CFPB Announces Plans to Fundamentally Change Indirect Auto Lending Practices
The Consumer Financial Protection Bureau (CFPB) issued an innocuously named bulletin, "Indirect Auto Lending and Compliance with the Equal Credit Opportunity Act," on March 21, 2013, that amounts to a manifesto to fundamentally reform the indirect auto lending market.
At issue is a common practice where auto dealers originate financing documents for auto sales, and then assign the contract to a lender. Dealers often earn a payment known in the industry as “participation,” which is based on the annual percentage rate of the contract ― the higher the rate, the higher the participation paid by the lender and the higher the dealer’s profits. The CFPB, while not seeking an abolition of participation per se, is seeking to fundamentally reform the market by eliminating the dealer’s discretion in setting the interest rate in the financial contracts being assigned to the dealer. In essence, the CFPB is taking the position that exercising such discretion amounts to unlawful conduct under federal law.
This action was foreshadowed in December 2012 when the CFPB announced that it would be looking at the potential discriminatory impact of participation practices, which occur on a routine basis in the indirect auto lending world. The CFPB’s announcement in December was followed up by news reports in February of this year that a number of major lenders have been given notice of the intent by the CFPB that it could bring suit against them based on participation practices that might appear discriminatory and disparately impact protected classes of consumers.
Yesterday’s CFPB bulletin goes several steps further in what appears to be an all-out attempt to eliminate a dealer’s ability to set interest rates to increase its participation. The bulletin conclusively states that an “an indirect auto lender’s markup and compensation policies may alone be sufficient to trigger liability under ECOA.” (Emphasis added.) The CFPB expressed concern that discretionary pricing by dealers can have discriminatory impact on protected groups. In other words, the CFPB believes that the effect of allowing discretion is that protected groups will end up paying more for credit. The CFPB then strongly suggests that a legally compliant indirect lending payment to an auto dealer could be based on a “fair” flat payment that is not based on a dealer’s ability to set the annual percentage rate.
The Bulletin
The bulletin reinforces the CFPB’s earlier announcement regarding its authority to supervise indirect auto lenders to ensure “compliance with the ECOA and Regulation B as applied to dealer markup and compensation policies.” According to the CFPB, “[b]ecause of the incentives these policies create, and the discretion they permit, there is a significant risk that they will result in pricing disparities on the basis of race, national origin, and potentially other prohibited bases.” Further, the CFPB has determined that indirect auto lenders are liable as “creditors” under ECOA, even as assignees of an installment contract, if they “regularly participate in a credit decision.” The CFPB notes that the “standard practices” that it has observed of indirect auto lenders demonstrate a strong likelihood that they are engaged in conduct that would be considered as “participation in a credit decision under the ECOA and Regulation B.” The CFPB will, therefore, be closely examining the “disparate treatment” and “disparate impact” of participation practices to determine whether lenders are in violation of ECOA. Thus, as announced in the bulletin, “when [pricing] disparities exist within an indirect lender’s portfolio, lenders may be liable under the legal doctrines of both disparate treatment and disparate impact.”
Significantly, as part of the CFPB’s efforts to fundamentally alter the participation practices of the automobile industry and effect market change, the bulletin enumerates several steps that an indirect auto lender should take to ensure compliance with ECOA and Regulation B. As set forth by the CFPB, these steps include, but are not limited to, the following:
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Eliminating dealer discretion to mark up buy rates and fairly compensating dealers using another mechanism, such as a flat fee per transaction, that does not result in discrimination;
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Imposing controls on dealer markup and compensation policies as well as monitoring and addressing the effects of those policies, so as to address unexplained pricing disparities on prohibited bases; and
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Developing a strong fair lending compliance program, components of which should include:
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An up-to-date fair lending policy statement;
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Regular fair lending training for all employees, including officers and board members;
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Ongoing monitoring for compliance with fair lending policies and procedures;
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Review of lending policies for potential fair lending violations;
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Regular analysis of loan data for potential disparities on a prohibited basis in pricing, underwriting or other aspects of the credit transaction;
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Regular assessment of marketing of loan products; and
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Meaningful oversight of fair lending compliance by management as well as the financial institution’s board of directors.
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Further, the bulletin makes clear that indirect lenders are responsible for monitoring their automobile dealers. Lenders that continue to engage in participation practices are urged by the CFPB to implement systems for monitoring and imposing corrective actions to address the risks of continuing to engage in such conduct. The bulletin suggests that the following steps be taken:
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Sending communications to all participating dealers explaining ECOA and the dealer’s obligations to mark up rates in a non-discriminatory manner;
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Conducting regular analysis of both dealer-specific and portfolio-wide loan pricing data for potential disparities on a prohibited basis;
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Commencing prompt corrective action against dealers, including restricting or eliminating their use of dealer markup and compensation; and
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Promptly remunerating affected consumers when unexplained disparities on a prohibited basis are identified.
What Now?
Director Cordray’s comments from several weeks ago suggested that he views participation practices as being inherently problematic, given that the pricing discretion given to dealers could result in discriminatory impact. These comments, coupled with the recently announced enforcement actions and yesterday’s bulletin, signal that the CFPB questions the legality of these practices on a global basis, given that the CFPB's view seems to be that such practices inherently result in discriminatory impact.
Automobile dealers and indirect lenders must be prepared for CFPB inquiries into their activities. Further, implementation of the above compliance standards should be viewed by indirect lenders as the minimum necessary to ensure that any CFPB inquiry into their practices turns out favorably. The CFPB has clearly announced its intention to apply pressure on any indirect lender that engages in participation practices. The CFPB’s ultimate goal, however, appears to be a complete overhaul of the automobile financing industry through eradication of these types of practices altogether, and not just ending discriminatory impact where it has been found and proven to exist. In the end, the CFPB’s actions may result in larger market participants, which are subject to CFPB jurisdiction and which are in the market for dealer business as indirect auto lenders, being at a competitive disadvantage as compared to entities not under CFPB jurisdiction, such as community banks.
About Troutman Sanders
Troutman Sanders is an accomplished and experienced leader in providing litigation and regulatory advice to a broad spectrum of financial services institutions, including those engaged in indirect automobile lending and motor vehicle dealerships. Troutman Sanders’ CFPB Team monitors the development and activities of the CFPB on its CFPB Report blog and also advises clients on CFPB and Dodd-Frank issues. Additionally, Troutman Sanders’ Financial Services Litigation practice group has successfully litigated a wide variety of individual and class actions, as well as other federal and state consumer protection laws now under the umbrella of the CFPB.
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