In the 848 pages of the Dodd-Frank Act, a short provision, Section 1013, authorizes the new Consumer Financial Protection Bureau to take enforcement action to prevent "unfair, deceptive or abusive acts or practices" in connection with consumer financial transactions.
While this provision is a variant on UDAP language that has been a feature of federal law for many decades, in the hands of the CFPB and in the current environment, it could turn out to be the most consequential part of Dodd-Frank, changing the compliance paradigm for banks and other financial services providers.
Historically, consumer protection has been a check-the-boxes process in which banks were told to make sure that specific disclosures were provided and discrimination avoided. But, given the apparent ineffectiveness of the disclosure process in preventing many consumers from committing to loan terms that did not work for them, some consumer advocates urged enactment of legislation requiring lenders to assure that a loan was "suitable" for the borrower.
Banks understandably objected that this would impose on them a fiduciary duty to the borrower that is inconsistent with free market principles. The suitability standard was not included in the legislation, but what did emerge was a renewed congressional mandate that the consumer be treated fairly.
How will this fairness standard be applied in practice?
If a lender were to promote or facilitate a loan that is clearly inappropriate for the borrower, the CFPB can be expected to deem that practice unfair. Not only at origination, but throughout the life of the loan, lenders will have to take care to avoid unreasonable requirements or clearly excessive charges for services that would be judged to be unfair by an objective observer.
While the fairness standard will be a powerful enforcement tool in the hands of the CFPB, the agency would be wise to promptly exercise its statutory authority to provide written guidance regarding fairness to the companies it regulates. If the CFPB simply relies on enforcement actions or compelled settlements to define fairness, this might itself be judged unfair by the courts.
What can be expected to emerge over time from a combination of written guidance and enforcement actions will be a sort of common law of fairness governing financial institutions' dealings with their customers.
This will require strong and wise leadership at the CFPB. And, having made such a broad grant of authority to the CFPB, Congress would do well to exercise its oversight powers to review how the UDAP provisions of Dodd-Frank are being implemented.
It would be a serious mistake for any bank or other provider of financial services to sit back and wait to see what happens with respect to the Dodd-Frank UDAP provision.
To assure enterprise risk management, bank boards of directors and senior management should move promptly to establish a fairness-awareness culture to assure that every product, service and interaction the bank has with the consumer is fair. No longer will it be sufficient to check the boxes to be sure that consumer disclosures have properly provided and that there has been no discrimination against a member of a protected class. Assuring fairness will need to be a part of the DNA of every bank, informing every decision a bank makes that impacts a consumer.
The first step a bank should take is to conduct an enterprisewide review of each interaction it has with consumers.
Every loan product, every fee, every underwriting guideline, every pricing matrix, every servicing policy, every communication (including internal communications) should be reviewed. It may be found that to enhance revenue, certain fees that bear no relationship to services rendered have accreted to the bank's customary fees and charges. Or it may be found that a consumer's ability to meet his or her credit commitments has not been adequately tested in the loan underwriting process.
The shift to a fairness-awareness culture will force a re-examination of a wide range of practices.
A good test might be, "If my child were a customer at another bank, would I feel she was treated fairly if that bank adopted the practices that are standard at my own bank?"
Of course, properly implemented, fairness awareness should enhance the bank's relationship with its customers, building brand loyalty.
At the very least, a fairness-awareness process should protect the bank from the legal, monetary and reputational risk associated with a CFPB enforcement action. In any case, making fairness awareness a strategic priority should be at or near the top of the to-do list for every bank CEO and board of directors.
