Update on Unfair and Deceptive Acts and Practices (UDAP): Select Regulatory and Legislative Activity A presentation to the Financial Service Committee of the Association of Corporate Counsel By: John T. Collins, Esq. January 23, 2008 In the past two years, as subprime problems have escalated, federal bank regulators and Congress have sought to develop standards designed to prevent abusive lending practices. Agreement among regulators and Congress is growing on how to define subprime loans for example, regarding interest rate differentials, there is increasing acceptance that a first mortgage with a rate 3 percentage points above the comparable Treasury rate and a second mortgage with a rate 5 percentage points above the comparable Treasury rate would be deemed to be subprime. But there is less agreement on how to define or prohibit deceptive acts or practices in mortgage lending. Banking agencies have approached the matter with what many view as more caution than Congress, developing proposals that, in the Fed s words, attempt to balance the need for regulation and the need for credit. This summarizes relevant provisions of the FTC Act regarding unfair and deceptive practices and bank agency and Congressional powers and actions to deter such practices. FTC Act A. General UDAP Authority, 15 USC 45. (Sec. 5 of the FTC Act) The FTC is hereby empowered and directed to prevent persons, partnerships, or corporations, except banks, savings and loan institutions and credit unions, from using unfair or deceptive acts or practices in or affecting commerce. B. Bank Regulator UDAP Enforcement and Rulemaking, 15 USC 57a(f). (Sec. 18(f) of the FTC Act) 1. To prevent unfair or deceptive acts or practices by banks or savings and loan institutions, the Act requires each federal bank regulator Fed, OCC, FDIC and OTS and the NCUA to establish a division of consumer affairs to receive and take appropriate action in response to such acts or practices. 2. The Fed, OTS and NCUA are to promulgate rules regarding unfair or deceptive acts or practices by banks and savings and loan institutions. Whenever the FTC prescribes a UDAP rule, within 60 days after such rule takes effect the bank regulators must promulgate substantially similar regulations prohibiting acts or practices of banks or savings and loan institutions. As described below, there is pending legislation to provide the same rulemaking authority that the Fed, OTS and NCUA now possess to the OCC and FDIC. 3. Each of the agencies shall enforce these regulations under 12 USC 1818, the provision of the Federal Deposit Insurance Act which provides all federal bank regulators with cease and desist and other enforcement powers.
C. OCC View of its UDAP Authority In a March 2002 speech, Julie Williams, Chief Counsel of OCC, described the application of section 5 of the FTC ACT to banks, as follows. The question that has been raised recently is whether banks can be held accountable by the banking agencies for violations of section 5 of the FTC Act itself -- or only for violations of a Federal Reserve Board regulation that provides that a specific practice is unfair or deceptive. The answer to that question, from our perspective, is clear just by looking at the FTC Act itself. The Act does not exempt banks from its prohibition on unfair or deceptive practices nor does it provide that enforcement of FTC Act regulations is the exclusive method for enforcing the FTC Act. The answer also is clear if you look at the legislative history of the FTC Act and its amendments. The legislative history does not suggest that when Congress amended the FTC Act to let the Federal Reserve Board issue regulations, it intended to cut back on the authority the banking agencies already had to enforce the general ban on unfair or deceptive practices in section 5. If Congress had intended that, the OCC, FDIC and the Federal Reserve would be left powerless to prevent a bank from engaging in blatantly unfair or deceptive practices that harmed consumers, until the Federal Reserve Board issued a regulation declaring those specific practices to be unlawful under the FTC Act. It is simply implausible that Congress would have intended to create such a void. To put it simply, we believe that if a bank engages in a practice that is unfair or deceptive under the FTC Act, but that has not been defined as such in a Federal Reserve Board regulation, it has nevertheless violated a law and the banking agencies can use their enforcement authority to address the violation. D. The Existing FTC Model The FTC has established a set of guidelines to outline what constitutes an unfair or deceptive act or practice, and the Federal Reserve, FDIC and OCC have incorporated these guidelines into their own guidance on UDAP. Current FTC guidance -- an act or practice is unfair where the act or practice causes or is likely to cause substantial injury to consumers; consumers cannot reasonably avoid the injury; and the injury is not outweighed by countervailing benefits to consumers or to competition. When determining whether an act or practice is unfair, public policy is also taken into consideration. Separately, an act or practice is deceptive under the FTC guidelines if there is a representation, omission or other act or practice that misleads or is likely to mislead the consumer; where, under the circumstances, the consumer makes a reasonable interpretation; and the act or practice is material. The FTC has taken enforcement against non-depository mortgage lenders and brokers to enforce these rules. For example, the agency has taken action to stop aggressive solicitations that misrepresent loan fees, misrepresentation about origination fees, or deception about the true elements of key terms of a loan. D. Fed, OTS and NCUA -- Credit Practices Rules (adopted in 1985 following the adoption by FTC of a similar rule) The Credit Practice Rules prohibited: 1. (a) confessions of judgment, (b) certain waivers regarding attachments of personal or real property, and (c) assignment of wages or other earnings. 2. Misrepresenting the nature of a cosigner s liability. 3. Imposing delinquency charges on late fees and delinquency charges on prior payments. - 2-
E. OCC Advisory Letter on Unfair and Deceptive Acts and Practices (2002) OCC issued this Letter to set out its standards in this area which OCC indicated also reflected FTC pronouncements. Under the Advisory Letter, a deceptive act or practice generally involves a representation or omission that is likely to mislead a reasonable consumer in some material way. Whether particular conduct constitutes an unfair act or practice would depend on the particular facts and circumstances presented, but generally would involve acts or practices that are unscrupulous, unconscionable, or contrary to public policy, and that harm consumers. Three elements need to be met to find an act deceptive: 1. To be deceptive, the act or practice does not need to actually mislead -- it just needs to be likely to mislead. So, a showing that consumers were actually misled would not be necessary. Instead, in determining if something is likely to mislead, one must consider the overall impression created by the representations or omissions of information to see how they reasonably could be interpreted. 2. Something is likely to mislead if it is likely to mislead a reasonable consumer. The reasonable consumer is a consumer from the class of people to whom the advertisement or solicitation is directed. 3. Any deception needs to material. Materiality means that the deceptive omission or representation is likely to affect the customer s decision about the product -- particularly, if it concerns the cost of the credit product or some other key consideration. A practice also may be found to be unfair and therefore unlawful under section 5 of the FTC Act generally if the net effect of the practice is to cause substantial consumer harm that could not reasonably have been avoided by the consumer. In 2000, OCC first used its authority under the FTC Act to take action against a national bank that it determined had engaged in deceptive marketing of credit cards targeted to borrowers with weak credit histories. G. OCC Preemption Final Rule (Questions and Answers, January 7, 2004) Consumer complaints and protection: The final rule revises the OCC s anti-predatory lending standard so that it expressly prohibits national banks from engaging in unfair and deceptive trade practices under Section 5 of the FTC Act in making any loans. H. 2007 --- Fed HOEPA proposal; OTS Advanced Notice of Proposed Rulemaking on Deceptive Acts or Practices; and Congressional proposals to extend rulemaking to OCC and FDIC 1. Agency actions December 12, 2007 -- Fed HOEPA Proposal criticized for not being tough enough --- e.g., regarding subprime loans, only prohibits creditors from engaging in a pattern or practice of making such loans without regard to repayment ability; permits prepayment penalties up to 60 days before the first reset; and regarding all loans, would permit YSPs if properly disclosed to a borrower. August 6, 2007 -- OTS ANPR purpose was to review its regulations dealing with unfair or deceptive acts or practices to determine what additional regulation is needed to ensure consumers are treated fairly. Raised issues and approaches. Comment period closed November 5. Covers all loans but OTS staff says any final action will not overlap with the Fed s HOEPA proposal. - 3-
2. H.R. 3526 Passed by House this past December would amend section 18(f) of the FTC Act to: a. provide the OCC and FDIC with the same rulemaking authority as the Fed and OTS currently possess under that provision. b. require that bank agencies consult with the FTC before promulgating regulations. c. require that bank agencies promulgate rules jointly to the extent practicable. Note: a principal purpose of the bill was to push the Fed along in its HOEPA rulemaking. The House Financial Services Committee Report on the legislation (H.Rept. 110-472, 12/5/08) included the following discussion of the UDAP rulemaking provision: Since this authority was granted in the 1970s, the three named agencies [Fed, OTS and NCUA] have used it very sparingly. Despite a statutory requirement (Section 18(f)(1) of the Act) that they shall prescribe regulations identifying and preventing such acts and practices, the agencies have issued only a handful of rules, generally only acting following formal rulemakings by the Federal Trade Commission. For example, in 1985 the agencies issued equivalents of the FTC s Credit Practices Rule following the FTC s action in 1984. There has been no major rulemaking under this authority since, however. While the statute requires the three banking agencies to act when the FTC does, their authority (and mandate) to issue rules of their own is not dependent upon FTC action. This lack of clear rules has led to an absence of consumer protections across a broad range of financial products and services (emphasis added). Consumer advocates have identified many financial practices in areas ranging from checking account overdraft fees to universal default credit card interest rate increases that can disadvantage consumers, yet few of these have been addressed by an open, transparent regulatory process. Regulators have claimed that their private examination procedures and enforcement actions are designed to address many unfair and deceptive practices, but neither the Committee nor the public has the ability to evaluate the effectiveness of these processes they are by nature closed to public scrutiny. In addition, such non-public enforcement, unlike a standard rulemaking, provides no guidance either to other institutions or to consumers about which practices are unfair or deceptive. In a July 25, 2007 Financial Services Committee hearing, consumer witnesses argued that consumers and financial institutions alike would benefit substantially from transparent, clear rules and enforcement. In a June 13, 2007 hearing, the Comptroller of the Currency and the Chairman of the FDIC, two agencies that have taken independent enforcement actions against unfair and deceptive practices but do not have rule writing authority under the FTC Act, recommended that the Committee make these changes. FDIC Chairman Sheila Bair s testimony stated: In order to further strengthen the use of the FTC Act s rulemaking provisions, the FDIC recommends that Congress consider granting Section 5 rulemaking authority to all federal banking regulators. By limiting FTC rulemaking authority to the FRB, OTS and NCUA, current law excludes participation by the primary federal supervisors of about 7,000 banks. Including the perspectives of the supervisor of some of the nation s largest banks and the perspectives of the supervisor of the largest number of banks, as well as the deposit insurer, would provide valuable input and expertise to the rulemaking process. As a practical matter, these rulemakings would be done on an interagency basis and would benefit from the input of all interested parties. Comptroller John Dugan s testimony stated: * * * [T]he OCC would support the extension of FTC Act rulemaking authority to all of the federal banking agencies, so that we could, as necessary, write joint rules that define unfair or deceptive practices and establish requirements that are designed to prevent such acts or practices. Such authority would be helpful to establish across the- board rules to prohibit especially egregious practices. - 4-
3. S. 2452 Subprime/anti-predatory lending bill introduced by Senator Dodd earlier in January. Similar to H.R. 3526 regarding UDAP, but: a. does not require consultation or joint rulemaking. b. specifically indicates that a violation of a bank agency rule would constitute a violation of a requirement imposed under the FTC Act. c. bank agency rules under this provision would be considered supplemental to State unfair and deceptive acts and practices laws and may not be construed to preempt any State law that provides equal or greater protection. John T. Collins is a partner in the Financial Service Practice in the Washington, DC office of Steptoe & Johnson LLP. Read more about John by visiting http://www.steptoe.com/professionals-159.html John can be reached at 202.429.8047 or jcollins@steptoe.com - 5-