United States: The "Spitzer Effect" On Administrative Fair Lending Enforcement

Recent press releases by consumer advocates and state officials have indicated that these groups believe that the 2004 HMDA data will support claims of fair lending violations by mortgage lenders and other entities. Among other things, many consumer advocates and governmental entities have pointed out that data voluntarily released by mortgage lenders includes several troublesome elements, including evidence of a higher "incidence" of certain minorities receiving "reportable loans," as well as evidence that minorities receiving reportable loans may be disadvantaged in the APR received as compared to similarly situated non-minority individuals.¹

Notwithstanding these press reports, up until very recently the federal agencies responsible for the enforcement of the fair lending laws had maintained a neutral policy position, and in fact issued a joint press release that supports the view that the 2004 HMDA data will not—at least on a stand-alone-basis—support a claim of discriminatory lending by mortgage lenders.²

This neutral position by the federal regulators has apparently changed as a result of the entry into the debate by New York’s Attorney General, Elliot Spitzer. Mr. Spitzer recently issued a series of high-profile press releases involving the issuance of administrative subpoenas against several lenders operating in the State of New York.

Almost immediately following Mr. Spitzer’s media blitz, the administrative landscape became more chaotic. First, the Federal Reserve Board (the "FRB") staff indicated that the FRB has revised its timetable to complete and issue its compilation of the 2004 HMDA (which the FRB staff had previously announced would be delayed until September of this year). Based upon informal conversations this year, it now appears that the FRB may issue its compilation of the 2004 HMDA data for each HMDAreporting lender on or about August 1.

Second, even though many other state agencies charged with fair lending enforcement already were actively preparing for investigations and possible enforcement actions, Mr. Spitzer’s public pronouncements spurred the FRB to accelerate its regression analysis of entities regulated by federal agencies, including the federal banking agencies, the Department of Housing and Urban Development ("HUD") and the Department of Justice (the "DOJ"). Moreover, these federal agencies appear to have initiated their own internal discussions to review the data prior to the release of the FRB’s compilation and analysis to the public—the result being that it is now more possible these agencies may commence investigations or enforcement actions prior to August.³

Third, whether or not Mr. Spitzer’s actions caused or were merely coincidental to the determinations by the federal agencies to revise their respective policy and enforcement positions, the fact remains that there is a pronounced heightened awareness among state and federal regulatory agencies of the possible need to respond to the regulatory challenge presented by the release of the 2004 HMDA data. Accordingly, this issue of Reed Smith’s Fair Lending Update summarizes the statutory and regulatory authorities of the primary federal and state agencies that are likely to be active in the fair lending arena, including: (a) the federal banking agencies; (b) HUD and the DOJ; (c) state fair lending and antidiscrimination agencies; and (d) state attorneys general.

As noted in a recent Reed Smith client memorandum on the subject, the federal banking agencies (the "Banking Agencies") possess extraordinary authority to examine and take enforcement action against bank and savings and loan holding companies, FDICinsured institutions, and their subsidiaries and affiliates.⁴

As a part of this authority, the Banking Agencies are charged with enforcement of the Equal Credit Opportunity Act (the "ECOA") and the Fair Housing Act (the "FHA")⁵ . A favored tool to accomplish this goal is the use of the examination and supervision authority, which traditionally has been deemed by the Banking Agencies to permit them to review virtually all documents within the examination review authority of the particular Banking Agency. While the issue is not without doubt, the Banking Agencies have frequently taken the position that this authority includes access to data that would otherwise be deemed privileged when held by nonregulated companies.⁶

In addition to this authority, the ECOA and the FHA require that the Banking Agencies refer a supervised institution or affiliate to HUD or the DOJ upon a determination that the supervised entity has engaged in a pattern of discriminatory lending behavior.⁷ This factor alone frequently requires entities under scrutiny by a Banking Agency for alleged discriminatory lending to cooperate in any manner possible in order to avoid referral to a less friendly agency (i.e ., to HUD or the DOJ).

A copy of the Reed Smith client memorandum discussing in detail responding to examination and enforcement actions by the Banking Agencies—including enforcement authority pursuant to Section 8 of the Federal Deposit Insurance Act—is available at the Reed Smith web site.

Besides the special jurisdiction for financial institutions granted to the Banking Agencies, HUD and the DOJ share primary responsibility for the administrative enforcement of the fair lending laws—which is described at length in the implementing regulations of the ECOA and the FHA.

As a general matter, HUD has traditionally performed an investigative and oversight function, partly because of its office of Fair Housing Enforcement—which focuses on that policy objective. However, as witnessed by the activism displayed during the Clinton Administration, the DOJ’s investigative and enforcement capabilities are co-extensive with that of HUD, and are less frequently employed only because of prioritization of missions between those federal agencies.

Lenders should be aware that both HUD’s and the DOJ’s record of fair lending enforcement indicate a pronounced focus on ECOA and FHA violations that are susceptible to a disparate treatment (i.e ., intentional discrimination) analysis. Stated another way, cases these agencies have elected to prosecute have virtually all been relatively straightforward and easily proved because the element of specific intent to discriminate has arguably been clear in all such cases. Again, in virtually all instances the cases brought were investigated and settled—with the complaints and settlements filed simultaneously.

Unlike the procedural ambiguity frequently experienced with state agencies, discussed below, both the DOJ and HUD possess significant sophistication and expertise—which argues strongly on the part of a targeted lender to actively participate in investigations and any analysis conducted by agency staff personnel. Specifically, our experience is that the DOJ and HUD are receptive to explanations regarding favorable data interpretation and mitigation information—both of which diminish the value of instituting a high-profile enforcement action.

Of course, the critical element for successfully participating in any administrative investigation or enforcement action is preparation— which we strongly recommend be undertaken by all HMDAreporting lenders immediately. For example, in instances in which raw HMDA data suggests lending disparities between racial or ethnic groups, such disparities might be explainable by the application of race-neutral loan factors such as risk-based pricing, credit history, LTVs, income, appraisals and similar mortgage lending factors. (In regard to mitigation, evidence of broker supervision, fair lending compliance and non-targeted advertising programs may all be useful to reduce or diminish perceived culpability.) Following the completion of a more through analysis, a media-friendly presentation might be considered in anticipation of press inquiries that are likely to occur.

The FHA and the ECOA create a multi-tiered and parallel course of administrative remedies to address allegations of discriminatory lending conduct. While HUD might be viewed as sharing at the federal level co-equal jurisdiction with the DOJ to investigate claims of discrimination, the FHA also creates a referral system to state and local agencies that are authorized to receive discrimination claims and investigate the same upon the receipt of a HUD referral.

The list of authorized or "certified" state and local agencies is extensive, and in many jurisdictions includes not only state agencies but local and regional entities as well.⁸ These state agencies are part of the "substantial equivalency" program supervised by HUD that permits a state or local agency to apply pursuant to Section 810 and 817 of the FHA for a determination by HUD that the state agency enforces a law that provides "substantive rights, procedures, remedies and judicial review provisions that are substantially equivalent" to the FHA.⁹ The net effect of HUD’s certification process has been to underwrite through federal funding the creation, organization and operation of state and local enforcement entities that possess discretion to prioritize local discrimination claims—and to investigate and prosecute the same.

Unfortunately, while many of these state and local agencies have diligently attempted over the years to fulfill their respective policy missions and directives, they may be ill-equipped to address fair lending claims—particularly disparate treatment and disparate impact claims that might be based upon the 2004 HMDA data. For example, even though many state agencies may be loath to admit as much, state anti-discrimination laws as applied to mortgage lending are neither well defined in regard to tests and proofs imposed on the parties nor do they clearly delineate available remedies. Specifically, many of the burdens of proof imposed for allegations of "disparate treatment" or "disparate impact" have either never been clearly articulated or have been adopted in judicial settings in which a "result orientation" is clearly discernable by the written determinations of the courts or administrative entities.

As evidenced by recent anecdotal experiences reported by mortgage lenders, due process protections imbedded in administrative procedures are frequently overlooked or else completely ignored by agency staff. For example, many lenders have received extraordinarily broad requests for documents and data that exceed local jurisdictional limits, or are unmanageable in regard to scope and operational limitations relating to data retrieval.

When faced with this dilemma—which we believe may become a frequent occurrence in the next several months—lenders receiving requests for fair lending data whether on a voluntary or involuntary basis will likely be forced to determine an appropriate response in an environment in which procedural objections to discoverable materials may not be recognized. Among other things, this may mean intervening at the staff level of the state or local agency and negotiating acceptable compliance to a formal or informal investigative subpoena or similar inquiry.

Finally, we note that interaction with state agency personnel presents the opportunity to engage in educating the staff personnel about the targeted company, as well as in presenting the lender’s own HMDA analysis in a manner that attempts to anticipate and respond to possible allegations of discriminatory behavior. (Again, preparation is the critical element to implement this strategy.)

The laws of every state invest the office of the attorney general with the enforcement of local laws and regulations—and provide broad investigative and enforcement authority to attorneys general to prioritize and remedy violations that impact the public weal.

While it is impossible to compartmentalize the approach of every state attorney general regarding effectuation of this public policy mandate—particularly in regard to the enforcement of state fair lending laws—it is also impossible to ignore the frequent interaction between a determination by a state attorney general to initiate a high-profile investigation and an underlying political agenda.

We note that, while it is not infrequent at the state agency level to encounter staff personnel ignoring procedural safeguards in their zeal to effectuate fair lending policy, our experience is that state attorneys general frequently ignore statutory and regulatory limits on their investigative authority in order to promote high-visibility media events. This places targeted entities in the position of attempting to respond to investigative requests for information with knowledge that a particular outcome to a investigation has been pre-determined.

In a typical business situation that does not involve fair lending concerns, it is not uncommon for a targeted entity to cooperate with an attorney general investigation because of the value of a prompt settlement with the government. However, this tactical option may not be as useful in the fair lending context because of extensive— and unknown—civil damage exposure, as well as reputational issues that could result in severe business interruption or protracted additional administrative actions such as license revocation.

If faced with an investigative demand by an attorney general or similar entity, it is essential that a lender appreciate the potential political implications of the situation. Clearly, dialogue and negotiation may be essential to create an atmosphere in which an optimal resolution might be achieved—assuming that the merits are being fairly and objectively received and reviewed by staff personnel.

In the situation in which meaningful negotiation is of no value, we note that strategic determinations might be required, such as insistence upon compliance with procedural requirements. In addition, we also note that the charter form of an entity under investigation may be pertinent. Both the OCC and the OTS have indicated in various pronouncements over the past several years that state discrimination laws are either preempted—or else the enforcement authority for such laws lies with the federal regulators.

This article is presented for informational purposes only and is not intended to constitute legal advice.