Following up on a threat it made back in 2018, the New York State Department of Financial Services (DFS) announced on October 6, 2022 that it entered into a consent order with Rhinebeck Bank (“Rhinebeck”) to settle discrimination claims involving discretionary dealer markups on retail installment contracts with minority borrowers.  Under the settlement, Rhinebeck will pay a $950,000 civil money penalty, provide restitution to borrowers, and develop a compliance plan which includes updates to its auto policies to cap dealer markups on installment contracts purchased by the bank.

Rhinebeck is a New York chartered bank with fifteen branches serving consumer and commercial customers in New York’s Hudson Valley.  As a participant in the indirect auto finance market, Rhinebeck provides auto financing through auto dealers and has no direct interaction with consumers during the financing application process.  As alleged in the Consent Order, Rhinebeck allowed auto dealers discretion to mark up borrower’s interest rates above the “Buy Rate” determined by the bank’s underwriting, which is the minimum rate at which the bank would agree to buy an installment contract originated by the dealer.

Between January 1, 2017 and December 15, 2020, it was Rhinebeck’s general policy to allow dealer markups ranging from 1.5% to 2.5% (and up to 3%, in a small number of cases) depending on the term of the contract.  The dealer markup was capped at 2% after December 15, 2020.  A DFS analysis of the dealer markups of the contracts purchased by Rhinebeck during the relevant time period found that Black, Hispanic, and Asian borrowers, on average, paid more in discretionary dealer markups than non-Hispanic white borrowers at statistically significant rates ranging from 15% to 39%.  Although DFS did not find evidence of any intentional discrimination by Rhinebeck or its employees, it alleged that the bank’s policies and practices around dealer markups resulted in statistically significant disparities in the rates extended to borrowers that were not based on creditworthiness or other objective risk criteria.

While creditors are allowed to price loans differently based on objective differences in creditworthiness, New York’s Fair Lending Law prohibits discrimination against protected classes for the granting, withholding, extending, renewing of credit or in the fixing of interest rates, terms or conditions of any form of credit. NY Exec. L. §§ 296-a(1)(b) and (3).  Although there appears to be little case law on point, the DFS takes the position that the Fair Lending Law prohibits both disparate treatment and practices that have a disparate impact on a prohibited basis. 

Rhinebeck issued a statement saying it disagreed with the findings and denied the allegations, but wanted to avoid a lengthy legal fight.  According to Rhinebeck’s President and CEO Michael J. Quinn:

This settlement reflects a striking departure by DFS from the current approach of virtually every federal and state banking regulator and enforcement agency on fair lending cases involving dealer [markups].  Dealers, not banks, determine how much markup to charge customers.  Banks do not know the racial or ethnic characteristics of borrowers before a [contract] is originated.  In fact, banks are prohibited by law from ever asking for that information, which means the DFS action is based on allegations where the affected customers are only presumed to be members of a particular race or ethnicity, based on their last name and geographic location, as a proxy for those borrower characteristics.

Rhinebeck is correct that the installment contracts analyzed by DFS in the action did not contain information on the race or national origin of borrowers.  Instead, DFS states in the consent order that it “assigned race and national origin probabilities to applicants and utilized a proxy methodology that combines geography-based and name-based probabilities, based on public data published by the United States Census Bureau, to form a joint probability using the Bayesian Improved Surname Geocoding (“BISG”) method.”  This methodology is commonly used and has been the basis for similar enforcement actions brought by DOJ and the CFPB against indirect auto finance companies alleging ECOA violations through discretionary dealer markups, despite serious concerns as to its validity and reliability.  

We have taken issue with this type of enforcement action in the past, for several reasons.  First, banks do not control dealer finance charges, and dealers may choose to sell installment contracts to a variety of assignees.  A cap on discretionary markups by a bank may simply mean a dealer will look elsewhere to sell their installment contracts.  Second, actions such as this hold the bank or buyer of an installment contract accountable for the discriminatory actions of the dealer even though the bank was not involved in the negotiation or discriminatory pricing.  Third, as noted, the use of proxy data (here, BISG coding) may result in findings of disparate impact that are actually due to errors in the coding, not actual discrimination.  Fourth, disparate impact analysis is often performed on an assignee level rather than on a dealer-by-dealer basis.  A hypothetical example we have used in the past illustrates how this can result in a finding of disparate impact even where no discrimination has occurred: an assignee purchases retail installment sale contracts from two dealers: one of them always sets the contract APR 2% above the assignee’s Buy Rate, and the other always sets the contract APR at the wholesale Buy Rate without any rate spread increment.  If both dealers apply these retail pricing policies consistently, no consumer is ever treated differently by either dealer.  But if there is any difference in the demographic makeup of the dealers’ customers, a regression analysis performed at the assignee level will reflect a false “disparate impact,” purely as a result of the accident of the nature of each dealer’s customer mix.

This DFS action is a reminder that states continue to take action under state fair lending laws.  The CFPB stepped back from enforcement of the ECOA in the context of indirect auto lending in 2018 when Congress passed a joint resolution withdrawing the CFPB Bulletin “Indirect Auto Lending and Compliance with the Equal Credit Opportunity Act.”  While New York’s Fair Lending Law is similar to the ECOA, DFS has viewed the rollback in federal enforcement as an opportunity to fill the void.  In issuing its own guidance regarding indirect auto lending in 2018, then-DFS Superintendent Maria Vullo stated “As the federal government stands down on protecting consumers from financial frauds and abuses, DFS stands up to safeguard New Yorkers from unfair lending practices.

Of particular note in this settlement are the 2% cap imposed by DFS on dealer markups under Rhinebeck’s policy moving forward and the requirement for a shift to a flat-fee model for some dealers on an escalated basis.  We have seen other actions where federal regulators and states have pushed for lower dealer markup caps, most recently in an enforcement action brought by the Federal Trade Commission and the Illinois Attorney General which set a cap on dealer markups of 185 basis points above the Buy Rate.  Auto finance companies purchasing retail installment contracts that include dealer markups above the 1.5% to 2% range should be on notice that regulators may view that discretion as too permissive and an open door to potential discrimination.

Banks should consult with counsel about the best steps to take to ensure that states do not attack their fair lending compliance in their indirect auto programs. These steps might include setting limitations on dealer markups, ensuring annual notices regarding fair lending and ECOA compliance and the lender’s expectations are sent to all dealers participating in an indirect auto lending program, and engaging outside counsel to conduct periodic portfolio reviews to monitor for disparities.