In May 2022, the CFPB issued Circular 2022-3 addressing Equal Credit Opportunity Act (ECOA) adverse action notice requirements in connection with credit decisions based on algorithms. The CFPB is now revisiting the issue in Circular 2023-3.

The recent Circular begins with the following question presented: “When using artificial intelligence or complex credit models, may creditors rely on the checklist of reasons provided in CFPB sample forms for adverse action notices even when those sample reasons do not accurately or specifically identify the reasons for the adverse action?”

The following brief response to the question is set forth: “No, creditors may not rely on the checklist of reasons provided in the sample forms (currently codified in Regulation B) to satisfy their obligations under ECOA if those reasons do not specifically and accurately indicate the principal reason(s) for the adverse action. Nor, as a general matter, may creditors rely on overly broad or vague reasons to the extent that they obscure the specific and accurate reasons relied upon.”

The remainder of the Circular is devoted to an analysis of the issue. The ECOA rule, Regulation B, requires that a creditor provide a denied applicant with a “statement of specific reasons for the action taken.” Further, the Regulation B Commentary provides that the “specific reasons disclosed . . . must relate to and accurately describe the factors actually considered or scored by a creditor.”

The CFPB notes that Regulation B includes sample adverse action notices that set forth many of the typical reasons for the denial of credit. The CFPB then advises that:

“As explained in Regulation B, “[i]f the reasons listed on the forms are not the factors actually used, a creditor will not satisfy the notice requirement by simply checking the closest identifiable factor listed.” Rather, the sample forms merely provide an illustrative and non-exclusive list. Thus, if the principal reason(s) a creditor actually relies on is not accurately reflected in the checklist of reasons in the sample forms, it is the duty of the creditor—if it chooses to use the sample forms—to either modify the form or check “other” and include the appropriate explanation, so that the applicant against whom adverse action is taken receives a statement of reasons that is specific and indicates the principal reason(s) for the action taken. Creditors that simply select the closest, but nevertheless inaccurate, identifiable factors from the checklist of sample reasons are not in compliance with the law.” (Footnotes omitted.)

This is a correct observation. A creditor cannot simply select the denial reasons in a sample form that are the closest to the actual denial reasons—the creditor must identify the actual reasons. The CFPB also advises that:

“Specificity is particularly important when creditors utilize complex algorithms. Consumers may not anticipate that certain data gathered outside of their application or credit file and fed into an algorithmic decision-making model may be a principal reason in a credit decision, particularly if the data are not intuitively related to their finances or financial capacity. As noted in the Official Commentary to Regulation B, a creditor must “disclose the actual reasons for denial . . . even if the relationship of that factor to predicting creditworthiness may not be clear to the applicant.” For instance, if a complex algorithm results in a denial of a credit application due to an applicant’s chosen profession, a statement that the applicant had “insufficient projected income” or “income insufficient for amount of credit requested” would likely fail to meet the creditor’s legal obligations.” (Footnote omitted.)

While the CFPB correctly notes the need for a creditor to identify the actual reasons for a decision to deny credit, citing a 1983 case and 1970’s U.S. Senate report, it veers off the rails with the following statement:

“Adverse action notice requirements promote fairness and equal opportunity for consumers engaged in credit transactions, by serving as a tool to prevent and identify discrimination through the requirement that creditors must affirmatively explain their decisions. In addition, such notices provide consumers with a key educational tool allowing them to understand the reasons for a creditor’s action and take steps to improve their credit status or rectify mistakes made by creditors.” (Emphasis added.)

In the second indented paragraph above the CFPB correctly notes the Regulation B Commentary provides that the “creditor must disclose the actual reasons for denial (for example, “age of automobile”) even if the relationship of that factor to predicting creditworthiness may not be clear to the applicant.” The Commentary also provides that a “creditor need not describe how or why a factor adversely affected an applicant. For example, the notice may say “length of residence” rather than “too short a period of residence.” Thus, Regulation B requires that a creditor disclose the actual reasons for denial. No more, no less. Regulation B does not require the creditor to explain to the consumer how those reasons resulted in a denial of credit.

It also appears as if the CFPB is taking the position that the reasons for a denial decision must be stated with a level of specificity beyond what Regulation B requires. The CFPB observes that:

“Concerns regarding specificity may also arise when creditors take adverse action against consumers with existing credit lines. For example, if a creditor decides to lower the limit on, or close altogether, a consumer’s credit line based on behavioral data, such as the type of establishment at which a consumer shops or the type of goods purchased, it would likely be insufficient for the creditor to simply state “purchasing history” or “disfavored business patronage” as the principal reason for adverse action.”

As one authority for this position, the CFPB cites a 2008 complaint of the Federal Trade Commission against CompuCredit Corporation, which being only a complaint and not a court decision was a deceptive marketing case and not an adverse action case. Further, following the CFPB’s approach, it would appear that a creditor could never use from the model adverse action notice the (1) “Credit application incomplete” denial reason because it does not specify what is missing from the application, or (2) the “Unacceptable type of credit references provided” denial reason because it does not specify what “type” of credit references were unacceptable.