On Thursday, March 21, the Consumer Financial Protection Bureau (the CFPB) issued a bulletin 1 to provide guidance on the applicability of fair lending requirements to indirect auto lenders that permit auto dealers to increase interest rates and then compensate such dealers with a share of the revenues from those rates.
The bulletin states that the CFPB believes, in circumstances in which auto dealers have the ability to control interest rates or benefit from higher rates on auto loans, there is a significant risk this circumstance will result in pricing disparities on the basis of race, national origin, and potentially other prohibited bases under the Equal Credit Opportunity Act (ECOA) 2 and Regulation B.3
ECOA makes it unlawful for a “creditor” to discriminate on a prohibited basis in a credit transaction. The definition of the term “creditor” expressly includes any assignee who participates in the decision to extend credit.4 Information gathered by the CFPB suggests that the standard practices of indirect auto lenders likely constitute participation in a credit decision. The CFPB cited the example of a lender evaluating an applicant’s information, establishing a buy rate (the minimum interest rate at which the lender is willing to purchase the contract), and communicating that to the dealer. Another example cited by the CFPB is a lender providing rate sheets to a dealer establishing buy rates and then the lender allowing the dealer to mark up those rates.
The CFPB cautioned that, when pricing disparities on a prohibited basis exist within an indirect auto lender’s portfolio, it may be liable for both disparate treatment and disparate impact. The CFPB expressly did not distinguish between disparities arising within a particular dealer’s transactions or across different dealers in the lender’s portfolio.
Regulation B expressly provides, however, that a person is not a “creditor” regarding any violation 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 transaction.5 The CFPB explained that, in its view, this does not limit a creditor’s liability for violations arising from its own markup and compensation policies. The CFPB suggests in the Bulletin that indirect auto dealers should either impose controls on dealer markup and compensation policies to address unexplained pricing disparities on prohibited bases or eliminate dealer pricing discretion and compensate dealers with another mechanism such as a flat fee per transaction.
The CFPB also encouraged lenders to have a strong fair lending compliance program. Specifically, it suggested four things that an indirect auto lender might do to avoid problems in this area. First, it suggested sending communications about ECOA and the CFPB’s views on the disparate impact of dealer influence on pricing to all participating auto dealers. Second, it suggested regular analysis of both dealer-specific and portfolio-wide loan pricing data for disparities on a prohibited basis. Third, it suggested action against dealers when unexplained prohibited bases disparities are identified. Finally, it suggested prompt remuneration of affected customers when unexplained disparities on a prohibited basis are identified.
This is not the first time that the argument has been made that ECOA applies to indirect auto lending. In 2009, the Justice Department filed a complaint against Nara Bank alleging that the bank had violated ECOA by charging higher overages on loans to Hispanic borrowers than on loans to Asian borrowers.6 However, this bulletin raises a number of issues ranging from economic impact to the validity of disparate impact theory.
First, since the CFPB has no jurisdiction over auto dealers, some suggest that this Bulletin is an effort by the CFPB to do indirectly what it lawfully cannot do directly.
Second, most fair lending cases have been brought in the realm of residential mortgage lending because lenders are legally required by the Home Mortgage Disclosure Act to collect and report data on mortgage lending to protected classes. Similar data on auto finance is not generally available.
Third, the number of auto contracts sold by any given dealer is not likely to be sufficiently great to serve as the basis for meaningful statistical regression analysis to supporting a finding of unlawful discrimination.
Fourth, under the Administrative Procedure Act, a regulatory agency wishing to adopt a policy on indirect auto lending and discretionary pricing by auto dealers would propose a regulation for public comment, consider those comments so as to ensure its understanding of all of the consequences of what it proposed, revise the proposed regulation to take into account those concerns, and give those affected sufficient time in which to comply with the new policy. The CFPB has not done so in this case.
Fifth, application of disparate impact theory is becoming increasingly controversial. The U.S. Supreme Court accepted a petition for certiorari in a case challenging the theory under the Fair Housing Act in 2011. However, the Justice Department, in what has now become a highly publicized effort, pressured the appellant to withdraw the petition which some have taken as a signal of a lack of confidence in the legal basis of the theory.7 Another petition for certiorari on the same issue is currently under consideration by the Supreme Court.
Finally, the most ardent advocates of the disparate impact theory recognize a business justification defense, where the discriminatory practice serves a legitimate business purpose. The burden is on the government then to prove that the same purpose could be served by a practice that does not have a discriminatory effect. Unfortunately, the CFPB’s bulletin on indirect auto lending does not mention such a defense.