Summary
On October 13, 2011 the Bureau issued a thick Compliance Manual for its examiners in the field, covering the preexisting Federal consumer financial laws (e.g., Truth in Lending) and also UDAAP, covering Unfair, Deceptive and Abusive Acts and Practices. The Bureau has begun examinations of Depository Institutions with assets greater than $10 billion.

Examiners will create a Risk Assessment for each institution subject to examination, using the Risk Template from the Manual. The examiners will score the institution’s inherent risk of harm to consumers, using various tools such as the institution’s website and prior examinations. Examiners will assess all of the institution’s products for customer risk, using the multitude of factors set forth in the Manual, and then proceed to assess the effectiveness of the institution’s compliance program in mitigating the inherent risk of consumer harm. This will result in an assessment of residual or overall risk.

Institutions should use the Bureau’s manual to conduct a self assessment of all products, in their entire life cycle from development, to marketing, to sales, to servicing, to complaints and collection, using especially the UDAAP template to be used by Bureau examiners. Institutions should evaluate their compliance programs against the Bureau’s checklists, and especially review all aspects of their complaint handling resolution process.

The following is a more thorough discussion.

Discussion
On October 13 the CFPB published its Supervision and Examination Manual (“Manual”). Most of the thick volume is occupied by procedures for the pre-existing federal consumer financial laws (TIL, RESPA, TILA, etc.) adopted from existing Federal Financial Institutions Examination Council examination procedures. The most significant aspect of the Manual lies in those sections devoted to the new UDAAP provision from Section 1031 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), part of Title X, the Consumer Financial Protection Act of 2010.

The Manual contains three sections that cover the CFPB’s UDAAP procedures: 
  • Explanation of the Bureau’s interpretation/definition of the terms “unfair,” “deceptive” and “abusive.” 
  • The UDAAP Examination Procedures to be followed by the Bureau’s examiners 
  • The Risk Assessment Template to be completed by the Lead Examiner

While the Explanation sheds light on how the Bureau intends to implement the new “triple standard” of unfair, deceptive, and the brand new standard of “abusive,” the Examination Procedures and Risk Assessment are actually more enlightening – an “on the ground” roadmap for what institutions can expect both for insured depository institutions of over $10 billion in assets and for other depositories who can expect their Prudential Regulator to follow the Bureau’s lead.

Under Section 1036 of Dodd-Frank the Bureau has the authority to promulgate rules identifying specific acts, practices and products as unfair, deceptive and abusive, and with the recent appointment made by the President on January 4, 2012, the Bureau will now be able to move forward to exercise this authority.

The Bureau is remaining consistent with prior FTC action in defining/explaining “unfair” and “deceptive.” 

1) Unfair. Section 1036 defines an “unfair” act or practice: 
  • The act or practice causes or is likely to cause substantial injury to consumers. 
  • The injury is not reasonably avoidable by consumers. 
  • The injury is not outweighed by countervailing benefits to consumers or to competition.
Predictably, these statutory terms are expanded by the regulator:
  • Substantial injury is present even where the harm to individual consumers is insubstantial, if there are a large number of persons affected (a small number times a big number is a big number). 
  • Only trivial and merely speculative injuries fail to meet the test. 
  • “Likely to cause substantial injury” is expanded/changed to “a significant risk of concrete harm.”
“Not reasonably avoidable” means the consumer cannot take reasonable steps to avoid harm. This means: 
  • The act or practice “interferes” with her ability to effectively make decisions or take action.
  • The product is repriced or modified after the consumer is committed. 
  • The customer is coerced. 
  • The transaction occurs without the consumer’s knowledge or consent.

The question is whether an act or practice “hinders a consumer’s decision-making.”

And, if “everybody does it” – i.e. all banks, then of course the consumer has no chance to avoid the harm.

The Bureau also takes the liberty of including public policy as established by the agency into the mix.

2. Deceptive. The Bureau’s articulation of “deceptive” follows the FTC’s; beginning with the inclusion not only of acts or practices but also representations and omissions. There is not just an obligation to avoid lying, there is an affirmative obligation of full disclosure.

The Bureau adopts the FTC’s “four P’s” – prominence; presentation (easy to understand, not contradicted and timely); placement where consumers are expected to look or hear; close proximity to the claim qualified. Where the marketing targets an audience (e.g., elderly) that targeted audience is the basis for determining reasonable interpretation. All it takes is that a significant minority of consumers are misled. If there is more than one meaning, one false, the bank loses. Costs, benefits, restrictions on use or availability are presumed to be material. Implied claims are presumed to be material. Claims made with knowledge they are false are presumed to be material.

And here is the most important advice on deception from the Bureau, which creates an affirmative obligation not to omit any information necessary for full customer evaluation of the product: omissions will be presumed to be material when the financial institution knew or should have known that the consumer needed the omitted information to evaluate the product or service.

3. Abusive. Which brings us to the new standard of “abusive.” Up to this point, it would seem that a bank could comply and avoid the clutches of enforcement by disclosing six ways to Sunday what it is selling. Although unfairness is a term that could be applied to the sale of a product that isn’t worth what the consumer is paying, the definition keys off avoidability, and ample disclosure cuts off that avenue of attack. So too for deception. Abusive, on the other hand, has been defined more in terms of what kind of deal the customer is getting. Here, there are four separate ways in which an act or practice can be found to be abusive under Section 1031 of the Act:
  • Material interference with the consumer’s ability to understand a term or condition.
Taking unreasonable advantage of: 
  • The consumer’s lack of understanding of material risks, costs or conditions. 
  • The inability of the consumer to protect himself in selecting or using the product/service. 
  • The consumer’s reasonable reliance on the covered person to act in the consumer’s interest.

4. Possible combinations of unfair, deceptive, abusive. We see that under the three separate tests - unfair, deceptive, abusive - a given act or practice can theoretically fall into any one of seven categories, e.g. an unfair act could be unfair, but not deceptive and not abusive, or deceptive, but not unfair or abusive, or abusive, but not unfair or deceptive, or unfair and deceptive but not abusive, or unfair and abusive but not deceptive, or deceptive and abusive, but not unfair, or unfair, deceptive and abusive. Using A, B, C the possible combinations are A, B, C, ABC, AB, AC, BC. The Manual makes it clear that any one of these combinations is possible because there are three separate and distinct tests:

Although abusive acts also may be unfair or deceptive, examiners should be aware that the legal standards for abusive, unfair, and deceptive each are separate.

It is, however, highly unlikely that anything found to be unfair or deceptive will not be abusive. It is more possible, though still probably less than likely, that an act or practice could be abusive yet not be unfair or deceptive. This is so because while a fully and properly and timely disclosed product will probably satisfy the “material interference to understanding” and “lack of understanding of risks, costs and conditions,” the other two possibilities – consumer’s inability to protect himself, and reasonable reliance on the covered person to look out for the consumer - can be present even with a completely transparent product. Take loans (suitability), take debit card fees, take NSF fees, all fully disclosed in every aspect and permutation. These can all be challenged on the grounds that the lender/banker should know necessitous consumers are walking into a bad deal. These latter two definitions of abusive acts and practices open the door to substantive analysis – is the consumer getting what he is paying for - is this a bad deal? Is the bank taking advantage? Is the bank making too much money? Is the profit too much, i.e., the price not warranted by the cost.

Carried to its logical conclusion, the Bureau will now be defining all the terms of consumer financial services and products through its enforcement of the prohibition against abusive acts and practices. 

5. Examination Manual. The Examination Manual sets forth a roadmap for this process. The Risk Assessment template that examiners are to use lays out the factors that point to a problem. Here is the lineup: 
  • The profitability of a product is dependent upon penalty fees (e.g., fees for a late payment, for exceeding a credit limit, or for overdrawing deposited funds). 
  • The terms of the product are subject to change at the discretion of the entity, and the entity has frequently made changes in the terms. 
  • The entity reverses fees at a significantly higher rate than other entities of similar size offering similar products. 
  • Pricing structure (interest rate, points, fees) and other features and terms are combined in a manner that is likely to make the total costs of the product difficult for consumers to understand. 
  • Products are bundled in a way that may obscure relative costs. 
  • Consumers pay penalties to terminate a relationship, including forgoing money or benefits they would otherwise earn. 
  • Consumers face barriers to information, such as costs to access customer service or information about their account. 
  • Credit decision-makers have wide discretion over setting terms and features of products with inadequate policies and procedures and addressing appropriate exercise of that discretion. 
  • Credit products are not underwritten based upon the likely ability of the consumer to make the required (or, in the case of adjustable rate products, potentially required) payments over the term of the loan.
The extent to which the marketing of a product or service is targeted to particular populations including: 
  • Students or young adults. 
  • Elderly. 
  • Minorities. 
  • Immigrants. 
  • Consumers of certain national origins. 
  • Members of specific religious groups or denominations. 
  • Military service members or former service members. 
  • Consumers with limited education. 
  • Consumers with limited English proficiency. 
  • Low-income consumers or consumers on limited fixed incomes. 
  • Consumers receiving any type of public assistance. 
  • Consumers with limited experience with financial products or services. 
  • Consumers in, or who have recently experienced, financial distress. 
  • Consumers with low credit scores (e.g., FICO below 620). 
  • Consumers of a certain gender or marital status. 
  • Products targeted to consumers who fall in multiple categories may be of particular concern. 
  • Consider whether any particular populations are missing or excluded from the entity’s advertising.

Incentives and Compensation
Incentives encourage the sale of high-cost products regardless of consumers’ request or situation.

Compensation or performance evaluation of person-to-person sales staff (telephone, face-to-face) is based on:

  • the number of sales made, 
  • the size of the sales made (for example, average loan size) or the volume of sales, 
  • the price of the product sold or 
  • the particular product sold,

without consideration of product outcomes or performance (for example, default or attrition rates, etc.). 

  • Person-to-person sales staff has discretion to set prices (interest rate, points, fees) with inadequate policies and procedures addressing exercise of that discretion. 
  • Person-to-person sales staff are not accountable for product outcomes or performance (default rates, attrition rates, etc.).
Marketing and Advertising 
  • Marketing materials are not written in a language or at a level understandable by targeted consumers. 
  • Key product terms or features are not readily available to consumers. 
  • Targeted consumers would not likely qualify for advertised products or terms. 
  • Advertising includes teaser rates or low fees with little or no information about important conditions (such as periodic or exit charges). 
  • Complex products are marketed to consumers not likely to benefit from them or who may likely be harmed by them. 
  • Product marketing and sales, including branch locations, are targeted in a manner that may be discriminatory. 
  • Advertising utilizes media outlets targeted to particular populations only to advertise its higher-cost products and not its full range of products.
Ongoing Customer Relationship Management 
  • Employees with customer service responsibilities, including collections, are not evaluated or compensated based on the quality of service or level of customer satisfaction 
  • The compensation of customer service representatives with discretion to adjust prices or modify other terms is impacted by the frequency and/or size of such adjustments. 
  • Customer service representatives with discretion to adjust prices or modify other terms operate with inadequate policies and procedures addressing exercise of that discretion. 
  • Vendors with customer service responsibilities, including collections, are not evaluated based on quality of service or level of customer satisfaction. 
  • The compensation of vendors that provide customer service representatives with discretion to adjust prices or modify other terms is impacted by the frequency and/or size of such adjustments.
  • Vendors that provide customer service representatives with discretion in pricing operate with inadequate policies and procedures addressing exercise of that discretion. 
  • The number of customer service staff is insufficient to provide timely service. 
  • Customer service information systems do not have sufficient capacity to support the number of customers.

6. Examination Guidance. The Bureau’s Examination Guidance reiterates what they will target:

Product Features 
  • The entity does not underwrite a given credit product on the basis of ability to repay. 
  • A product’s profitability depends significantly on penalty fees or “back-end” rather than upfront fees. 
  • A product has high rates of repricing or other changes in terms. 
  • A product combines features and terms in a manner that can increase the difficulty of consumer understanding of the overall costs or risks of the product and the potential harm. 
  • Penalties are imposed on a customer when he terminates his relationship with the entity. 
  • Fees or other costs are imposed on a consumer to obtain information about his account. 
  • A product is targeted to particular populations, without appropriate tailoring of marketing, disclosures, and other materials designed to ensure understanding by the consumers.
Marketing and Disclosures
Through a review of marketing materials, customer agreements, and other disclosures, determine whether, before the consumer chooses to obtain the product or service:
  • All representations are factually based. 
  • All materials describe clearly, prominently, and accurately: 
    • costs, benefits, and other material terms of the products or services being offered; 
    • related products or services being offered either as an option or required to obtained certain terms; and 
    • material limitations or conditions on the terms or availability of products and services, such as time limitations for favorable rates, promotional features, expiration dates, prerequisites for obtaining particular products or services, or conditions for canceling services. 
  • The customer’s attention is drawn to key terms, including limitations and conditions, that are important to enable the consumer to make an informed decision. 
  • All materials clearly and prominently disclose the fees, penalties, and other charges that may be imposed and the reason for the imposition. 
  • Contracts clearly inform customers of contract provisions that permit changes in terms and conditions of the product or service. 
  • All materials clearly communicate the costs, benefits, availability, and other terms in language that can be understood when products are targeted to particular populations, such as reverse mortgage loans for the elderly. 
  • Materials do not misrepresent costs, conditions, limitations, or other terms either affirmatively or by omission. 
  • The entity avoids advertising terms that are generally not available to the typical targeted consumer.
Availability of Terms or Services as Advertised
Determine whether:
  • Consumers are reasonably able to obtain the products and services, including interest rates or rewards, as represented by the entity. 
  • Consumers receive the specific product or service that they request. 
  • Counter-offers clearly, prominently, and accurately explain the difference between the original product or services requested and the one being offered.
Credit
  • The available credit is sufficient to allow the consumer to use the product as advertised and disclosed to the consumer. 
  • The fees and charges, typically imposed on the average targeted customer, both initially and throughout the term of the loan, remain in a range that does not prevent the availability of credit. 
  • The entity honors convenience checks when used by the customer in a manner consistent with introductory or promotional materials and disclosures.
Third-Party Providers
  • The entity ensures that employees and third parties who market or promote products or services are adequately trained so that they do not engage in unfair, deceptive, or abusive acts or practices. 
  • The entity conducts periodic evaluations or audits to check whether employees or third parties follow the entity’s training and procedures and has a disciplinary policy in place to deal with any deficiencies. 
  • The entity reviews compensation arrangements for employees, third-party contractors, and service providers to ensure that they do not create unintended incentives to engage in unfair, deceptive, or abusive acts or practices, particularly with respect to product sales, loan originations, and collections. 
  • Performance evaluation criteria do not create unintended incentives to engage in unfair, deceptive, or abusive acts or practices, including criteria for sales personnel based on sales volume, size, terms of sale, or account performance. 
  • The entity implements and maintains effective risk and supervisory controls to select and manage third-party contractors and service providers.
Collections/Servicing
  • The entity has policies detailing servicing and collections practices and has monitoring systems to prevent unfair, deceptive or abusive acts or practices. 
  • Call centers, either operated by the entity itself or by third parties, effectively respond to consumers’ calls. 
  • The entity ensures that employees and third-party contractors: 
    • represent fees or charges on periodic statements in a manner that is not misleading, 
    • post and credit consumer payments in a timely manner, 
    • apply payments in a manner that does not unnecessarily increase customer payments, without clear justification, 
    • only charge customers for products and services, such as insurance or credit protection programs, that are specifically agreed to, 
    • mail periodic statements in time to provide the consumer ample opportunity to avoid late payments, and 
    • do not represent to consumers that they may pay less than the minimum amount without clearly and prominently disclosing any fees for paying the reduced amount. 
  • The entity has policies to ensure compliance with the standards under the Fair Debt Collections Practices Act to prevent abusive, deceptive or unfair debt collection practices. 
  • Employees and third party contractors clearly indicate to consumers that they are calling about the collection of a debt. 
  • Employees and third party contractors do not disclose the existence of a consumer’s debt to the public without the consent of the consumer, except as permitted by law. 
  • The entity has policies on avoiding repeated telephone calls to consumers that annoy, abuse, or harass any person at the number called.

7. Complaints. The Bureau has indicated in many ways the importance customer complaints will play in the UDAAP process. They will begin with “external” customer complaints made to all sources – including the Bureau, the Prudential Regulator and online to the several consumer complaint blogs. An institution cannot do enough to monitor, respond to, and otherwise address customer complaints.

Recommendations:
  • Bankers should perform a complete and thorough Self Assessment of all their consumer products specifically for UDAAP, and especially for “abusive” elements. 
    • This includes, as the Bureau says: the entire product and service life cycle (i.e., servicing, collection, etc. in addition to the sale/structure of the product) 
    • Using counsel may provide some confidentiality, but one must assume that the Self Assessment may be obtained by the Bureau 
  • Bankers should do a top to bottom evaluation/redo as necessary of their compliance program. 
  • Complaints. Institutions should redouble/retriple their efforts to address customer complaints. These should be addressed through a formal program that goes all the way to board reports.