THE FAIR CREDIT REPORTING ACT: COMMON PITFALLS FOR EMPLOYERS AND LITIGANTS

By Bruce S. Harrison

Elizabeth Torphy-Donzella

I. Introduction

Employers and their lawyers generally understand that pre-employment checks of prospective employees undertaken by third parties for a fee trigger duties under the Fair Credit Reporting Act ("FCRA" or "Act"). [i] These duties, in general terms, include providing notice to and obtaining the consent of the person upon whom the check is to be made before procuring the information; providing notice of the employer's intent to take adverse action based in whole or in part on the report prior to taking such action (along with a copy of the report); and giving notice of certain rights at the time the adverse action is ultimately taken. [ii] Employers, and even their lawyers, however, often fail to appreciate that the FCRA reaches a host of investigations and checks of employees that reach well beyond this context.

This article provides an overview of the background checks and investigative devices which an employer or its lawyer may use to obtain information about a prospective, current, or former employee that implicate the FCRA, and its notice and disclosure obligations. The article also offers lessons on how to obtain information about individuals without violating the FCRA.

II. FCRA BASICS

In order to understand the FCRA, and its application to the employment context, one must understand how the Act defines key terms, and how those terms have been interpreted by the Federal Trade Commission ("FTC"), the agency with jurisdiction over this law, and the courts.

A. The Statutory Definitions: Reports.

Consumer Report: Under the FCRA, the term "consumer report" includes "any written, oral, or other communication of any information by a consumer reporting agency bearing on a consumer's credit worthiness, credit standing, credit capacity, character, general reputation, personal characteristics, or mode of living which is used or expected to be used or collected in whole or in part for the purpose of serving as a factor in establishing the consumer's eligibility for . . . employment purposes." [iii]

Investigative Consumer Report: The Act defines an "investigative consumer report as "a consumer report or portion thereof in which information on a consumer's character, general reputation, personal characteristics, or mode of living is obtained through personal interviews with neighbors, friends, or associates of the consumer reported on or with others with whom he is acquainted or who may have knowledge concerning any such information." [iv]

Key Exclusion: A report that deals solely with the "transactions or experiences" between the consumer and the third party preparing the report (i.e. is based on conversations, first hand observations, and the like) is excluded from the definitions of "consumer report." [v]

B. Statutory Definitions: Reporting Agency

Consumer Reporting Agency ("CRA"): A CRA is defined as "any person which, for monetary fees, dues, or on a cooperative nonprofit basis, regularly engages in whole or in part in the practice of assembling or evaluating consumer credit information or other information on consumers for the purpose of furnishing consumer reports to third parties, and which uses any means or facility of interstate commerce for the purpose of preparing or furnishing consumer reports." [vi] As discussed below, FTC opinion letters have indicated that private investigation firms and even law firms can, by their activities, come within the scope of this broad definition when they undertake employment-related investigations.

C. Special Definitions for Employment.

Employment Purposes: This term, under the FCRA, "means a report used for the purpose of evaluating a consumer for employment, promotion, reassignment or retention as an employee" [vii]

Adverse Action: Under the FCRA, a person who suffers an adverse action as a result of a consumer report may be entitled to recover under the Act if he or she was not provided with the appropriate notices. An "adverse action" in the employment context includes "a denial of employment or any other decision for employment purposes that adversely affects any current or prospective employee." [viii]

D. Penalties.

In addition to potential criminal penalties, the penalties for non-compliance with any provision of the FCRA are actual damages, costs, attorneys fees and, for a willful violation, punitive damages. [ix]

III. FCRA APPLIED TO EMPLOYERS AND THEIR LAWYERS.

A. Pre-employment Reference Checks and Consent.

1. Reference Checks.

An employer that calls the references and prior employers identified by an applicant has no concern for the FCRA. The Act is not in the picture unless a third party is used. When, however, the employer contracts with a firm to handle the background check for a fee, this activity is squarely within the FCRA. Any firm that regularly "assembles or evaluates" information on individuals for another for a fee is a CRA. Thus, when such third parties perform criminal record checks, [x] educational background checks, [xi] license checks, [xii] reference checks, [xiii] and the like, an employer must provide the notices and obtain the consent mandated by the Act before proceeding. Furthermore, in the event that the employer intends to make a decision adverse to the subject of the report based in whole or in part on the report, additional disclosures are required.

By contrast, where an employer receives a report about an applicant from an employment agency rather than an employment screening firm, it need not be concerned about the FCRA because the burden is on the agency, not the employer, to comply with the Act. [xiv]

2. "E-Signed" FCRA Consents.

The Electronic Signatures in Global and National Commerce Act ("ESIGN") [xv] was designed to give electronic signatures the same force and effect as paper signatures, so long as certain requirements are met. The FTC Staff has concluded that an FCRA consent may be executed by ESIGN, but "the electronic authorization must be in a form that can be retained and retrieved in perceivable form as specified by Section 101(3) of the ESIGN Act." [xvi] The FTC Staffer noted that whether an "e-mail, mouse click 'yes' or other electronic means" reliably communicates the consumer's intent "will depend on the specific facts of the situation." [xvii]

B.                Internal Investigations Conducted by Outsiders:

Sexual Harassment, Employee Theft and Other Misconduct.

 

1. Sexual Harassment Investigations: The Vail Letter.

Many employment practitioners will recall their astonishment and consternation in 1999 at reading an FTC Staff Opinion letter that concluded that a law firm's investigation of a sexual harassment complaint by a client's employee might constitute a consumer report requiring the consent of the accused before proceeding. [xviii] The Vail letter reasoned that a sexual harassment investigation conducted by an outside law firm would constitute an investigative consumer report because it would involve the collection of information about an individual (the accused) from friends and associates (the coworkers) by a third party (the law firm), resulting in a report to the employer (a communication from the law firm of its conclusions). Accordingly, the Vail letter stated that if the investigation was the basis for an adverse action, the accused would be entitled to the full panoply of rights under the FCRA, including a copy of the unredacted report.

2. Iterations on the Vail Letter.

Subsequently, an official of the Society for Human Resources Management wrote the FTC to express concerns about the implications of the Vail letter. [xix] The writer, Ms. Meisinger, noted the dilemma inherent in providing notice to and obtaining consent from an employee before investigating his or her misconduct. While the FTC Staff person responded by expressing sympathy for such practical problems, he noted that this was the effect of the legislation. He suggested "that an employee's consent to procurement of a consumer report . . . can routinely be obtained at the start of employment, thereby relieving the employer of the awkward prospect of having to ask a suspected wrongdoer for permission to allow a third party to provide an investigative (or other) consumer report to the employer." [xx] He also suggested that, if an employer had not obtained such prior notice, it could ask all employees to sign a consent form so as not to alert the wrongdoer. Finally, he offered that the provider of the report might wish to exercise discretion in drafting the report "to minimize risks attendant to such disclosure, most importantly by not naming parties that provide negative information regarding the employee." [xxi]

In a footnote in the Meisinger letter, the Staff Person noted that the FCRA would not be implicated if the employer used a third party that did not "regularly engage" in preparing such reports, and therefore would not constitute a CRA. It was this reasoning that caused a court to conclude a month later in Friend v. Ancilla Syst., Inc. [xxii] that an internal investigation of a company's CFO, conducted by a law firm on behalf of a client and that led to the CFO's termination, was not a consumer report under the FCRA. The court also found that even if the law firm could be said to "regularly" conduct such investigations, "it is undisputed that any report made in the instant case involved plaintiff's transactions or experiences as defendant's CFO. A report containing information solely as to transactions or experiences between the consumer and the person making the report is specifically excluded from the term "consumer report." [xxiii]

3. Investigations of Suspected Employee Misconduct.

Investigations of employee theft, drug use and other misconduct by third parties can also trigger duties under the FCRA, depending on the nature of the investigation. In Salazar v. Golden State Warriors, the court found that a private investigator that conducted video surveillance of an employee for an employer in order to determine whether the employee was using illegal drugs did not thereby create a consumer report on the employee. [xxiv] The court held that the investigator's activities fell within an exception that excludes from the definition of consumer reports, "any report containing information solely as to transactions of experiences between the consumer and the person making the report." [xxv] Because the investigator was merely relaying to the employer his own firsthand transactions and experiences from his covert surveillance, his activities were found to be "squarely within the FTC interpretive regulations." [xxvi]

Based on the same reasoning, the FTC Staff has found that drug tests administered on employees for employers by laboratories for a fee do not fall within the FCRA. The laboratory is merely reporting the results of its "transactions and experiences" with the subject. [xxvii]

By contrast, if an intermediary, such as a commercial drug testing firm, administers the process of drug testing for an employer by contracting with a laboratory for testing its clients' employees, then assembles the results and relays them to the employer, the FCRA will come into play. To summarize, "an intermediary that provides only mechanical services (such as arranging for a lab test, collecting and forwarding samples to the lab, and transmitting test results) probably would not be a CRA making a "consumer report." At the other end of the scale, an intermediary that retains copies of tests performed by drug labs and regularly sells this information to third parties for a fee is a CRA whose reports of drug test results are "consumer reports covered by the FRCA." [xxviii]

4. Lessons.

Law firms that occasionally perform investigations of employee misconduct for clients, including complaints of sexual harassment, should not be deemed to be engaging in activities covered by the FCRA. By contrast, entities that regularly perform investigations for clients, such as human resource consulting firms and ancillary businesses founded by law firms to perform such human resources functions, should expect to be deemed CRAs when they engage in these activities. Such firms must recognize that they will have to provide copies of any report prepared to an individual who suffers an adverse action based in whole or in part on the report. It also should be noted that an oral report is equally subject to disclosure as is a written report. [xxix]

In order to avoid potential liability and to maintain flexibility, companies should obtain consent to background investigations from employees at the pre-hire stage broad enough to cover not just the pre-employment background check, but also post-hire investigations and inquiries. This will give companies latitude to investigate employee misconduct whenever it occurs, without having to "tip off" employees suspected of wrongdoing. It will not, however, relieve the employer of its obligation to provide a copy of the report if it forms the basis, in whole or in part, of an employment action that is adverse to the employee.

C.  Background Checks During Litigation.

1. Obtaining Credit Reports Parties to Lawsuits.

"Information is power, as an good attorney knows." [xxx] So began the U.S. Court of Appeals for the Sixth Circuit in a decision holding that a law firm could be held liable under the FCRA for obtaining a consumer report on the plaintiff for purposes of the litigation.

In Duncan v. Handmaker, Middleton & Reutlinger, P.S.C., the defense counsel became a defendant when he obtained a copy of plaintiff's credit report for purposes of litigation. In the course of defending a mortgage company sued for an allegedly defective home inspection, and armed with this report, Handmaker asked Mrs. Duncan [during her deposition] whether she described the property as worthless on applications for loans she received subsequent to filing the lawsuits against Banker's Mortgage. Handmaker also questioned Mrs. Duncan about why she did not list an existing mortgage as a contingent liability on her application for a loan from Banker's Mortgage." [xxxi]

After her deposition, Mrs. Duncan filed suit against the law firm, claiming that the lawyer had obtained her report without any lawful justification. The firm argued in response that the attorney's receipt of the report was proper because it was procured for a "legitimate business need," [xxxii] which is identified by the FCRA as a permissible purpose for obtaining a consumer report. The firm said it needed the information to prepare a defense. The court disagreed, because there was no related business transaction to which the report related. The Court distinguished cases in which the suit at issue involved a debt, where a consumer report might legitimately be needed for defense, from the case before it involving a common negligence claim related to a home purchase. "Given these circumstances, we cannot deem preparation for a negligence suit ëa legitimate business need . . . in connection with a business transaction." [xxxiii]

Another attorney was found to have wrongfully procured consumer reports during litigation in Bakker v. McKinnon. [xxxiv] The attorney repeatedly obtained reports on a doctor who she was threatening to sue, and, in letters to the doctor, "threatened to destroy and ruin [his] dental practice through litigation and publicity" and "improperly accused [him] of being a child molester." [xxxv] The attorney argued that she needed the report to see if the doctor could satisfy a large judgment, and thus had a "legitimate business need" for the report. The district court, in a bench trial, found instead that the attorney had obtained the credit report without any legitimate justification in a "blatant attempt to coerce a settlement" from the insurance carrier and assessed both compensatory and punitive damages. [xxxvi]

A litigant (as opposed to its counsel) was found to have violated the FCRA by obtaining a consumer report in Comeaux v. Brown & Williamson Tobacco Co. [xxxvii] The company was sued under various theories by a person it had refused to hire. The company obtained a report on the plaintiff by falsely advising a CRA that it wanted a the report for "employment purposes." Although the FCRA normally gives rise to liability for the false procurement of a report, the company argued that since the report actually was obtained for a non-consumer purpose (litigation), it was not governed by the FCRA. The court rejected this strained construction as one that would allow "those who request reports under false pretenses, stating a permissible purpose, to be exempt from [the Act] by using the report for a non-permissible purpose." [xxxviii] Such a conclusion, the court ruled, "has no basis in the law of this or any other circuit." [xxxix]

2. Hiring a PI to Investigate a Party.

While the previously discussed decisions addressed the use of financial credit reports in litigation, these rules apply equally to many background checks conducted by private investigators. FTC opinion letters have taken the position that private investigators and firms that provide criminal record searches for a fee are "consumer reporting agencies" within the meaning of the Act. [xl] Similarly, where a private investigator examines the background of an individual "through interviews with friends, neighbors, associates and others with knowledge of the consumer, [the investigator] is making a particular type of consumer report known as an "investigative consumer report.: [xli]

By contrast, as noted previously, the court, in Salazar v. Golden State Warriors found that a private investigator that conducted video surveillance of an employee for an employer in order to determine whether the employee was using illegal drugs did not thereby create a consumer report on the employee. [xlii] The court held that such activities fell within the "transactions or experiences" exception to the FCRA. [xliii]

3. Lessons for Lawyers and Litigants.

If lawyers wish to avoid becoming litigants themselves, they must be mindful that using third parties to obtain information about a party to a lawsuit may implicate the FCRA and its penalties, including punitive damages. On the other hand, the lawyer should not run afoul of the Act by conducting such background investigations on her own during the course of defending a matter (unless, of course, the lawyer's engagement by the client is for this very purpose and the lawyer regularly engages in such services for a fee). [xliv] Similarly, reports by private investigators that are based solely on their own observations of the plaintiff should not trigger the FCRA in light of the "transactions or experiences" exception.