One of the areas of greatest concern for financial institutions continues to relate to Unfair, Deceptive, or Abusive Acts or Practices (UDAAP). While UDAAP violations have been on the forefront of the minds of most compliance officers since the Dodd-Frank Act added “abusive” into the mix, this area still causes challenges for financial institutions as regulators continue to cite financial institutions for UDAAP violations for practices that had not previously been identified as unfair, deceptive, or abusive.
For this reason, it is important for financial institutions to work to self-identify any UDAAP concerns they may have in their organizations so that they can self-correct any issues before they are identified by their regulators. The challenge in self-identifying UDAAP violations, however, is that existing UDAAP rules focus on how to determine whether an act or practices would be considered a UDAAP violation rather than helping financial institutions to uncover areas of concern. In other words, the UDAAP rules don’t really help financial institutions to find UDAAP violations - they help financial institutions to determine whether a previously identified act or practice is, in fact, a violation of UDAAP rules.
As financial institutions understand the importance of identifying applicable acts or practices that could be viewed as a UDAAP violation, they continue to look for ways to evaluate their risk of potential UDAAP violations. One of the best ways to identify UDAAP risk in a financial institution is to compare the organization’s acts and practices against UDAAP violation examples that have been cited in other financial institutions.
Examples of an Unfair UDAAP Violation
The first type of UDAAP violation relates to unfair acts or practices. Under the Dodd-Frank Act, the standard for unfairness is that an act or practice is unfair when:
It causes or is likely to cause substantial injury to consumers,
The injury is not reasonably avoidable by consumers, and
The injury is not outweighed by countervailing benefits to consumers or to competition.
While this “3-prong test” can actually be quite complicated, it is easier to look at a UDAAP violation example in order to understand what would be considered an unfair act or practice. For example, regulators brought enforcement actions against a credit card issuer that sent convenience checks with stated credit limits and expiration dates to customers. For a significant percentage of consumers, the issuer reduced credit lines after the checks were presented, and then the issuer dishonored the consumers’ checks.
In simple terms, this credit card issuer conducted a “bait and switch” tactic where they said (disclosed) one thing, but did another. While this practice is easily identifiable as “not cool,” we must turn to the 3-prong test to determine if this practice is considered unfair, and thus a violation of UDAAP.
Another example of an unfair UDAAP violation would be when a servicer refuses to release a lien after a consumer pays off their mortgage loan. This practice, like the other example provided above, is a “bait and switch” tactic where consumers would not have expected to be unable to get their liens released after paying of their mortgage loan. A video explaining this UDAAP violation example can be found here.
Examples of a Deceptive UDAAP Violation
The second test under UDAAP is to determine whether or not an act or practices is “deceptive.” Under FTC enforcement (as adopted by the CFPB), “deceptive” also has its own unique three-prong test to determine whether an act or practice violates the prohibition under UDAAP. In other words, the following three-prong test is unique to “deceptive” acts and practices and does not apply to the “unfair” (as described previously) or “abusive” tests.
The unique three-part test used to determine whether a representation, omission, or practice is “deceptive” is as follows:
First, the representation, omission, act, or practice must mislead or be likely to mislead the consumer;
Second, the consumer’s interpretation of the representation, omission, act, or practice must be reasonable under the circumstances; and
Lastly, the misleading representation, omission, act, or practice must be material.
For example, a deceptive UDAAP violation could occur when a lender misrepresents loan terms to consumers. Specifically, the FTC sued a mortgage broker advertising mortgage refinance loans at “3.5% fixed payment 30-year loan” or “3.5% fixed payment for 30 years,” implying that the offer was for a 30-year loan with a 3.5% fixed interest rate. Instead, the FTC claimed that the broker offered adjustable rate mortgages (ARMs) with an option to pay various amounts, including a minimum monthly payment that represented only a portion of the required interest. As a result, unpaid interest was added to the principal of the loan, resulting in negative amortization. As you can see, this mortgage broker was deceptive in their advertising as they were saying things that were not correct - ARM loans don’t have “fixed payments for 30 years.”
Another example of a deceptive UDAAP violation would be Inadequate disclosure of material lease terms in television advertising. Specifically, the FTC brought actions against vehicle leasing companies due to their television advertisements deceiving consumers as to what was really required. A video explaining this deceptive UDAAP violation can be found here.
Example of an Abusive UDAAP Violation
The final test under UDAAP is to determine whether or not an act or practices is “abusive.” As “abusive” was not part of the original FTC rule, the test for determining what is considered “abusive” is not as defined as either “unfair” or “deceptive.” In other words, the test for “abusive” is still in its infancy - meaning that the boundaries of what is considered a violation of UDAAP under this test are not clearly defined. Therefore, it is important for financial institutions to appropriately weigh the risks associated with certain acts and practices, and when applicable, to error on the side of caution.
An abusive act or practice:
Materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service or
Takes unreasonable advantage of:
A lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;
The inability of the consumer to protect its interests in selecting or using a consumer financial product or service; or
The reasonable reliance by the consumer on a covered person to act in the interests of the consumer.
The challenge with “abusive” acts or practices is that this term is still new and relatively undefined. Therefore, there aren’t many clear examples of abusive acts and practices. That said, a June 24, 2019 CFPB symposium debated “abusive” acts and practices. In his written statement, panelist Eric J. Mogilnicki described a number of allegations of abusive acts and practices and provided several examples of how, in similar cases, the CFPB has been inconsistent in calling an act or practice abusive:
“In 2013, the Bureau sued two debt assistance firms for falsely promising to help debtors, but charged only one with “abusive” conduct – despite calling the conduct of both “abusive.”
In 2014, the Bureau sued two companies on the same day for false marketing that induced consumers to seek their help repaying student loans. The Bureau charged only one of them with “abusive” conduct – despite a press release that referred to them both as “scams that illegally tricked borrowers.”
In 2015, the Bureau alleged that creating “an artificial sense of urgency” to encourage a consumer to take out a loan was deceptive despite having alleged a year earlier that creating “an artificial sense of urgency” to encourage a consumer to take out a loan was “abusive.”
In September 2016, the Bureau brought two cases alleging improper sales practices that focused consumers on the size of their monthly payments in order to hide the true costs of a loan. This conduct was alleged to be deceptive (but not “abusive”) in one case and “abusive” (but not deceptive) in the other.”
The point of including this information is to point out that examples of abusive UDAAP violations are not as clearly defined as unfair or deceptive UDAAP violations.
The full written statement by panelist Eric J. Mogilnicki can be found here.