I. INTRODUCTION
The Federal Reserve Board (FRB) and the Department of Housing and Urban Development (HUD) issued similar regulations that create a legal privilege for the results of “self-tests” when lenders voluntarily conduct self-testing to determine the level of compliance with the Equal Credit Opportunity Act (ECOA) or the Fair Housing Act (FHA). The regulations became effective on January 30, 1998. This regulatory privilege protects self-testing results from being disclosed to anyone (either to regulators or to private litigants) when certain conditions are met. The self-testing privilege only applies if the lender takes appropriate corrective action to address possible discrimination found in the “self-tests.”
Federal statutes form the basis of these regulations. The intent of the law is to remove the “disincentive” to gather information designed to monitor and critically evaluate a financial institution’s fair lending compliance. Otherwise, the information could be examined by regulators and potentially obtained by plaintiffs in connection with private litigation. The privilege serves as an incentive, by assuring that evidence of discrimination voluntarily produced by a self-test will not be used against a lender, provided the lender takes appropriate corrective actions for any discrimination that is found.
II. SELF-TESTING DEFINED
The regulations define “self-test” as “any program, practice or study that is designed and used specifically to determine the extent or effectiveness of a lender’s compliance with the ECOA or Regulation B, if it creates data or factual information that is not available and cannot be derived from loan or application files or other records relating to credit transactions.” The definition of “self-test” includes, but is not limited to, the practice of using fictitious applicants for credit (testers). A lender may also develop and use other methods of generating information that is not available in loan and application files, e.g., by surveying mortgage loan applicants to assess whether applications were processed appropriately. The definition does not include lender reviews and evaluations of loan and application files, either with or without a statistical analysis.
The regulations create a privilege against disclosure (either to regulators or to litigants suing under a covered fair lending statute) with respect to: (1) the report or results of a self-test; (2) data or factual information created by the self-test; (3) work papers, draft documents and final documents; and (4) analyses, opinions, and conclusions if they directly result from the self-test report or results.
The principal attribute of self-testing is that it constitutes a voluntary undertaking by the lender to produce new data or factual information that otherwise would not be available and could not be derived from loan or application files or other records related to credit transactions. A lender’s evaluation or analysis of credit applications, loan files, HMDA data or similar types of records (e.g., broker or loan officer compensation records) does not produce new factual information about a lender’s compliance and is not a self-test for purposes of the regulation. Information derived from such records, even if aggregated or reorganized to facilitate the lender’s analysis, is not privileged. Similarly, a statistical data analysis derived from existing loan files is not privileged.
The privilege does not prevent access to documents that lenders already have or could produce from what they already typically have. Rather, the privilege induces lenders to gather totally new types of information (within the definition of “self-test”) that otherwise would not be available and allows lenders to protect that information if corrective action is taken.
To qualify for the privilege, a self-test must be sufficient to constitute a determination of the extent or effectiveness of the lender’s compliance with the ECOA and FHA. A self-test is only privileged if it is designed and used for such purpose. A self-test that is designed and used to determine compliance with other laws or regulations or for other purposes, is not privileged (e.g., a self-test designed to evaluate employee efficiency or customers’ satisfaction with the level of service provided by the lender is not privileged even if evidence of discrimination is uncovered incidentally). If a self-test is designed for multiple purposes, only the portion designed to determine compliance with the ECOA or FHA is eligible for the privilege.
III. PRIVILEGED INFORMATION
The regulatory privilege applies to the report or results of the self-test, data or factual information created by the self-test and any analysis, opinions and conclusions pertaining to the self-test report or results. The privilege covers work-papers or draft documents as well as final documents.
IV. NON-PRIVILEGED INFORMATION
The regulatory privilege does not apply to: (i) information about whether a lender conducted a self-test, the methodology used or the scope of the self-test, the time period covered by the self-test or the dates it was conducted; (ii) loan and application files or other business records related to credit transactions and information derived from such files and records, even if it has been aggregated, summarized, or reorganized to facilitate analysis. The fact that a lender has conducted a self-test, the methodology used or the scope of the self-test, the time period covered by the self-test and the dates when it was conducted are all available for disclosure (allowing regulators to examine the appropriateness of the institution’s approach, but without examining the results of the self-test).
Examples of records that are not privileged include: property appraisal reports, loan policies or procedures, underwriting standards, employee or broker compensation records and minutes of loan committee meetings or other documents reflecting the basis for a decision to approve or deny an application. If a lender arranges for testers to submit loan applications for processing, the records are not related to actual credit transactions for purposes of these rules and may be privileged self-testing records.
V. APPROPRIATE CORRECTIVE ACTION
A lender cannot conduct a self-test and then “sit on” the results, protected by the privilege – rather, it “must take action reasonably likely to remedy the cause and effect of the likely violation . . .” Taking appropriate corrective action is not an admission that a violation occurred. Corrective action is required when the results of a self-test show that it is more likely than not that one or more violations occurred. In determining whether it is more likely than not that a violation occurred, a lender must treat testers as if they are actual applicants for credit. A lender may not refuse to take appropriate corrective action under these rules because the self-test used fictitious loan applicants. The fact that a tester’s agreement with the lender waives the tester’s legal right to assert a violation does not eliminate the requirement for the lender to take appropriate corrective action, even though no remedial relief for the tester is required.
A lender must take corrective actions that are reasonably likely to remedy both the cause and effect of any likely violation. This requires identification of the practice or policy that is the likely cause and an assessment of the extent and scope of the violation, a determination that must be made on a case-by-case basis. In identifying the policies or practices that are the likely cause of the violation, a lender might identify: inadequate or improper lending policies; failure to implement established policies; employee conduct; or other causes. Determining which areas of operations that are likely to be affected by those policies and practices may identify the extent and scope of a likely violation. For example, by determining the types of loans and stages of the application process involved and the branches or offices where the violations may have occurred.
VI. TYPES OF RELIEF
Appropriate corrective action may include both remedying past situations and changing future policies and actions. For the privilege to apply, a lender must take corrective action that is appropriate for the type of self-test and the scope of the likely violation. A lender is required to provide remedial relief to an applicant identified by the self-test as one whose rights were more likely than not violated, but is not required to identify other persons who might have been adversely affected. The use of pre-application testers to identify policies and practices that illegally discriminate does not require lenders to review existing loan files for the purpose of identifying and compensating applicants who might have been adversely affected.
The rule clarifies that a lender is not required to provide remedial relief to an applicant if the statute of limitations expired before the results of the self-test were obtained or if the applicant is otherwise ineligible for such relief (e.g., the lender need not offer credit to a denied applicant who no longer qualifies for the credit due to a change in financial circumstances, although some other type of relief might be appropriate).
Depending on the facts, appropriate corrective action may include any of the following items: (1) offering to extend credit to persons whose applications were improperly denied, together with out-of-pocket and compensatory damages; (2) correcting institutional policies or procedures; (3) identifying and training and/or disciplining the employees involved; (4) developing outreach programs, marketing strategies or loan products to more effectively reach the affected segments of the market; and (5) improving audit and oversight systems to avoid repeating the violations.
VII. SCOPE OF PRIVILEGE
Privileged documents may not be obtained by a government agency for use in an examination or investigation relating to compliance with the ECOA or FHA, or by a government agency or applicant (including prospective applicants alleging that they were discouraged from pursuing an application on a prohibited basis) in any civil proceeding in which a violation of the ECOA, Regulation B or the FHA is alleged.
A privilege does not apply in other cases, e.g., litigation filed solely under a state’s fair lending law. In such cases, if a court orders a lender to disclose self-test results, the disclosure is not a voluntary disclosure or waiver of the privileges under this regulation. Lenders may protect the information by seeking a protective order to limit availability and use of the self-testing data and prevent dissemination beyond what is necessary in that case.
VIII. RECORD RETENTION
The regulations require a lender to retain all written information about a self-test for 25 months, and for a longer time if the financial institution is under investigation or subject to an enforcement proceeding. In such cases, the lender must retain the information until final disposition of the matter, unless the appropriate agency or court order allows an earlier time.
IX. LOSS OF PRIVILEGE
Corrective action taken by a lender, by itself, is not considered a voluntary disclosure of the self-test report or results (e.g., a lender does not disclose the results of the self-test merely by offering to extend credit to a denied applicant or by inviting the applicant to reapply for credit). Voluntary disclosure could occur, however, if the lender discloses self-test results in connection with a new offer of credit. Disclosure of self-testing results to an independent contractor acting as an auditor or consultant for the lender on compliance matters does not result in loss of the privilege. The privilege will be lost if the lender discloses privileged information, such as the results of the self-test, however, the privilege is not lost if the lender merely reveals or refers to the existence of the self-test itself.
A lender’s claim of privilege may be challenged in a court or administrative law proceeding with appropriate jurisdiction. If a lender’s claim to privilege is challenged, a judge can examine these records “in chambers” to determine whether the institution has taken necessary corrective action in response to the self-test to maintain the privilege. If a lender fails or is unable to produce such records, the privilege will be lost.
A lender may also be forced to disclose the results of a self-test after a violation of fair lending laws has been adjudicated or admitted, but only for use in determining the appropriate penalty or remedy (e.g., appropriate corrective voluntarily taken in response to a self-test would be a mitigating factor. Inadequate action taken would be a negative factor).
X. EXCEPTION TO GENERAL PROHIBITION ON COLLECTION OF INFORMATION ON APPLICANT CHARACTERISTICS IN CONNECTION WITH NONMORTGAGE CREDIT
Regulation B, § 202.5 contains a general prohibition against inquiring about or noting an applicant’s sex, race, color, religion or national origin in nonmortgage credit transactions. The regulation contains a narrow exception to this general prohibition. This information may be collected only for the purpose of conducting a self-test that meets the requirements of § 202.15. Regulation B, Appendix C, Model Form C-10 (See, below)provides the disclosure requirements for creditors that request applicants’ race, ethnicity and other such characteristics in connection with a self-test.
FORM C-10—SAMPLE DISCLOSURE ABOUT VOLUNTARY DATA NOTATION We are requesting the following information to monitor our compliance with the federal Equal Credit Opportunity Act, which prohibits unlawful discrimination. You are not required to provide this information. We will not take this information (or your decision not to provide this information) into account in connection with your application or credit transaction. The law provides that a creditor may not discriminate based on this information, or based on whether or not you choose to provide it. [If you choose not to provide the information, we will note it by visual observation or surname].
XI. CONCLUSION
Critics argue that its scope of this privilege is too narrow, particularly the definition of “self-test.” Although the self-testing compliance privilege may be less effective than originally hoped, lenders wishing to take advantage of the privilege must strictly adhere to its requirements.