Judge's Dismissal of Disparate Impact May Presage SCOTUS Ruling

WASHINGTON — A U.S. District Court decision this week that blocked the use of a controversial legal theory in a fair housing case on discrimination has ignited industry hopes that the Supreme Court will take a similar stance on a separate, larger case pending before it.

Judge Richard Leon of the District of Columbia ruled Monday that the use of disparate impact — in which lenders are cited for unintentional discrimination against minorities and others — is a violation of the Fair Housing Act.

The case concerned two insurance trade groups that challenged the Department of Housing and Urban Development's rulemaking last year that relied on the use of disparate impact under the Fair Housing Act. It is unlikely to stop other regulators, including the Consumer Financial Protection Bureau, from their own use of the theory in other circumstances, but sources said it will slow down what HUD can do under disparate impact until the Supreme Court issues a ruling on a similar case before it.

"I see this [federal court] case more as vindication of the industry's position rather than a 'big win' in the sense that I think people are going to be very careful between now and the Supreme Court ruling with changing their policies and procedures until" then, said Donald Lampe, a partner in the financial services group at Morrison & Foerster. Judge Leon "carefully applied the law and wasn't really persuaded by what amounts to policy arguments... This may clip HUD's wings for the time being."

As is typical for Leon — who often issues strongly worded opinions — the judge blasted the use of disparate impact, saying the Fair Housing Act "only" prohibits disparate "treatment," or intentional discrimination. Responding to an argument by the government that his court was precluded from weighing in on the use of disparate impact, Leon replied, "Please!"

"The expansion of FHA to include disparate-impact liability would not only have wide-ranging disruptive effect on the pricing and provision of homeowner's insurance, but would also require insurers to collect and analyze certain types of race-based data on their clients and prospective clients," Leon said in the final opinion.

He added that the case was "another example of an administrative agency trying desperately to write into law that which Congress never intended to sanction."

The case before Leon comes as the Supreme Court has agreed to hear a case likely early next year between the Texas Department of Housing and Community Affairs and a Dallas-based integrated housing group, which also turns on whether disparate impact is valid under the Fair Housing Act. This is the third time the high court has agreed to tackle the issue in recent years, but the first two were settled before the Supreme Court could hear the case.

The decision made by Judge Leon is "more of a signal of the debate to come than an indicator of the Supreme Court's" pending decision, said Isaac Boltansky, a policy analyst at Compass Point Research & Trading. "With that being said, I still think the Supreme Court is likely to curtail the use of disparate impact theory in the Fair Housing Act and over time, the same for disparate impact usage under" the Equal Credit Opportunity Act.

The two cases do not directly extend to the Equal Credit Opportunity Act (or ECOA), which the CFPB has used to cite finance companies on disparate impact. When the Supreme Court decided to hear the case related to the Fair Housing Act, observers questioned whether it could be extended to ECOA and ultimately stop the CFPB from using disparate impact.

Still, if the Supreme Court decides that the use of disparate impact is unconstitutional under the Fair Housing Act, observers say it would only entice companies to challenge regulators on using the same theory under ECOA.

The federal court decision "is simply mortgages under the Federal Housing Act but if the Supreme Court strikes it down, it's fair to assume that in time a future enforcement action under the disparate impact theory for ECOA could be challenged in same vein," Boltansky said.

In the meantime, some observers sense regulators are treading more cautiously as they await a Supreme Court decision. They say there have been fewer actions publicly brought by regulators related to disparate impact.

Even if HUD challenges Judge Leon's decision in the court of appeals, "the Supreme Court decision will likely precede that. And the path that it's on right now is that the argument will be heard in January or February," barring outside intervention, said Paul Hancock, an attorney at K&L Gates who's represented the banking industry in fair-lending cases. "We expect a decision by the spring time... so I would hope that the government agencies would hold their fire in the meantime."