It is a well-documented fact that the Consumer Financial Protection Bureau (CFPB) takes a dim view of dealers participating in the revenue that flows from financing vehicle purchases. This practice, known as dealer reserve, markup or participation, is that amount added to the wholesale cost of credit that finance sources extend to dealers (a.k.a. the “buy rate”). The CFPB clearly doesn’t like it.
Why the animosity? One year ago, the CFPB issued its Fair Lending

Guidance Bulletin, stating that finance sources are liable for discriminatory pricing by dealers whose paper they buy. Note that the CFPB did not allege (must less prove) that discrimination actually occurs in the marketplace. Rather, the CFPB merely stated the obvious: Because dealers have discretion in the markup they charge above the buy rate, it is possible that dealers could discriminate. And that mere possibility is apparently enough to start the ball rolling toward greater scrutiny of finance reserve.

To its credit, the National Automobile Dealers Association took the CFPB bulletin seriously. The NADA expended great effort toward crafting a response for its members to consider implementing in their dealerships. NADA issued its Fair Credit Compliance Policy & Program in January 2014 and promoted it in conjunction with its annual convention, which took place one month later in New Orleans.

In my opinion, the NADA response goes too far and will prove impractical in its execution. The specifics of my objections, however, need to wait awhile. In order to properly consider the NADA program, it is first necessary to understand the evil it is designed to address. That evil is not dealer participation; it’s discrimination. And it is that topic this article will examine.

What Is Discrimination?
Discrimination is outlawed under federal, state and local laws. The Civil Rights Act of 1964, for example, prohibits discrimination based on race or ethnicity in programs that receive federal funding. Following that act, and more germane to our present discussion, came the Equal Credit Opportunity Act (ECOA) in 1974. This federal law prohibits discriminating against a credit applicant on the basis of color, race, religion, national origin, marital status and other, less common, bases.
Federal legislation eventually extended these prohibitions to housing (Fair Housing Act of 1968), employment (Equal Pay Act of 1963; Executive Order 11246 of 1965; Age Discrimination in Employment Act of 1967; Civil Rights Act of 1991), and certain handicaps (Americans with Disabilities Act of 1990).

All those acts — and more besides — prohibit discrimination. But what is discrimination? In broad terms, it comes in two flavors:

Requiring prospective firefighters to carry heavy equipment could have an unintended discriminatory impact on female applicants who, as a group, may be less likely to meet the standard.

Requiring prospective firefighters to carry heavy equipment could have an unintended discriminatory impact on female applicants who, as a group, may be less likely to meet the standard. 

Flavor No. 1: Disparate Treatment
The type of discrimination most people think of when they hear the word is called “disparate treatment.” As the name implies, disparate treatment occurs when people are treated differently — that’s what “disparate” means — based on a protected status such as race, gender or age. A classic example of disparate treatment is an employment ad that includes “Irish need not apply.” Or a lunch counter that refuses service to a black person while serving whites. Or a dealership that won’t give a woman a test drive unless her husband comes to the store.

Let me be clear: disparate treatment is illegal, immoral, and just plain wrong. It has no place in a dealership or anywhere else. Disparate treatment was the kind of discrimination the Civil Rights Act of 1964 was intended to restrict. And discriminatory intent did not have to be proven, just the discriminatory act.

Is disparate treatment widespread in the automotive industry? To answer that question, let me relate a recent experience. I traveled to New Orleans the day before NADA 2014 began. I was honored to address the Chrysler Minority Dealers Association at their annual gathering. As this event occurred the same week as our nation marked Martin Luther King Jr. Day, I began by reflecting on how far we had come in reducing discrimination since Dr. King’s famous “I have a dream” speech. At the time he delivered that speech, the meeting I participated in was not only undreamed of — it would have been illegal, for New Orleans was a segregated city. Those minority dealers would have been servants at the host hotel if they were admitted at all. And yet today they were the honored guests, and I — a middle-aged white guy — was there to serve them.

That is not discrimination. That is progress.

As I got into my prepared remarks, discussing the CFPB’s implicit belief that the possibility of discrimination equals actual discrimination, I asked the crowd for a show of hands of those who discriminate against black customers. As you would expect, no hands went up. Same when asked if they discriminated against Latinos or women. And when I asked if they give special discounts to white people, they laughed.

All this illustrates a simple fact: Car dealers — black or white — see only one color: green. All successful dealers sell their wares for the maximum possible profit, limited only by the law, ethical practices, and what the market will bear. Put another way, dealers charge what they charge because they can, not because of a person’s race, sex or national origin.

In short, I believe actual discrimination is effectively limited by market forces and existing law. And if the CFPB is not alleging disparate treatment, it must believe that, too.

Flavor No. 2: Disparate Impact
So what happens if no observable discrimination occurs, or no discriminatory intent can be proved? Opponents of discrimination still have one weapon in their arsenal: disparate impact.

Disparate impact arises when facially neutral policies have a discriminatory impact in practice. Though disparate impact was never even mentioned in the Civil Rights Act of 1964, it began to gain traction in the employment arena following that law’s enactment.

Here’s an example of disparate impact in the employment field: Say a fire department has an employment requirement that is facially neutral (meaning it doesn’t explicitly discriminate against any protect class), namely the requirement that job candidates be able to carry 100 pounds of hose up three flights of stairs. This seems like a reasonable requirement, and does not on its face discriminate against anyone.

But in practice, such a requirement would have the effect of discriminating against women who, as a class, are generally less strong than men. This is what we call disparate impact: The impact of an otherwise neutral policy has, in practice, a discriminatory impact.

If disparate impact is found to exist, employers can overcome the prohibition by proving a rational, job-related necessity for the requirement. In the case of the hypothetical fire department, the requirement seems reasonable for actual firefighters. But it would be hard to defend when the job to which the requirement applies is a deskbound dispatcher.

In the employment field, this type of actionable discrimination hardly seems objectionable. The Supreme Court affirmed this approach in 1971 in the case of Griggs v. Duke Power Co. In Griggs, a potential employer required a high school diploma (and IQ test) of all job applicants it considered. Because black applicants at that time and in that place were less likely to have achieved a high school diploma, the race-neutral policy had a disparate impact on black applicants.

At trial, the plaintiff proved that long-serving white employees who did not have a high school diploma performed their job duties just as well as those who did. In short, there was no rational reason for the requirement and it was struck down.

The bottom line is that disparate impact can, in certain contexts, reflect actual, actionable discrimination. Title VII of the Civil Rights Act of 1964, for example, specifically prohibits disparate impact by employers (not creditors). The Age Discrimination in Employment Act also prohibits disparate impact in the employment arena.

I mention Title VII and ADEA because the CFPB is not attempting to enforce employment laws that prohibit disparate impact, but the ECOA, which does not.

Theory vs. Reality
Disparate impact analysis works in the realm of employment because there is a clear line between the neutral policy and a discriminatory impact, as seen in our fire department hypothetical and the actual Griggs case. No such clear connection exists in the real world of automobile dealerships.

Cost of money — interest rates — are only one variable in the calculation of a final price and the amount of monthly payment. Other variables include discount from MSRP, amount of down payment, F&I products selected and the final negotiated price of each, length of time before first payment, and the list goes on. So it is entirely possible for a customer to pay a higher interest rate to finance the purchase, but less money overall.

We haven’t seen the CFPB address this reality. And if the CFPB takes the position that it doesn’t matter whether the transaction as whole exhibits disparate impact so long as one element of it might, is that really discrimination by any meaningful measure? Is that a problem at all, much less one requiring federal intervention?

I do not believe disparate treatment is a significant problem in the automobile industry. I do not believe there is a legal basis to prosecute an action against a dealer based on disparate impact, nor do I believe as a matter of fact that disparate impact is a problem in the industry. If those assumptions are true, it follows that the NADA Fair Lending Compliance Policy and Program is an overreaction.

That is not to say dealers should not take this opportunity to reexamine their policies, procedures, and training to address disparate treatment, or to reaffirm their commitment to the fair treatment of every customer. But that is another article for another day.

James S. Ganther, Esq., is the co-founder and CEO of Mosaic Dealer Services. He is a legal and compliance expert and a prolific writer and speaker.
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