A Federal Reserve Board enforcement action is raising new questions about whether a bank that buys consumer loans from retailers, such as car dealers, can be held responsible for violations of fair-lending law.
The Fed's Regulation B shields lenders against liability for violations committed by third parties unless they are aware of an act, policy, or practice of discrimination before buying the loan.
In a Dec. 6 release, the Fed accused Foxdale Bank, a $45 million-asset institution in South Elgin, Ill., of knowing car dealers were discriminating but buying loans from them anyway.
Without admitting any wrongdoing, the four-year-old bank agreed to figure out which borrowers had been discriminated against and then reimburse them or reduce their loan balances. The bank has until Jan. 18 to compile a list of indirect loan customers who got less favorable terms than other borrowers in similar financial circumstances during the two years through March 25.
By mid-February, Foxdale also must supply a list of any direct borrower who got less favorable terms than "similarly situated" customers. These people also must be compensated.
Fed officials refused to comment on the enforcement action's implications, but industry lawyers are interpreting it broadly.
"It's the first time the feds have formally taken a lender to task for an action that the industry does not believe is unlawful," said Lawrence E. Platt, a partner at Kirkpatrick & Lockhart.
Andrew L. Sandler, a partner in Skadden, Arps, Slate, Meagher & Flom, agreed.
"What this written agreement does is for the first time say that any time a bank purchases a loan from a retailer, it is responsible for the terms of the loan," he said. "This agreement suggests the direction that some government personnel would like to take. It's unclear whether that effort will be successful."
Mr. Sandler predicted the Fed will go after other indirect lenders but said larger institutions will fight the government in court.
Mr. Platt said bankers have been asking regulators for detailed guidance on how they are expected to determine whether third parties are discriminating but have gotten no answer. "Instead they pick on some small institution to make a statement," he said. "To me that's just bully politics."
David S. Willenzik, a partner of McGlinchey & Stafford in New Orleans, said he has begun to advise lenders to make dealers sign a contract agreeing to take responsibility for fair-lending violations. Though not ironclad, it gives banks some recourse against an originating creditor that commits violations.
But Mr. Willenzik said he does not think the Foxdale Bank order spells trouble for all indirect lenders.
"The only way [regulators] can go after the bank is saying the bank had knowledge of discrimination," he said. "I haven't seen a lot of overt discrimination, particularly against people who buy $25,000 automobiles."
As for Foxdale, it plans to meet both deadlines set by the Fed, according to chief financial officer Marianne Luczak. But it is leaving the indirect loan business, which makes up 15% of its portfolio.
"We've chosen to not be in that business because there is not any way that we can control the rates that the dealerships charge," she said. "The legal battle would be much more expensive than doing what we've been asked to do. We agreed to disagree."