Compliance vs. Ethics: The Lines are Getting Blurry in the Car Business

Ethics and compliance are different from each other, but both are vitally important to the long-term success of dealerships and automotive professionals. Often the terms “unethical” and “illegal” are used interchangeably. Ethics is personal - it means the process of discerning what the correct action is. Law is impersonal and requires no discernment, just compliance. Ethics refers to moral principles and values that guide a person or an organization, and ethical conduct refers to knowing the difference between right and wrong and choosing to do what is right. A company or person can be unethical without breaking laws.

For instance, it’s not illegal per se to charge different prices for the same F&I products – and many finance practitioners do so on a regular basis. They’ll charge one customer $795 for GAP and another $1500 for the same coverage because “X Bank allows that much”. Another example I recently read about is that some dealers charge a “certified pre-owned” fee to customers on CPO vehicles they sell. Although that practice may be against OEM guidelines, it’s not necessarily unlawful from a strict legal standpoint.

One more illustration of dubious ethics in my opinion is vehicles that are marketed as a “CarFax One Owner”, even when the “one owner” was a rental car company. Even though the “one owner” statement may be technically true, the descriptions I’ve seen for some of these vehicles are questionable at best: “With just one previous owner, who treated this vehicle like a member of the family, you'll really hit the jackpot when you drive home with this terrific car”; “This 2010 Elantra is for Hyundai fans that are searching for that babied, one-owner creampuff” and “From the looks of it, I'd say this car has been garage kept and babied regularly. If only my wife treated me as nice!!!”

Now some will argue that these statements are just harmless puffery that is intended to make the vehicles stand out, but isn’t it safe to assume that most consumers place more value in a true one-owner car than a prior rental? Even if the dealership discloses the vehicles’ previous histories at some point, is it OK for the first contact with a consumer to be secured by misleading claims? Even if it’s legal, is it truly ethical?

The reality of the car business is that pay plans and sales quotas can sometimes make acting ethically a challenge. Dealership personnel may be under continuous pressure to abandon their personal standards to achieve sales goals. The actions of salespeople mirror the behavior and expectations of their managers. The words and actions of sales and F&I managers often reflects the moral and ethical considerations of top management’s philosophy.

Ethics can be a very personal decision and different people will have different opinions about the above scenarios, but here’s where the lines have gotten blurry: While I agree that “profit is not a dirty word”, it appears that regulators and consumer attorneys have been redefining what is “legal” by applying their own interpretations of “ethical” standards.

In the last few years we’re seeing more and more enforcement actions and lawsuits against dealers for a number of seemingly “legal” activities. Recent cases have charged dealerships with assessing dealer fees that were deemed excessive even though they aren’t regulated by state laws. Another target for regulators is pricing of add-on products. For instance, NY Attorney General Schneiderman said in a statement announcing a $14 million settlement “New York consumers must beware: Car dealerships sometimes pad their pockets by charging for worthless after-sale items, which inflate the price of their car. These items are often ones that consumers don’t need, did not ask for and often are not even told about. Businesses need to make a profit to survive, but it’s illegal to do so by duping consumers.” Whether or not these products are “worthless” is a matter of opinion, but these consumer watchdogs seem to think so.

Another notable case is where a dealer group agreed to pay $1.6 million to settle a class-action lawsuit that claimed the dealerships sold car buyers an over-priced window etch package (and they were only charging $295!)

Former CFPB official Rick Hackett had this to say at an industry event: “If I found out that Walmart set the price of their products at different levels, and they were all the same product, and they were just hoping I would buy one for $20.95 because I was a particularly gullible consumer, I’d be grumpy. That’s the bureau’s perspective of variable pricing of ancillary products.”

We can complain all we want that it’s not fair for the government to limit our profits but it’s clear that they’ve drawn a line in the sand and there’s no relief in sight.

But here’s the good news. Taking an ethical approach has several benefits beyond just avoiding legal issues:

Increased Closing Ratios and Higher Product Penetrations - Higher levels of satisfaction with the selling process result in higher closing rates and higher sales. The more people trust you, the more likely they will buy from you.

Lower Cancellations and Chargebacks – How many times do your customers read the contract after the sale and realize they paid much more than they thought? How many times are credit unions, insurance companies, friends or family members telling your customers they paid too much? Even if you hold their feet to the fire for non-cancellable products, what are the chances you’ll ever see that customer again?

Improved Reputation (your REAL reputation, not necessarily the one you “manage” online) - A dealership’s reputation is difficult, if not impossible, to maintain when staff members depend on “old school” practices. Customers often make decisions during a vehicle sale transaction that they come to regret after the “ether has worn off”. You can be sure they’re telling somebody about the transaction. Or perhaps they’re telling thousands of people online?

Increased Customer Satisfaction - Lack of ethical behavior and old school tactics invariably diminish the customer experience. Nobody likes surprises. Sure, you made the deal but are your customers truly satisfied with your processes or do you just wear them down? At the end of the day higher customer satisfaction translates into more repeat and referral business.

Increased Customer Loyalty - Customers only have loyalty if you earn it from them. Ethical processes help build customer loyalty and retention. You’ll find that customers will be willing to spend more when they feel they’re buying from a business they can trust.

You’ll Exceed Customer Expectations - Your potential customers have unprecedented access to information in real time. The increase in the amount of data available to consumers has brought them a quick and easy way to analyze not only different prices but also to identify who they want to do business with. Car shoppers simply have too many choices and will quickly discard dealers they feel are hiding something. Holding back information or playing fast and loose with the truth will only make them trust you less.

You’ll Stand Out From Your Competition – Progressive dealers can easily differentiate themselves by marketing their ethical processes and demonstrating their honesty. Consumers will respond - after all, how many consumers prefer old-school tactics?

Good ethics can be the pot of gold at the end of the rainbow. An ethical business model can greatly enhance your sales, reputation, customer retention, and bottom line. The most successful dealerships have not only a standard of “don’t break the law” but a standard of “always do the right things”.

Here’s something to think about: If you treat each customer as you would like your mother to be treated, you’re most likely practicing good ethics. After all, it was probably your mom who first said “just because you can, doesn’t mean you should.”

F&I Fact vs. Fiction

It’s not uncommon for me to be asked to weigh in on the occasional compliance conundrum posed on some social media forum. Many such inquiries involve disagreements about long-held beliefs in F&I and whether or not they’re legally valid. 

So I’ve decided to take a crack at clarifying some of the issues surrounding these pervasive compliance myths. Now, there’s no legal advice here — just my thoughts based on a bit of common sense and my years of being a compliance car guy. Ultimately, it’s up to you to decide what works best for you, your customers and your dealership.

Myth No. 1: The 300% rule is a compliance tool

Many F&I processes that started out as solid sales techniques have somehow morphed into compliance requirements. The 300% rule is a great example of this phenomenon. I wholeheartedly agree with this rule from a sales perspective. As they say, you’ll miss 100% of the shots you don’t take. But as a compliance requirement, I’m not so sure.

First, let’s look at why failing to adhere to the 300% rule is considered a compliance blunder. A common rationale is that if you don’t offer protection products to your customers that they end up needing, you can be sued. I have, in fact, heard of lawsuits where a customer wasn’t offered credit life insurance, subsequently died and the spouse sued the dealership.

However, this scenario seems far less likely when it comes to other products. For instance, credit life insurance is only available from the dealer at the time of sale, so there may indeed be an obligation to inform eligible customers of its availability. On the other hand, many other products sold in the F&I office are available elsewhere. I recently purchased a new car, and within days my inbox was full of offers from independent service-contract providers. I’m not sure even the most desperate attorney would want to file a lawsuit against a dealer for not offering products that are readily available on the open market.

But some F&I pros insist on practicing the 300% rule without exception and having a signed declination sheet in every deal jacket to avoid claims of discriminatory treatment. Discrimination is defined as treatment of an individual or group based on their actual or perceived membership in a certain group or social category, “in a way that is worse than the way people are usually treated.”

In my view, if you fail to offer all of your customers all of your products all of the time, it would be a big hill to climb to prove that you’re being discriminatory. On the other hand, if you adhere to the 300% rule but offer your products at different prices,  that discrimination claim may very well be low-hanging legal fruit. But there are other potential issues that subscribing to the 300% rule could raise.

Let’s say, for example, you present your customer with 100% of your products and she says, “I’ll take it all.” So far, so good, right? But you then discover your lender won’t allow you to finance it all. Besides the obvious customer satisfaction issues, you’ve made an offer on which you can’t deliver. Is it conceivable that a lawyer may try to make a contractual legal issue out of that? It certainly wouldn’t surprise me. The same applies with max loan-to-value (LTV) or amount-financed callbacks. If you present 100% of your products in these scenarios, I suggest you let the customer know up front how much more money he or she will need to come up with. 

There are also situations where the customer shouldn’t be offered all of your products. For instance, you wouldn’t sell GAP protection on a cash or low LTV deal (especially when the LTV falls below state or lender limitations), or a service contract on a car that’s exceeded your program’s mileage limit. Offering such products in these situations could result in deceptive practices or fraud claims.

The same principle applies to declination sheets. They certainly come in handy when a customer complains that he wasn’t offered a product that turned out to be needed. But the significance of declination sheets as a compliance tool has been somewhat overstated, in my opinion. From a sales standpoint, declination sheets can provide you with one additional chance to sell products, but they should be used accurately. Products that aren’t available to particular customers shouldn’t show up on their declination sheets. If they do, they should be marked “N/A” or “Unavailable.”

Myth No. 2: It’s illegal to give a customer a copy of their credit report

This myth has no basis in law, as far as I am aware. In fact, the Fair Credit Reporting Act specifically states that a credit bureau provider cannot prohibit a user (the dealer) from disclosing the contents of the credit report to the consumer. However, contracts with some credit bureau providers may prohibit the dealer from giving the consumer a copy of his or her credit report.

Telling customers it’s illegal to give them a copy of their credit report when that information is inaccurate is not a good idea, at least in my opinion. On the other hand, telling the customer you can’t hand over a copy of his or her credit report because your company’s contract with the credit reporting agency prohibits it is accurate and true. There’s never a downside to telling the truth.

Myth No. 3: It’s illegal to highlight a contract

Many automotive professionals believe that this is a no-no because you can be accused of “leading” the customer to sign the highlighted areas without reading the rest of the contract. In reality, you can lead a customer by pointing your finger to the signature sections and saying, “Sign here.” It appears this folklore originated with a case where a creditor utilizing a motor vehicle pawn contract was sued for failure to disclose the APR as conspicuously as other disclosures on the contract.

The court ruled that the creditor violated the Truth in Lending Act (TILA) because it put dashes and arrows pointing to the due date, thereby making the due date disclosure more conspicuous than the APR and finance charge. So there was far more going on than highlighting. In fact, according to the court’s decision, there was handwriting and other markings on the contract, and the annual percentage rate on the contract was 304.24%. No surprise there.

So while highlighting customer signature areas probably isn’t a big issue, make sure certain TILA disclosures aren’t more prominent than others. Of course, if you work with a lender that won’t accept a contract with highlighted signatures, you’ll probably want to avoid the practice altogether.

Myth No. 4: A contract is valid once signed by both parties, even if the customer hasn’t taken physical delivery

The validity of this statement depends on where you conduct business. Some states specifically define when a contract is considered valid. For instance, California law states that “a sale is deemed completed and consummated when the purchaser of the vehicle has paid the purchase price, or, in lieu thereof, has signed a purchase contract or security agreement and has taken physical possession or delivery of the vehicle.”

So before you attempt to hold a customer’s feet to the fire prior to the delivery of the vehicle, you may want to check the laws in your state.

Myth No. 5: Menus are required to disclose the base payment

This has been the subject of much spirited debate in F&I circles. First, menus are not required by law at all. In fact, contrary to popular opinion, even California doesn’t require the use of a menu. All that is required is a “pre-contract disclosure” that shows the monthly installment payment with and without the optional products or services.

So, really, there is no such thing as a legally compliant menu as some vendors claim. But it’s not a bad idea to include the base payment in your menu presentation (and in your write-up as well).

Myth No. 6: Everyone must be charged the same doc fee

This notion again stems from worries about discrimination claims. The thought is that if a dealership charges one customer a fee, it has to charge everyone the same fee to avoid potential litigation.

So, could charging varying doc fees attract the attention of regulators? Well, we’ve certainly heard enough about alleged discrimination in rate markups over the last few years. And as recent actions by the Consumer Financial Protection Bureau (CFPB) and Department of Justice (DOJ) show, even if there’s no intent to discriminate, you can still face fines if protected classes pay more than non-protected classes.

So the easy answer is to just charge everyone the same doc fee, right? Perhaps. But here’s the rub: Doc fees are dealer-imposed charges and therefore not mandatory;  only government fees are compulsory. So it is improper to tell a customer that you must charge them the fee, as you could be setting yourself up for a deceptive practices claim. Some states, like Washington, require you to inform the customer that the doc fee is negotiable.

So to avoid potential discrimination claims, be sure you can show proof that any downward deviations in fees are for valid business reasons, such as needing to match the doc fee offered by a competitive dealer in order to close the deal. Remember, documentation is key.

Myth No. 7: Payment ranges up to $XX are allowed

To many regulators and plaintiffs’ attorneys, using a payment range in certain circumstances could be a sign of payment packing. While it’s generally acceptable to quote a range of payments using an average APR before the customer’s credit report is pulled, once a credit profile is accessed, a best practice is to quote an exact payment.

Let’s say you’ve pulled the customer’s credit but aren’t sure what her rate is because you’re waiting for a callback from the bank. If you pencil the deal back with a payment range, it’s a good idea to include an APR range as well. Once you determine the actual terms of the deal, a final base payment should be disclosed. Also, if you’re using a payment range to account for variations in days to first payment, you should disclose the exact payment at each level. In other words, never give any impression that would allow a regulator or court to infer that the payments quoted are in any way misleading.

So there you have it: my take on some of F&I’s most common compliance myths. Again, how you handle these issues may depend on the laws in your state and your individual processes and philosophies. You may agree or disagree with my analysis and that’s OK. My goal here is not to steer you in any particular direction, but to simply give you something to think about beyond the status quo.

Dealer Fees Under Attack

Two recent actions for alleged dealer fee violations in South Carolina and Indiana are a potential cause for concern in other states due to the likelihood of copycat legal actions. While these states had no caps on dealer fees, a private lawsuit in South Carolina resulted in a $3.6 million verdict and an attorney general action in Indiana resulted in a $625K settlement. Both cases alleged that the dealers overcharged customers because their fees did not reflect expenses actually incurred by the dealers for services. 

Although the state doesn’t offer guidance on what dealers can charge, the court in South Carolina interpreted “closing fee” to mean a “predetermined set fee for the reimbursement of closing costs, but only those actually incurred by the dealer and necessary to the closing transaction.” Under that interpretation, the court reasoned that the dealer had to provide evidence it calculated the cost comprising its closing fee, which it could not do. Further, a justice stated “Although we agree that the Closing Fee Statute is a disclosure statement and the department serves as a repository for the required filings, we find that the Closing Fee Statute does more than require disclosure of the 'Closing Fee.'”

According to a press release from the office of Indiana attorney general “Under Indiana’s Motor Vehicle Dealer Unfair Practices Act, auto dealers cannot require a motor vehicle purchaser to pay a document preparation fee unless the fee reflects expenses actually incurred for the preparation of documents and was negotiated by and disclosed to the customer.” The dealer was found to have charged doc fees around $479, which the AG ruled was higher than could be justified to cover costs. 

Indiana law is more specific than South Carolina as far as the requirement that actual expenses be calculated: “It is an unfair practice for a dealer to require a purchaser of a motor vehicle as a condition of the sale and delivery of the motor vehicle to pay a document preparation fee, unless the fee:

• Reflects expenses actually incurred for the preparation of documents;
• Was affirmatively disclosed by the dealer;
• Was negotiated by the dealer and the purchaser;
• Is not for the preparation, handling, or service of documents that are incidental to the extension of credit; and
• Is set forth on a buyer’s order or similar agreement by a means other than preprinting.”

Other states, such as Connecticut, have regulations that are similar to South Carolina’s in that they primarily address disclosure of the dealer fee but do not offer guidance on the amount a dealer can charge: “A ‘dealer conveyance fee’ or ‘processing fee’ means a fee charged by a dealer to recover reasonable costs for processing all documentation and performing services related to the closing of a sale, including, but not limited to, the registration and transfer of ownership of the motor vehicle which is the subject of the sale.” 

So, in a private lawsuit or AG action in a state like Connecticut, the questions may well be what amount is considered “reasonable” and how are the costs justified?

Although all cases are different, information from the South Carolina court may lend some insight on how to avoid or defend against dealer fee attacks. The following excerpts from the case would seem relevant:

The dealership’s expert witness in the SC case testified that the dealership’s average closing costs, which were $506.96, greatly exceeded the $299 fee the plaintiff paid. But in calculating the average closing cost, he included expenses for the salaries of finance and sales managers, the building, utilities and outside services.” The court disagreed. “All of these are general operating expenses and not directly tied to the closing of motor vehicle sales. If a motor vehicle dealer wishes to be compensated for these expenses, it may include them as part of the overall purchase price of a vehicle.”

 

The court further opined that the term "cost" in the context of the "Closing Fee" Statute "would refer to the amount of money a dealer is required to expend to perform the services it provides to a customer at closing, and to otherwise comply with the disclosure, documentation, and record retention requirements imposed under state and federal law. While we recognize the difficulty a dealer may face in determining the exact amount of a specific purchaser's closing fee prior to closing, we agree with the trial judge's interpretation that the amount charged must bear some relation to the actual expenses incurred for the closing.”

The court emphasized that a "closing fee" is not limited to expenses incurred for document preparation, retrieval, and storage. However, any costs sought to be recovered by a dealer under a closing fee charge must be directly related to the services rendered and expenses incurred in closing the purchase of a vehicle. Given that each vehicle purchase is different, compliance with the "Closing Fee" Statute does not require that the dealer hit the "bull's-eye" for each purchase. A dealer may comply with the statute by setting a closing fee in an amount that is an average of the costs actually incurred in all closings of the prior year.

Based on the above, some ideas for what may constitute “reasonable costs for processing all documentation and performing services related to the closing of a sale” include:

• Processing and submission of credit applications to finance companies*
• Preparation of finance or lease documents*
• Preparation and submission of vehicle registrations both manually and electronically with the DMV
• Filing and releasing security liens on purchased and traded vehicles as contractually required by lending institutions
• Processing applications for new or duplicate title documents with the DMV
• Processing the pay-off of an existing lien on any vehicle offered in trade
• DMS (Dealer Management System) costs to process paperwork
• Software such as Dealertrack or RouteOne to investigate credit*, print required disclosures, and run Red Flags and OFAC checks
• Forms, toner, etc.
• Compliance training and auditing costs
• Fees to attorneys for vetting documents

* Some states prohibit the inclusion of fees to process loan documents in the dealer fee

OTHER DEALER FEE ISSUES

TILA Disclosures - Other lawsuits have claimed that the dealer fee is a finance charge for federal Truth in Lending Act (TILA) disclosure purposes. To avoid this, it’s important to also charge dealer fees on comparable cash transactions. Since you obviously wouldn’t incur credit-related costs listed above on cash transactions, the SC court’s suggested method of averaging the costs in all closings of the prior year would appear to be beneficial.

Negotiation of Dealer Fees – Although a number of state regulations indicate that dealer fees must be negotiated with customers, this raises concerns about potential discrimination claims. The reasoning is that if a dealership charges one customer a fee of any kind they have to charge everyone the same fee, or they open themselves up to a lawsuit.

Another fear is that charging a different dealer fee to different customers is “illegal”. This does not appear to be the case unless state law specifically prohibits dealerships from charging any customer a different doc fee amount than any other customer. The only state of which I’m aware that has such a prohibition is West Virginia.  In a 2014 case brought by the West Virginia Automobile & Truck Dealers Association against Ford Motor Company, the court disagreed that charging different doc fees is prohibited by West Virginia Consumer Credit and Protection Act, but agreed that guidance from the West Virginia Motor Vehicle Dealers Advisory Board prohibits dealerships from charging any customer a higher doc fee than any other customer. (Arguably, this is not a violation of WV law and thus not “illegal” per se, but simply guidance from the WVMVDAB who’s “statutory purpose is to assist and to advise the Commissioner of the Division of Motor Vehicles on the administration of laws regulating the motor vehicle industry; to work with the commissioner in developing new laws, rules or policies regarding the motor vehicles industry; and to give the commissioner such further advice and assistance as he or she may from time to time require.” Regardless, WV dealers are bound to follow the Dealer Advisory Board’s directions).

So the easy answer is to just charge everyone the same doc fee, right? Perhaps. But here’s the rub: Conveyance/Processing fees are dealer-imposed charges and therefore not mandatory - only government fees are compulsory. So it is improper to tell a customer that you MUST charge them the fee – this could lead to a deceptive practices claim.

So how do you avoid potential discrimination claims? By being able to show proof that any downward deviations in fees are for valid business reasons. For example, if a manufacturer limits the doc fee for an employee purchase, that reason should be documented in writing and a copy kept in the deal jacket. Another example would be that a competitive dealer offered a lower doc fee that you needed to match to make the deal. Again, documentation is key. This follows the same line of reasoning as NADA’s Fair Credit Compliance Program for rate markups.

The information presented in this article is solely the opinion of the author and is not intended to convey or constitute legal advice, and is not a substitute for obtaining legal advice from a qualified attorney. You should not act upon any such information without first seeking qualified professional counsel on your specific matter.