In my previous column I promised to address the laws and regulations which affect you, and how you can take some simple, effective and inexpensive steps to comply with them. In the aftermath of the NADA Convention, the greatest and immediate issue which affects dealers is the disparate impact theory. It is the legal basis advanced by the Consumer Financial Protection Bureau (CFPB) for its recent $98,000,000 settlement with Ally Bank regarding the reserve. I will offer an immediate solution to this problem, as well as a general remedy which should assist dealers with a long term solution to compliance issues.
As you may recall the CFPB is a creation of the Dodd-Frank Act and has been given vast powers to study, investigate, prosecute and promulgate laws regarding various business interests as a federal agency. Fortunately, franchise dealers are not directly within its jurisdiction. BHPH dealers and some independent dealers are, however, as are many financing sources. A legal theory advanced by the CFPB regarding Fair Lending, referred to as disparate impact, produced this result with Ally Bank. It may affect all dealers which sell or assign their Retail Installment Sale Contracts and Lease Contracts to financing sources.
Fair Lending – Disparate Impact
One of the CFPB’s missions is to police fair lending. American consumers should have access to credit in a fair way. Discriminating against credit applicants is prohibited pursuant to the Equal Credit Opportunity Act (ECOA) and its corresponding regulation, Regulation B, on the bases of race, color, religion, national origin and other factors. These different groups are considered the protected classes. “Reg B,” as it is usually called states that this prohibition applies, not just to intentional discrimination, but also to credit practices that result in a negative “disparate impact” on consumers based on one of these prohibited factors.
In other words, financing sources can be held liable for results they aren’t directly aware of. They may have to pay fines for allowing dealers to negotiate the APR with consumers which lead to disparities in the yield premium of these protected classes.
It’s important to note that financing sources, as well as dealers, may not realize that there has been a disparate impact as to interest rates until after the fact. A number of Retail Installment Sale Contracts would have to be sold to that financing source before the disparate impact effect could be ascertained.
The CFPB recognizes that dealers need to be compensated for assisting consumers in selling or assigning Retail Installment Sale Contracts. However, the preferred compensation method would appear to be flat amounts of payment not contingent on the difference between the wholesale and retail rates of the APR. The CFPB refers to it as a “mark-up,” a possibly pejorative term, when, in fact, it is a true retail margin. Consumers do not purchase things at the wholesale price; they purchase things at the retail price. The difference between these two prices is the dealer profit, or reserve, and covers the cost of doing business. There is nothing improper about the reserve.
The CFPB released a “guidance bulletin” in March 2013, addressing this issue and essentially announced its preferred methods of eliminating the disparate impact risk by either:
- substituting flat fees for the reserve thereby eliminating dealer pricing discretion of the rate; or
- using a series of significant protocols to greatly limit dealer pricing discretion.
As a personal opinion, I do not believe that disparate impact, and the alleged discrimination, is a compelling legal theory. The discrepancies in the reserve alleged in the Ally settlement are extremely minor. Moreover, the CFPB’s methodology in attempting to prove its case, the “proxy method” is not entirely reliable. The remedy for the harm being asserted far outweighs its cost to the industry and the public. Nevertheless, the industry needs to protect itself if it wishes to continue availing itself of the reserve.The Immediate Solution
The NADA has produced a brilliant program to address this problem entitled the Fair Credit Compliance Policy & Program. It can be accessed at www.nada.org/faircredit. The NADA solution is based upon a case brought by the U.S. Department of Justice against a dealership in Pennsylvania, Pacifico Ford. This case provides a framework for dealers to continue to conduct business as they have traditionally done.
The solution, in simple terms, is that a dealer would establish a maximum difference between its retail and wholesale rates. For example, 200 basis points (i.e., 2%) would be chosen by a dealer to be charged for every transaction as its maximum. However, the dealer could depart from this amount for reasons such as the consumer has been offered a lower rate by his credit union, subvention or the consumer can’t afford the full retail rate. The dealer could only reduce the rate from the maximum: it couldn’t increase it. And, the dealer would have to document the reduction. The Pacifico Ford case allows for seven reasons why a dealer could reduce this rate. The dealer would have to document in the file which of the seven reasons apply.
This program is more involved than this simple explanation, but the NADA Fair Credit Compliance Policy & Program does a superb job in explaining the program.
Unfortunately, this solution would require more work on the part of dealers. But, even more unfortunately, the demands on dealers for continuing layers of compliance will continue. As a result, dealers need to create a whole new continuing compliance program with a permanent compliance officer in preparation for their current compliance demands and future ones which, like death and taxes, are assuredly on their way.A General Remedy and Long Term Solution
As dealers already know, the federal Safeguards Rule and the Red Flags Rule require that dealers need to appoint a compliance officer to discharge the obligations of these two rules. The NADA Fair Credit Compliance Policy & Program also recommends appointing a compliance officer to administer its program. The general remedy and long term solution is for dealers to establish a Compliance Management System.
This type of system would mean that a dealer would combine certain present responsibilities into a new department with the expectation that other demands will be added later. Present responsibilities, such as observing the Safeguards and Privacy Rules, F&I requirements and following advertising laws, would be delegated to one person at the store who would oversee the dealership’s compliance program. Here are the basics of such a Compliance Management System:
- Establish a formal Compliance Program
- Appoint a Board with Management Oversight
- Appoint a permanent Compliance Officer
- Have a Consumer Complaint processing and response program
- Perform Compliance Audits regularly by a 3rd independent party.
The fact that a dealer may initiate a new program, such as a compliance management system, doesn’t mean that there will be a lot of extra expense. In reality, consolidating some of these functions, and appointing one person to oversee them, may lower costs. There are numerous good programs for educating and preparing this compliance officer for his obligations, such as AFIP; and reasonably priced guides, such as the NADA Fair Credit Compliance Policy & Program provide the needed direction for part of the compliance program. All the compliance officer needs to do is to study these available materials and apply them.
I will further elaborate upon these issues in future columns.DISCLAIMER
This article is not meant to provide you with legal advice. Please consult your attorney for this legal advice.