The Consumer Financial Protection Bureau (the CFPB) 2015 Arbitration Study, released yesterday in conjunction with a speech by CFPB Director Richard Cordray, lays the groundwork for rule making to broadly restrict the use of arbitration provisions – including class-action waivers – in consumer financial services contracts.

The CFPB’s Study arises under the Dodd-Frank Wall Street Reform and Consumer Protection Act’s requirement that the CFPB prepare and submit to Congress a report on the use of pre-dispute arbitration clauses in consumer financial contracts. Three years in the making, this newly released Study foreshadows a seismic change for any company that operates a retail-banking unit or – more broadly –any business that offers or provides to consumers a financial product or service through a contract that includes arbitration clauses, including but not limited to agreements for credit cards, checking accounts or debit cards, auto loans, prepaid cards, payday loans and retail-installment contracts. In the credit card industry alone, the Study estimates that contracts containing such clauses could bind at least 80 million Americans.

While the immediate effect of this Study and the CFPB’s follow-on rule making will impact banks and more traditional financial services companies, the ultimate effect may spill over into many other consumer contracts. The Study and future rule making should be viewed as the beginning of efforts to significantly restrict both the use of arbitration provisions and class-action waivers in most consumer contracts even when the affected business is not directly involved in the provision of financial products to consumers. 

What is the purpose of the Study?

Arbitration clauses have long been used to resolve business-to-business contractual disputes. Arbitration clauses began to appear frequently in consumer contracts only within the last two decades. Counsel in-house and at outside firms are well aware of the Federal Arbitration Act (FAA) and its gravitas as reiterated in the Supreme Court’s 2011 landmark decision in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 179 (2011), holding that state laws deeming class-action waivers in arbitration agreements unenforceable under certain conditions are preempted by the FAA such that the state must enforce arbitration agreements. It is against this backdrop that the CFPB released the Study – the first ever of its kind – in conjunction with a field hearing and comments by Director Cordray regarding consumer arbitration provisions.

In announcing the Study, Director Cordray explained that, while the Study does not cover arbitration agreements in commercial settings, the Study finds them to be problematic in a consumer setting. The reasoning for this determination comports with the stance of the CFPB underlying all of its consumer education efforts to date and CFPB’s enforcement actions, which have secured more than $5.3 billion in consumer relief since the CFPB’s inception: where uneven bargaining powers may exist between a consumer plaintiff and a corporate defendant in purchasing or using consumer financial services, the goal of consumer protection includes an obligation to help level the playing field for consumers. The Dodd-Frank Act authorizes the CFPB to address this issue in the context of arbitration agreements. Section 1028 therein not only mandated the Study but also provided that the CFPB “by regulation, may prohibit or impose conditions or limitations on the use of” arbitration clauses in consumer financial contracts if the CFPB finds that a prohibition or limitation on their use “is in the public interest and for the protection of consumers” and the findings in such a rule are “consistent with the study” performed by the CFPB. Given the release of the Study, the CFPB is now well along in the process of addressing consumer arbitration provisions.   

How did the Study arrive at its findings?

The Study was based on an empirical review of at least 850 consumer finance agreements, 1,800 consumer finance arbitration disputes, 562 consumer finance class actions filed in federal or state courts, 40,000 small claims filings, 400 consumer finance class action settlements in federal court, and over 1,100 government enforcement actions in the consumer finance context. In addition, the Study examined data comparing companies that dropped their arbitration clauses versus companies that kept arbitration clauses to assess whether inclusion of arbitration provisions meant lower costs or greater financial benefits for consumers. Lastly, the Study also incorporated the results from a national phone survey of 1,000 credit card consumers to probe whether consumers truly understood the language in their arbitration contracts.

What did the Study conclude?

The findings of the Study are numerous, but it reached certain core conclusions that will form a basis for future efforts to restrict the use of arbitration and class-action waiver provisions in consumer arbitration agreements. Among these conclusions, the Study determined that:

  • Consumer arbitration clauses are prevalent; credit card issuers representing more than half of all credit card debt have arbitration clauses in their consumer contracts
  • Consumers are sometimes afforded an opportunity to opt out of arbitration clauses, but they generally are unaware of this option or do not exercise it
  • Individual consumers are more likely to bring a lawsuit in court than to pursue a dispute in an arbitration proceeding, although arbitration proceedings conclude more rapidly than most court actions
  • Although class action litigation resulted in changes to the consumer financial market that includes tangible (monetary relief) and intangible (changes in corporate behavior) benefits, the private sector may not be doing enough to stem potentially unfair practices, and further regulation is needed
  • Arbitration clauses are effective for eliminating class actions; for instance, when credit card issuers with an arbitration clause were sued in a class action, the issuers invoked arbitration clauses to dismiss the class action nearly 66 percent of the time
  • When comparing samples of consumer accounts for companies that dropped their arbitration clauses versus those for companies that continued to use arbitration clauses, no evidence existed of either (i) a price increase to consumers or (ii) a reduced access to credit for consumers when arbitration provisions were deleted, suggesting that arguments about the business costs of foreclosing arbitration are overstated
  • Most consumers are unaware of or confused about arbitration provisions; among consumers who reported knowing what an arbitration provision was, 75 percent did not know that they were subject to an arbitration clause; also, of consumers who were subject to arbitration clause and reported knowing what a class action was, nearly 50 percent of such consumers believed that they could still participate in a class action, reflecting their lack of understanding of the effects of an arbitration agreement
  • While assessing the overlap between private class actions and public enforcement actions in the context of consumer financial litigation, there was no overlapping private class action complaint in 88 percent of the enforcement actions; similarly, there was no overlapping public enforcement action case in related public enforcement actions 68 percent of the time, again underscoring that many aspects of consumer financial services disputes are not addressed by the private sector
  • Where overlapping activity did exist, the Study found that public enforcement activity was preceded by private activity 71 percent of the time; by contrast, private class action complaints were preceded by public enforcement activity only 36 percent of the time.  

The Study illuminates point-by-point each of the CFPB’s justifications for a future rule making that would dramatically alter the landscape in the consumer financial services context through restricting mandatory consumer arbitration. Here are links to the report and fact sheet.

Since the Study is only a report to Congress and has no force of law, why does it matter now?

The Study has earthshattering implications even though it is currently presented in the form of a report to Congress. Never before has a federal regulator proposed rules that would make it unlawful to force consumers to go to arbitration, and the Study signals that this may happen vigorously. This represents a sea change in the ability of companies to resolve consumer disputes by arbitration. 

The lead-up to the Study, including the CFPB’s initial Request for Information nearly three years ago seeking public input on the scope of the Study and the preliminary results released in December 2013, reveal the energies exerted by the CFPB to ensure that the final Study appeared to be data-driven, thorough and objective. The CFPB’s broad authority under the Dodd-Frank Act to promulgate rules governing arbitration provisions and the express statutory requirement that any rules ought to comport with the findings of the CFPB’s own Study – combined with the content of the Study itself – show that a rule making to prohibit or otherwise restrict the use of pre-dispute arbitration provisions is on the horizon.

What can businesses expect from future rule making efforts by the CFPB?

(1) CFPB rule making to restrict arbitration in consumer financial services contracts:  The CFPB will spare no expense or effort in future rule making to limit arbitration and will do so aggressively. In many ways, arbitration clauses strike at the heart of the reason why the CFPB exists. Given the consumer complaints reviewed in the Study, it is apparent that the CFPB seeks to respect dual objectives in carrying out its mission: a commitment to the market and to consumers.

Whereas rational economics dictate that in a free market, private parties to a contract are free to agree on provisions in arms’ length transactions, the Study seems to show that the CFPB believes that arbitration clauses for consumers are contracts of adhesion, involving no bargaining and an offering of provisions on a take-it-or-leave-it basis. Even if servicing errors, billing errors and other back-office functions cannot be made unlawful per se because consumers in the free market can choose the products they want, the arbitration provision is anathema to the CFPB. It is – based on the Study’s research – not a result of free-market bargaining and wipes away whatever last-ditch solution customers might have to remedy mistreatment in the private market: the assumptions that individual actors have agency to act and may pursue self-help mechanisms in the courts if the contract is not performed to satisfaction are evaporated with arbitration clauses.

The CFPB likely will conclude that arbitration clauses (or at least “no-class arbitration” provisions) have a very limited place – or no place at all – in consumer financial services contracts. If this is the ultimate result of the CFBP’s rule making efforts, almost all consumer financial services disputes will need to be resolved in court rather than by arbitration or arbitration tribunals will see greater attempts by consumers to proceed on a class basis.

(2) The CFPB may rely on unfairness to eliminate or restrict consumer arbitration provisions:  The Study’s findings foreshadow a possible intention of the CFPB to regulate consumer arbitration clauses through the legal doctrine of unfairness. The three elements under CFPB and Federal Trade Commission (FTC) jurisprudence to demonstrate an act or practice is unfair are that (i) the practice was likely to cause substantial harm to consumers; (ii) where such harm could not be reasonably avoided by consumers; and (iii) the practice had no countervailing benefit to consumers or competition. By reporting that arbitration clauses are in standard-form contracts and that consumers are unaware of their actual effect, the Study sets the stage for the CFPB to decide that consumers are unable to reasonably avoid the harm flowing from purportedly injurious provisions when they are unable to bargain them away or even intellectually appreciate their significance. FTC and CFPB case precedents support the assertion that consumers, under such conditions, are not able to reasonably avoid harm through a consumer’s own responsible conduct, which enables the CFPB to prove a practice satisfies element (ii) of an unfairness claim (“Unfairness”).

Similarly, the Study’s assertion that companies that dropped arbitration clauses offered products that did not increase financial harm to consumers or restrict consumers’ access to credit is telling. This finding elucidates the CFPB’s likely intent to lay groundwork in rule making for finding that the practice of inserting arbitration clauses in consumer contracts does not have a genuine countervailing benefit to consumers, meeting element (iii) of Unfairness. Accordingly, companies should expect to see early movements in the initial rulemaking process by the CFPB to entertain a potential rule that restricts or prohibits arbitration clauses through the Unfairness prohibition in Sections 1036(a) and 1031(a) of the Dodd-Frank Act.   

(3) Private class actions are not sufficient to address the issue:  The potential for class action lawyers to be driven to maximize personal financial gains more vigorously than consumers’ well-being will not change the CFPB’s anticipated Unfairness analysis. Although the industry and commentators have opined on the harm that elimination of mandatory arbitration will cause through higher costs from frivolous class action litigation, in the calculus of the CFPB, it is not a zero-sum game. The externalities imposed by class action lawyers’ conduct who may act based on financial incentives are considered to be unfortunate downfalls of the legal system for consumer financial protection, which the CFPB likely considers to be vastly offset by the benefits achieved from class action litigation. The CFPB has implicitly admitted in its Study that (1) enforcement programs, even its own, are no silver bullet for identifying and redressing harms that the CFPB believes are inflicted on consumers and (2) private class action litigation (versus a government enforcement action) is more likely to be filed first in these matters. Thus, despite the disproportionately high incidence of private litigation that could arise solely from plaintiffs’ attorneys’ profit motivations, the CFPB may view a single class action success as important for consumers and society. For these reasons, the legitimate arguments regarding the flaws of the class action system are likely to fall on deaf ears at the CFPB.

(4) More litigation is to be expected: If arbitration clauses are prohibited or restricted by the CFPB, businesses will see a marked increase in the amount of litigation asserted by consumers under many consumer financial protection laws, including the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practice Act, the Fair Credit Billing Act, the Fair Credit Reporting Act, the Homeowner Protection Act of 1998, the Real Estate Settlement Procedures Act, the Truth in Savings Act, the Truth in Lending Act, the Credit Repair Organization Act, and the Telephone Consumer Protection Act, among others.

How can businesses mitigate risks now? 6 steps

  • Get ahead of the problem now: develop and implement processes and employee training to maximize customer satisfaction so customer complaints are resolved before they ripen into litigation.
  • Review arbitration and class action waivers in all consumer contracts – are they written in plain language and clearly disclosed? Are they understandable to the average consumer?
  • Consider offering an opt-out provision, with robust verbal and written disclosure, to show consumer choice and to mitigate any perceived unfairness.
  • Assess your litigation risks, particularly class action risks, and consider business changes in advance of future CFPB rulemaking.
  • Leverage a key attribute of the CFPB – a commitment to a data-driven approachto your advantage by employing a multi-step approach:
    • First, understand your customers’ complaints and the scope and financial impact of customers’ complaints.
    • Second, assess the impact of consumer financial issues, with the help of counsel to ensure attorney-client privilege shields the information from disclosure, so that financial projections are in line with potential impacts from future CFPB rulemaking. 
    • Third, commit to resolving consumer complaints to avoid regulatory scrutiny or class action risks. 
  • If you decide to participate in rulemaking or to accept Director Cordray’s invitation to stakeholders to engage the CFPB about the Study, prepare in advance with assistance from counsel, ensuring that your best Unfairness arguments regarding arbitration provisions are presented in a way that reveals a commitment to customers and addresses the CFPB’s desire for data-driven decision-making.

Conclusion

While the Study reports a wealth of empirical information, ultimately it will be used to justify the CFPB’s future conduct in upcoming rulemaking that is likely to greatly limit or eliminate arbitration provisions or class-action waivers in consumer financial services contracts. Resulting restrictions in the availability of consumer arbitration provisions will spill over into other consumer contracts. Businesses can mitigate these coming risks by using the time before the rule making to make thoughtful comments to the CFPB and to assess their dispute-resolution provisions and their business practices and procedures.