The CFPB and the Auto IndustryAaron E. Lunt, JD, CPCU, AReAssistant General Counsel Head of Regulatory AffairsSeptember 9, 2015

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Presentation Overview

• Part I: CFPB creation, powers and jurisdiction

• Part II: CFPB activity—related to the automobile industry

• Part III: What does the future hold?

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Part I

CFPB creation, powers and jurisdiction

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CFPB Creation

• The Consumer Financial Protection Bureau (CFPB) is an independent bureau in the Federal Reserve System

• Authorized by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act

• Created with a mandate to supervise consumer financial services companies and large depository institutions and their affiliates

• Originally proposed in 2007 by current Senator Elizabeth Warren (former Harvard Law Professor)

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Key Features

• Bureau instead of a commission Contrast to the SEC and FDIC among many other federal

agencies which are led by a commission

• Funding comes from the Federal Reserve system (% of budget) rather than congressional appropriations

• Controversial recess appointment of current Director Richard Cordray in January 2013

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CFPB Powers – 3 Main Powers

1. Enforcement – Can enforce over 20 consumer financial laws and regulations, including: • Consumer Financial Protection Act• Truth in Lending Act (TILA)• Fair Credit Reporting Act • Equal Credit Opportunity Act (ECOA) • Unfair Deceptive, or Abusive Acts or Practices

(UDAAP)

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CFPB Powers cont.

2. Supervision – Broad authority to examine and supervise “covered persons” engaging in, offering, or providing consumer financial products or services Focus on compliance with federal consumer financial

laws, risks to consumers and markets

3. Rulemaking – Authority to prescribe rules and guidelines for many consumer financial laws along with many laws established under Dodd-Frank

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CFPB Jurisdiction: “Covered Persons”

2 Types:

1. Depository institutions—banks a. Large insured depository institutions and credit unions with

$10B+ in assets b. Banks less than $10B in assets

2. Non-depository institutions—non-banks Mortgage market Payday lenders Private education lenders “Larger participant” of a market for other consumer

financial products or services

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Service Providers

• CFPB has authority over certain service providers to banks and non-banks (“covered persons”)

• “Service provider” must provide a “material service to a covered person in connection with the offering or provision by such covered person of a consumer financial product or service” Includes designing, operating or maintaining consumer

financial products and processing transactions related to consumer financial products

• Banks, non-banks and service providers can fall within the CFPB’s jurisdiction

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Exemptions From CFPB Jurisdiction: Auto Dealers

• Section 1029 of Dodd-Frank states:

“The Bureau may not exercise any rulemaking, supervisory, enforcement or any other authority, including any authority to order assessments, over a motor vehicle dealer that is predominantly engaged in the sale and servicing of motor vehicles, the leasing and servicing of motor vehicles.”

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Auto Dealer Exemption cont.

“Auto dealers got a specific exemption from CFPB oversight, and it is no coincidence that auto loans are now the most troubled consumer financial product.”

— Sen. Elizabeth Warren, April 2015

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Further Exemptions From CFPB Jurisdiction: Insurance

• The “business of insurance” is excluded from the list of financial products and services subject to the CFPB’s jurisdiction

• The CFPB is prohibited from enforcing provisions of Dodd-Frank against any person regulated by a state insurance regulator

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Part II

CFPB Activity Related to the Automobile Industry

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CFPB and the Auto Industry

“The consumer bureau has been waging a proxy war against car dealers by shaking down the banks that provide auto loans.”

The Wall Street Journal—August 2, 2015

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CFPB Aim at Auto Industry

• March 2013 – CFPB Publishes bulletin addressing indirect auto lending and ECOA including guidance to eliminate dealer discretion to mark up buy rates

• December 2013 – CFPB and large bank agreed to a $98m settlement involving alleged violations of ECOA for auto lending practices

• September 2014 – CFPB publishes a proposed rule defining “larger participants” of the automobile financing market

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CFPB Aim at Auto Industry cont.

• June 2015 – CFPB publishes final Auto Finance Larger Participant Rule and Auto Finance Exam Procedures, effective date of August 31, 2015

• July 2015 – CFPB and large OEM captive finance company reach $24m settlement over alleged discriminatory lending practices and OEM agrees to limit dealer reserve

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• “A non-bank auto finance company that makes, acquires, or refinances 10,000 or more loans or leases in a year will be considered a larger participant”• Final rule did not include investments in asset-backed

securities which was part of the proposed Rule

Defining a “Larger Participant”

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• The CFPB estimates that it will have authority to supervise 34 of the largest nonbank auto finance companies and their affiliated companies • Captive sales finance companies, specialty finance

companies in markets such as subprime, and BHPH finance companies

• Approximately 90% of activity in the non-bank auto financing market will now fall under CFPB supervision

Defining a “Larger Participant” cont.

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What it Means – Impact to the Auto Industry

• Allows CFPB to have supervisory authority in addition to their current enforcement authority

• Supervisory examinations will commence around the effective date of the rule on August 31, 2015

• Focus on three areas: 1) Compliance with federal consumer financial laws;

2) Compliance managements systems, and

3) Risk to consumers and markets

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What it Means – Impact to the Auto Industry cont.

• CFPB authority in examinations extends to “Service Providers” and could lead to onsite review(s)

• Use supervisory, enforcement and rule making authority for auto lending to expand closer to regulating auto dealers

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CFPB Tools: Discriminatory Practices

• To date CFPB enforcement actions in the auto industry have focused on perceived discriminatory practices in connection with auto lending using a disparate impact legal theory

• Disparate Impact• Legal theory that a policy or practice can be deemed

discriminatory and illegal if it has a disproportionate effect on minorities or other protected classes, even if unintentional

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CFPB Tools: Discriminatory Practices cont.

• This year the Supreme Court upheld the ability to bring disparate impact claims under the Fair Housing Act

• CFPB can use the decision to support their own use of disparate impact theory when bringing actions against the industry

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Disparate Impact Methodology

• The CFPB uses the Bayesian Improved Surname Geocoding proxy methodology to identify discrimination by a lender Estimates race and ethnicity based on the loan

applicants name and census data

• Federal law prohibits auto lenders from collecting demographic data such as race and ethnicity

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Disparate Impact Methodology cont.

• Study on the proxy methodology commissioned by the American Financial Services Association and performed by Charles River Associates found the methodology conceptually flawed:

• Frequently misidentifies background of consumers and dramatically overestimates markups paid by different groups

• Methodology only correctly identifies African Americans less than 25% of the time

• AFSA President and CEO Chris Stinebert added: “Alleged pricing discrepancies between minorities and non-minorities for auto finance rates are simply not supported by data.”

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Key Enforcement Actions in the Auto Industry

• A significant large bank lender of Automotive F&I products and services: Agreed to a $98m settlement involving alleged

violations of ECOA for auto lending practices Settlement included an $18m civil penalty to

the CFPB Did not limit the dealer markup and agreed to

monitoring of lending practices

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Enforcement Actions cont.

• A notable OEM finance division Agreed to a $24m settlement for alleged discrimination

in lending practices in violation of ECOA No civil penalty Cap on dealer markups at 1.25% above the

buy rate for auto loans of 5 years or less and a cap of 1% for loans with longer terms

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Enforcement Actions cont.

• Two other consequential OEM finance divisions are currently being looked at by the CFPB for allegedly allowing dealers to charge higher interest rates on loans to minority buyers

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Impact of Enforcement Actions

• CFPB wants the notable OEM finance division settlement to become a blueprint for other auto lenders

• Pattern emerging of forcing a settlement that includes a cap on dealer markup in exchange for reduced monetary penalty

• Appears to be a systematic attempt by the CFPB to eliminate dealer discretion to mark up buy rates and impose a flat cap on the mark up/dealer reserve

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Impact of Enforcement Actions cont.

• NADA Fair Credit Compliance Policy and Program Optional program designed to strengthen dealership’s

compliance with fair credit laws Recommends dealer establishes a pre-set dealer reserve Deviate only for documented business reasons

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What About Add-on/Ancillary Products?

“I think the CFPB is going to look at auto dealer aftermarket products.” – Gerald Sachs, former CFPB enforcement attorney

Automotive News – August 12, 2015

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What About Add-on/Ancillary Products? cont.

• Automobile Finance Examination Procedures were issued in conjunction with the final Auto Finance Larger Participant Rule and specifically mention “GAP Insurance,” “Extended Warranty,” and “Vehicle Add-Ons”

• The Examination Procedures require examiners to review the “Larger Participants” relationship with third parties offering add-on and ancillary products including their contracts, disclosures, data security and other areas that may pose risks to consumers.

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What about Add-on/Ancillary Products? cont.

• CFPB may attempt to exercise authority over these types of products through unfair, deceptive or abusive acts or practice (UDAAP) violations Service Contract, GAP Waiver and ancillary products

(PDR, Tire and Wheel, Windshield) are being financed through a loan or a lease offered by either a “larger participant” or bank

The provider of these products may be considered a “service provider” to the “larger participant” or bank

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What about Add-on/Ancillary Products? cont.

• The CFPB has already brought enforcement actions against banks and “service providers” in connection with credit card ancillary products and identify theft monitoring products, using UDAAP

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Add-On/Ancillary Products Enforcement:

• CFPB brought action against both the financial institution (“covered person”) and the product provider (“service provider”) Alleged UDAAP and TILA violations focused on GAP and

service contracts that were part of a loan program for service members

Specific allegations related to disclosure practices and marketing of the products

$3.2m penalty for financial institution (“covered person”) $3.3m penalty for product provider (“service provider”)

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Learnings, Potential Areas of Focus

• Based upon CFPB publications and prior consent orders the CFPB is may focus on a number of areas in connection with add on/ancillary products Advertising and Marketing

• Disclosure of material terms and limitations • Deceptive representations

Compliance management systems Third party management

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Learnings, Potential Areas of Focus cont.

• Sales practices and enrollment—clear affirmative consent of purchase

• Payment plans and crediting of payments • Cancellations

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Part III

What does the future hold?

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Political Environment

• CFPB is established and focused on auto industry

• Currently a number of pieces of legislation in Congress would make meaningful changes to the CFPB Change from a bureau to a commission

(HR 1266 and HR 1263) Repeal 2013 guidance on indirect auto lending and

require a more transparent process (HR 1737) Eliminate the CFPB entirely (S 1804)

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Political Environment cont.

• Some of the bills have bipartisan support, others do not

• Legislation eroding the CFPB’s power would likely be vetoed by President Obama

Thank You

This slide presentation is for educational purposes only and any opinions therein do not represent the official position of the The Warranty Group, nor any of its subsidiaries. These slides should not be disseminated without the prior written consent of The Warranty Group.