Exercise Caution in Disclosing "Bonus Rates"
by Mary Beth Guard
With interest rates so low, attracting deposits is a major challenge for financial institutions, and marketing professionals are working hard to construct creative offers to bring depositors in. Compliance officers must be especially vigilant to ensure these innovative offers don't create compliance problems like the one that spawned a lawsuit against a bank in New Jersey.
In bold letters and large type, Amboy National Bank's newspaper ad offered "a 3-month bonus of 6.00% APY". In smaller print, there was a statement that "[a]fter the bonus your yield is based on the 3-month Treasury Bill. Plus, we'll guarantee that the yield will always be higher than the combined average yield offered by the 3 largest NJ banks." The advertisement also noted the APY that the accounts had earned during the previous year.
Martin Schnall opened the advertised account with $20,000 after seeing the newspaper ads, talking to the bank, and receiving a copy of the Truth in Savings account disclosures. Approximately one year later, on October 18, 1999, Mr. Schnall filed suit against the bank on his own behalf and on behalf of a putative class of all persons who had deposited at least $20,000 into a Money Market Account with the Bank during the period from October 18, 1998 to October 18, 1999. In his suit, he alleged the bank violated the Truth in Savings Act because the annual percentage yield that appeared in the bank's ads and account disclosures did not comply with the required method of calculating the APY under TISA and Regulation DD.
Schnall claimed it is impermissible for the Bank to advertise a 6% APY for the first three months and a variable rate APY for the remainder of the account term; instead, he contended, the bank should have disclosed a single "blended" or "composite" APY that represents the total yield on the account over a term of one year.
There were two major issues in the case. The first was whether the advertisements (and the account disclosure, which read the same way) violated TISA and Reg DD. The second was whether a customer could sue for a TISA violation without having to demonstrate that he had been misled, or had relied to his detriment, or had been financially harmed by the non-compliant disclosure.
Although the federal district court ruled in the bank's favor, holding there was no violation and, even if there was, that the customer couldn't sue absent a showing that he was misled, the federal Court of Appeals for the Third Circuit sang a different tune. The court of appeals ruled that the advertisements and disclosures at issue did violate TISA and Regulation DD. It also held that TISA imposes strict liability on institutions that violate its disclosure requirements and a plaintiff does not need to show that he relied to his detriment on the advertised APY, that he was misled by the advertised APY, or that he was financially harmed by the TISA violations.
The court looked at the specific language on account disclosures in Section 230.4 of Regulation DD. Under the regulation, account disclosures and advertisements that state a rate of return are required to state the account's annual percentage yield, which is "a percentage rate reflecting the total amount of interest paid on an account, based on the interest rate and the frequency of compounding for a 365 day period and calculated according to the rules in appendix A of this part."
That appendix provides that "[f]or accounts without a stated maturity date (such as typical savings or transaction account] the calculation shall be based on an assumed term of 365 days."
The advertisements run by Amboy related to an account that did not have a stated maturity date. Therefore, they should have assumed a term of 365 days. Since the initial rate was only in effect for a 90 day period, the account would fall into the realm of a "stepped-rate account". The appendix provides guidance for how to disclose in such a circumstance: "For accounts with two or more interest rates applied in succeeding periods . . . an institution shall assume each interest rate is in effect for the length of time provided for in the deposit contract."
Part I.C of appendix A specifies how this blended rate calculation should be performed for a variable rate account. For purposes of the calculation, the bank should assume that the variable rate that is in effect at the time of the disclosure will remain in effect throughout the term, even though that assumption means the APY that the regulations require the bank to advertise will differ from the actual APY the consumer will earn on the account if the variable rate changes.
According to the court, the bank's advertisements and account disclosures violate Regulation DD because they failed to state the APY as a single composite rate computed on a one-year term, as required by appendix A. The bank should have calculated the APY by applying the introductory 6% rate for the first three months (which is the time period it would be in effect) and using the variable rate that was in effect at the time of the disclosure for purposes of the calculation for the remaining nine months.
The civil liability section of the Truth in Savings Act (12 U.S.C. 4310), which established authority for both individual and class action civil suits to be filed against financial institutions for violations of the Truth in Savings provisions, has been repealed. Congress enacted the repealer in 1996, but chose to make the repeal effective September 30, 2001. The suit by Schnall was allowed to proceed because it was commenced prior to the effective date of the repeal. Remember, however, if the customers can't get you, the examiners always can! See 12 U.S.C. 4309 for administrative enforcement.
Lessons to be learned: Carefully scrutinize your deposit account advertisements and disclosures. If you are delving into new territory with a unique promotion, head back to the regulation, the Commentary, and the Appendices for a quick refresher course.
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