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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