We discovered an issue with some of our adjustable rate mortgages (ARMs). For some of our ARMs that closed in 2009 and earlier, we provided early disclosures that omitted a lifetime floor for the interest rate. But the promissory notes for the loans do include a floor, which we have enforced. Is this a UDAAP violation? Do we need to reimburse customers?

We agree that having omitted the interest rate floor in your ARM disclosures creates a range of risks for your bank. Both the present version of Regulation Z and the version in effect in 2009 require lenders to disclose how the interest rate for a variable rate loan will be calculated, including “an explanation of interest rate or payment limitations.” The failure to disclose an interest floor likely violated this requirement, and its omission for multiple loans could be considered a deceptive practice.

The term “deceptive” is defined in a Federal Trade Commission (FTC) policy statement to include the omission of material information that “is likely to mislead the consumer.” (Although the Dodd-Frank Act transferred enforcement authority for UDAAP violations from the FTC to the CFPB, the CFPB has not yet defined “deceptive” and has instructed its examiners to “be informed” by FTC policy statements; similarly, the FDIC’s compliance examination manual continues to reference FTC policy statements.) In this situation, the omission of the interest rate floor may have led customers to believe that the loan’s interest rate would follow the disclosed index without limitation, when in fact the interest rate floor prevented the interest rate from falling below a certain minimum rate.

While voluntarily reimbursing your affected customers is a business decision, your examiners may order you to provide restitution, even if these were relatively isolated cases. The Truth in Lending Act leaves it to your examiners’ discretion as to whether they will order you to provide restitution on discovering a disclosure violation (these provisions are found in the Act itself and not in Regulation Z). We believe it would be helpful in dealing with your examiners if the bank could demonstrate that it has taken proactive steps to rectify this error — at a minimum by reimbursing the customers who paid interest rates at the floor rate when the index rate had dipped below the floor rate.

In light of the risks attendant to this situation, we do recommend that you consult with your bank counsel on this question.

For resources related to our guidance, please see:

As effective in 2017, Regulation Z, 12 CFR 1026.19(b)(2)(vii) (“Except as provided in paragraph (d) of this section, if the annual percentage rate may increase after consummation in a transaction secured by the consumer’s principal dwelling with a term greater than one year, the following disclosures must be provided at the time an application form is provided or before the consumer pays a non-refundable fee, whichever is earlier (except that the disclosures may be delivered or placed in the mail not later than three business days following receipt of a consumer’s application when the application reaches the creditor by telephone, or through an intermediary agent or broker): . . . (vii) Any rules relating to changes in the index, interest rate, payment amount, and outstanding loan balance including, for example, an explanation of interest rate or payment limitations, negative amortization, and interest rate carryover.”)
As effective in 2009, Regulation Z, 12 CFR 226.19(b)(2)(vii) (“If the annual percentage rate may increase after consummation in a transaction secured by the consumer’s principal dwelling with a term greater than one year, the following disclosures must be provided at the time an application form is provided or before the consumer pays a non-refundable fee, whichever is earlier: . . . (vii) Any rules relating to changes in the index, interest rate, payment amount, and outstanding loan balance including, for example, an explanation of interest rate or payment limitations, negative amortization, and interest rate carryover.”)
FTC Policy Statement on Deceptiveness (“Certain elements undergird all deception cases. First, there must be a representation, omission or practice that is likely to mislead the consumer. . . . Second, we examine the practice from the perspective of a consumer acting reasonably in the circumstances. . . . Third, the representation, omission, or practice must be a ‘material’ one. . . .”)
CFPB Supervision and Examination Manual, Page 178, footnote 10 (“See FTC Policy Statement on Deception, available at http://www.ftc.gov/bcp/policystmt/ad-decept.htm. Examiners should be informed by the FTC’s standard for deception.”)
FDIC Compliance Examination Manual, Unfair and Deceptive Practices, page 3 (“A three-part test is used to determine whether a representation, omission, or practice is deceptive. . . .” [citing the FTC Policy Statement on Deception.])
Joint Policy Statement, Administrative Enforcement of the Truth in Lending Act — Restitution, 63 Fed. Reg. 47495, 47497 (September 8, 1998) (The Truth in Lending Act “generally requires the [federal banking regulatory] agencies to order restitution when such disclosure errors resulted from a clear and consistent pattern or practice of violations, gross negligence, or a willful violation which was intended to mislead the person to whom the credit was extended. However, the Act does not preclude the agencies from ordering restitution for isolated disclosure errors.”)
Truth in Lending Act,15 USC 1607(e)(6) (“A creditor shall not be subject to an order to make an adjustment, if within sixty days after discovering a disclosure error, whether pursuant to a final written examination report or through the creditor’s own procedures, the creditor notifies the person concerned of the error and adjusts the account so as to assure that such person will not be required to pay a finance charge in excess of the finance charge actually disclosed or the dollar equivalent of the annual percentage rate actually disclosed, whichever is lower.”)
Questions and Answers Regarding Joint Statement, pages 6–8 (“Question 7. How will the Policy Guide apply if a creditor disclosed that a rate will be prospectively subject to increase, but the APR disclosed or the finance charge disclosed or both were originally understated? . . . If only the APR is understated, reimbursement will be required only for the period of time before the first scheduled change in rate under the variable rate feature in the contract. . . .”)