Earlier this month, the Consumer Financial Protection Bureau (CFPB) announced a joint enforcement action with the Department of Justice (DOJ) against Toyota Motor Credit Corporation (TMCC), an indirect auto lender, which, among other things, requires TMCC to pay $21.9 million in restitution to affected borrowers. Indirect auto lending is the most common type of auto financing. Through this process, the dealership collects credit information from the consumer, and forwards it to prospective indirect auto lenders for consideration. The indirect auto lender then sends the dealership eligibility criteria and stipulations including a “buy rate,” which is discussed in more detail below.

The CFPB and DOJ alleged that TMCC engaged in discriminatory lending practices in violation of the Equal Credit Opportunity Act (“ECOA”). Specifically, they alleged that TMCC allowed car dealerships to charge up to 2.5% interest over the “buy rate,” which is the lowest interest rate at which TMCC will purchase the auto loan contract entered into between the dealership and the borrower. This so-called “dealer markup” gives dealers discretion to charge consumers different rates, regardless of creditworthiness, and results in additional compensation paid by the lender to the dealer. The CFPB and DOJ alleged that the dealer markup had a disparate impact on blacks, Asians, and Pacific Islanders resulting in those borrowers paying higher interest rates than white borrowers.

The consent order entered in the case requires TMCC to: (1) establish a $21.9 million dollar settlement fund to compensate affected borrowers; (2) pay for the costs of a settlement administrator to distribute the settlement fund, and (3) limit car dealerships’ “mark up” discretion to 1.25% above the “buy rate” for loans with five year terms or less, and to 1% for loans longer than five years.

This is the CFPB’s fourth enforcement action since December 2013 against an indirect auto lender for alleged discriminatory practices related to auto dealership “mark ups.” Each has resulted in a settlement fund ranging from $14 million to $80 million to compensate the allegedly harmed borrowers. One also resulted in an $18 million penalty.

The CFPB’s aggressive enforcement actions against indirect auto lenders have been controversial for several reasons. First, the Dodd-Frank Act created the CFPB but expressly prohibited it from regulating auto dealerships. Critics, including House Republicans on the Committee of Financial Services, have suggested that the CFPB has worked around this prohibition by targeting indirect auto lenders that partner with auto dealerships. Rep. Roger Williams (R. Tex.) remarked, “I find it incredible myself that an agency which under federal law has no supervisory, enforcement or regulatory authority over auto dealers is still attempting, I believe, to dictate the manner in which auto dealers are compensated and how much they should be compensated for facilitating an auto loan for their customers.”

Second, while many have called for the CFPB to issue a dealer “mark up” rule to provide increased guidance and transparency, the CFPB has taken no steps toward implementation of such a rule. In an internal April 3, 2013 memorandum, the CFPB expressed concerns with the rulemaking approach:

First, the legal authority for all of the potential rulemakings is unclear given our lack of authority over dealers . . .. Second, the bureau would face considerable pressure from external groups if it sought to regulate or ban the practice of markup itself — pressure that should not be underestimated. The rule could be perceived as an attempt to circumvent our lack of regulatory authority over auto dealers, and that presents both legal and political risks that our rule could be overturned by a court or by Congress.

Indeed, as in other areas, the CFPB has preferred to address the alleged discriminatory lending practices through enforcement actions with the apparent hope that a few large penalties will influence the market. The April 24 memorandum acknowledged a meeting “to continue our discussion around a market-tipping settlement that would resolve the discriminatory disparities caused by dealer markup by eliminating markup at many major auto lenders.”

Third, while the CFPB typically targets practices that are the subject of extensive consumer complaints for enforcement, the Bureau has not said that its focus on dealership “mark ups” is motivated by consumer complaints.

Fourth, the CFPB has no direct evidence of disparate impact discrimination. On March 21, 2013, the agency released a bulletin suggesting it would use disparate impact analysis to determine if minority borrowers were being charged more for car loans. The problem, however, is that retail installment sales contracts do not show the race or gender of the borrower.  Thus, the CFPB utilizes a proxy method to estimate borrower demographics and use that to penalize lenders for unintentional discrimination.  While the CFPB issued a white paper describing its methodology, many insiders complain that the paper lacks precision and specificity, particularly in offering compliance guidance. The CFPB’s methodology uses census data and analyzes zip codes and last names to create a “proxy probability” for race and ethnicity. This methodology naturally results in capturing a population that is simultaneously over- and under-inclusive.

The TMCC consent order signals that CFPB will continue to regulate alleged discriminatory lending practices by indirect auto lenders through enforcement actions rather than any attempt at rulemaking. To avoid being targeted by the CFPB, indirect auto lenders may want to consider taking proactive steps to implement dealers “mark-up” caps similar to those set by the TMCC consent order.