7th Circuit Affirms that Regulation O Could Not Shrink Statutory Exemption for Practice of Law, Vacates CFPB Penalty, Restitution Award

The U.S. Court of Appeals for the Seventh Circuit recently affirmed in part and vacated in part a district court’s decision, largely affirming the portions that invalidated Regulation O’s attempt to narrow a statutory exemption for attorneys practicing law, and vacating the award of some $59 million in relief to the CFPB.

By way of background, following the mortgage crisis, Congress tasked the FTC with regulating for-profit mortgage-assistance relief services (MARS) providers.  The FTC subsequently issued the MARS Rule, which was reissued by the CFPB when regulatory authority was transferred to the CFPB (and is now known as Regulation O).  Regulation O purports to exempt attorneys who 1) provide MARS as part of their practice of law; 2) are licensed to practice law in the state in which their clients reside; and 3) comply with state laws and regulations that govern the same type of conduct as Regulation O.  However, Congress, in the CFPA, stripped the CFPB of the authority to regulate attorneys engaged in the practice of law, recognizing states’ role in regulating attorney conduct.

In 2014, the CFPB brought an action against two law firms and their attorneys (collectively, the Providers) alleging they misrepresented their services, failed to make mandatory disclosures, and collected unlawful advance fees in violation of Regulation O.  The majority of the firms’ loan-modification services were handled by 30-40 non-attorneys, and the fees the firms collected only covered those services.

On the CFPB’s summary judgment motion, the district court invalidated the portions of Regulation O’s exemptions that required attorneys to comply with state laws and regulations because those exemptions were drafted more narrowly than the statutory exemption they purported to implement.  In its post-trial order, however, the district court held that the Providers were not exempt because their services did not amount to the practice of law.  It awarded approximately $22 million in restitution, based on the firms’ net revenues, and $37 million in penalties, based on findings of recklessness and strict liability.

On appeal, the Seventh Circuit affirmed the district court’s decision to invalidate certain provisions of Regulation O that purported to impose conditions or limitations on the attorney exemption.  It also invalidated an additional provision, which purported to require that attorneys be licensed in the state in which their clients resided because it, too, conflicted with the plain statutory language.  The requirement that attorneys be engaged in the practice of law in order for their activities to be exempt from Regulation O was not challenged.  On that issue, the Seventh Circuit found no clear error with the district court’s factual findings that the Providers were not engaged in the practice of law, and the resulting findings of liability.

The Seventh Circuit vacated, however, the district court’s order imposing monetary relief.  With respect to the order of $22 million in restitution entered against the Providers, the court of appeals remanded for recalculation consistent with the U.S. Supreme Court’s recent ruling in Liu v. SEC, 140 S. Ct. 1936 (2020).  In Liu, the Supreme Court held that a disgorgement award could not exceed a firm’s net profits.  On appeal, the CFPB argued that Liu did not apply here because that case dealt with disgorgement.  The Seventh Circuit disagreed, finding that Liu applied to all categories of equitable relief, including restitution, and that restitution and disgorgement were the same for purposes of calculating remedies.  The Seventh Circuit also remanded for recalculation the award of $37 million in penalties that were based in part on the district court’s findings of recklessness, finding that the violations here did not amount to recklessness because the question of whether the Providers had been engaged in the practice of law (which would have exempted them from Regulation O) was legitimate.