SMAARTBank.Compliance Insights

Wells Fargo Sales Incentives Case--Lessons for Directors

Read the Banking Exchange Blog Column about what bank directors should learn from the recent Wells Fargo Sales Incentive Case settlment with regard to assessing compliance risk and making their compliance programs accountable to early Board engagement when an institution's ethics are compromised. 

Posted on Saturday, October 29, 2016 by Registered CommenterWebmaster | Comments Off

Managing Fair Lending Risk After Inclusive Communities (Epilog)

The remand of the underlying controversy in Inclusive Communities has finally been decided by Judge Fitzwater of the Northern District of Texas. Applying the robust causality requirement articulated by Justice Kennedy, the lower Court found that plaintiffs failed to meet the burden of proving a prima facie case and dismissed the complaint.  The District Court took great pains to examine the record against a variety of alleged claims, but found them all wanting.

The District Court Memorandum Opinion emphasizes several points that prior analysis in this series discussed:

1)      Demonstrating a prima facie case is a fundamental obligation of the plaintiff and a key focus for defendants who seek to prevail in disparate impact cases.

2)      Wards Cove remains a viable precedent post-Inclusive Communities for defining the hurdles to be cleared when proving a prima facie case.

3)      The Inclusive Communities robust causality requirement compels plaintiff to identify a specific neutral policy that erects an impermissible barrier to housing opportunity.

Part B of Judge Fitzwater’s Opinion (Slip Opinion p. 16 – 18) also finds that plaintiff’s assertion of discriminatory discretion is not a valid disparate impact claim about a neutral policy, but is instead a disparate treatment claim about the exercise of discretion, not the existence of discretion. As a disparate treatment claim, plaintiff would be obligated to prove intent.

An analysis of the opinion appears on the Nixon Peabody site.

Posted on Tuesday, October 18, 2016 by Registered CommenterWebmaster | Comments Off

Managing Fair Lending Risk After Inclusive Communities (Part III)

Although the Supreme Court’s decision in Inclusive Communities is focused on interpreting the Fair Housing Act, its reasoning turns out to have considerable import for enforcement of the Equal Credit Opportunity Act (ECOA.) ECOA as implemented by Regulation B is expressly tied to the Griggs and Albermarle Paper Company v. Moody line of disparate impact or effects discrimination cases. 12 C.F.R. 1002.6(a): “The legislative history of the Act indicates that the Congress intended an “effects test” concept, as outlined in the employment field by the Supreme Court in the cases of Griggs v. Duke Power Co., 401 U.S. 424 (1971), and Albemarle Paper Co. v. Moody, 422 U.S. 405 (1975), to be applicable to a creditor’s determination of creditworthiness.” Quoted and endorsed by the Consumer Financial Protection Bureau in Bulletin 2012-04.

 A look back at the history of Regulation B provides further support for incorporating subsequent interpretation of the Griggs line of cases to current application of effects discrimination enforcement under ECOA.  As the Federal Reserve Board noted in 1977 when adopting Griggs as the lodestar for effects discrimination in the credit context: “As a judicial doctrine, the effects test is not well suited to regulatory implementation.  In addition, it is, of course, subject to change as it is examined and applied by the courts.” (Emphasis added.) 42 FR 1246 (1-6-77).

Inclusive Communities is such an authoritative application of the Griggs effects test. It puts primary emphasis on the importance of fulfilling the requirements for establishing a prima facie case of disparate impact or effects discrimination.  The Supreme Court underscores that “a statistical disparity must fail if the plaintiff cannot point to a defendant’s policy or policies causing that disparity.” Slip Op. at 20. Inclusive Communities goes on to demonstrate the continued vitality of Wards Cove Packing v. Atonio  490 U.S. 642 (1989) in articulating the requirements of the prima facie case and the significance of those obligations in “protect[ing] defendants from being held liable for racial disparities they did not create.” Slip Op. at 20.

Other necessary elements of a prima facie case in the Griggs, Albermarle and Wards Cove line of authority include plaintiff’s obligation to

  1. Prove that the plaintiff (or adversely affected person) is a member of the prohibited basis group, McDonnell Douglas v. Green 411 U.S. 792, 802 (1973)—a particularly relevant requirement that error-filled proxies would not appear to satisfy;
  2. Demonstrate that the plaintiff qualifies for the credit in question under applicable criteria other than the challenged policy, Id. at 802;  Griggs at 424; and
  3. Conduct its statistical analysis such that the alleged disparity is predicated on a proper comparison between the racial composition of the creditor’s borrowers and the racial composition of the qualified prospective borrowers in the relevant credit market, Wards Cove supra. at 651; Hazelwood School Dist. V. United States 433 U.S. 299, 308 (1977).

Inclusive Communities further emphasizes the importance of the prima facie case as a material hurdle to protect defendants from the deleterious effects of asserting unfounded claims.  “Without adequate safeguards at the prima facie stage, disparate-impact liability might cause race to be used and considered in a pervasive way…. Courts must therefore examine with care whether a plaintiff has made out a prima facie case… and prompt resolution of these cases is important.” Slip Op. at 20. This admonition of prompt resolution and disposal at the prima facie stage by courts should be similarly applicable to supervisory officials.

As important as the prima facie case is, Inclusive Communities also provides significant guidance on the second prong of the disparate-impact test.  As the Supreme Court notes, entrepreneurs must “be allowed to maintain a policy if they can prove it is necessary to achieve a valid interest… [and] must be given latitude to consider market factors… [among] a mix of factors.” After all “were standards for proceeding with disparate-impact suits not to incorporate at least the safeguards discussed [in the majority opinion], then disparate-impact liability might displace valid governmental and private priorities, rather than solely ‘removing … artificial, arbitrary and unnecessary barriers.’” Slip Op. at 19.

In summary, as Regulation B’s history makes clear, enforcement of disparate-impact claims under ECOA is constrained by the development of the Griggs and Albermarle case law as construed by the subsequent pronouncements in Wards Cove and Inclusive Communities. Consequently, agency supervisory and enforcement activities under ECOA should be conducted in a manner accountable to this Supreme Court precedent—“Governmental or private policies are not contrary to the disparate-impact requirement unless they are ‘artificial, arbitrary, and unnecessary barriers.’” Slip Op. at 21.

Posted on Saturday, August 29, 2015 by Registered CommenterWebmaster | Comments Off

Managing Fair Lending Risk After Inclusive Communities (Part II)

In less than a month, the constructive impact of Inclusive Communities is being demonstrated in other litigation. In City of Los Angeles v. Wells Fargo, Judge Otis Wright of the United States District Court for the Central District of California ruled against the City’s claims that Wells Fargo engaged in discriminatory lending by, among other things, making high cost and FHA loans with a statistically disproportionate incidence among minority borrowers.

Judge Wright applied the “cautionary standards” articulated by Justice Kennedy in Inclusive Communities stressing that LA’s “entire disparate impact claim must ‘solely’ seek to remove a policy that is ‘artificial, arbitrary and [an] unnecessary barrier[].’” After applying these standards, the District Court reached the following conclusions:

First, inadequate risk management monitoring practices are not the type of barrier erecting policies that can be said to cause the adverse statistical disparity sought to be redressed by a disparate impact claim.  Indeed were such monitoring of “relevant data” implemented with the purpose “to identify and correct the disproportionate issuance of high cost loans to minority borrowers,” the result, the Court reasoned, would be a “roundabout way of arguing for a racial quota” that “is inapposite to the instructions of the Supreme Court … [which] specifically noted that the disparate impact claims must not force private actors to ‘adopt racial quotas.’”

Second, adherence to government loan program requirements and procedures which in turn “’contributes to the disproportionate issuance of loans to minority borrowers’ … cannot mean that [the lender] created an artificial, arbitrary or unnecessary barrier…. If any disparate impact results from [such] loans, it is a result of federal policy and not [lender] policy.” In other words, the governmental loan program elements that an FHA lender is bound to apply demonstrate an instance alluded to by Justice Kennedy in Inclusive Communities, where [a plaintiff] “cannot show a causal connection between the [lender’s] policy and a disparate impact … because federal law substantially limits the [lender’s] discretion” and, consequently, “should result in dismissal of the case.” (Inclusive Communities, Slip Opinion at p.21.) Accordingly, Judge Wright found that the City had not demonstrated the necessary robust causality required by Inclusive Communities and granted Wells Fargo’s Motion for Summary Judgment.

While Judge Wright’s decision represents one District Court and may face appeal, the analysis it embodies should be incorporated in measured form by lenders evaluating their fair lending compliance programs and assessing the regulatory risk they face for disparate impact Fair Housing Act claims, as well as, the appetite they have for such risk or for defending their programs.  As previously noted in my prior post of Part I, Inclusive Communities provides support for why compliance with CFPB mortgage rules implementing Dodd-Frank Title XIV regarding Ability to Repay and Qualified Mortgages should not place lenders in jeopardy for the “double bind of liability” due to any statistical impact on the lender’s portfolio resulting from such compliance.

Posted on Monday, August 3, 2015 by Registered CommenterWebmaster | Comments Off

Managing Fair Lending Risk after Inclusive Communities (Part I)

The opinions of the Supreme Court Justices in Texas Department of Housing and Community Affairs v. Inclusive Communities Project will be parsed for meanings across a range of subjects from rules of statutory construction, to the state of judicial deference to administrative action, and naturally, the impact on municipal housing policy. For the banking industry, the importance of these opinions will extend beyond the implementation of the disparate impact standard on mortgage credit under the Fair Housing Act (FHA) and include discussion on how instructive the opinions are on the prospects for disparate impact enforcement under the Equal Credit Opportunity Act (ECOA). In this posting, I will focus my comments on what I consider to be the more immediate practical lessons in managing fair lending risk in housing finance.

Highlights from an Initial Reading of Inclusive Communities

First, the Supreme Court’s narrow majority holding that the Fair Housing Act recognizes a disparate impact standard for asserting claims of statutory violation confirms a supervisory status quo that bankers have endured for 21 years.  The April 1994 issuance of the interagency Policy Statement on Discrimination in Lending has long represented a consensus among the banking regulatory agencies, the Justice Department and HUD that discrimination in lending could be proven under both ECOA and FHA using an “effects discrimination” or “disparate impact” standard. No significant challenge to this consensus was seriously considered by the defense bar until Smith v. City of Jackson, 544 U.S. 228 (2005), determined that a statutory foundation for disparate impact liability was a necessary prerequisite to application of the Griggs “effects discrimination” theory to other anti-discrimination laws. See, Griggs v. Duke Power Co., 401 U.S. 424 (1971).

While the majority opinion snuffs out the candle City of Jackson lit, it makes repeated reference in the space of 5 pages to the Griggs direction that a disparate impact challenge only applies to “artificial, arbitrary and unnecessary barriers.” This is strong evidence that Inclusive Communities does not make new disparate impact law, but instead underscores the limit of the theory to the judicial moorings established for the approach 44 years ago—and so regularly emphasized as to earn Justice Kennedy’s description as “the heartland of disparate impact suits.” (Slip Op. at p. 18.)

Second, the majority opinion takes pains to further constrain the ramifications of its holding by stressing the following points: (1) a statistical imbalance is not alone sufficient to prove a prima facie case for disparate impact liability; (2) a robust causal connection between effect and offending policy must be demonstrated by the plaintiff which “protects defendants from being held liable for racial disparities they did not create” (Slip Op. p. 22;)and (3) a valid business or policy purpose rebuts a prima facie case.

Unfortunately, these admonitions are somewhat less reassuring than they appear at first blush. Because the Supreme Court declined to grant certiorari on the question of the appropriate standard of proof for disparate impact claims, one must temper one’s reliance on what are essentially dicta. That said, to the extent these admonitions are well-founded in pre-existing disparate impact precedent (and I believe they are) they lose none of their authority from their repetition here.

It will be difficult to imagine the lower court on remand not being constrained by Justice Kennedy’s admonitions at least as law of the case--including the remarkable endorsement of Judge Jones’ advisory opinion that federal restraint on the latitude of a defendant’s discretion can preclude a plaintiff from establishing the necessary causal connection and merit dismissal of the case. A watchful eye should be trained on final resolution of this case on remand, especially with respect to the lower court’s ability to act promptly as charged by Justice Kennedy.

Third, the HUD rule on disparate impact has not been reviewed by this Court. Whatever lukewarm citation of the HUD rule-making is contained in the majority opinion, it is clear that the Supreme Court—all nine Justices—did not decide the validity of the HUD regulation and did not accord it Chevron deference. Justice Kennedy’s confidence in finding a disparate impact claim cognizable under the FHA takes no comfort from the HUD rule-making.  It is entirely a reading of Congressional intent built upon an inference of legislative incorporation of the judicial creature that disparate impact cum Griggs represents without the intervention of administrative interpretation.

Fourth, most bankers will take little solace from the majority’s almost surprising out-of-context endorsement of private discretion that; “Entrepreneurs must be given latitude to consider market factors.” Other welcome statements such as courts being expected to engage in “prompt resolution” of prima facie case determinations; and avoiding disparate impact liability interpretations “so expansive as to inject racial considerations into every housing decision” are as yet unproven checks on agency supervisory positions, HUD or DOJ prosecutorial discretion, or the creativity of plaintiffs’ bar. The majority’s confidence that judicial intervention is the key to timely market responsiveness is incredible to those constrained by the deliberate pace and leverage of regulatory supervision. The dissenters have a far better appreciation for the legal uncertainties and litigation pressures that compound the compliance risk that Inclusive Communities leaves in its wake for bankers and other lenders to manage.

SMAART Steps to Consider in ADApTing Your Compliance Program to Inclusive Communities

Against this backdrop of lessons drawn from Inclusive Communities what is a banker to do?

First, disparate impact remains a legally difficult standard for plaintiffs to meet, even though it is too often mistakenly invoked by agencies without sufficient proof. Nevertheless, banks are still best advised to lay a solid foundation of fair lending risk management built around SMAART compliance that guards against disparate treatment liability by assuring they treat similarly situated people the same. (See e.g., American Bankers Association Fair Lending Toolbox (2012 and as updated).) This includes where appropriate the use of valid statistical analysis, since such a tool is not limited to disparate impact cases, but is a recognized component of disparate treatment cases as well.

Second, make considered use of the agency guidance contained in the 1994 Policy Statement on Discrimination in Lending regarding the types of neutral mortgage underwriting standards that the agencies recognize as passing muster from a disparate impact business necessity standard. This line of consideration is extended in the 2013 Interagency Statement on Fair Lending Compliance and the Ability-to-Repay and the Qualified Mortgage Standards Rule covering the standards for qualified mortgages in the post-Dodd Frank Act era.  This later issuance should draw a degree of new reliability from the Inclusive Communities’ endorsement of the argument that governmental limits on lender discretion can merit dismissal of disparate impact claims for actions constrained by such limits.

Third, be alert to evolving underwriting and pricing market practices. Today’s legitimate lending purposes may be viewed as less justifiable—and arguably more artificial or arbitrary—if more favorable lending criteria better identify qualified borrowers, especially if they result in a less disproportionately adverse distribution of credit. From an industry perspective such advances in lending underwriting offer more opportunities to extend credit for the benefit of your customers and your communities.

Fourth, large institutions in particular should consider including within your lending compliance risk assessment an up-to-date evaluation of disparate impact liability. This should be built around a complete consideration of the proper three prong test for a valid disparate impact claim against your lending products and practices.  Of course, a true measure of your institution’s risk appetite for lending compliance must also consider the legal uncertainty and supervisory expectations (well founded or unwarranted) that can complicate the best legal assessment of disparate impact risk. Ultimately, your risk appetite should match your bank’s leadership’s willingness to rebut improperly asserted disparate impact claims. If your bank’s senior management and directors are more likely to concede than to contest unfounded regulatory assertions, everyone is better off recognizing that in advance rather than operating with a false confidence.

In summary, a fair reading of Inclusive Communities represents more of a mid-course correction than a change in the destination of fair lending jurisprudence or risk management. Hopefully that is how bank regulators and other law enforcement agencies will apply it in developing supervisory expectations or asserting legal claims. The best spirit of Justice Kennedy’s majority opinion lies in its balance of qualified borrowers being served by legitimate business practices. We hope that his conviction is not misplaced in trusting government agencies to act in accordance with his aspirations that keep the focus on “the heartland of disparate impact suits targeting artificial barriers.”

Posted on Sunday, June 28, 2015 by Registered CommenterWebmaster | Comments Off