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Volume XII, Number 183

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CFPB Provides New Guidance on Discrimination in Algorithmic Credit Decisions

As we have repeatedly discussed this year in our Financial Services Perspectives blog, the current leadership of the CFPB has placed a significant emphasis upon fair lending. Seemingly once a month, or even more frequently at times, Director Rohit Chopra has announced a new initiative concerning fair lending and discrimination in the financial services industry. In February, for instance, the CFPB released a blog post to discuss possible discrimination in the appraisal process, and in March, the CFPB set forth major changes to its supervisory operations with respect to “unfair” discriminatory practices in the financial services industry. Also in March, Director Chopra issued a statement regarding the final report of the Interagency Task Force on Property Appraisal and Valuation Equity (PAVE) and in doing so, emphasized accuracy and non-discrimination in algorithmic home valuations. To this end, Director Chopra and other CFPB personnel have also made numerous recent public statements to express their concerns regarding “algorithmic bias,” “digital redlining,” and “robo discrimination.”

The trend continued this week, as the CFPB issued a circular (Circular 2022-03) on May 26, 2022, to clarify creditors’ responsibilities to consumers when relying upon “black-box” or “algorithmic” underwriting models to make credit decisions. In conjunction with issuing Circular 2022-03, the CFPB also issued a press release to explain the rationale for issuing new guidance regarding creditors’ adverse action notice requirements under the Equal Credit Opportunity Act (ECOA). Per Director Chopra, “[c]ompanies are not absolved of their legal responsibilities when they let a black-box model make lending decisions,” as “[t]he law gives every applicant the right to a specific explanation if their application for credit was denied, and that right is not diminished simply because a company uses a complex algorithm that it doesn’t understand.”

Circular 2022-03 provides guidance to answer the following question: “When creditors make credit decisions based on complex algorithms that prevent creditors from accurately identifying the specific reasons for denying credit or taking other adverse actions, do these creditors need to comply with the Equal Credit Opportunity Act’s requirement to provide a statement of specific reasons to applicants against whom adverse action is taken?” Given the CFPB’s recent scrutiny of algorithmic loan decision-making, the response to this question was, somewhat unsurprisingly, “Yes.” In answering this question, the CFPB provided the following guidance:

  • “ECOA does not permit creditors to use technology that prevents them from providing specific and accurate reasons for adverse actions. Creditors’ use of complex algorithms should not limit enforcement of ECOA or other federal consumer financial protection laws.” In providing this clarification, the CFPB explained that creditors subject to Regulation B must be able to provide a statement of reasons for any adverse action that (a) is “specific” and (b) indicates the principal reason(s) for adverse action.

  • Creditors cannot justify noncompliance with ECOA based on the mere fact that the technology they use to evaluate credit applications is too complicated, too opaque in its decision-making, or too new. There is no exception for violating the law because a creditor is using technology that has not been adequately designed, tested, or understood. As a result of this guidance, creditors must be in a position to understand the nuances of the technology that provides credit decisions because they must be able to communicate the required adverse action information to consumers.

  • Critically, “[a] creditor’s lack of understanding of its own methods is therefore not a cognizable defense against liability for violating ECOA and Regulation B’s requirements.”

  • The CFPB encouraged whistleblowers to come forward to provide information about “black-box models” that violate various federal consumer protection laws, including ECOA.

In our estimation, there are a number of practical impacts that will follow from this guidance, including:

  • Financial services entities that use AI, machine learning, or other algorithmic coding to help make credit decisions are now clearly on notice that they must comply with ECOA’s adverse action requirements. This will require knowledge of the principal reason(s) for any adverse action in order to communicate that information to consumers.

  • Financial services entities may not use ignorance as an excuse. This is important because many vendors are reluctant to provide the trade secrets/coding underlying their technology, and therefore it is sometimes hard for financial services entities to understand exactly why an adverse action has been taken. It is clear, in light of Circular 2022-03, that vendor management is now going to be a bigger issue – and compliant financial services entities will need to work with vendors to provide some transparency to allow for fulsome adverse action statements to consumers.

  • In addition to ECOA/Regulation B impacts associated with this guidance, it is important to remember that discrimination is now considered to be a UDAAP per recent CFPB guidance. As a result, the information financial services entities are now required to understand to comply with adverse action requirements is also subject to being measured for discrimination analysis purposes.

Takeaway

This most recent CFPB circular lies at the nexus of two important regulatory trends: an increased focus on fair lending and multiple statements about the importance of vendor management. Because most lenders seeking to utilize algorithmic credit decisioning will use outside vendors with the requisite technical capability, it is critical that lenders be prepared to require – as a term of a vendor services agreement – that the service provider has the capability to ensure that Regulation B’s adverse action notice requirement can be met. Moreover, lenders currently using these models must take time to ensure that their current vendors provide discrete reasons for the adverse action. Lenders should remember that, ultimately, a vendor’s ability to do business with them depends on their ability to facilitate compliance with the universe of federal laws and regulations.

© 2022 Bradley Arant Boult Cummings LLPNational Law Review, Volume XII, Number 147
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About this Author

Andrew J. Narod Financial Lawyer Bradley Arant Boult Cummings LLP
Partner

Andrew Narod is an experienced litigator who represents bank and non-bank financial services institutions and other types of businesses in class-action litigation, complex commercial litigation, and other high-profile litigation disputes nationwide. His clients entrust him to navigate some of their most sensitive litigation matters in some of the most difficult venues in the country.

A considerable amount of Andrew’s practice is devoted to representing bank and non-bank financial services entities in class-action litigation and other consumer litigation matters. His clients include...

202-719-8271
Christopher Friedman Nashville Lawyer Bradley Arant Boult Cummings Law Firm
Associate

Chris Friedman is a regulatory compliance attorney and litigator who focuses on helping consumer finance companies and small business lenders, as well as banks, fintech companies, and other participants in the financial services industry, address the challenges of operating in a highly regulated sector. Chris focuses on both small business lenders and alternative business finance products and has helped non-bank small business lenders, banks who make small business loans, commercial credit counselors, lead generators, and others in the industry. He helps clients launch new products,...

615-252-3504
David T. Long Jr. Associate Bradley Arant Boult Cummings LLP
Associate

David Long counsels clients in complex banking and financial services matters in both state and federal courts across the country. Based upon the specific needs of his clients, he advises individuals and corporate clients on their claims and outlines strategies to achieve the best result for each client.

David also has extensive experience representing and advising multinational corporations to ensure compliance with state and federal regulations.

*Admitted only in Virginia; practicing law in the District of...

202-719-8239
Beryl Newchurch Billings Financing Attorney Bradley Arant Boult Cummings Birmingham
Associate

Beryl Billings is an associate in the Banking and Financial Services Practice Group.

Beryl received her J.D. from the University of Tennessee College of Law. While in law school, she was a judicial intern for the Hon. R. David Proctor of the United States District Court for the Northern District of Alabama. She earned a B.S. in Political Science from Spring Hill College, where she was captain of the women’s soccer team and served as president of the Student Athletics Advisory Committee.

205-521-8800
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