CFPB Eliminates Disparate Impact

YOUR QUESTION 

YouTube

You may have heard about a major change to Regulation B. They eliminated disparate impact. I also learned that they changed a few other areas that were working to reduce discrimination. As an underwriter, I think this is wrong-headed. I think this reduces fair lending protection. 

We met with our lawyer because we have a second review process, which weeds out potential discrimination in our loan process. Our lawyer says there is a shift away from not having to prove intent to discriminate to now having to prove intent. She says that this is a problem because proving intent is extremely difficult. In other words, discrimination is now possible without having to prove intent to discriminate – only the outcome matters. 

So, if I get this right, even if the outcome is discrimination, the company that discriminated won't be held responsible if you can't prove an intent to discriminate. I don't understand why disparate impact protection is being weakened. It’s scary! 

Do the changes to Regulation B basically eliminate disparate impact? 

OUR COMPLIANCE SOLUTION 

Policies and Procedures 

OUR RESPONSE 

I am going to be blunt: the CFPB's April 2026 Final Rule ("Rule") amending Regulation B eliminates the "effects test" – that is, "disparate impact" – of the Equal Credit Opportunity Act (ECOA), while also restricting special-purpose credit programs (SPCPs), and narrowing the definition of "discouragement" of applicants or prospective applicants. This is clearly a significant regulatory shift away from fair lending restrictions. 

However, saying it eliminates disparate impact and fair lending is not accurate. The Rule eliminates disparate impact liability specifically under ECOA and Regulation B. That's significant, but ECOA is only one of several legal frameworks that govern lending discrimination. The Rule does not affect several others that remain fully intact. 

The Fair Housing Act (FHA) still recognizes disparate impact for mortgage lending. The Supreme Court confirmed this in Texas Department of Housing v. Inclusive Communities Project (2015), and the Rule expressly does not touch FHA liability. So a mortgage lender whose policies produce racially skewed outcomes can still face a disparate impact challenge under the FHA, which is a completely separate statute.

State fair lending laws are arguably the bigger remaining protection. Many states – for instance, California, New York, Illinois, and others – have their own anti-discrimination statutes that incorporate disparate impact standards, and federal rulemaking cannot preempt those. State attorneys general were among the most vocal opponents of the Rule precisely because they intend to continue using their own authorities. 

The Department of Justice retains independent enforcement tools. And the Community Reinvestment Act, which addresses lending patterns in lower-income communities, operates on its own separate framework. 

HOW DID THIS HAPPEN? 

The CFPB received over 64,500 public comments, including ours. The overwhelming majority of comments opposed the Rule. Nevertheless, the Rule is now law. The compliance effective date is July 21, 2026. Whatever the comments offered, pro or con, the Rule largely finalizes a November 2025 proposal, with only clarifying edits rather than substantive revisions. 

Since your question specifically involves the change to disparate impact, I will discuss it primarily. The other changes are also very significant and should be incorporated into your policies and procedures. 

Eliminating the “effects test,” a change supposedly meant to lower compliance costs, actually gives lenders greater freedom to target protected groups. 

WHAT IS THE EFFECTS TEST? 

The purpose of the “effects test” is ultimately to protect against disparate impact. The "effects test" is actually a legal doctrine used to determine if a lender’s facially neutral policy creates a discriminatory, disproportionate impact on a protected class (for instance, race, gender, or age). It means a creditor can be liable for discrimination, even without discriminatory intent, if their practices have a discriminatory effect. 

Most regulators know full well that they can challenge lending policies that, while appearing neutral, create a negative impact on protected groups. Most compliance lawyers know full well that a financial institution can expose itself to a disparate impact violation by creating a pattern or practice that results from defective lending policies. And most financial institutions know, or should know, that if a policy has a discriminatory effect, they must prove that a legitimate business necessity justifies it. 

What the CFPB has done is to remove the “effects test” from Regulation B, thereby promulgating that ECOA does not recognize disparate impact liability. The focus now is on the intent to discriminate.

“Woke” Policies in Mortgage Banking

QUESTION 

There was a big argument in a sales meeting last week. The loan officers got into a verbal fight over the use of the word “woke.” After the meeting, the whole company was talking about it. HR and Compliance got involved. I’m not sure what will happen next. But there is a lot of hate churning up in the company. This has never happened before. We were all friends, but now everyone is taking sides. All over the word “woke.” 

During the sales meeting, they discussed expanding into a mostly minority area. One of the loan officers got up and said he refuses to go into that area and is sick and tired of these “woke” policies that make him do deals with people based on their being minorities. Another loan officer got up and said he agreed and none of the loan officers should be forced to abide by these “woke” rules. 

The loan officers said they were not being racist or discriminatory. They just said they don’t feel safe and that loans from that area don’t close. There was a lot of pushback. Most loan officers disagreed, saying they never feel threatened, and most of their loans do close. There was a big shouting match. The sales manager ended the meeting, and everyone left, but they continued shouting at each other in the parking lot. 

I know this is a touchy subject. But you have taken on controversial subjects many times. I hope you can help to shed some light on the situation we’re in. I want things to go back to normal. 

Is there really a “woke” policy that forces loan officers to take applications in minority areas? 

COMPLIANCE SOLUTION 

ECOA Tune-up 

ANSWER 

Several benign words have come into the American idiom that morphed into a malignant meaning, and “woke” is one of those words. A few years ago, it meant being aware or well-informed politically or culturally. I believe it first entered the Oxford English Dictionary in 2017. 

“WOKE” 

The word “woke” was derived from Black culture. I believe it goes back to the 1940s. To be “woke” or to “stay woke” meant to wake up in the sense of being alert to social justice and preserving African American rights. Recently, the term has had negative overtones, especially in the context of demeaning the politics relating to the left-of-center, a kind of weaponizing by right-of-center and far-right politicians as a way to denigrate left-of-center politics. 

Because right-of-center politicians have adopted “woke” from Black culture, sociologically speaking, it is a form of “cultural appropriation,” although I’ve heard it described as “cultural theft.” Cultural appropriation happens when a majority group adopts elements of a minority group in an exploitative, disrespectful, and stereotypical way.[i] So, if “woke” is used in such a manner, it is inherently a racist term. 

Not all cultural appropriation is intrinsically wrong when there is proper attribution and respectful use of the cultural artifact, keeping honestly to its use and meaning. People who use the term to disparage are not necessarily racist, but if used improperly – lacking attribution, not using it respectfully, being dishonest in use and meaning – it is a proxy for taboo words that are more explicitly racist. 

“WOKE” POLICIES 

Thus, in your specific scenario, when a loan officer says a policy is “woke,” they may be using it disparagingly, generalizing left-of-center policies, which they deem unacceptable to their right-of-center and far-right politics. Their use of the word doesn’t make them racists. They may simply be identifying a left-of-center policy they do not want to accept. However, it could also be a proxy for socially unacceptable racist lingo. 

There are no “woke” policies in mortgage banking. The regulations that financial institutions follow are extensively vetted over generations and many federal and state administrations. A mountain of litigation determines the legal interpretation of the applicable statutes. The rules are often refined to respond to economic demands and ensure appropriate consumer protection, such as the protection afforded through fair lending prohibitions relating to a protected class. 

PROTECTED CLASS 

I have heard grumbling over the years about “protected classes.” These are the categories of groups that are legally protected. I have listened to complaining for and against age as a protected class. From time to time, someone moans about allowing protected class status for sexual and transgender orientation. 

A CEO I spoke to a few years ago felt that political affiliation should never be a protected class. His view was that he is legally allowed to discriminate against an at-will employee or candidate as a direct result of their political beliefs or activities. He held that First Amendment protections do not apply to private employment. He need not fear. Title VII of the Civil Rights Act of 1964 does not deem political affiliation to be a protected class. Public employees have a few more rights regarding political activity protections, but these rights are not absolute. 

GOING ROGUE 

Your loan officers who refuse to work in minority areas are walking on thin ice. The sales manager may choose to assign them elsewhere, but this is a very litigious terrain. There are two primary acts relating to protected classes. I fail to see that either of them falls into the black hole of being “woke”— unless “woke” means acts whose goal is to allow consumers to be treated fairly in the marketplace. 

If loan officers object to treating consumers fairly, maybe they should find another line of work. Lenders strive mightily to build a strong and upstanding reputation. They don’t need some rogue loan officers undermining their reputation or putting them at regulatory risk. 

In any event, I suggest you retain competent counsel to ensure that a decision to withhold loan origination personnel from a minority area would not violate the law, especially the two following acts. 

REGULATIONS 

The Fair Housing Act (FHAct), among its list of illegal, discriminatory practices, includes this example of lending discrimination:

 

Providing a different customer service experience to mortgage applicants depending on their race, color, religion, sex (including gender identity and sexual orientation), familial status, national origin or disability.[ii] [My emphasis.] 

A different “service experience” would be discrimination in approvals and denials, loan terms, advertising, mortgage broker and other loan originator services, property appraisals, mortgage servicing, loan modification assistance, and homeowners insurance. 

Be advised: anyone can file a complaint with the Department of Housing and Urban Development (HUD), which administers and enforces the FHAct. Once the complaint is filed, the Office of Fair Housing and Equal Opportunity (FHEO) immediately opens an investigation to enforce applicable policies and laws. And, I can assure you, a complaint may be filed if a member of a minority community believes your firm is deliberately curtailing or shutting down access to loans in their area. 

The Equal Credit Opportunity Act (ECOA), taken together with the FHAct, covers a wide spectrum of anti-discrimination protections. For instance, the ECOA prohibits discrimination in any aspect of a credit transaction. Prohibitions consist of discrimination based on race or color, religion, national origin, sex, marital status, age (provided the applicant can legally contract), applicant’s receipt of income derived from any public assistance program, or the applicant’s exercise, in good faith, of any right under the Consumer Credit Protection Act.[iii] 

Under both the ECOA and the FHAct, it is illegal for a lender to discriminate on a prohibited basis in a residential real estate-related transaction. And, among other things, under one or both of these acts, a lender may not:

 

·       Fail to provide information or services or provide different information or services regarding any aspect of the lending process, including credit availability, application procedures, or lending standards.

 

·       Discourage or selectively encourage applicants concerning inquiries about or applications for credit. 

BUZZSAWS 

Without more information than you provided, it seems your loan officers – and, by extension, your company – risk running straight into the buzzsaw of a prohibited factor! Indeed, to go further, a lender may not discriminate on a prohibited basis because the present or prospective occupants of either the property to be financed or the characteristics of the neighborhood or other area where the property to be financed is located. Deliberately avoiding minority communities with respect to originating loans substantially increases legal and regulatory risk. 

If your firm were to pull back from or shut down originations in a minority area, it could trigger disparate treatment violations. All it takes for an illegal disparate treatment allegation to be set in motion is the establishment either by statements revealing that a lender explicitly considered prohibited factors (overt evidence) or by differences in treatment that are not fully explained by legitimate, nondiscriminatory factors (comparative evidence).[iv] 

Indeed, when a lender applies a racially or otherwise neutral policy or practice equally to all credit applicants but disproportionately excludes or burdens certain persons on a prohibited basis, the policy or practice is described as having a disparate impact. 

Your scenario manages to trigger all three types of lending discrimination: overt evidence of disparate treatment, comparative evidence of disparate treatment, and evidence of disparate impact. Here’s how. 

First, there is overt evidence of disparate treatment because, as described above, your firm would be openly discriminating on a prohibited basis. 

Secondly, there is comparative evidence of disparate treatment because your firm would treat a credit applicant differently based on one of the prohibited bases. It does not require any showing that the treatment was motivated by prejudice or a conscious intention to discriminate against a person beyond the difference in the treatment itself. 

Third, there is a disparate impact because your firm would apply a racially or otherwise neutral policy or practice equally to all credit applicants, disproportionately excluding or burdening persons on a prohibited basis. 

REDLINING 

A final word about redlining, a form of disparate treatment that your loan officers seem to be suggesting. Your firm may be exposing itself to a redlining allegation if it provides unequal access to credit or unequal terms of credit because of the race, color, national origin, or other prohibited characteristic(s) of the residents of the area in which the credit seeker resides or will reside or in which the residential property to be mortgaged is located. Redlining is a double-whammy: it often violates both the FHAct and the ECOA. 

Hopefully, your loan officers will worry less about “woke” policies and more about not violating fair lending laws. If your firm treats similar applicants differently based on a prohibited factor, it must explain the difference in treatment. If the explanation is not found to be credible, a supervision and enforcement agency may find that your financial institution discriminated.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

---

[i] See What Is Cultural Appropriation?, Encyclopedia Britannica, December 2023

[ii] Fair Lending: Learn the Fact, Fair Lending Guide, U.S. Department of Housing and Urban Development

[iii] § 1002.5(b), Title 12, Chapter X, Part 1002

[iv] Consumer Compliance Examination Manual, March 2021, IV. Fair Lending – Fair Lending Laws and Regulations, Federal Deposit Insurance Corporation

Reconsideration of Value and Appraisal Independence

QUESTION 

We are a large wholesale lender. I am a senior underwriter. Every week, we get requests from our broker partners to have properties reappraised. When the appraisal comes back below what they need, they complain to the Account Executives, who then request that we ask for an appraisal re-evaluation.   

Whether we use an AMC or a staff appraiser, we go through a set of procedures to request a second appraisal review to get a valuation closer to the broker’s expectations. It doesn’t always work out, but sometimes we find deficiencies in the original appraisal report, which, if adjusted for, can change the valuation. 

We have a Reconsideration of Value policy and procedure for this process. Our problem is that the new compliance officer is taking the position that this process interferes with appraisal independence. I would like to know if appraisal independence is compromised by requesting a re-evaluation. 

Does Reconsideration of Value compromise appraisal independence? 

Are there procedures we can implement to avoid compromising appraisal independence? 

ANSWER 

There are risks associated with deficient residential real estate valuations. However, financial institutions may incorporate Reconsideration of Value (“ROV”) processes and controls into established risk management functions.[i] The risk occurs not only in collateral valuation models but also in the risk of discrimination impacting residential real estate valuations. 

One problem in providing guidance to you is that no existing requirements are specific to ROV processes. For purposes of this article, I will define an ROV as a request from the financial institution to the appraiser or other preparer of the valuation report to re-assess the report based upon potential deficiencies or other information that may affect the value conclusion. There is some uncertainty in the industry on how ROVs intersect with appraisal independence requirements and compliance with Federal consumer protection laws, including those related to nondiscrimination. 

Collateral valuations may be deficient due to prohibited discrimination; errors or omissions; or valuation methods, assumptions, data sources, or conclusions that are otherwise unreasonable, unsupported, unrealistic, or inappropriate. The concern is that deficient collateral valuations can keep individuals, families, and neighborhoods from building wealth through homeownership by potentially preventing homeowners from accessing accumulated equity, preventing prospective buyers from purchasing homes, thereby making it harder for homeowners to sell or refinance their homes, and increasing the risk of default. 

Up front, it should be understood that valuations that are not credible may pose risks to a financial institution's financial condition and operations. Such risks may include loan losses, violations of law, fines, civil monetary penalties, payment of damages, and civil litigation. 

Regulatory Framework

There are several regulatory frameworks that, taken together, form the basis for ROV activities. For instance, the Equal Credit Opportunity Act (ECOA), and its implementing regulation, Regulation B, prohibit discrimination in any aspect of a credit transaction. The Fair Housing Act (FH Act) and its implementing regulation prohibit discrimination in all aspects of residential real estate-related transactions. ECOA and the FH Act prohibit discrimination based on race and certain other characteristics in residential real estate-related transactions, including in real estate valuations. 

In addition, section 5 of the Federal Trade Commission Act prohibits unfair or deceptive acts or practices, and the Consumer Financial Protection Act prohibits any covered person or service provider of a covered person from engaging in any unfair, deceptive, or abusive act or practice. 

The Truth in Lending Act (TILA) and its implementing regulation, Regulation Z, establish certain federal appraisal independence requirements. Specifically, TILA and Regulation Z prohibit compensation, coercion, extortion, bribery, or other efforts that may impede the appraiser’s independent valuation in connection with any covered transaction. However, Regulation Z also explicitly clarifies that it is permissible for covered persons to, among other things, request the valuation preparer to consider additional, appropriate property information, including information about comparable properties, or to correct errors in the valuation. 

The appraisal regulations implementing Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 require all appraisals conducted in connection with federally related transactions to conform with the Uniform Standards of Professional Appraisal Practice (USPAP), which requires compliance with all applicable laws and regulations including nondiscrimination requirements. 

Applicable appraisal regulations also require appraisals to be subject to appropriate review for compliance with USPAP. Financial institutions generally conduct an independent review prior to providing the consumer a copy of the appraisal or evaluation; however, an additional review may be warranted if the consumer provides information that could affect the value conclusion or if deficiencies are identified in the original appraisal. 

An appraisal does not comply with USPAP if it relies on a prohibited basis set forth in either the ECOA or the FH Act or contains material errors, including errors of omission or commission. If a financial institution determines through the appraisal review process, or after consideration of information later provided by the consumer, that the appraisal does not meet the minimum standards outlined in the appraisal regulations and if the deficiencies remain uncorrected, the appraisal cannot be used as part of the credit decision. 

Interagency Guidance

The Federal Reserve Board, FDIC, NCUA, and OCC have issued interagency guidance describing actions that financial institutions may take to resolve valuation deficiencies. These actions include the following:

• resolving the deficiencies with the appraiser or preparer of the valuation report; 
• requesting a valuation review by an independent, qualified, and competent state-certified or licensed appraiser; or
• obtaining a second appraisal or evaluation. 

Deficiencies may be identified through the financial institution’s valuation review or consumer-provided information. The regulatory framework does permit financial institutions to implement ROV policies, procedures, and control systems that allow consumers to provide and the financial institution to review relevant information that may not have been considered during the appraisal or evaluation process.

Appraisers and Third Parties 

You mentioned the use of AMCs. You must know that a financial institution’s use of third parties in the valuation review process does not diminish its responsibility to comply with applicable laws and regulations. Moreover, whether valuation review activities and resolving deficiencies are performed internally or via a third party, financial institutions supervised by the Board, FDIC, NCUA, and the OCC are required to operate safely and soundly and in compliance with applicable laws and regulations, including those designed to protect consumers. 

In addition, the CFPB expects financial institutions to oversee their business relationships with service providers in a manner that ensures compliance with Federal consumer protection laws, which are designed to protect the interests of consumers and avoid consumer harm. A financial institution’s risk management practices include managing the risks arising from its third-party valuations and valuation review functions. 

Now to turn to Reconsideration of Value itself in the loan flow process. 

Reconsideration of Value

An ROV request by the financial institution to the appraiser or other preparer of the valuation report encompasses a request to reassess the appraisal report based on deficiencies or information that may affect the value conclusion. A financial institution may initiate a request for an ROV because of the financial institution’s valuation review activities or after consideration of information received from a consumer through a complaint or appeal to the loan officer or other lender representative. 

A consumer inquiry or complaint regarding a valuation would generally occur after the financial institution has conducted its initial appraisal or evaluation review and resolved any issues identified. Given this timing, a consumer may provide specific and verifiable information that may not have been available or considered when the initial valuation and review were performed. Regardless of how the request for an ROV is initiated, a request could be resolved through a financial institution’s independent valuation review or other processes to ensure credible appraisals and evaluations. 

An ROV request may include consideration of comparable properties not previously identified, property characteristics, or other information about the property that may have been incorrectly reported or not previously considered, which may affect the value conclusion. To resolve deficiencies, including those related to potential discrimination, financial institutions can communicate relevant information to the original valuation preparer and, when appropriate, request an ROV. 

Complaint Resolution

At the core of the complaint that triggers the ROV request is the complaint resolution process. Financial institutions can capture consumer feedback regarding potential valuation deficiencies through existing complaint resolution processes. The complaint resolution process may capture complaints and inquiries about the financial institution’s products and services offered across all lines of business, including those provided by third parties, as well as complaints from various channels (such as letters, phone calls, in-person, transmittal from regulators, third-party valuation service providers, emails, and social media). 

Depending on the nature and volume, appraisal and other valuation-based complaints and inquiries can be important indicators of potential risks and risk management weaknesses. Appropriate policies, procedures, and control systems can adequately address the monitoring, escalating, and resolving of complaints, including determining the merits of the complaint and whether a financial institution should initiate an ROV.

Policies and Procedures

With respect to procedures you can implement to avoid compromising appraisal independence, there are several policies, procedures, and control systems that should be considered. I will offer a brief outline of such systemic activities that should be installed in the loan flow process.

Niche Product that violates ECOA

QUESTION

Most of our loan products are geared toward consumers of all ages. But we linked a person's age to the eligibility criteria for one of our products and then correlated it to income from public assistance. The aim was to offer a loan product that would benefit older adults on public assistance. 

This did not sit well with our regulator. We're now in hot water for violations of ECOA. Our compliance team reviewed this loan, and our attorneys reviewed it, too. Yet, here we are, facing down the barrel of a regulatory nightmare. 

I am an underwriter and just following the guidelines. But even I knew this loan was going to be risky. 

How should we figure a person's age in evaluating the application? 

And, is there a rule for considering income from public assistance of an applicant? 

ANSWER

I wish you had contacted me before getting into such a debacle. Combining age eligibility with public assistance criteria is like mixing water and oil. Under the Equal Credit Opportunity Act (ECOA), that's two strikes – not three! – and you're out. 

Let's keep it real. With limited exception, a creditor may not take into account an applicant's age (provided that the applicant has the capacity to enter into a binding contract).[i] 

There are primarily three criteria that a creditor can use to take the age of an applicant into account. 

They are: 

1. In an empirically derived, demonstrably and statistically sound credit scoring system, a creditor may use an applicant's age as a predictive variable, provided that the age of the elderly applicant is not assigned a negative factor or value. With respect to an "empirically derived, demonstrably and statistically sound credit scoring system," prepare to be seriously challenged on its validity! I'll comment more about the "negative factor or value" assignation below. 

2. In a judgmental system of evaluating creditworthiness, a creditor may consider an applicant's age only to determine a pertinent element of creditworthiness. Read on for my comment on a "pertinent element of creditworthiness." 

3. In any system of evaluating creditworthiness, a creditor may consider the age of an elderly applicant when such age is used to favor the elderly applicant in extending credit.[ii] 

Regulation B, the implementing regulation of ECOA, provides in its Commentary additional details on the consideration of age in the evaluation of an applicant.[iii] 

Concerning a "negative factor or value," as these elements pertain to the age of elderly applicants, you need to be very careful in such evaluations. The use of such features means utilizing a factor, value, or weight that is less favorable regarding elderly applicants than the creditor's experience warrants or is less favorable than the factor, value, or weight assigned to the class of applicants that are not classified as elderly and are most favored by a creditor on the basis of age.[iv] 

A "pertinent element of creditworthiness" is complex in theory and even more labyrinthine, complicated, circuitous, and tortuous in practice. In relation to a judgmental system of evaluating applicants, it means any information about applicants that a creditor obtains and considers and that has a demonstrable relationship to a determination of creditworthiness.[v] I know that sounds convoluted, and in a sense, it seems so (but it's not). Here is an example. Many lenders know that they may not reject an application because an applicant is sixty years old, but they do not know that they may relate the applicant's age to other information about the applicant that the creditor considers in evaluating creditworthiness, such as the applicant's occupation and length of time to retirement to ascertain whether the applicant's income (including retirement income) will support the extension of credit to its maturity.[vi] This scenario may have been the chute that your compliance people fell through into a regulatory crisis. If not structured properly and narrowly, your loan product was ripe for adverse regulatory findings, all things considered. 

I'll get over to the public assistance part of your question momentarily. But should you ask if any other prohibited basis factor in an empirically derived, demonstrably and statistically sound, credit scoring system may be applied, the answer is unequivocally no. Period. A creditor may not take a prohibited basis into account in any system of evaluating an applicant's creditworthiness, except as provided in ECOA and Regulation B.[vii] And this is why you must get competent and experienced guidance from a compliance professional that actually has substantial familiarity with ECOA and Regulation B. 

Now, about public assistance income in the evaluation of an applicant. Generally, a creditor may not consider whether an applicant's income derives from any public assistance program.[viii] However, when considering income derived from a public assistance program, a creditor may take into account certain primary factors, such as: 

1. The length of time an applicant will likely remain eligible to receive such income; 

2. Whether the applicant will continue to qualify for benefits based on the status of the applicant's dependents. An example here would be Temporary Aid to Needy Families or Social Security payments to a minor); and

 3. Whether the creditor can attach or garnish the income to ensure payment of the debt in the event of default.[ix]

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

---

[i] 12 CFR § 202.6(b)(2)

[ii] 12 CFR § 202.6(b)(2)(ii)-(iv); 12 CFR Supp. I to pt. 202 – Offical Staff Interpretations § 202.2(p)-1

[iii] 12 CFR Supp. I to pt. 202 – Official Staff Interpretations § 202.6(b)(2)

[iv] 12 CFR § 202.2(v)

[v] 12 CFR § 202.2(y)

[vi] 12 CFR Supp I to pt 202 – Official Staff Interpretations § 202.6(b)(2)-3

[vii] 12 CFR § 202.6(b)

[viii] 12 CFR § 202.6(b)(2)(iii)

[ix] 12 CFR Supp. I to pt. 202 – Official Staff Interpretations § 202.6(b)(2)-6

Adverse Action Conundrum

QUESTION 

I have been told conflicting advice about the adverse action notice. Supposedly, these are people who are in the know. However, I am a compliance manager with no staff and don’t have a clear answer to my concerns. 

First, I want to know what information I need from a credit bureau to issue an adverse action notice. 

Secondly, I want to know what information I need from third parties that are not credit bureaus for me to issue the adverse action notice. 

Third, and the biggest issue for me, I want to know who we should notify when multiple applicants are on a loan application. I say this is the biggest issue because this is the one on which I get a lot of conflicting advice. 

So, here are my questions. 

What is required for adverse action based on credit bureau information? 

What is required for adverse action based on third parties? 

And, who is supposed to get the adverse action notice when the loan is for multiple applicants? 

ANSWER 

You are not alone in feeling some consternation. Many compliance professionals express some confusion about the notification requirements of adverse action. Section 615 of the Fair Credit Reporting Act (FCRA)[i] requires lenders to provide adverse action notices in cases where information from a consumer reporting agency is used and instances where information from other third parties is used to make the adverse credit decision. 

If you use a consumer credit report to take any type of adverse action that is based at least in part on information contained in a consumer report, you are required by the FCRA[ii] to notify the consumer. The notification may be in writing, orally, or by electronic means. 

You may already be familiar with what the notice must contain, such as: 

·      A numerical credit score[iii] used in taking any adverse action based in whole or in part on any information in a consumer report along with the following related information:[iv] 

o   The range of possible credit scores under the model used;

o   All of the key factors that adversely affected the credit score of the consumer in the model used, not to exceed four;

o   The date on which the credit score was created; and

o   The name of the person or entity that provided the credit score or credit file upon which the credit score was created. 

However, the adverse action notice must also include the following: 

-  The name, address, and telephone number of the credit reporting agency (CRA) (including a toll-free telephone number, if it is a nationwide CRA) that provided the report;

-  A statement that the CRA did not make the adverse decision and cannot explain why the decision was made;

-  A statement setting forth the consumer’s right to obtain a free disclosure of the consumer’s file from the CRA if the consumer requests the report within 60 days; and

-  A statement setting forth the consumer’s right to dispute directly with the CRA the accuracy or completeness of any information provided by the CRA. 

I suggest you review the model adverse action forms in Appendix C of Regulation B, the implementing regulation of the Equal Credit Opportunity Act (ECOA), which include model language for making the above disclosures, including the credit score information. 

Your second question is about adverse action notices based on information obtained from third parties that are not CRAs. I would add affiliates to that category. When a lender denies (or increases the charge for) credit for personal, family, or household purposes based either wholly or partly on information from a person other than a consumer reporting agency (such as a credit bureau), the FCRA[v] requires that the institution clearly and accurately discloses to the consumer their right to obtain disclosure of the nature of the information that was relied on by making a written request within 60 days of notification. The financial institution must provide the disclosure within a reasonable period of time following the consumer’s written request. 

You may take an adverse action involving insurance, employment, or a credit transaction initiated by the consumer, based on information of the type covered by the FCRA. If this information was obtained from an entity affiliated with the institution by common ownership or control, the FCRA[vi] requires the financial institution to notify the consumer of the adverse action. The notification must inform the consumer that they may obtain a disclosure of the nature of the information relied on by making a written request within 60 days of receiving the adverse action notice. And if the consumer makes such a request, the financial institution must disclose the nature of the information no later than 30 days after receiving the request. The applicable section of the FCRA[vii], however, does not cover information obtained directly from an affiliated entity relating solely to its transactions or experiences with the consumer and information from a consumer report obtained from an affiliate. 

Finally, you wanted to know about disclosing the adverse action notice where multiple applicants are on a loan application. The answer invokes both Regulation B as well as the Fair Trade Commission’s interpretation of the FCRA. In some cases, the rules of Regulation B regarding who must be provided the adverse action notice will differ from the rules under the FCRA. This is due to a Federal Trade Commission interpretation of Section 615(a) of the FCRA. The explanation is going to be a bit nerdy, but hang in there! 

Section 615(a) of the FCRA requires that “any consumer,” with respect to whom adverse action is taken, must receive the disclosures mandated by this section if that action is based “in whole or in part” on information from a consumer report. In the FTC’s view, the plain language “any consumer” includes a co-applicant. Neither the applicable section of Regulation B[viii] nor the combined disclosure permitted in Appendix C remove or modify that requirement for co-applicants. The objective of the combined disclosures permitted by the Federal Reserve Board in Appendix C to Regulation B is only to simplify the paperwork involved in making ECOA and FCRA notifications to a single applicant, where both are required – for instance, where the action by the creditor is both adverse to the applicant (ECOA) and is based in whole or in part on information from that applicant’s consumer report (FCRA).

UDAAP: Unintended Consequences

QUESTION 

We have never had a banking department issue an action against us for discrimination – until now. Last week, our banking department came after us for discriminating through “unfair acts or practices.” We think this is outrageous, as our firm is devoted to supporting communities of color. Our home office and branches are located, for the most part, in minority communities. 

The baking department is citing their UDAAP examination and one that was done by the CFPB last year. It issued an administrative action. As the company’s Chief Compliance Officer, I can say we always had decent exam outcomes. Now, this is a bad mark and will cause not only regulatory risk but also reputation risk. With the permission of management, I sent you a redacted banking report that shows the alleged violations. 

The crux of the issue comes down to whether the alleged violations were intentional or unintentional. We can provide evidence that any such alleged violations were totally unintentional. Our attorney is now working with the banking department to find a resolution. 

Is it the case that unintentional “unfair acts or practices” are a violation of UDAAP guidelines? 

ANSWER 

I recognize that you are upset by the banking department’s administrative action. I applaud you for being devoted to expanding financial opportunities in minority communities. But I have news for you: unintentional actions implicate UDAAP just as much as intentional actions. 

The CFPB takes the position that discrimination, both intentional and unintentional, and in connection with any financial products, constitutes an Unfair, Deceptive, or Abusive Acts or Practices (“UDAAP”) under the Consumer Financial Protection Act (“CFPA”). Dodd-Frank specifically makes it unlawful for any provider of consumer financial products, services, or service provider to engage in any unfair, deceptive, or abusive acts or practices.[i] 

We find in our UDAAP Tune-up a recurring set of violations that show or could show UDAAP violations. Once we provide a report, it is incumbent on the financial institution to implement the changes needed. It is a good compliance policy to be proactive and make those changes rather than being reactive to a banking department’s findings. 

If you want information about the UDAAP Tune-up, please contact us HERE. 

It would help if you had a broader understanding of what examiners look at when they examine for UDAAP. From a legal point of view, the standards for abusive, unfair, and deceptive acts or practices are separate, although CFPB examiners will audit for abusive acts being both unfair or deceptive. Let me give you some hints. There are at least four guidelines that examiners audit.

Four Guidelines 

First, they want to know if you have clear and unambiguous principles of unfairness, deception, and abuse in the context of offering and providing consumer financial products and services;

 

Second, they’ll want to know your institution goes about assessing the risk that its practices may be unfair, deceptive, or abusive;

 

Third, they will audit for your means of identifying unfair, deceptive, or abusive acts or practices (including by providing examples of potentially unfair or deceptive acts and practices); and

 

Fourth, they will gauge your understanding of the interplay between unfair, deceptive, or abusive acts or practices and other consumer protection and antidiscrimination statutes. 

If you cannot provide persuasive, compelling, and dispositive responses to these guidelines, you are not ready for a UDAAP examination. 

Furthermore, if you do not have actionable, auditable standards consistent with Dodd-Frank, your institution is essentially flying blind into the winds of UDAAP mandates. 

Three fundamental standards determine if an act or practice is unfair. [ii]

Three Standards

Standard # 1: Does the act of practice cause or is likely to cause substantial injury to consumers?

 

Standard # 2: Is the injury reasonably avoidable by consumers?

 

Standard # 3: Is the injury not outweighed by countervailing benefits to consumers or competition? 

If you do not have standards firmly in place and are not monitoring them continuously, you are not ready for a UDAAP examination. 

How do you gauge whether an act or practice is deceptive? 

The CFPB considers three criteria.[iii]

Three Criteria 

1.  The representation, omission, act, or practice misleads or is likely to mislead the consumer.

 

Comment: The representation, omission, act, or practice misleads or is likely to mislead the consumer. I like the FTC’s “Four Ps” test to evaluate whether a representation, omission, act, or practice is likely to mislead.[iv]

                      Four Ps Test

 

1.  Is the statement prominent enough for the consumer to notice?

2.  Is the information presented in an easy-to-understand format that does not contradict other information in the package and at a time when the consumer’s attention is not distracted elsewhere?

3.  Is the placement of the information in a location where consumers can be expected to look or hear?

4.  Finally, is the information in close proximity to the claim it qualifies? 

2.  The consumer’s interpretation of the representation, omission, act, or practice is reasonable under the circumstances. 

Comment: The consumer’s interpretation of the representation, omission, act, or practice is reasonable under the circumstances. Eliminate “puffery” – the legal term for exaggerated claims – unless you can show that the claims would not be taken seriously by a reasonable consumer.

 

You must show that the consumer’s interpretation of or reaction to the representation, omission, act, or practice is reasonable under the circumstances; whether an act or practice is deceptive depends on how a reasonable member of the target audience would interpret the representation.

 

A representation may be deceptive if the majority of consumers in the target class do not share the consumer’s interpretation, so long as a significant minority of such consumers is misled. When a seller’s representation conveys more than one meaning to reasonable consumers, one of which is false, the seller is liable for the misleading interpretation.

ECOA's Regulation B protects Existing Customers

QUESTION

We originate mortgages in 35 states, and all loan originations are retail. I am the company’s Chief Risk Officer. For years, we took the position that ECOA only applies to people who are applying for loans. We checked around and found that many banks had the same policy. Then, in 2020, we learned about a lawsuit against Bank of America, which changed our policy. 

Apparently, Bank of America argued that it could disregard ECOA when it comes to existing customers. The dispute was over them not having to issue an adverse action notice. This did not go over well with the CFPB, which contended that ignoring the ECOA for existing customers would undermine anti-discrimination protections. 

I’ve been told that the CFPB is now doing examination and enforcement audits to see if companies provide ECOA rules to applicants and existing customers. 

Can you provide some insight into Regulation B’s protection of existing customers? 

ANSWER

The case you referenced concerns the CFPB’s involvement in 2021.[i] Bank of America contended that it did not have to send an adverse action notice to an existing customer. The CFPB filed an amicus curiae (legalese for a brief filed as “friend of the court”), arguing that Bank of America’s position was contradicted by the language and history of the law. 

According to the CFPB, the Equal Credit Opportunity Act (ECOA) protections against credit discrimination do not disappear when credit is extended; instead, ECOA shields existing borrowers from discrimination in all aspects of a credit arrangement. 

You mentioned in your inquiry that my firm conducted an ECOA Tune-up® for you in 2020, and you now plan to do another one this year. We consider ECOA to be one of the primary regulations in mortgage banking. If others want information about the ECOA Tune-up®, please contact us HERE. 

Briefly put, the CFPB contended that ECOA and its implementing rule, Regulation B, include those currently seeking credit and those who sought and have now received credit. The Bureau determined that this interpretation is the best reading of the statute itself. Any doubt whether the term “applicant” includes current borrowers is put to rest by Regulation B, which has expressly defined the term to include current borrowers for decades. 

ECOA has been law since 1974. So, it is odd to have a big controversy over something like issuing an adverse action notice to existing customers. You would think that in ECOA’s nearly 50-year history, a matter such as issuing an adverse action notice would have been thoroughly vetted! 

The first thing we need to do is define what an “applicant” is. Is an applicant a person who applies for an extension of credit? That would be logical, given Webster’s definition: “a person who applied for something (as a job).” I believe Clarence Darrow once said, ‘the trouble with the law is lawyers.’ If you want to be logical about definitions, be advised, lawspeak and common parlance do not always mesh well. 

The ECOA is abundantly clear about the definition of an applicant, to wit,

 

“… any person who applies to a creditor directly for an extension, renewal, or continuation of credit, or applies to a creditor indirectly by use of an existing credit plan for an amount exceeding a previously established credit limit.”[ii] [Emphasized]

 

Furthermore, adverse action is codified in ECOA’s prohibition on discrimination as it applies

 

“… to all credit transactions including the approval, denial, renewal, continuation, or revocation of any open-end consumer credit account.” [Emphasized]

 

But the Federal Reserve Board (FRB), in promulgating Regulation B, left no uncertainty about whether ECOA should be applied to existing customers. It did so by defining “applicant” to expressly include not only

 

“… any person who applies to a creditor directly for an extension, renewal or continuation of credit” but also, “[w]ith respect to any creditor[,] . . . any person to whom credit is or has been extended by that creditor.”[iii] [Emphasized]

 

The FRB then locked in any attempt to skirt this provision by noting that ECOA’s express terms and its legislative history

 

“demonstrate that Congress intended to reach discrimination . . . ‘in any aspect of a credit transaction.’”[iv] [Emphasized]

 

It could be asserted that there’s a difference between a credit applicant and a debtor. That’s fair as far as it goes. But, the FRB had the last say because it revised Regulation B’s definition of “applicant” to include both those who request credit and debtors,[v]  stating that an “applicant” includes

 

“any person who requests or [who] has received an extension of credit from a creditor.”[vi] [Emphasized]

You are correct that the CFPB is conducting examinations involving Regulation B compliance, but this is not something new, and it is not happening just now. The CFPB has been examining ECOA compliance for years. Perhaps you are more aware of the Bureau’s ECOA examination activities because it recently issued an advisory opinion (“Advisory”) on ECOA compliance concerning revocations or unfavorable changes to terms of existing credit arrangements.[vii] 

With this Advisory, the CFPB affirms the established requirements to issue adverse action notices to an existing borrower. The Bureau clarifies that Regulation B protection is afforded to borrowers after they have applied for and received credit. 

Lenders may not discriminate against borrowers with existing credit. For instance, the ECOA prohibits lenders from lowering the credit limit of certain borrowers’ accounts or subjecting certain borrowers to more aggressive collections practices on a prohibited basis, such as race. 

ECOA’s private right of action points to supporting alleged discrimination from persons who have already received credit. Thus, an aggrieved “applicant” can bring suit against creditors who fail to comply with the ECOA or Regulation B. In effect, the history of the ECOA’s Regulation B and its judicial interpretation of an “applicant” cannot be understood to refer only to those with pending credit applications. If it were otherwise, a person whose application was denied on a prohibited basis would have no recourse under ECOA’s private right of action, which Congress intended would be the Act’s “chief enforcement tool.”[viii] Instead, the term “applicant” is not limited to those currently applying for credit. 

If you have been holding off from doing an ECOA Tune-up®, I encourage you to consider it now, especially since the CFPB’s Advisory regarding ECOA compliance demonstrates a heightened interest in examination and enforcement. If you want information about an ECOA Tune-up®, please contact us HERE.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

---

[i] Fralish v Bank of America, N.A., US District Court, 21-2846, 7^th Circuit, (9.29.21); Fralish v Bank of America, N.A., US Court of Appeals, 7^th Circuit (1.28.22)

[ii] Pub. L. 93-495, sec. 503, 88 Stat. at 1522 (codified at 15 U.S.C. 1691a(b))

[iii] 12 CFR 202.3(c) (1976); see also 40 FR at 49306

[iv] 40 FR at 49298 (quoting 15 U.S.C. 1691(a))

[v] 41 FR 29870, 29871 (July 20, 1976) (proposed rule)

[vi] 12 CFR 202.2(e) (1978) (emphasis added); see also 42 FR 1242, 1252 (Jan. 6, 1977) (final rule)

[vii] Equal Credit Opportunity (Regulation B); Revocations or Unfavorable Changes to the Terms of Existing Credit Arrangements, Advisory Opinion, 12 CFR Part 1002, Consumer Financial Protection Bureau, May 9, 2022

[viii] S. Rep. 94-589, at 13