The Return of the Regulatory Cicadas: A Scylla and Charybdis Cautionary Tale
Defining the Terms
Brood X and Brood R, 2003, the new FTC, United States v. Guaranteed Auto Sales, and Chopra, are all featured in this cautionary tale regarding dealers being presented with old, but new, dangers and choosing a route that avoids these hazardous perils.
Brood X and Brood R
Brood X is the term for the cicadas that have returned from their 17-year slumber to bedevil people in the eastern half of the country. As with Brood X, dealers must address government regulators who are returning to issues that had laid dormant until now. One could term this development as the return of Brood R, the “R” representing regulators.
2003 and Brood R
The year of 2003 is the year that the Safeguards Rule came into effect, 18 years ago, which is similar to the timespan of the return of Brood X. The Safeguards Rule was derived from the Gramm-Leach-Bliley Act (GLBA), promulgated in 1999. The Rule has not been updated since 2003. Brood R has returned from its 18-year slumber to torment dealers, once again, by potentially modifying the rule at great potential cost.
The Federal Trade Commission (FTC) proposed updates to the GLBA Safeguards Rule in April 2019, which requires dealers to develop, implement, and maintain a comprehensive information security program. There have been hearings regarding this proposal and comments have been submitted to the FTC regarding these proposed updates. The significance of this development will be addressed shortly.
The New FTC
The FTC’s fifth commissioner, Lina Khan, was recently confirmed. FTC Commissioner Rohit Chopra will probably be moving to the Consumer Financial Protection Bureau (CFPB) as the new director. It is anticipated that President Biden will be appointing Karl Racine, the District of Columbia Attorney General, to replace Chopra and Racine will probably become the FTC chairman. Rebecca Kelly Slaughter is the acting chairman who has already exhibited her contempt for dealer sales practices. The new FTC agenda will be advanced, including amendments to the Safeguards Rule.
United States v. Guaranteed Auto Sales…and Bronx Honda
In the past year, the Department of Justice (DOJ) settled a case where it sent undercover shoppers to ascertain whether a small “buy here, pay here” (BHPH) dealer was engaging in discrimination against black customers. The DOJ concluded that it had. Discrimination was alleged and the dealership was required to adopt Fair Lending policies that standardize down payments and other terms, conduct training, keep records, and submit reports. This case is important, as one must consider that a major government agency investigated a small BHPH dealer regarding the issue of discrimination. This case is a foreshadowing of the future Biden-Harris regulatory course of actions. Discrimination is a continuing key issue for prosecution by federal agencies.
The Bronx Honda case has been discussed at length. It, too, was a case based upon discrimination against blacks and Hispanics. Black and Hispanic customers paid more for financing than similarly situated non-Hispanic white consumers. Evidently, these two discrete and insular groups were charged higher financing markups and fees. (The term “markup” is the term used by the FTC and is often used pejoratively. The difference between the buy and sell rate is not a markup but is a legitimate cost of transacting business, a retail margin or the reserve.)
The Bronx complaint alleged that the defendants violated the FTC Act, TILA, and the ECOA. In addition to the $1.5 million restitution amount, there were other stipulations in the settlement including implementing a Fair Lending program that will, among other components, cap the amount of additional retail margin the dealer can charge consumers.
Fair lending and discrimination are the key issues in these two cases. They have returned.
Rohit Chopra currently serves on the FTC Commission but is being proposed as the new director of the CFPB. As with FTC Commissioner Slaughter, he has expressed his scorn regarding the car business. He will probably be confirmed. He has indicated his agenda will includes a return to prosecuting discrimination by advancing Fair Lending. Emulating the original CFPB director, Richard Cordray, Chopra will undoubtedly prosecute Cordray’s “four D’s” — discrimination, deception, debt traps, and dead ends.
Scylla and Charybdis
The expression “between a rock and a hard place” is derived from Greek mythology in the myth of Scylla and Charybdis, both sea monsters, which lived on two sides of a small ocean channel. The multi-headed giant Scylla would grab sailors in its mouth while Charybdis swallowed huge amounts of water, belching it back out, creating titanic whirlpools. To be between these deadly monsters means to be challenged with two compelling perils. The mission is to find a route that avoids both. Dealers need to navigate this route between the regulatory monsters that include the DOJ, FTC, CFPB, and state regulators, especially regarding the two lurking issues of the Safeguards Rule and Fair Lending, a term that has taken on a portentous meaning.
The Issues in the Return of the Regulatory Cicadas: The Safeguards Rule and Fair Lending
The two returning issues are the proposed amendments to the Safeguards Rule and Fair Lending. Fair Lending encompasses the issues of discrimination, equity, and the reserve.
The Proposed “New and Improved” Safeguards Rule
The Safeguards Rule requires dealers, who are all under FTC jurisdiction, to have measures in place to keep customer information secure. As explained above, there are proposed changes that have a likelihood of being promulgated. The key proposed changes to the Safeguards Rule address the following subjects, among others:
- Chief Information Security Officer (CISO)
- Appoint a CISO to supervise the program
- Board of Directors
- Establish such a board for oversight
- Multifactor Authentication
- Require such authentication
- Penetration Testing
- Including vulnerability assessments
- Data and systems would be required to be inventoried
- Incident Response Plan
- Audit Trails
- Service Provider Safeguards
- Data would be required to be encrypted at rest and in transit
- Monitoring Authorized Users
- Employee Training
Most reasonable people agree that data should be safeguarded. However, the costs associated with these proposals may be a challenge for dealers. According to the NADA Cost Study, the initial cost to establish this program, per each franchised dealership, will be approximately $294,000 with annual costs being around $277,000. These costs are substantial when considering the current compliance costs each dealer already bears.
An avowed objective of the Biden-Harris administration is to eliminate discrimination and pursue an agenda of equity. The pursuit of equity is to achieve similar results for all consumers. Regulation by enforcement and regulation, unto itself, will be the means to this end. For example, an attempt at applying the disparate impact theory, in a new way, could return. Moreover, regulating, or possibly eliminating the reserve, may be attempted.
Eight years ago, in 2013, the CFPB issued automobile finance guidance, an official statement recommending that certain standards be met in conducting business, respecting the discrimination standards in the Equal Credit Opportunity Act (ECOA). (When the CFPB issues “guidance,” it means that if businesses don’t follow the statement, they will be sued.) Thus began the wrongheaded disparate impact cases.
No law, including the ECOA, prohibits dealer retail margins. However, that certainly didn’t prevent the CFBP from seeking to nullify these retail margins through enforcement actions, the disparate impact prosecutions. (Regulation by enforcement, as opposed to promulgating regulations in advance of enforcement, is a preferred method of activist agencies. Regulation by enforcement is also wrongheaded.) However, this original guidance, and the consequential disparate impact prosecutions, were later nullified in 2018 by a joint congressional resolution.
The CFPB has a Division of Supervision, Enforcement, and Fair Lending (SEFL) and an Office of Fair Lending and Equal Opportunity (Fair Lending Office). Originally, the Fair Lending Office was part of SEFL but was rendered ineffectual in 2018 by it being moved to the director’s office. In order for the Fair Lending Office to become once again relevant, Chopra will return the Fair Lending Office to SEFL.
It’s important to note that in the CFPB’s 2020 Fair Lending Report to Congress, it stated that the CFPB would advance Fair Lending and address racial equity.
Sailing the Remedies Galleon through the Isthmus of the Safeguards Rule and Fair Lending
Many companies and organizations offer assistance in complying with the Safeguards Rule and Fair Lending. Many of them are excellent. However, a biblical reference is apropos: Cura te ipsum, or physician heal thyself. When applied to dealers, it means cure your operations first. In other words, dealers should initially address these problems internally.
As to the Safeguards Rule, dealers should evaluate their current programs to see if they currently are fully compliant with all the requirements of the rule. If they are, any added requirements will be easier and less costly to augment. If there are areas where dealers are non-compliant, now would be a good time to correct them. Dealers should note that any regulatory activity, such as the Safeguards Rule proposed amendments, will spur regulators to investigate present compliance before any changes are made to the Rule.
As to Fair Lending, dealers need to evaluate their current programs. Is there presently a standard protocol in assessing the interest rate being charged to consumers? Could testing or data analysis lead to the conclusion that there is apparent discrimination? In addition to assisting consumers with financing, dealers should be proactive and include an analysis of their voluntary protection product procedures.
Two programs offered by the NADA address these Fair Lending and discrimination issues quite effectively and should either be implemented or serve as a template: Fair Credit Compliance Policy and Program and Voluntary Protection Products: A Model Dealership Policy. These two programs would provide compelling defenses to regulator investigations. Such protocols should be standards in every dealer.
The vast swarm of Brood X are pests. The vast swarm of Brood R are pests. Pests need to be contained. Dealers need to use the best pesticides that are available to avoid a rock and a hard place.
Govern yourselves accordingly.
Terrence J. O’Loughlin, J.D., M.B.A. is director of compliance at The Reynolds and Reynolds Company.