InfoBytes Blog
Filter
Subscribe to our InfoBytes Blog weekly newsletter and other publications for news affecting the financial services industry.
CFPB's Summer Edition of Supervisory Highlights Discloses Issues across Various Financial Markets
On June 30, the CFPB released its twelfth edition of Supervisory Highlights providing supervisory observations from its examiners in the areas of auto origination, debt collection, mortgage origination, small-dollar lending, and fair lending. In the area of auto origination, examiners determined that one or more institutions engaged in deceptive advertising practices related to the benefits of gap coverage products and the effects of payment deferrals, and failed to implement adequate compliance management systems. In the area of debt collection, examiners found that debt sellers sold thousands of debts that were unsuitable for sale because: (i) the accounts were in bankruptcy; (ii) the debts were the product of fraud; or (iii) the accounts had been paid in full. CFPB examiners further observed violations of the Fair Debt Collection Practices Act (FDCPA), determining that at least one collector falsely represented to consumers that a down payment was necessary in order to establish a repayment arrangement, when no such down payment was required by the collectors’ policies and procedures. For mortgage origination, CFPB examiners focused on compliance with provisions of CFPB’s Title XIV rules, the Truth in Lending Act (TILA), as implemented by Regulation Z, and the Real Estate Settlement Procedures Act (RESPA), as implemented by Regulation X, disclosure provisions, and other applicable consumer financial laws. According to the report, CFPB examiners found that one or more institutions violated TILA by miscalculating loan financing amounts, which resulted in a negative finance charge and an amount financed that was greater than the stated loan amount. The report also highlights (i) violations of RESPA’s prohibition against improper referral arrangements; (ii) failure to implement policies and procedures and to provide sufficient training related to the Fair Credit Reporting Act’s requirement to provide consumers with notice of any adverse action, such as denial of credit; (iii) failure to properly disclose interest on interest-only loans in violation of TILA; and (iv) weak oversight of compliance management systems. In the area of small dollar lending, CFPB examiners assessed compliance with the Electronic Fund Transfer Act (Regulation E), and found that the installment loan agreements of one or more entities failed to set out an acceptable range of amounts to be debited because they contained ambiguous or undefined terms in their descriptions of the upper and lower limits of the range. Finally, regarding fair lending, the report covers violations relating to the Home Mortgage Disclosure Act (Regulation C) and the Equal Credit Opportunity Act (Regulation B).
According to the report, the CFPB’s supervisory resolutions from January 2016 through April 2016 resulted in more than 257,000 consumers receiving approximately $24.5 million in restitution.
CFPB and DOJ Take Action Against Bank over Mortgage Lending Practices
On June 29, the CFPB announced a joint action with the DOJ against a regional bank with operations in Memphis, Tennessee for allegedly engaging in discriminatory mortgage lending practices in violation of the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA). According to the CFPB’s and the DOJ’s complaint, between January 1, 2011 and December 31, 2015, the bank (i) engaged in redlining practices in the Memphis area by structuring its business to meet the credit needs of majority-White neighborhoods while ignoring the credit needs of individuals in majority-minority neighborhoods; (ii) discriminated against African American borrowers by allowing its employees to practice discretion in making credit decisions on mortgage loans, which ultimately resulted in African Americans being denied certain mortgages at significantly greater rates than similarly situated white applicants; (iii) charged African Americans, on average, 30 basis points more for first lien and 64 basis points more for second lien mortgage loans than similarly situated white borrowers; and (iv) implemented a policy under which loan officers were advised to deny minority applicants more quickly than other applicants and to deny credit assistance to “borderline” applicants. The complaint further alleges that a series of matched-pair tests at Memphis branches “revealed that the Bank treated African American testers less favorably than similarly situated white testers.”
Subject to approval, the proposed consent order would require the bank to take several remedial actions to improve its allegedly discriminatory mortgage lending practices, among which include: (i) allocating $4 million to a loan subsidy program that offers mortgage loans on a more affordable basis to applicants in majority-minority neighborhoods; (ii) spending at least $300,000 on a targeted advertising and outreach campaign that considers the results of a credit needs assessment performed by an independent third-party auditor, advertises the loan subsidy program, and generates mortgage loan applicants from qualified residents in majority-minority neighborhoods; (iii) spending $500,000 on local partnerships that provide education, credit repair, and other assistance in majority-minority neighborhoods; (iv) opening an additional branch or loan production office in a high-minority neighborhood; (v) extending credit offers to African American consumers who were denied mortgage loans as a result of the bank’s allegedly discriminatory underwriting policy; and (vi) implementing policies that ensure employees provide equal assistance to mortgage loan applicants, regardless of race or other prohibited characteristics. Under the proposed consent order, the bank would pay $2.78 million in consumer redress and a $3 million civil penalty. The CFPB’s proposed consent order notes that the bank has “recently taken a number of steps to improve its compliance management system, reduce its fair lending risk, and increase its lending in minority areas.”
CFPB Report Reviews 2015 Fair Lending Activities and Notes Continuing Priorities
On April 29, the CFPB released its fourth annual report to Congress on fair lending activities. The report recaps the CFPB’s 2015 supervisory and enforcement efforts around fair lending and identifies ongoing priorities in the areas of: (i) mortgage lending, noting a continuing focus on HMDA data integrity and fair lending risks related to redlining, underwriting, and pricing; (ii) indirect auto lending, noting targeted ECOA reviews in examinations; (iii) credit cards, focusing “on the quality of fair lending compliance management systems and on fair lending risks in underwriting, line assignment, and servicing”; and (iv) other product areas including small-business lending, focusing on risks in underwriting, pricing, and redlining, and offering that “current and future small business lending supervisory activity will help expand and enhance the Bureau’s knowledge in this area, including the credit process; existing data collection processes; and the nature, extent, and management of fair lending risk.” The report highlights that “supervisory work on mortgage servicing has included use of the ECOA Baseline Review Modules … to identify potential fair lending risk in mortgage servicing and inform [its] prioritization of mortgage servicers.” In addition to recaps of its 2015 rulemaking, published guidance and efforts at interagency cooperation (including its MOU and sharing of customer complaints with HUD), the report also indicates that the CFPB had a number of authorized enforcement actions in settlement negotiations or pending investigations at year end in areas including mortgage lending, indirect auto lending, and credit cards.
FTC Submits Letter to CFPB Regarding ECOA Enforcement and Education Activities
On February 8, the FTC sent the CFPB a letter summarizing the FTC’s enforcement activities related to compliance with the Equal Credit Opportunity Act (ECOA) and implementing Regulation B during 2015. The annual letter reviews the FTC’s responsibilities with regard to ECOA enforcement and education to most non-bank financial service providers. Highlights of the letter include, but are not limited to, (i) the FTC’s public workshop on the growing use of online lead generation in industries such as lending and education; (ii) the FTC’s Federal Register Notice seeking comments on a proposed survey of consumers regarding their experiences in buying and financing automobiles at dealerships, over which the FTC has broad authority to enforce the FTC Act and ECOA; and (iii) updates to the FTC’s Mortgage Discrimination publication, which includes information about ECOA and warns consumers of illegal practices. Finally, the FTC emphasized that, since 2011, it has brought over 25 cases in the auto purchase and financing industry, “including those in a federal-state effort that yielded more than 200 actions for fraud, deception, and other illegal practices.”
CFPB and DOJ Announce Joint Settlement with Indirect Auto Lender over Alleged ECOA Violations
On February 2, the CFPB and the DOJ announced a joint enforcement action against an indirect auto lender for alleged violations of the Equal Credit Opportunity Act (ECOA) and implementing Regulation B. In April 2013, the CFPB and the DOJ began an investigation into the indirect auto lender’s compliance with the ECOA and found that its policies allowed for dealers to mark up a consumer’s interest rate on the retail installment contract above the established risk-based buy rate, known as “dealer markup.” The dealers received greater compensation from the indirect auto lender on loans with a higher interest rate. The DOJ and the CFPB determined that the respondent’s practice of allowing pricing discretion resulted in qualified African-American/Pacific Islander borrowers paying more than qualified white borrowers. To resolve the DOJ and the CFPB’s allegations, the respondent agreed to (i) reduce the amount by which loans can be marked up to only 1.25% above the established buy rate for auto loans with terms of five years or less, and 1% for loans with longer terms; (ii) pay at least $19.9 million in redress to borrowers affected by its finance practices from January 2011 to February 2, 2016, and up to $2 million more from the date of the action until it implements a new pricing and compensation structure, which must be in place by August 2016; and (iii) hire a settlement administrator to ensure that affected borrowers receive compensation.
These enforcement actions are the fourth in a series of joint CFPB and DOJ actions addressing fair lending risks in the indirect auto lending industry.
House Financial Services Committee: CFPB Removed Safeguards to Achieve Political Goals
On January 20, Republicans on the House Committee on Financial Services issued a report alleging that the CFPB removed a number of safeguards from the claims process after it secured its first settlement with an auto finance company and the company’s subsidiary bank in 2013. The Committee’s most recent report follows a November 2015 report in which the Republican staff (i) criticized the CFPB’s approach for determining discrimination in the auto lending industry; and (ii) questioned the CFPB’s authority to bring claims against banks involved in indirect auto lending under ECOA on a disparate impact theory. According to the more recently published report, the CFPB failed to confirm that funds from the 2013 settlement would be distributed to eligible recipients. Specifically, the report states that when CFPB Director Cordray announced that $80 million would be paid to consumers affected by the auto finance company’s practices, he “did not know the race of a single borrower in any vehicle finance contract purchased by [the company].” The report further comments that, “Bureau officials knew that in order to generate a sufficient number of check recipients, they would have to remove a number of safeguards from the claims process, including confirming the race of claimants alleged to have been discriminated against, thus making it more likely that non-minority consumers would receive remuneration.”
FTC Issues Report on Big Data
On January 6, the FTC published a report titled, “Big Data: A Tool for Inclusion or Exclusion? Understanding the Issues.” The report, which draws from information from a September 2014 FTC workshop, as well as public comments and research, primarily focuses on the final stage in the life cycle of big data use by addressing the commercial use of consumer data and its effect on low-income and underserved populations. According to the report, participants in the 2014 workshop expressed concern that potential inaccuracies and biases from big data may lead companies to “exclude low-income and underserved communities from credit and employment opportunities.” For example, the report states that, “if big data analytics incorrectly predicts that particular consumers are not good candidates for prime credit offers, educational opportunities, or certain lucrative jobs, such educational opportunities, employment, and credit may never be offered to these consumers.” In order to minimize legal and ethical risks, and to avoid possible exclusion and/or discrimination, the report suggests that companies should obtain an understanding of various laws that may apply to their big data practices, including the FCRA, equal opportunity laws, and the FTC Act. The report provides a basic overview of these laws and presents companies with a number of questions to consider when examining whether or not their data practices comply with such laws, including, but not limited to, whether or not a company maintains reasonable security over consumer data, and whether it complies with requirements under the Equal Credit Opportunity Act regarding requests for information and record retention. In addition to these questions, the report advises companies to consider the following four key policy questions: (i) How representative is your data set? (ii) Does your data model account for biases? (iii) How accurate are your predictions based on big data? (iv) Does your reliance on big data raise ethical or fairness concerns? Finally, while the report acknowledges the benefits of big data, such as providing access to credit using non-traditional methods and increasing equal access to employment, the FTC’s report stresses the significance of examining and raising awareness about big data practices that have the potential to adversely impact low-income and underserved populations.
House Report Examines the CFPB's Methodology in Auto Finance Investigations
On November 24, Republicans on the House Committee on Financial Services issued a report regarding the CFPB’s approach for determining discrimination in the auto lending industry. The report questions the CFPB’s proxy methodology and its authority to bring claims against banks involved in indirect auto lending under the Equal Credit Opportunity Act’s (ECOA) disparate impact theory. According to the report, disparate impact “is a controversial legal theory of liability in discrimination cases.” The report further states that, even if it assumes that the ECOA permits disparate impact claims, the CFPB is nonetheless required to identify the following to establish a prima facie case: (i) a specific policy or practice adopted by the creditor; (ii) disparate impact on a prohibited basis; and (iii) a causal relationship between the challenged practice and the alleged disparate impact. The report states, “[d]ocuments obtained by the Committee show that the Bureau will likely have difficulty proving any one of these requirements, much less all three.” Notably, the report criticizes the CFPB’s adoption of the Bayesian Improved Surname Geocoding proxy method, which “combines surname- and geography-based information into a single proxy probability for race and ethnicity,” labeling it as “faulty and unreliable.” The report further suggests that the CFPB observed the method to be “less accurate . . . than some proprietary proxy methods that use nonpublic data.” In closing, the report comments on the CFPB’s “ambition to eliminate dealer markup” by summarizing (i) a December 2013 settlement in which the CFPB used its leverage over a bank holding company to negotiate the settlement terms; (ii) the agency’s plans to increase the number of individual enforcement actions on dealer markup and compensation policies; and (iii) potential ECOA rulemaking to “promulgate a regulation prohibiting lenders from compensating dealers based on the terms of a loan.”
DOJ Announces Mortgage Lending Discrimination Charges Against Massachusetts Bank
On November 30, the DOJ announced the filing of a complaint and proposed consent order against a Massachusetts-based bank alleged to have violated the Fair Housing Act (FHA) and the Equal Credit Opportunity Act (ECOA) by charging African-American and Hispanic borrowers higher prices for home loans than similarly situated white borrowers. From 2011 until at least 2014, the bank allegedly used a “target pricing” mortgage origination policy, assigning loan officers with a Minimum Base Price (MBP) they were expected to achieve on each home loan without regard to the borrower’s creditworthiness. According to the DOJ’s complaint, “African-American and Hispanic borrowers were served disproportionately by loan officers with higher MBPs than the loan officers serving white borrowers.” The complaint further alleges that, from April 2011 through December 2013, the bank authorized loan officers to price a loan higher than their assigned MBP, without documenting the reasons for doing so. Pending court approval, the DOJ’s proposed consent order will require the bank to (i) pay $1,175,000 as compensation to borrowers affected by its practices; (ii) establish a new loan pricing policy and a new loan officer compensation policy; (iii) provide fair lending and fair housing training to loan officers and bank employees; and (iv) establish a monitoring program designed to, at a minimum, assess loan pricing disparities.
In May 2013, the FDIC conducted a consumer compliance examination of the bank and found reason to believe that its lending practices violated the FHA and ECOA, prompting the agency to refer the matter to the DOJ on February 7, 2014.
Special Alert: Disparate Impact Under the Equal Credit Opportunity Act After Inclusive Communities
On June 25, the Supreme Court in Texas Department of Housing and Community Affairs v. Inclusive Communities Project, Inc. held that disparate-impact claims are cognizable under the Fair Housing Act (FHA). The Court, in a 5-4 decision, concluded that the FHA permits disparate-impact claims based on its interpretation of the FHA’s language, the amendment history of the FHA, and the purpose of the FHA.
Applicability to ECOA
When certiorari was granted in Inclusive Communities, senior officials from the CFPB and DOJ made clear that they would continue to enforce the disparate impact theory under the Equal Credit Opportunity Act (ECOA) even if the Supreme Court held that disparate-impact claims were not cognizable under the FHA. It is reasonable to expect that the Court’s decision will embolden the agencies, as well as private litigants, to assert even more aggressively the disparate impact theory under ECOA.
But just as the federal officials had stated that they would continue to assert disparate impact under ECOA if Inclusive Communities invalidated disparate impact under the FHA, lenders still have a number of arguments that the Inclusive Communities Court’s analysis does not apply to ECOA, given the material differences between the text and history of the FHA and ECOA. First, the Court principally based its textual arguments on the use of “otherwise make unavailable” in Section 804 of the FHA—a section that applies to the sale and rental of housing but not to lending. The Court stated that this effects-based language “is of central importance” to its analysis. Although the Court also stated that it had construed statutory language similar to FHA Section 805—which applies to lending—the discussion of Section 805 is so brief as to suggest it was merely an afterthought. The Court repeatedly states its textual analysis focused on the text “otherwise make unavailable.” But ECOA contains no similar effects-based language.
Second, the Court’s analysis of the FHA’s amendment history is inapplicable to ECOA. The Court focused principally on three provisions which it characterized as “exemptions” from disparate-impact liability, and concluded that such exemptions made sense only if Congress were acknowledging the validity of disparate impact claims. But ECOA contains no similar “exemptions” from disparate-impact liability that might otherwise lead to the conclusion disparate impact is cognizable under ECOA.
Finally, while the Court also notes that disparate-impact claims are “consistent with the FHA’s central purpose,” this justification appears merely to support the Court’s textual and historical arguments. The Court has repeatedly cautioned that a statute’s purpose does not trump its text. Whatever similarities may exist between the purpose of the FHA and ECOA, the material textual and historical differences weigh heavily against treating the two statutes the same for disparate-impact purposes.
Burden Shifting Framework
Even if the Inclusive Communities analysis could apply to ECOA, the Court’s emphasis on rigorous application of the three-step burden-shifting framework to analyze disparate impact claims—and protect against “abusive disparate-impact claims” —is likely to impose significant burdens on regulators and plaintiffs seeking to bring disparate impact claims under ECOA. The Court’s articulation of the steps in the burden-shifting framework are materially different—and more friendly to lenders—than those applied by federal agencies (e.g., in HUD’s disparate impact rule). While it is possible that the government and private plaintiffs will argue that the burden shifting framework outlined in Inclusive Communities applies only to the FHA, the Court’s reasoning supports applying the same framework to other civil rights laws—including ECOA.
First, the Court has reaffirmed the significant burden plaintiffs must bear in satisfying the first step of the burden-shifting framework: establishing a prima facie case. The Court noted that a “robust causality requirement” must be satisfied to show that a specific policy caused a statistical disparity to “protect[] defendants from being held liable for racial disparities they did not create.” “[A] disparate-impact claim that relies on a statistical disparity must fail if the plaintiff cannot point to a defendant’s policy or policies causing that disparity.” The Court emphasized that “prompt resolution of these cases [by courts] is important.” This, when taken together with the Court’s decision in Wal-Mart Stores, Inc. v. Dukes, may make maintaining a disparate impact claim under ECOA particularly difficult when addressing such practices as discretionary pricing (e.g., dealer markup in the auto finance context).
Second, with respect to the second step of the framework, the Court explained that “[g]overnmental or private policies are not contrary to the disparate-impact requirement unless they are ‘artificial, arbitrary, and unnecessary barriers.’” The Court noted that this is critical to ensure that defendants “must not be prevented from achieving legitimate objectives.” Specifically, the Court endorsed the importance of considering “practical business choices and profit-related decisions that sustain a vibrant and dynamic free-enterprise system” in determining whether a company’s policy is supported by a legitimate business justification. The Court further explained that “entrepreneurs must be given latitude to consider market factors,” as well as other “objective” and “subjective” factors.
Third, the Court emphasized that before rejecting a “business justification,” a court “must determine that a plaintiff has shown that there is an available alternative practice that has less disparate impact and serves the entity’s legitimate needs.” (internal quotations and alterations omitted). Significantly, and in contrast to previous interpretations by federal agencies, the Court clarified that the plaintiff bears the burden of showing a less discriminatory alternative in the third step of the burden-shifting framework.
The Court cautioned that a rigorous application of the burden-shifting framework is necessary to prevent disparate-impact liability from supplanting nondiscriminatory private choice: “Were standards for proceeding with disparate-impact suits not to incorporate at least the safeguards discussed here, then disparate-impact liability might displace valid governmental and private priorities, rather than solely removing artificial, arbitrary, and unnecessary barriers. And that, in turn, would set our Nation back in its quest to reduce the salience of race in our social and economic system.” (internal citations and alterations omitted).