UDAAP: Definition and Best Practices

QUESTION

My colleagues and I love your weekly FAQs. Thank you for this obvious labor of love! You have written many FAQs about UDAAP. As a compliance attorney, I realize that UDAAP violations are broadly applied. What I would like to see is a general definition of UDAAP. Also, what do you recommend for a policy statement affirming a company’s commitment to UDAAP? What do you consider the high-risk areas of UDAAP? Finally, can you let us know some Best Practices for UDAAP compliance?

ANSWER

Thank you for your kind words. It is a labor of love – one that we embrace gladly! The weekly FAQ is an extension of our commitment to provide an elevated level of compliance services from a dedicated team!

We feel so strongly about the importance of monitoring UDAAPs that we provide the UDAAP Tune-up!™

Let’s lay out some basic details. Section 5(a) of the Federal Trade Commission Act (“Act” or “FTCA”) [15 USC 45(a)(1)] prohibits "unfair or deceptive acts or practices” (“UDAP”) in or affecting commerce. The Act applies to all entities engaged in commerce, including banks. Federal regulators are charged with taking appropriate action when unfair or deceptive acts or practices are discovered. For instance, the Federal Reserve Board’s (FRB) Regulation AA specifically proscribes unfair or deceptive practices. The Consumer Financial Protection Bureau (CFPB) has set forth rules about UDAAPs, and the Federal Trade Commission (FTC) helps enforce them. Indeed, federal and state regulatory examiners are looking for UDAAP violations as a part of their routine compliance examinations.

Put more concretely, the Dodd-Frank Act made it unlawful to engage in any “unfair, deceptive or abusive act or practice” – “UDAAP,” note the two As. [Dodd-Frank Act, Title X, Subtitle C, Sec. 1036; PL 111-203 (July 21, 2010)] The responsibility for enforcing the prohibition against "abusive" acts or practices was given to the Consumer Financial Protection Bureau (CFPB) under Dodd-Frank, but the prudential regulators still retain their authority to enforce UDAP under Section 5 of the FTCA.

With regards to a brief, general UDAAP definition, I will venture the following:

An act or practice that is unfair if it (1) causes or is likely to cause substantial injury to consumers, (2) cannot be reasonably avoided by consumers, and (3) is not outweighed by countervailing consumer benefits. An act or practice is deceptive when a representation, omission, or practice misleads (or is likely to mislead) consumers, and the misleading representation, omission, or practice is material. An act or practice is abusive when (a) it materially interferes with the ability of consumers to understand a term or condition of a consumer financial product or service; (b) takes unreasonable advantage of consumers’ lack of understanding of the material risks, costs, or conditions of the product or service; (c) disadvantages consumers in protecting their interests in selecting or using a consumer financial product or service; and (d) exploits the consumers’ reasonable reliance on an institution to act in the consumers’ interests.

Most of our clients ask us to provide policies and procedures, either for new versions or by reviewing existing versions. We encourage an affirmation statement – which we sometimes call a “Preamble” – in the policy document. For a UDAAP policy, the following is some helpful verbiage (though a company’s size, complexity, and risk profile would affect the wording of the statement):

It is the policy of this financial institution to fully comply with FRB Regulation AA and Section 5(a) of the Federal Trade Commission Act (FTCA). Both Regulation AA and the FTCA prohibit unfair or deceptive acts or practices. The Consumer Financial Protection Bureau (CFPB) makes rules about UDAAPs, and the Federal Trade Commission (FTC) enforces them. This financial institution fully recognizes that unfair or deceptive practices are prima facie wrong, and it also recognizes that it must have compliance procedures in place to prevent unintended violations of Regulation AA and the FTCA. Therefore, the Board has directed that management develop a document containing appropriate compliance procedures and train employees periodically regarding unfair, deceptive, or abusive acts or practices.

There are numerous ways to trigger UDAAP violations. Here are just a few.

Advertising Representations made in a financial institution’s advertising must be accurate and clear. When preparing an advertisement, omission of important information or failure to fairly disclose the terms and conditions of a product or service would be a UDAAP violation and is therefore against the institution’s policy.

Disclosures Representations made in disclosure documents must be accurate, clear, and informative. When preparing a disclosure document, the omission of important information or failure to fairly disclose the terms and conditions of a product or service is a UDAAP violation and against an institution’s policy.

Contract Documents Loan documents are legal contracts between a mortgage lender and the consumers. Representations made in these contracts must be accurate and clear. When preparing a contract document, the omission of important information or failure to fairly disclose the terms and conditions contained in the contract is a UDAAP violation and against the institution’s policy.

Higher-Risk Products By their nature, some loan products have more potential for UDAAP violations than others. Among the higher-risk products or services are credit cards, overdraft protection, rewards checking, and products developed specifically for the elderly or the unsophisticated. (The compliance officer must monitor these products regularly for potential violations of UDAAP).

Third Parties Financial institutions from time to time contract with third parties for marketing, credit/debit card support, credit/life insurance, mortgage loan support, and bad debt collection support. Each poses significant UDAAP risk. (The compliance officer must monitor these products regularly for UDAAP violations.)

In the limited space available in an FAQ, I will mention a few Best Practices.

The institution should ensure that all affected employees follow these practices: 

• Review all promotional materials to make sure they contain no UDAAP violations. There must be no fine print provisions, inconspicuous negative disclosures, or misleading headlines. There must be a factual basis for all representations in promotional materials.
• During one-on-one discussions with consumers, bring to the consumers’ attention key terms, limitations, or other items of a negative nature. Consumers are entitled to make informed decisions.
• When a product contains favorable introductory terms, clearly disclose the expiration date of the introductory terms.
• Clearly and timely disclose to consumers information about fees, penalties, and other charges.
• Be extremely cautious about the use of the terms “pre-approved” or “guaranteed.” As a general rule, do not use these terms in promotional materials.
• Clearly inform consumers of any contract provisions that permit the institution to change the terms and conditions of consumers’ agreements.
• Clearly inform consumers when approving them for a product or service and the terms and conditions of approval are less favorable than those previously stated to consumers or in an advertisement.
• Tailor advertisements to meet the level of sophistication of intended recipients. Avoid advertising terms that are not available to most consumers who will be viewing the piece.
• Exercise sufficient controls over third parties to prevent them from committing UDAAP violations.
• Inform co-signers in writing of their responsibilities and potential liabilities before becoming obligated on a loan. Do this by providing the co-signer with a written notice.

Jonathan Foxx, PhD., MBA
Chairman & Managing Director
Lenders Compliance Group