The political jousting over the structure and leadership of the Consumer Financial Protection Bureau continues, but the real work of the agency and its professionals has begun. That work will ultimately determine, among other things, whether the CFPB will be a rules-based or enforcement-based agency.
Financial institutions are accustomed to the rules-based culture of the federal banking agencies, where the first option is usually the proposal and adoption of a regulation. Once a rule is adopted, it may of course be followed by enforcement where violations occur.
In enforcement-based agencies, rules may not be the first option, and targeted enforcement actions may be relied on to create de facto rules. The differences between these approaches are sometimes quite nuanced, and both methods of creating public policy may be equally effective. But they are not always equivalent in the eyes of the businesses they may impact. Indeed, which methodology becomes dominant is critical to determining how companies interact with an agency.
The creation of regulations require formal administrative rulemaking, which includes public comment before a rule can be finalized and carry the force and effect of law. The Administrative Procedure Act ensures that this is not a hollow exercise by holding agencies to strict standards by which they must analyze and evaluate the public input that they receive, and explain their final positions in a statement of basis and purpose, also known as the "preamble," which accompanies the final regulation. The final regulation is then subject to challenge in federal court under standards established by the APA. Such a challenge may be brought by a wide array of parties, including trade associations, which may have federal standing on behalf of their members.
Alternatively, federal agencies create de facto standards of conduct through the initiation of formal enforcement or litigation actions. Those actions need not necessarily be based upon rules that have previously been articulated or publicly aired. Such enforcement actions are also subject to challenge in federal court, but mounting such challenges can be a more complex problem for several reasons: the continuing reputational impact they may have on the financial institution involved, the higher legal hurdles that must be met to set aside formal enforcement and litigation actions, and the fact that only the financial institution that is the target of the enforcement action may challenge it. As a result, most enforcement actions are settled before a court ever gets to decide the issue, in effect establishing the agency’s view of the law as the standard.
The Department of Justice's approach to fair lending cases during the 1990s, though not a perfect example of this form of de facto regulation, illustrates the potential impact of creating policy through enforcement or litigation. In those cases, all of which ended in settlements as opposed to judicial decisions, the DOJ was able to establish how the concepts of "disparate impact" and "disparate treatment" should apply to loan approvals, pricing and marketing, though they had never been defined in a regulation. Moreover, the financial institutions whose conduct was challenged by the DOJ typically chose in all cases to settle them to avoid, among other things, the reputational harm that could arise from a protracted suit by the government for alleged discriminatory practices.
As a result, the theories of the law relied upon by the DOJ, though never upheld by a court, effectively became the law. Anti-money laundering and bank secrecy act cases have generally also been settled over the last decade, and the impact is similar — standards have been created without the give and take of a rulemaking process or the affirmation of a court.