HUD Proposal to Codify FHA Interpretations Should Limit Disparate Impact Challenges to Ordinary Business Practices

Limitations on Using Disparate Impact Claims to Challenge Ordinary Business Practices

Regulators and private plaintiffs in certain cases have used disparate impact claims to aggressively challenge ordinary business practices. This has been possible in certain instances, in part, because of the somewhat ill-defined parameters of the disparate impact doctrine and the understandable desire of businesses to avoid defending their practices against discrimination challenges in public lawsuits, even if the practices are entirely legal.

In 2015, the United States Supreme Court held in Texas Department of Housing and Community Affairs v. Inclusive Communities Project, Inc. ("Inclusive Communities")² that the FHA permits a claim for discrimination based on disparate impact. In doing so, however, the Supreme Court also recognized that there must be appropriate safeguards to prevent the improper use of disparate impact claims to hinder proper business practices. In the Proposed Rule, HUD noted that Inclusive Communities provided that “disparate-impact liability must be limited so that ... entities are able to make the practical business choices and profit-related decisions that sustain a vibrant and dynamic free-enterprise system,” noting that the Supreme Court placed special emphasis on the importance of the plaintiff’s prima facie burden, and warned that constitutional issues could be raised if there were not adequate safeguards to allow defense of disparate impact claims at the pleading stage of a case.³ HUD also stated that Inclusive Communities cautioned that the disparate impact liability should not be so expansive as to inject racial considerations into every business decision or to second-guess between two reasonable business decisions. HUD indicated that instead, under Inclusive Communities, the disparate impact doctrine under the FHA should be limited to specifically identified policies that are “artificial, arbitrary and unnecessary barriers” to housing.⁴

The Proposed Rule would limit the use of disparate impact claims to challenge ordinary business practices by providing defendants the ability to defend against meritless claims at the pleading stage of a case by more clearly stating the allegations that a plaintiff must make to successfully establish a prima facie case. First, under the Proposed Rule, the plaintiff must identify a specific, identifiable policy or practice that causes the disparate impact; it is insufficient to merely identify a program as a whole without explaining how a specific element of the program causes the disparate impact. Second, the plaintiff must allege the following five specific elements with respect to the identified specific, identifiable policy or practice:

1. The challenged policy or practice is arbitrary, artificial and unnecessary to achieve a valid interest or legitimate objective such as a practical business, profit, policy consideration or requirement of law.
2. There is a robust causal link between the challenged policy or practice and a disparate impact on members of a protected class that shows the specific practice is the direct cause of the discriminatory effect.
3. The alleged disparity caused by the policy or practice has an adverse effect on members of a protected class in that class’s capacity as a group (e.g., it is insufficient merely for a plaintiff to show he or she would be discriminated against under the policy and are themselves members of a protected class).
4. The alleged disparity caused by the policy or practice is significant.
5. There is a direct link between the disparate impact and the complaining party’s alleged injury.⁵

Several aspects of the Proposed Rule should aid businesses in quickly disposing of meritless disparate impact claims. For example, it may be challenging for a plaintiff to allege facts necessary to show that a policy or practice is “arbitrary, artificial and unnecessary to a valid interest or legitimate objective” in the case of ordinary business practices. Similarly, the requirement to allege facts supporting a “robust causal link between the challenged policy or practice and a disparate impact on members of a protected class” should help prevent businesses from being subject to disparate impact claims where the disparate impact is the result of historical circumstances or general economic considerations and not any policy or practice of the business.

Express Defenses for Credit Scoring and Other Models

Creditors and other businesses have increasingly relied on data analytics to make better business decisions. Objective modeling, as opposed to subjective decision-making, should reduce the risk of illegal discrimination by ensuring that decisions are made on data that can be shown analytically to achieve legitimate business objectives. However, the prospect of disparate impact claims has been a cloud over development in this area, especially given the lack of any clear guidance on the limits of such claims.

The Proposed Rule would provide substantial benefits to creditors and others using credit scoring and other models in avoiding improper disparate impact challenges. It provides the following three specific and separate ways in which a disparate impact claim regarding use of a model can be defeated:

1. The model’s “material factors” used as inputs do not rely in any material part on factors that are “substitutes or close proxies” for protected classes under the FHA and the model is predictive of credit risk or other similar valid objective;
2. The model is produced, maintained or distributed by a “recognized third party that determines industry standards,” the inputs and methods within the model are not determined by the defendant, and the defendant is using the model as intended by the third party; or
3. The model has been subject to critical review and validated by an objective and unbiased neutral third party that has analyzed the challenged model and found that the model was empirically derived and is a demonstrably and statistically sound algorithm that accurately predicts risk or other valid objectives, and that none of the factors used in the algorithm rely in any material part on factors that are “substitutes or close proxies” for protected classes under the FHA.⁶

The Proposed Rule would appropriately provide businesses with significant protections against disparate impact claims challenging the use of legitimate modeling practices. For example, the first and third defenses should apply to a large number of modeling programs that are developed under general statistical approaches, although it would be helpful if HUD clarified that factors should not be considered “substitutes or close proxies” for prohibited basis of discrimination except in circumstances that demonstrate an intent to consider such basis indirectly. Similarly, the second defense should allow many businesses to rely on modeling provided by third-party experts that participate broadly in an industry, although it also would be helpful if HUD interpreted the “industry standard” requirement broadly, such as modeling that is generally available or used in a marketplace.

* * *

The Proposed Rule would substantially aid businesses in defending meritless disparate impact claims challenging ordinary business practices to the benefit of consumers and businesses alike. However, the Proposed Rule would expressly apply only to FHA claims and not to potential disparate impact claims under the Equal Credit Opportunity Act ("ECOA"). Although the Supreme Court has not yet ruled on whether disparate impact claims are cognizable under the ECOA, lower courts and the Consumer Financial Protection Bureau ("CFPB") have concluded that the ECOA encompasses disparate impact claims. While the Proposed Rule provides helpful arguments to support similar interpretations in the context of ECOA disparate impact claims, the CFPB should consider publishing revisions to Regulation B,⁷ which interprets the ECOA, that follow HUD’s provisions in the Proposed Rule.

¹ HUD’s Implementation of the Fair Housing Act’s Disparate Impact Standard, 84 Fed. Reg. 42854 (Aug. 19, 2019).

² 135 S. Ct. 2507 (2015).

³ Proposed Rule at 42855.

⁴ Proposed Rule at 42856.

⁵ See Proposed Rule revised 24 CFR § 100.500.

⁶ See Proposed Rule revised 24 CFR § 100.500(c); Proposed Rule at 42859. Protected classes under the FHA include race, color, religion, sex, disability, familial status and national origin.

⁷ 12 CFR Part 1002.