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ACI - 20th National Forum on Consumer Finance Class Action & Litigation

James M. Milano

Partner

Weiner Brodsky Kider PC

1300 19th Street NW 5th Floor

Washington, DC 20036

202-628-2000

milano@thewbkfirm.com

The Latest Targets in Auto Financing: Dealer Participation Claims Under

Indirect Auto Lending Paul D. Metrey

Chief Regulatory Counsel

Financial Services, Privacy, and Tax

National Automobile Dealers Association

McLean, VA 22102

(703) 821-7040

pmetrey@nada.org

Oct. 23 – 24, 2014

Tweeting about this conference?

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ECOA & Reg. B Enforcement

•Department of Justice • Civil Rights Division

•Consumer Financial Protection Bureau (CFPB)

• Joint Enforcement • December 6, 2012 Memorandum of Understanding

• “Sharing information and preserving its confidentiality”

• “Joint investigation and coordination”

• “Referrals and notifications between the agencies” • Referral from the CFPB to DOJ does not mean CFPB cannot still pursue

individual enforcement

• ECOA § 706(g) permits CFPB to refer ECOA matters to DOJ

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CFPB Powers

• Investigation • Subpoenas

• Civil Investigative Demands

•Administrative Enforcement • Cease and Desist Orders

• Judicial Enforcement • Must first notify DOJ

• Injunctions

• Compensatory Damages

• Civil Monetary Penalties

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CFPB Limits

•May not take action against auto dealers (except BHPH dealers), but CFPB actions affecting indirect finance sources impact dealers relying on lenders covered by the CFPB. • “[W]e do have jurisdiction over the largest auto

lenders and their lending programs.” – Richard Cordray, CFPB Director (Nov. 11, 2013)

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CFPB Auto Guidance

• CFPB Bulletin 2013-02 (Mar. 21, 2013) • Tackles ECOA vis-à-vis Indirect Auto Lending

• Targeting dealer participation generating compensation for dealerships with discretion to provide different rates for reasons independent of creditworthiness

• Indirect Auto lenders are creditors under ECOA

• Indirect auto lender participation and policies alone can trigger ECOA liability if the lender participates in discriminatory credit decisions

• CFPB Recommends Avoidance by • Eliminating or controlling dealer participation

• Monitoring dealer participation policies

• Applying fair lending compliance programs

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U.S. v. Union Auto Sales

• DOJ final partial consent decree (Sept. 4, 2013) • Originally part of United States v. Nara Bank, et al. (see next slide)

• Dealer allegedly violated ECOA by “charging non-Asian customers higher interest rates than other customers for a period of at least three years.”

• UAS’ policy: Giving employees “subjective, unguided discretion to add dealer participation to the final cost of a vehicle purchase loan” due to “factors unrelated to objective creditworthiness[.]” • Dealer Discretion is a significant concern for both Dealers and

Lenders

• $125,000 settlement to pay victims for purchases between 2004 and 2006 (seven years earlier)

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United States v. Nara Bank

• Nara Bank was lender to Union Auto Sales and other dealers, and same allegations applied regarding charging higher dealer participation to non-Asian customers.

• Nara reviewed contracts presented by dealers to assure they complied with the Bank’s own guidelines and terms.

• DOJ concerned about level of discretion and oversight.

• “[D]ealership employees do not use formal, written, or uniform guidelines and procedures to set overages or dealer mark-ups.”

• Lack of Lender oversight is evidence of participation in ECOA violations.

• CFPB ECOA Examination Procedures ask “How does the entity monitor compliance?,” reinforcing that the onus is on lenders to monitor dealer policy.

• Bank claimed consumer sophistication in negotiations affected any aggregate statistics.

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United States v. Nara Bank

• Partial Consent Decree (Nov. 18, 2009) • General Nondiscrimination Injunction • Notice of Non-Discrimination and Booklet “Understanding Vehicle Financing”

disseminated to consumers and employees • Fair lending training for all officers and individual lenders • Maximum Rate Spread Limits • $410,000 victim compensation • $100,000/year for term of the consent decree to federal program supporting

consumer literacy

• In 2010, Dealer Defendants’ motion to dismiss is granted by C.D. Cal., but later overturned by the 9th Circuit, and ultimately resolved in a consent decree between DOJ and Union Auto Sales. • District Court condemned government’s statistical methodolgy: “The statistics, if assumed to

be correct as they must be at this stage of litigation, do not show any discrimination. All that Plaintiff says is that half of the non-Asians were treated worse than the Asians. The other half, of course, might have been treated better. […] So to say that half of the non-Asians were treated worse than the average Asian is to not say much at all.” 2010 WL 2766992 at *3.

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U.S. v. Ally Financial & Ally Bank

• Ally is an indirect auto financer, purchasing RICs from over 12,000 dealers. • April 1, 2011 to end of 2013, Ally purchased 2.1 million RICs • RICs and documentation contain no race or ethnicity information

• Ally policy allowed dealer discretion to add dealer participation to Ally’s wholesale buy rate.

• DOJ & CFPB Joint Investigation • Alleged ECOA Violations

• Discrimination against 235,000 African-American, Hispanic, Asian and Pacific Islander borrowers by “systematically charging higher dealer interest rate markups” than white borrowers.

• Ally was “not offer[ing] comprehensive fair lending training to dealers.” • Recall, 12,000 dealers!

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U.S. v. Ally Financial & Ally Bank

• ECOA Disparate Impact Evidence: • “To evaluate any difference in dealer markup, the CFPB and DOJ

assigned a race and national origin probabilities to applicants...employ[ing] a proxy methodology that combines geography-based and name-based probabilities…to form a joint probability [later] used directly in the CFPB’s and DOJ’s models to estimate any disparities in dealer participation on the basis of race or national origin.

• Findings (average participation differential from white borrowers): • African-American borrowers: 29 basis points (.29%) higher

• Hispanic borrowers: 20 basis points (.2%) higher

• Asians and Pacific Islanders: 22 basis points (.22%) higher

• Proxy methods use public census data (more on this later)

• Disparities are found “statistically significant [and] based on race[.]”

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U.S. v. Ally Financial & Ally Bank

• Consent Order (Dec. 20, 2013)

• $80M Settlement Fund

• $18M Civil Money Penalty

• Compliance Plan Implementation • Dealer Compensation Plan

• Limits Maximum Rate Spread between buy rate and contract rate

• Regular Notices to Dealers explaining ECOA

• Regular Analysis of Dealer-Specific & Portfolio-Wide Pricing Data

• Ally to look specifically for indicia of disparity on a prohibited basis

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U.S. v. Ally Financial & Ally Bank

• Consent Order (Dec. 20, 2013)

• Ally issued a press release when the consent orders were announced stating that Ally found (based on the application of its own disparate impact testing methodology) no measurable discrimination by the auto dealers from which it purchased retail installment sale contracts

• See https://media.ally.com/2013-12-20-Ally-Financial-Statement-on-Auto-Financing-Consent-Orders

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Disparate Impact Theory

• Disparate Treatment: Intentionally treating similarly situated people adversely on a prohibited basis (e.g., race, gender, age).

• Disparate Impact: Facially neutral policy employed, the impact of which is disproportionately adverse to members of a protected class. • NO INTENTION TO DISCRIMINATE NECESSARY • Defense: Business Necessity • CFPB and DOJ’s position: Disparate Impact Claims are viable under ECOA • CFPB uses disparate impact results for auto lending enforcement actions. • CFPB Bulletin 2013-02: Disparate impact may alone constitute an ECOA

violation.

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Disparate Impact – Proxy Use

• Ally complaint: “BISG (proxy) method is recognized by social scientists, statisticians, and economists as a tested and accurate way to determine differences in experiences based on race or ethnicity[.]” • “As used in this Complaint, an outcome is statistically

significant if the probability that it could have occurred by chance is less than 5%.” • Zip Code Database to assign racial probability

• Predominantly used to assign proxies for African-American borrowers

• Last Name Database to assign ethnic proxy • Predominantly used to assign proxies for Asian or Hispanic borrowers

• CFPB and DOJ apply statistical analyses at assignee/lender level and dealership level to test for differences in dealer participation between protected classes. • Aggregate lender portfolio-level analysis can find ‘discrimination’

even if none exists at the dealer level.

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Disparate Impact – Proxy War

• No showing of error rate or evidence of reliability or validity of BISG method in the Ally complaint beyond blanket statements.

• “[T]he House Financial Services Committee, [22] Senators, and [16] members of Florida’s House delegation [have] implored the [CFPB] to reverse its previous refusals to provide anyone with the raw data and analytical methods it is using in its disparate impact analyses.”

• - D. Hirschmann, President & CEO of Center for Capital Markets Competitiveness letter to Dir. Cordray (2014)

• Using last names as proxies fails to account for names acquired by marriage and other circumstances.

• 2010 Pew Research Center Report: • 14.6% of 2008 American marriages are interracial or interethnic

• 25.7% of Hispanics married outside ethnicity

• 27.7% of Asians married outside ethnicity

• 24% of African American males married outside race

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Redlining & Reverse Redlining

•Redlining: Refusing to lend or discouraging lending to people, typically within a defined geographic area, on a prohibited basis.

•Reverse Redlining: Targeting protected classes, typically within a defined geographic area, with predatory terms or unfair prices.

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U.S. & N.C. v. Auto Fare, Inc.

• U.S. sues North Carolina used auto dealer for Reverse Redlining practice

• Allegations by DOJ and State AG that Defendant “intentionally target[ed] African Americans for the extension and servicing of credit on unfair and predatory terms without meaningfully assessing the customers’ creditworthiness.” • Disproportionately high APRs and downpayments

• State AG seeking $5k per violation under state consumer protection law

• Action is currently pending.

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Class Action – Wal-Mart Fallout

• Immediate fall-out of Wal-Mart v. Dukes (131 S.Ct. 2541, 2011) was the rejection of class certification in private fair lending class actions.

• Disparate impact claims in auto lending typically involve individual discretion of dealer and lender employees, and thus commonality of the class is problematic for purposes of class certification.

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Class Action – Post Wal-Mart

• In re Wells Fargo Residential Mortgage Lending Discrimination Litigation

• Class Certification of 1M denied on Wal-Mart basis.

• Plaintiffs offered their own regression analysis, but failed to show a “common mode of [decision-makers] exercising [such] discretion.”

• 2012 DOJ Settlement: • Over $175M in relief for African-American and Hispanic

borrowers

• Less likelihood of future class actions based on disparate impact, but enforcement action may substitute. • i.e. Less Dukes v. Wal-Mart, more United States v. Wal-Mart

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Pacifico & Springfield • 2007 Dealer Enforcement Actions by DOJ • Pacifico Ford Allegations:

• ECOA (and implementing Regulation B) violations • Pacifico refers applications to 15+ lenders who determine creditworthiness • Pacifico received lender’s buy-rates, and adds dealer participation to

present the consumer the “contract rate” • Pacifico received 50-80% incentive for “dealer participation” • No formal, uniform underwriting guidelines

• Springfield Ford allegations mirror Pacifico’s • Consent Orders

• General Nondiscrimination Injunction • Victim funds ($363,166 for Pacifico, $94,565 for Springfield) • Limit on Dealer Reserve Rates • Record-Keeping and Reporting • Equal Credit Opportunity and Fair Lending Training Programs • Public Notices to consumers of non-discrimination and APR negotiability

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Going Forward

• Dodd-Frank requires greater transparency and data from lenders, increasing review for disparities and subsequent enforcement action. • More reporting = More risk; but transparency is valued

• UDAAP Violation Enforcement • Abusive: Act or practice that—

• “materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or

• “takes unreasonable advantage of • (A) a lack of [consumer understanding [of] the material risks, costs, or

conditions of the product or service” • (B) consumer inability to protect his own interests • (C) reasonable reliance on a covered person acting in the consumer’s best

interest

• Actions based on ‘abusive’ acts or practices are not yet common. • CFPB sees UDAAP violations connected to lending discrimination.

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Going Forward • CFPB still endorses disparate impact theory

• CFPB Bulletin 2013-02: “the legal doctrine of disparate impact remains applicable as the CFPB exercises its supervision and enforcement authority to enforce compliance with the ECOA and Regulation B”

• But note, the U.S. Supreme Court has granted cert. on its third review of disparate impact theory - Texas Dept. of Housing vs. Inclusive Communities

• Self-Reporting • CFPB Bulletin 2013-06 encourages self-policing and cooperation • 2014 Consent Order with a Connecticut mortgage lender on RESPA

violations had ‘favorable’ terms consistent with CFPB’s taking into account investigative cooperation and self-reporting and self-policing. (1st Alliance Lending, LLC Consent Order, Feb. 24, 2014)

• Self-Reporting may not be the end of the world. • Enforcement Action may be!

• Rising costs for consumers? • Economics theory that consumers will be willing to pay more for

products and services that are viewed as fairer and non-discriminatory.

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Statistical Analysis Value & Use

• Nara consent decree ordered Nara Bank to “develop and implement procedures for statistically monitoring the overages charged to each dealership.”

• NADA has created optional fair credit compliance program that is based on DOJ fair credit risk mitigation model contained in Pacifico Ford and Springfield Ford consent orders (see next slide).

• CFPB Exam Procedures for ECOA compliance ask lenders what “statistical analysis” is used in fair lending oversight.

• Dealer-Level & Assignee-Level Analysis are both important. • Lenders should ensure that their dealer-level and portfolio-level

analysis does not reflect unexplained statistical disparities among similarly-situated consumers on a prohibited basis.

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Establishing Dealership Policies • Eliminating Dealer Pricing Discretion • Dealer Compensation Plans (i.e., flat fee per transaction); but see “The

Fallacy of Flats” – P. Metrey, NADA, May 2014

• Constraining Dealer Pricing Discretion • Limiting Rate Spreads - 2.5% cap on terms up to 60 months and

2.0% cap on terms exceeding 60 months are numbers that reappear in enforcement actions as part of compliance plans

• CFPB recommends as “features of a strong fair lending compliance program” (CFPB Bulletin 2013-02): • Fair lending policy statements and training • Lending policy review for evidence of any violations • Statistical Analysis to review for evidence of potential disparate

impact • Loan data review for evidence of prohibited disparities • Monitoring for compliance by managers and trained employees • Oversight of compliance by management or legal counsel • Corrective Action Plans

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Establishing Dealership Policies NADA Fair Credit Compliance

Policy & Program

• Jointly released by NADA, American International Automobile Dealers Association (AIADA), and National Association of Minority Automobile Dealers (NAMAD) in January 2014

• A dealer who adopts the program – • Establishes Standard Dealer

Participation Rate (SDPR) for all transactions involving dealer participation;

• Only deviates from SDPR for a pre-set, good faith, competitive reason that is documented; and

• Reviews the pricing determination and otherwise conducts robust training, oversight, and reporting to ensure the program is faithfully executed.

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More Recent Developments • CFPB Field Hearing in Indianapolis (9/18/14)

• Director announced -

• Proposed Larger Market Participant Rule for Nonbank Finance Companies

• Size threshold set at 10,000 aggregate annual originations

• Covers 7% of (38) nonbank finance companies w/ 91% nonbank market share

• ECOA Supervisory Highlights

• CFPB has conducted supervisory examinations of finance sources representing >30% of indirect financing market

• CFPB reached nonpublic supervisory ECOA resolutions w/ finance sources involving $56M in redress for “up to 190,000 consumers”

• “White Paper” on Proxy Methodology for Race & Ethnicity

• Focuses exclusively on probabilities

• Does not address several related issues

• Panel presentation followed

• Opening Statement of P. Metrey available at: www.nadafrontpage.com/NADA_Paul_Metrey_Testifies_CFPB_Hearing_September_2014.xml

• AFSA is preparing study that will address BISG methodology and related topics

• H.R. 5403 Introduced

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H.R. 5403

• Introduced in U.S. House of Representatives in Sep 2014

• Has 69 Republican & 45 Democratic Co-Sponsors (as of 10/10)

• Provisions

• Nullifies CFPB Bulletin 2013-02

• Requires that, prior to issuing future guidance on indirect auto financing, the Bureau…

• Provide for public notice and comment

• Make publicly available all studies, data, methodologies, analyses, and other info relied upon by Bureau in preparing guidance

• Consult with the FRB, FTC, and DOJ

• Study the cost and impact of the guidance on consumers as well as women-owned, minority-owned, an small businesses

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Impact on Overall Business

•Greater focus on training

•Managerial oversight

•Communication with all parties – lenders, dealerships, personnel

• Internal Audits

• Increased compliance costs = Decreased risk of violations