Industry's Hopes of Killing 'Disparate Impact' End with Thud

WASHINGTON — When the Supreme Court agreed to hear a Texas "disparate impact" case last year, banks hoped it would end the use of the divisive legal theory used by regulators and other authorities. But the court's Thursday decision, by contrast, appears to strengthen the government's hand.

The court's decision upholding disparate impact — which makes defendants liable in fair-housing and fair-lending cases even if discrimination was unintentional — bolsters efforts by the Consumer Financial Protection Bureau and other agencies as well as consumer advocates to bring claims while dampening other challenges to the theory, observers said.

"It will embolden activist groups, private plaintiffs and the government — in particular the CFPB, the Department of Justice's civil rights division, prudential banking regulators and [the Department of Housing and Urban Development] — to continue to advance in both examinations and investigations inquiries into policies and practices that are predicated on disparate impact analysis," said Benjamin Saul, a partner at Goodwin Procter LLP.

Yet at the same time, banking industry representatives did see positives in the ruling, which was supported by five of the court's nine justices. The decision in the Texas Department of Housing and Community Affairs v. the Inclusive Communities Project appeared to set clear hurdles for plaintiffs to prove disparate impact claims, give defendants the ability to seek dismissal of cases early on and limit the damages for clear violations.

"It suggests that" a fair-lending violation "shouldn't warrant penalties. It should focus on correcting practices that caused the disparities," said Paul Hancock, a partner at K&L Gates.

Still, the ruling further cemented the use of "disparate impact." Experts said activists and regulators will likely continue to cite it in cases not just dealing with housing claims. The CFPB, for example, has used "disparate impact" in alleging discriminatory effects on car loan borrowers as well.

"I wouldn't want to be someone who is in the auto lending industry who disparately impacts people of color and expect that I would be protected down the line," said John Taylor, the chief executive of the National Community Reinvestment Coalition. "The court affirmed what people who understood the context of disparate impact already knew. One may not be able to show direct discrimination in auto lending or housing. But if you can show that, because of decisions made by the company, the policy had the same impact as if you were doing direct discrimination, that's no longer a safe harbor."

The case involved affordable housing tax credits distributed by the state of Texas. The Inclusive Communities Project — a housing advocacy group — sued over claims that the state's distribution method led to affordable housing options being overly concentrated in minority areas.

The court concluded in the case that "disparate impact" is recognized — or "cognizable" — under the Fair Housing Act, meaning plaintiffs can allege discrimination in housing-related decisions that negatively affect minority areas even if no discriminatory treatment was intended.

"In light of the longstanding judicial interpretation of the FHA to encompass disparate-impact claims and congressional reaffirmation of that result, residents and policymakers have come to rely on the availability of disparate-impact claims," Justice Anthony Kennedy, who ruled along with the court's four progressive justices, wrote in the court's opinion. He noted that "many of our Nation's largest cities — entities that are potential defendants in disparate-impact suits — have submitted an amicus brief in this case supporting disparate-impact liability under the FHA."

The decision is a huge setback to lenders and industry advocates who say disparate impact unfairly victimizes financial institutions that are not aware that their credit policies may have a disproportionate effect on minority neighborhoods.

The American Bankers Association "and our members are strong advocates for fair lending and enforcement of the Fair Housing Act. Disparate Impact theory, however, is not the right tool to achieve fairness and prevent discrimination in lending," Frank Keating, the ABA's president and chief executive, said in a statement. "This approach can have unintended consequences, such as causing financial institutions to shrink their operations rather than risk litigation, hurting the very groups it is intended to help."

But consumer groups, regulators, civil rights attorneys and Democratic lawmakers all applauded the decision.

"The court's ruling preserves one of the most important tools we have to fight discrimination and ensure that all Americans have fair access to housing and economic opportunity," Sen. Sherrod Brown, D-Ohio, the ranking member of the Senate Banking Committee, said in a statement. "We need to continue efforts to combat discriminatory practices, not just in housing but in all consumer financial markets."

Yet some observers said the immediate impact of the ruling may be limited, since banks had assumed "disparate impact" to be the law of the land unless overturned by the courts.

"The industry has been operating form a presumption that it's susceptible to disparate impact risk over the years," Saul said. "Most industry players have put in place a compliance regime meant to mitigate inherent disparate impact fair lending risk. Those efforts will continue and probably intensify now that it's very clear that disparate impact claims are cognizable under the FHA."

Much of the banking industry's concerns about "disparate impact" have originated in CFPB cases. The consumer bureau has cited the availability of the legal theory in the Equal Credit Opportunity Act — instead of the FHA — but Saul said Thursday's decision could dampen efforts to challenge the ECOA as well.

"Had this decision been decided in a manner consistent with the dissenters, what would have likely happened is that a similar challenge to the cognizability of ECOA would have made its way through the courts," he said. "But the decision will take the wind out of the sails of those efforts somewhat, if not entirely."

CFPB Director Richard Cordray said in a statement that even though the bureau does not enforce the FHA, "we are encouraged that today's decision will continue to promote fair housing and help protect Americans from unlawful discrimination."

"As an agency responsible for enforcing the Equal Credit Opportunity Act, we will continue our own work to ensure nondiscriminatory access to credit for all Americans," Cordray said.

But industry representatives did point to some silver linings from the decision. Kennedy's opinion imposes a standard on plaintiffs to prove violations not just from statistical data demonstrating a discriminatory effect. Under the decision, a claim has to show a link between a policy of the defendant and the discriminatory effect.

"This decision on the whole imposes limitations on the use of this theory that have not been recognized prior to today," Hancock said.

The decision also contains language that appears to limit what kinds of penalties can be imposed on defendants that are found to be liable for a disparate-impact claim.

"It must be noted further that, even when courts do find liability under a disparate-impact theory, their remedial orders must be consistent with the Constitution," Kennedy wrote in the opinion. "Remedial orders in disparate-impact cases should concentrate on the elimination of the offending practice."

But in a dissenting opinion, Justice Samuel Alito went further, writing that the court's approach in justifying the disparate-impact theory "is a serious mistake.

"The Fair Housing Act does not create disparate-impact liability, nor do this Court's precedents. And today's decision will have unfortunate consequences for local government, private enterprise, and those living in poverty," he wrote.