If the Consumer Financial Protection Bureau’s proposed mandatory arbitration rule is finalized, it will likely expose consumer financial services companies to class action lawsuits and administrative compliance burdens. As such, financial services companies must start taking action now to understand the scope of the rule and what steps are necessary to take to protect their interests.
On May 5, the Consumer Financial Protection Bureau (CFPB) announced a long-awaited proposed mandatory arbitration rule. If adopted, the rule would prohibit certain financial services companies from banning consumer class actions as part of mandatory pre-dispute arbitration agreements and require companies to report certain arbitration data to the CFPB.
If the proposed rule is finalized, it will likely expose consumer financial services companies to class action lawsuits and administrative compliance burdens. As such, financial services companies must start taking action now to understand the scope of the rule and what steps are necessary to take to protect their interests.
The Proposed Rule
The proposed rule essentially strives to do two things. First, the rule would prohibit certain entities and persons (referred to as providers) that offer or provide financial products or services to consumers, from using pre-dispute arbitration agreements to bar consumers from bringing class action lawsuits against the providers in connection with the covered financial products and services.
Further, the proposed rule would require any provider using a pre-dispute arbitration agreement with a consumer to include in the agreement certain information regarding the rule’s restrictions, such as: “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.”
Second, the proposed rule would require providers that use pre-dispute arbitration agreements to submit certain records and information concerning arbitration to the CFPB, which the agency will utilize to determine if further arbitration-related rulemaking is necessary. The information that must be submitted includes: (i) the initial claim and any counterclaim; (ii) the applicable pre-dispute arbitration agreement; (iii) the judgment or award, if any; and (iv) if an arbitrator refuses to administer or dismisses the claim due to the provider’s failure to pay required filing or administrative fees, any communications from the arbitrator concerning that refusal.
The scope of the proposed rule is incredibly expansive in terms of the covered products and services, as well as the entities or persons to which the rule will or could apply. For example, the proposed rule is designed to target financial products and services in the “core consumer financial markets” of lending money, storing money, and moving or exchanging money, which includes providers engaged in:
- Extending or regularly participating in decisions concerning consumer credit, engaging primarily in the business of providing referrals or selecting creditors for consumers to obtain such credit, and acquiring, purchasing, selling, or servicing of such credit;
- Extending or brokering certain automobile leases;
- Providing services related to debt management or debt settlement;
- Providing consumer reports directly to consumers;
- Providing accounts under the Truth in Savings Act and accounts and remittance transfers subject to the Electronic Fund Transfer Act;
- Transmitting or exchanging funds (except when the transfer is integral to another product or service not covered by the proposed rule) or providing certain other payment processing services, check cashing, check collection, or check guaranty services; and
- Collecting debt arising from any of the above products or services.
The proposed rule does exclude certain entities, such as broker-dealers that are already covered by Securities and Exchange Commission rules, and smaller participants, which the CFPB defines as those that provide financial products or services to 25 or fewer consumers per year. Further, the proposed rule would not prohibit a provider and a consumer from entering into an agreement to arbitrate a dispute as long as that agreement occurred after the dispute arose.
The CFPB is accepting comments on the proposed rule until August 22, 2016. The proposed rule, if finalized, will take effect sometime in late 2017 or 2018 after the 90-day public comment period and time allotted for drafting the final rule. Covered providers will not have to comply with the rule until 210 days after the final rule is published in the Federal Register.
Impact on the Financial Industry
Perhaps the most significant impact this proposed rule would have on the financial industry is the likely increase in class action lawsuits. Eliminating class action waivers in consumer finance agreements will almost certainly increase the number of class action lawsuits filed against financial institutions.
Indeed, class action plaintiffs’ lawyers are unlikely to miss the opportunity to bring class action lawsuits—whether they are meritorious or not—against unwitting financial institutions that fail to preserve class action waivers following the CFPB’s rulemaking process. With each lawsuit comes increased litigation costs in terms of attorneys’ fees incurred in defending the actions, settlements, and possible judgments. Those expenses only increase in the context of potentially multiple class action lawsuits.
Even if financial institutions decide to forego class action waivers and opt for arbitration provisions, covered providers still face costs and other consequences. That is, institutions that continue to use pre-dispute arbitration agreements to settle disputes with consumers will be forced to submit to the CFPB certain documents and other information concerning the arbitrations. Not only is there upfront costs associated with training and compliance with those requirements, but there is still significant uncertainty related to how the CFPB plans to use the information submitted to it and whether it will publish some or all of the data for the public to view.
Depending on what, if anything, the CFPB shares with the public about a specific financial institution’s arbitration history, that data could lead to so-called “copycat” lawsuits, provide opposing counsel and adverse consumers valuable settlement information, and lead to reputational harm.
Submit comments on the proposed rule: As an initial response to the CFPB’s actions, financial institutions must take steps to understand the full scope and ramifications of the proposed rule, and those that will be subject the rule should consider submitting comments to the CFPB either directly or through industry groups, such as bankers’ associations. Because the rule is so broad and relates to so many types of products, services, and providers, there are many opportunities to provide comments to attempt to limit the scope of the final rule. Thus, affected institutions should consult with counsel to develop and submit appropriate comments.
Review affected consumer agreements: Once financial institutions have submitted comments on the proposed rule to the CFPB, they should review their consumer finance contracts to get a better understanding of which of their agreements may be affected. Institutions should consider whether to amend consumer agreements that contain mandatory arbitration provisions, by removing those provisions in order to preserve the right to block class actions.
The proposed rule, if passed, would prohibit affected financial institutions from pairing mandatory arbitration provisions with class action waivers. However, the proposed rule would not bar the use of consumer class action waivers outside of arbitration. Thus, financial institutions must weigh the convenience and relatively minor cost of arbitration against the benefits of class action waivers in their agreements.
Consideration should also be given to the reporting issues facing financial institutions that continue to rely on arbitration provisions. Because it is still unknown if and how the CFPB will use the data submitted concerning arbitration outcomes, the financial industry should use caution in proceeding with that course.
Further, if a financial institution chooses to preserve class action waivers in lieu of arbitration agreements, it should ensure that it is careful to only change those contracts that are subject to this proposed rule. The proposed rule only applies to specific types of products and services.
It is possible that certain agreements related to one type of product or service would be subject to the proposed rule, but other agreements related to different products and services would not be subject to the rule. To ensure the financial institution is making changes to appropriate agreements, it should work with experienced counsel to identify the affected agreements.
It is also important to remember that changes to the agreements do not need to occur yet, as the rule would apply only to agreements entered into after the rule goes into effect (i.e., 210 days after it is published). Importantly, because agreements in existence prior to the effective date are excluded from the rule, the financial institution should also consider adding arbitration provisions with class action waivers to contracts that do not already contain those provisions and which will be executed prior to the effective date.
Litigation challenging the CFPB’s actions is almost certain. Although there are numerous possible grounds for challenging the CFPB’s proposed rule, the most likely will be based on whether the CFPB acted within the scope of its authority given to it by the Dodd-Frank Act in proposing and ultimately finalizing this rule.
Specifically, while the Dodd-Frank Act authorizes the CFPB to issue regulations that “may prohibit or impose conditions or limitations on the use of” arbitration agreements, it only permits that action if the CFPB finds “that such a prohibition or imposition of conditions or limitations is in the public interest and for the protection of consumers.” Further, Dodd-Frank expressly requires that the CFPB conduct a study of the use of arbitration agreements between providers and consumers and that any findings made by the CFPB to support a proposed rule concerning arbitration agreements “shall be consistent with the study conducted.”
In March 2015, the CFPB released a report on a study it conducted to evaluate the impact of arbitration provisions on consumers. The CFPB conducted the study as mandated by the Dodd-Frank Act, as mentioned above. The CFPB has relied on that study in justifying the proposals outlined in the current arbitration rule.
However, despite the CFPB’s reliance on that study to justify its current rulemaking efforts, the study has been widely criticized as having relied on insufficient data and ignoring certain information that would lead to conclusions not favorable to the CFPB’s current proposed rule. In other words, the CFPB is accused of using flawed and insufficient data to reach its desired outcome of restricting arbitration clauses and class action waivers.
For example, the CFPB collected much of its data through a telephone survey of consumers, rather than collecting data directly from regulated entities. Further, the largest percentage of data came from the auto and student lending industries, rather than being evenly spread across the affected industries. Further, contrary to the CFPB’s ultimate conclusions, its own data suggests that arbitration is simple and inexpensive and that consumers often achieve more positive results.
In addition, there are other unanswered legal questions concerning how the CFPB’s proposed rule comports with the numerous U.S. Supreme Court cases that uphold class action waivers in arbitration agreements. Further, just last month, the U.S. Court of Appeals for the D.C. Circuit heard oral arguments inPHH Corporation, et al. v. The Consumer Financial Protection Bureau, in which one of the issues on appeal relates to the constitutionality of the CFPB.
If the D.C. Circuit rules in favor of PHH and holds that the CFPB is unconstitutional, serious questions remain about the validity of any action taken by the CFPB up to that point, including enacting or enforcing the current proposed rule.
Bottom line: although the financial industry must begin to take steps to prepare for the effects of this proposed rule, if the rule is ultimately enacted, the fight will have likely just begun.