The Consumer Financial Protection Bureau is finally moving forward with rulemaking under Section 1071 of the Dodd-Frank Act, which will require “financial institutions” to collect, maintain and report to the CFPB data on credit applications made by women-owned, minority-owned, and small businesses. In its Spring 2021 Rulemaking Agenda, the Bureau projected that it will issue a Notice of Proposed Rulemaking around September of this year.
CFPB Acting Director Dave Uejio has made “racial equity” one of the top two priorities for the Bureau, so the focus on completing this rulemaking is no surprise. The stated purpose of Section 1071 is to “facilitate enforcement of fair lending laws and enable communities, governmental entities, and creditors to identify business and community development needs and opportunities of women-owned, minority-owned, and small businesses.” Thus, the CFPB is likely to use 1071 data to bring enforcement actions against small business finance companies.
There are a number of open issues the rulemaking is likely to resolve, as reflected by the final report of the Small Business Regulatory Enforcement Fairness Act (SBREFA) panel regarding the rule. For example, will the term “financial institution” be defined to include companies offering products that are not traditionally considered “credit” under the Equal Credit Opportunity Act, such as merchant cash advances, factoring and equipment leasing? What exclusions will be included based on matters such as financing amounts? The House of Representatives recently added another open question, by passing a bill that would also require lenders to report on credit applications by LGBTQ-owned businesses. If that bill becomes law, the new requirement could be rolled into the rulemaking.
Once the rulemaking is completed and Section 1071 takes effect, “financial institutions” will need to collect data including the race, sex and ethnicity of the principal owners of the business, information that creditors are generally prohibited from collecting by Regulation B. Because of the risk of discriminatory decision-making on the basis of this information, Section 1071 requires financial institutions to either create a firewall between the information and underwriters or other decision-makers, or, alternatively, to provide notice to the applicants that the underwriters have access to the information and are prohibited from discriminating on that basis.
While the effective date of the final rule is likely more than a year away, small-business finance companies should consider proactive fair lending reviews of practices that will be subject to fair lending scrutiny, including underwriting, fraud prevention and targeting of marketing and advertising. These reviews can identify variables that are potential proxies for prohibited bases. By identifying these variables and removing them from the model or replacing them with less discriminatory alternatives, financial institutions can reduce the risk that the CFPB will find a disparate impact in Section 1071 data.