Five Things to Watch in CFPB's Arbitration Proposal

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The Consumer Financial Protection Bureau is expected to issue a proposal Thursday that would limit the use of arbitration clauses on millions of financial contracts, including cellphones, credit cards and checking accounts.

The plan is likely to allow consumers to band together in class-action lawsuits against financial institutions, rather than be forced to resolve disputes entirely through arbitration. But restrictions on arbitration clauses have been met with fierce opposition from the lending industry, which has billions of dollars at stake.

"I'm expecting a huge uptick in class-action litigation, probably in late summer of next year or early fall," said Alan Kaplinsky, who leads the consumer financial services group at Ballard Spahr.

The bureau's proposal is expected to broadly track a 32-page outline released in October as part of a small-business panel review, but there are several outstanding questions about specific requirements.

Following are five issues to watch when the agency formally unveils the plan at a public field hearing in Albuquerque, N.M.

Arbitration vs. class actions

Financial institutions say arbitration is a faster and cheaper way to resolve disputes, offering consumers more benefits than class-action lawsuits. Consumer advocates maintain that mandatory arbitration clauses deprive individuals of bringing group claims and from seeking relief for wrongdoing against powerful economic entities.

The CFPB is not expected to ban arbitration clauses outright. Rather, the agency is trying to curb the use of arbitration clauses as a way to block consumers from bringing group claims, especially if many consumers are injured by the same conduct. The bureau will probably still allow arbitration in individual claims, lawyers said.

Paul Bland, the executive director at Public Justice, said the proposal is modeled on a similar rule for the Financial Industry Regulatory Authority, known as Finra, which allows individual investors to bring class-action claims against brokerages.

"Companies can offer arbitration, they just can't ban class actions," Bland said. "It's about whether or not arbitration clauses that ban class actions will be permitted."

The CFPB also is expected to try and collect data from companies that decide to use arbitration clauses to resolve individual disputes. It plans to monitor the process to ensure it is fair.

Still, the consumer finance industry believes any limit to arbitration amounts to a de facto ban.

"This is like saying to your teenager, I'm not taking away your car, I'm just taking away your keys," said Travis Norton, the executive director with the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce.

The chamber sent a letter Monday to CFPB Director Richard Cordray asking that he verbally address at the field hearing whether prohibiting class-action waivers would have the effect of eliminating arbitration.

"At a minimum, [the proposal] is going to ban class-action waivers and that's going to lead to a lot of banks and other companies abandoning the use of arbitration," Kaplinsky said.

Andrew Pincus, a partner at Mayer Brown, and a former assistant to the solicitor general in the Justice Department, said companies will not be able to pay for the cost of an arbitration process while reserving millions of dollars for class-action defense.

"If you're a company, you're basically running two different dispute resolution systems that are very expensive, especially the litigation costs associated with class actions," he said. "The virtue of arbitration [for the consumer] is you don't need a lawyer and the company pays all the filing costs."

What companies are affected?

Both sides agree that a large number of industries will be affected by any effort to curb arbitration agreements.

The proposal would impact credit cards, checking and deposit accounts, certain auto loans, money transfer services, prepaid cards, small dollar or payday loans, private student loans, and installment loans.

Mandatory arbitration clauses were prohibited in 2013 from being used in contracts for residential mortgages and home equity lines of credit.

Isaac Boltansky, a policy analyst at Compass Point Research & Trading, wrote in a research note that curtailing mandatory arbitration clauses "could ultimately result in higher operational and litigation expenses for impacted industries including credit cards, for-profit education and marketplace lenders."

With respect to auto finance, auto dealers themselves are largely outside the CFPB's authority but that is not true for the auto finance companies that draft and purchase retail installment sales contracts from dealers.

"Over the years, the auto finance industry and auto dealers have benefited substantially from the widespread use of arbitration provisions with class-action waivers," says Richard Gottlieb, a partner in the Los Angeles office of Manatt, Phelps & Phillips LLP. "Prohibiting these provisions will greatly increase the number of individual and class-action suits arising out of auto consumer finance transactions because auto finance companies will no longer be able to purchase contracts containing those provisions."

Implementation date

Consumer finance companies are paying close attention to the timing of the proposal to determine when they should make changes to current contracts.

The new restrictions would apply to arbitration agreements entered into 210 days after a final rule is published.

Many in the industry believe the agency will try to get a final rule out before the presidential election, which means the regulation would apply to arbitration contracts entered into after mid-2017. All other arbitration contracts would get grandfathered in.

Data interpretation

Both sides of the debate are expected to use the CFPB's arbitration study, released last year, to support claims that arbitration helps or hurts consumers.

The CFPB's study found that 75% of consumers surveyed were not aware of an arbitration clause and worse, only 7% knew the contracts had a clause that restricted them from suing. Millions more consumers could be missing out on refunds from class-action lawsuits because many agreements restrict a consumer from filing a claim in court.

Meanwhile, the American Bankers Association and other industry trade groups submitted comments to the CFPB stating that "arbitration has significant, demonstrable benefits over litigation in general and class action litigation in particular."

The CFPB study also found that 87% of class actions provided no money to consumers. Of the 13% that involved settlements only 4% of consumers received a payout, and the payouts averaged just $32, Norton said.

"The bureau acknowledges that arbitration is an accepted means for solving disputes, which is why they aren't proposing to ban them completely," Norton said.

He cited efforts by some members of Congress and the business community that wants the CFPB to reopen the study to address what the industry considers deficiencies in its survey.

But Bland said only a small number of consumers, about 400 over several years, actually file cases in arbitration. In addition, the CFPB study found that roughly 13 million consumers received more than $1 billion in payouts, and even more substantial injunctive relief in the form of having illegal debts wiped out through settlements.

The industry is crying "all these crocodile tears about how consumers will lose the amazing benefits available under arbitration, when next to no consumers actually go to arbitration," Bland said.

Likely legal challenge

The 2010 Dodd-Frank Act mandated that the CFPB release a study on arbitration and that the agency write arbitration rules. But there are questions about whether the bureau was given the power to invalidate arbitration agreements preventing class actions.

The Supreme Court has upheld in three decisions since 2011 the right of private contracts to arbitrate disputes rather than litigate them. Some lawyers suggest that recent Supreme Court decisions make it difficult to invalidate arbitration clauses without a legislative amendment to the Federal Arbitration Act of 1925.

"The Supreme Court has looked at class-action waivers and upheld the use of them," Norton said.

As with so many issues involving the CFPB, legal challenges are expected.

"How they exercise their authority and if it satisfies the special requirements of Dodd-Frank is something that I'm sure will be litigated in court," Pincus said. "Rules get challenged all the time, especially with something of this broad an impact."

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Law and regulation Dodd-Frank Consumer banking