A federal appeals court is set to hear oral arguments Wednesday in a highly anticipated case that is the first significant challenge to the constitutionality of the Consumer Financial Protection Bureau.

The case, PHH Corp. v. CFPB, is being watched closely because depending on the outcome, it could give President Trump the power to immediately fire Richard Cordray, the agency’s director.

The case has also attracted attention because the Justice Department has switched sides on the case, backing the CFPB under the Obama administration, while joining PHH, a New Jersey mortgage lender and servicer, after President Trump was elected.

CFPB Director Richard Cordray
The court could ultimately decide to avoid the question of whether President Trump can fire CFPB Director Richard Cordray at will. Bloomberg News

While a final ruling is not likely until 2018, the hearing by 10 judges on the court — six appointed by Democrats and four appointed by Republicans — will be the first opportunity to glimpse what they might decide.

Here's what to expect at Wednesday's hearing:

The constitutional question

In February, the U.S. Court of Appeals for the D.C. Circuit asked both sides in the case to weigh in on three questions; two addressed whether the CFPB's single-director structure is consistent with the Constitution.

At issue is language in the Dodd-Frank Act that says a CFPB director can only be fired “for cause.” In October, a three-judge panel for the U.S. Court of Appeals found that the agency was structured without appropriate checks and balances. Its solution was to strike the “for cause” language, allowing the president to fire a CFPB director at will.

But the CFPB argued that decision was in error and successfully appealed for an “en banc” review, allowing all the judges on the Appeals Court to decide the case. (There are 11 judges on the panel, but one, Merrick Garland, has recused himself from the matter.)

The panel has asked PHH and CFPB two questions related to constitutionality: Is the single-director structure consistent with the Constitution and, if not, what is the way to solve that problem? And, can the court decide the case without addressing the question of constitutionality?

If the panel decides that the CFPB’s structure is unconstitutional, the most likely outcome is that it will strike the “for cause” language, rather than taking more drastic action, such as disbanding the agency. Even the Justice Department, which now sides with PHH, has said that striking the language would be a sufficient remedy. Though such a decision could be appealed by the CFPB to the Supreme Court, it would likely give President Trump leeway to fire Cordray immediately.

If the panel rules that the existing structure is constitutional, then it’s up to PHH to appeal the case to the Supreme Court. Until then, however, it would be difficult for a president to fire the CFPB director.

To be sure, the court may avoid the issue of constitutionality altogether, deciding the case on a third issue.

"There is a significant possibility that PHH will not be decided on the constitutionality of the CFPB's structure," said Quyen Truong, a partner at Stroock & Stroock & Lavan and a former CFPB assistant director and deputy general counsel.

The third question

The panel also asked PHH and the CFPB to discuss whether the administrative law judge in the case, Cameron Elliot, who was borrowed from the Securities and Exchange Commission, was able to rule in the case.

In 2014, Elliot ruled that PHH's reinsurance agreements violated the Real Estate Settlement Procedures Act's prohibition on kickbacks in exchange for referrals. He ordered PHH to disgorge more than $6 million. In 2015, Cordray overruled that decision and ordered PHH to pay $109 million, which led PHH to file suit.

But the court is now weighing whether Elliot had the right to rule in the first place. If it decides that he didn’t, the case would be kicked back to the CFPB—and there is no ruling on the constitutionality question.

Some lawyers have suggested such an outcome is a bit absurd, but the court is already concerned about administrative judges and their powers. The judges on the D.C. Circuit are also hearing a related case, Lucia v. SEC, before oral arguments in the PHH case.

What about Respa?

On the surface it appears that issues related to the Real Estate Settlement Procedures Act, known as Respa, have taken a back seat to the constitutional issues in the case.
Yet the mortgage industry is desperate for clarity on Section 8 of Respa, which allows for exemptions for certain fees, and a decision here could have an impact.

The full D.C. Circuit is expected to rehash the underlying Respa issues, focusing on whether it is illegal to give or receive anything of value, and whether each payment constitutes a separate violation, experts said.

PHH has argued that the fees it received represented "bona fide" payments for services performed. The CFPB has alleged that PHH received up to 40% of the insurance premiums that borrowers paid to mortgage insurers, resulting in hundreds of millions of dollars in kickbacks.

"There are people that think the court will rule on the Respa issue in such a way that may render the constitutional issues moot," said James Kim, of counsel at Ballard Spahr and a former CFPB enforcement attorney. "They are going to explore the issue of who has the burden of proof," Kim said.

Cordray also significantly increased the penalty against PHH by claiming that each payment was a separate Respa violation.

"They are going to explore the issue of whether each payment is an independent Respa violation," Kim said. "Of all the arguments, the bureau is on stronger footing because the statute suggests that each payment is a violation."

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