For years, the Consumer Financial Protection Bureau (CFPB) has been using its authority under the Equal Credit Opportunity Act (ECOA) and Regulation B to address what it calls “modern day redlining.” Rich Horn, co-managing partner at Garris Horn, prefers to call it “marketing discrimination.”

“It has nothing to do with how these companies treat actual applicants,” he told RESPA News. “It just has to do with where they market and the federal government believing that they don’t market enough to a particular demographic.”

This legal theory has been around since the ’90s, long before the CFPB was created, and had not been tested in the courts because when the issue came up, every subject bank and non-bank settled before a complaint was officially filed.

Until now.

In 2017, Horn was contacted by his client, Barry Sturner, owner of Townstone Financial in Chicago. His small mortgage company received a civil investigative demand (CID) from the CFPB and needed guidance on what to do next. What followed was a years-long legal battle, ending with the court siding with Townstone and its argument the bureau was overreaching its statutory authority.

RESPA News had the opportunity to talk with the legal team who won the case about their journey, the impact the ruling may have on the CFPB, and what the industry can learn from the proceedings.

Gathering the team

Townstone has been in the mortgage business for over 20 years, and during the relevant time period had at most six loan officers on staff, and the CFPB wanted a large amount information about its marketing and lending practices, Horn said. For a small mortgage company, the CID was unexpected and somewhat daunting. 6

“We’ve heard that the CFPB during that timeframe had sent CIDs to several nonbank mortgage companies on this topic of redlining,” he said. “It probably wanted the first redlining lawsuit or enforcement action against a nonbank mortgage company, to make that big landmark case.”

While forming Townstone’s response to the lengthy CID, Horn realized he needed assistance from expert litigators. This is how Sean Burke, partner at Mattingly Burke Cohen & Biederman, LLP and partner at Proteus Discovery Group, became involved in the case. Ultimately, the Townstone team submitted over 500 gigabytes of information to the bureau in their CID response.

After submission, it was a while before Sturner heard from the CFPB. It was 2019 when the CFPB contacted Horn again, informing him Townstone was about to be sued for ECOA violations. Burke and Horn then contacted Marx Sterbcow, managing attorney at the Sterbcow Law Group, LLC, to join the fight.

The legal team pushed for the CFPB to use its discretion to allow a Notice and Opportunity to Respond and Advise (NORA) process before issuing an official complaint. This process affords individuals and entities under investigation to present their positions to bureau staff before a lawsuit is filed.

Horn said the bureau was initially reluctant, but eventually allowed Townstone to submit a NORA-like response in the summer of 2019, which specifically informed the CFPB of the legal defenses it would use if sued. Jim Bopp of the Bopp Law Firm, a noted campaign finance and first amendment attorney, assisted with the NORA submission.

Almost a year later, the bureau informed Townstone it would be filing a lawsuit, and in July 2020, the complaint was filed in the U.S. District Court for the Northern District of Illinois, alleging Townstone violated ECOA and Reg B. The CFPB claimed statements made on the company’s weekly radio shows and podcasts used to market its services would discourage African-American applicants from applying; discouraged prospective applicants living in African-American neighborhoods in the Chicago metropolitan statistical area (MSA) from applying; and discouraged prospective applicants living in other areas from applying to Townstone for mortgage loans for properties located in African-American neighborhoods in the Chicago MSA. It pointed to the company’s data submitted under the Home Mortgage Disclosures Act (HMDA) as circumstantial evidence of the alleged activities.

Townstone filed its motion to dismiss in October of 2020, accompanied by dense briefs with arguments focused on the CFPB’s lack of statutory authority under ECOA and violation of the First Amendment’s freedom of speech. During this period, the bureau amended its complaint against Townstone to include Sturner individually as well, claiming he had inappropriately withdrawn funds by removing invested money out of the company accounts. In actuality, the legal team stated, Sturner needed to downsize the company, in part to keep up with the rising costs of the investigation and changes in the mortgage markets, and had previously informed the CFPB of this action and its purpose.

While the parties waited on the judge’s ruling on Townstone’s motion to dismiss, the court gave the green light for discovery to commence, meaning the costs of fighting the complaint were about to increase exponentially.

“At that time, we made the rounds on industry media hoping to find some help in funding this litigation, so Barry wouldn’t be forced to settle due to cost,” Burke said. “That process was not particularly successful.”

The campaign did provide one lead, and in early 2022, the Townstone legal team reached out to the Pacific Legal Foundation (PLF), where they spoke to Steve Simpson, senior attorney, and Jessica Thompson, attorney.

PLF is an organization known for tackling constitutional issues and specializing in combating government overreach. Their joining the case gave Townstone and Sturner a reprieve in the litigation costs – PLF represents its clients free of charge – and Simpson’s and Thompson’s expertise on constitutional issues. Simpson ultimately argued an oral hearing on the motion to dismiss in August 2022.

“We were really lucky to find Rich, Sean, and this case, and to be able to jump in and help Barry, because it’s rare that you find someone who is as principled as Barry, believes in the rule of law, and has the courage to stand up for what’s right, and be able to defend them,” Thompson said. “It was a great opportunity for us.”

The ruling and what it means for the CFPB

Over two years after the initial motion to dismiss was filed, Federal Judge Franklin Valderrama of the U.S. District Court for the Northern District of Illinois, Eastern Division, granted it, agreeing with Townstone and Sturner that the CFPB improperly attempted to expand ECOA’s reach beyond the explicit language of the statute.

In a succinct opinion, the judge used the legal test under Chevron, USA v. Natural Res. Def. Council, 467 U.S. 837 (1984), which requires deference to an agency’s interpretation of the laws it administers so long as Congress has not spoken to the precise question at issue, and the court finds the interpretation reflects a permissible construction of the statute.

“Judge Valderrama appropriately looked to the text of the statute, and saw that ‘applicant’ was defined by Congress when they passed this law in 1974,” Thompson said. “And they used the word ‘applicant’ over two dozen times throughout the statute, and not once does ‘prospective applicant’ appear.

“And so, there was no statutory ambiguity, and there was no need to defer to the agency,” she continued.

“The Supreme Court has indicated a reluctance to grant Chevron deference to agencies. But we haven’t seen that trend continue as prominently through the district courts and the courts of appeals.”

Thompson said Valderrama’s ruling is an example of the lower courts taking the lead from the Supreme Court in how to approach these interpretation issues, and will have a broader effect on agencies attempting to rewrite a statute or interpret it in such a way as to circumvent Congress’ original meaning or intent.

“When we were working on the motion to dismiss, a lot of other attorneys and other law firms said there was no way we were going to win,” Horn said. “‘No court is going to believe that a decades-long rule – Regulation B – should be overturned and doesn’t support this claim,’ we heard from many folks.

“Now, we have a really good ruling that can help others facing this claim and even future cases on issues other than redlining,” he continued.

The CFPB’s response to Townstone’s motion to dismiss had stated that how ECOA defined “applicant” was irrelevant, because the CFPB was not attempting to interpret that term. Instead, it had argued its general rulemaking authority allowed the bureau to issue any rule that furthered the purpose of the statute or prevented evasion of the statute.

“The bureau was trying to tell the court it had carte blanche to basically issue any rule it wants, and that’s not the law,” Horn said. “Agencies aren’t allowed to make the law, it’s only in Congress’ power to do so. And the court rejected that general rulemaking authority argument.”

The reason this has a greater impact than just redlining is the CFPB relies on its general rulemaking authority “all the time,” Horn said. Other statutes and rules enforced and promulgated by the bureau have the same or very similar general rulemaking authority provisions. The court rejecting the bureau’s argument on the subject may provide the industry precedent for future challenges to these other regulations under the bureau’s purview.

While the case may have bigger ramifications for the bureau, there are some limitations to keep in mind, such as whether other agencies can bring these type of redlining cases under different statutes, and where the opinion was issued.

For instance, the Department of Justice (DOJ) does not need ECOA to go after redlining. Instead, the DOJ addresses this and similar issues by taking action under the Fair Housing Act.

As for the opinion’s applicability, it currently is a binding decision only in the Northern District of Illinois, though that might change depending on whether the bureau appeals the case to the Seventh Circuit.

“Time will tell how effective this ruling is on curbing general abuses of government overreach,” Burke said. “But I think this particular agency, on this particular issue, is fighting an uphill challenge in bringing similar claims, at least and until they are successful on appeal or different legislation is passed. And I think that’s big.”

Industry impact and takeaways

Horn said the industry should not expect the agencies to stop using this legal theory. To reduce risk, he recommended industry participants should stay cognizant of the facts agencies bring up in these cases, keep an eye on their respective market and demographics, and do their own peer analysis of HMDA data.

For a case like this, Horn said the big takeway is: “Sometimes it pays to stand up and fight.”

“The CFPB is an aggressive agency, and it pushes the envelope. We’ve seen it time and time again,” he said. “Unfortunately, most companies settle, and their internal decision-making on that point might be sound. … But the agency is not foolproof. They make bad calls, like in this case.”

He hoped this case encouraged the industry to challenge the bureau on questionable edicts, and noted there has been an uptick in recent years in those choosing to take on the bureau, such as Pay Pal challenging the prepaid card rule, and the Chamber of Commerce of the United States of America’s suit over changes to the bureau’s unfair, deceptive, or abusive acts or practices manual to include discrimination.

“The CFPB is still trying to figure out what its appropriate boundaries are,” Burke said. “We’ve worked with some really smart and impressive people at the CFPB. It’s a worthwhile organization that has an important role to play but it needs to be right sized. And I hope this case starts that process.”

Closing statements

Thompson said they are still waiting to see if the CFPB will appeal this decision to the Seventh Circuit, and the bureau will likely have some things to consider before doing so. What the bureau risks by appealing to the circuit is the district court’s opinion being affirmed and expanding its precedence to a larger, influential jurisdiction.

“While this case is only binding law in the Northern District of Illinois, the order is well-reasoned and well-articulated throughout,” Thompson said. “It would be extremely persuasive authority if the CFPB tried to pursue the same legal theory in a different court, especially because this is the first and only opinion that squarely deals with this issue. So, without any other precedent from any other courts, this well-reasoned opinion is even more persuasive.”

She said Sturner is relieved the fight with the CFPB is over, at least for now. Thompson said Sturner was encouraged that the positive ruling hopefully will prevent other people from having to go through what he’s had to go through.

However, Thompson echoed a similar concern previously voiced by Sterbcow – how does Sturner recoup those non-physical costs, like his reputation?

“Because the CFPB has made these allegations throughout the news media and throughout its filings, and, essentially, under Judge Valderrama’s order, it never had the authority to bring it,” she said. “Barry has had to deal with this for six years now. This really is an important example of the harms that can come from government overreach, and we’re very thankful Barry was willing to fight back.”

Horn mentioned other serious financial impacts besides the cost of the lawsuit, including having to downsize his business, to miss out on merger opportunities, and competitors using the investigation against him.

“It’s unfortunate that the people who find themselves on the other end of these CFPB-envelope-pushing cases have real negative impacts,” Horn said. “Think about the employees who no longer have jobs at Townstone because it had to downsize. These are real impacts, and unfortunately, when the CFPB loses, it doesn’t feel it the same way.”

Burke said while the lawyers are thrilled the case resolved relatively early in its life-cycle, it did mean Barry lost the opportunity to tell his story at trial.

“He would have gotten to show he is a responsible businessman who has worked in the mortgage business for years, and never had a complaint,” Burke said. “He had African American customers in his ads all across the Chicago area. He had been a good player here. And he didn’t get to tell that story.”

Horn also mentioned the consumer testing Townstone’s legal team had done during the investigation, where they asked African American residents for their reaction to the statements the bureau found problematic. None took offense, and all said they would recommend Townstone to their friends and family. A few, he recalled, even asked for Townstone’s information to utilize its services.

“The actual reactions from African Americans on the south side of Chicago was the exact opposite of what the bureau alleged,” he said.

Thompson said her biggest takeaway from working on this case was not to be discouraged by the initial optics of a suit.

“The CFPB had all but painted Townstone as a company hellbent on redlining and full of racists,” she said. “But once we dug into the actual radio shows and saw that, in the broader context of these statements, they’re trying to help people buy homes and take out mortgages in lower income areas.

“There’s never actually been a complaint from an applicant against Townstone,” Thompson continued. “As we dug in more, we realized this is someone who absolutely needs our help.”

Burke said he was heartened by the case, and it was evidence the rule of law is still important.

“The system may work slowly, but it works,” Burke said. “And if you have principled positions, it doesn’t matter how big or small you are, you can stand up for those positions and you can win. And it feels good when you do.”

Horn mentioned it will be interesting to see how this decision will affect the CFPB’s approach to the small-business loan data rule it is under court order to roll out this spring. The rule will require supervised entities to provide certain data about small-business loans, including the race and ethnicity of proprietors. Whether the bureau or other agencies want to use ECOA to apply this redlining theory to a new dataset is something to look for in the future.

“It was a privilege to represent Townstone’s employees and former employees, and I admire their courage to stand up to a really unaccountable and unbounded federal agency like the CFPB,” Thompson said. “That’s serious courage, and it’s been a pleasure working with them, as well as Rich, Marx, and Sean. It was a great team effort."

This article is part of our Fair Lending special report, available now for purchase. Free for RESPA News subscribers, the report provides more information on how agencies are enforcing fair lending regulations and what you can do to stay compliant with anti-discrimination laws.