On July 16, the Fifth Circuit Court of Appeals ruled that the Federal Housing Finance Agency (FHFA) which oversees two government services enterprises (GSEs), is unconstitutionally structured because it is excessively insulated from Executive Branch oversight.
The FHFA was created by the Housing and Economic Recovery Act of 2008 (HERA) to oversee Fannie Mae and Freddie Mac. The parties challenging the FHFA’s constitutionality were shareholders of the GSEs who were seeking to invalidate an amendment to a preferred stock agreement between the Treasury and the FHFA as conservator for the GSEs that required the GSEs to pay quarterly dividends to the government equal to the GSEs’ excess net worth after accounting for prescribed capital reserves.
Counsel for the Plaintiffs, David H. Thompson of Cooper & Kirk, discusses the decision and its implications.
David H. Thompson, Managing Partner, Cooper & Kirk PLLC
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Operator: Welcome to The Federalist Society's Practice Group Podcast. The following podcast, hosted by The Federalist Society's Administrative Law & Regulation Practice Group, was recorded on Friday, August 24, 2018 during a live teleforum conference call held exclusively for Federalist Society members.
Micah Wallen: Welcome to The Federalist Society's teleforum conference call. This afternoon our topic is on the litigation update on Collins v. Federal Housing Finance Agency. My name is Micah Wallen, and I'm the Assistant Director of Practice Groups here at The Federalist Society.
As always, please note that all expressions of opinion are those of the expert on today's call.
Today we are fortunate to have with us David H. Thompson, who is a Managing Partner at Cooper & Kirk. After our speaker gives his opening remarks, we will then go to audience Q&A. Thank you for speaking with us. David, the floor is yours.
David H. Thompson: Thank you, Micah. And it's a pleasure to be with everyone today, and as you noted, I'll be addressing the Fifth Circuit's recent decision in Collins v. FHFA. And I'd like to start by giving a brief factual background and overview, then get into the court's legal reasoning, discuss where the case is headed, and what the implications of the case are.
So let's start with the facts. And Fannie and Freddie are two of the world's largest financial institutions in the world. Together, they ensure $5.4 trillion of assets. And in 2008, some in Washington D.C. were concerned about the capital levels of the companies, even though they were adequately capitalized. And others in Congress were looking for ways to kill the companies off. And regardless of motivation, Congress in July of 2008, passed HERA, the Housing and Economic Recovery Act. And HERA established as Fannie Mae and Freddie Mac's regulator the FHFA, and there are several features of that agency that are unusual.
It's independent; it has a single director, whereas almost all independent agencies with a couple of minor exceptions that I'll address in a moment have had a multi-member, bipartisan requirements. The head of the agency can only be removed for cause. The funding for the agency comes from the companies, not from Congress. So it is not subject to the normal appropriations process. And it has a provision of law that immunizes it from judicial intervention for violations of federal and local statutes, unless it's violating HERA. If it's violating its organic statute, it can be enjoined. But otherwise, it cannot be. So it's a series of unusual features and it became the model for Dodd Frank a couple of years later.
Now, another piece of the factual puzzle that everyone needs to understand is the standing of my client, and it relates to the net worth sweep. And we could do a whole separate call on the sweep and the facts surrounding that, but I'll just give you the CliffNotes version, which is that when the government provided capital, access to funds, in 2008, the government cut a very generous deal for itself. A 10 to 12 percent return on the capital, which recall were in a close to zero percent interest rate environment. Plus warrants for 79.9 percent of the common stock. And so this was a great deal for the taxpayers, and the taxpayers have made tens of billions of dollars under that deal.
Then a couple of years later as the conservatorship went on, the Obama administration, its Treasury Department -- we have a memo that's been made public, and it says that the Obama administration had a commitment to ensure that private shareholders never saw any profits from Fannie Mae or Freddie Mac. And then August of 2012 when the companies were on the precipice of generating huge profits in excess of $100 billion dollars combined and well in excess of the 10 to 12 percent return, the Obama administration swept in and changed the rules. And instead of the 10 to 12 percent return said, "We're going to take all of the profit forever, and we're going to take all of the net worth off the balance sheets of the companies in perpetuity." And to my knowledge, this is the largest expropriation of value in U.S. history. There was $33 billion of junior preferred that was wiped out alone by the net worth sweep. And then there were tens of billions of dollars of common stock value also wiped out. There is, as you can imagine in the face of that sort of regulatory excess and government overreach, there've been a variety of litigation challenges, including under the Administrative Procedures Act, the Takings Clause, and for breach of contract.
But for today, I really want to focus on the constitutionality of the FHFA. And if you look across all the cases that are out there, there are three challenges to the constitutionality of the FHFA and its conduct here.
Number one is an Appointment's Clause challenge. Now, this isn't in the Collins case, so I'm not going to discuss it at any depth. But I did want you to be aware that there is an Appointment's Clause challenge that grows out of the fact that Acting Director DeMarco, who signed the net worth sweep on behalf of the FHFA, had been in acting capacity for three years at the time of the sweep. And the plaintiffs in a case called Bhatti, B-h-a-t-t-i, out in the Eighth Circuit and in a case in the Western District of Michigan called Rop, R-o-p, have put forth the theory that you can't be acting for the full term of an administration. You can't be there for three or four years. Otherwise, that would render the Appointment's Clause a nullity if you could just evade Senate confirmation by putting your whole cabinet in there and in acting capacity. And we point to the Recess Appointment's Clause, which has a two-year time limit, as delineating the bright line. So that's one constitutional challenge.
Another is the non-delegation doctrine. We are told in some of these APA cases that have come out from some of the appellate courts that FHFA has permission to do essentially whatever it wants without any meaningful constraints whatsoever. And if that's true, that's a non-delegation problem. And, again, that's in the Bhatti and the Rop cases.
The third theory is in Bhatti and Rop but it's also in Collins, and it relates to the structural violation of the separation of powers that emanates out of those features of the FHFA that I mentioned at the top of the call.
Now, before I get into the merits of the Fifth Circuit's decision, I want to talk about standing for a moment because I would've thought and hoped that the standing of my client's would've been self-evident. They had a valuable security, and it's been wiped out; its economic value's been wiped out in "toto." But in the Bhatti case in Minnesota, the district court judge held that there was no standing to challenge the constitutionality of the FHFA. And his reasoning was that if he enjoined the net worth sweep, it would simply return the private shareholders to the prior regime, which itself was the fruit of, and the product of, an unconstitutional actor. And he was troubled by, "gee, you're complaining that this agency's unconstitutional, and yet, you're asking me to put you back under a regime that was promulgated by that same agency." To which we responded, number one it's hardly surprising that we challenged that which is within the statute of limitations and that injured us. Under Article III, we can't complain about other regimes that may not have injured us as directly. And number two, if the court wants to unwind everything, that's fine. We'd have hundreds of billions of dollars of capital on the balance sheet of these two companies but for the government intervention and the preferred stock would be worth par value today. So the standing point we think is pretty trivial, and it didn't take the Fifth Circuit very long to find that we had standing.
Now getting to the merits, Judge Willett wrote a truly masterful opinion. He was joined by Judge Haynes. And he focused on the structure of the FHFA, and the fact that is has been set up by Congress to be independent of all three branches of government actually contemplated by the Founders. We look at the Executive Branch, the President cannot fire or remove the director except for cause. Now, it's true, as the government points out, that Humphrey's Executor blessed this sort of for-cause removal, but that was in the context of a multi-member panel with bipartisanship. And here we have neither, and that's important in terms of individual liberty and accountability. In terms of individual liberty, obviously if you have a multi-member panel that is bipartisan, you're going to have compromise, and it'll be much harder to have an out-of-control bureaucrat acting in a tyrannical fashion. If one only needs to think of what would the Supreme Court be like if it just had one member, perhaps Justice Sotomayor?
So having that multi-member protection is important. In addition, there's a five-year term here. So you can have a situation where President Obama appoints the director, Director Watt now, and he's there, it could be for all of President Trump's term. Now, it turns out that Director Watt isn't slated to be there all five years, but that's built into certainly during the first couple of years of President Trump's tenure, he had no influence over the policy of this agency whatsoever without bipartisanship and the multi-member panel.
Now, the government will say, "Well, this isn't the only agency that's like that," and there're a couple of other minor agencies in recent times that have had somewhat similar structures, but one of them was the Office of Special Counsel, which doesn't have any rulemaking authority and is truly executive in nature. And the other is the Social Security Administration, which has a fairly narrow compass and certainly doesn't justify the sort of departure from the structures set up by the Founders. And here, of course, we've got an agency that is regulating trillions of dollars of assets. So it's a very significant structural problem.
Second of all, Judge Willett looked at Congress and the appropriations power. And here, as I noted, the FHFA is totally independent from Congress, in the sense of there is no appropriation; it gets its money from the companies itself; and without the appropriation process, the President cannot veto and appropriation. So it also diminishes the power of the President. And it's a big difference. If you look at the way the CFPB, which has some of these same features and the same appropriation feature, operates when it gets a request from Congress for information, the CFPB at least prior to Director Mulvaney being over there, was pretty cavalier about answering. Why? Because it didn't have to worry about getting funding from Congress. And so it's a very different dynamic in terms of accountability when you have an agency that can fund itself without having to go through the political process.
In addition, Judge Willett pointed to the fact that there's no other agency that really can tell it what to do. There's an oversight board, but it's purely advisory. It has no power whatsoever. Judge Willett could have pointed to the judicial review provision, too, as another fairly extraordinary provision of this law, but he didn't have to. And concluding on pointing to the factors that I've already outlined, he said that this was unconstitutional; it's totally unaccountable. Where would you go to complain about the FHFA director? There's no one you can complain to. And this is totally foreign to the entire conception of government established by the Founders.
Judge Stewart wrote a dissent and really followed the D.C. Circuit's en banc majority in a case called PHH. This whole theory of a multi- -- excuse me, a single director, non-bipartisan, independent agency with for-cause removal protection being a problem, came up first—in the appellate courts anyway—in a case called PHH. Judge Kavanaugh wrote an outstanding majority opinion at the panel, but that was reversed en banc and Judge Stewart basically just followed the reasoning of the D.C. Circuit.
Now, that's on liability. There was also at the end of the opinion a discussion of remedy. What's the remedy for this? And what the court did was it struck down the for-cause removal provision for the director, and respectfully because this opinion really is a masterpiece, we think this feature of it was in error. There is, if we look at the Appointment's Clause in cases like Noel Canning or Lucia where you have an officer who doesn't have power to act constitutionally, the Supreme Court does not hesitate to vacate the action that the officer took. And so, too, here. If we have an agency that is without power to act constitutionally, we submit that the same results should obtain here. And so we think that was in error.
Now, where is the case headed from here? We have filed an en banc petition on the remedial question. We've also filed a petition for rehearing en banc on that statutory APA claim that I mentioned at the top. Basically, we say that the agency did not have the authority to do this because it's supposed to operate the companies in a sound manner, and stripping all their capital off their balance sheet is the opposite of sound. And we also point out that they're supposed to preserve and conserve the assets, and shipping all the assets of the balance sheet, and siphoning them off is word Judge Willett used in dissent, is not persevering and conserving assets.
And so, we've got that petition out there. Will the FHFA cross petition on the constitutional issue, liability? It might. Ultimately, we think this case, and this issue I should say, is headed to the Supreme Court. There is to my knowledge one case challenging the CFPB's conduct in the D.C. Circuit, which is ahead of this case. But that's one in which my understanding as Judge Kavanaugh sat on the panel opinion on a prior duration of it relating to standing, and so presumably, he would have to recuse, making it a bad vehicle at the Supreme Court. And so to our knowledge, this Collins case is the case that is furthest along, and at least on present trajectory, most likely to make it to the Supreme Court first.
In terms of the implications of this decision, I think they're threefold. Number one, in terms of the net worth sweep, if we're right, that remedy it will be vacated. And this is a huge issue for anyone who cares about private property or the rule of law and finds to be distasteful the Obama-era commitment to ensure that private shareholders don't realize any value. In addition, it will have the consequences for the FHFA in terms of can their director be fired by the President and can the President put in someone who is to his liking? And then, finally, it will have significant consequences for the CFPB.
Now, the CFPB is, I would submit, unconstitutional for much the same reasons as the FHFA. It's true that it's maybe not quite as bad because there's something called the Financial Stability Oversight Council, which has some modest influence over the CFPB. But I don't think that's sufficient to save the CFPB being deemed unconstitutional. So I think it's quite likely that if Collins goes to the Supreme Court first and if the Court strikes down the FHFA, as I believe it should, then the CFPB will likely to be held unconstitutional as well.
So, Micah, let me turn it back over to you and those who are listening for any questions. But that's my take on the case.
Micah Wallen: Wonderful. Thank you so much, David, for those opening remarks. Let's go to audience questions. Not seeing any questions yet, David, was there any remarks you wanted to just add on here while we wait for our first question?
David H. Thompson: Well, I think one of the things that those of us who live inside the Beltway and our interest in these types of things is what would happen if Director Watt were replaced? What would the President do at that point if the mandate issues, for example, and the President has the ability to remove Director Watt even without cause? And one of the noxious provisions of this statute that I didn’t mention is that President Trump does not have the authority to put in whomever he would like as an acting director. His choice would be confined to one of three deputy directors all of whom were appointed by Director Watt, a Democrat. So some people look at the fact that Director Watt will be leaving office no later than January and think that there may be a change at FHFA. There may be, but until someone is confirmed, it won't be someone truly of the President's own choosing.
Micah Wallen: Interesting. And we do have a question lined up now, so without further ado, let's go to our first question.
Mike Daugherty [sp]: Hi. Thanks for taking my call. This is Mike Daugherty. I've got a question about this whole concept of excessive insulation from the Executive Branch versus what is not excessive insulation? And is it totally relying on the fact that they just don’t get their money from Congress at all? Because obviously, I think the American public senses something's wrong, although the administrative state's been kind of growing now for a century, and we're wordsmithing with words like "excessively insulated." So I was wondering if you could address that and how they're defining these things.
David H. Thompson: Sure. And you make a good point because particularly here where you've got this confluence of different factors. As I mentioned, you've got the for-cause removal protection, you've got the lack of funding, you've got some constraints on what the judiciary can do. This case, I would submit, is an easy case because it is so insulated and so unaccountable. But where is that line? And that's something the Court would presumably have to grapple with down the line.
I think the best reading of Judge Kavanaugh's decision, and perhaps Judge Willett's as well, is that the provision that they have found to be most problematic, and we see this in the remedy that Judge Willett fashioned, is that for-cause removal protection; the fact that the President is unable to put someone in charge of this agency who shares his policies, his values, and it might be for five years as well. It could be during the entirety of the President's term. And that there's no bipartisanship requirement. It's a single member. So he doesn't have any voice. So I think this is a pretty easy case. But your question is a good one that when you're dealing with concepts like "excessive insulation," drawing the line down the next one may be a little bit harder.
Micah Wallen: And, actually, I had another question kind of going off of what you were going through earlier with how the President would have to choose amongst the three deputies. Is there much difference between the three deputies currently on there? Is there a preference? And are there any limits on which one of those that he would pick?
David H. Thompson: Well, and I don't know who the three deputies are, so from a policy perspective, I don't know what the difference is, if any, they might have. But what I do know is they were selected by Director Watt. And just from a constitutional perspective, wholly apart from them as individuals, it's problematic to have someone of one party—in this case, a Democrat—appointing three people who presumably share his policy preferences, democratic policy preferences. And now you've got a Republican president who's being told, oh sure, you can put someone in in an acting capacity, but it has to be a Democrat or a democratically appointed person, someone appointed by a Democrat. I don't know what the politics of these three individuals are, but that's really beside the point. It's a structural point that this is a significant handcuff on the President, and just yet another way that makes this agency quite noxious.
And I think it's also important just to emphasize that we all get somewhat inured by the overreach of these administrative agencies, but this really is new and different and worse than what we've seen before, both at the CFPB and the FHFA.
Micah Wallen: Thank you so much. Not seeing any more questions lined up, I'm sure it's due to the comprehensive nature and the detailed nature of your opening remarks. Did you want to take any additional time for some closing remarks?
David H. Thompson: Well, just to say that I think these cases are significant. This is, as I mentioned, the largest expropriation of value in U.S. history that I know of. And so, it's really important for the rule of law, and I think for our capital markets and just private property, that this not be allowed to stand. And I remain confident that the courts will invalidate the net worth sweep.
Micah Wallen: Well, thank you so much. And on behalf of The Federalist Society, I want to thank our expert for the benefit of his valuable time and expertise today. We welcome listener feedback by email at firstname.lastname@example.org. Thank you all for joining us. We are adjourned.
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