October 13 2005
The Federal Trade Commission Act(1) has prohibited unfair and deceptive acts or practices in commerce for almost 70 years. However, until the turn of the century, federally regulated financial institutions rarely needed to be concerned that their practices might be challenged as unfair or deceptive. The enforcement climate has now changed.
Although primary authority for enforcing the act rests with the Federal Trade
Commission (FTC), the federal financial regulatory agencies(2)
now themselves enforce the act's provisions as to the institutions under their
regulatory authority. As this new enforcement structure has emerged, the FTC
has placed renewed emphasis on challenging practices that are deemed to be 'unfair',
even if deception did not accompany implementation of the acts or practices.
The regulators have followed this lead and have alleged violations of the act
in connection with credit card solicitations, loan terms and loan servicing
The compliance challenge is complicated by the fact that specific, detailed guidance has not been provided by either the FTC or the regulators. In contrast, regulations, which are quite specific, guide enforcement of other laws designed to protect consumers, such as the Truth in Lending Act(3) and the Equal Credit Opportunity Act.(4) Financial institutions should not expect comparable guidance for complying with the FTC Act.
Rather, banks and other financial institutions must develop their own plans for compliance. To do so, it is important to understand the meaning of the terms 'unfair' and 'deceptive', and also to master the analytical framework applied by the FTC and the regulators to examine the same issues. The regulators have supplied some helpful guidance in this regard.
The task is by no means easy, since subjective judgements play a major role in the final outcome. This is particularly true in evaluating an act or practice that might be challenged as unfair. Definitions of the legal terms to guide enforcement are now available, but the definition applied by former Supreme Court Justice Potter Stewart to the term 'obscenity' is equally applicable to 'unfairness': "I know it when I see it."(5)
Bankers may take some comfort in knowing that federal enforcement officials
themselves have been confused for many years as to the meaning of these terms
and how they might apply to federally regulated financial institutions. It is
useful to understand this background. The criticisms encountered by the FTC
for applying 'unfairness' in the past suggests that the agency will be judicious
in relying on that authority in the future. At the same time, the failure of
the regulators to enforce the FTC Act until recently has caused them to be quite
aggressive in enforcing the law today.
The compliance challenge can be significant since marketing and sales staff generally strive to emphasize the benefits of their products and services to consumers, while giving scant notice of the limitations. Deceptive marketing, for example, may increase business profits, which is the primary objective of the sales and marketing staff. The profit can quickly disappear, however, if the institution is charged with a violation of the FTC Act. In fact, the reputational damage caused by such an accusation may be irreparable.
Application to Federally Regulated Financial Institutions(6)
The Federal Trade Commission Act was originally enacted in 1914 and was amended
in 1938 to prohibit "unfair or deceptive acts or practices in or affecting
commerce".(7) Enforcement of the
law was assigned to the FTC, but banks were exempted from the FTC enforcement
authority. In the early 1970s, exchanges between members of Congress and the
banking agencies considered whether the banking agencies themselves had the
authority to enforce the FTC Act as to the institutions they regulated, with
some of the agencies opining that such authority existed pursuant to a provision
of the Federal Deposit Insurance Act that granted authority to remedy a violation
of any "law, rule or regulation".(8)
In 1975 Congress again amended the FTC Act to require each banking regulatory agency to establish a division of consumer affairs to address complaints alleging violations of the FTC Act, and also required the Federal Reserve Board to develop regulations "defining with specificity such unfair or deceptive acts or practices, and containing requirements prescribed for the purpose of preventing such acts or practices".(9)
The wording of the amended law created uncertainty as to whether a banking agency's authority was limited to enforcing regulations that the Federal Reserve Board might adopt, or whether the agency could enforce the FTC Act itself. If the former were the standard, the agencies would be quite limited inasmuch as the Federal Reserve Board issued regulations only once and addressed only limited issues.(10)
The issue lingered for 25 years until the comptroller of the currency concluded, in connection with a 2000 supervisory action, that the agency had authority to address a violation of the FTC Act even if the challenged practice had not been prohibited by regulation.(11) In 2002 Federal Reserve Board Chairman Alan Greenspan agreed that the agencies had authority to enforce the FTC Act, contending:
"it is difficult to craft a generalized rule sufficiently narrow to target specific acts or practices determined to be unfair or deceptive, but not to allow for easy circumvention or have the unintended consequence of stopping acceptable behaviour."(13)
Thus, in order for federally regulated institutions to comply with the FTC
Act, an understanding of what is deemed to be an 'unfair' and 'deceptive' act
or practice is crucial.
Application of 'Unfair' Prong of the Act
Just as the financial regulatory agencies struggled with their authority to enforce the FTC Act, the FTC itself struggled with the substantive interpretation of the act, particularly the portion designed to prohibit practices that might be perceived as unfair. In the 1970s, for example, the FTC viewed the 'unfair' prong of the statute as allowing the agency to address practices that, in its view, offended public policy or were immoral, unethical, oppressive or unscrupulous, or caused substantial injury to consumers.(14) Critics charged that such a standard authorized enforcement based on the personal values of the enforcement officials. Using such a standard, the FTC tried to ban all advertising directed at children, and suggested its authority could be used to restrict the employment of illegal aliens and to punish tax cheats and polluters.(15) A Washington Post editorial referred to the FTC as the "National Nanny".(16)
Congressional opposition to the FTC's views was strong. At one point the agency was shut down for a few days because of a lack of funding, and Congress did not reauthorize the FTC for a period of 14 years.
On December 17 1980 the FTC adopted the Unfairness Policy Statement, which was designed to address these criticisms.(17) The policy identified consumer injury as the most important component of an unfairness analysis. Such injury:
This new policy was applied cautiously through the 1980s, and finally in 1994
Congress reauthorized the FTC and formally amended the law to adopt the definition
of 'unfairness' stated in the Unfairness Policy Statement. Congress also codified
the limited role that public policy may play in FTC decision making. The FTC
may consider public policies, but it cannot use public policy as an independent
basis for finding unfairness.(20)
Even though the congressional action seemingly resolved the long debate, the FTC rarely used the new statutory definition to label practices as unfair for several years after the 1994 amendments. As the decade approached its end, however, the agency began to identify a role for the unfairness authority, challenging unauthorized billing (or 'cramming') by telephone companies and newly emerging internet trickery.(21) In recent years the agency has concluded that certain lending practices, particularly those that might be deemed to be predatory, are appropriate for challenge using the unfairness authority.
The Meaning of 'Unfair' and 'Deceptive' Today
Each enforcement agency is guided by the statutory principle that unfair or deceptive practices are unlawful. Now defined by statute, 'unfairness' challenges will be raised if an agency concludes that the act or practice:
Each of these factors is an important part of the legal analysis. For example,
an act or practice will not be challenged as unfair unless the agency concludes
that the act or practice has caused or is likely to cause substantial injury
to consumers.(23) This usually means
monetary harm and generally does not include intangible factors such as emotional
distress. The harm need not actually have occurred, however, if the agency concludes
that the harm was likely to occur. Also, the agencies will consider the harm
to be substantial even if no individual consumer suffered a major harm, as long
as a large number of consumers suffered at least some harm. The harm to consumers
is the most significant factor in agency consideration, and without substantial
consumer harm it is unlikely that enforcement agencies will label an act or
practice as unlawfully unfair.
Even if substantial consumer harm is present or likely, enforcement agencies will evaluate whether consumers could reasonably avoid the injury. Agencies try not to second-guess the decision of an informed consumer even if the decision was unwise. However, the agencies will consider whether material information was withheld from the consumer so that the choice made was not, in fact, informed.
Equally significant, enforcement agencies will consider whether the consumer injury, even if reasonably unavoidable, is outweighed by countervailing benefits to consumers or to competition. For example, the FTC declined to prohibit provisions of consumer credit contracts requiring debtors to pay attorneys' fees in debt collection proceedings. Obviously, such a provision might harm consumers, but the agency recognized that creditors are often not fully reimbursed for collection costs and that prohibiting the provision might increase legal costs by encouraging additional litigation. On balance, the agency concluded that the costs of the considered prohibition outweighed the benefits that might be achieved.(24)
In sum, application of the unfairness standard is essentially a cost-benefit analysis, starting with the harm to consumers and balancing such harms against countervailing benefits to consumers or to competition. Considerations of public policy may play some role in the analysis, but will not serve as the primary basis for the ultimate decision.
Like the unfairness analysis, the primary focus of challenges based on a claim of deception is on preventing consumer injury. The deception analysis, however, does not look for offsetting benefits to consumers or to competition. Rather, it is presumed either that false or misleading statements have no benefit or that the injury that is inflicted on consumers could be avoided at little cost to the organization responsible for the deception.
A deceptive act or practice is a representation, omission or practice that is likely to mislead consumers who are acting reasonably in the circumstances presented. To be unlawful, the representation, omission or practice must be material - that is, it must be likely to affect a consumer's choice to buy or use the product.(25) In general, information about costs, benefits or restrictions on the use or availability of a product or service is material.(26) Knowingly false statements will be presumed to be material, and omissions will be presumed to be material when the advertiser knew or should have known that the consumer needed the information to evaluate the product or service.(27)
An FTC official recently summarized the types of unlawful deception by stating:
An act or practice may be challenged as unfair or deceptive even if it technically
complies with other laws that are designed to protect consumers, such as the
Truth in Lending Act,(32) the Truth
in Savings Act,(33) the Equal Credit
Opportunity Act,(34) the Fair Housing
Act(35) or the Fair Debt Collection
Practices Act.(36) For example, a creditor's
disclosures may comply with the Truth in Lending Act, but the accompanying solicitation
may be deemed deceptive if it states falsely that the rate is guaranteed for
life. Similarly, an unfair or deceptive act or practice can also violate other
consumer protection laws. For example, predatory lending practices targeted
at minority consumers may constitute a violation of both the FTC Act and the
Fair Housing Act.
FTC Enforcement of the Act
By filing more than 20 cases since 1998, the Federal Trade Commission has applied its enforcement authority to challenge lending practices that it views as predatory.(37) The great majority of these actions challenged practices that were deemed to be deceptive. For example, in 2000 the FTC filed a lawsuit against First Alliance Mortgage Company alleging that the company misled consumers regarding loan fees and interest rates, such that "consumers believe they are borrowing less money at a lower interest rate than they actually are".(38)
In a 2002 settlement involving The Associates, the FTC obtained the largest monetary award for consumers in the agency's history, after alleging that the company utilized deceptive lending practices, such as the packing of unwanted credit insurance on consumers' loans.(39) The next year, in a 2003 action against Stewart Finance, the agency again alleged that the company deceptively sold other products with its personal loans, such as insurance and car club memberships.(40)
As the FTC enforcement drive has continued, the agency has utilized its authority to challenge practices that, even if not 'deceptive', were deemed to be 'unfair'. For example, in a November 2003 settlement with Fairbanks Capital, a company engaged in the servicing of subprime loans, the FTC alleged that the company implemented both unfair and deceptive practices. The 'unfairness' authority provided a neat fit for portions of the challenge since, as a servicer, the defendant had made few representations to the borrowers, but was nevertheless implementing practices that cried out for legal challenge, such as failing to post loan payments when received and then charging a late fee when the payment was finally posted after the due date.(41)
Enforcement by Federal Financial Regulatory Agencies
All indications are that the federal financial regulatory agencies will closely mirror the FTC efforts as to lenders under their supervisory authority. For example, in 2004 the Office of Thrift Supervision entered into a supervisory agreement with Ocwen Federal Bank, applying the FTC Fairbanks model to address issues of deception and unfairness in the servicing of subprime loans.(42)
The Office of the Comptroller of the Currency (OCC) boasts on the agency's website that: "The OCC has taken the lead among bank regulatory agencies in developing effective approaches to protecting America's consumers."(43) Since its first FTC Act enforcement case in 2000, the OCC has filed nine other enforcement actions under the FTC Act. Like the FTC, most of the OCC's actions have addressed deceptive practices (particularly in credit card marketing), but the agency's more recent actions have included claims based on unfairness.(44)
The OCC has released guidance on several occasions in recent years. On March 22 2002 the OCC issued an advisory letter entitled "Guidance on Unfair or Deceptive Acts or Practices", to "help national banks avoid being placed in jeopardy of penalties, judgments and harm to their reputation that can result from [unfair or deceptive] practices".(45) In April 2004 the agency issued an advisory letter providing a stern warning regarding the terms of secured credit cards.(46) In September 2004 the agency provided guidance on other credit card practices that may constitute unfair or deceptive acts or practices.(47) More recently, in February 2005 the agency released OCC Guidelines Establishing Standards for Residential Mortgage Lending Practices.(48) An overarching objective of the most recent guidance is that a "[b]ank must not become engaged in abusive, predatory, unfair or deceptive practices, directly, indirectly through mortgage brokers or other intermediaries, or through purchased loans".(49)
On March 11 2004 the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System issued joint guidance entitled "Unfair or Deceptive Acts or Practices by State-Chartered Banks".(50) The agencies said the purpose of the guidance is:
Other credit card practices that have evoked agency attention include 'up to'
marketing (eg, 'You can receive a credit limit of up to $10,000'), and promotional
or teaser rate marketing (eg, 'We are offering a promotional interest rate of
only 4%'). Neither practice is unlawful per se, but the agencies will
examine whether the promotional materials are likely to mislead consumers. For
example, the materials may cross the line into deception if, in fact, a very
small percentage of consumers receiving the solicitation are actually eligible
for the $10,000 credit limit. Similarly, the limitations of the teaser rates
would have to be fully disclosed (under the four Ps test) to ensure against
a challenge based on deception.
Further, the agencies will attempt to determine the impact of the overall solicitation and disclosures from the perspective of the audience to whom the creditor was marketing. A credit card solicitation programme directed towards an immigrant neighbourhood, for example, might require more careful disclosures than the same product marketed towards a neighbourhood composed of persons with greater credit experience and sophistication.
Developing a Plan for Compliance
It is important that bank compliance officials fully understand the analytical framework of the regulators, and that they themselves apply the analyses to the institution's policies, practices, procedures and marketing programmes. The agencies' publications cited above provide helpful guidance for compliance officials, such as the following:(53)
The need for clear and accurate disclosures that are sensitive to the sophistication of the target audience is heightened for products and services that have been associated with abusive practices. Accordingly, banks should take particular care in marketing credit and other products and services to the elderly, the financially vulnerable and customers who are not financially sophisticated. In addition, creditors should pay particular attention to ensure that disclosures are clear and accurate with respect to:
Agency officials have also stressed the importance of providing a clear avenue
for consumers to voice complaints that they may have regarding practices they
view as unfair or deceptive. It is suggested that banks and other creditors
clearly disclose a telephone number or mailing address, email or website address
that consumers may use to contact the bank or its third-party representative
regarding any complaints they may have. Banks should implement procedures for
fairly addressing and resolving such complaints. The complaints themselves can
be used as a vehicle for evaluating whether marketing or other materials are
actually conveying the message to the target audience as intended by the institution.(55)
In addition, a meaningful compliance plan requires the delegation of substantial authority to the compliance staff. It should be expected that compliance officials frequently may clash with sales staff and marketing officials in light of their differing roles. The usual objective of sales and marketing officials is to maximize profits. Thus, such officials want to emphasize the benefits of products and services, and not the limitations. However, if the limitations are not fully disclosed to consumers, the institution may be charged with implementing unfair or deceptive practices. Thus, meaningful input from the compliance staff is crucial for compliance.
Similar issues may arise in dealing with outside companies, such as marketing or solicitation firms, which are hired to perform services on behalf of the institution. Banks must be cautious to remember that they can be liable for the acts and practices of those with which they establish certain business relationships.
For example, promotional or teaser rates for mortgages or credit cards are designed to attract new customers to an institution. Marketing staff, or outside vendors, may argue for fine print explaining that the rate remains in effect for a brief period or that it is applicable only to certain charges, such as balance transfers. In reality, such personnel may not want the consumer to focus on these limitations. However, unless the marketing material is presented in a manner that effectively informs the consumer of the limitations of the programme, the institution may be charged with a violation of the FTC Act.
The message of compliance must emanate from the top officials of an institution.
Each department may have its own parochial interests, but senior management
needs to provide the balance that considers all interests, and, most importantly,
mandates decision-making that minimizes the risks of non-compliance. Although
it may hurt an institution to reimburse consumers at the directive of a regulatory
agency, it is even more harmful to face the reputational damage that is caused
by a finding that the institution has engaged in acts or practices that are
unfair or deceptive. Such damage often is irreparable.
Compliance with the FTC Act presents new challenges for federally regulated financial institutions. In five brief years, the regulatory agencies have dramatically increased their focus on compliance with this act and the FTC has found new methods of addressing issues in the lending industry. At the same time, guidance now is available for the development of a compliance plan. Financial institutions may be required to apply compliance methodologies and thought processes differently than they have applied in the past, but an understanding of the analytical framework utilized by the agencies provides a strong foundation for a compliance plan. As bank officials focus on these issues, they likely will agree that their acts and practices should not be unfair or deceptive to consumers, and a sound compliance plan should promote a realization of that objective.
(2) The term 'federal financial regulatory agencies' encompasses the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency and the Office of Thrift Supervision.
(6) The history of enforcement of the FTC Act by the federal financial regulatory agencies is derived from "On the Same Page: Federal Banking Agency Enforcement of the FTC Act to Address Unfair and Deceptive Practices by Banks" by Julie L Williams and Michael S Bylsma, The Business Lawyer, Vol 58, at 1243-58 (May 2003). Readers are referred to the article for a more complete analysis of the background.
(12) Letter from Chairman Alan Greenspan to Representative John J LaFalce (May 30 2002) available at www.federalreserve.gov/boarddocs/press/bcreg/2002/20020530/attachment.pdf.
(14) The history of the FTC's use of the 'unfairness' authority as described in the text is taken from a paper prepared by J Howard Beales, III, a former director of the FTC's Bureau of Consumer Protection. The paper is entitled "The FTC's Use of Unfairness Authority: Its Rise, Fall and Resurrection" and is available at www.ftc.gov/speeches/beales/unfair0603.htm.
(23) On November 30 2004 the American Bankers Association (ABA) conducted a telephone briefing entitled "Unfair or Deceptive Acts and Practices: The New Supervisory Enforcement Spectre". Presenters included Peggy L Twohig of the Federal Trade Commission, Robert E Cook of the Federal Reserve Board, Michael S Bylsma of the Office of the Comptroller of the Currency and the author of this update. The text above summarizes the views of the representatives of the regulatory agencies that were expressed during the briefing and the written materials they submitted. A recording of the briefing and the written materials utilized are available from the ABA. A transcript of the presentations is available from the author.
(26) See, for example, Statement of Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, entitled "Unfair or Deceptive Acts or Practices by State-Chartered Banks", dated May 11 2004, at 4. The statement is available at www.federalreserve.gov/boarddocs/press/bcreg/2004/20040311/default.htm.
(37) A listing of the FTC's actions against subprime lenders is available at www.ftc.gov/opa/2002/07/subprimelendingcases.htm.
(38) Federal Trade Commission v First Alliance Mortgage Company, Civil No SACV 00-964-DOC (MLGx)(CD Calf), settlement announced on October 4 2000. See www.ftc.gov//bcp/conline/edcams/famco/index.html. State attorneys general enforce state laws that are comparable to the federal FTC Act. These laws are often referred to as 'mini-FTC acts'. State attorneys general also have been aggressive in challenging lending practices that they believe to be unfair or deceptive. The action against First Alliance Mortgage Company was a joint effort between the FTC and a number of state attorneys general. In fact, state attorneys general obtained the largest direct restitution amount ever in a state or federal consumer case (approximately $484 million) in their action against Household Finance Corp. See www.naag.org/issues/20021011-multi-household.php.
(39) Federal Trade Commission v Associates First Capital Corp, No 1:01-CV-00606 JTC (ND Ga), settlement announced on September 19 2002. See www.ftc.gov/os/2002/09/associates.pdf.
(40) Federal Trade Commission v Stewart Finance Company Holdings, Inc, Civ No 103CV-2648 ND Ga), settlement announced on October 28 2003. See www.ftc.gov/opa/2003/10/stewart.htm.
(41) United States v Fairbanks Capital Corp, Civil No 03-12219 (D Mass), settlement announced on November 12 2003. See www.ftc.gov/opa/2003/11/fairbanks.htm.
(42) The Supervisory Agreement is available at www.ots.treas.gov/docs/9/93606.pdf
(43) See www.occ.gov/consumernews.htm.
(45) OCC Advisory Letter AL 2002-3 (March 22 2002), available at www.occ.gov/ftp/advisory/2002-3.doc.
(46) See www.occ.gov/ftp/advisory/2004-4.doc. The letter "discusses the OCC's particular concerns regarding secured credit card programmes in which security deposits (and fees) are charged to the credit card account, with the result that the consumer has little or no available credit or card utility at account opening", and adds that "this type of secured credit card product is not appropriate for national banks, and should not be offered by them".
(47) See www.occ.gov/ftp/advisory/2004-10.txt.
(48) See www.occ.gov/ftp/bulletin/2005-3a.pdf.
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