TEST: UDAAP 101

UDAAP is an important area of focus for compliance officers and financial institutions. It was a key area discussion at this year's ABA Regulatory Compliance Conference. UDAAP kept surfacing and we thought it might be helpful to do a brief refresher on some UDAAP basics.

In this post, you'll learn what UDAAP is, important definitions, and how to approach some of the key risks.

As compliance professionals work to manage risk, one area of focus is UDAAP. It's a broad topic that intersects with other areas of consumer compliance, such as Fair Lending.

In fact, it is changing the landscape of Fair Lending. Some experts are combining the two, and referring to them as "Fair and Responsible Banking."

UDAAP stands for "Unfair, Deceptive and Abusive Acts or Practices."

In spirit, the UDAAP regulations are designed to protect "vulnerable consumers" and ensure that financial institutions are working to protect their current customers in addition to any consumers.

A vulnerable consumer is often described in terms of consumer characteristics or demographics such as age, disability, gender, race/ethnicity, low or limited literacy, receipt of public assistance, and education level. It's similar to protected classes in Fair Lending compliance. 

The first version of UDAAP, originally referred to as Section 5 of the FTC Act, was introduced in 1938. In 2004, the FTC expanded the section to include deceptive and unfair acts and practices, and UDAP was born.

2010's Dodd-Frank Wall Street Reform Act introduced the "abusive" statutory standard, changing UDAP to UDAAP, and refocused regulatory attention on this area of compliance. In addition, Dodd-Frank made the Consumer Financial Protection Bureau the primary enforcer of the law. In 2011, the CFPB began oversight of UDAAP compliance.

Even it isn't exactly new, UDAAP can be challenging to understand and comply with. This is due, in part at least, to the following factors:

• It's broad in scope and may lack formal or complete definitions.
• Although it is a singular law, UDAAP is broad and can intertwine with other consumer protection laws and regulations. This may lead to varying interpretations.
• Regulatory standards and perspectives as evident in recent cases aren't always consistent.
• UDAAP is sometimes used more generally to include regulations related to good and fair practices.

We've reconnected in the last few weeks with how flexible UDAAP can be, particularly in great sessions at the ABA's Regulatory Compliance Conference in Orlando (pictured). Given the potential for interpretation and changing regulatory guidance, it may be helpful to approach UDAAP compliance efforts with a little flexibility.

But let's start with easy parts: UDAAP definitions! Read on to learn the details of important UDAAP definitions, and some tips for avoiding risk exposure.

Defining "Unfair" for UDAAP Compliance

Below are the definitions for unfair, deceptive and abusive for UDAAP compliance, gathered from Section 1031 of the Dodd-Frank Act. It's important to note that some of these definitions are subjective; that's part of what makes UDAAP potentially tricky.

Acts and practices are considered "unfair" if they:

1. May cause substantial injury. Interpretation of this is often subjective, but below are some considerations:
   • May or may not include monetary harm;
   • Small amount of harm to a large number of people or substantial harm to one person;
   • Actual injury is not required, as harm could be substantial if it merely raises the risk of harm;
   • Emotional harm is not typically part of the definition.
2. Not reasonably avoidable.
   • Interferes with the consumer's ability to effectively make decisions or to avoid the injury.
   • Prevents a consumer from comparison shopping or choosing advantageous alternatives.
   • If the practice is pervasive in the industry, regulators are more likely to find the practice unfair if there aren't alternatives.
3. Injury is not outweighed by benefit.
   • Offsetting benefits could include lower prices to the consumer or a wider availability of products and services because of competition. 
   • The costs to society as a whole are high due to any increased burdens. 

Defining "Deceptive" for UDAAP Compliance

Statements or omissions are considered "deceptive" if they are:

• Misleading or likely to mislead.
• A reasonable consumer would be misled. That is, a consumer's interpretation of the statement or omission is not reasonable under the circumstances.
• A representation, omission or practice is material. 

Here are a few additional points to remember about "deceptive" statements, omissions, acts or practices:

• Intent is not required to be considered deceptive.
• Actual deception is not required, only an interpretation.
• Deception may occur if you are misleading to a consumer through words, silence or action.
• Acting in good faith is not a defense.

You may have noticed the phrase "likely to mislead" above in the definition of "deceptive." That can be a vague phrase, so for UDAAP compliance, it needs to be defined more clearly. An act or practice is likely to mislead when:

• It omits key terms and conditions; and
• Terms and conditions are present, but key requirements are obscured. For example:
  • Fine print;
  • Oral delivery that is fast-paced;
  • Bait-and-switch communications.

Another word, "material," leaves room for individual interpretation. Consider the following when determining whether an act, practice, representation or omission may be considered material:

• Materiality is assessed by the ability of the consumer to make and understand a decision.
• Deception of a consumer occurs if their understanding of cost or restrictions is not clear and concise.

“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.”

- Richard Cordray, Director of the CFPB

Some experts have said that as much as 90 percent of UDAAP regulatory actions focus on deception.

Defining "Abusive" for UDAAP Compliance

An abusive act or practice is defined as one that:

• 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 consumer’s:
  • Lack of understanding of the material risks, costs or conditions of the product or service;
  • Inability to protect its interests in selecting or using a consumer financial product or service; or
  • Reasonable reliance on a covered person to act in the interests of the consumer.

Abusive can be difficult to define, and is sometimes applied inconsistently. 

3 Tips for Avoiding UDAAP Violations & Understanding Your Risk

It is clear that UDAAP is still in the spotlight for the regulators. Compliance officers nationwide are working to manage their compliance risk and understand the way that UDAAP is woven into other areas of consumer compliance.

Here are a few tips for avoiding UDAAP violations and understanding the UDAAP risks facing your institution:

1. Pay attention to vulnerable consumers and provide more options to help them. For example, on a telephone script, the product script should be more than one-size-fits-all.
2. Consumer complaints play a key role in the detection of unfair, deceptive and/or abusive practices. Consumer complaints act as an essential source of information for you and your institution, as well as for regulators and examiners in their regulatory enforcement and rule-making.
3. Consider talking to consultants and internal and external counsel before making any changes. Regulators will have access to any documentation or written materials about your compliance program. Depending on your regulator, geography and other factors, an examiner may view improvement efforts as admission of awareness of UDAAP violations, and critique your institution for not making improvements quickly enough. In addition, you may want some of your work covered by attorney-client privilege, so that community groups and journalists don't have access.

Unfair, deceptive and abusive acts and practices pose a great threat to your institution as regulators refocus attention on UDAAP compliance. While we are still learning how the regulators interpret UDAAP through regulatory news, lawsuits and enforcement actions, you can begin taking positive steps toward better UDAAP compliance today. 

Related: How to Build a Strong Fair Lending & Redlining Compliance Management System