By Lyn Farrell
Surely the most puzzling questions in the field of bank compliance nowadays is this one: Does this practice have UDAAP risk or not?
Warning: there is almost never a concrete answer; UDAAP is a bit of a fuzzy concept.
First, to clarify a key fact: only a judge can answer this question with certainty. The Unfair Deceptive or Abusive Acts or Practices (“UDAAP”) laws are based on principles, not technical rules. So it is impossible for anyone to know for sure that a particular practice violates the law, short of a court ruling. However, unless an organization wants to fight a regulatory order in court, it’s best to use some common sense principles as a lens through which practices can be evaluated for their UDAAP risk.
UDAAP is different from technical regulations because it requires a holistic view of the circumstances and it must be viewed from a reasonable consumer’s perspective. It does not matter if the typical banker can understand how a product works, the question is, can a reasonable consumer understand?
One way to make UDAAP concepts more tangible, is to distill them into four principles such as the following:
- Value: Does the product or service offer the consumer a value that is commensurate with the cost charged for it? Issues have come up when institutions offer products that have exclusions that prevent the purchaser from receiving the value for the product.
- Understanding: Is the product described clearly enough for the consumer to understand how it works at the time of purchase? In some cases, products are so complicated or advertising pieces are so opaque that a consumer cannot understand how the product works from the very beginning.
- Predictability: Can the consumer predict how the product works in all circumstances? In some cases a product may look understandable on its face, but glitches in the operations of the product cause it to be unpredictable. If a consumer cannot understand the product’s operations well enough to avoid fees or penalties that can be avoided, then the product is not predictable.
- Appropriateness: Does the institution offer a large enough group of products so that some of them are appropriate for the consumer in question? If not, the institution should take care to explain to a consumer why the product may not be right for him or her.
Using these more specific principles as our lens, here are some case studies to evaluate.
Case Study No.1
A local newspaper publishes mortgage rates of local banks and financial companies as a service to its readers. The newspaper obtains the rates by calling the institutions. The rates published this week have a typo that shows ABC Bank’s rate as 1 percent lower than it actually is. The Bank had nothing to do with the error, but is now facing several angry applicants who came to the bank to get a mortgage at the published rate.
Is this a UDAAP issue or not?
This is probably not a UDAAP issue for the bank as long as it quickly corrects the impression given to applicants. It should make sure that they are aware of the correct rate before they begin the application process. The bank should notify the newspaper and ask them to immediately post a prominent correction notice to avoid as much confusion as possible.
Case Study No. 2
The bank has a policy of placing holds on funds spent through debit card transactions. Since the bank is obligated to pay the transactions once they are approved, this practice is seen as a prudent safety and soundness measure. Consumers can see the hold on their mobile devices and on their Internet banking pages.
The hold is placed for one day only and then the funds are released back into the account even if the transaction has not been presented for settlement. Sometimes, when the settlement takes more than one day, funds are used up by the time the debit transaction is actually presented for payment, and then, if the consumer has opted into debit card overdraft protection, an overdraft fee will be charged.
Is this a UDAAP issue or not?
It is necessary to consider this practice from the consumer’s standpoint. The consumer has made a purchase that was approved by the bank through the debit card system. At that time, a hold was placed on the funds. At the time of the hold the consumer had an expectation that those funds will be there when the debit transaction arrives at the bank for settlement. But, if the bank releases the funds too early, they could be used up by paying checks, ACH transactions, cash withdrawals or anything else. Then when the approved debit transaction comes in, it could incur an overdraft fee for which the consumer was not prepared. Most of the banking agencies consider this to be a UDAAP problem based on the fact that it is deceptive not to hold funds until the payment when the consumer would reasonably expect it based on the initial hold. This is a predictability problem. The service is not behaving in a way the consumer expects. Most of these problems can be prevented by holding the debit card transaction funds for 2 or 3 days instead of just one day.
Case Study No. 3
The bank has introduced a new credit card called the “Intelligence” card that offers a richer reward program than any other the bank offers. The bank requires a 720 FICO score to get this card. It has a lower APR than any other card in the bank’s stable of cards. The bank launches a massive advertising campaign on this card. The campaign is so effective that current customers in other products call to transfer their accounts to this card.
The bank would like to transfer the cardholders but many of them do not have the 720 score. The bank would like to transfer the cardholders to an Intelligence card but with the borrower’s current APR—allowing customers the richer rewards but not the lower rate—due to their disqualified credit score.
Is there a UDAAP problem?
Yes, the Intelligence card is well branded and the characteristics of the card have been so well advertised that it is misleading to give borrowers an “Intelligence” card with a higher than advertised rate.%
Case Study No. 4
The bank is including each customer’s credit score monthly on their checking account statements if they have opted into overdraft protection. The score is a generic and proprietary score the bank purchases from a credit reporting agency. It is not a score that is used by lenders like FICO. The statement has a disclaimer that the score is for the consumer’s educational purpose only. The disclaimer says: “This creditor score may help you determine your own credit worthiness. It is not used by lenders and is only for your own educational purposes.” The bank uses the fact that customers will get this credit score each month in its advertising for overdraft protection. The ad also has the same disclaimer in small print at the bottom of the page.
Is this a UDAAP issue or not?
This issue is related to the value principle. What is the value the consumer expects to receive? Again we need to view this from the perspective of the consumer. The score being provided may have some value, but clearly it is not as valuable as a score actually used by lenders. Since there are disclaimers in the ad and on the statement, the bank is trying to make that fact clear, so there will not be a misunderstanding. The question: Is the disclaimer prominent enough so that it will be seen by anyone who is thinking about the benefit of the credit score while they are considering signing up for the overdraft protection service? One mitigating factor here is that if consumers decide that they do not like the credit score, they can opt out of overdraft protection at any time. The main factor in deciding whether or not this is a UDAAP problem is how prominent the declaimers are in the advertising and on the statement itself.
Case Study No. 5
The bank has experienced an increase in fraudulent debit card transactions conducted by family members of the cardholder. It would like to implement a policy to tighten up the practice of investigating unauthorized debit card transactions. Currently the bank has the cardholder sign a simple statement that affirms that he/she has not authorized the transactions in question. The bank would like to add to its statement the following two provisions:
- At the bank’s request, the cardholder would agree to file a police report affirming that he has been defrauded; and
- Require the cardholder to agree to assist the bank prosecute any fraudster found to have used the card
Are these UDAAP issues or not?
This is a basic fairness issue that is related to predictability. The consumer cardholders have rights under the Electronic Fund Transfer Act (EFTA) to be reimbursed for unauthorized charges on their debit cards with only a few restrictions. Generally, consumers are aware of these rights and the EFTA disclosure, given to them at the time they open accounts, generally reinforces their expectations. The bank in this case is placing more requirements on the consumer than the law does. In fact, the requirement to file a police report and assist the bank in prosecution are fairly onerous. Regulatory agencies have considered requirements like these that limit debit card reimbursements to be unfair and burdensome and therefore a UDAAP issue.
Case Study No. 6
Friendly Bank has a large servicing portfolio containing all types of consumer loans. The bank frequently receives payments from consumers that are more than the amount owed. Sometimes in these cases the consumer provides instructions for the overpayment. They may want the extra funds applied to a different loan or they may want the funds applied as a principal reduction. In cases where the borrower sends no instructions, Friendly Bank’s policy is to hold the funds in a suspense account and apply them to the next payment at the time the next payment is due.
Is this a UDAAP issue or not?
This is a potential UDAAP issue for the bank. Holding the payments without giving the borrower credit for the overpayment is potentially an unfair practice. Again, this problem is one of predictability. The consumer has reasonable expectations for how the funds would be treated and presumably those expectations include the funds being credited in a way that is advantageous to him or her.
The consumer sent extra funds to the bank with some intent. That intent is unknown because the consumer did not send instructions with the payment. However, the bank should either get into contact with each borrower when the funds are received to determine their wishes, or the bank should formulate a policy that provides that the funds will be applied in a manner that is the most advantageous to the borrower, such as crediting them to the principal balance. Once a policy is formulated, borrowers should be notified so they will know what to expect when overpayments are made with no specific instructions.
UDAAP issues are, by their nature, difficult to identify, particularly in complex institutions like banks. The best risk management control for UDAAP issues is a consumer-centric culture that promotes fair treatment of customers. Individual employees should be trained to watch for unintended consequences of product and service operations. If employees are empowered to speak up when they see negative consumer outcomes, they can operate as very effective early warning systems for the institution. Effective UDAAP training and publicly rewarding employees for raising UDAAP concerns is the best defense an organization can have against UDAAP enforcement actions.
Lyn Farrell is a managing director at Treliant Risk Advisors, LLC, where she co-leads the regulatory compliance practice. Lyn the author of the ABA’s Reference Guide to Regulatory Compliance and Law and Banking. Telephone: (713)-204-9500.