By a 4-1 vote on June 23, 2022, the US Federal Trade Commission (FTC) issued a notice of proposed rulemaking that is squarely aimed at changing the way dealers interact with customers in the automotive financing process, with an ancillary but material impact on both original equipment manufacturer (OEM) affiliated and other finance companies. The proposed rule follows multiple FTC enforcement actions and consent orders over the last two years, particularly the Bronx Honda, Tate Auto, and Napleton cases, which foretold nearly all of the provisions of the proposed rule.
The proposed rule would do the following:
- Bring certain already-prohibited deceptive dealer practices within the FTC’s civil penalty authority. The FTC has the power to seek civil penalties for deceptive trade practices proscribed by a trade regulation rule only. In defining a specific universe of misrepresentations made in the course of selling, leasing, or arranging financing for motor vehicles, the rule would not likely prohibit any new conduct but would subject violations of the provision to civil penalties up to approximately $50,000 per violation.
- Mandate specific new financing disclosures. The proposed rule would go beyond existing disclosure requirements under Regulations M and Z by requiring clear and conspicuous disclosure of additional information about the purchase price of the vehicle and prices for optional products. A price list for optional products must be posted on the dealership’s website.
- Require dealers to obtain consumers’ “express informed consent” to any charges related to the sale or lease. The FTC would expand the Napleton consent order’s requirement of express informed consent to vehicle sale and lease charges to the entire industry. The definition requires truthful, clear, and conspicuous disclosure, both in writing and (for in-person transactions) orally, of the reason for the charge and the amount of the charge, followed by affirmative, unambiguous assent to be charged. In addition, for optional products, the rule would require the dealer to obtain the consumer’s written rejection of an offer to sell the vehicle at a specific price without optional products before the dealer could charge a borrower for the options the buyer has accepted.
- Prohibit the sale of add-on products and services that “provide no benefit” to the consumer. The proposed rule targets both products and services that the FTC believes provide no value to any consumer—such as nitrogen tire products that do not include more than ambient atmospheric nitrogen—and those that provide no value to the specific consumer—such as, per the FTC, guaranteed asset protection (GAP) agreements when the loan-to-value (LTV) ratio is already low or duplicative warranty coverage. The latter category will be the most subjective and difficult to assess.
- Impose a two-year recordkeeping requirement on dealers. Dealers would be required to create and retain records showing compliance, including advertisements, price lists, customer correspondence, financing documentation, LTV calculations for all sales of GAP coverage, and customer complaints.
The rule comes after years of statements from Democratic FTC commissioners in response to enforcement actions against auto dealers criticizing the way in which cars are sold and financed in the United States as a “broken” market in need of regulatory intervention.
During the last 10 years, the FTC has brought more than 50 law enforcement actions related to automobiles and helped lead two nationwide law enforcement sweeps that included 181 state-level enforcement actions in these areas. In addition, complaints from consumers related to automobiles remain in the top 10 complaint types received by the FTC, with more than 100,000 complaints from consumers annually over the last three years.
After the FTC lost the AMG case in the US Supreme Court—sharply curtailing the agency’s ability to pursue monetary relief where the agency had not first undertaken a rulemaking—the agency turned its focus in part to laying out rules that could provide such a predicate. Under the Dodd-Frank Act, the FTC was granted the authority to issue consumer protection regulations governing auto dealers using an expedited process, which made the industry a likely target for action.
With one major omission, the scope of the rule hews closely to both the fundamental allegations and the remedies adopted in recent cases, and similarly tracks factual findings from the FTC’s recent research efforts into the market. The agency’s concern about the prices of optional products—what the FTC’s official press release terms “junk fees”—also ties in with the Consumer Financial Protection Bureau (CFPB) junk fee initiative.
Conspicuously missing from the rule is any regulation of dealer markup, which was a significant focus of both the Bronx Honda and Napleton cases. While a substantial part of the preamble to the proposed rule explains the role of markup in automotive finance, nothing in the rule would require additional disclosures or limits on dealer markups. The FTC and CFPB have both focused on antidiscrimination concerns associated with dealer markup for years, and at least one current FTC commissioner has explicitly called for the regulation of markup in the past.
There are two possible explanations for this omission. One is that the agency may be willing to wait and see if these enhanced disclosures result in more competitive pricing and fewer unexplained pricing variances along racial lines. The other is that a second, more contentious regulation may yet be forthcoming. But by focusing on core unfairness and deception issues grounded in prior enforcement actions, the agency secured the vote of Republican Commissioner Phillips and may better insulate this proposed rule from challenge.
IMPLICATIONS FOR AUTOMOTIVE LENDERS
The potential effects on dealers themselves will undoubtedly be substantial. The effects on the automotive lending market are subtler and may take longer to be felt—but may be no less significant.
- Reduced optional products revenue. The FTC expressly intends the rule to reduce dealers’ sales of optional products. How dealers will react could result in pressures across the automotive lending market. Dealers may increase vehicle sales prices to replace lost revenue or seek higher dealer reserves in financing transactions. The countervailing pressures of inflation and rising interest rates may mean that dealers react unpredictably and variably within their customer population. Indirect lenders should be prepared to respond to these market changes.
- Holder Rule risks to assignees. While the rule, like the FTC Act itself, does not contain a private right of action, many states’ unfair or deceptive acts or practices (UDAP) laws do—and many treat the FTC’s determination by rule that a practice is unfair or deceptive as legally conclusive. Customers and plaintiffs’ lawyers may therefore be more willing to consider bringing suits for dealer conduct that they contend violates the proposed rule. The FTC Holder Rule can be read to allow consumers to bring those claims against assignees for indirect auto loans—particularly following April 2021 guidance rejecting the existence of a “large transaction” ceiling on that rule’s applicability. These considerations counsel in favor of greater due diligence by assignees, establishment of standards for assignment of loans, and indemnification provisions related to noncompliance.
- Follow-on CFPB and state scrutiny of automotive lenders. Many automotive lenders are banks or other finance companies that fall outside the FTC’s jurisdiction. But the FTC, the CFPB, and state enforcement officials such as state attorneys general and financial regulators collaborate closely, and automotive lenders should expect that these agencies will look carefully at whether they are purchasing retail installment contracts (RICs) that comply with the proposed rule, with a specific focus on financed optional products that generate additional interest revenue to the lender. Enforcement officials have historically had little tolerance for arguments that the dealer is solely responsible for compliance with the rule and will likely expect lenders to monitor the contracts they are purchasing for facial violations and suspicious patterns; there is no reason to believe that this will change with this development. As the enforcement agencies routinely take the position that both primary and secondary actors bear the same responsibilities, there will be an increased need for due diligence, monitoring and documentation with respect to the processing and acceptance of RICs, and documentation by the lenders of the practices and charges that are not acceptable when they take assignment of RICs. These are all measures that, in parallel, will help mitigate litigation and regulatory exposure for sales and finance companies.
- Additional and more complex recordkeeping and compliance requirements create added financial costs for dealers as well as the automotive lenders that must police those requirements. The prospect of significant per-violation penalties means that the costs of compliance measures, although significant, are necessary.
The notice of proposed rulemaking seeks comments within 60 days after its publication in the Federal Register. In her dissenting statement, Republican Commissioner Christine Wilson expressed concern about unintended negative consequences of the rule for innovation and consumers, and particularly solicited industry comments that would help the agency avoid inadvertently calcifying the market. She also questioned the potential effectiveness and completeness of any such rule, given the evolution of sales practices: Consumer car shopping has more recently moved online with services that assist consumers in price negotiation and location of desired vehicles, and some companies have introduced sales models that eliminate the need to enter a dealership at all.
NEXT STEPS FOR DEALERS AND LENDERS
- Consider filing comments on the proposed rule through the Administrative Procedures Act process, with a focus on the relative costs and benefits as well as the impact on the fragile marketplace.
- Start the process of reviewing compliance and processes.
- Automotive finance companies should discuss with dealers early on so that they can and do undertake to confirm compliance (or compliance undertakings) and can make informed decisions on how to proceed in terms of accepting RIC assignments and mitigating associated risks.