Auto Finance Industry in the CFPB's Crosshairs/media/files/events/... · 4/16/2013  · other auto finance companies settled private class actions alleging discriminatory impact (e.g.,

Auto Finance Industry in the CFPB's Crosshairs April 16, 2013 Alan S. Kaplinsky, Practice Leader

Consumer Financial Services 215.864.8544

[email protected]

John L. Culhane, Jr. Consumer Financial Services

215.864.8535 [email protected]

Christopher J. Willis Consumer Financial Services

678.420.9436 [email protected]

Copyright 2013 by Ballard Spahr LLP

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Moderator – Alan S. Kaplinsky

• Practice Leader of the Consumer Financial Services Group at Ballard Spahr

• Devotes his practice to counseling financial institutions with respect to bank regulatory and transactional matters and defending them in individual and class action lawsuits (including CFPB investigations and government enforcement matters)

• First President of the American College of Consumer Financial Services Lawyers

• Former Chair of the American Bar Association Committee on Consumer Financial Services of the Business Law Section

• Co-Chair of the Practising Law Institute's Annual Consumer Financial Services Institute, now on its 18th year

• Has been named as a tier one banking and consumer financial services lawyer in the 2006 through 2012 editions of Chambers USA

• Has been named in The Best Lawyers in America under financial services regulation law and banking and finance litigation from 2007 to 2013

• Named the 2012 Philadelphia Lawyer of the Year for Litigation-Banking & Finance

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Panelist – John L. Culhane, Jr.

• Partner at Ballard Spahr and a member of the firm’s Consumer Financial Services, Higher Education, Mortgage Banking, and Bank Regulation and Supervision Groups as well as the firm’s Fair Lending Task Force

• Practice emphasizes advising clients offering multi-state direct and indirect consumer and residential mortgage loan and financing programs, including counseling on ECOA and FHA compliance issues

• Experience includes conducting fair lending assessments of financial institutions and assisting in the defense of fair lending-related class actions, attorney general investigations, and agency enforcement actions

• Charter member of the American College of Consumer Financial Services Lawyers

• Former Chair of the Subcommittee on Fair Lending of the ABA Committee on Consumer Financial Services

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Panelist – Christopher J. Willis

• Partner at Ballard Spahr and a member of the firm’s Consumer Financial Services and Mortgage Banking Groups

• Counsels financial institutions on regulatory matters, advises them on compliance with consumer financial services laws, and defends them in both individual and class action lawsuits, as well as governmental enforcement actions (including CFPB investigations)

• Chairs the firm’s Fair Lending Task Force and Collection Documentation Task Force

• Named in The Best Lawyers in America for banking and finance litigation and commercial litigation for 2013

• Frequent author and speaker on issues relating to consumer financial services regulation and litigation

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The Practices at Issue • Auto finance company sets a wholesale “buy rate” for a

potential retail installment sale contract (RISC) and communicates that rate to dealer.

• So-called “policy” of allowing dealer to contract with buyer

for a higher rate (pejoratively referred to by the CFPB as the dealer “markup”).

• If the contract rate is higher than the wholesale buy rate,

and the contract is assigned to the finance company, the dealer receives an amount referred to as a “reserve” (or “finance charge participation”).

DMEAST #16677375 v1

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The Practices at Issue (cont.)

• The compensation is based on the difference between and the contract rate and the wholesale buy rate established by the finance company assignee.

• Compensation may vary from finance company to finance company and from program to program within the same finance company.

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Prior History

• Beginning in the mid-1990’s, regulators and the Department of Justice warned creditors of the potential for claims of unlawful discrimination.

• From 2000 through 2008 the major captives as well as

other auto finance companies settled private class actions alleging discriminatory impact (e.g., Coleman v. GMAC, Jones v. Ford Motor Credit, Smith v. Chrysler Finance, Cason v. Nissan Motor Acceptance Corp., Baltimore v. Toyota Motor Credit, Willis v. American Honda Finance Corp).

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Prior History (cont.)

• During the same period, the Department of Justice likewise settled cases against certain auto dealers (e.g., Pacifico Ford, Springfield Ford).

• Settlements tended to permit rate increases of different

percentage points, depending on the term of the financing – with some establishing a two tiered approach, 2.5% (60 months or less) and 2.0% (61 months or more), and some establishing a three tiered approach, 2.5% (60 months or less), 2.0% (61 to 72 months), and 1.5% (73 months or more).

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Some CFPB History

• CFPB Exam Manual v. 1.0, released October 13, 2011, included instructions for addressing “disproportionate adverse impact” violations.

• CFPB Bulletin No. 2012-04, issued April 18, 2012,

reaffirmed CFPB’s commitment to disparate impact theory of liability under the ECOA and Regulation B.

• First Annual Fair Lending Report, released December of

2012, stated that CFPB had been conducting “in-depth reviews of products or activities that pose a heightened fair lending risk to consumers” (no mention of auto finance).

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Some CFPB History (cont.)

• Bloomberg reported on February 21, 2013, that CFPB had informed at least four banks that “it may sue them over vehicle loans and interest-rate markups by auto dealers that appear discriminatory.”

• And then ....

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CFPB Bulletin No. 2013-02

• CFPB Bulletin No. 2013-02 on Indirect Auto Lending and Compliance with the Equal Credit Opportunity Act issued March 21, 2013.

• CFPB says its supervisory experience confirms that some

“indirect auto lenders” have policies that allow dealers to “markup” buy rates and that those companies then compensate the dealers for doing so.

• CFPB criticizes the incentives created by these policies and

the discretion permitted dealers under these policies.

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CFPB Bulletin No. 2013-02 (cont.)

• CFPB warns that there is a significant risk that these policies will result in pricing disparities on one or more prohibited bases, in violation of both the ECOA and Regulation B.

• CFPB then elaborates on how purchasers or RISCs can be creditors under the ECOA and Regulation B.

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Purchasers of RISCs as Creditors

• CFPB states that a finance company assignee of RISCs is a creditor under the ECOA and Regulation B if in the ordinary course of business it regularly participates in credit decisions (citing Section 702(e) of the ECOA and Section 1002.2(l) of Regulation B).

• CFPB purports to recognize that “there is a continuum of

… participation” and that different assignees “may be at various points along this continuum.”

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Purchasers of RISCs as Creditors (cont.)

• CFPB provides no guidance as to what assignees may be doing that would place them at a safe point on the continuum.

• Instead, CFPB states that the information it has suggests that “the standard practices” of assignees constitute participation in credit decisions, thus invoking the coverage of the ECOA and Regulation B.

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CFPB View of Liability for Pricing Disparities • Liability may be based on disparate treatment or disparate

impact • Assignee may be liable for evaluating a particular

application, establishing a buy rate, and then communicating that buy rate, if discrimination results from the assignee’s own policies (disparate treatment and/or disparate impact, not limited by multiple creditor rule).

• Assignee may be liable for providing rate sheets to a dealer establishing buy rates and then later purchasing a RISC from that dealer, if discrimination results from the assignee’s own policies (disparate treatment and/or disparate impact, not limited by multiple creditor rule).

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CFPB View of Liability (cont.)

• Assignee may be liable for purchasing RISCs with knowledge or reasonable notice of a dealer’s discriminatory conduct, “depending on the facts and circumstances” (disparate treatment and multiple creditor rule?).

• Do these results really follow from the language of the ECOA and Regulation B?

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Are Disparate Impact Claims Cognizable Under the ECOA?

• This threshold issue of statutory interpretation is discussed thoroughly in Peter N. Cubita & Michelle Hartmann, The ECOA Proscription and Disparate Impact – Interpreting the Meaning of the Words That Actually Are There, 61 BUS. LAW. 829 (2006).

• The ECOA declares it unlawful “to discriminate against” any applicant on a prohibited basis in connection with any aspect of a credit transaction.

• Disparate impact claims have been held to be cognizable under certain employment discrimination laws that proscribe certain adverse affects. Griggs v. Duke Power Co., 401 U.S. 424, 425 n.1, 429-30 (1971). See also Smith v. City of Jackson, 544 U.S. 228 (2005).

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Are Disparate Impact Claims Cognizable Under the ECOA?

• Unlike certain employment discrimination statutes, the ECOA does not prohibit practices that “adversely affect” an applicant on a prohibited basis.

• See Garcia v. Johanns, 444 F.3d 625, 633 at n.9 (D.C. Cir. 2006) (“Both Title VII and the Age Discrimination in Employment Act . . . prohibit actions that ‘otherwise adversely affect’ a protected individual. . . . The Supreme Court has held that this language gives rise to a cause of action for disparate impact discrimination under Title VII and the ADEA. . . . [The] ECOA contains no such language. We express no opinion about whether a disparate impact claim can be pursued under the ECOA.”) (emphasis added) (citations omitted).

• A picture is worth a thousand words . . .

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The Words That Actually Are There

Title VII, Sec. 703(a) ADEA, Sec. 4(a) ECOA, Sec. 701(a)(1)

Disparate Treatment Proscription

(a) It shall be an unlawful employment practice for an employer-

(1) to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual’s race, color, religion, sex, or national origin;

(a) It shall be unlawful for an employer: (1) to fail or refuse to hire or to discharge any individual or otherwise discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual’s age;

(a) It shall be unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction —

(1) on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract);

Disparate Impact Proscription

(a) It shall be an unlawful employment practice for an employer- . . .

(2) to limit, segregate, or classify his employees or applicants for employment in any way which would deprive or tend to deprive any individual of employment opportunities or otherwise adversely affect his status as an employee, because of such individual’s race, color, religion, sex, or national origin.

(a) It shall be unlawful for an employer: . . .

(2) to limit, segregate, or classify his employees in any way which would deprive or tend to deprive any individual of employment opportunities or otherwise adversely affect his status as an employee, because of such individual’s age….

None.

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The Alleged “Policy” of “Allowing” Dealers to Negotiate Contract APRs

• This disparate impact theory of liability is based upon an analogy to Watson v. Fort Worth Bank & Trust, 487 U.S. 977 (1988), which involved subjective hiring decisions made by employees who were subject to the control of their employer.

• Dealerships are independent, unaffiliated third parties whose retail pricing decisions are not subject to the control of RISC assignees

• The asserted “policy” is, in fact, the essence of the motor vehicle sales finance business – the practice of purchasing RISCs from retail installment sellers at a discount.

• Can this “policy” properly serve as the foundation of a disparate impact claim given the requirement that a disparate impact plaintiff identify a specific policy or practice of the defendant that causes a discriminatory effect?

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The Alleged “Policy” of “Allowing” Dealers to Negotiate Contract APRs

• The asserted policy of the assignee has no effect, discriminatory or non-discriminatory, absent intervening conduct by independent dealers.

• This use of disparate impact theory is reminiscent of the “non-delegable duty” doctrine rejected by the U.S. Supreme Court in that it attempts to render a purchaser of RISCs strictly liable for alleged disparate treatment by employees of independent, unaffiliated dealers.

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ECOA “Creditor” Definition: Dealerships

• Reg. B defines a “creditor” to mean “a person who, in the ordinary course of business, regularly participates in a credit decision, including setting the terms of the credit.”) (emphasis added). 12 C.F.R. § 1002.2(l).

• Auto dealers regularly negotiate contract APRs with the retail buyers with whom they contract.

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ECOA “Creditor” Definition: Assignees

• The Commentary to Regulation B specifies, in transaction-specific terms, when a prospective assignee may be deemed to have participated in a credit decision:

• Assignees. The term creditor includes all persons participating in the credit decision. This may include an assignee or a potential purchaser of the obligation who influences the credit decision by indicating whether or not it will purchase the obligation if the transaction is consummated. 12 C.F.R. Part 1002, Supp. I, ¶ 1002.2(l)-1 (emphasis added).

• In the case of a “spot delivery,” the dealer enters into a RISC and delivers the vehicle to the buyer prior to learning whether a prospective assignee will purchase the RISC.

• In a “spot delivery” scenario, how can an assignee fairly be said to have “participated” in a dealer’s decision to enter into a RISC?

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ECOA Multiple Creditor Liability Rule

• MCLR: “A person is not a creditor regarding any violation of the Act or this regulation committed by another creditor unless the person knew or had reasonable notice of the act, policy, or practice that constituted the violation before becoming involved in the credit transaction.” 12 C.F.R. § 1002.2(l) (emphasis added).

• The Bulletin asserts that the MCLR is not implicated because the asserted disparate impact liability would be premised upon the assignee’s own policy.

• But the asserted policy of the assignee has no impact whatsoever absent intervening conduct of independent, unaffiliated dealerships.

• The situation therefore is not comparable to a minimum income policy or to any other facially-neutral policy whose effects do not depend upon the conduct of third parties. The “effects” are not self-effectuating.

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Factual Issues: Unknown Race and Ethnicity

• The assignee does not know the race or ethnicity of the retail buyer

• Proxies for race and ethnicity must be used to perform a regression analysis

• Proxies have error rates associated with them

• Inverse relationship between the percentage of the target group captured by a geographic proxy and the accuracy of the proxy

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Factual Issues: Retail Installment Sales Are Multi-Faceted Transactions

• The dealership is the retail installment seller of the motor vehicle and any ancillary products included in the RISC

• The dealership may earn profit on the cash sale price of the vehicle and in connection with the sale of certain ancillary products such as service contracts and the like

• Regression analyses focus solely on dealer finance income, thereby failing to control for these other types of dealer profit opportunities

• Arthur P. Baines and Marsha J. Courchane, How the CFPB's Auto Financing Rule Affects Consumers, American Banker (Apr. 10, 2013) (available at http://www.americanbanker.com/bankthink/how-the-cfpbs-auto-financing-rule-affects-consumers-1058204-1.html)

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Factual Issues: Non-Discriminatory Factors

• Non-discriminatory factors not captured by regression analyses may influence the contract APR negotiated between the dealer and buyer.

• Negotiating ability and position

• Access to alternative sources of credit on more favorable terms

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Portfolio Level Analysis

• Assignee portfolios are an aggregation of whatever RISCs thousands of dealers decided to assign to them over an extended period of time.

• A “portfolio imbalance” at the assignee level may be attributable to differences in pricing practices among dealers rather than discriminatory pricing by any particular dealer.

• Analyzing rate spread differences with respect to an assignee’s portfolio of acquired RISCs does not enable an assignee to determine whether any dealer has engaged in discriminatory pricing

• Analysis of RISCs acquired by assignees is fundamentally inconsistent with the underlying legal theory, which depends upon how individual dealerships exercise the so-called subjective decision making authority “allowed” by the assignee

• The assignee data set will include RISCs resulting from “spot deliveries”

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Factual Issues: Portfolio Level Analysis

• “For example, determining the damages of each class member in this case would involve investigation into the practices of multiple auto dealerships whereas a back pay claim typically involves the practices of a single employer.” Coleman v. GMAC, 296 F.3d 443, 450 (6th Cir. 2002) (emphasis added).

• In Osborne v. AmSouth Bank Corp., No 3:02-0577, 2003 WL 22025067, at *2 (M.D. Tenn. July 15, 2003), SJ was awarded to AmSouth based upon a comparison the named plaintiffs’ circumstances with those reflected in RISCs with white buyers that the dealer with whom they dealt had assigned to AmSouth Bank during two time periods.

• The Osbornes’ rate spread was the lowest of all of the RISCs that the contracting dealer had sold to AmSouth during the month that they entered into their RISC.

• The Osbornes’ rate spread “was below the average markup for white customers during the relevant time period,” which was the five calendar month period encompassing the month in which the Osbornes entered into their RISC. Osborne v. AmSouth Bank Corp., 2003 WL 22025067, at *2.

• What factually questionable result might have obtained had the AmSouth summary judgment analysis been performed by reference to the assignee portfolio as a whole rather than just the RISCs that the dealership assigned during a limited time frame?

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Business Justification Standard and the Burden of Proof

• Consider Wards Cove Packing Co. v. Atonio, 490 U.S. 642 (1989), and the fact that Congress amended only Title VII in response to Wards Cove.

• “Though we have phrased the query differently in different cases, it is generally well established that at the justification stage of such a disparate-impact case, the dispositive issue is whether a challenged practice serves, in a significant way, the legitimate employment goals of the employer.” Wards Cove, 490 U.S. at 659.

• “[T]here is no requirement that the challenged practice be ‘essential’ or ‘indispensable’ to the employer’s business for it to pass muster: this degree of scrutiny would be almost impossible for most employers to meet, and would result in a host of evils we have identified above.” Wards Cove, 490 U.S. at 659.

• “In this [justification] phase, the employer carries the burden of producing evidence of a business justification for his employment practice. The burden of persuasion, however, remains with the disparate-impact plaintiff.” Wards Cove, 490 U.S. at 659.

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Business Justification Standard and the Burden of Proof (cont.)

• Stated Purpose of the Civil Rights Act of 1991 amendment to Title VII was “to codify the concepts of ‘business necessity’ and ‘job related’ enunciated by the Supreme Court in Griggs v. Duke Power Co., 401 U.S. 424 (1971), and in the other Supreme Court decisions prior to Wards Cove Packing Co. v. Atonio, 490 U.S. 642 (1989).”

• Cf. 12 C.F.R. Part 1002, Supp. I, ¶ 6(a)-2 (“. . . and the burdens of proof for such employment cases were codified by Congress in the Civil Rights Act of 1991 (42 USC 2000e-2)”)

• See Smith v. City of Jackson, 544 S. Ct. at 268-69 (“if disparate impact claims are to be permitted under the ADEA, they are governed by the standards set forth in our decision in Wards Cove Packing Co. v. Atonio, 490 U.S. 642 (1989). This . . . means that once the employer has produced evidence that its action was based on a reasonable nonage factor, the plaintiff bears the burden of disproving this assertion.”) (O’Connor, J., concurring in judgment).

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The CFPB’s Recommendations in Bulletin 2013-02

• Impose controls on dealer “markup” and compensation policies

• “Otherwise revise” dealer “markup” and compensation policies

• Eliminate dealer “markup” and change compensation policies

• Monitor and take prompt corrective action to address disparate impact (may be necessary in all circumstances, even if dealer “markup” is eliminated)

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Imposing Controls

• No real guidance as to what “controls” would be permissible.

• Appears to sanction the use of a narrow band for increases.

• However, prior DOJ and class action settlements allowing finance charge rate spreads are clearly being criticized.

• Is it really a “control” to say that the dealer may contract for a higher rate as long as the dealer does so in a non-discriminatory fashion?

• Do “controls” invite the dealer to request and/or record monitoring information?

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“Otherwise Revising”

• No real guidance as to what “otherwise revising” means

• Is a “subtraction” policy permissible?

• Could a pre-requisite to any compensation be participation in educational and/or training programs? Consent to mystery shopping?

• Could a compliance bonus be paid to a dealer if an analysis shows that the there was no disparate impact?

• Are there any other options here? If so, why didn’t the CFPB elaborate on them?

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Eliminating Finance Charge Rate Spreads

• What alternatives exist? Flat fee? Fee for services? Fee for volume? Other?

• What are the implications of a flat fee? Would this just result in dealer assignments to the purchaser paying the highest fee?

• How would a fee for services work? What services could be compensated?

• What issues might be associated with a volume fee? Would a volume fee really survive regulatory criticism? (In other contexts, volume fees are viewed as providing incentives for inappropriate conduct.)

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Monitoring and Taking Prompt Corrective Action

• Should all deals be monitored? What about spot deliveries? How can those transactions be segregated from any monitoring?

• Are all dealer analyses and all portfolio analyses going to be meaningful? What if the dealer analysis and portfolio analysis differ? Can a dealer influence the analysis?

• What about the uneven impact on different purchasers of RISCs? Would a smaller purchaser of RISCs have any choice other than to exit the market?

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Monitoring etc. (cont.)

• How should consumer remediation be handled given the use of proxies?

• Isn’t any corrective action going to spur private class action litigation?

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4 More Hot Compliance Issues in Auto Finance

1. Add-on products

2. Disclosures related to the impact of “simple interest” calculation

3. Vendor management

4. Discretionary decisions in servicing and collections

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Add-On Products

• Add-on products have historically been an area of regulatory focus

• CFPB Consent Orders relating to add-on products related to credit cards

• Potential risk areas: • Pricing of products in relation to “value” • Dealer training, sales materials, and representations regarding

products, and monitoring of same • Detecting and responding to complaints • Cancellation and refund policies and procedures • Dealer pricing discretion • Oversight of vendors who provide or administer add-on products

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“Simple Interest” Disclosures

• “Simple interest” contracts are common in the auto finance industry

• There is a potential for consumer confusion relating to the impact of early/late payments on the total finance charge

• Disclosure in contracts can be difficult, especially in drawing distinction between grace period for late charge avoidance and finance charge accrual

• Dealer training/explanations on this point may need to be assessed, or supplemented by separate disclosure provided by RISC purchaser

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Vendor Management

• CFPB has placed great emphasis on vendor management • Certain vendors – especially those involved in collections and

repossession – pose the highest levels of risk to RIC owners • Lead generators, if used, may also present risks relating to how

leads are developed and selected • High-risk vendors should be the subject of:

• Careful and documented pre-relationship due diligence • Contract provisions that specifically address compliance

issues and responsibilities in detail • Auditing and monitoring for compliance issues

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Discretion in Servicing and Collections

• The CFPB has made it clear that it intends to apply fair lending principles in servicing and collection operations

• Fair lending concepts are mentioned prominently in the Mortgage Servicing Exam Procedures and the Debt Collection Exam Procedures

• The same principles would seem applicable in servicing and collections relating to auto finance

• Examples: late fee waivers; recovery decisions; settlements of deficiency balances

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Questions?

If you have questions about anything we covered today, please contact:

Alan S. Kaplinsky, Practice Leader Consumer Financial Services

215.864.8544 [email protected]

John L. Culhane, Jr. Consumer Financial Services

215.864.8535 [email protected]

Christopher J. Willis Consumer Financial Services

678.420.9436 [email protected]