The Supreme Court’s recent ruling that the disparate impact theory of liability can be applied to the Fair Housing Act means mortgage lenders must be even more vigilant in their ongoing testing and evaluation of business practices that could be interpreted as even unintentional discrimination.
Among other things, the Fair Housing Act makes it illegal to “refuse to sell or rent, to deny or otherwise make unavailable a dwelling to a person…or to discriminate against any person making certain real estate transactions because of race or other protected characteristic.”
The Court, which split 5-4 on the case, ruled that the language in the Department of Housing and Urban Development’s Fair Housing Act, including the phrase to “otherwise make unavailable” indicated that neutral policies and/or practices that cause discriminatory effects could be subject to action, even if intent to discriminate isn’t found.
In a disparate treatment case, a lender accused of discrimination would only need to provide (not prove) that a practice or policy that has a discriminatory effect had a legitimate, nondiscriminatory reason. As long as a plaintiff could not prove the policy or practice was a pretext for discrimination, the lender prevails.
In a disparate impact case, the burden on the lender is far greater. Instead of having the burden to articulate a legitimate reason, a plaintiff merely needs to show that a seemingly-neutral policy caused discrimination. Once that is shown, the burden shifts to the lender to prove that the practice in question is a business necessity.
A business necessity is a practice that serves the legitimate employment goals of the lender in a significant way. Importantly, in describing the business necessity defense, the Court noted that businesses need to be free to make “practical business choices and profit-related decisions that sustain a vibrant and dynamic free enterprise system.”
Yet, even if a lender meets this burden, the plaintiff might still prevail by showing that other practices would serve the lender’s interest with less of a discriminatory effect.
Ultimately, what this means for lenders is that regular regression testing is essential. A lender with disparate lending patterns will have to prove that any challenged practices are necessary, and such practices were put into place due to a lack of less-discriminatory alternatives available to reach the same goal.
Lenders should also immediately review their pricing policies; the discretion given to loan officers in pricing; pricing exception policies; and branch, loan officer and manager compensation practices.
Obviously, lenders who do not have statistically significant lending disparities do not have to worry about disparate impact claims, but they cannot thumbnail such conclusions or merely rely upon shortcuts.
Lenders must perform regular regression analyses consistent with those performed by the Equal Employment Opportunity Commission, and should do so at corporate, branch and regional levels.
Moreover, lenders should carefully examine the reasons why they maintain certain pricing and compensation practices and ensure they can explain their necessity, even if no disparity exists.
Many lenders will need to consider placing additional controls in place so as to ensure their policies and practices are not unnecessarily broad.
Beyond the compliance concerns, lenders should consider how this decision could impact day-to-day business. In many respects, larger institutions will need to be more careful about pricing and compensation. Even small numerical disparities can give rise to statistically significant disparities given the overall volume of business.
The bandwidth of a standard deviation (the test that measures the disparity) gets smaller the larger the number of data points.
Smaller lenders in fact, could actually benefit because the smaller number of files likely provide a slightly greater degree of flexibility. Since pricing will likely need to be flatter across the board, lenders that are capable of providing more personalized service and faster decision-making will have an advantage.
Relationships with referral sources and overall reputation for service will be key as the pricing distinctions become blurred.
Overall, the Supreme Court’s decision will significantly affect the lending industry and lenders should carefully evaluate their compliance, origination, pricing and compensation strategies.