Sizing Up the CFPB’s Threat

They came looking for answers. Instead, attendees of the 2013 F&I Conference and Expo found an industry digging in for a long fight to prevent the Consumer Financial Protection Bureau (CFPB) from altering how dealers participate in the indirect financing channel.

F&I and Showroom’s annual conference was held at the Paris Las Vegas in mid-September. David Westcott, the National Automobile Dealers Association (NADA)’s 2013 chairman, opened the proceedings. He made clear his frustration with what he described as a one-sided discussion between the industry and the CFPB. “Creditors don’t even see the standard the CFPB will judge them on,” he said. “This is simply unacceptable. We started a dialogue in Washington and now it’s time to take it everywhere else.”

Terry O’Loughlin, who spent 16 years in the Florida attorney general’s office before joining Reynolds and Reynolds Co. as its director of compliance, said there’s a reason for the CFPB’s lack of transparency. “If you’re not sure how to react or behave, then you might overcompensate,” he said. “For agencies, that’s a great result because it makes you that much more careful.”

The standing room-only crowd also learned that the bureau is no longer bent on eliminating dealer compensation. But it does want to bring structure to how they’re compensated. The good news is a key tool in the bureau’s drive for transparency — the disparate impact theory — is being threatened by a potential Supreme Court ruling.

“If they rule [there’s no disparate impact theory], there’s going to be a complete sea change in everything we’re talking about today,” said Andy Koblenz, executive vice president and general counsel for the NADA. “Their primary tool will no longer be available to them and they’ll be back to the drawing board.”

In Need of Guidance
The two-day conference featured 15 sessions. Two of the sessions centered on the CFPB — one of which was Westcott’s keynote address. The other was “Dodd-Frank and F&I’s Gray Zone,” a panel discussion that included Koblenz and O’Loughlin as well as Nikki Munro, a partner with Hudson Cook LLP, David Robertson, executive director of the Association of Finance & Insurance Professionals (AFIP), and Damon Wiener, senior vice president and general counsel of Safe-Guard Products International.

Compliance consultant Robert Harkins served as moderator. His first question garnered a colorful description of the CFPB from Munro. “I like to say it’s been as busy as a two-year-old on a sugar high. In the last two years, it has initiated investigations, settled enforcement actions, released reports, defined larger participants in consumer reporting and debt-collection industries, and initiated a number of regulations and compliance bulletins.”

Munro also noted the CFPB has yet to initiate regulations impacting the auto industry. It has issued its first public enforcement action against an auto finance source, as well as a guidance bulletin detailing its approach to dealer compensation policies.

The bulletin, issued this past March, explained the bureau’s understanding of rate participation, claiming that “such policies could result in pricing disparities on the basis of race, national origin and other prohibited bases.” The bulletin stated that if such disparities exist within a finance source’s portfolio, it would be held liable under the legal doctrines of both disparate treatment and disparate impact.

Koblenz explained that, to prove discrimination — intentional or otherwise — the CFPB would have to create a statistical methodology to divide the world up into minorities and nonminorities. He believes the bureau is using census tracks to do so. “That’s great,” he said, “but you have a huge part of the United States that’s not predominantly minority and nonminority.”

The CFPB also must identify every possible variable that might explain a pricing disparity, an assignment Koblenz doubted it could fulfill. Once it did, the CFPB would then need to determine the metric it uses to draw its conclusions. “Until you establish the correct metric — and we think the agency has the wrong metric — you can’t do the analysis,” he said, speculating that the bureau’s metric is based on basis points vs. the dollar value of the service provided, which the NADA prefers.

“You need to break the world up properly into minorities and nonminorities, you have to progress out all the variables that should be held constant so you get similarly situated minorities and nonminorities, and then you have to measure them using the right metric,” he added. “So how much of that has the agency disclosed? They’ve said, ‘We are using geography and surnames’ — they don’t say which method. And they have categorically refused to identify the progression analysis they’re using.”

Fueling the assumption that the bureau uses basis points as its metric stems from notices finance sources have issued to dealers this year regarding their rate markup policies. Harkins read one such notice aloud. It requested the dealer explain a 39-basis point difference in what some car buyers were charged.

“Thirty-nine basis points is the differential. That sounds like it might be within the statistical noise prospect given all those uncertainties,” Koblenz commented. “These letters raise a tremendous number of questions and we need to push back to the banks. In fairness to the banks, all they’re doing is reacting to the strong-arming of the agency … but we think there is an opportunity to ask these data questions to reveal the problem being asserted doesn’t exist.”

Those questions could be moot as the Supreme Court and its conservative majority prepares to hear the Mount Holly, N.J., housing discrimination case. Twenty low-income, African-American and Hispanic households sued their township in 2008 over plans to demolish and redevelop a rundown neighborhood. They claim those plans unfairly price minorities out of the market. Barring a settlement, the high court would focus on whether minority residents can sue under the Fair Housing Act when a policy has a disparate impact on them.

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“The concept of disparate impact grew up in the employment law area, where the law has two sentences in it. Sentence one says it’s illegal to discriminate in employment on the basis of race, etc. The second one says it’s illegal to engage in behavior that has the effect of discrimination,” Koblenz explained. “When it comes to the ECOA, you only have one sentence: It’s illegal to discriminate in lending on the basis of race, etc. The second one doesn’t exist. That’s why this theory is somewhat suspect.

“Observers think there’s a really good chance if [the Supreme Court] reviews the merits of the case, they will rule there’s no disparate impact,” he added.

Clarity Through Enforcement
Panelists weren’t so critical of the bureau’s first public enforcement action in the auto arena, with Wiener saying the orders against U.S. Bank and its non-banking partner, Dealers’ Financial Services (DFS), provided more guidance than the CFPB’s bulletin on dealer compensation.

The CFPB ordered US Bank and DFS to return $6.5 million to servicemembers for failing to properly disclose fees charged to participants in their direct-to-consumer, Military Installment Loan and Educational Service (MILES) program, and for misrepresenting the true cost and coverage of the program’s add-on service contract and GAP products.

“There are lots of things that make it seem like they are not attacking products … but the way they are marketing those products,” Wiener said. “What I like is it gives us parameters and how to play by them.”

But even Wiener acknowledged the industry will need to engage the bureau. “We need to, at some point, bring the CFPB up to speed on products and industry standards,” he said.

In Munro’s view, the CFPB doesn’t have jurisdiction over the F&I products industry. She noted that the Dodd-Frank Act contains a catch-all provision that raises more questions than it answers. “There’s a lot of gray area there,” she said. “With aftermarket products that are financial in nature — and the easiest one to refer to is GAP — we think the CFPB can exercise jurisdiction over those types of products because they are related to the extension of credit — they pay off the extension of credit if there’s a total loss.

“With nonfinancial products like vehicle service contracts, tire and wheel, paintless dent repair ... we’re just not sure,” she added. “The CFPB will probably take the position that those types of products offered in connection with the loan gives them jurisdiction.”

Exemption Exception
Franchised dealers are shielded from the CFPB’s direct oversight thanks to the hard-fought exemption the NADA won in June 2010. It’s a distinction they share with stockbrokers, accountants and attorneys. “During the debates, the folks on the other side of this issue were arguing that every penny paid through dealer financing was an overcharge and unjustified,” Koblenz told the audience. “That’s why the legislation battle was fiercely fought.

“What [the CFPB] is now focusing on is not whether dealers get compensated, but actually what the structure should be,” he added, saying the CFPB believes the existence of the negotiation system and dealers’ ability to discount credit present a risk of discrimination.

But if the CFPB suspects discrimination, it must demonstrate why it’s an unfair, deceptive or abusive act or practice for a financial institution to purchase a retail installment sales contract before taking action — an extra step created by the dealer exemption. Koblenz wondered if that meant the CFPB expects finance sources to delve into dealer negotiations, which he believes goes against the bureau’s Congressional directive.  

O’Loughlin said there are other ways the bureau can affect the dealer business, pointing out that the Dodd-Frank Act calls for the CFPB to coordinate its efforts with state regulators. He also noted that Richard Cordray, the bureau’s director and a former Ohio attorney general, has made clear his desire to augment the CFPB’s power through attorneys general. “So not just 700 attorneys for the CFPB, you’re looking at 50 different attorneys’ general offices that are going to be implementing CFPB policy,” he said. “More threatening than that, attorneys general are not limited by the CFPB. They can go further.”

He added that a memorandum of understanding between attorneys general and the CFPB poses yet another threat. The bureau and state regulators can share data the CFPB collects through civil investigative demands. “I think that’s an even more startling concern, because your attorney general is a lot closer to you than some bureau in Washington, D.C.,” he said.

The Federal Trade Commission represents yet another threat to dealers. It was granted new rulemaking authority under Section 1029 of the Dodd-Frank Act — the same section containing the dealer exemption.

“They have been saber rattling and have been doing some enforcement actions lately, particularly in the advertising area,” Koblenz said. “But they conducted a year and a half of motor vehicle roundtables, specifically to explore whether or not there was any activity going on in the [auto] retailing arena that warranted them using their streamlined rulemaking authority to promulgate regulations. They did not, in the end, issue any rules.”

With so many uncertainties, the AFIP’s Robertson said there’s one thing dealers can do. “The quickest way to keep the government out of your dealerships … is to know the rules and properly apply the rules,” he said. “And don’t give them a reason to be there to start with.”