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UPDATE 3-Dueling directors create confusion at U.S. consumer protection agency

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* Mulvaney tells staff to ignore English

* Both signing off as "acting director" (Adds English meeting with Senator Warren, details)

WASHINGTON, Nov 27 (Reuters) - With doughnuts in hand, President Donald Trump's pick to head the U.S. government consumer watchdog agency turned up for work on Monday, challenging the acting appointee of the Obama-era leader in an partisan showdown over how the U.S. financial system should be regulated.

Mick Mulvaney, the White House budget chief, was named acting director of the Consumer Financial Protection Bureau (CFPB) by Trump last week. But Mulvaney, who tried to dismantle the agency when he served in the U.S. House of Representatives, faced a challenge from Leandra English, who had been named temporary head of CFPB by outgoing director Richard Cordray.

Mulvaney and English both issued statements on Monday morning indicating they were in charge of the 1,600-employee CFPB.

The battle over the small agency will lay bare deep divisions between Republicans and Democrats over how tightly to control a banking industry that taxpayers had to bail out to the tune of $700 billion less than a decade ago.

English sent an email in which she welcomed staff back from the Thanksgiving holiday and signed off as "acting director," according to a source.

But Mulvaney quickly installed himself in Cordray's former office and stood his ground, writing in a staff email an hour later:

"Please disregard any instructions you receive from Ms. English in her presumed capacity as Acting Director," he said in a memo seen by Reuters. "If you receive additional communications from her today ... please inform the General Counsel."

Mulvaney also signed off as "acting director" and invited staff to pop by his office on the fourth floor to "grab a donut."

The Republican Trump campaigned for president saying Wall Street "gets away with murder," but at the same time promised to defang or abolish the CFPB, the brainchild of progressive U.S. Senator Elizabeth Warren that was championed by President Barack Obama.

Since taking office, Trump has tried to undo a number of his Democratic predecessor's initiatives, mostly famously the 2010 Affordable Care Act that the Republican-controlled Congress has been unable to repeal and replace.

HARD AT WORK

Mulvaney's communications director tweeted a picture of him hard at work as acting director with the bureaus transition briefing handbook on his desk.

It was not clear if English was in the building. She was due to meet later on Monday with Warren, an aide to the lawmaker said.

As Mulvaney was getting settled in, the source told Reuters, CFPB general counsel Mary McLeod sent a memo to the CFPB's legal division agreeing with the U.S. Justice Department that Trump had the power to appoint Mulvaney as temporary leader of the watchdog.

Late on Sunday, English sued the Trump administration seeking to block Mulvaney's appointment. The move means a federal court will decide which law applies when filling a temporary leadership vacancy at the relatively new agency.

It was not clear when the court would rule.

The CFPB conflict began when Cordray formally resigned from the bureau, which was established in 2011 in the wake of the 2007-2009 financial crisis to protect consumers from predatory and deceptive mortgage and lending practices, and named English, his chief of staff, as temporary director.

Hours later, Trump sought to overrule that move by naming Mulvaney acting director until he can get a permanent successor confirmed by the U.S. Senate, a process that could take months.

The CFPB is hated by Republicans who think it wields too much power and burdens banks and other lenders with unnecessary red tape.

About 20 protesters rallied at CFPB headquarters on Monday morning to demonstrate support for the agency.

Obama appointed Cordray, a Democrat, as the CFPB's first director and he developed a reputation for drafting aggressive rules curbing products such as payday loans while issuing multimillion-dollar fines against large financial institutions such as Wells Fargo.

In a weekend tweet that did not mention specifics, Trump called the agency a "total disaster" that had "devastated" financial institutions. He has pledged to roll back many Obama-era financial regulations.

As acting director, Mulvaney would have the power to make far-reaching decisions on enforcement and supervision of financial firms.

Trump administration officials say the president has the power to appoint an acting director under the 1998 Federal Vacancies Reform Act and McLeod's Nov. 25 memo agreed.

Mulvaney once described the CFPB as a "sad, sick joke" and tried to get rid of it when he was a Republican congressman and English alluded to those views in her lawsuit. She has argued that the 2010 Dodd-Frank Wall Street reform law that created the bureau stipulated that its deputy director would take over on an interim basis when a director departs. While the legal battle rages, the CFPB's enforcement work will be put in limbo.

"Anything that the agency does or fails to do could be subject to challenge until this cloud is removed," said Harvard Law School professor Laurence Tribe.

(Reporting by Patrick Rucker; Additional reporting by Pete Schroeder; Writing by Carmel Crimmins; Editing by Eric Meijer and Bill Trott)