Consumer protection agency wants to promote private enforcement of finance laws.
Banks, credit card issuers, and student lenders may find themselves in court more often if the nation’s consumer financial protection regulator gets its way. That regulator, the Consumer Financial Protection Bureau (CFPB), recently announced plans to propose a rule prohibiting contracts under which financial consumers sign away their right to pursue class action lawsuits.
A class action lawsuit allows people with similar claims against the same business to join together in court. Currently, companies can prevent consumers from pursuing any court action at all by inserting mandatory arbitration provisions in loan agreements and other contracts. These provisions require claims to be settled outside of court through a process called arbitration. They also usually prohibit multiple claims being joined together in one arbitration proceeding.
Sometimes, individual claims against a company are so small that it costs more to sue than to simply take the loss. Yet although each individual claim may be small, they may stem from practices that affect millions. When consumers can bring claims as a class, they can share legal costs, from lawyers to filing fees, and bring meritorious claims. For example, a toothpaste and personal care company recently settled a class action lawsuit regarding its use of the term “natural” on its products. While each claim roughly equates to the price of a tube of toothpaste, class members claimed a right to challenge the company’s alleged false advertising.
Companies further shield themselves through mandatory arbitration clauses. By having consumers contract away their right to pursue certain claims in court, companies can sidestep the justice system and arbitrate claims before privately appointed individuals.
The post-2008 Recession’s Dodd-Frank Act banned mandatory arbitration provisions entirely in mortgage contracts, and required the CFPB to investigate arbitration provisions in other financial service contracts. The CFPB found that arbitration provisions are increasingly common features of basic financial services contracts. These provisions appear in about half of the credit card and checking account markets, and nearly all of the prepaid card market.
Dodd-Frank also authorized the CFPB to regulate arbitration provisions if the agency found it would serve the public interest and protect consumers. The agency’s study found that private litigation complements public enforcement. Not only do private litigants provide resources beyond agency budgets; they also pursue different types of claims. According to the CFPB, regulators were not pursuing two-thirds of the types of claims sought by private parties.
As a result, the agency concluded that issuing a proposed rule to preserve the right to pursue a class action lawsuit would allow consumers to pursue small claims and encourage financial institutions to comply with legal obligations. The announcement highlights that many consumer finance laws explicitly authorize private class action suits as an important part of their statutory scheme.
However, the CFPB’s possible class action rule proposal does not scrub away mandatory individual arbitration clauses. Although the agency considered banning arbitration in all circumstances, it is not proposing a complete ban at this time. Instead, the CFPB is considering whether to require disclosure of arbitration complaints and awards. This information would inform the agency’s future decision-making about whether to prohibit mandatory arbitration provisions in consumer finance contracts.
The CFPB considered, but has for now rejected, the option of permitting arbitration provisions that prohibit class action lawsuits but allow groups of individuals to arbitrate their claims together. California previously regulated arbitration agreements this way, but the Supreme Court ruled that only the federal government could make such a rule. Since the contracts that the Bureau examined seemingly preferred class action in court to group arbitration, the CFPB decided against permitting class arbitration.
The CFPB’s planned proposal has its critics. The Consumer Bankers Association argues that mandatory arbitration provisions benefit consumers by keeping other costs low. The CFPB analyzed whether there were higher interest rates or fees between credit card firms that use arbitration clauses and those that do not, but found no significant difference in that market.
Some lawyers and scholars believe that the CFPB does not have authority to block arbitration provisions. They claim that the CFPB’s own study does not support the inference that the regulation would serve the public interest, and that the rule is an unwarranted restriction on the right to enter contracts.
Before formally proposing the rule, the CFPB is working with other agencies to assess its potential impact. The agency, the Office of Management and Budget, and the Small Business Administration are seeking input about the planned rule from small businesses before moving forward.
The CFPB predicts that the planned rule would have a minimal impact on small businesses. Arbitration provisions are most common among larger institutions, and small businesses are rarely subjected to class action lawsuits. The study found that three-fourths of the largest banks used arbitration provisions, but only three percent of surveyed credit unions did the same.
The CFPB proposal would extend to companies beyond just lenders. It would also apply to transfer services, reporting agencies, debt buyers, and many other financial service providers.
The planned rule would not apply, however, to brokerage or commodities services. Arbitration provisions for those services are already restricted by the Securities Exchange Commission and Commodities Futures Trading Commission, respectively.