Temperature Rising: Fair Lending Law Gets Hotter, Puts New Focus on Disparate Impact Doctrine

Posted on 01-02-2014 by
Tags: Real Law

Brought to you by the Real Law Editorial Team

The School of the Seven Bells is a fabled academy for pickpockets and thieves that supposedly exists somewhere in Colombia. The mysterious educational institution gets its name from the final exam its students must pass. In that test, the instructor’s clothing is booby-trapped with seven strategically placed small bells. The students must slip valuables from the instructor’s pockets without allowing any of the bells to ring.

The story often changes, but whatever the truth—if there is any—the legend of such an academy for advancing the fine art of petty larceny refuses to die.

Perhaps that’s because pickpocketing itself has a rich and colorful history. As entertainment, the art can be both astounding and at times downright hilarious. It is less so when it is conducted with more serious intent. In such circumstances, law enforcement officials naturally take a dim view of the activity.

So, too, do some federal agencies when they liken certain discriminatory practices to “silent pickpocketing.” They are referring to actions—intentional or otherwise—that unlawfully price out or deny segments of society from fair access to credit markets.

Those agencies are now intensifying their efforts to stamp out such practices. Fair lending law is heating up, and with that a fresh debate concerning the “disparate impact” classification of discrimination has been ignited.

The Shape of Things to Come

What’s happening now has been in the making for several years. When President Obama took office in 2009, for example, his administration inherited a financial crisis that disproportionately affected minorities. And while there are increasing signs of a recovery from the Great Recession, years of economic progress have vanished for many African Americans and Hispanics in particular, and home ownership remains largely out of reach. That has put new energy into efforts to ensure that the economic turnaround is more inclusive.

Another factor is the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which was passed by Congress in 2010. It brought about the creation of the Consumer Financial Protection Bureau (CFPB), which has since joined other federal agencies in supervising fair lending practices. In view of the CFPB’s broad mandate, lenders will need to be more vigilant than ever in their compliance with a wide range of anti-discrimination laws and regulations.

“The CFPB’s work in the area of fair lending is a priority and has only just begun,” the agency declared in its first report on the subject to Congress in December 2012. In a statement accompanying the report, Patrice Alexander Ficklin, the CFPB’s Assistant Director for Fair Lending and Equal Opportunity, said she will provide a “fresh look at ways that a federal agency with fair lending supervisory, enforcement and rule-making responsibilities can ensure compliance with the federal fair lending laws, while also promoting access to responsible credit for underserved markets and consumers.”

Such remarks alarmed the financial industry at the time, and while the agency has since worked hard to be cordial in its dealings with lending institutions it has also shown a firm resolve to make good on its promise to protect consumers by various means at its disposal.

In Hot Pursuit

One way the CFPB has put lenders on notice is by signaling that it intends to play hardball when it comes to Home Mortgage Disclosure Act (HMDA) data integrity. To prove the point, it has conducted reviews at dozens of mortgage companies and released consent orders with civil penalties for significant data errors.

The CFPB has also moved aggressively to put its stamp on auto financing. “Consumers should not have to pay more for a car loan simply based on their race,” said CFPB Director Richard Cordray in a media release accompanying the issuance of a March 2013 bulletin intended to clarify the agency’s “authority to pursue auto lenders whose policies harm consumers through unlawful discrimination.”

The bulletin provided guidance for indirect auto lenders on ways to limit fair lending risk, while reminding its readers that the Equal Credit Opportunity Act makes it illegal for a creditor to discriminate in any way, including based on race, color, religion, national origin, sex, marital status and age.

With that in mind, the CFPB recommended that indirect auto lenders should “take steps to ensure that they are operating in compliance with fair lending laws as applied to dealer markup and compensation policies.”

Other Factors in Play

Of course, that’s not the only news in fair lending law. A set of sweeping new CFPB rules stemming from Dodd-Frank are expected to fundamentally alter how the U.S. mortgage industry functions. From a high level, the new rules implement various Dodd-Frank sections and amend several existing regulations, including Regulations Z, X and B, which implement the Truth in Lending Act, Real Estate Settlement Procedures Act and Equal Credit Opportunity Act, respectively.

The Ability-to-Repay (ATR) and Qualified Mortgage (QM) Standards Rule has garnered the most attention. It is intended to protect consumers from “irresponsible” mortgage lending by requiring that lenders follow strict procedures for determining that prospective borrowers can actually repay their loans. “We believe it is critical to move forward so these rules can deliver the new protections intended for consumers,” Director Cordray has remarked repeatedly.

That message concerns many in the mortgage industry who say that the new rules will require additional effort and resources to ensure compliance. There’s also a worry that the ATR/QM rule could expose financial institutions to greater risk of federal scrutiny under the disparate impact doctrine that, along with overt and comparative disparate treatment, is fundamental to anti-discrimination laws.

Specifically, lenders are concerned that a facially neutral policy (e.g., issuing Qualified Mortgages only) could be perceived to have a disproportionately negative effect on a protected class. That fear prompted federal bank regulatory agencies and the CFPB to issue an Interagency Statement on Fair Lending Compliance on October 22, 2013. In it, the agencies outlined some principles that will guide supervision and enforcement, while indicating that a lender’s decision to originate only Qualified Mortgages would not elevate the institution’s fair-lending risk, “absent any other factors.”

Still, the unease persists. Mortgage applicants in protected classes will disproportionately fail to meet ATR/QM requirements, given the current home ownership landscape. Also, while the regulatory agencies have weighed in on the matter with general and specific guidance, there remains the potential for private litigation based on disparate impact theory.

Silver Linings for Some

Indeed, such litigation has already occurred. The result so far is that the disparate impact doctrine remains intact, but that’s largely by default. Two cases that might have settled whether disparate impact should apply under the Fair Housing Act (FHA), for example, were settled shortly before they were to be argued before the Supreme Court, thereby sparing the government potentially risky showdowns over the doctrine’s legitimacy.

The court had agreed to consider the issue in Magner v. Gallagher, a test of disparate impact involving the city of St. Paul, Minnesota. However, that opportunity was scuttled when the city dropped its appeal at the urging of the Justice Department. That bought the federal government some time—and also some unwanted controversy. As head of the DOJ’s Civil Rights Division, current Labor Secretary Thomas Perez reportedly arranged a deal under which St. Paul withdrew its appeal and the Department agreed not to pursue a fraud suit against the city.

More recently, the Supreme Court agreed to hear Township of Mount Holly v. Mt. Holly Gardens Citizens in Action, in which a group of residents of Mount Holly, New Jersey, argued that redevelopment efforts by the city had a disparate impact on an area’s predominantly African American and Hispanic populations. But that, too, was settled shortly before the case was to be heard, thus delaying a debate about whether such claims could be brought under the FHA. Moreover, questions were raised about the source of funding used to settle the dispute.

In both instances, critics—who, feeling suddenly deprived, might have easily invoked pickpocket analogies of their own—questioned federal involvement in derailing the cases.

Whether there is anything to such accusations, the fact remains that the cases were not heard. However, there might still be an opportunity to test the disparate impact theory in court.

The American Insurance Association and the National Association of Mutual Insurance Companies—organizations whose members sell homeowners insurance—have filed a lawsuit in the U.S. District Court for the District of Columbia in which they are challenging the Department of Housing and Urban Development’s February 2013 final rule formalizing the use of disparate impact under the FHA. The associations are seeking to invalidate the rule on the grounds that the FHA prohibits only intentional discrimination. It’s not yet known when the case will be heard.

In the meantime, the federal crackdown on discriminatory practices goes on, and disparate impact is often invoked in lawsuits against banks and other institutions. Those suits are paying handsome dividends, too. For example, Bank of America Corp., Wells Fargo & Co. and SunTrust Banks Inc. are just a few prominent institutions that have agreed to pay at least $480 million to settle claims since 2011, the non-profit news organization ProPublica has reported.

Without a doubt, fair lending law is getting hotter. The good news? According to The Wall Street Journal, top in-house lawyers will likely benefit, as general counsels play an increasingly key role in helping organizations navigate a multitude of new regulations and other legal challenges.

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