohibit unfair, deceptive or abusive practices but has not specified which lending practices would be considered abusive. The plaintiffs also argue the bureau — which receives funding from the Federal Reserve, where it is housed, rather than through the appropriations process — lacks congressional oversight.
They also take issue with its structure: The bureau has a lone director rather than a multimember commission, and that director can be removed only by the president and only for cause. The plaintiffs further argue that Obama’s recess appointment in January of Richard Cordray as director was unconstitutional because the Senate was not in formal recess.
The complaint’s other target is the FSOC, an assembly of regulators established to monitor risks to the broader financial system. The law gives the council the power to designate certain companies “systemically important,” a label that brings heightened supervisory and regulatory requirements yet also, critics say, gives these “too big to fail” institutions an unfair advantage.
And the plaintiffs charge that the agency has “sweeping and unprecedented” power and that the agency cannot be challenged adequately in the courts.
Adding heft to the challenge, state attorneys general from Oklahoma, South Carolina and Michigan last month joined the lawsuit; their complaint targets the law’s orderly liquidation authority, a provision that grew out of one of the most controversial government responses to the 2008 financial crisis.
Four years ago, as it became clear that a series of collapses by major financial firms could have cataclysmic consequences, the federal government stepped in to rescue the financial industry. In an effort to prevent future bailouts and to discard the concept of “too big to fail,” lawmakers gave the Treasury secretary and the Federal Deposit Insurance Corporation new powers to dismantle large failing companies in an orderly way, without undermining the stability of the financial system. The provision violates separation of powers because, the three states say, it does not allow for meaningful oversight by the other branches of government. And the provision violates the Fifth Amendment’s due process clause, they charge, because the companies’ creditors could lose their investments — in this case, state pension funds — in liquidation with no legal recourse.
Dodd-Frank Fight Shifts to Courts
The administration is expected to respond formally to the lawsuit by Oct. 26. The government is likely to seek a complete dismissal of the suit, which it views as “a rehash of old arguments by those who oppose Wall Street reform,” according to a Treasury spokesperson.
The case, although nascent, has generated comment among legal scholars; some parts of the challenge, they say, appear to be on firmer ground than others.
“I don’t think the part of the lawsuit that deals with the CFPB is particularly substantive,” says Arthur E. Wilmarth Jr., a George Washington University law professor and executive director of the law school’s Center for Law, Economics and Finance. “They make some arguments that the agency’s powers are unprecedented. I disagree. Financial regulatory agencies have always had a pretty impressive panoply of powers.”
The consumer bureau’s structure is similar to that of the Office of the Comptroller of the Currency, which has overseen national banks since its creation, in 1863. Both agencies are headed by a single individual, and neither receives appropriations from Congress.
Wilmarth expects the courts to reject the challenge to the FSOC as well.
Obama’s recess appointment of Cordray, however, may raise serious questions. The Constitution allows the president to make appointments during a Senate recess, but the plaintiffs — and dozens of GOP senators — argue that the Senate, which was convening every three days for pro forma sessions, had not fully recessed.
On the day of that appointment, Steven S. Smith, a political scientist at Washington University in St. Louis, wrote on the Monkey Cage political blog that even though the issue was “one of many frustrating ambiguities in the Constitution,” he believed that the courts eventually would rule against the president. A separate legal challenge — to recess appointments made on the same day, to the National Labor Relations Board — also is under way; it is backed by the U.S. Chamber of Commerce.
Closing the Books
The thorniest legal questions may be raised by authority for the orderly liquidation of financial institutions — a crucial element and one intended to prevent more bank bailouts.
“I think there are some serious constitutional problems there,” says Thomas W. Merrill, a professor at Columbia Law School. “I think it could have easily been avoided.”
Under the law, the Treasury secretary may ask the U.S. District Court to authorize the appointment of the FDIC as receiver if the secretary determines that a company must be seized and liquidated in order to prevent harm to the broader financial system. But the statute, which constrains the court’s actions, may be problematic legally. The court must conduct a confidential hearing and make a decision within 24 hours. Also, the court is limited in what it can consider: The statute permits the court to review Treasury’s contention that a firm is in financial distress but not the effect, on the rest of the financial system, of the firm’s failure.
“I think there’s lots of due process problems there, and I think there’s the problem of strong-arming the court into making a decision of this magnitude,” Merrill says.
Dodd-Frank Fight Shifts to Courts
Merrill is developing a paper, to be submitted for publication next year, that discusses constitutional issues with the orderly liquidation authority. The paper also will touch on “unforced errors,” he says, which could have been avoided with relatively minor changes in the legislation.
Wilmarth agrees that the challenge to the orderly liquidation authority may have some legal weight, particularly the complaint that the court is unduly restricted in what it can review when ruling on a Treasury petition.
“It certainly strikes me as unusual that the court can’t look at these issues,” he says. “At least it gives them a ring of plausibility, that this is really unusual and unprecedented.”
Those involved in writing the law counter that the new authority effectively extends the FDIC’s existing power to seize failing banks, which has long been upheld by the courts.
“It is well established that companies in a regulated industry can be subject to closure if they are not solvent or cannot meet regulatory requirements, and resolved through an administrative process,” says Michael H. Krimminger, who served as special adviser for policy to former FDIC Chairwoman Sheila Bair during the development of Dodd-Frank.
Krimminger, now a partner at the law firm Cleary Gottlieb Steen & Hamilton, argues the law does provide for judicial review, noting a federal court decision on a Treasury petition may be challenged at the U.S. Court of Appeals and then at the Supreme Court.
Still, supporters of strict financial regulations are keeping a close eye on the case as it begins what could be a lengthy journey that could end up at the Supreme Court. “You never know,” says Marcus Stanley, the policy director for Americans for Financial Reform, which is backed by labor unions and consumer groups. “The Supreme Court recently has made a number of decisions that constitutional lawyers thought it would not make.”
FOR FURTHER READING:
Regulations challenged, 2012 CQ Weekly, p. 1082; CFPB restructured (