Minimizing UDAAP Risks for Consumer Financial Services

Minimizing UDAAP Risks for Consumer Financial ServicesLessons From CFPB Enforcement Actions and Other UDAP Litigation

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TUESDAY, AUGUST 13, 2013

Presenting a live 90‐minute webinar with interactive Q&A

Kathlyn L. Farrell, Managing Director, Treliant Risk Advisors, Washington, D.C.

Karla L. Reyerson, Fredrikson & Byron, Minneapolis

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Minimizing UDAAPRisks

August 13, 2013

Kathlyn L. FarrellTreliant Risk Advisors

2300 N Street NW, Suite 2100Washington, DC 20037

[email protected]

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“If our society were to start with a clean slate to design a body of banking laws and regulations to protect consumers and support communities, it

seems unlikely that we would create the regulatory system we have today.”

“Common Ground” 1993

UDAP Beginnings

• 1914 passage of the FTC Act• 1938 addition of “unfair and deceptive” • 1975 authority given to banking regulatory

agencies; required office of consumer affairs

• 1985 issuance of Regulation AA

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Section 5

Section 5(a) of the FTC Act prohibits “unfair or deceptive acts or practices in or affecting commerce”

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Applicability of Section 5

• The prohibition applies to all persons engaged in commerce, including banks.

• In 1975, an revision of the FTC Act mandated the then five financial institution regulators (the FDIC, the FRB, OCC, OTS and NCUA) to enforce UDAP, and to issue rules and regulations for handling consumer complaints involving unfair or deceptive acts or practices by banks under its jurisdiction.

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Impact of Dodd Frank

• Dodd-Frank essentially maintains the FTC Act's definitions of "unfair" and "deceptive," while also adding a third element, "abusive"(making the acronym UDAAP), and requiring the CFPB to enforce UDAAP for institutions with over $10 billion in assets.

• Dodd-Frank empowers the CFPB to serve as a new rule maker and enforcer of UDAAP.

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UDAP to UDAAP

Dodd-Frank did not reinvent unfair or deceptive

– “Unfair” and “deceptive” are well-established and have been litigated; “abusive” is all-new

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Dodd Frank Act 1031(a)

• Dodd-Frank Act 1031(a):

– “The Bureau may take any action…to prevent a covered person or service provider from committing or engaging in an unfair, deceptive, or abusive act or practice under Federal law in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service”

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Unfair• 3 factors that make a practice unfair

under both UDAP and UDAAP:

1. Causes or is likely to cause substantial injury

2. Cannot be reasonably avoided

3. Injury is not outweighed by any benefits

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Unfair• Practice causes or is likely to cause

substantial injury

– “Substantial injury” usually means monetary harm or loss, but doesn’t mean each individual consumer must lose a lot of money

– If many people are caused a small harm, substantial injury may be found

– Injury could also be substantial if it merely raises a risk of harm

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Unfair• Injury cannot reasonably be avoided

– Injury is unavoidable when a practice interferes with a consumer’s ability to make an informed decision

– Consumer’s actual decision won’t be judged here

• Standard is whether practice interfered with rational and reasonable decision-making process

• Example: important information left out of an ad

– Consumer cannot make a rational decision regarding the product because all relevant facts are not available

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Unfair• Injury is not outweighed by any benefits

–Net impact of the practice is to harm the consumer

–High hurdle to overcome, however, and is rare

• Any perceived benefit to consumers will not counterbalance the harm caused

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Unfair• Public policy considerations

– Existing laws, regulations, and judicial decisions, are factors in determining whether a particular practice is unfair

– If practice violates other regulations (e.g. Reg. DD or Z) much easier to determine overall impact as unfair

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‘Unfairness’ In Other Regulations• Unfairness is already built into other rules

– Especially related to advertising

• Reg. Z requires only “actually available terms” be offered: “only those terms that actually are or will be arranged or offered by the creditor” be stated

• Reg. DD prohibits “misleading or inaccurate advertisements,” further stating that an advertisement “shall not misrepresent a depository institution’s contract”

– Reg. B, FHA, and fair lending

• If a practice unfairly targets or has a disparate impact on members of a protected class, it may also be considered unfair

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Deceptive• Dodd-Frank does not define what would

make a practice “deceptive”

• Rely on the FTC Act – 3 factors whether a practice is deceptive:

1. Representation, omission, or practice misleads or likely to mislead

2. “Reasonable” consumer would be misled

3. Representation, omission, or practice is material

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Deceptive• Practice misleads or is likely to mislead

–Can mislead by what is not said as well as by what is said

–Even if all relevant information is included and accurate, layout or structure, or the manner message communicated may be misleading

• If attention is directed away from important information

–Bait-and-switch is an example of a misleading practice

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Deceptive

• “Reasonable” consumer would be misled

–Based on target audience, considers how a member of that group would likely respond

–Group’s “net impression”; interpretation may differ depending on sophistication of that audience

–Consumer’s interpretation is what matters, not the institution’s intention with its message or practice

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Deceptive• Misleading practices cannot be “cured” by

qualifying disclosures

–Fine print cannot explain away misleading headline

• Standard is likelihood of deception

– If attention is directed toward misleading information or away from qualifying language, the likelihood of deception greatly increases

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Deceptive• Representation, omission, or practice is

material

– “Material” means likely to affect a choice

• Would consumer be more likely to take action based on the overall impact or the practice?

• Cost or restriction information is almost always considered material

• If information necessary to make a rational decision regarding a product or service is not included, omission will be material

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Abusive• Defined in 1031(d) as an act or practice that:

1. materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or

2. takes unreasonable advantage of—

A. a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service

B. the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service, or

C. the reasonable reliance by the consumer on a covered person to act in the interests of the consumer

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Abusive• Material interference

– Consumer’s ability to understand a term or condition

– Disclosure is critical

• Clear information = educated decision

• What might interfere with a clear understanding?

– Products with multiple features, some more beneficial to the consumer than others

– Products with frequently changing terms

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Abusive• Rely on model disclosure forms?

– Might not be enough if consumer still can’t understand complexities of a product or service

• Safe harbor not so safe?

– “Plain language” disclosures good enough?

– Additional information, documentation might be needed to ensure understanding

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Abusive• Taking unreasonable advantage

–Similar to target audience’s interpretation of information considered in “deceptive”

• Example:

–Offering products or services to consumers having a low level of sophistication and clearly do not fully understand financial concepts

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Abusive

• Not limited only to the disclosure process

• Taking unreasonable advantage of a consumer’s lack of sophistication if institution fails to prevent overuse of certain services that generate fees

–Overdraft is an obvious example

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Abusive• In the interests of the consumer

–An act or practice may be considered abusive if it takes “unreasonable advantage of …reasonable reliance by the consumer on a covered person to act in the interests of the consumer”

–Sounds almost like a fiduciary duty, placing burden on institutions to act in consumers’ best interests rather than their own

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Abusive• What are “interests of the consumer”?

– Sacrifice profitability for consumers’ interests? Yes

– Considering Durbin Amendment, overdraft, guidance, mortgage rules, and more

• Intent of Dodd-Frank Title X, which created CFPB

– Protect consumers and ensure products and services are principally in their interests, not the institution’s

– It’s the CFPB’s reason for being

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Analysis of UDAAP Standards and their Application to Products

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“An exclusive invitation to earn $100 cash back”

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What is “CASH BACK”?

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UDAAP Fairness Principles

• Value• Predictability• Understanding• Appropriateness

These principles should be applied to the bank’s products, services and practices. They should also be applied to third party vendor activities and products.

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Value

The consumer receives value that is reasonably related to the cost of the product or service.

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Value

• Is the Bank’s pricing similar to others or is it an outlier?

• Is the Bank’s profit margin in line with other similar products sold by competitors?

• Can the value proposition be clearly articulated to a consumer or another third party?

• Considering the cost of the product, is it offering a net benefit to the consumer?

• Is consumer feedback incorporated into product changes?

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Predictability

The consumer can predict how the product or service will perform.

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Predictability

• From the information provided, can the consumer predict the performance of the product or service?

• Are fees or penalties timed throughout the lifecycle so that a consumer can avoid them?

• Is important information (such as exclusions) omitted from product brochures or other written material?

• Do most customers receive the essential benefit of the product or service that was promoted or sold?

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Understanding

The consumer understands the terms and conditions of the product or service (particularly

any limitations or exclusions).

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Understanding• Are all advertising and marketing written in simple

language so that the average consumer can understand it?

• Is enough information provided in product information and disclosures to allow the average consumer to clearly understand the terms and conditions?

• Is critical information isolated and/or highlighted to draw customers’ attention to factors that should shape their choices?

• If marketing information is provided in a language other than English, are product terms and conditions also provided in that language?

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Appropriateness

The bank provides products that are appropriate for their customers and their customers can rely on

the bank to show them the most appropriate product.

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Appropriateness• If the product is specifically aimed at a “vulnerable” customer

segment, is extra care given to assure customer understanding and appropriate choices?

• Does the bank strive to offer the consumer products that are appropriate for him or her?

• If the consumer chooses an inappropriate product does the bank explain that fact to him or her?

• Are product marketing campaigns aimed at appropriate consumers?

• Are bank sales tools written so that employees will offer appropriate products?

• Are sales incentives designed to avoid encouraging inappropriate sales?

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Example—Overdraft Protection

POS Debit Authorization Case

Transaction BalanceAccount Balance on Day 1 $110

Debit card transaction authorized ($100) $10(for a purchase at Target)Check #1 ($20) ($10)Check #2 ($20) ($30)

Account Balance on Day 2 ($30)

Release debit hold $100 $70OD Fee for Check #1 ($35) $35OD Fee for Check #2 ($35) $0Debit transaction settlement ($100) ($100)OD fee for Target debit transaction ($35) ($135)

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Enforcement Actions

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CFPB Actions

• Capital One Bank• Discover Bank• American Express• Paul Taylor Homes• U.S. Bank Corporation• Dealer Financial Services

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Karla L. ReyersonFredrikson & Byron, P.A.200 South Sixth Street

Suite 4000Minneapolis, MN [email protected]

© 2013 Fredrikson & Byron, P.A.


OCC Enforcement: Woodforest Bank / Woodland National Bank

(OCC/OTS 2010)

• Promoted account products as “free” or “low cost” while omitting information regarding costly product features

• Used misleading promotional material regarding suitability of account products

• Provided misleading information regarding suspension and automatic reinstatement into overdraft program

• Failed to monitor overdraft program for excessive usage or to set limits

• Charged “continuous overdraft fee”• Paid $1.4M in CMPs and $12M in restitution 47

OCC Enforcement:BankAtlantic (2012)

• Appealed OTS finding of unfair and deceptive practices related to overdraft program

• OCC agreed with “deceptive” practices findings

• OCC did not agree with OTS that failure to set limit on aggregate overdraft fees was, in itself, “unfair”

• Resulted in CRA downgrade to “Needs To Improve”


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OCC Enforcement:RBS Citizens, N.A. (2013)

• Violations related to overdrafts, checking rewards and stop payment process for preauthorized recurring EFTs– Incomplete / inaccurate disclosures for overdraft program– Failure to stop payments as promised– Failure to give all rewards as promised

• Tripped on technical limitations

• Paid $5M in CMPs


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OCC Enforcement:JP Morgan Chase (2011)

• Violations related to debt cancellation and debt suspension products (auto, home, credit card loans)

• High-pressure sales tactics included deceptive rebuttals for customers who declined product

• Restitution and $2M in CMPs

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FDIC Enforcement:Higher One, Inc. / Bancorp Bank (2011)

• Violations stemmed from student debit card program

• Charged multiple NSF fees for one transaction

• Allowed accounts to remain overdrawn for long periods

• Required to modify NSF policies and avoid misleading marketing

• Restitution: $11M

• CMPs: $282K total


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FDIC Enforcement:Republic Bank and Trust (2011)

• Violations in connection with refund anticipation loans

• Numerous violations and unsafe/unsound practices found

• UDAP kicker (misleading marketing)

• Example of how a single action can result in multiple infractions

• Third party provider issues

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FDIC Enforcement:First California Bank /

Achieve Financial Services (2013)• Violations related to prepaid, reloadable debit card

• Deceptively advertised bill pay feature as “free”

• Promoted features and services that were unavailable

• Charged fees that were not clearly disclosed

• Failed to disclose certain error resolution requirements

• Restitution of $1.1M to over 64,000 cardholders

• CMPs totaling $710,00053


Additional Guidance

• Regulators’ Examination Manuals

• CFPB Bulletin 2012-06: Marketing of Credit Card Add-On Products

• CFPB Bulletin 2013-07: Prohibition of Unfair, Deceptive, or Abusive Acts or Practices in the Collection of Consumer Debts

• http://www.consumerfinance.gov/guidance/54

Additional Guidance

• Unfair or Deceptive Acts or Practices by State-Chartered Banks, March 11, 2004 (FDIC and Fed)

• “Unfair or Deceptive Acts or Practices: Applicability of the Federal Trade Commission Act,” FIL 57-2002, May 30, 2002 (FDIC)

• “Chasing the Asterisk: A Field Guide to Caveats, Exceptions, Material Misrepresentations, and Other Unfair or Deceptive Acts or Practices,” last updated January 16, 2007 (FDIC)


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Additional Guidance

• “From the Examiner’s Desk: Unfair and Deceptive Acts and Practices: Recent FDIC Experience,” last updated January 13, 2009 (FDIC)

• “Guidance on Unfair or Deceptive Acts or Practices,” AL 2002-3, March 22, 2002 (OCC)

• FTC Policy Statement on Unfairness, December 17, 1980

• FTC Policy Statement on Deception, October 14, 1983


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Don’t Forget Regulation AA12 CFR Part 227

• Complaint procedure

• Unfair credit contract remedies– Confession of judgment– Waiver of exemption– Wage assignment – Security interest in household goods

• Unfair practices involving cosigners

• Unfair late charges (pyramiding)


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State Enforcement Actions and Litigation


“Little FTC Acts”

• Every state has one or more UDAP laws

• These laws prohibit deceptive practices in consumer transactions and, in many states, also prohibit unfair or unconscionable practices

• The scope and strength of these laws vary widely

• All include a private right of action, plus government action

• Only a few include a public interest requirement for private actions


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“Little FTC Acts”

• Remedies may include:– Injunction– Cease and desist orders– Consent decrees– Restitution– Statutory damages (including treble or punitive damages)– Discretionary award of attorneys’ fees

• Most do not require consumer plaintiff to show reliance

• Court decisions may expand or contract statute


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Recent State Trends

• UDAP cases abundant via AG actions and private litigation

• California and Massachusetts most active

• Common areas:– Overdraft protection– Late fees– Credit card add-ons– Mortgage lending and servicing

• Class actions common


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Gutierrez v. Wells Fargo (CA)

• Class action involving 1M current and former customers

• Misrepresentations claimed in these areas:– Balance disclosures– Overdraft fees– Largest to smallest transaction posting

• Filed in 2008 and ongoing

• In May 2013, judge reinstated award of $203M

• B of A and JPMorgan Chase settled ($410M and $110M)


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Massachusetts v. Fremont (2009)

• Four characteristics determined to create subprime loan that was “presumptively unfair”:– ARM with introductory period of 3 years or less– Teaser rate that was at least 3% lower than fully-indexed rate– DTI ratio exceeding 50% if measured by fully-indexed rate– LTV ratio 100% or substantial prepayment penalty or prepayment

penalty extending beyond introductory period

• Vulnerable borrowers set up to default• Injunction from foreclosures; $8M consumer relief; $1M

CMPs; $1M costs and attorneys’ fees


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Regulators Talk

• State and federal regulators and AGs often work together, share information, monitor actions

• Lawsuit / enforcement action in one state or federal jurisdiction can lead to others

• Dodd-Frank Act strengthened states’ rights over federal preemption and encouraged collaboration


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Mortgage Servicing Settlement (2012)

• DOJ, HUD, 49 state AGs, state and federal regulators v. 5 largest mortgage servicers

• Largest federal-state civil settlement ever

• Alleged violations stemmed from robo-signing, servicing misconduct, etc.

• $20B in financial relief for borrowers; $5B to state and federal governments


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Best Practices

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UDAAP RISKS HIDE IN THE CRACKS

Strategies for Creating Fair Products

1. Develop a formal process for new product design and implementation

2. Make sure risk and compliance is involved from the very start

3. Determine the characteristics of the product’s target customer

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4. Gain a thorough understanding of the product’s terms and conditions

5. Understand how each cost or fee will be assessed and collected

6. Determine if there is burden on the consumer to activate the product or to get the benefit

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7. Test the product in live circumstances to understand how it works in all possible transaction types

8. Use an outside party to provide a consumer perspective on the product

9. Review all proposed marketing and advertising strategies

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10. Review a detailed plan of all sales practices, including proposed scripts, guidance documents, sales aids, targeted market, etc.

11. Conduct periodic reviews of the sales and marketing efforts and customer complaints; revise the product as needed

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Factors for Determining Fee Risk1. Is it a service charge or a penalty?2. Is the fee reasonably related to the cost of

providing the service?3. Is the product complex or simple?4. Are disclosures effective?5. Can it be easily explained?6. Is the fee significantly greater than competitors?7. Is the product aimed at vulnerable populations?8. Are vendors involved in delivering the product?

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Treliant Product Fairness Map

Increasing Bank Benefit

Increasin

g Con

sumer Ben

efit

Product Fairness Map Instructions

1. List the features of the potential product2. Divide the features between the following

categories:• Good for the Bank• Good for the Customer• Good for Both• Bad for the Bank• Bad for the Customer• Bad for Both

3. For each category, determine the magnitude of each feature

4. Plot each one on the Fairness Map5. Determine where there is a cluster‐these are

the most dominant characteristics6. Features that are bad for the customer and

the Bank should be eliminated from the product

7. Consider whether negative features can be altered to improve their benefits for both (the goal should be that the product should be good for both the customer and the bank)

8. Carefully scrutinize any product in the “good for the Bank; bad for the Customer” category. This is a UDAAP red flag

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Transformation: Shifting to Optimized Compliance

Tactical Strategic

Reactive Proactive

Siloed Integrated

Low tech/high cost Efficient

Regulation/Product Centric Consumer-Centric

Rules-Based Principles-Based

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Fee Risk Assessment

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Best Practices for UDAAP Compliance Programs

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UDAAP Programs

• Must be proactive—not just reactive• Must be strategic—not just tactical• Must engage the entire staff—not just

compliance and risk

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UDAAP Program Elements

Governance

• Senior Leadership Involvement• Board of Director engagement• Oversight Committees• Line of Business participation

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Culture

• Active cultivation of a fairness culture• “Tone at the Top” is important• Establish culture barometers• All culture components should be reviewed for

fairness (compensation, corporate messaging, etc.)

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UDAAP Strategy

• Align UDAAP with overall organization strategy• UDAAP strategy should consider marketing

plans• Should help to integrate risk silos• Strategy should address all UDAAP program

elements

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Enterprise UDAAP Policy

• Foundation for the fairness program• Commit to fairness and transparency in all

customer interactions• Policy should cover all types of transactions,

products and services, throughout their lifecycle• Should cover third party relationships• Be approved by the board of directors

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UDAAP Training

• Include all appropriate employees• Utilize general and job-specific training• Concentrate on new and emerging risks• Use complaint data • Use formal training and informal messaging

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Consumer Advocate

• Purpose is to perceive bank transactions from a consumer’s perspective

• Review– Marketing– New products and services– Questionable transactions or fairness based

complaints• Can be housed in compliance or in a business unit

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UDAAP Monitoring and Testing

• Compliance functions/business functions should incorporate UDAAP monitoring procedures to regularly monitor all functions

• Compliance monitoring is housed in the compliance function but is often done in conjunction with the business

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Advertising and Marketing Reviews

• Customer communications should include a UDAAP review

• Ad copy should be reviewed every time; even if content does not change

• Complaints may also prompt mid-stream advertising reviews

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Advertising/Marketing Terms

• Strives for simplicity and clarity• Leads consumers to make an informed decision• Promotes understanding• Watch for internal/external consistency• Limit the use of special terms such as “free”,

“guaranteed”, “up to..”, “as high as…” etc.• Ensure that the terms of the marketing material

can be completely fulfilled

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UDAAP Procedures

• Procedures integrated into business procedures are ideal

• Should be approved both by the line of business and compliance

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Management Reporting

• Meaningful UDAAP compliance reporting is essential

• Complaint data and trends • UDAAP red flags for products and practices

should be the goal

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Proactive Regulatory Relations

• Design and execute a proactive approach • Cultivate communication channels• Encourage ongoing dialogue • Work proactively to resolve issues as they arise

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UDAAP Risk Assessments

• UDAAP Risk Assessments will vary by institution• Essential to effective UDAAP compliance• Common issues to consider:

1. Scope2. Approach3. Assessing risks and controls

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UDAAP Auditing

• Internal audit function• Must be appropriately scoped• Should focus on high risk areas• Use risk assessment and complaints in scoping

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Complaint Management Systems: Key Building Blocks

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Compliant DefinitionEscalation ProcessesRoot Cause DeterminationRemediation ProgramManagement and Trend Reports

Tips for Third-Party Agreements


Third-Party Relationships

• Bad acts of third party service providers or joint marketers will be attributed to the bank

• Perform a risk assessment

• Thorough due diligence is essential and expected

• Protect your institution through carefully drafted contracts

• Monitor the third party’s actions and compliance

• Cost/benefit analysis


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Third-Party Contract Provisions

• Scope of the arrangement – be sure to discuss customer support and employee training when relevant

• Information Sharing – ensure agreement is consistent with bank privacy policies; address information security, security breaches, and service outages; require copies of all complaints and enforcement actions and notice of litigation

• Compliance – third party must comply with bank laws


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• Audit – third party should agree to audits / examinations by bank and its regulators

• Compensation Structure – be careful not to incentivize bad behavior

• Indemnification – protect bank from bad acts of third party

• Advertisements – include right to approve ads and press releases that include bank name or product


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• Default – include violation of applicable laws

• Term – shorter term is usually best, especially with new relationships

• Termination – include termination without penalty upon regulator objection and upon failure to comply with agreement and applicable law (including UDAP laws)


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Third-Party Relationships

FOLLOW THROUGH!!!

• Monitor using similar standards as would be in place if activities performed internally

• Audit regularly using bank or outside auditors

• Ensure you receive information contracted for and review it for potential concerns

• Document your efforts


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Additional Guidance

• “Third Party Risk: Guidance for Managing Third Party Risk,” FIL-44-2008, June 6, 2008 (FDIC)

• “Third Party Relationships,” OCC 2001-47, November 1, 2001


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Contract and Ad Terms

• Be careful with loaded terms (always, never, free, as low as, up to, guaranteed, prequalified, lifetime)

– Example: “Your interest rate will never fall below 7.99%”

• Include a “change in terms” provision, but don’t bet the farm on it

• Check for consistency across ads, agreements, disclosures, statement stuffers, anything the customer will receive in connection with a particular product


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Contract and Ad Terms

Know Your Audience

• Be careful with print size

• Avoid complex sentence structures

• Beware of language barriers


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Karla L. Reyerson, Esq.Karla is a senior associate in Fredrikson & Byron’s Bank & Finance Group. She is an attorney licensed in Minnesota and focuses her practice on advising banks and other financial institutions regarding regulatory matters.

Karla has extensive knowledge in a number of financial regulatory areas, including those related to safety and soundness, compliance, licensing, and structural matters. Prior to joining Fredrikson & Byron, Karla worked in banking for six years as a compliance analyst where she focused on consumer protection regulations and transaction documentation.


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Lyn Farrell, JD, CRCM, CAMSLyn Farrell, Managing Director, Treliant Risk Advisors LLC, has over 30 years of experience in bank law and regulatory compliance. She is an attorney licensed in Texas and has functioned as in-house counsel and compliance officer to medium and large financial institutions. She was previously the Managing Director of Risk Management Services for Sheshunoff Consulting + Solutions.

Lyn is experienced in regulatory compliance, BSA/AML consulting, payment operations, lending and real estate transactions, litigation and bankruptcy, enforcement action compliance and drafting and negotiating contracts. She frequently speaks at industry events and regularly publishes articles on a variety of banking-related topics. She is the author of the Reference Guide to Regulatory Compliance, and Law and Banking, both published by the American Bankers Association, the official study guide to the CRCM examination.

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Documents

Minimizing UDAAP Risks for Consumer Financial Services