FRB Proposes Rule on Self-Testing

The Federal Reserve Board has published for comment regulations to implement the 1996 amendments to the Equal Credit Opportunity Act. The amendments provide lenders with protection in the form of legal privilege for information developed in self-tests.

The Economic Growth and Regulatory Paperwork Reduction Act of 1996 ("EGRPRA") also amended the Fair Housing Act and directed the Department of Housing and Urban Development to develop regulations under that act.

EGRPRA also directed the two agencies to develop and issue regulations that are substantially similar. The statute specified that regulations should be issued within six months of the date of enactment, September 30, 1996. This means that HUD and the FRB have a target of the end of March, 1997 for final regulations. To enable the FRB to meet this statutory deadline, there is only a 30 day comment period for the proposal. Comments are due on January 31, 1997.

The incentive
The proposal would create a new section of Regulation B, Section 202.15. The general rule would provide that the report or results of a self-test are privileged under certain conditions.

The privilege would mean that the self-test and materials generated by the self-test could not be obtained or used by a government agency in an examination or investigation. The privilege also would prevent discovery by either a government agency or an applicant in any proceeding or civil action in which a violation of ECOA is alleged.

The privilege would be lost if information subject to the privilege is voluntarily disclosed or raised as an affirmative defense.

Definition of self-test
The proposed definition of self-test restricts the term to meaning any form of self-analysis that is not derived from or based on existing documents. It would be a program, practice or study that creates data or factual information that is not available and cannot be derived from loan or application files and is used to measure compliance with Regulation B's general rule, Section 202.4 or the prohibition against pre-screening, Section 202.5(a).The practical result of the proposed definition is that only activities such as mystery shopping and customer surveys would be subject to the privilege. Any form of audit, file comparison analysis, or statistical analysis of loan files would not be subject to the new protection of privilege because they would be based on existing loan or application files.

The privilege would apply only to the report or results of the self-test, including any data generated by the test, and an analysis of the results. It would also extend to workpapers. However, the privilege would not extend to any existing loan files or application documents.

The self-test definition contains several additional conditions which the creditor must meet in order to be subject to the privilege. The self-test must be voluntary Any findings from a regulatory examination or similar procedure would not be subject to privilege.

Second, in order for the privilege to be available, the creditor conducting the self-test must take action to "fully remedy" any possible violations identified in the test. This includes actions to correct both the cause of the possible violation and the effect or result of the violation. When the self-test does not produce questions of discrimination, corrective action would not be necessary.The privilege would not be limited to self-testing conducted by the creditor. The privilege would be available for any self-test whether conducted by the creditor or by a third party.

Rationale for limited definition
The proposal's narrow definition of self-test confines the availability of privilege to mystery shopping. It leaves all forms of compliance audits exposed to review by examiners and potentially referred to the Department of Justice for further investigation.

The Board is seeking comment for whether a broader definition would provide added incentive for self-analysis and corrective action or whether a broader definition would impede the ability of enforcement agencies to obtain "needed information."

The Board states that the Congressional purpose of the privilege was to encourage creditor self-monitoring and self-correction. However, the Board observes that because the creditor must have adequate policies and procedures in place to ensure compliance and because lenders must have audit and control systems, there is no need to provide a protection for these procedures. They will be conducted without the incentive of privilege. In any event, the underlying loan records would be subject to examination by the regulatory and enforcement agencies.

Corrective Action
To ensure the availability of the privilege, the creditor would have to take corrective action in response to any findings of possible discrimination. The actions should be designed to respond to and eliminate any possible discrimination and to remedy the impact of any past discrimination, if appropriate.

In the process of deciding upon appropriate corrective action, the creditor would need to identify the policies or practices that are the probable cause of the violation, assess the scope of the violation, and determine the staff or branches involved.

Corrective action should fully respond to the findings and establish a compliance process to prevent recurrence.

ACTION STEPS

Brief your management on this proposal. Discuss the methods for fair lending self-assessment that are appropriate for your bank. Consider whether this proposed regulation in fact provides any protection.
Review your fair lending self-assessment procedures, including compliance monitoring and compliance audits. Review the findings and decide whether it is in the bank's interest to have these procedures subject to privilege. Look for good examples of why they should be privileged.
Write a comment letter. Use the model provided in this issue or compose your own. Be sure it arrives at the FRB by January 31,1997.