Fair Lending Laws and UDAAP

New Developments, Compliance

Strategies, and Risk Management

Philip R. Stein, Partner

305-350-7220

PStein@bilzin.com

Bilzin Sumberg Baena Price & Axelrod LLP

3903520.V1

Overview of Program

Focus Areas:

The Evolving Definitions of "Fair Lending"

and UDAAP

Impact of the CFPB on These Areas

Compliance Strategies

Recent Litigation Developments

What is "Fair Lending"?

Dodd-Frank definition:

"Fair lending" means "fair, equitable, and

nondiscriminatory access to credit for

consumers."

Fair Lending - Governing Laws

Two primary federal laws govern fair lending

practices:

Equal Credit Opportunity Act ("ECOA") and

Regulation B (CFPB) (15 USC §1691; 12 CFR

Part 1002):

ECOA, enacted in 1974, prohibits

discrimination based on race, color, religion,

national origin, sex, marital status, age,

source of income, or whether person

exercises rights granted under Consumer

Credit Protection Act for any aspect of

consumer or business credit transaction.

Fair Lending - Governing Laws

Two primary federal laws govern fair lending

practices:

Fair Housing Act ("FHA") and HUD Regulations

(42 USC §3605; 24 CFR Part 100):

Part of Civil Rights Act of 1968; unlawful for

any lender to discriminate in "residential real

estate-related transaction" against any

person because of his or her race, color,

religion, national origin, sex, familial status,

or handicap.

State or local laws may include additional

prohibited bases, such as sexual orientation.

Scope of Fair Lending Laws

Fair lending laws and regulations apply to:

All credit products and services for both

consumer and business purposes; and

Entire loan life cycle, including collections

and servicing.

ECOA - Anti-Discrimination

Requirements

ECOA prohibits discrimination in any aspect of

a credit transaction:

Applies to any extension of credit, whether

consumer or business, including extension

of credit to small businesses, corporations,

partnerships and trusts, and across loan's

life cycle.

ECOA also prohibits discouraging

application, which may impede access to

credit.

Other Fair Lending Laws

Other federal laws that relate to fair lending:

Community Reinvestment Act ("CRA")

(12 USC 2901 et. Seq.):

CRA and Regulation BB encourage

financial institutions to meet credit needs

of communities they serve. A poor "fair

lending" record can negatively affect CRA

rating and result in denial of applications

to open branch, relocate office, or acquire

another financial institution.

Fair Lending - Three Legal

Theories of Discrimination

Regulators or plaintiffs may bring fair lending

enforcement actions or litigation based on three

different legal theories of lending discrimination:

Overt discrimination.

Disparate treatment.

Disparate impact.

Fair Lending - Overt

Discrimination

Overt discrimination:

Direct evidence that lender intentionally

discriminated on prohibited basis or

expressed discriminatory preference, even

without acting on that preference.

Fair Lending - Disparate

Treatment

Disparate treatment:

Circumstantial evidence that lender

intentionally treated similarly situation

persons differently on prohibited basis.

Even if not motivated by prejudice or

conscious intent to discriminate, differences

in treatment are considered "intentional" if

no credible, non-discriminatory reason(s)

can be given to explain policy or practice.

Fair Lending - Disparate Impact

Disparate impact:

Evidence that lender applied neutral policy

or practice uniformly to all credit applicants,

but the policy or practice has a

disproportionately adverse impact on

members of protected class group without

proper business justification.

Fair Lending - Disparate Impact

Disparate impact description:

The effect of differential results that arise

from "practices that are facially neutral in

their treatment of different groups but that in

fact fall more harshly on one group than

another."

Fair Lending - Disparate Impact

Disparate impact description:

A plaintiff must:

Identify the specific policy or practice of

the defendant;

Establish a disparate impact through the

use of statistical evidence; and

Prove the existence of a causal link

between the identified policy and the

disparate impact.

Fair Lending - Other Forms of

Discrimination

Redlining:

Redlining is a practice of denying credit to

specific geographic areas due to race,

ethnicity or some other protected class of its

residents. Historically, concept of redlining

referred to lender's unwillingness to lend to

certain neighborhoods within urban cities

where minority populations were primarily

located.

Fair Lending - Other Forms of

Discrimination

Reverse redlining:

Reverse redlining is opposite concept, in

which protected classes are targeted for

certain products with less favorable terms,

conditions, and/or pricing on prohibited

basis.

UDAAP

Unfair, deceptive, or abusive acts or practices -

prohibited by Dodd-Frank:

Not limited to "Larger Participants" or

expressly regulated industries.

UDAAP compliance = key CFPB concern.

Interpretation of UDAAP up to CFPB.

Aimed at similar, yet broader, activity than state

"UDAP" laws.

Interplay Between UDAAP and

Fair Lending

UDAAP most powerful tool in CFPB arsenal:

Almost ANY practice can be attacked under

broad UDAAP standards applied by CFPB.

Fair lending as powerful alternative: "Disparate

impact" analysis, despite its questionable legal

footing under ECOA/FHA, may be used to

attack practices that, while not violating UDAAP,

have a disparate impact on protected classes.

UDAAP: Vagueness Concerns

- Defined Case-By-Case

"The possibilities here for injuring consumers are

almost limitless. Maybe a customer service

representative provided misleading information.

Maybe consumers were told only about the benefits

of a product and not about any of the limitations or

risky features. Maybe important information about

rates or fees was hidden or obscured. Or maybe

consumers were told that they would have the

chance to consider the matter further, and later

found they were already signed up and charged for

a service without ever giving their actual consent." CFPB Director Richard Cordray, Feb. 21, 2013

UDAAP "Unfairness" Standard

Causes, or likely to cause, substantial injury to

consumers;

The injury is not reasonably avoidable by

consumers; and

The injury is not outweighed by countervailing

benefits to consumers or to competition.

UDAAP "Unfairness" Standard

Important Considerations from CFPB

When determining monetary harm, consider that

an act or practice that causes a small amount of

harm to a large number of people may be

deemed to cause substantial injury.

Actual injury not required; significant risk of

concrete harm is sufficient.

UDAAP "Deceptive" Standard

The representation, omission, act or practice

misleads or is likely to mislead the consumer;

The consumer's interpretation of the

representation, omission, act or practice is

reasonable under the circumstances; and

The misleading representation, omission, act or

practice is material.

UDAAP "Abusive" Standard

Materially interferes with the ability of a

consumer to understand a term or condition of a

consumer financial product or service; or

Takes unreasonable advantage of:

A lack of understanding on the part of the

consumer of the material risks, costs, or

conditions of the product or service;

The inability of the consumer to protect its

interests in selecting or using a consumer

financial product or service.

CFPB and "Abusive" Practices

No rules further define "abusive."

Director Cordray: "I'll know it when I see it" [to

Senate, 2012].

UDAAP: Role of Complaints

CFPB admits that consumer complaints play a

key role in the detection of unfair, deceptive or

abusive practices.

Consumer complaints can indicate weaknesses

in elements of the institution's compliance

management system, such as training, internal

controls or monitoring.

Companies should track categories of

complaints reported by CFPB.

CFPB Enforcement of UDAAP

CFPB v. American Debt Settlement Solutions,

Inc., 9:13-cv-80548 (S.D. Fla. May 30, 2013): First enforcement action against entity for "abusive"

practices (UDAAP).

June 6, 2013 - Settlement and Final Order -

including:

Ban on debt relief products and services;

$499,247.96 in equitable monetary relief and

damages;

$15,000 civil money penalty; and

2 years of intense compliance monitoring by the

CFPB and reporting by ADSS.

CFPB Enforcement of Debt

Collection

CFPB v. Gordon, CV12-06147 (C.D. Cal.

July 18, 2012): CFPB obtained TRO freezing defendants' assets and

appointing temporary receiver.

Complaint alleges, among other things, that

defendants deceived consumers for mortgage relief

services.

CFPB Criminal Referral

U.S. v. Mission Settlement Agency, et al. (May 7,

2013 S.D.N.Y.).

CFPB civil enforcement action and complaint.

Simultaneous criminal indictment filed by U.S.

Attorney for SDNY.

Debt relief company, its president, and three

employees charged with mail fraud, wire fraud,

and conspiracy.

Unprecedented venture into criminal arena.

Disability

Bank of America

(DOJ Settlement Agreement, Sept. 2012):

Bank allegedly required disability income

documents and medical documentation for

mortgage loan applications. Bank agreed to

pay $125,000 to the complainants, conduct

additional training, and application

monitoring.

Fair Lending Risk Management

Compliance Management

Systems: CFPB Expectations

Four components to Compliance Management

System:

Board/Management Oversight: Involvement in

the entire process (creation, implementation, and

review).

Compliance Program: Independent of business

lines; includes policies, training, monitoring, and

corrective action.

Consumer Complaint Management Program.

Compliance Audits: Independent of compliance

and business functions; direct report to board of

directors.

CFPB UDAAP Examination

Training materials;

Disclosures, notices, agreements and account

statements;

Procedure manuals and written policies,

including those related to servicing and

collections;

Minutes of board and committee meetings,

particularly those relating to compliance;

Internal control monitoring and auditing

materials;

CFPB UDAAP Examination --

What Might Be Reviewed?

Compensation arrangements and incentive

programs;

Documentation regarding new product

development;

Marketing and advertising materials (disclosures

important);

Scripts for telemarketing and collections;

Organization charts;

Agreements with affiliates and third parties; and

Consumer complaint files.

UDAAP: Marketing "No-No"s

Targeting of the elderly and military;

Deceptive use of official-looking seals or logos to

suggest government endorsement;

Misrepresentation of costs, terms and risks;

Failure to completely disclose;

Claims that consumer would have no payments

in reverse mortgages even though there are

required payments (e.g., taxes, insurance);

Enclosure of mock checks; and

Suggestion of pre-approval of certain amount.

Compliance Questions

Does compliance with investor requirements

qualify as a legally sufficient justification?

HUD declined to expressly state that

compliance with third-party requirements

constitutes a legally sufficient justification

under the final rule.

Issue therefore unresolved.

Compliance Questions

Are increasing profits or avoiding losses

sufficient justifications?

HUD stated that what qualifies as a

substantial, legitimate, nondiscriminatory

interest is fact-specific and must be

determined on a case-by-case basis.

"Tipping Points" That Spur

Allegations

Common themes in the allegations of discriminatory

pricing or steering:

Broad discretion allegedly resulted in a

"disparate impact" on a prohibited basis;

A lack of clear policies and/or controls governing

the exercise of discretion;

Little or no documentation of the business

rationale for discretionary pricing adjustments;

Financial incentives for loan originators to charge

higher rates or fees or to steer borrowers to

higher cost products.

What Settlement Orders

Teach Us

Settlement orders have important implications for

the level of fair lending risk and financial exposure

facing lenders:

Potential liability can extend several years into

the past (e.g., as far back as 2004 in some

recent cases);

Broadly ranging investigations can be spawned

from a statistical disparity in a single geographic

area or from a consumer complaint or consumer

interest group study alleging discrimination;

Lenders face potential liability for the actions of

third parties such as mortgage brokers.

Key Settlement Themes

Key themes in settlement provisions:

Policies and procedures designed to avoid

discrimination.

Policies defining standards for discretionary

pricing and fees, such as:

Defined limits on pricing discretion.

Written explanations for amounts charged

in excess of some benchmark (including

from brokers).

A prohibition on funding loans that do not

comply.

Settlement Implications

Implications of settlement provisions for fair lending risk

management:

The terms of regulatory settlements tend, over time, to

become regulatory expectations.

Review, revise, and monitor policies, procedures, and

practices with respect to product offerings and pricing

outcomes.

Control, manage, and monitor discretion and

outcomes:

Manage discretionary pricing as you would exceptions,

whether or not they are considered policy exceptions.

Document business justifications for discretionary

pricing and underwriting decisions.