Tag Archive | "legal"

Disparate Impact 2.0

There is a knock on your favorite dealer’s door. He opens it to find a representative from his primary indirect lender, who announces they are going to do an unannounced deal-jacket audit to check for ECOA compliance. This could turn out to be a very long day, depending on the compliance program the dealer has in place.

Are your dealers ready for the next knock on the door? They should be, because federal regulators are putting immense pressure on banks and finance companies, and dealers are feeling it. Let’s discuss what auditors are looking for and how a clear understanding of the theory of “disparate impact” can help you prepare your dealers for any inquest.

Just a Theory

By way of refresher, the Consumer Financial Protection Bureau (CFPB) and the U.S. Department of Justice (DOJ) use disparate impact to go after indirect automotive lenders under ECOA, which is shorthand for the Equal Credit Opportunity Act. The ECOA generally makes it illegal to discriminate based upon race, gender, age, national origin, religion and other factors. Many car buyers are considered members of one or more protected classes under the law.

Under the disparate impact theory, an analysis is needed to determine if members of protected classes are being treated fairly compared to similarly situated individuals who are not in a protected class. To determine whether protected class members were involved in automobile loan transactions, the CFPB uses something called the Bayesian Improved Surname Geocoding (BISG) methodology.

The BISG theory is based on census data, and census data, in turn, is based on citizens making their own (unverified) report of their own ethnic background and providing their last name. BISG takes a portion of a ZIP code and list of surnames and concludes (arbitrarily) that if 80% or more of the census group were in a protected class, then 100% of their neighbors are deemed to be in the protected class as well.

The assumption here is that 80% somehow equals 100%. The further assumption is, for instance, that if a certain percentage of members of a protected class have a certain surname, then that percentage is present in the ZIP code being analyzed.

This whole process is sometimes referred to as using a “proxy,” since indirect automobile lenders cannot directly collect this information. Quite understandably, this use of BISG/proxies has been referred to as “junk science” by no less than the House of Representatives’ Financial Services Committee. In fact, the chairman of that committee, Rep. Jeb Hensarling (R-Texas), has gone so far as to refer to the CFPB as a “dangerously out of control agency” and said the CFPB is essentially “inventing” discrimination by using these methods.

While the withering criticism of the CFPB’s use of shaky theories to establish a disparate impact case is encouraging, it does not eliminate this practice, and disparate impact claims continue to exist in 2016. … Or do they?

Reason for Hope

Last June, the U.S. Supreme Court issued a decision in the Texas Department of Housing and Community Affairs v. Inclusive Communities Project Inc. The issue at hand was whether disparate impact theories can be used in a case arising out of the Fair Housing Act (FHA). Proponents of disparate impact theories and detractors of disparate impact theories both thought that the case may finally lay to rest any doubts about the validity of this theory.

In a 5-4 decision, the Supreme Court found that Congress intended to include disparate impact in the FHA. The CFPB might have claimed a total victory if the justices hadn’t gone on to say that mere statistical evidence is not enough to sustain a disparate impact claim. On the contrary, the Supreme Court imposed what they called a “robust causality requirement,” demanding proof that a particular policy caused the statistical disparity regarding the protected class.

This causation requirement gave renewed optimism to those seeking to eliminate the disparate impact theory from the CFPB’s arsenal. The Supreme Court also described a “valid interests” defense: If the underlying policies or policy was necessary to achieve a “valid interest,” then the disparate impact claim could be defeated. Keep in mind that the Inclusive Communities case was decided under the auspices of the FHA and not the ECOA, as applied to indirect automotive lenders.

So what is the final takeaway? Disparate impact claims appear to have survived the FHA case, although defenders of these claims have gained some insight into valid defenses, too. Neither side can claim complete victory. That leaves you, the agent, with two key questions to ask of all your dealer clients:

  • Does your dealership have written policies and procedures regarding your credit policy?
  • Does your dealership maintain written documentation of valid business reasons for deviating from your written credit policy?

If your dealers consistently apply and document their credit policies as part of a comprehensive compliance management system, their next unannounced audit visit from an indirect lender will go much more smoothly.

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Forecasting the Future Direction of the CFPB

Crowds gathered at the September P&A Leadership Summit and Industry Summit in Las Vegas to hear attorney, Rick Hackett’s forecast of the future direction of the Consumer Financial Protection Bureau (CFPB). Hackett is the former assistant director of installment and liquidity lending markets for the bureau’s division of research, and has been considered the point man for the auto finance industry.

Hackett addressed the current state of the industry and predicted what he referred to as “headwinds that may further develop in the future.” He likened his predictions to climatology or meteorology, with the caveat that though he could offer predictions, those predictions would be more like a weather forecast based on available information. And, he added humorously, “Most people abide by the rule ‘If you don’t like the weather, you don’t shoot the weather man.’”

Auto Finance Discrimination

First on Hackett’s agenda was the topic of auto finance discrimination. He explained the legal theory behind BSIG – Bayesian Improved Surname Geocoding. “There was a statistician and economist named Thomas Bayes who figured out how you could combine geocoding (the practice of using location to predict ethnicity and race) and surname in a secret formula to come up with a probability to predict race and ethnicity.”

For the sake of argument, Hackett asked the audience to “assume someone has a magic wand that can tell you the race and ethnicity of a name on a piece of paper with an address.”

The bureau, Hackett pointed out, identifies the buy rate as the true risk based price for credit because it takes into account the value of collateral and the borrower’s credit worthiness. It’s a baseline. The retail mark up (participation) is a matter of pure discretion. According to Hackett, the bureau says there is no business justification for a difference in dealer mark up based on credit risk. The dealer mark up should be set at a standard amount for all customers. Any difference in the final price should only result from a customer’s credit worthiness.

Despite this, Hackett explained that everyone knows there is a “rest of the deal” going on. He cited an example of a dealership car purchase where the consumer had “squeezed the price out of the middle as much as possible.” Once the consumer enters the F&I office, other factors might be needed to make the transaction come together. Hackett reported that the bureau’s current stance is, “Variables which affect the profitability of the overall deal, are not a business justification for credit pricing differences. “If there is a difference between whites and minorities with the same credit, you can’t look at anything other than credit reasons for that difference. Obviously, that is going to lead to some interesting difficulties.”

Disparate Impact or Disparate Treatment?

Hackett recalled meeting numerous individuals with significant seniority at various auto dealerships during his stint at the CFPB. Though the CFPB does not regulate dealerships, these individuals were concerned about the CFPB’s March 2013 bulletin on auto finance discrimination. Hackett recounted a conversation with one of these dealers/managers. The individual referred to the short period of time and limited information available to the finance manager to best put together a package including the vehicle, financing, F&I products, and enough profit for the business to survive. When it comes to things like pricing, the individual stated that F&I managers rely on certain known generalities such as “Asians are better credit risks,” illustrating the typical assumptions made in the marketplace.

The bureau, however, says this is not the statistical strangeness they refer to as disparate impact; rather, it is an example of disparate treatment. Hackett recounted an explanation he was given, “Folks [in the F&I office] are having to make decisions really quickly based on a lot of moving parts, some of which are subconscious assumptions about who knows what and who can negotiate better, and may include some parameters which happen to be illegal.”

Even though the Supreme Court could decide that disparate impact is not a valid legal theory, Hackett said disparate treatment is clearly a legal theory that works. Historically, disparate treatment occurs when the originator of a credit transaction has the freedom to price it, within bounds, wherever he or she wants, and gets paid more if the price is higher. Hackett said this happened frequently in the mortgage market, resulting in hundreds of millions of dollars in fines for large financial institutions.

Hackett explained that disparate treatment stems from the subconscious assumptions individuals make about customers that include race or ethnicity. The results may cause a dealership’s numbers to be skewed with regards to race and ethnicity. For a dealership to ensure everything that comes out of their portfolio is perfectly equalized and free from disparate treatment, their entire portfolio would have to pass this type of statistical test. Hackett described this as “pure disparate impact, and pure BISG.” He concluded that if you have a genuine business reason for treating customer “A” differently from customer “B,” then it’s not disparate treatment.


In their 2013 guidance, the CFPB mentioned flats and called for fair lending compliance management from dealers. However, Hackett said absent the inclusion of mechanics to follow, it’s difficult to interpret the bureau’s meaning.

Hackett pointed out that the NADA says flats are ordinarily reflected in the price of the credit. “So if I am going to pay 300 or 500 basis points in a flat, my retail credit charge is going to be higher,” explained Hackett, “Dealer Track and Route One are going to tell me, the dealer, who’s going to pay the most money. So whenever I can, I will push things toward the person who is paying the most to me, thus charging the most I can to the consumer.” Because of the typical subconscious assumptions occurring, discrimination occurs. However, it won’t be visible in a single lender’s portfolio. Hackett said from the CFPB’s perspective, this type of discrimination just goes away – only the Department of Justice (DOJ) and the Federal Trade Commission (FTC) can see it at the dealer level. In these instances, Hackett agrees with the NADA. He stated, “It’s not a good idea to swap out one system of ‘discrimination’ for another that puts the entire onus on the dealerships.”

Coming Soon from the CFPB Near You . . .

Hackett said a white paper focusing on economics could be expected soon from the CFPB. He expects it to address the bureau’s use of BISG and the allowance of controls. A control could be set for new versus used vehicle transactions. The white paper may also address dealer level monitoring and portfolio level monitoring. “It’s going to talk about the important technicalities, such as whether there is a minimum probability to trigger the analysis. “Is 51% African American enough to trigger it, or should it be 90%? And just maybe, if they are smart, the bureau will take this statistical thing they have created and test it against the tens of millions of known transactions in the national mortgage database; because mortgage loans collect both race and ethnicity data.”

While the CFPB is not going to broadcast what percentages they consider triggers, Hackett said the lawyers he works with estimate it to be around ten basis points. Reminding the audience again that he was only “the weatherman,” Hackett forecast an 80% likelihood for this scenario’s occurrence.

In March 2013, the CFPB issued a supervisory bulletin addressing indirect auto lending and compliance with the Equal Credit Opportunity Act (ECOA). With all the larger financial institutions in automotive already regularly examined by the bureau, Hackett said it would be rather disingenuous to assume that only a financial institution that has been publically flogged has had to deal with and resolve this situation. “Generally, when a resolution takes place with a large financial institution,” explained Hackett, “it’s nonpublic. It’s dealt with through an MOU (memorandum of understanding). Institutions will often concede many issues and be willing to concede a lot of things in order to do it in a supervisory, nonfinancial manner to avoid being publically flogged.”

Hackett said it is typical for the CFPB to make “supervisory highlights” around 18-24 months after a program or process starts in a supervisory area. He suggested that the CFPB’s intent could be expressed this way: “Hi. We’ve been out there working quietly and confidentially and we’d like to share – without naming names – what we’ve found and what people have decided to do.”

Ancillary Products and the CFPB

Hackett said the CFPB’s stance on vehicle service contracts (VSC) and ancillary products boils down to concern over consumers’ lack of knowledge of the products, their quality and their value. “Consumers know a lot about the quality and value of motor vehicles . . . They have many sources of information available to them. They know which vehicles work well and which don’t. They also know a ton about vehicle price. You all know these people – they go to a dealership, test drive a car, go home, and for a $12 dollar payment to TrueCar, they get a bid that they can take back into the dealership with all the profits stripped out of it. It seems easy, except, you can’t run a business that way – not if you are selling cars.”

To illustrate the bureau’s perspective on variable pricing of VSCs and ancillary products, Hackett described a hypothetical scenario at Wal-Mart: If Wal-Mart sold and advertised three VSCs priced side-by-side at $797, $1295, and $2095 a consumer would naturally want to know if the various products’ benefits justified the differences in price. They would probably seek out an expert in the store to provide them with product information. If the consumer learned Wal-Mart actually set the price, but in reality the VSCs were all the same product, the consumer would not be happy.

This translates into the CFPB’s argument that the difference in price goes back to the dealership – there is a possibility of unfair or deceptive sales practices going on because consumers don’t understand what they are being sold and they don’t understand that they are being sold a product that may have a variable price based on different coverages.

Despite their concerns with different pricing for the same product, Hackett said the CFPB could ultimately do little to address them. “The story is about unfairness or deception. That is a point of sale question and there is an invisible plastic bubble over the point of sale. If an auto dealership that sells or leases vehicles also has service facilities, and ordinarily sells most of its contracts to an unrelated third party, then they are not subject to enforcement or supervision. They are not subject to rule making [by the CFPB]; even the rules under truth in lending are still governed by the Federal Reserve Board when it comes to auto dealerships.”

Buy Here Pay Here (BHPH) dealerships are open for regulation because their business model is typically set up to keep contracts. But with BHPH customers, typically there is limited payment room for ancillary products and/or variable pricing. For this reason, Hackett doesn’t expect to see a lot of action from the CFPB on VSC and ancillary products in the BHPH space. Though Hackett said there are not a lot of smoking guns in the larger publically traded companies in the BHPH space, public filings show there are a few which have been under investigation for around two years but a resolution has not yet been reached.

Finance Companies Policing Dealers?

Hackett questioned the possibility of the CFPB’s potential attempt to make finance companies police dealer pricing on VSC and ancillary products in the future. “The bureau now has data on tens of millions of auto finance transactions and some of them have data with ancillary products. Therefore, they were able to pull out the information on dealer participation.”

The CFPB recently settled a case with a finance company whose business model Hackett described this way: “Go to Best Buy, buy a TV, put it in a small retail outlet at three times the price and then finance it at 18%. The bureau actually got them to sign a consent decree that said it was a scheme that artificially inflated the prices of consumer goods in order to hide finance charges. In this model, you can almost argue that it is obvious.” But Hackett said the problem with “it’s obvious” is determining where on the slippery slope the standard lies. At what point does the regulator say, “This is the real price.” The bureau looks at the final cost of a product and determines how much of that cost is finance charge, and how much is the actual price of the product. “If everything above $795 for the service contract is finance charge, they have a ‘hook’ into the whole transaction for the finance company.” Obviously, if this occurred, it would have the potential to change the entire landscape of vehicle transactions in F&I. Hackett likened the severity of impact to a mega tsunami creating beachfront property in Iowa.

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GM Legal Department Under Scrutiny in Company’s Recall Probe

Via Reuters:

General Motors’ legal department is the focus of an internal inquiry into how the company handled a vehicle safety defect linked to 13 deaths, the New York Times reported, citing two people with knowledge of the inquiry.

The U.S. government hit the automaker with a $35 million fine on Friday for its delayed response to an ignition switch defect in millions of vehicles. Regulators accused company officials of concealing the problem.

The largest U.S. automaker originally noticed the defect more than a decade ago but issued the first recalls only in February of this year despite years of consumer complaints.

In an article published on Saturday, the Times said a review of internal documents, emails and interviews showed that high-ranking officials “particularly in GM’s legal department, led by the general counsel Michael P. Millikin, acted with increasing urgency in the last 12 months to grapple with the spreading impact of the ignition problem.”

The newspaper said a number of GM departments stepped up efforts to fix the switches when depositions threatened to ensnare senior officials, and company lawyers moved to keep its actions secret from families of crash victims and others.

GM faces other federal investigations into its handling of the recall, which could produce more severe punishments. The $35 million fine was the maximum the U.S. Transportation Department could impose.

U.S. Transportation Secretary Anthony Foxx said GM had broken the law and failed to meet its obligations to public safety.

GM’s internal investigation is expected to be completed within the next two weeks. The U.S. Congress, Department of Justice, Securities and Exchange Commission and several states are also conducting investigations.

The Times said GM had declined to make Millikin or other executives available for interviews for its story. It said four senior executives have resigned or left the company since the recall began, including Jim Federico, a top engineer who avoided being deposed in a lawsuit last year when GM settled a case tied to a defective ignition switch.

The newspaper said GM lawyers unexpectedly approved the settlement last September in a lawsuit filed by the family of a Georgia woman who died in a Cobalt crash in 2010.

Documents indicate GM restarted its internal investigation because of information uncovered in the Georgia case, the Times said.

The faulty ignition switches on Chevrolet Cobalts, Saturn Ions and other GM vehicles can cause their engines to stall, which in turn prevents air bags from deploying during crashes. As well, power steering and power brakes do not operate when the ignition switch unexpectedly moves from the “on” position to “accessory.”

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An Interview With Tom Hudson of Hudson Cook LLP

There are few figures as recognizable in the automotive retail and finance industry as Thomas B. Hudson, a founding partner of Hudson Cook LLP. Hudson’s work as an attorney, author of legislation and his series of widely read legal guidebooks has put him in the center of the action for every major development affecting dealers for the past several decades. In 2009, in recognition of more than 35 years of service, Hudson received the American College of Consumer Financial Services Lawyers’ lifetime achievement award.

Today, in addition to his work with the firm, its 50 attorneys and their many clients, Hudson contributes to several of the industry’s leading publications, including F&I and Showroom magazine, and appears as a speaker at conferences and other events throughout the year. AE caught up with Hudson to hear the latest about his work and the compliance issues dealers are grappling with on a daily basis.

Tell us about the firm and its place in the industry.

As for the firm, it was founded in 1997 by me, Robert Cook and eight other lawyers, six of whom came with Robert and me from the Venable firm. Venable was, at the time, a 350-lawyer firm based in D.C. and Baltimore. Robert and I had run the Consumer Financial Services Practice at Venable since 1989. Before that, he and I spent three years at the D.C. office of a New York firm, Willkie, Farr and Gallagher.

I started out in 1973, after graduating from Georgetown Law School, with a Baltimore-based firm, Semmes, Bowen and Semmes, where the practice that our firm now does originated. That practice, which we call “consumer financial services,” involves all the credit products and services that have a consumer on one side and a creditor on the other. Examples are housing finance, auto sales, finance and leasing, credit cards, student loans, boat and RV financing, unsecured lending, insurance premium finance lending, title lending, payday lending – any transaction involving credit extended to a consumer.

Our practice involves compliance. We advise creditors about how to engage in these programs without running afoul of state or federal law. That’s all we do. We don’t litigate (at least not often), we don’t do employment or corporate work – just the compliance stuff.

Who are your clients?

We represent dealers, banks, finance companies, companies that sell F&I products, investment bankers, trade associations and anyone else with a presence in the consumer financial services marketplace.

What is the greatest regulatory challenge dealers face today?

Right this very moment, dealers aren’t looking at a legal landscape that’s much different from the one they were looking at before Dodd-Frank. The new Consumer Financial Protection Bureau hasn’t rolled out a lot of new regulations yet, nor has the Federal Trade Commission.

That isn’t to say that things haven’t changed, though. The roundtables held last year by the FTC focused on abuses, or alleged abuses, by dealers, and the FTC and the Bureau are both becoming active. The activity isn’t adopting new rules, though, but rather involves enforcing old rules that have been on the books for ages.

Examples are the FTC’s enforcement actions on negative equity financing and data breaches. We’ll see a lot more of that. Until the roundtables, the FTC had been pretty quiet regarding dealers. Now I think they feel that they are in competition with the Bureau to see who can be the strictest cop on the block.

The efforts of the agencies have increased to a noticeable degree. If as a kid, you ever played marbles, you’ll remember that you either played for fun, or played for “keepers,” which meant that you got to go home with the other guy’s marbles if you won. The federal agencies are now playing for keepers.

How has the industry changed in the past five years, and how do expect it to change in the near future?

The Dodd-Frank Act was the biggest thing to happen in the consumer financial services industry since the federal Truth in Lending Act of 1968. Few dealers appreciate the fact that they will now not be able to fly under the radar. Compliance with federal laws is no longer an option for those willing to bet that they won’t get hit with an enforcement action. The Bureau, especially, will be a powerful new force, with a big budget and a plan to clean up the industry and drive the bad actors out of business.

The resulting increased cost of compliance will lead to consolidation, as smaller dealers realize that they simply can’t afford the cost of implementing the sorts of compliance efforts that will be required going forward – the unpaved lot on the corner needs pretty much the same compliance program that CarMax has, and that’s going to cause small operators to throw in the towel. Only dealers with enough volume to spread the cost over a lot of sales will survive.

How do you like to spend your time off?

I read (a lot), I walk (a lot), I write (a lot), I garden when I’m in Maryland, where we have our “main” house, and I fish and crab when I’m at our place in Pawleys Island, S.C. We adopt older golden retrievers from the rescue organizations. We are now working on our seventh and eighth rescues.

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Hudson Cook Adds Former FTC Executive as Partner

HANOVER – Hudson Cook, LLP, a provider of legal compliance services for the financial services industry, announced the addition of Joel Winston as a partner in its Washington, DC office. Mr. Winston brings over 35 years experience in all aspects of consumer finance law and public policy with special emphasis on privacy, identity theft, data security and credit reporting.

“Joel’s extensive experience with consumer financial services regulation, privacy law, and advertising law will be a great addition to our practice,” explained Hudson Cook Chairman Tom Hudson. “His stellar reputation and depth of experience, along with his focus on finding innovative solutions that benefit our clients and their customers, is a great fit with the culture of our firm.”

Mr. Winston began his career at the Federal Trade Commission, working there from 1976 to 2011. He has held senior positions in the FTC’s Division of Advertising Practices, the Division of Financial Practices, and the Division of Privacy and Identity Protection, a new unit he helped create.

As the director of the Division of Financial Practices, he was responsible for protecting consumers of financial products and services through law enforcement, rulemaking, policy development and public outreach. He has been involved in the development of significant public policies, including several provisions of the Fair and Accurate Credit Transactions (FACT) Act. He served as a member of the President’s Identity Theft Task Force and is a recipient of the 2008 Presidential Rank Award for Meritorious Executive.

Joel received his Bachelor of Arts degree, magna cum laude, from the University of Michigan and a Juris Doctor degree, cum laude, from the University of Michigan Law School. He is a Certified Information Privacy Professional (CIPP), a credential issued by the International Association of Privacy Professionals and a member of the American College of Consumer Financial Services Lawyers, an honor “limited to those lawyers . . . who have achieved preeminence in the field of consumer financial services law and who have made repeated and substantial contributions to the promotion of learning and scholarship in consumer financial services law.”

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NADA University Announces Legal, Regulatory Webinars

McLEAN – NADA University announced it is now offering all of its legal and regulatory webinars – live and on-demand – at no cost to NADA and American Truck Dealer (ATD) members and their staffs.

Dealer members may extend this benefit to their contracted financial and legal professionals by adding those professionals as licensed users within their NADA University account.

“Dealers face an enormous challenge in staying updated and compliant on complex legal and regulatory requirements, so NADA U has responded by expanding access to critical information that will make that job a lot easier,” said Michelle Primm, managing partner of Cascade Auto Group and chair of NADA’s Dealership Operations Committee.

NADA U’s legal and regulatory webinars focus on a variety of topics, including the following:

  • Credit score disclosure requirements
  • The Family and Medical Leave Act
  • The Federal Trade Commission’s (FTC) new model privacy notice
  • FTC Red Flags Rule
  • The new Small Business Administration dealer floorplan loan program
  • Organized labor issues and response
  • Wage and hour compliance
  • Risk-based pricing rule
  • UNICAP safe harbor methods
  • Comprehensive Safety Analysis program

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