Recent developments in the auto finance industry suggest that a change is on the horizon for dealers who receive compensation based upon a dealer reserve.

Since its inception, the Consumer Financial Protection Bureau (“CFPB”) has been pressing lenders of consumer auto loans to abandon the dealer reserve system and adopt a flat rate system to compensate dealers for arranging loans. Typically, lenders give their dealers the discretion to apply a markup, or dealer reserve, to the buy rate on consumer paper and the lender pays the dealer based upon that margin. Even when dealers do not use race as a factor in determining the amount of the markup, the use of certain types of data could disproportionately disfavor minorities. According to the CFPB, the lender may be held accountable for any such disparate impact under the Equal Credit Opportunities Act.

Last year the CFPB began investigating several lenders who use a dealer reserve system. One such lender was Ally Financial, Inc. (formerly GMAC). Although Ally steadfastly denied that it tolerated discrimination, the CFPB employed an undisclosed methodology to determine that racial discrimination had in fact occurred. In order to resolve the resulting administrative action, Ally consented to an order in December 2013 and agreed to pay a total of $98 million to resolve the matter. The Ally consent order appears to have only whetted the CFPB’s appetite as Fifth Third Bancorp recently disclosed in its March 2014 10-Q that the lender’s auto loan portfolio is being investigated for discriminatory lending practices.

The CFPB’s tactics appear to be paying off. On April 21, 2014, BMO Harris Bank issued a notice to its dealer customers that it is immediately terminating its dealer reserve system and will now pay its dealers a flat fee of 3% of the amount financed, up to a maximum fee of $2,000. BMO’s decision to replace the dealer-favored markup system with a flat rate program may very well signal a coming tide of change in the auto sales and lending industries.

Notably, while part of the CFPB’s mission is to promote financial education, it seems that a refresher course in accounting could benefit the CFBP itself. A recent U.S. Government Accountability Office (“GAO”) audit revealed “multiple instances” where the CFPB did not properly review and record items. The GAO concluded that “we found that CFPB did not record or erroneously recorded approximately $4.2 million in accounts payable transactions.” The GAO report can be found here: www.gao.gov/products/GAO-14-455R.

Given the CFPB’s recent successes, it is unlikely that the CFPB will change its course or scale back its calls for a flat fee system. While the issue is still unfolding, these developments seem to suggest that auto dealers will have to adapt to yet another change in the coming months and years.