Why is there a
UDAAP?
The Background
At the end of the Great Depression, there was a public
outcry for changes in regulations that dealt with all manner of financial
institutions. During the financial crash
consumers found out that many of the promises that had been made by business
were not kept. Insurance companies did
not pay as promised, departments stores that had promised refunds for returns
reneged, banks closed overnight and business in general were able to avoid
payments to consumers that they had seemingly promised. Neither state governments nor individuals
had many options when they found that they had been misled or defrauded. A consumer who was defrauded often found
that fine print in the contract immunized the seller or creditor. Consumers
could fall back only on claims such as common law fraud, which requires
rigorous and often insurmountable proof of numerous elements, including the
seller’s state of mind. Even if a consumer could mount a claim, and even if the
consumer won, few states had any provisions for reimbursing the consumer for
attorney fees. As a result, even a consumer who won a case against a fraudulent
seller or creditor was rarely made whole. Without the possibility of
reimbursement from the seller, consumers could not even find an attorney in
many cases. [1]
Among the changes being requested were the laws that
prevented practices that were deceptive or fraudulent. Eventually it fell to the Federal Trade
Commission, FTC, to write regulations for consumer protection on a federal
level. UDAP statutes were passed in
recognition of these deficiencies. States worked from several different model
laws, all of which adopted at least some features of the Federal Trade
Commission Act by prohibiting at least some categories of unfair or deceptive
practices. But all go beyond the FTC Act by giving a state agency the authority
to enforce these prohibitions, and all but one also provide remedies that
consumers who have been cheated can invoke.
In addition to the FTC regulations, state laws and court decisions help
to shape the definition of unfair or deceptions business practices.
The Predecessor
The original UDAP (with one “A”) Unfair, Deceptive Acts or Practices
is derived from Regulation AA, also known as the Credit Practices Rule. The regulation was divided into two
subparts;
• Subpart
A outlines the process for submitting consumer complaints to the Board of Governors
of the Federal Reserve System’s Division of Consumer and Community Affairs
• Subpart
B puts forth the credit practice rules pertaining to the lending activities of
financial institutions. It defines certain unfair or deceptive acts or
practices that are unlawful in connection with extensions of credit to
consumers
• certain
provisions in their consumer credit contracts, including confessions of
judgment, waivers of exemptions, assignments of wages and security interests in
household goods unfair or deceptive practices involving co-signers
• pyramiding
late charges, in which a delinquency charge is assessed on a full payment even
though the only delinquency stems from a late fee that was assessed on an
earlier installment
Through the last half of the 20th century, UDAP
regulation was largely the purview of the Federal Trade Commission. Bank regulatory agencies generally issued
guidance for banks to follow and some the practices that we mention above were
specifically prohibited. However, the
truth of the matter was that UDAP enforcement was not exactly a matter of grave concern in the banking industry.
UDAAP-Supercharged
The financial meltdown of 2009 lead to many changes in
regulations including the passage of the Dodd-Frank Act. Among the changes brought about by
Dodd-Frank, was the supercharging of UDAP!
The regulation became the Unfair Deceptive Abusive Actions, Practices, or
UDAAP.
UDAAP with two ‘A’s goes beyond extensions of credit and
introduces an enterprise-wide focus on all the products and services offered by
your institution. The CFPB has been
given the authority to bring enforcement actions under UDAPP. Considered at a high level, UDAAP is more of
a concept than an individual set of regulations. The idea is that dealings with the public
must be fair and that financial institutions should in fact look after the best
interests of its customers.
Another key difference is that UDAAP coverage makes it
unlawful for any provider of consumer financial products or services to engage
in unfair, deceptive or abusive act or practices; therefore, this regulation
may be applicable far beyond financial institutions.
Under the new UDAAP regime, financial institutions can be
liable for the actions of the third party processors that they hire. This is one of the many reasons why vendor management
has become such an Important area.
Even though there a great number of laws that deal with
required disclosures on financial products such as loans and certificates of
deposit, these laws generally do not deal with the fairness of the terms or the
possibility that a consumer may unwittingly agree to additional fees and terms
that go well beyond the agreed to interest rate. UDAAP
is designed to address this problem.
The Basics
The basic definitions for UDAAP are as follows;
What is “unfair’?
•
The practice causes or is likely to cause substantial
injury.
•
The injury cannot reasonably be avoided.
•
The injury is not outweighed by any benefits.
Briefly, what this means is that
if a customer has to pay fees or costs because of some act by the bank that is deemed unfair, then a substantial injury
has occurred. The description of the
regulation does say that the injury does not necessarily have to be monetary,
it can be emotional. However, there are
no current examples of this second form of substantial injury. This is the section of the regulation that
is most often applied to overdraft programs.
Even in the cases where banks
allow overdrafts only after getting a customer’s permission and providing
monthly statements that show the amounts of overdraft fees that have been paid,
a substantial injury can be found.
What is “deceptive”?
• The
practice misleads or is likely to mislead.
• A
“reasonable” consumer would be misled.
• The
presentation, omission or practice is material.
According to
the CFPB, to determine whether or
To determine whether an act or practice
has actually misled or is likely to mislead a
consumer, the totality of the
circumstances is considered. Deceptive acts or
practices can take the form of a
representation or omission. The Bureau also looks at implied representations, including
any implications that statements about the
consumer’s debt can be supported.
Ensuring that claims are supported before they
are made will minimize the risk of
omitting material information and/or making
false statements that could mislead
consumers.
What is “abusive”?
•
The practice materially interferes with the
consumers ability to understand a term or condition of a product or service.
•
The practice takes unreasonable advantage of a
consumer’s lack of understanding of the risk, costs and conditions of a
products or service.
The CFPB description of this portion of the regulations
notes that a consumer can have a reasonable reliance on a financial institution
to act in his or her best interests.
This means that for products or services that are offered that have the
ability to add fees or costs , there is an affirmative duty to make sure that
the customer knows what it is that they are getting into.
UDAAP Pitfalls
Here is a list of practices that have come under scrutiny
for UDAAP consideration
•
Overdraft programs
•
Debt collection Practices
•
Loan payment processing
•
ATM fees
•
Loans with balloon payments
•
Credit life and disability insurance sales
•
Rewards programs
•
Gift card sales
•
Credit Card programs
This is not to say that any of these programs are forbidden
or even a bad idea. Instead, what is
necessary is to make sure that as you offer these programs or products, make
sure that the disclosures about them are both clear and consistent.
We recommend taking the followings steps when assessing
overall UDAAP potential problems at your bank:
1. Review all of the product features of consumer
products at your bank. For all products
that have the potential to add fees or costs (such as early withdrawal
penalties), review for potential UDAAP concerns;
2.
Have several members of staff review
product features to determine whether
the potential for misunderstanding exists;
3.
Review the revenue streams for consumer products
and look for increases of more than 1% per quarter. In the event that revenue has increased,
determine the reason for the increase;
4.
Review the written and oral disclosures that are
being given to customers to ensure that they are consistent and correct;
5.
Review current agreements with third party
servicers to make sure that there is a clear understanding of the services
being provided:
6.
Conduct thorough and regular due diligence on
third party servicers;
7.
Complete a regular check to ensure that the
language on all mediums of communication
with the public is consistent (a maintenance fee is a maintenance fee);
8.
Evaluate customer complaints for signs of more
serious systemic problems
We have provided for you on our website a checklist to assist you with you UDAAP review of products and services
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