By L. Jean Noonan*
On June 10, the Consumer
Financial Protection Bureau published its final "larger participant"
rule, which allows the agency to supervise larger nonbank auto finance
companies for the first time.
At the same time, the CFPB
announced that it updated its
Supervisory and Examination Manual to provide guidance on how the Bureau will
monitor the bank and nonbank auto finance companies it supervises.
Examiners will use the new
Automobile Finance Examination Procedures to assess potential risks to
consumers and determine if auto finance companies are complying with
requirements of federal consumer financial laws. Because these Procedures will
be the road map for examinations of auto creditors, it is critically important
that the Procedures accurately state an auto creditor's legal obligations.
Unfortunately, the Procedures fall short in several ways.
The CFPB's press release said
that, among other things, examiners will be evaluating if auto finance
- Fairly marketing and disclosing auto financing terms. The
Bureau will be examining auto finance companies that market directly to
consumers to ensure they are not using deceptive tactics to market loans
or leases. The Bureau would be concerned if consumers are being misled
about the benefits or terms of financial products. The Bureau is also
looking to ensure that consumers understand the terms they are getting.
- Providing accurate information to credit bureaus. The
Bureau will assess whether information auto finance companies provide to
credit bureaus is accurate. The CFPB recently took an enforcement action
against an auto finance company that the Bureau said distorted consumer
credit records by inaccurately reporting information like the consumers'
payment history and delinquency status to credit bureaus. The CFPB is
looking to prevent inaccurate information from being reported in the
- Treating consumers fairly when collecting debts.
The Bureau will assess whether auto finance companies are using illegal
debt collection tactics. The Bureau will be looking to ensure that
collectors are relying on accurate information and using legal processes
when they collect on debts. The Bureau also will review the repossession
process, including the practices of third-party service providers that are
employed to repossess autos.
- Lending fairly. The Bureau
will assess whether auto finance companies' practices comply with the
Equal Credit Opportunity Act and other Bureau authorities protecting
The Procedures that the Bureau
has published to guide its examiners may not be up to that task, however. The
Examination Procedures document is riddled with errors and questionable
descriptions of how auto financing works.
Let's start with the Bureau's
maddening and inexplicable refusal to use accurate terms to describe the auto
financing business. In too many places to count, the Procedures inaccurately
refer to "lenders" and "loans."
A loan transaction involves a
lender and a borrower, and the subject matter of the transaction is money. A
loan transaction is evidenced by a promissory note and, if applicable, a
security agreement. A credit sale transaction involves a credit seller and a
credit buyer, the subject matter of the transaction is the credit sale of a
vehicle, and it is evidenced by a retail installment contract.
Loans and credit sales share
some characteristics, but they are different creatures. Lions and elephants
both have four legs and nurse their young, but you don't refer to lions as elephants
or vice versa.
While some of the larger
participants may actually make loans to consumers, the vast majority of the
obligations held by these companies will be retail installment contracts. The
companies buy these retail installment contracts from the originating car
dealers and service them after purchase.
Whether the Bureau's ongoing
conflation of these terms is born of ignorance or is an intentional ploy to
advance parts of the Bureau's regulatory agenda, I don't know. Both
possibilities depress me.
And before you remark that
this is mere legal nitpicking, a matter of mere semantics, let me point out
that loans and credit sales are in fact different transactions, treated
differently under a host of federal and state laws. Maximum rates of finance charge,
late charges, grace periods, repossession rights and duties, disclosures,
assignee liability, and other legal requirements can vary depending on whether
a transaction is a loan or a retail installment sale. The Bureau does a
disservice to consumers and to the companies that it regulates by not calling
these transactions by their correct names. And it creates errors in the
Bureau's Examination Procedures.
A good example of how
confusing a loan with a retail installment contract can lead to legal errors is
the Exam Procedures' discussion of compliance with the Risk-Based Pricing Rule,
beginning on page 21. If a creditor makes a loan to a consumer to buy a car
(less typical), the creditor gives the RBP notice. If a dealer sells a car
using a retail installment contract (far more common for the larger
participants), the dealer gives the RBP notice, and the finance company that
takes assignment of the contract has no RBP obligation. A simple yet very
important distinction. The Bureau spends seven pages of its 54-page Procedures
on excruciatingly detailed instructions relating to RBP notices. But nowhere in
these pages does it explain that all this information is not relevant if the
finance company buys retail contracts rather than makes loans. In fact, it says
If you are a sales finance
company, you may find your examiner asking you for your compliance materials
relating to the RBP rule. What should you do? Explain that you are not the
initial creditor; that's the dealer. Gently point the examiner to the actual
RBP rule. Section 1022.75(b)(2) says: "A purchaser or assignee of a credit
contract with a consumer is not subject to the requirements of this subpart and
is not required to provide the risk-based pricing notice." If that doesn't
work, call your lawyer.
We know that GAP is an
insurance product in some states and a non-insurance product in other states.
But the CFPB apparently doesn't know this. On page 4, it tells examiners that
GAP is an insurance policy. We also know that a vehicle service contract is not
a warranty. That's an important point because there are many federal and state
laws that apply to warranties but not to vehicle service contracts. Examiners
need to know the difference. But page 4 of the Exam Procedures implies that they
are the same.
The CFPB should rip out page 4
of the Exam Procedures and start again. Here's another screwy description - a
discussion of "Buy Here Pay Here finance companies." By definition, a
finance company that buys paper from a dealer is not a "buy-here,
pay-here" business. The "buy" takes place at the dealership,
while the "pay" takes place at the finance company. What the
Procedures document seems to be describing when it describes a "BHPH
finance company" is an independent (non-manufacturer-affiliated) finance
company. Some dealers establish so-called "related finance companies"
that buy paper only from that one dealership, but that doesn't seem to be what
this language is describing.
The Bureau is, I suspect, in
for a bit of a surprise regarding advertisements. Few auto sales finance
companies have any advertisements that are governed by the Truth in Lending Act
and Regulation Z. Sales finance companies advertise rates and terms to dealers,
not to consumers. And there is that confusion over loans and retail installment
The CFPB shows its lack of
understanding of auto finance again when it talks about "repurchase"
programs for repossessed cars. On both pages 41 and 49, the Procedures document
states: "If the servicer offers repurchase programs for repossessed
vehicles, determine whether the servicer provides accurate information.
The Bureau certainly doesn't
mean "repurchase" programs because the consumer remains the owner of
the car until the secured party accepts it in satisfaction or (more common)
sells it under commercially reasonable provisions. So perhaps the Bureau means
the right to redeem a repossessed vehicle. But in describing this as a
"program," the Bureau suggests it is an option the secured party need
not offer rather than a right. But the right to redeem is the law in all 50
states under the Uniform Commercial Code. So we are left scratching our heads
about what the Exam Procedures document is talking about with optional
"repurchase programs" for repossessed vehicles.
The Procedures' section on
closed-end disclosures has the potential to create problems. The examiners are
told to look for disclosures that will almost never appear in the retail
installment contracts they are reviewing. Examples are disclosures relating to
the assumption of the "note" and a "no-guarantee to
refinance" statement. These disclosures are required only in real
estate-secured transactions, and such transactions will be as rare as hen's
teeth in the portfolios the examiners will be looking at. Granted, the
Procedures instruct examiners to look for the disclosures "as
applicable," but wouldn't it make more sense for the Procedures to address
the 99% of the transactions the examiners will be reviewing and add a comment
that other rules apply when there is real property securing the contract?
Because the federal consumer
financial laws (not to mention state laws that inform federal issues like
UDAAP) treat installment sales differently from loans, Bureau examiners deserve
an examination manual that is written to cover the vast majority of
transactions they will see. The Bureau has followed the practice of the
prudential regulators and not sought comment on its exam manuals. Perhaps this
is an opportunity for mutual benefit through a comment process, or at least an
informal opportunity for industry to educate the Bureau about the requirements
of applicable law. We hope the Bureau will consider such an effort now, and not
in post-exam disputes that are unnecessary.
Jean Noonan is a partner in the Washington, D.C.,
office of Hudson Cook, LLP. Jean can be reached at 202.327.9700 or by email at firstname.lastname@example.org.