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The United States Supreme Court (the Court) recently issued its long-awaited decision in Safeco Ins. Co. of America v. Burr concerning two important issues under section 615(a) of the Fair Credit Reporting Act (FCRA).1 This section requires users of consumer credit reports to notify consumers when they take adverse action based in whole or in part on information in the report. It is designed to alert consumers about negative information in their credit reports and encourage them to obtain a free copy of the report to address the negative issues, especially if the report contains incorrect information the consumer can easily correct by filing a dispute with the consumer reporting agency.
The Court consolidated for review two class-action decisions from the United States Court of Appeals for the Ninth Circuit against GEICO Insurance and against Safeco Insurance.2 The Ninth Circuit held in both cases that insurance companies using consumer reports are required to send adverse action notices to applicants if they are not offered the lowest premium available to consumers with the highest credit ratings. Since few applicants have credit ratings eligible to qualify for the lowest rates, the Ninth Circuit's ruling created headlines in business journals because it would have required insurance companies to send out a large number of adverse action notices. The Court also reviewed the legal standard for establishing a willful violation of the FCRA, an issue of concern to financial institutions because a damage award for willful violations can include actual damages, statutory damages, and punitive damages. While the case arose in the context of insurance, the Supreme Court's interpretation of section 615(a) applies to all users of consumer credit reports.
The Court reviewed GEICO's and Safeco's notice procedures to determine whether they violated section 615(a). In GEICO's case, when pricing an insurance application, it first calculated the hypothetical premium it would have charged if the applicant's credit report were not considered (the neutral premium) and compared it to the premium actually charged. If the actual premium exceeded the neutral premium, GEICO sent out an adverse action notice.
For Safeco, the issue was its notice procedures for applicants applying for the first time. Safeco did not send these applicants notices because it believed that section 615(a) only applied to insurance renewals, when the premium is increased because of negative information in the credit report. The Ninth Circuit held that both companies' procedures violated section 615(a) because it interpreted adverse action to include not offering a consumer the lowest premiums available to applicants with the highest credit ratings.
The Court reversed the Ninth Circuit's ruling. It held that section 615(a) requires an adverse action notice only when a creditor is charging a higher rate (or otherwise acting adversely to the consumer) based on information in the consumer's credit report. If the user of a consumer report examines it but does not take adverse action because of it, section 615(a) has not been violated. The Court illustrated this point with an example: "if a consumer's driving record is so poor that no insurer would give him anything but the highest possible rate regardless of his credit report, whether or not an insurer happened to look at his credit report should have no bearing on whether the consumer must receive notice, since he has not been treated differently as a result of it."
The Court found that GEICO's procedure complies with section 615(a). Sending out notices only when the actual premium exceeds the neutral premium that would have been charged if the credit report were not considered ensures that consumers are notified when information in their credit report negatively impacted a transaction.
The Court rejected the interpretation advanced by the plaintiffs that users of credit reports must send out an adverse action notice if consumers were not offered the lowest rate offered to those with the highest credit ratings. This interpretation would require creditors to inundate consumers with adverse action notices because only a small percentage of applicants have the highest credit ratings. In practice, consumers would learn to ignore adverse action notices, thus defeating the primary purpose of section 615(a) of alerting consumers to negative information in their credit report.
With respect to Safeco, the Court rejected the argument that section 615(a) did not apply to first-time applicants. However, because Safeco was charged with willfully violating the FCRA (as opposed to negligently violating it), the Court still had to determine whether Safeco's violation was willful. Safeco argued that a willful violation requires evidence that a creditor knowingly violated the FCRA, while the plaintiffs argued that a reckless violation would also qualify. The Court affirmed the Ninth Circuit's ruling that a company can be liable for a willful violation if it recklessly disregards the risk of violating the FCRA, framing the test as follows: "a company does not act in reckless disregard of the FCRA unless the action is not only a violation under a reasonable reading of the statute, but shows that the company ran a risk of violating the law substantially greater than the risk associated with a reading that was merely careless."
Significantly, the Court held that Safeco was not reckless because its belief that the FCRA did not apply to initial insurance policies, while erroneous, was a plausible reading of the statute. The Court noted that neither the Federal Trade Commission, which enforces the FCRA, nor the federal courts of appeals had addressed the issue, and that the FCRA is not a model of clarity. Under these circumstances, Safeco's violation was not willful.
The standard for a willful violation is important. For a negligent violation, a consumer is entitled to the actual damages sustained as a result of the violation along with court costs and attorney's fees. But proving actual damages is difficult because the consumer would have to demonstrate that if the creditor had provided the adverse action notice, the consumer would have obtained his credit report, taken steps to improve his credit score, and reduced the cost of credit.
Willful violations expose financial institutions and other users of credit reports to greater liability. For a willful violation, a consumer is entitled to actual or statutory damages (a minimum of $100 but not greater than $1,000), punitive damages as the court may award, court costs, and attorney's fees. The availability of statutory damages is a particular concern because it is likely to attract class actions, since every class member would be entitled to statutory damages ranging from a minimum of $100 up to $1,000. Those damages could be substantial for a willful violation in which a creditor failed to send adverse action notices to a large number of consumers. A court could also award punitive damages, which are not available for a negligent violation. By ruling that a plaintiff can establish a willful violation by showing that a company acted recklessly, the Court has made it somewhat easier to prove a willful violation.
The lesson for financial institutions from the Safeco decision is to ensure they have established procedures for sending out adverse action notices under section 615(a) of the FCRA whenever they take adverse action against consumers based on their credit report or score. By establishing such procedures, financial institutions can prevent costly lawsuits for violations, particularly willful violations.
The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.