On September 28, 2022, several industry groups representing banks and other entities subject to regulation by the Consumer Financial Protection Bureau, including the United States Chamber of Commerce, filed suit against the CFPB over the agency’s controversial updates last spring to its supervision manual. Those updates indicated the CFPB’s intent to examine financial institutions for potential discrimination under its authority to enforce violations of the Consumer Financial Protection Act of 2010’s (“CFPA”) prohibition against unfair, deceptive, or abusive acts or practices (“UDAAP”).
Our previous post on the Bureau’s examination manual updates can be found here. In announcing this update, the Bureau noted that it will closely examine financial institutions’ decision-making in advertising, pricing and other areas, as well as institutions’ use of algorithms and artificial intelligence (“AI”) models, for any discriminatory practices that could form the basis of potential UDAAP violations. CFPB Director Chopra has been outspoken about the potential for AI systems throughout the financial industry to perpetuate discriminatory outcomes. The CFPB’s updated supervision manual underscores these concerns by empowering examiners to (i) consider “discriminatory outcomes” on different demographic groups and (ii) request documentation regarding an institution’s use of models, algorithms and decision-making processes.
The lawsuit contends that, by proposing to expand its authority to examine institutions for discriminatory practices or discriminatory effects across various consumer financial products or services, the CFPB overreached its statutory authority under the CFPA, acted in an arbitrary and capricious manner, and failed to follow required notice-and-comment procedures in violation of the Administrative Procedure Act (“APA”), 5 U.S.C. § 551 et seq. Among other allegations, the trade groups argue that the CFPA does not provide sufficient authority for the CFPB to pursue disparate impact claims based on acts or practices that, regardless of intent, have a disproportionate negative impact on a protected class. With respect to disparate impact, the lawsuit argues that, by failing to provide instruction on what might constitute actionable disparate impact under the CFPA, including by not identifying protected classes or explaining how institutions should test for discrimination, the CFPB has increased compliance costs on institutions that must guess at what the Bureau might deem discriminatory.
The lawsuit is also the latest vehicle in which industry groups are challenging the CFPB’s funding mechanism as violating the Appropriations Clause of the United States Constitution. (The inclusion of several Texas plaintiffs undoubtedly seeks to take advantage of what is likely a receptive Fifth Circuit Court of Appeals to this argument, as indicated by concurring opinions by five judges in an en banc decision last spring concerning a CFPB enforcement action against All American Check Cashing, Inc.)
The district court may not need to reach the constitutional question, however. At the heart of this case is whether unfairness under the CFPA encompasses acts or practices that treat consumers disparately or have disparate impacts on consumers. Under the CFPA, an act or practice is unfair if it: (1) causes or is likely to cause substantial injury to consumers; (2) that is not reasonably avoidable by consumers; and (3) is not outweighed by countervailing benefits to consumers or competition. 12 U.S.C. § 5531. It is the last prong of the UDAAP analysis that cuts against the use of unfairness as an appropriate theory to challenge discriminatory conduct.
The typical unfair act or practice is undertaken by an entity for its benefit at the expense of both consumers and competition. For example, an institution might cut costs by not mailing certain required regulatory notices, a practice that would likely fail to benefit both consumers and compliant competitors, as compared to the potential injury consumers would suffer. A different practice could disparately impact certain consumers but could potentially benefit competitors whose practices do not distinguish among consumer populations, and thus would have to be weighed carefully to evaluate its potential unfairness within the meaning of the CFPA.
Contrast this with the analysis under the Equal Credit Opportunity Act (“ECOA”), which Congress passed in 1974, and makes discrimination against consumer and small business credit applicants on the basis of, among other things, membership in certain protected classes categorically unlawful. Under ECOA and its implementing Regulation B, a practice with a disparate impact on borrowers would be unlawful, unless “the creditor practice meets a legitimate business need that cannot reasonably be achieved as well by means that are less disparate in their impact.” 12 C.F.R. Part 1002 Supp. I Sec. 1002.6(a)-2.
UDAAP is a powerful tool, but using it to police discrimination in the consumer finance market places might stretch it beyond its limits.
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