In response to mounting pressure from Congress, the banking regulators have taken a series of headline-grabbing actions to address “consumer abuse.” These efforts have been two-pronged: the issuance of rules prohibiting certain conduct as an “unfair or deceptive act or practice” (UDAP) under Section 5 of the Federal Trade Commission Act, and enforcement actions for UDAP violations.
The Federal Reserve published a set of rules defining as a UDAP certain practices in the credit card industry and in the provision of overdraft services. In an enforcement action by the Office of the Comptroller of the Currency, Wachovia Bank was ordered to pay restitution and fined $140 million. The FDIC brought enforcement actions against three institutions for millions of dollars. These enforcement actions punish the banks for the bad acts of their customers or product partners.
A UDAP can cover a broad and undefined range of activities. Section 5 of the FTC Act prohibits “unfair or deceptive acts or practices in or affecting commerce.” The essence of the unfairness test under the statute is whether consumers, as a result of the act or practice, suffer “substantial injury.” Where an act imposes a small harm, but upon a large number of consumers, the regulators may deem the collection of small injuries “substantial.” With respect to the deception analysis, an act or practice is deceptive if there is a material representation, omission, act or practice that is likely to mislead a “reasonable consumer.” However, the “reasonable” standard under this test does not depend upon the reaction of the majority of consumers. Rather, if a representation has more than one reasonable interpretation, and if one such interpretation is misleading, then the representation is deceptive. Moreover, if a practice misleads a significant minority of consumers, it may be deemed deceptive even though the majority of consumers has not been misled.
The Federal Reserve is granted rulemaking authority under the FTC Act. In a belated exercise of this authority, the Fed, in May 2008, proposed rules that would amend Regulation AA to define as a UDAP under the FTC Act certain practices in connection with consumer credit card accounts and overdraft services. The Fed separately proposed amendments to Regulation Z, which implements the Truth in Lending Act and Home Ownership and Equity Protection Act, to enhance consumer protection against unfair or deceptive lending practices in the mortgage market.
An important question with respect to the proposed Fed rules defining practices as a UDAP is whether the rules apply retroactively. The Fed has not addressed the issue of how the new rules apply to acts or practices that are defined as unfair or deceptive under the new rules but occurred prior to the effective date of the rules.
In April 2008, the OCC trumpeted an enforcement action against Wachovia requiring the bank to make restitution payments to customers who had been harmed by the UDAP of telemarketers and third-party payment processors with account relationships with the bank. In addition to the restitution payments amounting to $125 million, the bank paid a civil penalty of $10 million and contributed $8.9 million to fund consumer education programs. The OCC sanctioned Wachovia because it said the bank failed to conduct the appropriate level of due diligence on the telemarketers and payment processors and lacked policies and procedures to effectively monitor the activities of these customers. Consequently, the OCC concluded that the bank engaged in unsafe or unsound banking practices and unfair practices under the FTC Act.
In June 2008, the FDIC instituted enforcement actions against First Bank of Delaware and First Bank & Trust for the marketing of subprime credit cards in violation of the FTC Act, seeking restitution payments for consumers who were harmed by the deceptive marketing practices as well as civil money penalties totaling $431,000. These two banks are fighting the charges. But a third bank, Columbus Bank and Trust, settled with the FDIC by agreeing to a Cease and Desist Order and a civil money penalty of $2.4 million. The allegedly deceptive practices involved credit card products marketed by the banks’ third-party partners. Solicitations in connection with those products were found to contain inadequate disclosures and misrepresentations. The FDIC blamed the banks for having lax policies and procedures that failed to ensure their third-party partners’ compliance with the FTC Act. As a result of the failure of oversight, the banks were found to have engaged in unsafe or unsound banking practices.
The enforcement actions are intended to and should get the attention of banks. Whether in the form of newly adopted rules or enforcement actions, banks need to be aware of the new regulatory focus on UDAP. It will not let up because Congress is forcing the regulators to take action and the regulators must respond. For example, on July 31, 2008, the House Financial Services Committee passed a credit card consumer protection bill enshrining in statutory form some of the rules in the Fed proposal without waiting for the comment period to expire. In a shot across the bow, Committee Chairman Barney Frank said the only reason the Fed acted was because of the threat that the bill would be passed. While the bill may not pass this year, the threat of legislation if the Fed does not act remains clear and imminent, and sends a message to all the banking regulators about the views of a Democratic Congress.
In addition to UDAP violations enforced by the federal regulators, various state attorneys general and banking departments now are pursuing actions against state-chartered banks for violations of state unfair trade and deceptive practices acts.
In light of the recent developments, banks should:
- review and update their risk management policies and procedures to ensure that they comply with the proposed UDAP regulations;
- review the activities of their credit card and other consumer lenders to ensure they meet the expectations of the banking regulators about their conduct and the conduct of their customers and partners; and
- review carefully any relationship, no matter how profitable, if bank personnel express concern about the appropriateness of the conduct of a customer or third-party partner in dealing with consumers.