The rising tide of UDAP risk.

• Author: Pareigat, Thomas G.
• Position: Unfair and Deceptive Acts or Practices

Marketers face expanded compliance headaches as the new 'abusiveness' standard creates an expectation that banks proactively protect consumers from their own bad choices. Here are some action steps to help your bank shore up its dike in advance of the flood waters of UDAP enforcement.

"Unfair or deceptive acts or practices in or affecting commerce are hereby declared unlawful."

THIS ONE SENTENCE, courtesy of Section 5 of the Federal Trade Commission Act [15 USC 45(a)(1)], is the statutory genesis of the rule we know fondly as "UDAP." While all businesses are generally covered by Section 5 of the FTC Act, federal banking regulators have the authority to cite institutions for engaging in practices that are considered unfair or deceptive.

In recent years, examining agencies have increased their UDAP-related scrutiny and stepped up enforcement activities in this area. Cease and desist orders citing UDAP violations are on the rise and by all indications will continue to grow. With the passage of the Dodd-Frank Act in 2010, supervisory focus on UDAP will become even more intense. The Dodd-Frank Act not only restates the general prohibition against "unfair or deceptive" practices, but it also adds a new standard--"abusive practices"--for which banks may soon be cited. Overall, the UDAP net has grown wider and is being cast even farther by policymakers and regulators. In the end, this means there is greater likelihood that banking practices may be caught in the snare of a UDAP finding.

Core UDAP concepts

Before we delve into the most recent developments in UDAP law and enforcement, let's review the foundational aspects of the rule. To bring clarity to the types of practices that are prohibited, the FTC developed policy statements containing key definitional elements of conduct or practices that may be considered "unfair" or "deceptive."

Over 30 years later, these general standards continue to serve as the foundation for UDAP analysis and enforcement. Over 10 years ago, when bank regulators began seriously enforcing the UDAP rule, they generally adopted the FTC standards, but built upon them with additional industry-specific guidance.

Overall, bank regulator guidance provides insights into how UDAP standards will be applied to the business of banking. We get further insight into how bank regulators, state attorneys general, and even civil courts interpret and apply the "deception" and "unfairness" standards through settlement agreements and other public announcements related to UDAP cases.

Deceptive practices

An act or practice is considered to be deceptive if it has the following three elements: (1) the representation, omission or practice is likely to mislead consumers (2) who are acting reasonably in the circumstances presented, and (3) the representation, omission or practice is material.

Note that under this standard the conduct needs only to be likely to mislead--there is no requirement that consumers were, in fact, misled. It is also important to remember that the focus is on the "reasonable consumer," which generally means the average person who is the intended target market of the product or service. (See sidebar above for examples of practices that have been deemed deceptive.)

Unfair practices

Regulators have more recently begun to rely on the unfairness standard, which defines an unfair practice as one that

* Causes or is likely to cause substantial consumer injury.

* The injury cannot be reasonably avoided.

* The injury is not outweighed by benefits to consumers or competition.

This standard generally focuses on the bank's course of conduct or business practices that result in financial harm. Here, the focus is generally on the lack of consumer choice, or situations where consumers appear to be taken advantage of--by being coerced into making a purchasing decision or by being powerless to avoid financial harm at the hands of the bank. (See sidebar on page 24 for examples of practices that have been deemed unfair.)

Remember when?

UDAP compliance standards have evolved over the years. As noted above, there was a time when UDAP compliance was primarily centered on a bank's disclosure practices--with a focus on accurate advertising copy, well-worded disclaimers and the like. The goal was to be certain that marketing messages and other disclosures were not misleading or deceptive. In response, banks generally developed a series of compliance controls focused on the marketing function--to ensure that the bank's promotional materials and product-related statements accurately described the products' features and benefits.

In today's regulatory regime, regulators continue to cite and prosecute UDAP cases based on this more traditional UDAP analysis, so a bank must not lose focus on ensuring that its marketing and product promotion practices are sound. But in recent years there seems to have been a shift--or perhaps an expansion of the traditional interpretation of UDAP--beyond the realm of appropriate disclosures and into a more paternalistic pattern. We will explore this development and...