Danger Ahead: Focus on "Unfair and Deceptive Risks and Practices" Has Now Sharpened. Its Scope Is Limitless; Its Standards Unclear: The Hidden Risks of "UDAP" Will Transform Compliance. Here's What You Must Do

[ILLUSTRATION OMITTED] Every bank is navigating the stormy seas consumer compliance. New rules are raining down and a new consumer protection entity looms on the horizon (at this writing, pending financial reform will either create an agency or, at the very least, sharply heighten scrutiny by existing regulators). The biggest risk ahead, however, is barely a blip on most banks' sensors, despite being huge, close, and coming fast. A new focus on unfair and deceptive acts and practices--UDAP--is about to transform bank risk. Most the industry hasn't yet spotted it, since examiners rarely raise concerns and enforcement cases are few. This issue, nevertheless, will soon be one the toughest compliance challenges banks have ever faced. Arguably, UDAP caused the financial crisis and recession. That's an oversimplification, obviously, but the meltdown started in subprime loans, and it involved products that largely met technical legal requirements. Despite this, they enticed millions people to take loans carrying huge and hidden dangers. Sales tactics mixed with product design left these borrowers, investors, and ultimately the financial system, vulnerable to a drastic misperception risk. The technical legal rules, the whole disclosure regime, failed. Regulators did issue guidance on some these practices. The industry did self-police. Most banks never touched these kinds products. Nevertheless, things went wrong in plain sight--inside the lines explicit legal rules. In such an environment, a vigorous regulatory response is inevitable. And on consumer issues, regulators have in their hands a highly potent tool--UDAP. There is no possibility that they will not use it. Unfair and deceptive practices were outlawed in the Federal Trade Commission (FTC) Act nearly 70 years ago. For much that period, bank regulators essentially argued that their supervisory obligations excluded the FTC Act, other than through Regulation AA--the Credit Practices Rule. Gradually, however, the banking agencies began issuing supervisory guidance on UDAP and related issues. They also began to bring enforcement cases. Then the Fed took the ground-breaking step citing UDAP as statutory authority in proposing new regulations. Caught between suitable and discriminatory All this has intensified since the financial crisis. The bank regulators face calls to strip them consumer protection jurisdiction. Their pushback includes, at this writing, development unprecedented joint examination procedures for UDAP. The pending reform legislation, meanwhile, will quite probably add the term to the statutory mix. A new agency, if created, will likely be charged broadly with monitoring developments in markets to identify risks to from unfair, deceptive, or abusive products, services, or sales practices. These would include activities and pricing the agency considers too complex for consumers to understand, and situations where it thinks lenders take unreasonable advantage of the consumer's trust. This language effectively embraces the concept suitability, which has (so far) been too controversial to legislate outright. It posits a bank obligation to make its products and prices appropriate for every customer. That in turn puts the bank on a knife's edge, barred from denying credit in ways that might be discriminatory, and also from extending services too liberally to financially-challenged customers. On top all this, banks must prepare for state enforcement--potentially even banks with national charters. Almost all states now have UDAP laws, and federal preemption has been weakened in the wake court rulings and the pending reform legislation. Highly subjective standards So the UDAP challenge is inevitable. It is also uniquely difficult to meet. First, it's a moving target, growing faster than most banks realize. …