Yesterday, the Consumer Financial Protection Agency and the Department of Justice announced a $21.9 million dollar settlement with the Toyota Motor Credit Corporation. It is the fourth recent action taken by these regulators involving fair lending risk in auto dealer incentives and discretion. The settlement – and the consent order that comes along with it – may seem of peripheral interest to the ARM industry, but the action offers sharp lessons for the ARM industry on how regulators are using data to track UDAAP violations and how regulators expect financial services agencies to balance employee discretion with agency-wide non-discrimination policies.
According to the CFPB and the DOJ, Toyota Motor Credit policy, which gives auto dealerships discretion in how much interest rate markup they pass along to consumers, resulted in higher rates for African-American and Pacific Islander loans. The order requires Toyota Motor Credit to pay up to $21.9 million in restitution to thousands of those African-American and Asian and Pacific Islander borrowers who, the agencies allege, “paid higher interest rates than white borrowers for their auto loans, without regard to their creditworthiness, as a result of its past practices.”
Specifically, per the CFPB, Toyota Motor Credit’s markup policy:
- Resulted in minority borrowers paying higher dealer markups: Toyota Motor Credit violated the Equal Credit Opportunity Act by adopting policies that resulted in African-American and Asian and Pacific Islander borrowers paying higher interest rates for their auto loans than non-Hispanic white borrowers as a result of the dealer markups that Toyota Motor Credit permitted and incentivized. These markups were without regard to the creditworthiness of the borrowers.
- Affected thousands of minority borrowers: Toyota Motor Credit’s pricing and compensation structure meant that for the period covered in the order, thousands of African-American borrowers were charged, on average, over $200 more for their auto loans, and thousands of Asian and Pacific Islander borrowers were charged, on average, over $100 more for their auto loans.
As we’ve noted, regulators in general and the CFPB in particular, have demonstrated an increased willingness to use data analysis to identify and pursue cases of disparate impact. As Kelly Knepper-Stephens argued earlier this week, a disparate impact policy needs to be “part of a fully developed compliance management system.”
As the CFPB consent order strongly suggests, the Bureau sees potential disparate risk when financial institutions give discretion to partner companies or front-line employees. Toyota Motor Credit’s policy did not explicitly call for discrimination. Rather, it gave dealerships room to make their own decisions regarding markups. From the regulatory point of view, that discretion resulted in disparate impact and a violation of fair lending law.
CFPB Director Richard Cordray made the connection explicit in his comments regarding the consent order.
“We are dedicated to promoting fair and equal access to credit in the auto finance marketplace,” said Cordray. “Toyota Motor Credit is among the largest indirect auto lenders, and we commend its industry leadership in shifting to reduced discretion to address the significant fair lending risks.” [Emphasis ours.]
Regulators are clearly pushing financial services firms to shift from case-by-case discretion to universal policy when it comes to financial services products. The CFPB and the DOJ not only pushed Toyota Motor Credit to pay restitution to those borrowers, but they also compelled the lender either to remove the discretion it gave partner dealerships or else monitor that discretion and police dealerships for potential disparate impact violations.
The consent order dovetails with the Bureau’s Summer 2014 edition of Supervisory Highlights, where the agency argues in favor of significantly limiting discretionary pricing adjustments as a way to reduce or effectively eliminate pricing disparities.
“Substantial limits on discretionary pricing like those imposed by today’s order can address the type of fair lending risk identified in the CFPB’s bulletin and Supervisory Highlights,” the Bureau advised.
What can you take away from the Toyota Motor Credit consent order?
1. Recognize that more discretion for front-line employees equals more regulatory risk. The CFPB and the DOJ view dealer discretion as being the prime factor behind the disparate impact in Toyota Motor Credit’s lending results.
2. If you allow for discretion in your operations, your policies need to account for the risk. Toyota Motor Credit’s policy allowed for pricing discretion but did not “employ adequate controls to prevent discrimination.” The consent order spells out exactly what regulators consider to be “adequate controls.” Regulators gave Toyota Motor Credit several options to modify its markup policy, including limiting the amount of markup dealers can provide, eliminating discretion by setting a fixed, universal markup, or letting dealers offer a smaller range, but documenting exceptions. Plus, the regulators want the company to send annual notices to dealers explaining Equal Credit Opportunity Act law, monitor outcomes to dealership markup discretion for compliance with new limits if the company opts to preserve that discretion, and submit data to the Fair Lending Director and the DOJ no less often than semiannually.