• developing and implementing effective compliance management systems
• avoiding and defending disparate impact claims
• identifying and curtailing unfair, deceptive, and abusive acts and practices
• understanding and preparing for examinations or investigations
• managing vendors appropriately

If you would like a copy of the materials from this event, please contact Melanie Brody (melanie.brody@klgates.com) or Stephanie Robinson (stephanie.robinson@klgates.com).

On Tuesday, March 5, senior staff with the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of San Francisco presented a webinar on the prohibitions on unfair and deceptive practices under the Dodd-Frank Act and the Federal Trade Commission Act, and presented a number of case studies and compliance pointers, based on the Federal Reserve’s own enforcement and investigatory matters.

Notably, the Federal Reserve staff only addressed unfair and deceptive acts or practices, as largely defined by existing FTC guidance on unfairness and deception that has been adopted, relied on, or cited with approval by the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation and Federal Reserve jointly. The Federal Reserve staff declined to discuss the new abusiveness standard added by the Dodd-Frank Act, saying that the agency needed to wait and see how the CFPB would interpret and apply it.

Throughout the presentation, the Federal Reserve staff used case studies to illustrate four key points that bear on both effective UDAP compliance and the potential risks of noncompliance. In summary, the staff provided the following advice and recommendations:

• Understand Your Enterprise-Wide UDAP Risk. Financial services providers should regularly evaluate every consumer-facing aspect of their business for UDAP risk—and then take action to mitigate risks identified. They should particularly review new products (both credit and deposit products, as applicable) and new sources of revenue. They should also focus on marketing and advertising campaigns, as well as disclosures, to avoid risks of misrepresentation/deception. For example, a bank should carefully review its Truth in Savings disclosures regarding future renewal rates for certificates of deposit (CDs), as it would be unfair or deceptive for the bank’s systems to renew those CDs automatically at a lower rate than represented. Financial services providers also should evaluate their compensation practices to avoid employee incentives to engage in any unfair or deceptive conduct.

• Third-Party Providers Can Create UDAP Risk. Vendors and other third-party providers can present a significant source of UDAP risk. Supervised institutions are expected to evaluate and manage that risk and may be held responsible for their vendors’ violations. For example, financial institutions should be sure to monitor the disclosure that third-party vendors provide to consumers. The staff discussed as an example one action in which the Federal Reserve alleged that a bank deceptively failed to provide consumers with sufficient information about alternatives to overdraft programs, so as to give consumers an opportunity to select these alternatives. The overdraft programs at issue were run by a third-party provider, and the Federal Reserve alleged that the bank failed to effectively control repeat overdraft usage. The staff noted that the bank was held responsible even though the issues derived at least in part from the vendor’s business practices.

• Monitor Consumer Complaints. The staff noted that complaints can provide both an early warning of UDAP risk and a guide for examiners in looking for compliance concerns. Financial services providers should have processes in place to review complaints both for consumer resolution and to help identify potential systemic problems. The staff discussed one example where bank employees routinely misrepresented customers’ income, assets, and debts in order to obtain approval for those customers’ mortgage loans. The staff noted that the bank had received consumer complaints and acted on them individually but failed to discern a larger trend. In another example, the staff explained that a bank failed to adequately investigate complaints that the bank was repeatedly posting single point-of-sale debit transactions when the consumer’s account was overdrawn. The agency alleged that the practice was unfair because it caused consumer injury in the form of multiple overdraft fees and could not be avoided because the consumer only chose to make the transaction once, but the bank elected to post it multiple times. The bank had received multiple complaints that it addressed individually, but the source of the problem turned out to be the bank’s transaction-process logic. The staff also encouraged institutions to look not just to complaints received but also to social media and consumer complaint websites to help identify possible trends.

• UDAP Risk Can Be Fair Lending Risk. UDAP violations in connection with credit products can directly or indirectly cause fair lending violations and adversely affect a bank’s Community Reinvestment Act rating. The Federal Reserve staff stated that they will routinely inquire as to whether the injury is unevenly distributed on a prohibited basis under applicable fair lending laws. For example, the staff explained that in one case (which predated the Regulation Z loan originator compensation rule), the Federal Reserve charged a bank with deception for falsely representing certain charges as “discount points,” when in fact the consumer received no reduction in his or her interest rate. The staff noted that, after concluding that the practice was deceptive, the examination team also conducted a fair lending review. The fair lending review disclosed apparent disparate impact on the basis of national origin, and the Federal Reserve forwarded the case to the Department of Justice as required by the Equal Credit Opportunity Act.

Finally, the Federal Reserve staff identified a handful of areas where they perceived emerging or increased UDAP concern:

• Credit Repair. The staff expressed concern about potentially misleading representations about the positive effects that credit products could have on consumers’ credit standing.

• Zombie Debt. The staff also identified efforts to collect on debts that are past their statute of limitations as potentially problematic, depending on the representations made as part of those efforts.

• Debt Servicing Practices. The staff cautioned that servicing remained an area that carries inherent unfairness risk because of the inability of consumers to change servicers.

• New Sources of Fee Income. The staff warned that institutions should carefully evaluate any new program or product that is designed to bring in new fee revenue for UDAP risk. As a rule of thumb, the staff suggested that any program or product that depends on a consumer making a bad financial decision to generate revenue would be suspect and require scrutiny.

• Third-Party Providers. As described above, the Federal Reserve staff cautioned again that third-party providers can create UDAP risk if not adequately managed and supervised.

The Federal Reserve’s guidance serves as an important reminder that financial regulatory agencies have used their UDAP authority as a powerful tool and that it continues to be an examination and enforcement focus. Financial services providers should keep abreast of the recent and constantly-changing developments in UDAP and the increasing relationship between UDAP and fair lending

On January 24, 2013, the Massachusetts Office of the Attorney General (“AG”) issued guidance to the industry interpreting its debt collection regulations (“Regulations”) that became effective March 2, 2012. The AG took this unusual step as it recognized that the Regulations raise unique compliance issues for servicers of consumer debt. The AG promulgated the Regulations pursuant to the rulemaking authority conferred by the Massachusetts Consumer Protection Act (“Chapter 93A”), “to establish standards, by defining unfair or deceptive acts or practices, for the collection of debts from persons within the Commonwealth of Massachusetts.” 940 C.M.R. 7.01. Although there is no private right of action, a violation may, nevertheless, constitute “an unfair or deceptive act or practice under Chapter 93A.”

One unique issue is the scope of the Regulations. The Regulations apply to a “creditor” defined to include “any person engaged in collecting a debt owed or alleged to be owed to him by a debtor,” as well as a buyer of delinquent debt. In contrast, the federal Fair Debt Collection Practices Act (“FDCPA”) applies only to consumer debts asserted to be owed to another person or institution. Thus, loans excluded from the scope of the FDCPA may be covered by the Regulations as the FDCPA applies to the purchaser of debt that is in default whereas the Regulations apply to a creditor. The guidance attempts to clarify several issues, including those addressed below, but, as we discuss, servicers of consumer debt will still have to contemplate many unanswered questions.

Do unsuccessful attempts to reach a debtor by telephone count toward the limitation of two calls in any seven day period?

The Regulations prohibit creditors from “initiating a communication with any debtor via telephone, either in person or via text messaging or recorded audio message, in excess of two such communications in each seven day period.” 940 C.M.R. 704(1)(f). While it seems like a simple limitation, this provision has raised many questions. Do unsuccessful attempts to reach a debtor by telephone count toward the limitation of two calls in any seven day period? What if a creditor uses an auto dialer that is programmed to disconnect if a call reaches an answering machine? The guidance indicates that attempts to reach a debtor are not counted towards this limit if the creditor is “truly unable” to leave a text or voice message. The guidance does not indicate whether a communication that causes a phone to ring but disconnects before leaving a message would be counted, although the guidance adds that the AG “may still consider enforcement action against any conduct, including initiation of communication via telephone, the natural consequence of which is to harass, oppress, or abuse a debtor.”

When is a communication in “collection of a debt?”

The Regulations require creditors to provide certain disclosures within five business days after the creditor initially communicates with a debtor about the “collection of a debt.” The guidance addresses when a communication is an “initial communication” made in connection with the collection of a debt that triggers disclosure requirements under the Regulations. Unfortunately, there is no bright line test to determine when a communication is made in connection with the collection of a debt. The guidance provides three factors to consider when making a determination: (1) whether there is any demand for payment or attempt to collect a debt; (2) whether the communication is an inducement to settle or discuss a debt; and (3) the relationship of the parties. On the third prong, the guidance provides that if a creditor has regular communication with a debtor (e.g., monthly statements), the communication is less likely to be in connection with the collection of a debt than if such communication is nonexistent.

In connection with a disputed debt, when is a creditor excused from sending a debt validation letter or information on loss mitigation?

Some clarity on the disputed debt provisions of the Regulations comes with the release of the guidance. The Regulations provide that a creditor shall cease all collection activities if the debtor “notifies the creditor in writing … that the debt, or any portion thereof, is disputed.” 940 C.M.R. 708(2). The Regulations do not specify whether a creditor is excused (or, for that matter, prohibited) from sending a debt validation letter in cases in which it receives a written dispute of the debt. The guidance does not address this question either. The guidance does indicate, however, that the Regulations do not prohibit a creditor from providing a debtor information about home preservation options or other loss mitigation programs during this “automatic stay” period. The AG reasons that “such contacts with a debtor are for servicing purposes in an effort to assist the consumer, and are not considered to be made in connection with collection of the debt.” While the Regulations indicate that documentary evidence verifying a debt includes all documents that bear the signature of a debtor, the guidance indicates that a creditor need not produce every signature-bearing document pertaining to individual transactions that are itemized on a statement. Thus, for example, a creditor on a loan or account accessed by a card need not produce signatures on each transaction and can comply with the verification requirement in the Regulations by producing an itemized statement.

Does the guidance extend to the Division of Banks regulations concerning the conduct of the business of debt collectors and loan servicers?

The guidance only applies to the Regulations and it remains to be seen whether the Massachusetts Division of Banks will follow this guidance in interpreting its regulations, 209 C.M.R. 18.00, which include provisions to the Regulations that apply to licensed third party debt collectors and loan servicers. For the sake of consistency, we hope the Division of Banks will follow the AG’s lead.

Payday lenders recently received their first peek at what life will be like under the CFPB’s watch, and it’s not a pretty picture. In the Bureau’s recently released examination procedures for payday lenders, the CFPB makes clear that it will examine every aspect of a payday lender’s operation, likely well beyond what most payday lenders have experienced to date with the patchwork of state regulation.

In conjunction with the release of the examination procedures, CFPB Director Richard Cordray made payday lending the topic of the Bureau’s first field hearing on January 19, 2012, stating that the Bureau will give payday lenders “much more attention” through a comprehensive system of federal regulation and oversight. While Cordray recognized that payday lending can be an appropriate financial option for consumers and committed to fostering a “fair, transparent and competitive” payday lending market, his speech left no doubt that payday lenders should expect tough oversight, guided by examination procedures that set forth ambiguous and undefined standards of appropriate conduct. Indeed, the CFPB has also solicited consumers’ stories on payday lending—not formal complaints, but unproven anecdotes—that will, presumably, guide the Bureau’s policymaking.

When examined by the Bureau, payday lenders can expect more than just a box-checking exercise. Sure, portions of the review will be amenable to clear yes-or-no answers, but the examiners’ mandate is much broader, encompassing such vague and subjective questions as: whether a lender’s compensation program “incentives behaviors or practices that result in heightened risk to consumers,” whether a lender “clearly and prominently discloses the material terms of a payday loan,” and whether “in the application and origination process, [a] lender makes statements, representations, or claims … that may mislead the consumer regarding the cost, value, availability, cost savings, benefits, or terms of the product or service.”

The CFPB’s examination procedures for payday lenders are divided over five “modules”:

• Marketing

• Application and origination

• Payment processing and sustained use

• Collections, accounts in default, and consumer reporting

• Third party relationships

Across these modules, the Bureau directs examiners to consider compliance with six federal statutes—Truth in Lending Act, Electronic Fund Transfer Act, Fair Debt Collection Practices Act, Fair Credit Reporting Act, Gramm-Leach-Bliley Act, and Equal Credit Opportunity Act—as well as Dodd-Frank’s UDAAP provision.

Marketing

In the marketing module, the Bureau identifies two key statutes for examination—TILA and ECOA—as well as a catch-all consideration of “Other Risks to Consumers,” which is largely directed towards the CFPB’s UDAAP authority and includes whether a lender’s marketing practices fail to clearly and prominently disclose the terms of credit. In reviewing a lender’s marketing practices, the examination procedures call on examiners to go beyond simply reviewing published marketing materials, but also to consider, for example, whether a lender’s compensation system “incentives behaviors or practices that result in heightened risk to consumers.” Examiners are also directed to review a lender’s lead generation practices to determine, among other things, if “statements and representations made by a company on another’s behalf are accurate and non-deceptive.”

Application and Origination

In the context of application and origination, the examination procedures identify four federal statutes for review—ECOA, FCRA, TILA, and EFTA—as well as the Bureau’s ever-present, UDAAP-centric “Other Risks to Consumers.” While this portion of the examination involves some relatively straightforward inquiries—such as whether the appropriate TILA disclosures are provided—it is also pointed towards questions that have no simple answer, such as whether “the lender makes statements, representations, or claims … that may mislead the consumer regarding the cost, value, availability, cost savings, benefits, or terms of the product or service.”

Payment Processing and Sustained Use

Here, the Bureau notes two statutes for examination—TILA and EFTA—but devotes considerable attention to the issue of “sustained use” (i.e., allowing a “borrower to modify or ‘roll over’ the loan by paying an additional fee to extend the loan term”). Long a subject of controversy by consumer advocates, and highlighted by Cordray at the field hearing, the examination procedures require examiners to take a long and hard look to determine if a lender has adequate controls on and disclosures concerning “sustained use.”

Collections, Accounts in Default, and Consumer Reporting

In addition to determining compliance with the FDCPA and FCRA, the examination procedures also direct examiners to consider if a lender—or a third party acting on its behalf—contacts borrowers in an appropriate manner, such as by adhering to the FDCPA’s collection practices. Not only does this appear to create potential liability for the lender if a third party debt collector violates the FDCPA, but it seems to impute upon payday lenders the substance of the FDCPA’s practice restrictions even if the FDCPA itself does not apply.

Third Party Relationships

The examination procedures set forth a short—and, not surprising, ambiguous—standard that payday lenders “may be responsible for the activities of third party service providers” and must “appropriately manage their relationships with third parties.” This requirement, which is on top of the obligation to comply with the GLBA and FCRA, appears to open the door to attempts by the Bureau to impute upon payday lenders the actions of third parties over which they have limited or no control.

The CFPB wants to get to know you – well. But it’s not a prelude to a kiss.

On January 12, 2012, the CFPB released its new Mortgage Origination Examination Procedures Governing Banks and Nonbanks (the “Procedures”). The release of the Procedures follows close on the heels of the CFPB’s October 13, 2011 release of its mortgage servicing examination procedures (see The CFPB Mortgage Servicing Examination Procedures Fail to Harmonize – Isn’t It Ironic? ), and its January 5, 2012 announcement of its nonbank supervision program (see CFPB Officially Launches Nonbank Supervision Program).

Mr. Cordray, the Director of the CFPB who President Obama appointed via a controversial “recess appointment,” described the CFPB’s nonbank supervision program (which also includes student lending and payday lending) as one of its top three priorities. He also told reporters that the CFPB expects “to have people on the ground in the next month or two” to start implementing the Procedures through examinations. Examinations are typically a prelude to enforcement. But with a former state Attorney General at the helm (Mr. Cordray was the Ohio AG before being appointed Director of the CFPB), the line between supervision and enforcement is likely to be blurred, with supervision potentially serving as pre-discovery for enforcement. In fact, even before the Procedures were released, the CFPB started exercising its enforcement muscles by initiating an investigation of bank and nonbank mortgage companies, alleging violations of RESPA’s kickback provisions. This may be a presage of what to expect from the CFPB’s exercise of its nonbank examination process. As explained below, some of that exercise will focus on issues to which most nonbank mortgage brokers and lenders have not previously been examined, including the amorphous unfair, deceptive and abusive acts and practices provisions and fair lending that are part of the CFPB’s purview.

CFPB examiners are instructed to use the newly issued Procedures in examinations of both mortgage brokers and mortgage lenders, including those that have no affiliation with depository institutions. The Procedures outline the CFPB’s supervisory approach to ensure mortgage lenders and brokers comply with federal consumer financial laws. They also describe the types of information that the CFPB’s examiners will gather to evaluate mortgage originators’ policies and procedures, assess whether originators are in compliance with applicable laws, and identify risks to consumers throughout the mortgage origination process. The examination manual tracks key mortgage originator activities, from initial advertisements and marketing practices to closing practices. The information that examiners are instructed to obtain and review is comprehensive, and is likely more extensive than that to which many nonbank lenders are accustomed.

The Procedures consist of modules covering the various elements of the mortgage origination process, with each module identifying specific matters for review. Each examination will cover one or more of the following modules:

• Company Business Model

• Advertising and Marketing

• Loan Disclosures and Terms

• Underwriting, Appraisals, and Originator Compensation

• Closing

• Fair Lending

• Privacy

A significant portion of the Procedures is spent on what can fairly be referred to as “Residential Lending Compliance 101.” For example, the procedures identify and describe the differences between types of loans and loan products, e.g., the differences between first and junior priority mortgage loans, fixed rate mortgages and adjustable rate mortgages, open end and closed end, prime and subprime, etc. The Procedures then provide a 30,000 foot view of the alphabet soup of consumer protection laws, including RESPA, TILA, ECOA, HMDA, GLBA, FCRA, the MAP Rule (mortgage advertising rule) and the SAFE Act.

There are a few issues to which mortgage brokers and lenders should pay particular attention – specifically, the sections addressing the CFPB’s new unfair, deceptive and abusive acts and practices authority, fair lending, and privacy. Because nonbank lenders have not traditionally been examined on these issues, they should start preparing themselves now for the CFPB’s focus on these issues.

The Procedures are likely just an opening salvo in the CFPB’s exercise of its authority to regulate nonbank consumer lending activities. As Director Cordray noted, “We have the opportunity now, we’re aggressively moving forward with non bank supervision . . . .”