Last week, we recapped Compli’s “Fair Lending in the Trump Era” webinar, which explored the past, present, and future of the Consumer Financial Protection Bureau. One of the key points in the CFPB’s development and regulatory focus, co-host Michael Benoit told us, is the theory of “disparate impact.”
While we defined this term in last week’s article, disparate impact is something that deserves its own blog post. Read on to learn about one of the CFPB’s guiding principles, and the ways in which significant cases have supported or challenged the theory.
(Before we dive in, I would like to thank Michael, whose words we adapted to create this blog post, for the many insights he shared over the course of his presentation.)
Disparate Impact 101
The theory of disparate impact predates the formation of the CFPB, and can be traced back to the Equal Credit Opportunity Act, which makes it illegal for a creditor to discriminate against a lender on a prohibitive basis such as that individual’s gender, race, ethnicity, or marital status. Before the the advent of the CFPB, the it was up to the Federal Reserve Board and the Department of Justice to enforce ECOA.
Throughout the course of enforcement, the DOJ and Federal Reserve Board decided that discrimination didn’t just mean discrimination against an individual, but that creditors should be prohibited from engaging in practice that is discriminatory in effect. Even though a creditor may have no intent to discriminate, and a practice appears neutral on its face, the practice may have a disproportionately negative impact on a certain group of consumers. A lending policy, for instance, may wind up precluding or imposing a higher rate on low-income applicants or applicants of a certain age. Unless the practice meets a legitimate business need that cannot be reasonably achieved by other means, the creditor is in trouble.
How Consumer Advocates Have Applied Disparate Impact
For years before the CFPB, consumer advocates applied the idea of disparate impact to disputes with lenders and automotive dealers, although not always successfully.
In the 1990s, the Department of Justice decided to investigate whether so-called “buy rates” led to disparate impact. (In the context of indirect lending, finance companies provide dealers a buy rate—a wholesale rate for credit—and dealers have discretion to mark it up to a retail rate, which reflects market competition, the internal cost to the dealer of finding financing, and countless other considerations.) After gathering and analyzing the data, the DOJ decided to close the investigation, most likely determining no violation—there was nothing they could prove as discriminatory that wasn’t counteracted by a legitimate business objective.
The pre-CFPB era saw several class action cases against dealers end in minor settlements, but there was at least one important outcome: the Fifth Circuit Court of Appeals made a ruling that certified a class for disparate impact for the violation itself, but not a class for damages, since damages must be paid to an individual. Thus, class action litigators alleging disparate impact would need to go through the laborious and time-consuming exercise of framing their arguments in individual analyses of everyone affected.
This decision at once frustrated and galvanized consumer advocates, who saw an opportunity with the CFPB’s formation in 2011. The Bureau adopted the theory of disparate impact from its forebears, and immediately set about using it in disputes with financial institutions. Although legislators insulated the automotive industry from CFPB jurisdiction during Congressional debates over Dodd-Frank Wall Street Reform and Consumer Protection Act, the Bureau nonetheless targeted dealerships.
Why the CFPB Floundered in Changing Dealership Lending Practices
In 2013, the CFPB issued guidance that recommended indirect auto lenders take steps to ensure that they’re operating in compliance with fair lending laws as applied to dealer markup and compensation policies. In essence, the Bureau wanted finance companies to impose controls on dealer markups or revise the policy, and to monitor or address the effects of these policies in their fair lending compliance programs.
Another option, per the CFPB’s recommendation, was to eliminate dealers’ ability to set rates at their own discretion. Instead, dealers should adhere to a mechanism, such as flat fees for transaction, that does not result in discrimination.
As the CFPB began examining institutions for disparate impact, it reached settlements in several private, confidential cases, as well as a few public disputes. The agency’s rationale throughout the proceedings was that dealers’ discretion to set retail rates disparately impacts racial minorities, which they CFPB chose to show by using statistics.
In the first public case, Ally Bank settled with the CFPB for $98 million, $80 million of which paid for restitution, with the rest going to penalties. Ally also agreed to conduct dealer monitoring and pay ongoing restitution as it discovered disparities going forward during the term of the settlement. Then came Fifth Third Bank, which agreed to pay $18 million in restitution but notably no civil penalty. Next came Honda and Toyota, each of which paid over $20 million in restitution—but, again, with no civil money penalty. Fifth Third, Honda, and Toyota each additionally agreed to cap dealer participation at 100 or 125 basis points—a rate of 1 or 1.25%.
In all these settlements, the CFPB never achieved the remedy it wanted: lenders still hadn’t moved to a flat fee dealer compensation structure. According to Michael, the Bureau miscalculated the environment of the auto finance industry, which is characterized by intricate relationships between relatively small players. Second, the CFPB’s recommendation inadvertently suppressed competition: the few companies that voluntarily switched to flat fees lost market share and, in some cases, exited the business.
And this is all before the Supreme Court weighed in. For the full history of disparate impact in auto lending, watch the archived version of Fair Lending in the Trump Era on demand.