Regulatory compliance and automobile finance

Jul 29, 2020

In recent history, the Consumer Financial Protection Bureau (CFPB) has taken a particular interest in automotive lending activities, both for captive lenders and traditional bank or credit union auto loans. Obviously, a wide range of regulations apply to automotive lending; however, a focus on unfair, deceptive or abusive acts or practices (UDAAPs) is at the forefront of that interest. UDAAPs are defined as items that can cause significant financial injury to consumers, erode consumer confidence and undermine the financial marketplace. The concept of UDAAPs was introduced as part of the Dodd-Frank Act via oversight from the CFPB.  

In order to understand how vast the CFPB’s UDAAP regulatory might is, let’s examine the general circumstances under which a violation is considered to occur. According to the CFPB, a representation, omission, act or practice is deceptive when:

  • The representation, omission, act or practice misleads or is likely to mislead the consumer
  • The consumer’s interpretation of the representation, omission, act or practice is reasonable under the circumstances
  • The misleading representation, omission, act or practice is material

From an automotive perspective, this has the potential to touch every portion of the loan or lease term from origination at the dealership to the practices governing how these accounts are serviced once funding occurs. The CFPB has published examination procedures whose scope can cover any of the following modules:

  • Company business model
  • Advertising and marketing
  • Application and origination
  • Payment processing and account maintenance
  • Collections, debt restructuring, repossession and bankruptcy
  • Credit reporting, information sharing and privacy

While consumer complaints are not always an indication of an actual UDAAP violation, the CFPB uses complaint themes as indicators of how to target the scope of examinations. To broaden that a bit more, examiners will also consider complaints against subsidiaries, affiliates and third parties whose products are being offered or financed as part of the automobile loan, including items such as prepaid maintenance, wheel and tire warranties, mechanical breakdown protection, or branded insurance and credit card products. Aside from being a regulatory requirement, the proper management (and resolution) of complaints allows an organization to self-identify and take corrective action of control weakness or process breakdowns.  

An effective complaints management program (CMP) should be governed by clear and concise policies and procedures as well as a simple mechanism for consumers to file complaints or voice concerns. This includes having policies in place that instruct first-line workers how to identify and log complaints into a centralized depository, and which subsequently allow an organization to direct complaints to the appropriate party for investigation and resolution/closure. While no company wishes to receive complaints on the products or services they offer, complaints can be an invaluable tool for companies to continue to revise and enhance service offerings consistent with consumer and regulatory demands alike. An important aspect regulators focus on is not only the handling of the specific complaint itself, but also how the organization leverages the complaint to implement corrective actions within processes (or products) to reduce the chance of reoccurrences.  

The foundation of any effective compliance program is firmly seated within the internal controls an organization has in place to identify and prevent process breakdowns. Regulators have an expectation that an organization’s internal controls and underlying processes are documented. This not only demonstrates to the regulator how an organization manages risks holistically, it provides the organization with clearly documented procedures and the associated internal controls for their employees to follow. Ensuring process and control documentation is current and complete for all areas of an organization is of great importance, along with how these processes and controls are monitored and tested on a regular basis.  

Of special note: the policies and processes associated with collection activities are receiving extra scrutiny. The Fair Debt Collection Practices Act (FDCPA) is of particular interest to the CFPB and is often a focus of examinations. Items such as the frequency of leaving messages, options for consumers to unsubscribe to communications, and prohibition on certain methods of communication are areas where regulators commonly focus. UDAAP can once again come into play with collections, as repeated calls or abusive or harassing language could trigger violations. It is important to note again that collection efforts made by a third party on a company’s behalf are viewed by the CFPB as being initiated by the company itself and are subject to the same standards as collection efforts made by their brick and mortar employees.  

An interesting area of UDAAP compliance that is rarely discussed is rate pricing and dealer reserve. As anyone with automotive finance is aware, a lender typically has a buy rate, which is essentially the lowest interest rate the lender allows the dealership to write a contract. Dealers are often allowed to markup this rate anywhere from 1 to 3% and earn a commission or reserve on the difference between the customer’s monthly payment calculated at buy rate and their payment calculated at the written contract rate. Let us assume two customers walk into a dealership with identical credit history and scores looking to purchase the exact same vehicle. Given the dealer’s ability to mark up the rate to generate reserve, Customer A may walk out of the dealership with a monthly car payment that is significantly cheaper than Customer B, even though in theory both customers were identical when referring to credit worthiness. This could potentially lead to allegations of discrimination or favoritism to certain customers.  A simple way to avoid this discrepancy is to pay dealerships a flat fee based on the amount financed on the contract rather than allowing for rate markup. The CFPB hasn’t yet been overly focused on this area, but given the vague nature of UDAAP, it is not far-fetched to believe this is on their radar (and organizations should be prepared for it).

As mentioned earlier, assessing policies and procedures in all parts of your organization for potential exposure to UDAAP is a hot topic within the automotive finance industry. We have just touched on a few areas here that could affect an organization; however, given the broad scope of UDAAP, it is imperative that all operations of the business are evaluated under the lens of UDAAP. While having robust written policies and procedures in place is important to regulators, how these policies are communicated and executed is of equal concern. Employees must undergo regular training to understand the compliance practices of the company. While not every employee needs to be a regulatory compliance subject matter expert, in order for them to avoid, identify or mitigate issues voiced by consumers, a baseline understanding of the regulatory landscape is critical.  

The CFPB has devoted quite a bit of time and energy to auto finance oversight in recent history. They have published a website, Auto Loans, for consumers that contains education on key loan aspects, loan shopping basics and common issues consumers face during the loan procurement process. The CFPB Automobile Finance Examination Procedures is accessible as well, which gives some insight into the areas of examination focus.  

Read over the procedures and determine if your organization is adequately prepared. Given this focus from the regulator, now is the time for organizations to assess their readiness for increased regulatory scrutiny.