While regulators have long warned about the potential unfairness s of authorized-positive-settle-negative (APSN) overdraft fees, this time, the CFPB took it one step further—APSN fees and all other unanticipated overdraft fees violate UDAAP because they are not the type of fee a consumer would expect.  In other words, the baseline for whether overdraft fees violate UDAAP is no longer whether adequate disclosures are provided but whether overdraft fees meet consumers’ subjective expectations of how such fees should be calculated.

This white paper provides an overview of the history and development of the regulation of overdraft protection programs, implications for the future, and best practices financial institutions should observe to avoid regulatory scrutiny.

History of Overdraft Protection Programs and Regulation

Generally, an overdraft occurs when a consumer does not have sufficient funds in their account, but the financial institution processes the transaction anyway, resulting in a negative account balance.  A financial institution will typically charge a flat fee for each transaction that results in an overdraft of a consumer’s account—such fees can be as high as $36 per transaction.  Interestingly, this type of fee is essentially a finance charge for a small short-term loan, but it is generally not subject to Truth in Lending requirements, annual percentage rate restrictions, usury laws, or other similar federal and state laws and regulations.

While today overdraft protection programs are widespread and known as revenue generators for financial institutions, this was not always the case.  In fact, when overdraft protection programs first developed, if used by a financial institution at all, it was on a limited, manual, and case-by-case basis for primarily checking transactions.  But as the use of cash and checks wanned and consumers’ reliance on debit cards exploded in the 1990s, overdraft protection programs expanded with the industry to an entirely new transaction type—debit transactions—and became automated, without human oversight or review.  As a result, overdraft fees have become a substantial portion of financial institutions’ revenue (many argue at the expense and financial well-being of consumers) and the subject of regulatory scrutiny.

Beginning in the early 2000s, federal banking regulators have been very vocal as to their view of overdraft protection programs and certain deceptive fee practices.  In its 2022 Circular, the CFPB provided a long list of prior guidance and rulemaking by federal banking regulators related to overdraft protection programs, including as follows:

• February 2005: the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC) published “Joint Guidance on Overdraft Protection Programs.” In this guidance, the agencies focused on issues related to the marketing of payment protection programs, generally warning financial institutions to ensure marketing efforts and other communications “do not mislead consumers to believe that the program is a traditional line of credit or that payment of overdrafts is guaranteed, do not mislead consumers about their account balance or the costs and scope of the overdraft protection offered, and do not encourage irresponsible consumer financial behavior that potentially may increase risk to the institution.” 70 FR 9127 (Feb. 24, 2005).
• May 2005: the FRB amended its Regulation DD (which implements the Truth in Savings Act) to expand disclosure requirements for financial institutions that advertise their overdraft programs by requiring disclosure of the aggregate totals for the statement period and the year-to-date on each periodic statement. 70 FR 29582 (May 24, 2005).
• January 2009: the FRB amended its Regulation DD, again, to require all financial institutions to disclose the aggregate totals for the statement period and the year to date on each periodic statement (not only those financial institutions that advertise their programs). 74 FR 5584 (Jan. 29, 2009).
• November 2009: the FRB amended Regulation E (which implements Electronic Fund Transfer Act) to require consumers to affirmatively “opt-in” to the assessment of overdraft fees arising from ATM and one-time debit card transactions. 74 FR 59033 (Nov. 17, 2009).
• November 2010: the FDIC issued “Final Overdraft Payment Supervisory Guidance.” Such guidance reinforced the FDIC’s concerns related to financial institutions’ marketing efforts of payment protection programs (as set forth in the February 2005 Joint Guidance) and provided regulatory expectations regarding the compliance and risk management of automated overdraft payment programs (generally requiring oversight and monitoring of such programs). See FDIC, Final Overdraft Payment Supervisory Guidance, FIL-81-2010 (Nov. 24, 2010), available at https://www.fdic.gov/news/financial-institution-letters/2010/fil10081.pdf.
• March 2015: in its “Winter 2015 Supervisory Highlights,” the CFPB noted that “examiners observed that one or more financial institutions switched from a ledger-balance method to an available-balance method…[and] these changes to the balance-calculation method used were not disclosed at all, or were not sufficiently disclosed.” Therefore, because certain transactions may not result in an overdraft fee under a ledger-balance method but will result in an overdraft fee under an available-balance method, failure to properly disclose such material practice was misleading and deceptive to consumers. See   CFPB Supervisory Highlights, Winter 2015, at 8-9, available at https://files.consumerfinance.gov/f/201503_cfpb_supervisory-highlights-winter-2015.pdf.
• July 2018: in an issue of its “Consumer Compliance Supervision Bulletin,” the FRB determined that APSN fees violate Section 5 of the FTC Act. See Federal Reserve Board, Consumer Compliance Supervision Bulletin 12 (July 2018), available at https://www.federalreserve.gov/publications/files/201807-consumer-compliance-supervision-bulletin.pdf.
• June 2019: in its “Consumer Compliance Supervisory Highlights,” the FDIC echoes the concerns of the other banking regulators over use the available balance method to calculate overdraft fees. The FDIC recommends that when using the available balance method, do not charge APSN fees— “financial institutions should ensure that any [transactions] authorized against a positive available balance does not incur an overdraft fee.” See FDIC, Consumer Compliance Supervisory Highlights 2-3 (June 2019), available at https://www.fdic.gov/regulations/examinations/consumercomplsupervisoryhighlights.pdf?source=govdelivery&utm%20_medium=email&utm_source=govdelivery.
• September 2022: in its “Consent Order In The Matter of Regions Bank,” the CFPB found that Regions Bank engaged in unfair and abusive conduct in violation of the CFPA by charging APSN fees to consumers. See CFPB, Regions Bank Consent Order, 2022-CFPB-0008 (Sept. 28, 2022).

Future Implications

Shortly following its Regions Bank Consent Order, the CFPB published its 2022 Circular providing greater detail and background related to its interpretation of deceptive overdraft fees, including, but not limited to, APSN fees.  However, as mentioned above, the CFPB took it one step further, extending UDAAP risk to all “unanticipated overdraft fees.”

Generally, as set forth in the 2022 Circular, an unanticipated overdraft fee “occurs when financial institutions assess overdraft fees on transactions that a consumer would not reasonably expect would give rise to such fees.” See Consumer Financial Protection Circular 2022-06, 5 (Oct. 26, 2022).  Therefore, regardless of the adequacy of the disclosure, if a consumer’s subjective expectation reasonably varies from a financial institution’s actual practices in determining overdraft fees, this could lead to a potential UDAAP violation.  The CFPB cites the following examples as circumstances that may create an “unanticipated overdraft fee”:

• Complex policies that are likely to be unintelligible to many consumers.
• Convoluted settlement processes, the intricacies of which are explained only in fine print, if at all, and of which the consumers have no control.
• Consumers utilizing mobile banking tools may reasonably expect that account balance displayed accurately reflects the balance they have available to conduct a transaction.
• Consumers may reasonably expect that a point of sale transaction that is authorized with sufficient funds will not later incur overdraft fees.

See Consumer Financial Protection Circular 2022-06, 6-7 (Oct. 26, 2022).

Although few would dare to argue that APSN fees fall outside of UDAAP, the broad brush used by the CFPB to paint this interpretation could have unintended future consequences.  For example, by introducing a subjective standard into its review of unfair and deceptive overdraft fees, the CFPB has laid the foundation to use this subjective standard to regulate other areas (beyond APSN and other overdraft fees).  No longer is a UDAAP violation measured by whether the injury is “reasonably avoidable by consumers,” but rather, a UDAAP violation may be measured by whether the resulting injury is of a type that is contrary to consumers’ reasonable expectations.  Essentially, permitting the CFPB to expand its regulatory authority in the guise of UDAAP.

Regulated entities and other companies should pay close attention to how the CFPB continues to develop its UDAAP authority, as this could have implications that stretch well beyond the financial services industry.

Best Practices for Overdraft Fees

If your financial institution is going to continue a policy of charging overdraft fees, you should comply with the guidance and best practices outlined by the banking regulators, including as follows:

• Provide clear and conspicuous disclosures related to the possible imposition of an overdraft fee and the methodology used to calculate such a fee. Such disclosure should not be misleading or contain incorrect information about the institution’s practices.
• Do not charge APSN fees — if using an available balance method to calculate overdraft fees, ensure that any transaction authorized against a positive available balance does not incur an overdraft fee, regardless of whether the transaction later settles against a negative available balance.
• Consider employing alerts when a consumer is at risk of an overdraft, setting limits on the overdraft fees charged to consumers, and monitoring for excessive use of overdrafts by consumers.
• Give consumers the opportunity to affirmatively choose the overdraft payment product that overall best meets their needs and honor requests to opt-out of overdraft fee programs.
• Do not process transactions in a manner designed to maximize the cost to consumers.
• Inform consumers how to access affordable financial education workshops or individualized financial counseling.

Contact us for more information.

Baldini Lang LLC has extensive experience assisting clients in building risk assessment programs and policies to comply with their legal requirements and establish best practice standards.  If you need additional information or would like assistance in drafting or revising your institution’s policies and disclosures to comply with overdraft fee regulations and best practice standards, contact us directly.