Busy Couple of Weeks for FICO

By Edward Jamison, Esq.

Over the past few weeks the news surrounding FICO has been coming fast and furious. The Federal lawsuit filed by FICO against Experian, TransUnion and VantageScore Solutions was partially dismissed but left several counts that will now proceed to trial later this year. Additionally, the credit scoring company announced that FICO 08, their newest credit score, would be available at all three of the national credit reporting agencies starting in August 2009. This means that Experian has finally agreed to install and make available the credit score several months after TransUnion and Equifax had done so.

Regarding the FICO lawsuit:

On July 24th the Honorable Ann Montgomery ruled on a request to dismiss a lawsuit filed in Federal court by FICO (more formally referred to as Fair Isaac) against VantageScore Solutions, TransUnion and Experian. Judge Montgomery dismissed some of the counts and left others in place therefore leading the parties toward trial later this year.

The lawsuit, among other things, claims breach of contract and trademark infringement. The Order sheds a public light on a number of very interesting things that were not previously known, including email communication between executives of the credit reporting agencies. Some of the more interesting nuggets of gold, with emphasis added, from the Order are;

1. The proposed joint venture between the three credit reporting agencies was referred to as either “Operation Triad” or “Project Trident” and eventually lead to the creation of VantageScore Solutions and subsequently the VantageScore scoring model. VantageScore is a credit risk score but uses a different credit scoring range (501-990) as the FICO score (300-850). VantageScore also converts their numeric score to an alpha display using the academic A-F range, which seems comical considering VantageScore is not a lender and doesn’t underwrite loans. The assertion that they know how to grade a consumer’s as being an “A” versus a “B” is a responsibility solely for a lender, not a credit score developer.

It’s also important to note that while Equifax was originally named as a defendant they reached a settlement with FICO on or around June of 2008 and is no longer a party to the lawsuit. The fact that the bureaus named the project after a military weapon sheds light on their mindset at the time.

2. In February of 2005 Experian enlisted the assistance of a consulting firm, which at the time was called Mercer Oliver Wyman. Today this firm is referred to as Oliver Wyman and is a division of Marsh & McLennan. According to the Order this firm created a document for Experian that suggested “through the joint venture (VantageScore), the credit bureaus could build their own scoring model and transfer Fair Isaac’s revenue ENTIRELY to themselves.” The difficulty of replacing entrenched credit scoring systems seems to have been grossly underestimated. I wonder if Experian asked for a refund considering the consultant’s misread of the market.

3. The original VantageScore scoring model “relied on the algorithms in Experian’s own in-house, tri-bureau scoring model, which Experian made available to the team.” The bureaus announced VantageScore to the market in March of 2006. FICO files their lawsuit on October 11th of the same year. This seems to contradict VantageScore’s marketing literature, “The nation’s three consumer credit reporting companies – Equifax, Experian and TransUnion – worked together to develop a tri-bureau generic credit scoring system.”

4. Each of the credit bureaus pays $300,000 annually to secure royalty-free and global licenses for the use of the VantageScore model.

5. Prior to the introduction of VantageScore TransUnion’s royalty payments to FICO was $40,000,000. After the introduction of VantageScore the royalty payments were $44,000,000. No time frames were given so these figures could represent an annual amount or cover some other period of time but assuming the comparison is apples to apples it seems to suggest that FICO has not lost any market share to VantageScore. This means consumers applying for credit will likely have their loans underwritten by a lender using a FICO score.

6. With respect to the confusion in the consumer market of other scores with similar score ranges to that of the FICO score (300-850), “The evidence identified by Fair Isaac lends support to the inference that Defendants intentionally copied Fair Isaac’s 300-850 mark and that consumers confused Defendants credit scores with FICO credit scores as a result.” In English what this means is the credit bureaus intentionally chose score ranges that were similar to FICO’s 300-850 in order to confuse consumers who were shopping online for the credit scores. This has been a consistent criticism of both Experian and TransUnion for years. Equifax does not sell any credit score to consumers other than the legitimate FICO score so they’re not a target of the criticism. The simple question “why did you choose a score range similar to FICO’s” is one that they finally had to answer in court, although smart consumers already knew what they were up to.

7. The published FICO score ranges of 300 to 850 seems to not be the actual FICO score range. From the Order “Fair Isaac argues in response that the term 300-850 is not the "actual scoring range for any of [Fair Isaac's] classic FICO credit scores. The actual scoring range for the first FICO score developed for Trans Union is 397-871, for Experian is 368-839, and for Equifax is 407-829. Every version of these scores has a different range-none of which is 300-850."

Regarding FICO 08:

According to a press release issued by FICO on July 22nd “FICO 08 Credit Score Available at All Three National Credit Reporting Agencies” by the end of July. Experian had refused to adopt the model because of their ongoing litigation with Fair Isaac. And already “five of the seven largest U.S. banks and four of the five largest credit card issuers” have begun testing or using the new score.

What this means is consumers who have a large amount of credit card debt or are highly utilized will likely see lower FICO 08 scores. This is because of the added importance of credit card debt built within the model. It also means adding yourself onto the credit card of another person in an attempt to “piggyback” your way to a better score will be impossible sooner rather than later.

A benefit to consumers is FICO 08’s logic, which ignores very low dollar collections, commonly referred to as nuisance collections. Consumers who are seeing their scores lowered by collections with an original amount less than $100 will see immediate benefit with FICO 08. This is an incentive for lenders to more quickly adopt the new score because savvy consumers who have these small collections will know that a lender who uses FICO 08 will see them in a much better light. Nothing will incent a lender to adopt the newer model faster than prospects going to competing banks just to ensure a better credit score.

This is the 20 year anniversary of the introduction of the FICO score at a credit bureau. Consumers who conduct banking or insurance business at pretty much any bank, mortgage lender, or insurance company are subject to FICO’s evaluation.