New CFPB/DOJ Enforcement Action Incentivizes Indirect Auto Lenders to Limit Discretionary Dealer Markups

On July 14, 2015, the Consumer Financial Protection Bureau (“CFPB”) and the U.S. Department of Justice (DOJ) announced a joint settlement of allegations that American Honda Finance Corporation (“Honda”), an indirect auto lender associated with the car manufacturer of the same name, violated the federal Equal Credit Opportunity Act by discriminating against African-American, Hispanic, and Asian and Pacific Islander borrowers in the pricing of auto loans. Notably, the terms of the CFPB’s consent order may indicate how indirect auto lenders in the future can avoid the most onerous financial penalties associated with allegedly unlawful pricing practices.

Honda and other indirect auto lenders generally set a risk-based interest rate, known as the “buy rate,” and pay additional compensation to the dealer if the dealer is able to negotiate a higher rate with the consumer in a process known as “dealer markup.” Critically, the dealer markup process does not consider the borrower’s creditworthiness. The CFPB’s consent order alleges that an analysis of Honda’s loans indicated that its dealer markup policies resulted in minority borrowers paying more than non-Hispanic white borrowers to obtain auto financing. Over a three-plus year period, the CFPB estimates that dealers charged minority borrowers between 25 and 35 basis points more than similarly situated non-Hispanic white borrowers, which would have caused the same minority borrowers to pay between $150 and $250 more than white borrowers over the terms of their loans.

During the time period in question, Honda allowed dealers to mark up consumers’ interest rates up to 2 percent above the buy rate, or 2.25 percent for loans with terms of five years or fewer. As part of the consent order, Honda agreed to reduce these limits to 1 percent and 1.25 percent, respectively, and the consent order also affords Honda the option to abandon discretionary dealer compensation entirely. CFPB Director Richard Cordray noted with approval Honda’s adoption of the lower markup caps, stating that it “demonstrates industry leadership and represents a significant step towards protecting consumers from discrimination.” While the consent order requires Honda to provide $24 million in restitution to consumers harmed by the allegedly unlawful practices, the CFPB declined to impose civil money penalties on Honda, citing its responsible conduct in voluntarily agreeing to reduce or even eliminate discretionary pricing.

In addition to foregoing the imposition of civil money penalties, the consent order also does not require Honda to proactively monitor its portfolio for ongoing disparities in dealer markup and pay remediation to borrowers on a going-forward basis. The absence of these provisions suggests that the CFPB believes that the markup caps set forth in the order are sufficient to eliminate or minimize the risk of ongoing disparities. It is also notable that the consent order permits Honda to elect to provide its dealers with a standard markup rate (as opposed to leaving the markup to dealer discretion). Although a standard markup would greatly reduce or eliminate the risk of price disparities, it also would potentially result in higher consumer prices, as it limits dealers’ ability to select a lower rate in most circumstances.

While the Dodd-Frank Act purports to exclude auto dealers from the ambit of the CFPB’s regulatory authority, Tuesday’s announcement is the latest step in the CFPB’s efforts, despite mounting Congressional criticism, to nonetheless regulate—albeit indirectly—the activities of auto dealers. In December 2013, the CFPB and DOJ announced the first enforcement action against an indirect auto lender, requiring Ally Financial Inc. and Ally Bank to provide $80 million in consumer restitution, to pay an $18 million civil money penalty, and to monitor their portfolio on a going-forward basis and pay consumer remuneration in the event of identified disparities. Thus, the terms of the Honda consent order provide valuable insight for auto lenders looking to mitigate the financial harm associated with a CFPB enforcement proceeding, as the terms of the consent order suggest that adopting lower limits on dealer discretion may suffice to address the CFPB’s concerns.

The DOJ’s proposed order was filed in U.S. District Court in California and is available here, while the CFPB filed a separate consent order administratively, available here.