Auto lenders should expect many more lawsuits that equate dealer markups on loans with racial discrimination, delegates to the Consumer Bankers Association Automobile Finance Conference were warned.
'Twenty-five percent of you within the next 24 months are going to be the subject of an investigation by a government agency; a focused examination by a bank regulatory agency; or private, class-action litigation,' Andrew Sandler, a partner at law firm Skadden, Arps, Meagher & Flom in Washington, said in a speech at the conference March 14.
'What you do, how you act, will not a have a great deal to do with whether you are hit. But what you do, and how you act, can have an impact on how bad it is when somebody comes knocking on your door to look at you,' he said.
Sandler's warning stems from lawsuits filed in several states alleging that dealer markups are anti-consumer and reflect racial bias.
Under the practice, dealers tack additional interest onto a loan approved by a captive finance company or bank. If, for example, Ford Motor Credit Co. tells the dealer it is willing to finance a customer at a 10.5 percent rate, the dealer is free to sign the customer to, say, a 13.5 percent rate.
The markup - three percentage points in the above example - then is rebated to the dealer. In some cases, it is shared with the lender.
Lenders usually set a ceiling for markups of a few percentage points above the rate they have agreed to give the borrower. In addition, most states have usury laws that set maximum limits on interest charges, but the limits usually are several times what a low-risk customer should expect to pay.
The markups are being challenged in several states. In Tennessee, plaintiffs contend black customers pay a significantly higher dealer markup than whites.
Government agencies are keen to protect 'the most vulnerable consumers,' subprime borrowers who often are minorities, Sandler said.
Of several suits filed in various states, two in U.S. District Court in Nashville have advanced the furthest.
One of the two, against Nissan Motor Acceptance Corp., is expected to go to trial in September. A nearly identical lawsuit against General Motors Acceptance Corp. has been set for trial in February 2002.
The U.S. Department of Justice filed a brief last year in support of the plaintiffs in Nashville, and Sandler said other federal agencies, bank regulators and state attorneys general are watching closely.
Sandler warned that it is politically popular to attack big lenders and car dealers, and told his audience they represent a large target of opportunity for regulators.
'There is a strong public policy reason why the government takes the view that you ought to be held responsible: They can expend their scarce resources going after the dealers, or conserve those resources and get you (lenders) to do it for them,' he said.
He pointed out that it is not so easy for lenders to avoid legal responsibility for dealer markup, since lenders often share in the profit.
Caps can help
Sandler said lenders should adopt reasonable caps on the dealer markup, and consider terminating dealerships that abuse it.
'Two percent of the dealers you do business with will create 98 percent of your problems. These are the guys who are really pushing the envelope in terms of up-pricing. Think hard: What business will you lose if you limit the dealer upside?' he said.
'Do you have reasonable caps? Would you be comfortable if you had to defend them? If you don't have caps other than the state usury law, maybe you ought to get them in place.'
He said lenders should respond quickly to complaints.
'You should have a way of ascertaining whether you are getting an unreasonable number of complaints on a certain dealer. Nine times out of 10, litigation comes from a consumer who initiated a consumer complaint to you and didn't feel you responded in an adequate manner,' he said.
Lenders do not routinely collect racial data on auto borrowers. If they do, they should be careful with the data, and, above all, decide before collecting the data what the bank will do if it finds discrimination, Sandler said.
'There is nothing you could do that's worse than testing (for race discrimination), then not doing anything to solve the problem. ... Never test to see a problem you already know you have. You should fix the problem first, then test the fix,' he said.
Well-meaning lenders who collect racial data in order to eliminate discrimination can be hung with their own data if regulators can prove the bank found discrimination but did not act on it, Sandler said.
'There's just one rule: No good deed goes unpunished,' Sandler said. 'The harder you work to control these things, the harder they will go to get you.'