July 2015
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 companies are:

• 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 future.
• 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 consumers.

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 the opposite.

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 contracts again.

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.

*L. 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 jnoonan@hudco.com.