Everyone in the non-prime industry has seen the headlines about the most recent “larger participant” rule from the Bureau of Consumer Financial Protection (CFPB), for non-bank auto lenders. It was announced in September 2014, published in the Federal Register in October, and after the 60-day public comment period ends, will result in a final rule coming out in 6 to 12 months. Since the CFPB can take enforcement action against any financial institution that it finds in violation of the many laws that govern them, it’s important for every non-prime auto lender to know what the rule will do and what the CFPB has on its enforcement agenda, even for those companies that will not be subject to supervision under the larger participant rule.
Let’s start with what is in the proposed rule. Keep in mind that there may be changes after the CFPB considers comments it receives. The rule has several principal features:
- The rule covers larger non-bank auto lenders since the CFPB already supervises the larger banks, including their auto lending practices. It includes both direct and indirect auto financing, and defines the term “indirect auto financing” as you would expect.
- A “larger participant” is one that has 10,000 or more originations per year (unless the threshold number is adjusted upwards or downwards in the final rule). “Originations” include granting credit for an auto purchase, refinancing a credit obligation, purchasing or otherwise acquiring a credit obligation, entering into an auto lease, or purchasing or acquiring an auto lease. Originations by corporate affiliates are aggregated.
- Auto leases are treated as the “functional equivalent” of auto purchases. The CFPB treats them as equivalent because the consumer goes through the same kind of credit application process in order to enter into “a major financial obligation in the form of a commitment to make a stream of payments over a period of time.” It cites statistics that 30% of new auto acquisitions are made by lease instead of by purchase, up from 20% five years ago, and that leases cover 14% of the total new and used car market.
- Auto title lending is excluded from coverage under the rule, at least for now, because it is a different product. Although Buy Here Pay Here (BHPH) dealers can be supervised by the CFPB under its Dodd-Frank Act authority, they are also excluded from application of the larger participant rule. However, lenders who finance purchases or leases for BHPH dealers are not excluded.
- Full-payout leases and net leases as defined in banking regulations, where financial institutions reasonably expect to realize the return of their full investment plus finance costs over the term of the lease, are also excluded.
The CFPB invited the public to comment on a number of items, particularly on the 10,000-origination threshold, which it had several things to say about. It found that there are three different kinds of lenders in this market: (1) captive finance companies; (2) specialty finance companies (including non-prime lenders); and (3) BHPH finance companies, which either are associated with particular BHPH dealers or finance sales by independent BHPH dealers. Of the 500 or so participants in this market, the top 40 produce 90% of the volume. The 10,000 annual origination threshold was set because an estimated 38 entities at that level have 91% of the market. If the threshold were set higher, at 50,000 annual originations, the rule would cover 17 entities with 86% of the market, but the rule would not cover “as varied a mix of non-bank larger participants.” If the threshold were set lower, at 5,000 annual originations, the rule would cover 55 entities with 93% of the market, “only a marginal increase in market coverage.”
The CFPB took note of the fact that the states regulate non-bank auto lenders, but it carefully refrained from predicting how often or how intensive its examinations would be for larger participants which will remain subject to state regulation. The CFPB stated that it would take into account the extent of state supervision. This may mean that where states conduct examinations more rigorously, the CFPB may ease off by letting the state examiners take the lead. Or it may not, especially if it uncovers what it considers to be problems.
The CFPB stated in its comments on the proposed rule that when it does conduct an on-site examination, it will focus on the following: (1) discussion of policies, processes and procedures; (2) reviewing documents and records; (3) testing transactional files for compliance with consumer finance laws; and (4) evaluating the institution’s compliance management system. The CFPB refers to its October 2012 Examination Manual, which lays out a detailed checklist for examinations of all types of financial institutions under its supervision. The CFPB notes that its examinations will include what the lender’s service providers do.
What will the CFPB be looking for when it does supervise non-bank auto finance larger participants? Here, we can get some hints from the CFPB’s previous track record.
A primary concern will be fair lending. This is shown by the only publicly announced CFPB fair lending enforcement action in the auto finance area, against Ally in December 2013. This resulted in $80 million in restitution to customers and an $18 million fine to the CFPB. When the larger participant rule was issued in September 2014, the CFPB also issued its Supervisory Highlights which quietly mentioned, without naming names, that it has secured another $56 million in relief from other auto finance companies. This is serious money, to say the least.
At the same time that it issued its proposed larger participant rule, the CFPB also released its proxy methodology for examining transactional files to determine whether protected classes of borrowers may have received unequal treatment. The auto lending area does not have a law like the Home Mortgage Disclosure Act (HMDA), which requires mortgage lenders to record and report the racial and national origin characteristics of their borrowers. Banks carefully check their annual HMDA data as an early warning system to see whether they may be discriminating, since the CFPB and other bank supervisors, as well as consumer advocates, do so every year.
Since HMDA-type data about borrowers is not available and can’t be collected for auto lending, the CFPB uses its proxy methodology to make what amounts to informed guesses about borrowers’ race and national origin. By releasing its methodology, the CFPB is providing a tool by which auto lenders can replicate what it will be doing to determine whether they may be discriminating against protected classes of consumers. Supervised auto finance larger participants will need to replicate this work as long as they continue to give dealers discretion to mark up interest rates from the buy rate in order to see how well they score on the fairness of their lending practices and to find whether they will have to take corrective action. Of course, lenders will remain free to avoid all of this compliance work by changing to a non-discretionary flat fee system for dealers, as advocated in the CFPB’s auto finance bulletin in March 2013.
Supervised larger participants that do not opt to go to a flat fee system will also need to institute and maintain a “robust” compliance management system in accordance with the March 2013 bulletin, if they have not done so already. The CFPB’s view of an appropriate compliance management system is one that includes all of the following: an up-to-date fair lending policy statement; regular fair lending training for all employees that deal with credit transactions, including the board of directors; ongoing monitoring for compliance with policies and procedures; appropriate controls on dealer discretion; “meaningful” board and management oversight of fair lending compliance; review after the fact of whether there has been a disparate impact on protected classes of borrowers through regular analysis of loan data and marketing practices; commencing prompt corrective action against dealers where warranted by disparate impact on protected classes; and promptly remunerating affected consumers.
Is there more on the CFPB’s agenda besides fair lending concerns? There certainly is. It announced settlements in June 2013 against U.S. Bank and Dealers’ Financial Services for deceptive practices in using military discretionary allotments to pay for cars. They allegedly failed to properly disclose allotment fees and misrepresented the true cost and coverage of add-on products that were financed along with the autos. This resulted in payment of $6.5 million in restitution to over 50,000 service members, and other relief.
Yet another theme was sounded in a consent decree between auto lender Consumer Portfolio Services and the CFPB’s friendly enforcement rival, the Federal Trade Commission (FTC), in May 2014. CPS allegedly used a variety of unfair and deceptive debt collection practices when it collected on its accounts. It was required to pay restitution of $3.5 million and pay a $2 million fine to the FTC. Debt collection practices are also a prime CFPB concern – its second larger participant rule (the auto finance rule is the fifth in the series) concerned debt collectors.
This theme was echoed in November when the CFPB entered into a consent decree with DriveTime, a BHPH dealer with its own captive lender that easily meets the 10,000-origination threshold with over 68,000 originations in 2013. The Consent Order and accompanying press release detailed numerous allegedly unfair and deceptive practices by DriveTime’s 370-person collection staff (including an offshore contractor) that “harassed and harmed countless consumers.” In addition to revamping its policies, practices and procedures and setting up a compliance mechanism that will make periodic reports to the CFPB for the next five years, DriveTime had to pay an $8 million fine to the CFPB.
Also cited in the DriveTime Consent Order were alleged deficiencies by another contractor in furnishing credit information to the credit reporting agencies for tens of thousands of accounts that DriveTime was aware of but did not do enough to correct. This violated the Furnisher Rule under the Fair Credit Reporting Act (FCRA). Allegedly poor handling of 22,000 consumer credit disputes also violated the FCRA. The CFPB’s first larger participant rule allowed it to supervise the credit reporting agencies, another prime CFPB concern.
The CFPB is still flexing its muscles in terms of exploring how far its authority extends to go after unfair, deceptive and abusive acts and practices (UDAAP), which goes one better than the FTC Act by giving it the authority to tackle “abusive” acts and practices as well as unfair and deceptive ones. For example, while the DriveTime Consent Order cited the CFPB’s UDAAP authority to deal with unfair, deceptive and abusive acts and practices, it only described DriveTime’s acts as “unfair and deceptive” but not as “abusive.” However, the CFPB’s examiners will certainly be looking for all three varieties of UDAAPs when they comb through the files of supervised larger participant auto finance companies.
When it announced the U.S. Bank and DFS settlements in June 2013, the CFPB issued another bulletin that outlined the factors that it will consider in exercising its enforcement discretion. The title pretty much sums it up: Responsible Business Conduct: Self-Policing, Self-Reporting, Remediation, and Cooperation. This was intended to give some good news to the CFPB’s supervised entities that “there are activities they can engage in both before and after the conduct in question has occurred that the Bureau may favorably consider in exercising its enforcement discretion.”
Companies that exercise “responsible conduct,” such as implementing and maintaining a robust compliance management system, are supposed get the benefit of the doubt when bad things happen. Whether a non-prime lender meets the definition of a “larger participant” or not, wherever the originations threshold is set in the final rule, the CFPB stands ready to enforce the consumer finance laws rigorously when violations occur, even if a company is already subject to state supervision. All non-prime lenders would be well advised to take heed of what the CFPB has said about “responsible conduct.”
John L. Ropiequet is a litigation counsel in the Chicago office of Arnstein & Lehr LLP and Co-Chair of its Consumer Finance Practice Group. He speaks and writes frequently on consumer finance law topics, is Vice President-Meetings of the Conference on Consumer Finance Law, and is Co-Editor of the Annual Survey on Consumer Financial Services Law in The Business Lawyer. He can be reached at firstname.lastname@example.org.