One of the most controversial rules proposed by the Consumer Financial Protection Bureau—banning companies from using mandatory arbitration clauses—is now final.
Think of it as an act of defiance as much as a new rule. Jeb Hensarling, the Texas Republican who heads the House Financial Services Committee, has gone so far as to threaten CFPB Director Richard Cordray with Congressional contempt charges if he moved forward with it.
The rule is also destined to face repeal under the Congressional Review Act, and it comes amid growing efforts to unseat Cordray and defang the Bureau by chipping away at the independency bestowed upon it by the Dodd-Frank Act.
“Arbitration clauses in contracts for products like bank accounts and credit cards make it nearly impossible for people to take companies to court when things go wrong,” Cordray said in a statement. “These clauses allow companies to avoid accountability by blocking group lawsuits and forcing people to go it alone or give up. Our new rule will stop companies from sidestepping the courts and ensure that people who are harmed together can take action together.”
Many consumer financial products like credit cards and bank accounts have arbitration clauses in their contracts that prevent consumers from filing class-action lawsuits and require the use of arbitration.
Mandatory arbitration clauses typically state that either the company or the consumer can require that disputes between them be resolved by privately appointed individuals (arbitrators) except for individual cases brought in small claims court.
While these clauses can block any lawsuit, companies almost exclusively use them to block group lawsuits, which are also known as “class action” lawsuits, a CFPB statement explains.
“With group lawsuits, a few consumers can pursue relief on behalf of everyone who has been harmed by a company’s practices,” the Bureau’s statement added. “Almost all mandatory arbitration clauses force each harmed consumer to pursue individual claims against the company, no matter how many consumers are injured by the same conduct. However, consumers almost never spend the time or money to pursue formal claims when the amounts at stake are small.”
The Dodd-Frank Act required the CFPB to study the use of mandatory arbitration clauses in consumer financial markets.
Congress also authorized the Bureau to issue regulations based on findings that are consistent with the Bureau’s study of arbitration. Released in March 2015, the study showed that credit card issuers representing more than half of all credit card debt and banks representing 44 percent of insured deposits used mandatory arbitration clauses. Yet, three out of four consumers the Bureau surveyed did not know whether their credit card agreement had an arbitration clause.
The CFPB’s rule restores consumers’ right to file or join group lawsuits. Companies can still include arbitration clauses in their contracts, but may not use arbitration clauses to stop consumers from being part of a group action. The rule includes specific language that companies will need to use if they include an arbitration clause in a new contract.
The Bureau will collect correspondence companies receive from arbitration administrators regarding a company’s non-payment of arbitration fees and its failure to follow the arbitrator’s fairness standards.
“This rule is a pragmatic step forward to ensure there is transparency, fairness, and accountability in consumer finance.”
Melissa Stegman, Senior Policy Counsel, Center for Responsible Lending
The new CFPB rule applies to the major markets for consumer financial products and services overseen by the Bureau, including those that lend money, store money, and move or exchange money. Congress already prohibits arbitration agreements in the largest market that the Bureau oversees—the residential mortgage market.
The rule’s exemptions include employers when offering consumer financial products or services for employees as an employee benefit; entities regulated by the Securities and Exchange Commission or the Commodity Futures Trading Commission, which have their own arbitration rules; broker-dealers and investment advisers overseen by state regulators; and state and tribal governments that have sovereign immunity from private lawsuits.
The rule’s effective date is 60 days following publication in the Federal Register and applies to contracts entered into more than 180 days after that.
Almost immediately, Republican critics attacked the new rule.
“The CFPB has gone rogue again, abusing its power in a particularly harmful way,” Sen. Tom Cotton (R-Ark.) said in a statement following the July 11 announcement of the rule. “The Bureau’s new rule on arbitration clauses ignores the consumer benefits of arbitration and treats [citizens] like helpless children, incapable of making business decisions in their own best interests.”
Cotton said he has “started the process of rescinding this rule using the Congressional Review Act.” legislators an opportunity to pass a resolution of disapproval to halt the regulation.
To improve regulatory cost accountability, in 1996 Congress passed the CRA. It provides a 60-day period following agency publication of a regulation during which an expedited Senate or bicameral vote can halt implementation. If a rule is disapproved after going into effect, it is treated as though it had never taken effect.
“The last thing Americans need is more anti-business regulation that will prompt frivolous lawsuits while hurting consumers,” Cotton said.
Consumer advocate are among those praising the CFPB’s latest battle.
“This rule is a pragmatic step forward to ensure there is transparency, fairness, and accountability in consumer finance,” says Melissa Stegman, senior policy counsel for the Center for Responsible Lending. “While it does not end all forced arbitration, it does return the opportunity for people to join together in court and hold companies accountable for systemic misconduct.”
“Last year’s Wells Fargo scandal highlights the real harm forced arbitration causes, as customers who attempted to bring class-action lawsuits against the bank over phony accounts were blocked from the court, keeping the growing problem out of the public eye,” she adds. “Everyone should be protected from rip-off clauses buried in the fine print of customer agreements.”
“Since most consumers cannot afford to take on a big corporation on their own, banks like Wells Fargo get away with ripping off large numbers of customers,” says Amanda Werner, arbitration campaign manager with Americans for Financial Reform and Public Citizen. “This new rule will help prevent this kind of widespread fraud and ensure consumers can fight back.”
While the financial world evaluates potential effects of the rule, some say it may backfire.
“The irony here is that CFPB enforcement is frequently a factor in preventing private class-action litigation, but this rule eliminating arbitration and the void left from Trump’s moves toward deregulation can act like supercollider for litigation against lenders, accelerating class actions and ricocheting through the credit markets,” says Joseph Cioffi, chair of the insolvency, creditors’ rights & financial products practice group at law firm Davis & Gilbert.
SUMMARY OF THE FINAL RULE
Below is an excerpt from the final rule.
The final rule applies to providers of certain consumer financial products and services in the core consumer financial markets of lending money, storing money, and moving or exchanging money, including, subject to certain exclusions specified in the rule, providers that are engaged in:
extending consumer credit, participating in consumer credit decisions, or referring or selecting creditors for non-incidental consumer credit, each when done by a creditor under Regulation B implementing the Equal Credit Opportunity Act (ECOA), acquiring or selling consumer credit, and servicing an extension of consumer credit;
extending or brokering automobile leases as defined in Bureau regulation;
providing services to assist with debt management or debt settlement, to modify the terms of any extension of consumer credit, or to avoid foreclosure, and providing products or services represented to remove derogatory information from, or to improve, a person’s credit history, credit record, or credit rating;
providing directly to a consumer a consumer report as defined in the Fair Credit Reporting Act (FCRA), a credit score, or other information specific to a consumer derived from a consumer file, except for certain exempted adverse action notices (such as those provided by employers);
providing accounts under the Truth in Savings Act (TISA) and accounts and remittance transfers subject to the Electronic Fund Transfer Act (EFTA);
transmitting or exchanging funds (except when necessary to another product or service not covered by this rule offered or provided by the person transmitting or exchanging funds), certain other payment processing services, and check cashing, check collection, or check guaranty services consistent with the Dodd-Frank Act; and
collecting debt arising from any of the above products or services by a provider of any of the above products or services, their affiliates, an acquirer or purchaser of consumer credit, or a person acting on behalf of any of these persons, or by a debt collector as defined by the Fair Debt Collection Practices Act (FDCPA).
Consistent with the Dodd-Frank Act, the final rule applies only to agreements entered into after the end of the 180-day period beginning on the regulation’s effective date. The Bureau is adopting an effective date of 60 days after the final rule is published in the Federal Register.
To facilitate implementation and ensure compliance, the final rule requires providers in most cases to insert specified language into their arbitration agreements to explain the effect of the rule.
The final rule also permits providers of general-purpose reloadable prepaid cards to continue selling packages that contain non-compliant arbitration agreements, if they give consumers a compliant agreement as soon as consumers register their cards and the providers comply with the final rule’s requirement not to use an arbitration agreement to block a class action.
Oliver Ireland, a partner at law firm Morrison & Foerster, says that class-action lawsuits are driven by lawyers, not by clients. “They are trawling for clients and lawsuits,” he says. “It is not a matter of persuading your customers that they don’t need to bring a class action, it would be a matter of persuading the lawyers that they don’t want to bring class actions.”
“We now have an agency that examines the large institutions, whether they are banks or not,” he adds, regarding the CFPB. “It has tremendous enforcement powers. Whatever the utility of class actions in encouraging compliance was in the past, the equation is clearly different now. Whatever benefits there once were to class actions, the world has changed.”
Ken Kliebard, partner and co-chair of Morgan Lewis’s financial services litigation practice, considers whether other regulators, such as the Securities and Exchange Commission, may ride political peer pressure and develop arbitration rules of their own.
“If I had to bet, I would say that the other agencies are going to sit on the sidelines and see what happens politically and judicially,” he says.
A wild card in debates over the rule is how strong post-crisis, anti-Wall Street and anti-bank feelings remain. “That is something that was part of President Trump’s base,” he says. “If the debate is cast in those terms, I wonder whether Republicans will have support among their constituents to do something that is seen as benefitting large banks.”
What should firms be doing in the interim, as the politics play out?
“The rule isn’t going to take place for at least 140 days, depending on when it gets published in the Federal Register,” Kliebard says. “If, as of today, a financial institution currently has an arbitration agreement with its customers it will still be enforceable in the future … For firms that have been thinking about arbitration, and were leaning in that direction but weren’t sure what to do, now might be the time to implement it and take advantage delay.”
There may, however, be unintended legal confusion. Especially in the credit card space, there is fine print and statement inserts that incorporate change-in-terms provisions. “There may be an agreement that is in place at the time you open your checking account, your credit account, or demand deposit account,” Kliebard says. “Over time, those terms and conditions change in terms of fees that can get charged and all sorts of other things.”
In the 1990s, when firms ramped up their use or arbitration, the change was implemented through change-of-use agreements.
“One issue that will arise, because banks tend to issue new terms and conditions pretty regularly, is whether that is going to constitute a new agreement,” he says. “If you, today, have an arbitration agreement with a customer and in a year you amend your agreement for an issue totally unrelated to arbitration, is that going to be considered a new agreement? Would the prospective nature of the rule no longer apply and you can no longer include arbitration? That is an unsettled issue.”
“If firms already have arbitration agreements and they intend to implement changes in their terms, they probably want to do that in the next 240 days in order to put off for as long as possible having to litigate that issue,” Kliebard advises.
He points out that using a federal forum for post-arbitration lawsuits does offer advantages over the forum shopping that once accompanied state lawsuits. There are, for example, heightened pleading standards and more beneficial rules of civil procedure.
“It is not so much a silver lining as a softening of the blow that the landscape has changed,” Kliebard says. “There are a lot of tools that financial institutions will be able to use if they are defendants in class actions that were not available to them 20 years ago when they first started including arbitration clauses in their agreements.”