UDAAP: Unintended Consequences

QUESTION 

We have never had a banking department issue an action against us for discrimination – until now. Last week, our banking department came after us for discriminating through “unfair acts or practices.” We think this is outrageous, as our firm is devoted to supporting communities of color. Our home office and branches are located, for the most part, in minority communities. 

The baking department is citing their UDAAP examination and one that was done by the CFPB last year. It issued an administrative action. As the company’s Chief Compliance Officer, I can say we always had decent exam outcomes. Now, this is a bad mark and will cause not only regulatory risk but also reputation risk. With the permission of management, I sent you a redacted banking report that shows the alleged violations. 

The crux of the issue comes down to whether the alleged violations were intentional or unintentional. We can provide evidence that any such alleged violations were totally unintentional. Our attorney is now working with the banking department to find a resolution. 

Is it the case that unintentional “unfair acts or practices” are a violation of UDAAP guidelines? 

ANSWER 

I recognize that you are upset by the banking department’s administrative action. I applaud you for being devoted to expanding financial opportunities in minority communities. But I have news for you: unintentional actions implicate UDAAP just as much as intentional actions. 

The CFPB takes the position that discrimination, both intentional and unintentional, and in connection with any financial products, constitutes an Unfair, Deceptive, or Abusive Acts or Practices (“UDAAP”) under the Consumer Financial Protection Act (“CFPA”). Dodd-Frank specifically makes it unlawful for any provider of consumer financial products, services, or service provider to engage in any unfair, deceptive, or abusive acts or practices.[i] 

We find in our UDAAP Tune-up a recurring set of violations that show or could show UDAAP violations. Once we provide a report, it is incumbent on the financial institution to implement the changes needed. It is a good compliance policy to be proactive and make those changes rather than being reactive to a banking department’s findings. 

If you want information about the UDAAP Tune-up, please contact us HERE. 

It would help if you had a broader understanding of what examiners look at when they examine for UDAAP. From a legal point of view, the standards for abusive, unfair, and deceptive acts or practices are separate, although CFPB examiners will audit for abusive acts being both unfair or deceptive. Let me give you some hints. There are at least four guidelines that examiners audit.

Four Guidelines 

First, they want to know if you have clear and unambiguous principles of unfairness, deception, and abuse in the context of offering and providing consumer financial products and services;

 

Second, they’ll want to know your institution goes about assessing the risk that its practices may be unfair, deceptive, or abusive;

 

Third, they will audit for your means of identifying unfair, deceptive, or abusive acts or practices (including by providing examples of potentially unfair or deceptive acts and practices); and

 

Fourth, they will gauge your understanding of the interplay between unfair, deceptive, or abusive acts or practices and other consumer protection and antidiscrimination statutes. 

If you cannot provide persuasive, compelling, and dispositive responses to these guidelines, you are not ready for a UDAAP examination. 

Furthermore, if you do not have actionable, auditable standards consistent with Dodd-Frank, your institution is essentially flying blind into the winds of UDAAP mandates. 

Three fundamental standards determine if an act or practice is unfair. [ii]

Three Standards

Standard # 1: Does the act of practice cause or is likely to cause substantial injury to consumers?

 

Standard # 2: Is the injury reasonably avoidable by consumers?

 

Standard # 3: Is the injury not outweighed by countervailing benefits to consumers or competition? 

If you do not have standards firmly in place and are not monitoring them continuously, you are not ready for a UDAAP examination. 

How do you gauge whether an act or practice is deceptive? 

The CFPB considers three criteria.[iii]

Three Criteria 

1.  The representation, omission, act, or practice misleads or is likely to mislead the consumer.

 

Comment: The representation, omission, act, or practice misleads or is likely to mislead the consumer. I like the FTC’s “Four Ps” test to evaluate whether a representation, omission, act, or practice is likely to mislead.[iv]

                      Four Ps Test

 

1.  Is the statement prominent enough for the consumer to notice?

2.  Is the information presented in an easy-to-understand format that does not contradict other information in the package and at a time when the consumer’s attention is not distracted elsewhere?

3.  Is the placement of the information in a location where consumers can be expected to look or hear?

4.  Finally, is the information in close proximity to the claim it qualifies? 

2.  The consumer’s interpretation of the representation, omission, act, or practice is reasonable under the circumstances. 

Comment: The consumer’s interpretation of the representation, omission, act, or practice is reasonable under the circumstances. Eliminate “puffery” – the legal term for exaggerated claims – unless you can show that the claims would not be taken seriously by a reasonable consumer.

 

You must show that the consumer’s interpretation of or reaction to the representation, omission, act, or practice is reasonable under the circumstances; whether an act or practice is deceptive depends on how a reasonable member of the target audience would interpret the representation.

 

A representation may be deceptive if the majority of consumers in the target class do not share the consumer’s interpretation, so long as a significant minority of such consumers is misled. When a seller’s representation conveys more than one meaning to reasonable consumers, one of which is false, the seller is liable for the misleading interpretation.

Duration of a Qualified Written Request

QUESTION 

We are a servicer in thirty-five states. As the company’s Chief Compliance Officer, I was notified about a concern found during a regulatory audit. The examiners took the position that we must respond to QWRs for a year after a loan has been discharged. This is contrary to my understanding. Our legal counsel sides with the regulators. So I want a second opinion. 

It makes no sense to me that a QWR should outlast the discharge of the loan. And I certainly do not think the QWR should survive past a foreclosure sale! I hope you can help provide some understanding. 

Must a servicer respond to a QWR after a foreclosure? 

ANSWER 

I’ve lost track of the cases litigated over issues involving the Qualified Written Request (“QWR”). There are multivolume treatises that could be written on this subject! But QWR is not as complicated as it seems – unless, of course, you are a litigator. 

Let’s start with a working definition of a QWR, using RESPA as our guide: 

“[A] written correspondence, other than notice on a payment coupon or other payment medium supplied by the servicer, that—(i) includes, or otherwise enables the servicer to identify, the name and account of the borrower; and (ii) includes a statement of the reasons for the belief of the borrower, to the extent applicable, that the account is in error or provides sufficient detail to the servicer regarding other information sought by the borrower.” 

The QWR provisions of Regulation X implement RESPA § 6 requirements by addressing Requests for Information (RFIs) and Notices of Error (NOE). 

You are claiming that a servicer’s duties under RESPA cease after foreclosure. That is not so. 

In fact, speaking of litigation, a servicer made your argument not long ago and lost in court.[i] Let me explain. 

The servicer, Clear Recon Corp, took the position that its obligation to respond to a QWR ended with a foreclosure sale. In 2001, the Kellys obtained a home loan. Between 2016 and 2018, they fell behind on their loan payments, and the lender accelerated the loan. On August 22, 2018, the beneficiary of their deed of trust appointed Clear Recon as the successor trustee. On that same day, Clear Recon recorded a Notice of Default, which stated that a foreclosure sale by public auction would occur on November 28, 2018. 

About November 19, 2018, one of the Kellys filed for bankruptcy, which stayed the foreclosure proceedings. After the bankruptcy proceedings were dismissed, Clear Recon conducted a foreclosure auction without notifying the Kellys of the time and place for the rescheduled sale. The Kellys remained unaware of the sale until Alaska Legal Services Corporation informed them of the sale. 

Following the sale, Clear Recon assigned the property to Fannie Mae, which scheduled a second sale of the property for April 8-10, 2019. On March 15, 2019, the Kellys requested information from the lender pursuant to RESPA. The lender did not respond. 

The Kellys sued, including a QWR claim. The servicer filed a motion to dismiss the QWR claim, arguing that it had no obligation to respond to the QWR because that obligation had ended with the foreclosure sale and no servicing relationship remained after the sale. 

According to the court, the foreclosure sale did not absolve the servicer from its duty to respond to the QWR. Once a loan is extinguished through a foreclosure sale, the lender is not freed of its obligations under RESPA. Regulation X contemplates borrowers requesting information from loan servicers up to one year after a loan is discharged, a position inconsistent with the servicer’s contention that its duties ceased after the foreclosure sale. 

Let me provide some background. When the CFPB adopted the current version of Requests for Information[ii], it stated: 

“The Bureau believes it would be impractical to require a servicer to resolve errors and provide information at a time when [RESPA] no longer requires the servicer to retain the relevant records. 

Conversely, the Bureau believes the servicer should be responsible to correct those records during the period when [RESPA] does require a servicer to retain records, if necessary, and provide borrowers information from the records. 

Further, the Bureau believes the use of the term ‘discharged’ is appropriate, especially given that the term is already used in the timing of the record-retention requirement. 

For purposes of the Bureau’s mortgage servicing rules, as opposed to bankruptcy purposes, a mortgage loan is discharged when both the debt and all corresponding liens have been extinguished or released, as applicable.”[iii] 

So, what is an untimely RFI? The statute is explicit: 

Untimely information request. The information request is delivered to a servicer more than one year after: 

(A) Servicing for the mortgage loan that is the subject of the information request was transferred from the servicer receiving the request for information to a transferee servicer; or 

(B) The mortgage loan is discharged.[iv] [Emphasized] 

Thus, according to the court, the Bureau clearly holds that servicers are obligated to respond to QWRs up to one year after a loan is discharged. The CFPB’s interpretation of the term “discharged” is distinguishable from the term’s use in the bankruptcy context. The court found that while the CFPB’s interpretation of its own regulation is not dispositive, the Bureau’s position was persuasive and consistent with the plain text of the statute, the statute’s implementing regulations, and Congress’s intent. 

In conclusion, the court rejected the servicer’s contention that the complaint should be dismissed because the Kellys did not sufficiently allege actual damages. The court found that the Kellys adequately pleaded damages in expenses such as “the costs of copying documents, travel expenses to and from their attorney’s office, [and] postage fees” that would arise from the servicer’s failure to respond to the QWR. 

The court did not find plausible the Kellys’ claim for “emotional and psychological damages,” without further elaboration. Although the Kellys mentioned circumstances in the years preceding their submission of the QWR, including family health challenges, falling behind on their payments, being victims of a scam organization, filing for bankruptcy, and having their home foreclosed upon, they did not explain how the servicer’s failure to respond to the QWR had caused discrete damages in the form of emotional and psychological distress after the alleged RESPA violation.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] Kelly v. Clear Recon Corp., 2021 U.S. Dist. (D. Alaska Aug. 13, 2021).

[ii] 12 CFR § 1024.36(f)(1)(v)(B), Requests for Information

[iii] See 78 Fed. Reg. 60382, 60392 (Oct. 1, 2013)

[iv] Op. cit. ii

ECOA's Regulation B protects Existing Customers

QUESTION

We originate mortgages in 35 states, and all loan originations are retail. I am the company’s Chief Risk Officer. For years, we took the position that ECOA only applies to people who are applying for loans. We checked around and found that many banks had the same policy. Then, in 2020, we learned about a lawsuit against Bank of America, which changed our policy. 

Apparently, Bank of America argued that it could disregard ECOA when it comes to existing customers. The dispute was over them not having to issue an adverse action notice. This did not go over well with the CFPB, which contended that ignoring the ECOA for existing customers would undermine anti-discrimination protections. 

I’ve been told that the CFPB is now doing examination and enforcement audits to see if companies provide ECOA rules to applicants and existing customers. 

Can you provide some insight into Regulation B’s protection of existing customers? 

ANSWER

The case you referenced concerns the CFPB’s involvement in 2021.[i] Bank of America contended that it did not have to send an adverse action notice to an existing customer. The CFPB filed an amicus curiae (legalese for a brief filed as “friend of the court”), arguing that Bank of America’s position was contradicted by the language and history of the law. 

According to the CFPB, the Equal Credit Opportunity Act (ECOA) protections against credit discrimination do not disappear when credit is extended; instead, ECOA shields existing borrowers from discrimination in all aspects of a credit arrangement. 

You mentioned in your inquiry that my firm conducted an ECOA Tune-up® for you in 2020, and you now plan to do another one this year. We consider ECOA to be one of the primary regulations in mortgage banking. If others want information about the ECOA Tune-up®, please contact us HERE. 

Briefly put, the CFPB contended that ECOA and its implementing rule, Regulation B, include those currently seeking credit and those who sought and have now received credit. The Bureau determined that this interpretation is the best reading of the statute itself. Any doubt whether the term “applicant” includes current borrowers is put to rest by Regulation B, which has expressly defined the term to include current borrowers for decades. 

ECOA has been law since 1974. So, it is odd to have a big controversy over something like issuing an adverse action notice to existing customers. You would think that in ECOA’s nearly 50-year history, a matter such as issuing an adverse action notice would have been thoroughly vetted! 

The first thing we need to do is define what an “applicant” is. Is an applicant a person who applies for an extension of credit? That would be logical, given Webster’s definition: “a person who applied for something (as a job).” I believe Clarence Darrow once said, ‘the trouble with the law is lawyers.’ If you want to be logical about definitions, be advised, lawspeak and common parlance do not always mesh well. 

The ECOA is abundantly clear about the definition of an applicant, to wit,

 

“… any person who applies to a creditor directly for an extension, renewal, or continuation of credit, or applies to a creditor indirectly by use of an existing credit plan for an amount exceeding a previously established credit limit.”[ii] [Emphasized]

 

Furthermore, adverse action is codified in ECOA’s prohibition on discrimination as it applies

 

“… to all credit transactions including the approval, denial, renewal, continuation, or revocation of any open-end consumer credit account.” [Emphasized]

 

But the Federal Reserve Board (FRB), in promulgating Regulation B, left no uncertainty about whether ECOA should be applied to existing customers. It did so by defining “applicant” to expressly include not only

 

“… any person who applies to a creditor directly for an extension, renewal or continuation of credit” but also, “[w]ith respect to any creditor[,] . . . any person to whom credit is or has been extended by that creditor.”[iii] [Emphasized]

 

The FRB then locked in any attempt to skirt this provision by noting that ECOA’s express terms and its legislative history

 

“demonstrate that Congress intended to reach discrimination . . . ‘in any aspect of a credit transaction.’”[iv] [Emphasized]

 

It could be asserted that there’s a difference between a credit applicant and a debtor. That’s fair as far as it goes. But, the FRB had the last say because it revised Regulation B’s definition of “applicant” to include both those who request credit and debtors,[v]  stating that an “applicant” includes

 

“any person who requests or [who] has received an extension of credit from a creditor.”[vi] [Emphasized]

You are correct that the CFPB is conducting examinations involving Regulation B compliance, but this is not something new, and it is not happening just now. The CFPB has been examining ECOA compliance for years. Perhaps you are more aware of the Bureau’s ECOA examination activities because it recently issued an advisory opinion (“Advisory”) on ECOA compliance concerning revocations or unfavorable changes to terms of existing credit arrangements.[vii] 

With this Advisory, the CFPB affirms the established requirements to issue adverse action notices to an existing borrower. The Bureau clarifies that Regulation B protection is afforded to borrowers after they have applied for and received credit. 

Lenders may not discriminate against borrowers with existing credit. For instance, the ECOA prohibits lenders from lowering the credit limit of certain borrowers’ accounts or subjecting certain borrowers to more aggressive collections practices on a prohibited basis, such as race. 

ECOA’s private right of action points to supporting alleged discrimination from persons who have already received credit. Thus, an aggrieved “applicant” can bring suit against creditors who fail to comply with the ECOA or Regulation B. In effect, the history of the ECOA’s Regulation B and its judicial interpretation of an “applicant” cannot be understood to refer only to those with pending credit applications. If it were otherwise, a person whose application was denied on a prohibited basis would have no recourse under ECOA’s private right of action, which Congress intended would be the Act’s “chief enforcement tool.”[viii] Instead, the term “applicant” is not limited to those currently applying for credit. 

If you have been holding off from doing an ECOA Tune-up®, I encourage you to consider it now, especially since the CFPB’s Advisory regarding ECOA compliance demonstrates a heightened interest in examination and enforcement. If you want information about an ECOA Tune-up®, please contact us HERE.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] Fralish v Bank of America, N.A., US District Court, 21-2846, 7^th Circuit, (9.29.21); Fralish v Bank of America, N.A., US Court of Appeals, 7^th Circuit (1.28.22)

[ii] Pub. L. 93-495, sec. 503, 88 Stat. at 1522 (codified at 15 U.S.C. 1691a(b))

[iii] 12 CFR 202.3(c) (1976); see also 40 FR at 49306

[iv] 40 FR at 49298 (quoting 15 U.S.C. 1691(a))

[v] 41 FR 29870, 29871 (July 20, 1976) (proposed rule)

[vi] 12 CFR 202.2(e) (1978) (emphasis added); see also 42 FR 1242, 1252 (Jan. 6, 1977) (final rule)

[vii] Equal Credit Opportunity (Regulation B); Revocations or Unfavorable Changes to the Terms of Existing Credit Arrangements, Advisory Opinion, 12 CFR Part 1002, Consumer Financial Protection Bureau, May 9, 2022

[viii] S. Rep. 94-589, at 13

Laundering a Kleptocracy

QUESTION 

We convened a staff meeting of compliance and legal personnel to discuss how our anti-money laundering program responds adequately to foreign corruption. Our bank and its nonbank mortgage division are involved in loans to foreign nationals, borrowers who are American citizens with foreign bank accounts and properties, and we also have borrowers, both foreign nationals and American citizens, whose assets are situated in kleptocratic regimes. 

Our employee training includes a section on fraud management, including procedures for identifying assets corrupted by kleptocracy. However, we need to outline the types and means by which kleptocracies engage in public corruption. Recently, we had to decide whether to approve a large loan to a Russian national. We denied it to comply with the sanctions mandate. 

We have completed your AML Test, which found some important weaknesses in our AML program. The recommendations were implemented.

Due to the sanctions, we want to outline the specific ways that foreign public corruption impacts our AML program. Please help us to answer two important questions: 

1. What types of kleptocratic crimes can show up in AML compliance? 

2. What are some Red Flags involving kleptocratically corrupted assets? 

ANSWER 

The Financial Crimes Enforcement Network (FinCEN) has issued an advisory on kleptocracy and foreign public corruption (“Advisory”).[i] It urges financial institutions to focus their efforts on detecting the proceeds of foreign public corruption. This implementation is a priority for the U.S. government as it continues to implement the U.S. Strategy on Countering Corruption.[ii] The Advisory provides typologies and potential indicators of kleptocracy and other forms of foreign public corruption, namely bribery, embezzlement, extortion, and the misappropriation of public assets. 

Last year, President Biden established the fight against corruption as a core national security interest.[iii] The proceeds of foreign public corruption travel across national borders and can affect economies and political systems far from the origin of the proceeds. 

To advance their strategic, financial, and personal goals, kleptocratic regimes and corrupt public officials may engage in bribery, embezzlement, extortion, or the misappropriation of public assets, among other forms of corrupt behavior. They may exploit the U.S. and international financial systems to launder illicit gains, including through shell companies, offshore financial centers, and professional service providers who enable the movement and laundering of illegal wealth, including in the United States and other rule-of-law-based democracies. These practices harm the competitive landscape of financial markets and often have long-term corrosive effects on good governance, democratic institutions, and human rights standards. 

As but one instance, we have all become aware of the Russian kleptocracy. Studies, investigatory books, and considerable reporting have shown that Russian kleptocrats and other corrupt public officials steal the public’s wealth for personal gain and use their positions of power and access to state-owned resources for their personal benefit. Like other criminal actors, corrupt public officials launder the proceeds of their corruption through various means, including funneling money through shell companies or purchasing various high-end assets, such as real estate, yachts, private jets, and high-value art. 

I mention Russia because it is of particular concern as a kleptocracy since it is founded on the nexus between corruption, money laundering, malign influence and armed interventions abroad, and sanctions evasion. The latter comes up continually in anti-money laundering compliance in Russia and other countries where sanctions apply. Corruption is widespread throughout the Russian government and manifests itself as bribery of officials, misuse of budgetary resources, theft of government property, kickbacks in the procurement process, extortion, and improper use of official positions to secure personal profits. 

Russia’s further invasion of Ukraine highlights foreign public corruption perpetrated by kleptocratic regimes like that of Russian President Vladimir Putin. Russia’s actions in Ukraine are supported and enabled by Russia’s elites and oligarchs, who control a majority of Russia’s economic interests. These individuals have a mutually beneficial relationship with President Putin that allows them to misappropriate assets from the Russian people while helping President Putin maintain his tight control on power. Oligarchs are believed to be directly financing off-budget projects that include political, malign, influence operations, and armed interventions abroad. 

The U.S. government has imposed sanctions on many of these individuals and the businesses and state-owned entities they control as part of U.S. efforts to hold President Putin and his supporters accountable for Russia’s invasion of Ukraine and restrict their access to assets to finance Russia’s destabilizing activities globally. 

Guided by some aspects of the Advisory, I will briefly outline the typologies and how money laundering is usually accomplished. Afterward, I will list ten Red Flags associated with kleptocracy and foreign public corruption. 

Typologies 

Wealth Extraction 

According to the Advisory, foreign public corruption can take many forms, and this corruption can occur at every level of government. For instance, in Russia, “President Putin has allowed the resources of the Russian people to be siphoned off by oligarchs and elites, who amassed their fortunes through their personal connections to Putin and the abuse of state-owned entities and assets.” This activity is not unique to Russia. Kleptocratic activities throughout the world are often associated with other criminal behavior. 

Bribery and Extortion 

Bribery schemes often involve payments to foreign government officials by persons and entities to obtain or retain business or other benefits. These schemes, which generally benefit both parties involved, may be employed to influence political outcomes, secure lucrative contracts with governments or state-owned enterprises, gain access to natural resources or obtain fraudulent documents such as passports or visas, among other purposes.