Ms. Garg is not admitted in D.C. She is supervised by Stephanie Robinson, a member of the D.C. Bar. Ms. Bieker is a law clerk and is not authorized to practice law.

The Consumer Financial Protection Bureau (“CFPB” or “Bureau”) issued a proposed rule on September 17, 2014,[1] that would empower the Bureau to supervise certain larger nonbank automobile finance companies. The CFPB proposed the rule pursuant to its authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) to supervise nonbank larger participants of certain financial product and service markets for compliance with federal consumer laws.[2]

If adopted, the proposed rule will be significant for several reasons, including that:

• It will be the first time that nonbank auto finance companies will be federally supervised, meaning that, among other matters, they will be subject to CFPB examination;
• Nonbank auto finance companies will be expected to establish and implement compliance management systems that are appropriate for their size and complexity; and
• The institutions covered by the rule will include not only entities that make auto finance loans and automobile leases, but also those who purchase them; although investors in asset-backed securities are expressly excluded from coverage, trusts, or other investment vehicles that purchase auto finance loans and issue securities or other interests based on and backed by the acquired loans may be covered.

If finalized, the proposed rule would become effective 60 days after publication in the Federal Register.

This client alert summarizes the proposed rule and analyzes the potential impact on nonbank auto finance companies.

I. Background
The CFPB’s interest in indirect auto lending is not new. Over the past two years, the CFPB has issued a fair lending bulletin for indirect auto lenders,[3] settled an historic $98 million fair lending case against an auto lender,[4] and conducted targeted ECOA examinations—focusing on credit approvals and denials, lender buy rates, and dealer mark ups—of several bank auto lenders, resulting in approximately $136 million in consumer redress.[5] The CFPB notes that auto loans are a Bureau priority because of “the important role automobiles and related financing play in consumers’ lives,” and because auto loans represent the third largest category of household debt, after mortgages and student loans.[6]

Although all non-bank auto lenders generally are subject to the CFPB’s regulatory and enforcement authority, if adopted, the proposed rule will open up larger participants in the auto financing market to the CFPB’s supervisory authority. Among other matters, this means that the CFPB will examine such institutions for ECOA compliance; unfair, deceptive or abusive acts or practices (“UDAAP”) compliance; and the adequacy of their compliance management systems. Given the time and effort needed to establish and implement adequate compliance management systems and the resources and costs associated with being examined by the CFPB, if adopted, the proposed rule will have a significant impact on the entities it brings under the Bureau’s supervisory authority.

A. Market for Automobile Financing
The proposed rule defines the market for “automobile financing.” Under the rule, automobile financing would consist of the following activities:

• Granting credit for the purchase of an automobile;[7]
• Refinancing  existing credit obligations or previously refinanced credit obligations made for the purchase of an automobile;[8]
• Purchasing or acquiring credit obligations (including refinancings);
• Providing automobile leases; and
• Purchasing or acquiring automobile lease agreements.

According to the proposed rule’s preamble, nonbank automobile financing participants would include (1) specialty finance companies, including those that serve subprime borrowers; (2) “captive” nonbanks;[9] and (3) “Buy Here Pay Here” finance companies.[10]

The proposed rule would expand the Bureau’s reach to encompass a broad range of auto leases. The Consumer Financial Protection Act (“CFPA”) already covers personal property leases that are the functional equivalent of purchase finance arrangements if the lease is on a non-operating basis and has an initial term of not less than 90 days.[11] The CFPB is concerned that this definition may not capture all auto leases and proposes to include as “other financial products or services” other automobile leases that do not meet the existing definition. The preamble to the proposal contains a long analysis of the leasing market, the Bureau’s jurisdiction over leasing, and requests comments on the same.

B. Exclusions
Certain entities and activities are not covered by the proposed rule, either expressly or by omission. First, the rule expressly excludes “investments in asset-backed securities.” According to the preamble, the “asset-backed securities... do not generally alter the contractual obligation between the consumer and the entity that granted the credit or services the loan,” and thus the Bureau does not believe that “such transactions” should be covered by the rule. Although use of the term “such transactions” suggests that the Bureau may intend to exclude the entire securitization process, the text of the proposed rule only excludes “investments.” Since the rule otherwise covers purchases of auto finance loans, trusts or other investment vehicles that purchase such loans and issue securities based on and backed by them could conceivably be covered.

According to the proposed rule’s preamble, the Bureau is not proposing to include automobile title lending (i.e.,making loans to consumers secured by the titles to the automobiles consumers own) within the meaning of “automobile financing.” [12]

Finally, the rule would expressly exclude from coverage those auto dealers that Dodd-Frank excluded from the CFPB’s jurisdiction, as well as certain other dealers “that extend retail credit or leases without routinely assigning them to unaffiliated third parties.”

C. Test to Determine Larger Participants
The proposed rule sets forth a mechanism to determine whether a nonbank covered person is a larger participant in the automobile financing market. A nonbank covered person would be a larger participant if it has at least 10,000 aggregate annual originations in the prior calendar year. The term “originations” includes the transactions under the definition of automobile financing listed above and includes originations of affiliates of the nonbank auto lender.  Only originations related to automobiles used primarily for personal, family, or household purposes count toward aggregate annual originations.

The CFPB estimates that the proposed threshold of 10,000 aggregate annual originations would allow it to supervise approximately 91 percent of the activity in the nonbank automobile financing market, amounting to approximately 38 nonbank entities. The CFPB is considering other measures to determine who are “larger participants,” including dollar volume of originations or dollar volume of outstanding loans, and invites comments on these and any other potential tests, as well as on whether it should adopt a lower or higher threshold.

Nonbank automobile lenders would be subject to the CFPB’s existing rules applicable to already-defined larger participants (“Larger Participant Rule”).[13] Any nonbank that qualifies as a larger participant would remain a larger participant until two years after the first day of the tax year in which the institution last met the applicable test.[14]

D. Technical Corrections to the Larger Participant Rule
The proposed rule makes a technical correction to the existing Larger Participant Rule by inserting the word “financial” before the term “product or service” in the definition of “nonbank covered person.”[15] The proposed rule also updates various provisions regarding “annual receipts” to clarify that when a company becomes affiliated or ceases to be affiliated during the applicable measurement period, the affiliated company’s receipts should still be aggregated with that of the covered person for the entire period of measurement.[16]

II. Impact of the Rule
As explained above, the proposed rule would subject larger nonbank auto finance companies to supervision by the CFPB. This means that the Bureau will likely examine such institutions for compliance with federal consumer financial law and the adequacy of their compliance management systems. In anticipation of such examinations, potentially covered entities should take particular note of two major areas of CFPB focus: fair lending and UDAAP.

A. Fair Lending
Fair lending continues to be among the CFPB’s top priorities. The Bureau released the proposed rule along with two fair lending-related documents: (1) a white paper[17] describing the Bureau’s proxying methodology for imputing race and ethnicity when statistically analyzing fair lending compliance on non-mortgage credit products; and (2) a special issue of Supervisory Highlights describing the CFPB’s recent examinations of bank auto lending activities.[18] These materials, along with Bulletin 2013-02, provide insight on how the CFPB views fair lending compliance in the auto lending space, and highlight the Bureau’s particular focus on discretion in pricing auto loans.

The white paper explains that when applicant race and ethnicity are not otherwise available, the Bureau uses a proxy methodology to impute this information by using the demographic composition of the applicant’s neighborhood and his or her surname. The CFPB can then use the imputed race and ethnicity information to statistically analyze the lender’s application data for fair lending compliance.

The Supervisory Highlights indicates that the CFPB has examined several banks that offer auto loans, and as part of its exams, has evaluated the banks’ compliance management systems and conducted statistical analyses of their auto loan credit decisions and buy rates, and any discretionary markups or adjustments to buy rates. The CFPB claims that most (but not all) of the bank indirect auto lenders it has examined have engaged in illegal discrimination, most often in connection with dealer mark ups. The Supervisory Highlights indicates that settlements with these supervised institutions will result in $136 million in consumer redress for up to 425,000 consumers. This amount includes the December 2013 CFPB and Department of Justice settlement with Ally Bank for alleged discriminatory auto pricing, which resulted in $80 million in consumer redress and $18 million in civil money penalties.[19]

Larger nonbank auto lenders should be prepared for similar examinations, with a likely focus on their markup and compensation policies and procedures and evaluation of their fair lending compliance infrastructure. As the CFPB has indicated, a robust fair lending compliance management system includes:

• An up-to-date fair lending policy statement;
• Regular fair lending training for all employees involved with any aspect of the institution’s credit transactions, as well as all officers and board members;
• Ongoing monitoring for compliance with fair lending policies and procedures;
• Ongoing monitoring for compliance with other policies and procedures that are intended to reduce fair lending risk (such as controls on dealer discretion);
• Review of lending policies for potential fair lending violations, including potential disparate impact;
• Regular analysis of loan data in all product areas for potential disparities on a prohibited basis in pricing, underwriting, or other aspects of the credit transaction;
• Regular assessment of the marketing of loan products; and
• Meaningful oversight of fair lending compliance by management and, where appropriate, the institution’s board of directors.

Nonbank auto lenders that are likely to be covered by the proposed rule should consider evaluating their own compliance infrastructure and performing statistical testing to assess fair lending risk in anticipation of future oversight by the CFPB.

B. UDAAP
Along with fair lending, the CFPA’s prohibition on UDAAP[20] is a major CFPB examination and enforcement priority.

1. Recent Enforcement Activity
Recent actions by the CFPB and the Federal Trade Commission (“FTC”) highlight the focus on UDAAP enforcement in the auto loan context.

For example, in August 2014, the CFPB brought an enforcement action against an auto finance company for allegedly providing inaccurate information about borrowers to credit reporting agencies.[21] In addition to alleged violations of the Fair Credit Reporting Act, the CFPB alleged that First Investors Financial Services Group misled borrowers by posting a “Frequently Asked Question” on the company’s website indicating that the company furnishes accurate information to consumer reporting agencies, and that this representation was deceptive. The company paid a $2.75 million civil money penalty.

In June 2013, the CFPB brought an enforcement action against a financial institution and its vendor for deceptive acts and practices regarding its auto loan program for servicemembers.[22] In addition to alleged violations of the Truth in Lending Act, the CFPB alleged that the institution’s improper loan disclosures and marketing practices regarding pricing and coverage of an add-on warranty program were deceptive. The institutions paid over $6.5 million in consumer redress.

In January 2014, the FTC announced settlements with nine auto dealers for allegedly deceptive print, Web, and video advertisements.[23] The FTC has also brought enforcement actions against auto lenders. In May 2014, the FTC brought a $5.5 million enforcement case against an auto lender alleging that, among other practices, the lender misrepresented fees and amounts owed under the loans, unfairly assessed and collected fees and other amounts not allowed under the retail installment sales contracts, unfairly modified the contracts, and failed to disclose the effects of an extension of the loan terms.[24] The FTC’s actions and related guidance on auto lenders and dealers are instructive on what the CFPB may consider deceptive advertising in the auto loan context.[25]

2. UDAAP Compliance
The proposed rule would subject larger nonbank auto finance companies to examination by the CFPB for UDAAP compliance. The CFPB expects supervised institutions to have in place a compliance management system to monitor and respond to UDAAP risks.[26] Among other things, the CFPB will examine an institution’s compliance management system for: appropriate board and management oversight; effective policies and procedures, including employee training, monitoring, and corrective action; a consumer complaint process that ensures complaints are collected, monitored, and resolved; and an independent audit function that reviews the entity for compliance with consumer finance laws and adherence to internal policies and procedures.[27]

As such, automobile finance companies that will likely become subject to the CFPB’s supervisory authority should consider evaluating their own UDAAP compliance to ensure that, among other matters:

• Their policies and practices comply with consumer finance laws, including collection practices;[28]
• Marketing materials and advertisements contain appropriate disclosures and accurate statements;
• Consumer-facing materials (such as Web content and call scripts) accurately represent the institution’s practices and are followed by consumer-facing employees;
• Consumer complaints are appropriately monitored, escalated, and resolved;
• Employees are appropriately trained in what constitutes UDAAP; and
• The institution performs regular audits of itself and third-party vendors.[29]

Note that this list is not exhaustive, and larger nonbank auto lenders should consider implementing a full UDAAP compliance management program to minimize the risk of UDAAP violations and to help ensure that they are ready for a Bureau examination.

III. Conclusion
The CFPB’s recent fair lending and UDAAP enforcement activities, along with its guidance documents on fair lending, UDAAP, and compliance management provide important information for institutions that are or will become subject to the Bureau’s supervisory authority. Nonbank auto lenders likely to be covered by the proposed rule should consider beginning to prepare now for the supervision that is to come.

Comments on the proposed rule are due on December 8, 2014. The CFPB is particularly interested in learning more about the auto lending market, including leases and refinancing. In addition, the Bureau is considering different options for the definition of annual originations, auto finance market, and what constitutes a motor vehicle. If you have any questions about the proposal or would like assistance with submitting comments, please let us know.

Notes:
[1] Defining Larger Participants of the Automobile Financing Market and Defining Certain Automobile Leasing Activity as a Financial Product or Service, 79 Fed. Reg. 60762 (Oct. 8, 2014) (to be codified at 12 C.F.R. Parts 1001 and 1090).

[2] The CFPB has authority to supervise all nonbank residential mortgage, private education, and payday lenders. It also has the authority to supervise nonbank “larger participants” in other consumer financial product and services markets, as defined through rulemaking. 12 U.S.C. § 5514(a)(1)(B). If adopted, the proposed rule will be the Bureau’s fifth larger participant rulemaking.

[3] Consumer Fin. Prot. Bureau, Bulletin 2013-02, Indirect Auto Lending and Compliance with the Equal Credit Opportunity Act (Mar. 21, 2013), available at http://files.consumerfinance.gov/f/201303_cfpb_march_-Auto-Finance-Bulletin.pdf. This Bulletin outlines the CFPB’s expectations for indirect auto lenders under the Equal Credit Opportunity Act (“ECOA”), particularly in connection with dealer mark ups. Among other matters, the Bureau expects indirect auto lenders to implement fair lending compliance management programs, and to manage the fair lending risks associated with dealer mark ups by, e.g., monitoring dealer mark ups on a dealer-level and across auto loan portfolios, imposing controls on markups and dealer compensation policies, and/or altogether eliminating dealer discretion to mark up the lender’s buy rates.

[4] K&L Gates, Ally Auto Lending Discrimination Settlement: What it Means for Indirect Auto and Other Lenders (Feb. 25, 2014), available at http://www.klgates.com/ally-auto-lending-discrimination-settlement-what-it-means-for-indirect-auto-and-other-lenders-02-25-2014/.

[5] Consumer Fin. Prot. Bureau, Supervisory Highlights: Summer 2014, available at http://files.consumerfinance.gov/f/201409_cfpb_supervisory-highlights_auto-lending_summer-2014.pdf.

[6] Consumer Fin. Prot. Bureau, CFPB Proposes New Federal Oversight of Nonbank Auto Finance Companies (Sept. 17, 2014), available at http://www.consumerfinance.gov/newsroom/cfpb-proposes-new-federal-oversight-of-nonbank-auto-finance-companies/.

[7] Under the proposed rule, an automobile is “any self-propelled vehicle primarily used for personal, family or household purposes for on-road transportation.” Motor homes, recreational vehicles, golf carts and motor scooters are excluded.  The preamble to the proposal states that the definition of automobile would include new or used cars, sports utility vehicles, light duty trucks, and motorcycles, but not heavy-duty trucks, buses, or ambulances.

[8] The proposed rule uses the existing definition of “refinancing” in Regulation Z. 12 C.F.R. § 1026.20. Under the proposed rule, however, the nonbank covered person need not be the original creditor or a holder or servicer of the original obligation.

[9] “Captive” nonbanks are subsidiary finance companies owned by automobile manufacturers.

[10] “Buy Here Pay Here” companies are similar to captives in that they typically are associated with specific “Buy Here Pay Here” automobile dealers, which traditionally have served the subprime market.

[11] 12 U.S.C. § 5481(15)(A)(ii). Note that the CFPB already has supervisory authority over existing covered persons that offer the leases described in Section 5481.

[12] The preamble hints, however, that auto title loans may be subject to future rulemaking.

[13] 12 C.F.R. Part 1090, Subpart A. Subpart A of the Larger Participant Rule contains basic definitions and generally applicable provisions. Subpart B outlines market-specific provisions based on the markets the CFPB has already defined (consumer reporting, debt collection, student loan servicing, and international money transfers).

[14] 12 C.F.R. § 1090.102. The existing Larger Participant Rule also contains a process by which an institution would be able to dispute its qualification as a larger participant. See 12 C.F.R. § 1090.103.

[15] 12 C.F.R. § 1090.101.

[16] 12 C.F.R. §§ 1090.104, 1090.105.

[17] Consumer Fin. Prot. Bureau, Using Publicly Available Information to Proxy for Unidentified Race and Ethnicity: A Methodology and Assessment (Sept. 2014), available at http://files.consumerfinance.gov/f/201409_cfpb_report_proxy-methodology.pdf. View our analysis of the white paper at K&L Gates, Big Data takes a Big Step: CFPB Offers Insight into Its Fair Lending Proxy Methodology (Sept. 18, 2014), available at http://www.consumerfinancialserviceswatch.com/2014/09/18/big-data-takes-a-big-step-cfpb-offers-insight-into-its-fair-lending-proxy-methodology/.

[18] Consumer Fin. Prot. Bureau, Supervisory Highlights: Summer 2014, available at http://files.consumerfinance.gov/f/201409_cfpb_supervisory-highlights_auto-lending_summer-2014.pdf.

[19] View our coverage of the Ally settlement at K&L Gates, Ally Auto Lending Discrimination Settlement: What it Means for Indirect Auto and Other Lenders (Feb. 25, 2014), available at http://www.klgates.com/ally-auto-lending-discrimination-settlement-what-it-means-for-indirect-auto-and-other-lenders-02-25-2014/.

[20] 12 U.S.C. §§ 5481, 5531 & 5536(a).

[21] Consumer Fin. Prot. Bureau, CFPB Takes Action Against Auto Finance Company for Distorting Borrower Credit Reports (Aug. 20, 2014), available at http://www.consumerfinance.gov/newsroom/cfpb-takes-action-against-auto-finance-company-for-distorting-borrower-credit-reports/.

[22] Consumer Fin. Prot. Bureau, CFPB Orders Auto Lenders to Refund Approximately $6.5 Million to Servicemembers (June 27, 2013), available at http://www.consumerfinance.gov/newsroom/cfpb-orders-auto-lenders-to-refund-approximately-6-5-million-to-servicemembers/.

[23] Fed. Trade Comm’n, FTC Announces Sweep Against 10 Auto Dealers: ‘Operation Steer Clear’ Drives Home That Auto Ads Must Be Truthful (Jan. 9, 2014), available at http://www.ftc.gov/news-events/press-releases/2014/01/ftc-announces-sweep-against-10-auto-dealers.

[24] Complaint, U.S. v. Consumer Portfolio Svcs., No. SACV14-00819 (May 28, 2014), available at http://www.ftc.gov/system/files/documents/cases/140529cpscmpt.pdf.

[25] The FTC also provides examples of what it considers deceptive auto advertisements: http://www.ftc.gov/sites/default/files/attachments/press-releases/ftc-announces-sweep-against-10-auto-dealers-operation-steer-clear-drives-home-auto-ads-must-be/auto-ads-full-size-ads.pdf.

[26] See generally Consumer Fin. Prot. Bureau Examination Manual v.2, UDAAP-1 et seq. (Oct. 2012), available at http://files.consumerfinance.gov/f/201210_cfpb_supervision-and-examination-manual-v2.pdf.

[27] Id., at CMR 3 - 13.

[28] See Consumer Fin. Prot. Bureau Bulletin 2013-07, Prohibition of Unfair, Deceptive, or Abusive Acts or Practices in the Collection of Consumer Debts (July 10, 2013), available at http://files.consumerfinance.gov/f/201307_cfpb_bulletin_unfair-deceptive-abusive-practices.pdf.

[29] See Consumer Fin. Prot. Bureau Bulletin 2012-03, Service Providers (Apr. 13, 2012), available at http://files.consumerfinance.gov/f/201204_cfpb_bulletin_service-providers.pdf.