As we have previously reported, there are several CFPB enforcement lawsuits pending in which the defendants have filed motions to dismiss based in whole or in part on the argument that subsequent to September 2022, all funding received by the CFPB from the Federal Reserve Board has been unlawfully received. That is a result of the fact that the Federal Reserve System began then to incur substantial losses after September 2022 which continue to this day with no profits being foreseen in the near future. The Dodd-Frank Act mandates that the Federal Reserve Board may only fund the CFPB out of “combined earnings of the Federal Reserve System”. The primary issue in the cases that have challenged the CFPB’s funding is whether “combined earnings” means profits as the defendants in these cases have maintained or whether it means revenues as the CFPB has maintained.

The purported “wins” for the CFPB occurred in CFPB v. Active Network, LLC (the “Active opinion”) No. 4:22-cv-00898, 2024 WL 4437639., at *2 (E.D. Tex. Oct. 7, 2024) (Judge Amos Mazzant); Texas v. Colony Ridge, Inc. (“Colony”) No. H-24-0941 (S.D. Tex. Oct. 11, 2024) (Memorandum and Recommendation (the “Colony MAR”) of Magistrate Judge Peter Bray) and Consumer Financial Protection Bureau v. SoLo Funds, Inc., No. 2:24-cv-4108 (C.D. Cal. Oct. 17, 2024) (Judge R. Gary Klausner).

The CFPB has already submitted the Active opinion and the Colony MAR as supplemental authority in the other CFPB enforcement actions where motions to dismiss are pending along with short briefs touting their importance. This is what the CFPB has stated in one of these briefs:

In Consumer Financial Protection Bureau v. Active Network, LLC, defendant Active Network argued—just like Defendant here—that a Bureau enforcement action must be dismissed because the Bureau may draw funds from the Federal Reserve System only when the System generates net excess earnings. Mot. to Dismiss at 22–24, CFPB v. Active Network, LLC, No. 4:22-cv-00898-ALM (E.D. Tex. June 17, 2024), ECF No. 28 (attached as Exhibit 1). On October 7, 2024, in CFPB v. Active Network, LLC the U.S. District Court for the Eastern District of Texas rejected that argument and denied Active Network’s motion. In Texas v. Colony Ridge, Inc., defendants likewise sought dismissal of claims brought under the Consumer Financial Protection Act (CFPA) (the claims were brought by the State of Texas under a Dodd-Frank provision (12 U.S.C. § 5552(a)) authorizing states to enforce the CFPA based on the same argument that the Federal Reserve System is not generating excess earnings. Texas opposed, arguing in part that the CFPA does not limit the Bureau to drawing funds only from the Federal Reserve’s excess earnings. On August 11, a magistrate judge of the U.S. District Court for the Southern District of Texas recommended denying the motion. See Mem. & Recommendation at 9, Texas v. Colony Ridge, Inc., No. H-24-0941 (S.D. Tex. Oct. 11, 2024), ECF No. (“Colony Ridge Op.”). Among other reasons, the magistrate noted that the Supreme Court in CFPB v. Community Financial Services Ass’n of America, Ltd., 601 U.S. 441 (2024) had “found that the CFPB is constitutionally funded” at a time that the defendants there argued the CFPB was not properly funded. Colony Ridge Op. at 9.

Let’s now take a deeper dive into the opinion and the Colony MAR.

CFPB v. Active Network, LLC

On October 18, 2022 the CFPB filed a lawsuit against Active, an online event registration company, in a Texas federal district court alleging that the company is deceiving customers into joining its fee-based membership club, “Active Advantage.” Event organizers seeking to host community activities, such as youth camps and charity race events, contract with Active to provide online registration and payment processing services. The Complaint alleges that, prior to the completion of those transactions, online consumers were presented an Active Advantage insert offer page through which many believed they were merely confirming their event enrollment, when they were actually enrolling in the membership club and were automatically charged annual fees following a short trial period. The Complaint alleges Active’s enrollment processes for this service are in violation of the CFPA’s prohibitions on deceptive and abusive acts or practices. The Complaint further alleges that Active’s failure to timely notify enrollees of a recent subscription fee increase was a violation of the Electronic Fund Transfer Act. The CFPB lawsuit seeks an order permanently enjoining Active from the allegedly unlawful enrollment and notification practices, reimbursement to consumers, and assessment of a civil penalty.

Active filed a voluminous motion to dismiss in which it provided multiple reasons why the Complaint should be dismissed:

Its lead and obviously most important argument, was that Active is not subject to the CFPB’s enforcement jurisdiction because it is not a “covered person” as that term is defined in the CFPA Active’s arguments are as follows:

First, the CFPB lacks enforcement authority over Active’s sale of Advantage. Indeed, Active falls squarely into the merchant exception under the CFPA, which exempts from the CFPB’s enforcement authority the payment activity of merchants who are selling their own products. As a result, Active is not a “covered person” as defined in the CFPA. Recognizing this fact, the CFPB has also asserted that the Advantage program falls within the agency’s enforcement jurisdiction because it is offered “in connection” with financial products or services. However, the financial product referenced is, as the Complaint acknowledges in passing, a software-as-a-service product provided directly to event organizers (not consumers) through an entirely different transaction that is unrelated to the Advantage program. What consumers obtain from Active is not payment processing services but event registrations. Because the CFPB lacks authority to bring this action, it is ultra vires and must be dismissed.

Second, the CFPB’s claims are barred by the applicable statute of limitations:

Third, even if the Court finds the CFPB’s claims are not ultra vires or time barred, the CFPB failed to state cognizable claims for deceptive or abusive practices under the CFPA. To support a claim for consumer deception, the CFPB is required to plead that a consumer acting reasonably would be deceived. Similarly, to support a claim for abusive conduct the CFPB is required to plausibly plead that Active took unreasonable advantage of consumers by creating confusion about whether the consumer was enrolling in the Advantage program. Contrary to Plaintiff’s unadorned conclusions, the facts pleaded in the Complaint demonstrate that Active clearly disclosed to consumers that they were enrolling in the Advantage program and consumers had to perform multiple actions to affirmatively indicate their decision to join the program before any consumer was enrolled. Those who accepted the terms and did not cancel during the free membership period did so willingly and knowingly. The CFPB’s contrary allegations ignore the reality of how the offer was presented and are not entitled to any favorable inferences. Absent these inferences, the claims fail.

Fourth and finally, the CFPB cannot act because it was unlawfully funded.

Although the CFPB had requested oral argument with respect to the numerous complex issues in this case, the Court did not honor that request and instead issued a 3-page ruling which simply denied the motion to dismiss in its entirety without separately discussing each of Active’s four arguments and its reason(s) for rejecting each argument. The Court’s ruling consists of just this one sentence. “After reviewing the relevant pleadings and the arguments contained in the briefing, the Court finds that the Consumer Financial Protection Bureau has stated plausible claims for relief for the purposes of defeating a Rule 12(b)(6) motion.”

Because this ruling does not set forth the reasoning supporting the ruling, it is not in any respect persuasive and it is unlikely that other courts will give it any weight when rendering their opinions. The CFPB offered a number of reasons for its position that its funding was lawful: (1) that the Supreme Court opinion in CFSA v. CFPB is controlling; (2) that Congress could never have intended for the CFPB to stop operating if the Federal Reserve System lacked profits; and (3) that “earnings” means “revenues.” It is impossible to decipher which one or more of those reasons the Court relied upon. Indeed, the Court might have relied on a reason not even proffered by the CFPB. There may be yet another factor at play. Since the denial of a motion to dismiss is not a final judgment, the court may have felt that it could postpone grappling with these complex issues until a later point in the case, perhaps after discovery has been concluded.

Although this ruling is not appealable, it is possible that Active may file a petition for a writ of mandamus in the Fifth Circuit and it is possible that such a writ may be granted. The Fifth Circuit has granted multiple petitions for writs of mandamus and reversed a district court’s lack of venue rulings in a lawsuit challenging the CFPB’S credit card late fee rule.

Texas v. Colony

This case is a textbook example of the adage that “bad facts make bad law.” Fortunately, at this point the Colony MAR is not the law of the case and should be unpersuasive to other courts facing the funding issue.

The State of Texas filed a voluminous complaint alleging that Colony, its affiliates and an individual engaged in a massive fraud in connection with the sale to Hispanic purchasers of land for the building of homes. The Complaint alleged violations of multiple Texas consumer protection statutes, a provision in the CFPA that, under certain circumstances, authorizes a state attorney general to assert a claims against certain companies for engaging in unfair, deceptive or abusive acts or practices and the Federal Interstate Land Sales Act.

Colony moved to dismiss the complaint for lack of federal subject matter jurisdiction and argued that the CFPA claims did not confer federal question jurisdiction on the court because the CFPB was unlawfully funded once the Federal Reserve System started losing money after September 2022. Even though the CFPB is not a plaintiff in this lawsuit, Colony argued that the CFPB needed to take certain action under the CFPA as a prerequisite to the Texas Attorney General asserting the CFPA claim. The Colony MAR correctly states that the Texas Attorney General was required to notify the CFPB of its intent to file a lawsuit asserting a CFPA claim before including such a claim in its lawsuit. Colony asserted that the CFPB was required to “receive” such notice and that limited action could not lawfully happen because of the CFPB being unlawfully funded when the notice was sent by the Texas Attorney General and received by the CFPB. That very limited action – receipt of a notice –seems de minimus and not remotely similar to the enormous activity of the CFPB when it investigates possible violations of the CFPA and then files an enforcement lawsuit. That all seems to make sense. However, the Colony MAR elaborated on the funding issue as follows in a manner that is not persuasive:

“Colony Ridge does not explain how funding for, or the budget of, an agency is tied to its lawful ability to act. Congress established the agency and authorized it to implement and enforce Federal consumer financial law. See 12 U.S.C. § 5511. Further, the Supreme Court found that the CFPB is constitutionally funded – and it did so during a time when Colony Ridge argues the CFPB was not funded. Consumer Fin. Prot. Bureau, 601 U.S. 441 (deciding the case May 16, 2024).”

First, the Supreme Court’s opinion did not deal with the funding issue raised in this case. It dealt only with the question of whether the Dodd-Frank language allowing the CFPB to be funded out of the “combined earnings of the Federal Reserve Banks” violated the Appropriations Clause in the Constitution. The Appropriations Clause states that all government expenditures from the Treasury must be authorized by Congress. The Supreme Court first held that the Appropriations Clause applies because any funds paid to the CFPB are being paid indirectly by the Treasury because, if the Federal Reserve Banks have remaining earnings after paying for their operational expenses, the expenses of the Federal Reserve Board and the amounts paid to the CFPB, all excess earnings must be turned over to the Treasury’s General Fund. To the extent that the Federal Reserve Banks must pay the funding request of the CFPB, the Federal Reserve Banks will obviously have less earnings to turn over to the Treasury. The Supreme Court had no occasion to determine whether the Federal Reserve Banks had earnings to fund the CFPB because that issue was never raised by the plaintiff in the lawsuit. That was for good reason. When that lawsuit got initiated in 2017 and for most of its life, the Federal Reserve Banks were extremely profitable.

Second, the Supreme Court held that it was sufficient for Congress in Dodd-Frank to simply authorize a source of funding and a purpose for the funding. After concluding that Congress had done that in Dodd-Frank, that was the end of the Supreme Court’s inquiry in the CFSA case.

The relevance of the CFSA case to the new round of funding challenges is only that if the Federal Reserve Banks have a surplus, they must turn it over to the Treasury after funding the CFPB. Unfortunately, after September 2022, there was no longer a surplus to turn over to the Treasury. Indeed, there was no surplus to fund the CFPB at that point.

Furthermore, the Colony MAR does not focus at all on the principal issue in the case and in the other CFPB enforcement lawsuits – namely, whether the term “combined earnings” means combined profits or combined revenues.

The Colony MAR is only a recommendation made by the magistrate judge to the federal district court judge who is free to reject the recommendation in whole or in part. Magistrate judges’ recommendations do not become precedent or even law of the case unless and until a district court judge approves of the recommendations by adopting the recommendations as the court’s opinion.

As stated above, the CFPB is not a party to this case and the Colony case does not establish that the CFPB will need to take any action requiring funding in order for Texas to prosecute the case. Thus, it seems unlikely that the district court judge will need to deal with any of the other core issues which must be dealt with in the CFPB enforcement cases.

The bottom line is that the Colony MAR has no persuasive value when it comes to determining whether the CFPB prosecuted enforcement cases with funds that were obtained unlawfully.

Consumer Financial Protection Bureau v. SoLo Funding, Inc.

On October 16, 2024, the Federal District Court for the Central District of California denied a motion to dismiss based in part on the funding argument. The court only briefly addressed the funding argument and ultimately decided that it did not need to interpret the funding statute because SoLo failed to show that CFPB’s “source of funding—even if illegitimate—is grounds for dismissal.” The court noted that SoLo failed to cite any authority that dismissed a case on similar grounds. The court also rejected SoLo’s arguments that certain counts of the Bureau’s complaint were inadequately pleaded.

SoLo can move for reconsideration until October 31, 2024.

The CFPB’s argument supporting the Court’s holding consisted of the following two sentences: In any event, even if SoLo were correct, dismissal would not be warranted. Congress—which has the power of the purse—has not provided that actions taken without proper funding must be undone. See generally Anti-Deficiency Act, 31 U.S.C. § 1341 et seq.

Solo’s response consisted of the following: “Finally, the Bureau complains about the remedy for its violation, arguing that Congress ‘has not provided that actions taken without proper funding must be undone’ (Opp. 6), but the Anti-Deficiency Act (“ADA”) does not displace a court’s authority to set aside agency action carried out with unlawfully obtained funds. E.g., 5 U.S.C. § 706. Even if the ADA itself does not require dismissal of this case, it prohibits the Bureau from continuing to prosecute it. See 31 U.S.C. § 1341.”

The court should not, as a matter of procedure, have considered the remedy, if any, before deciding whether the CFPB was unlawfully funded during the prosecution of the enforcement lawsuit. As seen above, the briefing on the remedy issue was very skimpy, to say the least. If the issue had been fully briefed, I’m sure that, at a minimum, SoLo would have cited the Fifth Circuit opinion in CFSA v. CFPB where the Court, after holding that the CFPB’s funding provision ran afoul of the Appropriations Clause of the Constitution, invalidated the CFPB’s final payday lending regulation on the logical basis that a federal agency cannot benefit from a regulation which was created with funding that was unlawful. While the Supreme Court reversed the Fifth Circuit’s opinion, it did so entirely based on its holding that the CFPB’s funding was not unconstitutional. Thus, the Supreme Court never reached or disturbed the Fifth Circuit’s opinion with respect to the appropriate remedy.