Letter to Readers

Welcome to the inaugural edition of Mayer Brown's Fair Lending Newsletter. Our goal in publishing this newsletter is to provide you with a quarterly resource covering the most notable fair-lending developments of the past three months. In this edition, we cover various topics, from the current state of fair lending at federal government agencies to recent regulatory developments affecting banks and other consumer financial services companies.

It's no secret that fair lending enforcement under the leadership of CFPB Director Kathleen Kraninger (and that of her predecessor, Acting Director Mick Mulvaney) has dwindled to near non-existence. Its specialized fair lending unit has been reorganized under a division that focuses on advocacy and education. In the time since former Director Richard Cordray left the Bureau nearly three years ago, the Bureau has filed only one discrimination-related lawsuit against a mortgage lender, and one enforcement action against a mortgage lender for submitting mortgage-loan data that contained errors in the reporting of race, ethnicity and gender information. The ten other federal agencies charged with administrative enforcement of the Equal Credit Opportunity Act similarly have stalled enforcement under the current presidential administration. In stark contrast to prior years, these agencies combined have made only a handful of fair-lending referrals to the Department of Justice under the current administration. Fair Housing Act enforcement likewise is down from prior years.

COVID-19 has overshadowed just about everything in the past six months, and federal and state offices and agencies will be paying close attention to how financial institutions are serving their customers during the pandemic, particularly as consumers experience financial distress. Despite this undercurrent, however, we have seen a number of fair lending developments over the past few months. Notwithstanding the dearth of publicly announced fair-lending enforcement actions, for example, the CFPB and other federal enforcement agencies are continuing to examine supervised institutions and are citing them for fair-lending violations through the non-public supervisory process. Violations cited include allegations of so-called "redlining," such as by discouraging consumers from applying for mortgage loans based on their race and making fewer mortgage loans in predominantly minority areas than peer lenders.

One of the most notable developments of this year is the Department of Housing and Urban Development's finalization of its disparate impact rule, revising the burden-shifting framework for determining whether a given practice has an unjustified discriminatory effect in violation of the Fair Housing Act to better align with the Supreme Court's 2015 decision in Inclusive Communities. Reliance on the disparate-impact theory of liability was commonplace under the Obama administration, but largely avoided under the Trump administration. We can be sure that if there is a change in administration after the November election, disparate impact will make a comeback. Indeed, if Mr. Biden wins the presidency, we can expect to see a seismic shift in fair lending and fair housing priorities—not only would a new administration likely install a new CFPB Director immediately, but the Biden campaign also is pledging to end redlining and other discriminatory practices by enacting legislation to protect homeowners from abusive lenders, reverse HUD's disparate impact rule, and expand the Community Reinvestment Act to apply to non-bank mortgage and insurance companies, among other things. And even if the administration does not change, we may still see an uptick in fair lending activities, given the Bureau's recent redlining lawsuit against a non-bank lender, its issuance of a Request for Information on ten fair lending topics, and Director Kraninger's recent public statements about the Bureau's focus on ensuring that companies treat consumers fairly.

We hope you will enjoy reading the inaugural edition of our Fair Lending Newsletter and future editions to come.

Fair Lending Considerations in a Time of COVID-19

As the effects of the COVID-19 pandemic continue to significantly impact daily life and the US economy, government agencies have emphasized the need for lenders to continue to comply with fair lending laws. Lenders face a number of new challenges due to the pandemic, including limited access to consumer financial data, increased requests for accommodations and modifications, and various new legal and regulatory requirements and programs (e.g., the Coronavirus Aid, Relief, and Economic Security Act (CARES Act)). Despite these challenges, regulators have emphasized the importance of continuing to comply with fair lending laws. Failure to do so could negatively impact actual and potential borrowers and expose financial institutions to compliance risk.

The Federal Financial Institutions Examination Council (FFIEC) is made up of the federal financial institution regulators (the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve (Federal Reserve Board or Board), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), and the Consumer Financial Protection Bureau (CFPB or Bureau)). The FFIEC issued a statement in early August providing guidance on how financial institutions should proceed as government-mandated and voluntary loan accommodation periods begin to end. In particular, the FFIEC encouraged financial institutions to provide clear, accurate, and timely information to borrowers regarding additional accommodation options before the end of their current accommodation periods, so that institutions and borrowers have ample time to work out affordable, sustainable solutions for consumers. In addition, financial institutions should ensure their policies and procedures reflect the available accommodation options and promote consistency with fair lending laws and regulations. The FFIEC also advised financial institutions to provide appropriate training to employees regarding additional accommodation policies, as well as ensure that staff are qualified and can efficiently handle expected workloads. The FFIEC also stressed the importance of testing by internal control functions to ensure that additional accommodation options offered to borrowers are presented and processed in a fair and consistent manner and are in compliance with fair lending laws and regulations. Communications with borrowers, as well as legal documentation, should be clear, accurate, timely, and in accordance with contractual terms, policy guidelines, and applicable laws and regulations.

The CFPB similarly released a statement stressing the importance of complying with fair lending laws during the COVID-19 pandemic, particularly because the small, minority-owned, and women-owned businesses that fair lending laws are designed to protect have suffered significant negative impacts due to the pandemic. In particular, the CFPB noted several warning signs of discriminatory lending that could arise as financial institutions provide loans and debt relief under the Paycheck Protection Program established by the CARES Act:

  • refusing available loans or workout options even though the borrower qualifies based on the advertised requirements;
  • offering credit or workout options at higher rates or worse terms than the borrower applied for, even though the borrower qualified for the better terms;
  • discouraging borrowers from applying for credit because of a protected characteristic;
  • denying credit without providing the borrower with a reason or a method to find out the reason; and
  • making negative comments about protected characteristics.

Notably, although regulators have eased certain regulatory requirements during the COVID-19 pandemic and have indicated that they will take into account good-faith efforts by institutions designed to assist consumers, regulators also have re-emphasized the importance of compliance with fair lending laws during the pandemic. Accordingly, despite the numerous challenges for financial institutions during the pandemic, lenders must continue to vigilantly consider applicable fair lending risks, implications, and risk mitigation strategies.

HUD Finalizes Disparate Impact Rule

The disparate impact theory of liability arguably has been the most controversial aspect of fair lending jurisprudence in the last decade. Over Labor Day weekend, the US Department of Housing and Urban Development (HUD) finalized its revised Disparate Impact Rule (Final Rule) which, unsurprisingly, also has been the subject of significant controversy.

HUD's Final Rule revises the Department's previous rule on this topic to align with the Supreme Court's 2015 decision in Texas Dept. of Housing and Community Affairs v. Inclusive Communities Project, Inc. (Inclusive Communities), a landmark Fair Housing Act case. In Inclusive Communities, the Supreme Court held that disparate impact is a viable theory of liability under the Fair Housing Act, but that "adequate safeguards" must be implemented to protect against "abusive" disparate impact litigation and ensure that "regulated entities are able to make the practical business choices and profit-related decisions that sustain a vibrant and dynamic free-enterprise system."

The Final Rule largely tracks the proposed rule and outlines five elements that a plaintiff must demonstrate at the pleading stage in order to bring a disparate impact claim under the Fair Housing Act. Specifically, a plaintiff must sufficiently plead facts to show that:

  1. The challenged policy or practice is arbitrary, artificial, and unnecessary to achieve a valid interest or legitimate objective such as a practical business, profit, policy consideration, or requirement of law;
  2. The challenged policy or practice has a disproportionately adverse effect on members of a protected class;
  3. There is a robust causal link between the challenged policy or practice and the adverse effect on members of a protected class, meaning that the specific policy or practice is the direct cause of the discriminatory effect;
  4. The alleged disparity caused by the policy or practice is significant; and
  5. There is a direct relation between the injury asserted and the injurious conduct alleged.

Under the Final Rule, a plaintiff must prove each of these elements by a preponderance of the evidence at the pleading stage. A defendant can rebut a plaintiff's allegations that the policy or practice is arbitrary, artificial, and unnecessary by producing evidence to show that the challenged policy or practice advances one or more valid interests. If a defendant is able to make that showing, then the plaintiff must prove that (i) the interest advanced by the defendant either is not valid or (ii) there is a less discriminatory policy or practice that would serve the defendant's identified interest in an equally effective manner without imposing materially greater costs on, or creating other material burdens for, the defendant.

The most significant change to the Final Rule was the removal of specific defenses to disparate impact claims for models and algorithms. This section of the proposed rule drew significant criticism from consumer advocacy groups, which argued that it improperly focused on whether a model's inputs included prohibited bases or proxies for prohibited bases, rather than focusing on the outputs of a model. HUD ultimately removed this section from the Final Rule, stating that it was premature to explicitly address defenses to claims involving models and algorithms at this time, as it expects further developments in the law in the areas of algorithms, machine learning, and artificial intelligence.

Although HUD removed the model defenses from the text of the Final Rule itself, the Rule's preamble provides some guidance regarding how defendants may justify and defend predictive models. According to HUD, a defendant can defend against a disparate impact claim based on a predictive model by showing that the model accurately assessed risk (which is a valid interest), and by demonstrating that the model is accurate by showing that it is not overly restrictive on members of a protected class. For example, if a plaintiff alleges that a lender rejects members of a protected class at higher rates than non-members, then the logical conclusion of such claim would be that members of the protected class who were approved (having been required to meet an unnecessarily restrictive standard) would default at a lower rate than individuals outside the protected class. Therefore, according to HUD, if the defendant demonstrates that a default risk assessment model leads to fewer loans being made to members of a protected class, but similar members of the protected class who did receive loans actually default more or just as often as similarly situated individuals outside the protected class, then the defendant could show that the predictive model was not overly restrictive. HUD indicates that it considers this to be an alternative to the model defenses that were laid out in the proposed rule.

Another notable aspect of the Final Rule is that it establishes a policy against the imposition of civil money penalties in administrative proceedings brought by the Department. HUD indicates that remedies in disparate impact cases should be focused on eliminating or reforming the discriminatory practice so as to eliminate disparities between persons in a particular protected class and other persons. The Final Rule provides that HUD will only seek equitable remedies in administrative proceedings involving disparate impact claims unless the defendant has been previously adjudged to have committed intentional discrimination in the last five years. Although this provision of the Final Rule does not foreclose the possibility of punitive damages in disparate impact litigation (as provided for in the Fair Housing Act), it clearly sets forth HUD's prioritization of equitable remedies in disparate impact cases.

Overall, the Final Rule arguably makes it more difficult for plaintiffs to bring disparate impact claims under the Fair Housing Act and provides defendants with enhanced safeguards for defending against such claims. HUD's Final Rule also reiterates what the Supreme Court has already declared—statistics alone are insufficient to prove a violation of the Fair Housing Act.

The Final Rule has been met with strong criticism from consumer advocacy groups and certain members of Congress. Nevertheless, it becomes effective on October 26, 2020, and will be the governing framework for evaluating disparate impact claims under the Fair Housing Act. Now that HUD has finalized its framework for evaluating disparate impact claims under the Fair Housing Act, all eyes are on the CFPB to see if it will adopt the same framework for disparate impact claims under the Equal Credit Opportunity Act (ECOA). Even though the Bureau has issued an RFI requesting feedback on the disparate impact framework under ECOA, it is unlikely that there will be any further movement from the Bureau on this issue before the November election.

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.