Supreme Court Ruling Could Impact Your Bank


disparate-impact-10-16-15.pngOn June 25, 2015, nearly four years after first agreeing to consider the question, the Supreme Court issued a decision in the case Texas Dept. of Housing and Community Affairs v. Inclusive Communities Project, Inc., holding that disparate impact claims may be brought under the Fair Housing Act (FHA). The Court’s decision confirms that, irrespective of intent, an institution engaged in residential real estate-related transactions such as mortgage lending may be held liable for a practice that has an adverse impact on members of a particular racial, religious, or other statutorily protected class.

However, the Court pointed out the following important limitations on the ability of plaintiffs to raise claims:

  • It is not sufficient to point out statistical disparities alone. Instead, plaintiffs must show that a defendant’s policy or policies caused that disparity.
  • Policies may only be challenged under disparate impact analysis if they are “artificial, arbitrary and unnecessary barriers.”
  • A defendant’s valid business justification may not be rejected unless a plaintiff identifies an alternative practice that has less disparate impact while still serving the entity’s legitimate needs.

To receive the benefit of any heightened standard resulting from the Court’s opinion, however, financial institutions must be willing to litigate. To avoid litigation in the first place, experience has shown that proactive steps taken by financial institutions can protect against possible disparate impact claims. Those steps include, for example:

Internal Audits and Fair Lending Risk Analysis
Financial institutions should be proactive in identifying and analyzing lending portfolios to identify areas susceptible to statistical challenge. One of the most reliable methods of doing so is to conduct routine statistical self-assessments on a portfolio-wide basis, appropriately structured to ensure attorney-client privilege will apply. Institutions should conduct periodic assessments, analyze the results (including file reviews of any outliers), and tailor policies and procedures to address the results, thus ensuring the institution is alert to potential disparities and can address any fair-lending related issues before they become supervisory concerns.

Policies and Procedures
Institutions should carefully review their policies and procedures to identify instances in which discretion is permitted in any aspect of underwriting or other credit processes, as discretion may give rise to discriminatory results. To the extent policies and procedures allow for discretion or exceptions, institutions should craft corporate governance mechanisms to approve such exceptions or departures from common practice as well as record keeping procedures to ensure proper documentation. In effect, the financial institution is creating a record of why it departed from its normal business practices. To the extent that the institution considers any changes to its policies and procedures as a result of its review, senior management should articulate the business- or risk-related reasons why such changes were or were not made.

Corporate Governance and Documentation
With increased scrutiny from regulators on fair lending issues, any business decisions that may involve practices that could have a disparate impact on a protected class, such as changing or discontinuing a particular product or service, should be carefully considered and the justifications for them should be clearly documented. Institutions should establish corporate governance procedures that provide for review of material changes to product and services offerings by senior management and fair lending/risk committees. The results of the review, including assessments of the reasons for the business decisions at issue, should be documented through meeting minutes and other records.

The Inclusive Communities decision almost certainly will embolden private plaintiffs and government agencies to assert claims of disparate impact discrimination. Proactive steps taken now can head off years of litigation and costly settlements by preventing statistical disparities from ripening into claims of discrimination. Financial institutions should aggressively review and enhance their compliance efforts to ensure the compliance of their business policies and practices.

Regulatory Punch List of Top Priorities for Bank Directors


8-26-13-Wolters.pngIn today’s banking world, exams are tougher, the supervisory focus is on fairness to consumers, data is heavily scrutinized and consequences for failing to mitigate risks are more severe than ever. It is incumbent upon bank directors to stay in front of high risk areas and make sure their institutions can survive and thrive in this challenging environment. I put together my punch list of some of the top challenges I see facing the industry to provide guidance on where you will want to focus.

Get Serious about Complaint Management
The Consumer Financial Protection Bureau (CFPB) continues to amass an unprecedented public database of complaints against specific financial institutions. The CFPB’s complaint system is informing many of their decisions about whom to examine and how to regulate. In the face of this, banks should strive to improve their own internal complaint systems. You don’t want those complaints going to the bureau. You want them coming to the bank so you can solve them.

Be Extra Vigilant When Choosing and Managing Vendors
Regulators are looking more closely at the way banks choose and manage their vendors and are holding banks responsible for the faults of their vendors. In fact, recent enforcement actions from the CFPB resulted in a combined $101.5 million in fines plus $435 million in restitution for the financial firms based on flaws in the way the banks monitored their vendors. Additionally, the CFPB issued a bulletin in April 2012, with the message that banks are responsible for any faults of the vendors they work with.

Don’t Let the Ease of Social Media Make Things Difficult
In the social channel, which demands quick responses, an outsider may see what he perceives to be a run-of-the-mill consumer complaint and hastily respond in a way that causes more trouble. Be sure to monitor social media activity continually in real time.

Don’t Wait for Clarity from Regulators—Monitor, Test and Correct Fair Lending Issues Now
The recent OCC order that hit a bank for discriminating against white males may have taken some bankers off guard, and moved several to demand more clarity from regulators. But in this enforcement heavy environment, the best option is for banks to heavily monitor, test and correct, when necessary, all of their credit products now.

Solidify a Regulatory Reform Process
In our Regulatory & Risk Management Indicator survey in June, we asked bankers which regulatory concerns keep them up at night, and 46 percent said regulatory reform—referring to new rules stemming from the Dodd-Frank Act and the CFPB. Make sure your bank can address three primary questions relating to compliance programs:

  1. What are the laws and regulations you are subject to across all the jurisdictions in which you operate?
  2. Are you confident you are complying with all of these laws and regulations?
  3. Can you prove it to third parties (e.g., board members, investors, regulators and other stakeholders)?

Leverage Technology to Adjust to Onslaught of New Rules
Once upon a time, when a bank had an enforcement action of a significant deficiency, the first thing senior management used to say was: Where is our chief compliance officer? How did this happen? Now the question is going to be: Where is our chief technology officer? Why didn’t technology come up with the means to implement these changes in a more effective, efficient and compliant way? If technology and compliance aren’t talking to each other, they need to get together.

When it Comes to Auto Lending, Be in the Driver’s Seat
The CFPB is cracking down on interest rate markups that automobile dealers add to the cost of car loans. If they’re done in a discriminatory manner, then the bank is responsible. The CFPB recently released a bulletin that said lenders must enhance their oversight of auto dealers with which they do business after a recent investigation revealed disparities in interest rates charged to minority borrowers versus non-minorities. The bigger-picture problem for banks is that the regulatory scrutiny requires them to monitor the loans being made by all of the auto dealers they work with. That’s sometimes more than 1,000 dealers. The CFPB is hoping that lenders will voluntarily place compensation restrictions on dealers.

Watch out for UDAAP
The Dodd-Frank Act adds an “A” (which stands for abusive) to UDAP—turning the Federal Trade Commission’s provisions into “unfair, deceptive or abusive acts or practices.” A lot of it depends on the consumer’s ability to understand what is being presented to them. The gap between what is presented to customers and how they perceive what they get as well as its value is where the danger appears to lie. From the moment that a deposit or mortgage product or service is developed and the process begins, compliance folks have to have a seat at the table. I recommend that banks perform some testing to be sure the information being conveyed is perceived by the consumer the way it was meant to be. If there is a complaint, and that complaint goes to the bureau, the lender is going to have to be prepared to defend his ability to provide a product that was not unfair, that was not deceptive and certainly was not abusive.

Gear up for New Mortgage Rules
Several new mortgage rules are on their way from the CFPB. Among the new rules is the QM, or qualified mortgage (ability-to-pay) rule, a provision related to high-cost mortgages, a rule impacting loan officer compensation, new servicing standards, an escrow rule about impounding accounts and tax insurance, an appraisal disclosure rule and another appraisal guideline related to high-cost mortgage. Even now that the QM rule is final and going into effect in January, the industry still has to focus on the qualified residential mortgage (risk-retention rule) and its impact on mortgage lending and the secondary market. For much of the industry, setting up systems to comply with QM is a big concern. Also, we still must find out how all these different rules conflict with each other. It will certainly be a challenge.