Federal Reserve Staff Offer UDAP Guidance
By: Soyong Cho , David I. Monteiro
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