UDAAP testing: A vital component of your internal monitoring program

I am sure that compliance officers often find themselves asking the same question that I repeatedly ask myself, “Could this be a UDAAP issue?” Unfair, Deceptive, or Abusive Acts or Practices (UDAAP) can be overwhelming to financial institutions since it can be very subjective and squeeze its way into the cracks of products and services that are compliant with all other consumer regulations. 

Because UDAAP is a principles-based requirement with an expansive scope, compliance officers are often unsure of where to start testing, but there are many areas that can easily be tested internally by financial institution staff. 

UDAAP testing should be part of an ongoing process that is built into routine monitoring activities.  

Here are some test steps that could be taken to help your financial institution avoid potential UDAAP issues.  

1. Review all disclosures provided to consumers to ensure they are presented in a clear manner so that even a second grader can understand the fees and benefits of the individual products. In addition to applicable fees for the product, the disclosures should clearly indicate any optional add-on products and associated fees. 
2. Regularly test the product disclosures and agreements against the core system parameters to ensure consistency for both deposit and loan products. The testing is also crucial after your institution implements core and software system updates because often a system update will cause a field to revert to a prior setting, resulting in discrepancies between the current disclosures provided to the consumer and what the system is actually doing. Examples of items to check on the system include: 
   • Name, amount and timing of fees as compared to the disclosures 
   • Interest rates 
   • Interest calculation and accrual methods 
   • Amount and timing of late charges
   • Calculations for minimum payment amounts and minimum finance charges 
   • Timing and limitations for interest rate changes for variable rate loans and deposits
3. Test to determine whether deposit accounts are set up in a manner that allows the average account holder to avoid fees. An easy test step for this is to determine whether the minimum balance to open an account is considerably less than the minimum amount to avoid a service fee. For example, consider a situation where a consumer opens an account with a minimum amount of $100, but a $10 monthly service fee is charged if the minimum account balance falls below $2,000; this could be considered deceptive.   Consider waiving the first month’s service fee in these cases to reduce UDAAP risk. 
4. Ensure consumers are not charged unfair fees for requesting information regarding their account. If the consumer will incur a penalty for closing an account, verify the penalty is clearly disclosed to the consumer and only assessed for appropriate situations.   
5. Test various requirements of Regulation E that also have UDAAP implications. Error resolution procedures should not require consumers to work with merchants or file police reports prior to the financial institution beginning the error resolution process. Not only does that violate Regulation E, it could also be considered unfair to the consumer. You should also test the overdraft program for the following: 
   • Ensure consumers are not required to opt in to the payment of overdrafts and related fees for one time point of sale or ATM transactions and confirm consumers who do opt in receive benefits that are not available to consumers who do not opt in. 
   • Check posting order of transactions to confirm that multiple overdraft fees are not charged for a single debit card transaction and ensure the posting order of transactions does not result in excessive fees.
   • Ensure overdraft and continuous overdraft fees are only charged as disclosed to the consumer, and only on business and processing days.
6. For loans, test to ensure that payment crediting is completed in a timely manner so a borrower is not charged an unfair late fee. Regulation Z contains specific requirements relative to the timing of payment receipt and crediting. You should also examine procedures for timely release of liens and refunding private mortgage insurance premiums upon payoff.  
7. Test flood insurance to determine whether any borrowers have flood insurance that exceeds the insurable value of the property securing the loan. If so, ensure that your institution did not require insurance at that level.
8. Test all marketing materials to ensure consistency with product disclosures. Marketing materials should include clear disclosures and other language allowing the consumer to easily understand the product. You should draw attention to the terms and conditions of the product and avoid fine print, especially when disclosing the required fees or limitations of the product. If a UDAAP issue is noted on an advertisement, it is important to correct other related advertisements such as on your financial institution’s website or social media posts. Including a line item to check for UDAAP on the approval of marketing pieces is an easy place to document that your institution considered UDAAP on the advertisement prior to its release.  
9. Test the complaint resolution process and ensure that management completed proper resolution for each complaint received. Often looking at all complaints, instead of each individually, can allow UDAAP issues to come to the surface. Specifically, complaints related to product terms or service features can indicate a UDAAP issue. For example, if a new product is implemented and many consumers are calling to question why they are being charged a fee, this could signal that the disclosures did not clearly inform the consumer of when and why they would be charged a fee. If you can generate a fee reversal report from the core system, you can use it to test potential areas of UDAAP concern. Even if a fee is reversed, employees need to include the consumer’s call/complaint on the complaint log for further analysis.  
10. Interview all employees who collect past due debt to ensure their current process does not misrepresent debt owed to the financial institution or otherwise violate UDAAP.
11. Test sales incentives, including mortgage loan originator compensation, new deposit account incentives and nondeposit investment product referrals, to determine whether the current structure could encourage an employee to mislead consumers into purchasing certain products that do not meet the consumers’ needs. 
12. Ensure your institution provides UDAAP training on a regular basis for all employees and documents the training. If the internal testing identifies potential training opportunities, employees should receive applicable targeted training as soon as possible to reduce the UDAAP risk. 

You can begin to address UDAAP testing internally by following the suggestions listed above. Conducting these tests and other tests will help your institution demonstrate your commitment to avoiding UDAAP issues, and it will allow examiners to observe the strong controls you’ve instituted to reduce UDAAP risk. Most importantly, testing of this nature will allow your institution to self-identify issues and promptly make appropriate changes to products, services, or practices that could otherwise result in consumer harm.

For assistance in establishing UDAAP or other internal monitoring procedures, contact Amanda Knudsen at aknudsen@wipfli.com.