July 2022 OBA Legal Briefs

• What’s new with Reg B? – A Lot!
• Electronic liens

What’s new with Reg B? – A lot!

by Andy Zavoina

In a world where Reg B has essentially been around since 1974 when Congress passed the Equal Credit Opportunity, after all these years there can’t be much new to it – right? WRONG! While it has not changed recently, Reg B has been in the news – a lot!

In this issue we will examine an advisory opinion from the CFPB on Reg B which describes some protections that apparently some creditors, “just don’t get” as to who is protected by Reg B and ECOA and deserving of required notices when adverse action is taken. Then we will look at another gray area involving adverse action notices and what information is not just a good idea to provide, but your legal requirement.

First, you may be asking if there is nothing new, why is Reg B worthy of this space and more importantly, your time? We need to start with a court case, Fralish v Bank of America. I will recap that case in a moment because it is what lead to a 16-page Advisory Opinion from the Consumer Financial Protection Bureau (CFPB). Understanding this requires some background on Reg B and this was described in detail in the Advisory Opinion. This background will also help you understand a second topic which pertains to a discussion clarifying why adverse action notices are given. Understanding their purpose helps us understand why there are content requirements for these disclosures. And last, we will do a little analysis on adverse action notices and what should be there, perhaps in moderation but in a misunderstood way, not necessarily.

Define Applicant

Fralish v. Bank of America (3:20-CV-418 RLM-MGG, United States District Court, Northern District of Indiana) is a suit brought by John Fralish in which he alleged Bank of America violated his rights under the Equal Credit Opportunity Act, which is implemented by Reg B. The suit actually cites the law at 15 USC § 1691(d) which addresses adverse action and notice requirements. Fralish had an existing loan account with Bank of America. That credit line was terminated. Fralish was not informed of the reasons for the adverse action and initiated a lawsuit for violations of the ECOA and Reg B.

In the U.S District Court, Bank of America moved for a judgment based on the pleadings as it contended that Fralish had no standing to sue under ECOA because he was not an “applicant” as defined in the law. Under ECOA, 15 USC 1691a(b), an applicant is defined as “any person who applies to a creditor directly for an extension, renewal, or continuation of credit, or applies to a creditor indirectly by use of an existing credit plan for an amount exceeding a previously established credit limit.” Bank of America was defending itself based on this definition maintaining that Fralish had not applied for any credit.

Reg B at § 1002.2(e) defines an applicant as, “any person who requests or who has received an extension of credit from a creditor, and includes any person who is or may become contractually liable regarding an extension of credit.”

The court also reviewed “adverse action.” as Fralish maintains he received no notification as to Bank of America’s reasoning for its action. “For purposes of this subsection, the term ‘adverse action’ means a denial or revocation of credit, a change in the terms of an existing credit arrangement, or a refusal to grant credit in substantially the amount or on substantially the terms requested. Such term does not include a refusal to extend additional credit under an existing credit arrangement where the applicant is delinquent or otherwise in default, or where such additional credit would exceed a previously established credit limit.” Key terms here are “revocation of credit, a change in the terms of an existing credit arrangement.” Must there be an application pending for a revocation of credit to be adverse action deserving a formal notice? That was one of the legal questions requiring an answer.

Bank of America maintained Fralish needed to show four points to continue his suit. That:

(1) Bank of America is a “creditor”;
(2) Mr. Fralish is an “applicant”;
(3) The Bank took adverse action with respect to his application for credit; and
(4) The Bank failed to provide Mr. Fralish with a notification that complied with the ECOA.

While Bank of America believes that to be an applicant as the term is defined, there must be a request for credit pending. The September 29, 2021, final decision from the court notes, “The vast majority of courts that have addressed the issue have found that the statutory definition of “applicant” is not ambiguous, and that existing account holders, like Mr. Fralish, aren’t “applicants” within the plain meaning of the ECOA because they weren’t applying for an extension, renewal, or continuation of his existing credit when the alleged violation (in this case the alleged failure to provide the notice of adverse action required under the statute) occurred, and don’t have standing to bring a claim under the ECOA’s notice provisions. The court finds the reasoning of those cases persuasive.”

This seemed to set of a bit of a compliance firestorm. By December the CFPB, the Federal Trade Commission, the U.S. Department of Justice and the Board of the Federal Reserve filed friend of the court (amicus) briefs with the United States Court of appeals for the Seventh Circuit. The CFPB said it was standing up for civil rights protections.

The CFPB’s premise is that if Bank of America argues, and a court agrees that the creditor can disregard ECOA provided rights for existing customers, it undermines the intended antidiscrimination protections. Acceptance of this could mean that a bank could offer a credit card, as an example, to a protected class and the law is complied with. It could then revoke that credit line because of the applicant’s demographics and because the consumer was not an applicant, it would still be compliant with the law.

Now fast forward to May 18, 2022, when the CFPB issued an Advisory Opinion on this topic. For the management version, succinctly it says that to comply with the spirit and intent as well as the commonly accepted definitions, a bank must provide ECOA and Reg B protections to the applicant throughout the life of the loan. An applicant’s rights do not end upon approval of a credit request.

Now the longer explanation adapted from the Advisory Opinion because these details must be understood by those who manage compliance in your bank.
To begin with, the Advisory Opinion applies to all “creditors” as this is a defined term under section 15 USC 1691a(e). It includes, “any person who regularly extends, renews, or continues credit; any person who regularly arranges for the extension, renewal, or continuation of credit; or any assignee of an original creditor who participates in the decision to extend, renew, or continue credit.” Yes, your bank is definitely a creditor.

And now let’s look at what an Advisory Opinion actually is. The CFPB is the agency empowered to interpret Reg B and, in this case, the Advisory Opinion is an interpretive rule under the Administrative Procedure Act (APA) that responds to a specific need for clarity on a statutory or regulatory interpretive question. It is not a change in a law or regulation and therefore requires no advance notice or comment period. It is the official interpretation. Period. As you will read the CFPB is providing the interpretation as an instructive document for banks, but it also seems to be directed to at least some courts. I recall a bit of a quip from a TV judge who said, “he wasn’t last because he was right, he was right because he was last.” The CFPB believes this is the last word.

The summary of the Advisory Opinion affirms Reg B protects those actively seeking credit as well as those who sought and received credit. To support this position the document states ECOA made it unlawful for “any creditor to discriminate against any applicant on the basis of sex or marital status with respect to any aspect of a credit transaction.” From the beginning, this prohibition has protected both those actively seeking credit and those who sought and have received credit.

ECOA has always defined “applicant” to mean “any person who applies to a creditor directly for an extension, renewal, or continuation of credit, or applies to a creditor indirectly by use of an existing credit plan for an amount exceeding a previously established credit limit.”

Here I must emphasize that ECOA’s prohibition on discrimination “applies to all credit transactions including the approval, denial, renewal, continuation, or revocation of any open-end consumer credit account.” I was always taught and do teach that Reg B applies to the entire life of a credit transaction. This is stated at § 1002.4(a) of Reg B, “A creditor shall not discriminate against an applicant on a prohibited basis regarding any aspect of a credit transaction.” “Any aspect” means the application, the credit decision process, terms, collections, etc. “All aspects” means all aspects. In the Bank of America case better legal minds than mine are arguing that the definition in ECOA is more limiting. As bankers we know we must follow Reg B which implements it. It makes me wonder if the attorneys are arguing their point because they must for their client, or because they believe that is a correct interpretation and action, with no regard for Reg B.

When ECOA first passed, the Federal Reserve had rule-writing and interpretive authority. To substantiate that the CFPB’s opinion is not new, it states “Reg B made clear that the new law’s protections against credit discrimination cover both those currently applying to receive credit and those who have already received it. It did so by defining ‘applicant’ to expressly include not only ‘any person who applies to a creditor directly for an extension, renewal or continuation of credit’ but also, ‘[w]ith respect to any creditor[,] . . . any person to whom credit is or has been extended by that creditor.’”

The original ECOA prohibited discrimination based on sex or marital status. Two years after ECOA passed, Congress added to the prohibited bases six more items, race, color, religion, national origin, age, and receipt of public assistance. It also added, “[e]ach applicant against whom adverse action is taken shall be entitled to a statement of reasons for such action from the creditor.” The amendments defined “adverse action” as “a denial or revocation of credit, a change in the terms of an existing credit arrangement, or a refusal to grant credit in substantially the amount or on substantially the terms requested.” Going back many years to compliance school in Norman we learned that adverse action notices were required when, as an example, a borrower did something and was no longer qualified for their credit. Applicants, (read that also as borrowers) are entitled to an explanation when adverse action is taken.

This explanation meets two objectives for ECOA and Reg B. It protects the consumer when an explanation must be provided because the bank knows it will have to provide a reasonable explanation. Reg B was enacted before my time on a compliance desk, but I heard stories from the old-timers who were there. I recall one who said he knew “a good ol’ boy” on the loan desk who swore if he had to make a loan to an unmarried woman he’d retire. And he did – retire. We could not fathom such an attitude today and would never expect to read as a reason for denial, “single woman.” Providing actual reasons for a declination of a loan request helps protect the applicant from an illegal discrimination-based decision.

The second objective is informing the applicant. When John Smith Sr. is denied a loan due to bad credit, he is told why that decision was made. Senior is also advised that a credit report was used and under the Fair Credit Reporting Act he knows which agency provided the information and can contact them to find out what was reported. Senior might then confirm the report with the creditor only to discover that it was actually John Smith Jr’s account that was bad. Very similar name, same address, erroneous reporting. Senior can then reapply and the corrected credit report should no longer be an obstacle. The same holds for debt-to-income ratios or too short a period of employment. When an applicant is informed as to the reasons for adverse action, they may be able to correct an error or have known parameters that must be met to qualify for credit with your bank. When the person can fix these issues, they are more likely to return to you because they believe they have overcome the stated objections to their last application.

The 1976 ECOA amendments not only included in adverse action the termination of an account or an unfavorable change in terms that does not affect all or substantially all of a class of the creditor’s accounts, but it required a statement of reasons. These are required to be specific and indicate the principal reasons causing the adverse action. We will discuss the reasons in more depth in a few minutes. For this Advisory Opinion and the Fralish case, suffice it to say that a reason must be provided and here, Bank of America failed to provide any because it maintains Fralish was not protected by the ECOA.

During this amendment, the Federal Reserve Board made a “minor editorial change” to Regulation B’s definition of “applicant.” The intent was to “express more succinctly the fact that the term includes both a person who requests credit and a debtor,” a debtor being one who has already requested and received credit.

Reg B originally defined “applicant” to include anyone who “applies to a creditor directly for an extension, renewal or continuation of credit” as well as, “with respect to any creditor . . . any person to whom credit is or has been extended by that creditor,” the revised definition clearly stated that “applicant” includes “any person who requests or who has received an extension of credit from a creditor.”

Bank of America was not alone in its stance on ECOA’s definition and application of the term “applicant.” The CFPB noted that other creditors also did not agree that both ECOA and Reg B apply to that debtor after an extension of credit is made and includes treatment when there is a revocation of credit or an unfavorable change to the terms of that credit agreement. It went on to say, “some creditors fail to provide applicants with required notifications that include a statement of the specific reasons for the adverse action taken or disclose an applicant’s right to such a statement.” As further explanation, a footnote stated,

Credit cards are one of the most commonly held and widely used financial products in America—over 175 million Americans hold at least one credit card. During the COVID-19 pandemic, credit cards played a vital role as both a source of credit in emergencies and a payment method as more transactions occurred online. According to the CFPB’s 2021 Credit Card Report, about 2%, or over 10 million credit card accounts, were closed in 2020 and consumers with low credit scores are two to three times more likely to have their accounts closed than those with a higher credit score. See Bureau of Consumer Fin. Prot., The Consumer Credit Card Market (Sept. 2021). Additionally, the same report shows that over 10 million accounts experienced a credit line decrease in 2020. See also 5 Reasons Credit Card Companies Close Accounts Without Notice – And How to Fix Them, USA TODAY (July 13, 2021).

To reinforce its opinion that the protections an applicant receives extend beyond the granting of a loan, it drew a parallel to a Supreme Court case, Robinson v. Shell Oil Co., where the Court held the use of “employees” in the Civil Rights Act of 1964, Section 704(a) included former employees who were subjected to discriminatory treatment as well. Justice Thomas explained in the decision that, “at first blush, the term ‘employees’ . . . would seem to refer to those having an existing employment relationship with the employer in question,”… that “initial impression … does not withstand scrutiny in the context of § 704(a).”

The Court observed, there is “no temporal qualifier in the statute such as would make plain that § 704(a) protects only persons still employed at the time of the retaliation.” The same reasoning applies to the term “applicant” in ECOA, which is not expressly limited to those currently in the process of seeking credit.

The Advisory adds to this that,

Reading ECOA’s definition of “applicant” alongside the Act’s other provisions makes clear that the term includes applicants who have received credit and become existing borrowers. For example, ECOA’s core anti-discrimination provision protects “applicant[s]” from discrimination “with respect to any aspect of a credit transaction”—not just during the application process itself. The phrase “any aspect of a credit transaction” is most naturally read to include both the initial formation of a credit agreement as well as the performance of that agreement. Consistent with this ordinary meaning, Regulation B has always defined the term “credit transaction” to encompass “every aspect of an applicant’s dealings with a creditor,” including elements of the transaction that take place after credit has been extended.”

Adverse action notices

Let’s spend a moment now on the notification of adverse action to an applicant. ECOA’s disclosure provision requires that creditors give a statement of reasons to “each applicant” against whom they take “adverse action.” In ECOA, adverse action is defined to include a “revocation of credit” as well as a “change in the terms of an existing credit arrangement.” Connecting the dots, the CFPB points out these are actions that can be taken only with respect to persons who have already received credit.

ECOA’s private right of action points in the same direction. It allows an aggrieved “applicant” to bring suit against creditors who fail to comply with ECOA or Reg B. These references to “applicant[s]” cannot be interpreted then, to refer only to those with credit applications awaiting decisions. Otherwise, a person whose application was denied on a prohibited basis would have no recourse under ECOA’s private right of action.

The point of the Advisory Opinion is to clarify any misunderstandings of these terms and the CFPB is pointing that out to courts and the judges who make rulings. The CFPB states, “Those courts that have properly read the term “applicant” in its statutory context, including the only court of appeals to have addressed the issue, have agreed that the statute protects existing borrowers.” Obviously then, it is stating there are courts which have ruled otherwise, and those lower courts were wrong. The Advisory goes on to say,

The Bureau acknowledges that a few other district court decisions have interpreted “applicant” to include only persons actively seeking credit, but the Bureau does not believe this interpretation is persuasive. No court of appeals has endorsed these district courts’ narrow reading. These district court decisions read “applicant” in isolation instead of reading this statutory term in context, as required by the Supreme Court. For example, these decisions did not attempt to square their interpretation with ECOA’s requirement that “applicants” receive an explanation when their existing credit is terminated or modified. Nor did they grapple with the clear loophole their interpretation would create or the degree to which it would frustrate the Act’s remedial purposes.

The point is to be clear that no court of appeals has disagreed with this interpretation of the term “applicant.”

In researching “John Fralish,” in addition to the suit against Bank of America in 2021, I also found John Fralish v Digital Media Solutions, (CASE NO. 3:21-CV-00045-JD-MGG) in 2021 dealing with spam calls to Fralish after his cell phone was on the Do Not Call list. There is also a class action suit against Early Warning Services, LLC in 2021 for violation of the Fair Credit Reporting Act. Early Warning Services is a consumer reporting agency out of Scottsdale, Arizona. It describes itself as being bank-owned and it sells credit reports to over 2,500 financial institutions. Fralish requested copies of his credit reports after being denied credit with one or more of his creditor banks. He claims to have not been advised by the lender why his credit was denied and he requested a copy of his credit report to review what his bank may have seen. This would allow him to have incorrect entries fixed but he was not provided with the information Early Warning Systems had on him.

I cannot render any opinions on the lawsuits involving John Fralish as I have no idea how much merit any of them has. But I will emphasize that compliance with the letter of the law, and the banking regulation, will help a bank avoid becoming the subject of a lawsuit, especially from a consumer looking for that single violation and an opportunity to file an action or class action suit. Often a bank will settle with a litigant to make the case go away and avoid the expense of a protracted lawsuit. The alternative may be to defend what your interpretation is and to pay for those legal defense costs for potentially years to come. Yes, your bank has to worry about that litigious consumer, but there is less worry if you stay current on the compliance requirements, train staff, and follow sound policies and procedures. I’m hoping your bank did not pass on studying this Advisory Opinion as it is the CFPB that has the last word on interpretating ECOA and its implementing Reg B. And the CFPB is not afraid to tell that to the courts as well. For a bank to challenge that it would need a very strong case and six or seven digits to the left of the decimal place in the legal defense section of its budget.

Recommended action

We recommend that banks take this opportunity to review Reg B and fair lending policies and procedures to ensure they are clear as to protections a customer has and that these are considered throughout all aspects of the life of a loan.

As you have read in prior Legal Briefs the CFPB has also opined that discriminatory acts are unfair. Read that to say that your deposit customers who are not protected under fair lending laws are protected under the prohibition on Unfair, Deceptive, or Abusive Acts or Practices (UDAAP), so broadly review fair lending more in the terms of fair banking.

We expect to see the CFPB continue to expand its supervisory and enforcement actions going forward. This is especially so in the area of fair lending/banking as the current administration has made fair access, including to credit, and equal treatment of all people a priority.

Reasons for Adverse Action

We have established that adverse action notices may be required to be given to an applicant and the purpose of such a disclosure includes stating the reason or reasons for denial. It is time to explore two facets of what this can mean.

To begin, Reg B § 1002.9(a)(2) requires that adverse action notices (in most cases, and here emphasis is on consumer loans) shall be in writing and contain four specific things, one of which includes a statement of specific reasons for the action taken. The Commentary to this section goes on to explain that “A creditor must disclose the principal reasons for denying an application or taking other adverse action. The regulation does not mandate that a specific number of reasons be disclosed, but disclosure of more than four reasons is not likely to be helpful to the applicant.” We will break this into two parts for discussion here, principal reasons, and then the number of reasons stated.

On May 26, 2022, the CFPB released a document titled, “CFPB Acts to Protect the Public from Black-Box Credit Models Using Complex Algorithms.” This emphasized that Reg B and ECOA, a federal antidiscrimination law, require specific reasons for taking adverse action. Above we described that is helps keep a creditor honest and informs the applicant. This notice is to emphasize that these rules apply even when using credit models which rely on complex algorithms.

In 1974, when ECOA and Reg B were conceived, a loan decision was based on an application for credit. A lender typically learned the five Cs of credit — character, capacity, capital, collateral and conditions — and applied them against the application. A human being made a decision and Reg B required that in the case of a denial, the reason would be given. It was not enough to say, “you do not meet our requirements for a loan,” as that was not a specific reason. The denial had to specify something about a debt ratio or excessive debt or length of employment. Remember part of the intent here is to inform the applicant so they can fix what is wrong and then reapply and receive credit.

In 2022 there is often less human being and more artificial intelligence involved. In a time of automation and analytics computer models use predictive analysis based on data input to compute credit scores, and to make loan decisions very quickly. “Companies are not absolved of their legal responsibilities when they let a black-box model make lending decisions,” said CFPB Director Rohit Chopra. “The 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.”

What the CFPB is cautioning lenders about is technology is driving the reasons for adverse action back to a nondescript, “you do not meet our requirements for a loan.” These lenders understand less of what went into the computer’s loan decision than they do about how to compute a credit score. And “the computer model said No” is not informing the applicant, nor is it keeping the lender honest. The CFPB has accused artificial intelligence models of discrimination already. If a lender cannot explain the principal reasons for a decision, it needs a different way to make the decision. Computer models’ reasons for denial must be specific for the lender to comply with Reg B.

Lastly, I want to revisit the required number of reasons for denial. The Commentary says, “The regulation does not mandate that a specific number of reasons be disclosed, but disclosure of more than four reasons is not likely to be helpful to the applicant.” Many lenders read this to say you cannot quote more than four reasons but that isn’t so. It says it does not mandate the number of reasons. If you are criticized for providing five or more, consider challenging the critic. But if you have four reasons that will be difficult for the applicant to overcome, you do not need to pile on more reasons. What you do not want is to have (say) six reasons but list only four which are easily fixable. The applicant corrects those and comes back in only to be refused for two others that are very difficult to correct. It’s like kicking them when they’re down. List the most severe and exceed four reasons when necessary.

Electronic liens

By Pauli Loeffler

The PowerPoint presentation from the informational session presented by the Oklahoma Tax Commission covering electronic liens is accessible through this link: https://www.oba.com/wp-content/uploads/2022/07/OK-Tax-Commission-power-point.pdf. It is also available on the OBA’s Legal Links Webpage.