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05.10.16

CFPB’s Proposal Restricts Arbitration Clauses, Now What?

paper_no_not_allowed_contract_gavel_iconThe CFPB has released a proposed rule that will place restrictions on arbitration clauses in financial services contracts. The proposal, unveiled on May 5 before a CFPB field hearing in Albuquerque, N.M, will not ban arbitration clauses, but covered institutions will be restricted from including class action waivers in their arbitration agreements and arbitration clauses will be required to contain notices to that effect.

One example included in the proposed rule reads: “We agree that neither we nor anyone else will use this agreement to stop you from being part of a class action case in court. You may file a class action in court or you may be a member of a class action even if you do not file it.” The proposed rule also would require companies with arbitration clauses to submit to the CFPB claims, awards and other documentation related to arbitration cases, enabling the bureau to “ensure that the arbitration process is fair for consumers,” the CFPB said. That information could then be published to the public by the agency. The proposed rule would apply to most consumer financial products and services the bureau oversees in the “core consumer financial markets of lending money, storing money, and moving or exchanging money,” which would include credit cards, checking and deposit accounts, and prepaid cards.

“Signing up for a credit card or opening a bank account can often mean signing away your right to take the company to court if things go wrong,” said CFPB Director Richard Cordray. “Many banks and financial companies avoid accountability by putting arbitration clauses in their contracts that block groups of their customers from suing them. Our proposal seeks comment on whether to ban this contract gotcha that effectively denies groups of consumers the right to seek justice and relief for wrongdoing.”

The CFPB has long had its sights set on mandatory arbitration clauses that block consumers from forming class action lawsuits to obtain compensation—instead requiring that disputes be resolved by appointed individual arbitrators. The CFPB has said that such clauses give companies a “free pass” to sidestep the legal system and continue to pursue practices that may violate the law and harm consumers. During a field hearing in October 2015 in Denver, the CFPB announced it was considering proposing rules that would ban class action waivers in arbitration clauses. The decision was based, in part, on a March 2015 CFPB study that found that “very few” consumers bring individual action against financial services providers, and concluded that class actions provide a more effective means of gaining financial relief. However, that study was later criticized for its methodology by several academics, including the Mercatus Center, which claimed it lacked much of the key information necessary to fully evaluate the relative benefits of arbitration and class actions in gaining relief for consumers.

Many in the financial services industry have claimed that the study actually shows that arbitration is a faster, less expensive and more effective way for consumers to resolve disputes. Of the 562 class action studied by the CFPB, the average cash settlement was $32.35 per consumer, and class action litigation took an average of two or more years. In contrast, the average amount received by consumers who prevailed in arbitration was $5,389, with an average arbitration timeframe of two to seven months.

“Arbitration is an important tool to facilitate dispute resolution and helps both consumers and banks avoid lengthy court proceedings and costly legal fees,” said Brad Fauss, CEO and president, Network Branded Prepaid Card Association. “The CFPB proposed arbitration rule is another bureaucratic government solution in search of a problem that will ultimately harm consumers and solely benefit trial lawyers.”

Prior to the CFPB’s proposal being released, experts at the Power of Prepaid in Washington, D.C., discussed the implications of restricting or banning arbitration clauses. “This is the scariest [regulatory issue] going,” said Brad Hanson, president of MetaBank and Meta Payment Systems. “This could significantly harm consumers,” he said, noting that the bank has been involved in a class action lawsuit for six years over a $15 fee. “This could have been resolved easily [with arbitration],” Hanson added. “Now, the consumer might not ever end up with anything and if she does, it’s going to go to support a big law firm.”

The threat of frivolous lawsuits has many in the industry concerned that not only will disputes take longer and potentially lead to smaller awards for consumers, but the threat also will increase costs across the board—costs likely to be passed on to consumers. And while the CFPB’s proposal doesn’t explicitly ban arbitration clauses, many in the industry feel the agency’s goal is to effectively eliminate arbitration as an option, leaving class action as consumers’ only method of redress.

Many observers also have pointed to the potential harm the proposed rule could have on small banks and financial services providers—which could lead to reduced competition and less consumer choice. As required by law when considering proposing a rule that could affect small entities, the CFPB last October convened a Small Business Regulatory Enforcement Fairness Act panel on arbitration. During the panel meeting, Trent Sorbe, president of Central Payments, a division of Central Bank of Kansas City, noted that banning or severely restricting mandatory arbitration clauses could increase the risk and cost of potential frivolous lawsuits, which small entities may not be able to bear. “Frivolous lawsuits—or just the threat thereof—will result in higher costs, a concentration of financial services products and fewer product choices for consumes,” Sorbe said.

Now that the rule is out, Sorbe tells Paybefore: “The CFPB believes that the agency lacks sufficient resources to adequately provide consumer protection in financial services. While that alone could serve as a subject of healthy debate, the CFPB seems to also believe that deputizing the plaintiff’s bar is an effective enforcement strategy.”

The CFPB is soliciting input on the proposed rule from the industry and public, with comments due within 90 days of the proposal being published in the Federal Register. Comments can be sent via email to FederalRegisterComments@cfpb.gov (include Docket No. CFPB-2016-0020 or RIN 3170-AA51 in the subject line of the email), online at www.regulations.gov, or by mail or hand delivery to: Monica Jackson, Office of the Executive Secretary, Consumer Financial Protection Bureau, 1700 G Street, NW, Washington, D.C. 20552.

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