Alston & Bird Consumer Finance Blog

Supreme Court Decisions

Affirmative Action in Lending: The Implications of the Harvard Decision on Financial Institutions

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Early this summer, the U.S. Supreme Court’s ruling in Students for Fair Admissions v. President and Fellow of Harvard College effectively ended race-conscious admission programs at colleges and universities across the country. Specifically, the Supreme Court held that decisions made “on the basis of race” do nothing more than further “stereotypes that treat individuals as the product of their race, evaluating their thoughts and efforts—their very worth as citizens—according to a criterion barred to the Government by history and the Constitution.”

In particular, the Supreme Court reasoned that “when a university admits students ‘on the basis of race, it engages in the offensive and demeaning assumption that [students] of a particular race, because of their race, think alike.’” Such stereotyping purportedly only causes “continued hurt and injury,” contrary as it is to the “core purpose” of the Equal Protection Clause. Ultimately, the Supreme Court reminded us that “ameliorating societal discrimination does not constitute a compelling interest that justifies race-based state action.”

In the context of lending, federal regulatory agencies expect and encourage financial institutions to explicitly consider race in their lending activities. While the Community Reinvestment Act has required banks to affirmatively consider the needs of low-to-moderate-income neighborhoods, regulatory enforcement actions over the last few years have required both bank and nonbank mortgage lenders to explicitly consider an applicant’s protected characteristics such as race and ethnicity—conduct plainly prohibited by fair lending laws.

Could the impact of the Supreme Court holding extend beyond education to lending and housing? Will the Harvard decision serve to undercut federal regulators’ legal theories for demonstrating redlining and present a challenge for special purpose credit programs that explicitly consider race or other protected characteristics?

Fair Lending Laws Prohibit Consideration of Race

The Equal Credit Opportunity Act (ECOA) prohibits a creditor from discriminating against any applicant, in any aspect of a credit transaction, on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract). Similarly, the Fair Housing Act prohibits discrimination against any person in making available a residential real-estate-related transaction, or in the terms or conditions of such a transaction, because of race, color, religion, sex, handicap, familial status, or national origin.

In March 2022, the Consumer Financial Protection Bureau (CFPB) went as far as to update its Examination Manual to provide that unfair, deceptive, or abusive acts and practices (UDAAPs) “include discrimination” and signaled that the CFPB will examine whether companies are adequately “testing for” discrimination in their advertising, pricing, and other activities. When challenged by various trade organizations, the U.S. District Court for the Eastern District of Texas ruled that the CFPB’s update exceeded the agency’s authority under the Dodd–Frank Act. This decision is limited, however, and enjoins the CFPB from pursuing its theory against those financial institutions that are members of the trade association plaintiffs. It is also unclear if the verdict will be appealed by the CFPB.

Despite federal prohibitions, regulators such as the CFPB and the U.S. Department of Justice (DOJ) expect, and at times even require, lenders to affirmatively target their marketing and lending efforts to certain borrowers and communities based on race and/or ethnicity.

Race-Based Decisions Are Encouraged and Even Required by Regulators

CFPB examiners often ask lenders to describe their affirmative, specialized efforts to target their lending to minority communities. If there have been no such explicit efforts by the institution, the CFPB penalizes these lenders for not explicitly considering race in their marketing and lending decisions. For example, in the CFPB’s redlining complaint against Townstone Financial, the CFPB alleged that “Townstone made no effort to market directly to African-Americans during the relevant period,” and that “Townstone has not specifically targeted any marketing toward African-Americans.”

What’s more, if enforcement culminates in a consent order, the CFPB and DOJ effectively impose race- based action by requiring lenders to fund loan subsidies or discounts that will be offered exclusively to consumers based on the predominant race or ethnicity of their neighborhood. In the CFPB/DOJ settlement with nonbank Trident Mortgage, the lender was required to set aside over $18 million toward offering residents of majority-minority neighborhoods “home mortgage loans on a more affordable basis than otherwise available.”

And in the more recent DOJ settlement with Washington Trust, the consent order required the lender to subsidize only those mortgage loans made to “qualified applicants,” defined in the settlement as consumers who either reside, or apply for a mortgage for a residential property located, in a majority-Black and Hispanic census tract. Such subsidies are a common feature of recent redlining settlements, which have been occurring with increased frequency since the DOJ announced its Combating Redlining Initiative in October 2021.

Not only do the CFPB and DOJ encourage, and in certain cases, even require, race-based lending in potential contravention of fair lending laws, but federal regulators also expect some degree of race-based hiring by lenders. This expectation is based on the stereotypical assumption that lenders need racial and ethnic minorities in their consumer-facing workforce to attract racial and ethnic minority loan applicants. In the Townstone complaint, for example, the CFPB chastised the lender for failing to “employ an African-American loan officer during the relevant period, even though it was aware that hiring a loan officer from a particular racial or ethnic group could increase the number of applications from members of that racial or ethnic group.”

Ultimately, all the recent redlining consent orders announced by the CFPB and DOJ impose at least some race-based requirement, which would seem to run afoul of fair lending laws and Supreme Court precedent.

Racial Quota-Based Metrics Used by Regulators

Further, when assessing whether a lender may have engaged in redlining against a particular racial or ethnic group, the CFPB and DOJ, as a matter of course, employ quota-based metrics to evaluate the “rates” or “percentages” of a lender’s activity in majority-minority geographic areas, specifically majority-minority census tracts (MMCTs). Then the regulators compare such rates or percentages of the lender’s loan applications or originations in MMCTs to those of other lenders. For example, in its complaint against Lakeland Bank, the DOJ focused on the alleged “disparity between the rate of applications generated by Lakeland and the rate generated by its peer lenders from majority-Black and Hispanic areas.” The agency criticized the bank’s “shortfalls in applications from individuals identifying as Black or Hispanic compared to the local demographics and aggregate HMDA averages.”

Undoubtedly, this approach utilizes nothing more than a quota-based metric, which the Supreme Court in Harvard squarely rejected. Indeed, the Supreme Court reasoned that race-based programs amount to little more than determining how “the breakdown of the [incoming] class compares to the prior year in terms of racial identities,” or comparing the racial makeup of the incoming class to the general population, to see whether some proportional goal or benchmark has been reached.

While the goal of meaningful representation and diversity is commendable, the Supreme Court emphasized that “outright racial balancing and quota systems remain patently unconstitutional.” And such a focus on racial quotas means that lenders could attempt to minimize or even eliminate their fair lending risk simply by decreasing their lending in majority-non-Hispanic-White neighborhoods—without ever increasing their loan applications or originations in majority-minority neighborhoods. Of course, this frustrates the essential purpose of ECOA and other fair lending laws.

Potential Constitutional Scrutiny of Race-Based Lending Efforts

If race-based state action, including the use of racial quotas, violates the Equal Protection Clause, it is possible that the race-based lending measures recently encouraged and even required by federal regulators may be constitutionally problematic. In addition to racially targeted loan subsidies and racially motivated loan officer hiring, regulators continue to encourage lenders to implement special purpose credit programs (SPCPs) to meet the credit needs of specific racial or ethnic groups. As the CFPB noted in its advisory opinion, “[b]y permitting the consideration of a prohibited basis such as race, national origin, or sex in connection with a special purpose credit program, Congress protected a broad array of programs ‘specifically designed to prefer members of economically disadvantaged classes’ and ‘to increase access to the credit market by persons previously foreclosed from it.’”

While SPCPs are explicitly permitted by the language of ECOA and its implementing regulation, Regulation B, as an exception to the statute’s mandate against considering a credit applicant’s protected characteristics, it is uncertain whether these provisions, if challenged, would survive constitutional scrutiny by the current Supreme Court.

Takeaways for Lenders

For the time being, lenders that offer SPCPs based on a protected characteristic should ensure that their written plans continue to meet the requirements of Section 1002.8(a)(3). As always, the justifications for lending decisions that could disproportionately affect consumers based on their race, ethnicity, or other protected characteristic should be well documented and justified by legitimate business needs. And if faced with a fair lending investigation or potential enforcement action, lenders should consider presenting to regulators any alternate data findings or conclusions that demonstrate the institution’s record of lending in MMCTs rather than focusing on the rates or percentages of other lenders in the geographic area.

Supreme Court Wrestles with Scope of Attorney-Client Privilege

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A&B Abstract:

On Monday, January 9, 2023, the United States Supreme Court heard argument in a case with potentially major implications for companies and individuals alike. In re Grand Jury asks the Court to give trial courts a definitive standard for determining if dual-purpose client communications containing both legal and nonlegal advice are protected under the attorney-client privilege.

The Case

In re Grand Jury is a unique case.  A person, whose identity is not publicly known, wished to expatriate from the United States and hired a law firm, whose identity is also not publicly known, for advice on how to do so.

The federal government suspected that the unknown individual was engaged in criminal activity, so it convened a grand jury, which subpoenaed records related to the law firm’s work. The law firm produced more than 1,700 documents but withheld others as protected by the attorney-client privilege, which protects communications exchanged between clients and their lawyers for the purpose of seeking legal advice. When the law firm refused to produce the withheld documents, the government moved to compel.

The California district court performed an in camera review of the documents using the “primary-purpose test.”  Under the “primary-purpose” test, a communication is protected by the attorney-client privilege only if the “primary purpose” of the communication is to obtain or give legal advice. If the communication’s primary purpose is non-legal, such as business advice, then the communication is not privileged, even if the communication also conveys legal advice.

Following its review, the California district court ordered the law firm to produce approximately fifty additional documents. The law firm refused to comply with the order, and the district court held it in contempt.

The Ninth Circuit affirmed the lower-court decision, holding the primary purpose of the documents was to provide tax advice.  In doing so, the court declined to adopt the “significant purpose” test of a 2014 opinion by then-Judge Brett Kavanaugh of the D.C. Circuit. Under the “significant purpose” test, a dual-purpose communication may be protected by the attorney-client privilege so long as legal advice represents a significant purpose for the communication, even if not the primary purpose.

In its petition, the unknown law firm asked the Court to cure the circuit split and observed that the approaches of both the Ninth and D.C. Circuits also conflict with the Seventh Circuit, in which a dual-purpose communication is never privileged. The Supreme Court granted certiorari.

Argument

Daniel B. Levin of Munger Tolles & Olson LLP, who argued on behalf of the unnamed firm, initially urged the court to adopt a test along the lines of the D.C. Circuit’s “significant purpose” test. But at oral argument, Levin expanded his definition of the word “significant.” He said if seeking legal advice was a client’s bona fide purpose then the dual-purpose communication should be protected.

Several justices took issue with this argument and Levin received several questions regarding proportionality. In particular, Justices Sotomayor and Jackson focused on Levin’s position that even if nonlegal advice far exceeded the lawyer’s legal advice, the entire communication would be privileged.  They expressed concern that such a sweeping view of privilege would allow sophisticated clients to cloak nearly all of their internal communications with the privilege.

In response to this concern, Levin argued that a primary-purpose test would require courts to disentangle competing purposes and identify the single most important one, which would unnecessarily burden district courts.  Chief Justice Roberts seemingly agreed with this argument and stated that the primary purpose test “really puts a lot of work on the judge.”

Justice Kagan, however, pushed back on this argument by noting that an overwhelming number of lower and state courts have adopted the “primary purpose” test for decades and there has not been an outcry from lower courts stating that the test is impractical or unwieldy. In that vein, Justice Kagan asked why the “ancient legal principle” of “if it ain’t broke, don’t fix it” should not apply. Justices Sotomayor, Barrett, and Jackson seemed to echo the same sentiments through their questions as well.

Masha Hansford argued on behalf of the Government that the “primary-purpose” test is the de facto test in nearly all jurisdictions, district judges have been able to implement the primary-purpose test for decades without issue, and a change to that test would be “destabilizing.”

Hansford faced a series of questions trying to tease out the difference between the words “primary” and “significant,” such as: how does a district judge decide whether legal advice was the primary purpose? In particular, Justice Gorsuch asked to what degree a communication needed to be for a legal purpose for the legal purpose to be primary.  For example, he wanted to know if it had to be 60/40 or 51/49 in favor of a legal purpose, or if it would be sufficient if legal and non-legal purposes were “in equipoise.”

Hansford pushed back and said that “judges don’t do math,” but even if they did, in most cases, district judges have been able to make that determination without too much difficulty. Hansford pointed out that there are very few opinions from district courts decrying the application of the primary purpose test. But the Government did concede that if there were a hard case, where the district judge was truly “stuck” and unable to determine the primary purpose of a communication, then the Government would be fine with a “tie goes for the runner” rule in favor of finding the communication privileged.

Takeaways

The questioning at oral argument indicated that the Justices are wrestling with the standard. We will be on the watch for the opinion to provide guidance across the Circuits.

38 Attorneys General Ask SCOTUS to Determine the CFPB’s Fate

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A&B Abstract:

In November, the Consumer Financial Protection Bureau (“CFPB”) filed a petition for a writ of certiorari in connection with the Fifth Circuit’s recent decision in Community Financial, which held that the CFPB’s funding structure violated the Constitution’s Appropriations Clause. (For a full discussion of the Community Financial decision, click here; for a full discussion of the CFPB’s petition, click here.).

One month later, thirty-eight state attorneys general have joined one of two separate amicus briefs asking the nation’s highest court to weigh in. While both amicus briefs support granting the CFPB’s petition, the similarities end there.

The Amicus Briefs

The first brief, filed by a coalition of twenty-two Democratic attorneys general, argues that the Fifth Circuit’s Community Financial decision created “confusion and regulatory chaos” by “stepp[ing] in to create a conflict between [Congress and the Executive branch] that did not otherwise exist.” Focusing principally on the Fifth Circuit’s decision to vacate the challenged CFPB rule it its entirety, these amici argue that Supreme Court precedent specifically rejects that challenged agency action must be completely undone just because the agency operated with a constitutional defect at the time of the action. Emphasizing the threat that Community Financial poses to many of the CFPB’s actions taken over the last decade, these amici suggest that a “‘judge made remedy’ that aligns with traditional remedial principles would address the specific constitutional defects in the CFPB’s funding” in a more tailored way. They ask that the Supreme Court “grant certiorari and confirm that the absence of valid appropriations does not make void a prior unfunded action.” These attorneys general represent the states of New York, California, Colorado, Connecticut, Delaware, Hawai’i, Illinois, Maine, Maryland, Massachusetts, Michigan, Minnesota, Nevada, New Jersey, New Mexico, North Carolina, Oregon, Pennsylvania, Rhode Island, Washington, Wisconsin, and the District of Columbia.

The second amicus brief, filed by sixteen Republican attorneys general, takes a very different approach. To start, these amici contend that the Court should grant the petition for review not because Community Financial was wrongly decided but because the Fifth Circuit’s ruling should apply nationwide. Referring to the CFPB as a “failed experiment,” these amici stress that the Appropriations Clause “serves a critically necessary purpose by giving States insight into agency action” that must be recognized. And because, in their view, the CFPB has “not convincingly explain[ed]” how the CFPB could act without appropriations, these amici conclude that the Fifth Circuit correctly elected to vacate the CFPB’s action altogether. Applauding the Fifth Circuit’s opinion as “right in every regard,” these amici request that the Court grant certiorari and confirm the Fifth Circuit’s reasoning. These attorneys general represent the states of West Virginia, Alabama, Arkansas, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Montana, Nebraska, Oklahoma, South Carolina, South Dakota, Texas, Utah, and Virginia.

Takeaways

The Fifth Circuit’s decision in Community Financial posed an existential threat to the CFPB. Now, leaders across the nation have asked the Supreme Court to take a side. If the Court accepts this invitation, its ultimate ruling will have important implications on the future of the CFPB.

 

CFPB Petitions High Court to Consider Decision Holding Funding Structure Unconstitutional

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A&B Abstract:

On November 14, 2022, the Consumer Financial Protection Bureau (“CFPB”) filed a petition for a writ of certiorari in connection with the Fifth Circuit’s recent decision in Community Financial, which held that the CFPB’s funding structure violated the Constitution’s Appropriations Clause.  (For a full discussion of the Community Financial decision, click here.)

The CFPB is asking that the Supreme Court set the case for argument this term during its April 2023 sitting.

The CFPB’s Petition

According to the CFPB, the Fifth Circuit’s ruling constituted an “unprecedented and erroneous understanding of the Appropriations Clause.”  In the CFPB’s view, the Appropriations Clause requires only that “Congress enact[] a statute explicitly authorizing . . . [the] use [of] a specified amount of funds from a specified source for specified purposes,” which Congress did in establishing the CFPB’s funding.  For support, the CFPB relied on the constitutional text, historical practice, and the Supreme Court’s precedent.  And it argued that “[n]o other court has ever held that Congress violated the Appropriations Clause by passing a statute authorizing spending.”

The CFPB also asserts that the Fifth Circuit “compounded its error by adopting a sweeping remedial approach that calls into question virtually every action the CFPB has taken in the 12 years since it was created.”  This remedy, the CFPB argues, “raises grave concerns not just for the CFPB and consumers, but for the entire financial industry,” as the vacatur of past CFPB actions could have “destabilizing consequences.”

The CFPB asked the Supreme Court to review the Fifth Circuit’s decision for several reasons.  First, the Fifth Circuit held an Act of Congress violates the Constitution, and there is a strong presumption in favor of granting writs of certiorari to review decisions holding federal statutes unconstitutional.  Second, the Fifth Circuit’s decision conflicts with the D.C. Circuit’s decision on the same issue, creating a circuit split that the Supreme Court should resolve.  Third, the Fifth Circuit’s decision has “immense legal and practical significance” that should be addressed promptly because it “threatens the validity of all past CFPB actions,” which, if unwound, could result in harm to consumers and the “entire financial industry.”

For these reasons, the CFPB asked the Supreme Court to set the case for argument this term.   Given what is at stake, the CFPB explained that it filed its petition “less than one month after the [Fifth Circuit’s] decision,” and “plans to waive the 14-day waiting period after the brief in opposition is filed,” so that the Supreme Court may “consider the petition at its January 6, 2023 conference and hear the case during its April 2023 sitting.”

Takeaways

The CFPB has acknowledged the significant existential threat that the Fifth Circuit’s Community Financial decision poses to its future, and has petitioned the Supreme Court for relief.  Stay tuned for further updates on whether the Supreme Court grants the CFPB’s petition.

CFPB’s SBREFA Outline on Automated Valuation Models Rekindles Debate over Disparate Impact Liability under the ECOA

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Section 1473(q) of the Dodd-Frank Act (now codified at 12 U.S.C. § 3354(q)) amended the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) to instruct the CFPB, Fed, OCC, FDIC, NCUA, and FHFA (collectively, the “agencies”) to jointly develop regulations for quality control standards for automated valuation models (“AVMs”), defined as “any computerized model used by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage secured by a consumer’s principal dwelling.” As part of the rulemaking process, the Small Business Regulatory Enforcement Fairness Act of 1996 (“SBREFA”) requires the CFPB to convene a Small Business Review Panel to consider whether the rule could have a significant economic impact on a substantial number of small entities. Accordingly, on February 23, 2022, the CFPB released an outline of proposals and alternatives under consideration by the agencies to seek informed feedback and recommendations from small businesses likely to be subject to the rule.

As amended, subparts (1) – (4) of FIRREA Section 1125(a) mandate that the agencies establish four specific quality control standards for AVMs. FIRREA Section 1125(a)(5) also affords the agencies discretion to adopt standards designed to “account for any other such factor that the agencies…determine to be appropriate.” As such, the CFPB’s SBREFA outline proposes creating a fifth such discretionary quality control standard “designed to protect against unlawful discrimination.”

In support of its proposal, the CFPB asserts that algorithmic systems such as AVMs are subject to Federal nondiscrimination laws, including the Equal Credit Opportunity Act (“ECOA”), because a lender evaluating an applicant’s collateral could use an AVM “in a way that would treat an applicant differently on a prohibited basis or result in unlawful discrimination against an applicant on a prohibited basis.” The CFPB then notes that it recognizes three different methods of proving discrimination under the ECOA and its implementing regulation (“Regulation B”): (1) overt discrimination; (2) disparate treatment; and (3) disparate impact. It is worth mentioning that overt discrimination has been viewed by federal regulators such as DOJ and the FDIC as a blatant type of disparate treatment that does not require an inference or presumption based on circumstantial evidence. However, it appears that the CFPB considers these theories to be distinct from one another.

The third method of proving discrimination articulated by the CFPB, disparate impact, has been a controversial theory of liability because it imposes liability on a creditor even where the creditor had no intent to discriminate against an applicant. Rather, the theory presumes that the creditor has treated applicants fairly and consistently in accordance with some facially neutral policy or procedure of the creditor. Of course, the disparate impact theory gained traction in the subprime lending cases post-2008 and then loomed large in the CFPB’s enforcement actions against indirect auto lenders, the latter of which were scrutinized by Congress in its decision to rescind the CFPB’s indirect auto lending guidance using the Congressional Review Act. In fact, it remains a legal question whether disparate impact claims are cognizable under the ECOA since the United States Supreme Court (“Supreme Court”) has never considered the issue, though civil rights advocates point to the Supreme Court’s willingness in the 2015 Inclusive Communities case to recognize the theory for discrimination claims brought under the Fair Housing Act (“FHA”).

Thus, should the agencies adopt a final rule that relies upon disparate impact under the ECOA as a legal basis to justify imposing a quality control standard on AVMs (or muddies the waters by relying upon both the ECOA and the FHA without distinction), it is possible that the rule could be challenged under the Administrative Procedures Act as not in accordance with the law. Alternatively, if the CFPB were to bring an enforcement action against a creditor for allegedly violating either the final rule’s quality control standard or ECOA itself on the basis of disparate impact, the creditor could defend itself by arguing among other things that disparate impact claims are not cognizable under the ECOA. Indeed, the ECOA lacks any “results-oriented” language like the “otherwise make available” language of the FHA or the “otherwise adversely affect” language of the Age Discrimination in Employment Act, which the Supreme Court, in decisions issued a decade apart, relied on in recognizing disparate impact liability.

Even if the plain language of the ECOA could not support a disparate impact claim, the CFPB might argue that the statute’s anti-discrimination provision is ambiguous (by asserting, for instance, that the word “discriminate” could be interpreted to encompass both intent-based and effects-based actions), in which case the CFPB may expect the reviewing court to grant its interpretation Chevron deference. See Chevron, U.S.A. v. Natural Resources Defense Council, Inc. 476 U.S. 837 (1984). But this argument also might prove difficult because Chevron deference is appropriate only when it appears that Congress has “delegated authority to the agency generally to make rules carrying the force of law, and … the agency interpretation claiming deference was promulgated in the exercise of such authority.” See Public Citizen, Inc. v. U.S. Dept. of Health and Human Services, 332 F.3d 654, 659 (D.C. Cir. 2003) (quoting U.S. v. Mead Corp., 533 U.S. 218 (2001)). In examining Regulation B, which was originally issued by the Fed and subsequently readopted by the CFPB, the only references to the concept of disparate impact appear in 12 C.F.R. § 1002.6(a) and Official Interpretation 6(a)-2. However, these provisions merely summarize the ECOA’s legislative history and Supreme Court precedent under Title VII of the Civil Rights Act, and even then, acknowledge only that the ECOA “may” prohibit acts that are discriminatory in effect. The CFPB has articulated its belief that disparate impact is cognizable under the ECOA elsewhere, including in a compliance bulletin and its examination manual, but those materials carry no force of law under the CFPB’s own recently-adopted rule. Thus, a reviewing court could conclude that the mere recitation of legislative history and of a judicial doctrine developed under an unrelated statute was not an actual exercise of rulemaking authority under the ECOA, and therefore that the agencies’ interpretation of the ECOA as expressed in Regulation B is not entitled to Chevron deference. In that circumstance, the reviewing court would be free to resolve any purported ambiguity in the ECOA according to its own construction, affording respect to the agencies’ position only to the extent it is persuasive. And should either of these issues – disparate impact under the ECOA or the availability of Chevron deference – ultimately be appealed to the Supreme Court, there may well be four justices willing to grant certiorari to consider them.

The uncertain outcome of any challenge to the CFPB’s use of disparate impact in a rulemaking or in enforcing the ECOA, given the stakes involved, suggests that the CFPB may seek to resolve matters via settlement rather than risking litigation in federal court. However, only time will tell whether the CFPB is spoiling for a fight.