On March 10, Director Richard Cordray of the Consumer Financial Protection Bureau (“Bureau” or “CFPB”) presided over a Field Hearing on Pre-Dispute Arbitration Clauses, discussing what he described as the “key findings” of the Bureau’s long-awaited 700-page Arbitration Report to Congress published earlier that morning. Reed Smith attorney Deepa Zavatsky attended the hearing, where Cordray expressed the CFPB’s view that pre-dispute arbitration is not a “better alternative” to litigation, and he foreshadowed the Bureau’s likely adoption of limitations to such mandatory provisions in consumer contracts.

CFPB suggests consumers do not understand arbitration clauses and class action waivers The Report reveals the Bureau’s belief that arbitration is still unknown and unused by the vast majority of consumers. Discussing the controversial CFPB-run 2014 telephone survey of credit card customers, Cordray noted that of survey respondents who even knew what arbitration was, three-quarters did not know if their financial contract contained an arbitration clause. Of respondents who believed they knew, over half were wrong about whether their contract did in fact contain such a provision.

Moreover, Cordray claimed that more than half of surveyed consumers whose arbitration clauses had a class action waiver still believed they could participate in class litigation. Even though a quarter of respondents’ arbitration provisions allowed a consumer to opt-out of the arbitration clause, only one surveyed consumer recalled being asked whether he wanted to exercise that opt-out, according to Cordray.

CFPB claims consumers benefit much more from class actions than from arbitration The Bureau also determined, Cordray stated, that consumers appear to receive less benefit from arbitration than from litigation. According to the Bureau, in 2010 and 2011 the studied arbitrations resulted in awards of less than $400,000 to consumers, but consumers were ordered to pay $2.8 million to their financial institutions in the arbitrations. By contrast, according to the Bureau’s study, class actions resulted in more than $2.7 billion paid to consumers, with their attorneys receiving $500 million, or 18 percent of the total awards.

CFPB says study of credit card costs shows no price difference based on arbitration clause, but marked difference in likelihood of consumers pursuing claims Cordray’s comments highlighted the Bureau’s apparent opinion that pre-dispute arbitration clauses have a chilling effect on consumer claims that is not outweighed by apparent benefits. According to the CFPB’s survey, when faced with a dispute relating to credit cards, only 2 percent of consumers surveyed would actually litigate or arbitrate the claim, with the vast majority preferring simply to cancel the credit card. The findings also indicated in Cordray’s view that it is rare for a financial institution to exercise the arbitration clause to move an individual suit into arbitration, but extremely common for an institution to raise that clause as a barrier when faced with a class action. Cordray disputed the argument from industry representatives that arbitration results in defrayed litigation costs and thereby leads to cost savings for borrowers. He said the Bureau’s study revealed that the cost of credit cards did not vary based on whether they contained an arbitration clause or not.

CFPB recommendation to restrict pre-dispute arbitration seems likely, if not inevitable The Director’s comments were met with vigorous dissent from industry representatives, who disputed the methodology of the study and specifically challenged the CFPB’s conclusions about the purported benefits of class actions to consumers. Not surprisingly, consumer advocates strongly supported the CFPB’s claims. The Bureau is seeking further input from the public, and no rulemaking or timeframe for any such action has yet been adopted. However, the tenor of Director Cordray’s comments, coupled with the Report, led Reed Smith associate Nick Smyth, who spent four years as an Enforcement Attorney at the CFPB, to predict that the Bureau will eventually recommend severe limitations on the use of pre-dispute arbitration clauses in financial contracts, similar to those in place with respect to residential mortgages: “I expect the Bureau will attempt to prohibit mandatory pre-dispute arbitration clauses and class action waivers through rulemaking, but the rulemaking process will be lengthy (at least three years), with many more opportunities for the industry to weigh in, before any such rule would take effect.”

Moreover, litigation over any rule prohibiting pre-dispute arbitration is likely, given that the rule would stimulate a flood of new class action litigation against financial institutions. Smyth added that he believes any such rule would permit financial institutions and consumers to mutually agree to enter binding arbitration after a dispute arises.