The Consumer Financial Protection Bureau has today published its final Arbitration Agreements Rule (10 CFR § 1040, et seq.), prohibiting mandatory arbitration provisions and class action waivers in consumer financial services contracts.
Despite over 110,000 comments, the final rule is very similar to the CFPB’s proposed rule, released a year ago. It becomes effective 60 days after publication (September 17, 2017) for all new consumer financial services contracts (i.e., those entered into 180 days after the effective date, or mid-March 2018). Existing contracts with arbitration provisions and class action waivers are not affected, except when a new financial services entity becomes a party to an older contract, it will no longer be able to invoke the arbitration provision or class action waiver in a later action with the consumer (see “Necessary Actions and Potential Pitfalls,” below).
CFPB Director Richard Cordray’s announcement of the final rule also removed any remaining doubt that the rule was designed to target banks and financial services providers for purported “wrongdoing” by using arbitration provisions to “sidestep the court system” and “avoid big refunds, and continue to pursue profitable practices that may violate the law and harm large numbers of consumers.”
While Director Cordray and the CFPB’s website touted the Bureau’s perception of financial benefit to consumers in class action lawsuits, the rule is also designed to deter companies from “pursuing profitable practices that may violate the law.” Cordray cited a finding from the CFPB’s 2015 Arbitration Study that claimed that “in 53 group settlements covering over 106 million consumers, companies agreed to change their business practices or implement new compliance programs.” This study, which was required by the statute and which purports to justify the rule, has been widely criticized by the financial services industry, which has also wondered whether the final rule was predetermined, and the results of the study and open comment period therefore merely theater.
WHAT THE RULE PROHIBITS AND REQUIRES
A. No class action waivers
The final rule prohibits pre-dispute arbitration clauses that waive class actions in new consumer financial contracts with all providers of covered consumer financial products and services. This includes any person or company that engages in an activity that is a covered consumer financial product or service to the extent that the person is not specifically excluded from coverage under the Arbitration Agreements Rule, including affiliates of those providers. 10 CFR § 1040.2(d). The rule applies to both stand-alone arbitration agreements and arbitration clauses that are part of other agreements or in other forms.
Director Cordray asserts that “the rule does not bar arbitration clauses outright,” but that is not the practical result. Rather, as the CFPB acknowledges, the rule prevents class action waivers, which was a primary reason that financial services companies relied on arbitration provisions. The rule requires providers to include some variant of the following language in all new consumer contracts to make it clear that consumer class actions in court are allowed:
“We agree that neither we nor anyone else will rely on 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 filed by someone else.”
B. New reporting requirements
The rule also imposes a new set of disclosures by financial services companies that arbitrate their disputes. Although the CFPB calls these required disclosures necessary to transparency and robust disclosure of consumer rights, they appear designed to facilitate information gathering and potential investigations by the Bureau.
Under the new rule, financial services companies will be required to provide extensive reporting to the CFPB on individual arbitrations undertaken pursuant to arbitration clauses in new contracts, as well as all court submissions asserting a pre-dispute arbitration clause in a contract.
In the event that a consumer pursues individual arbitration under a new contract, the financial services company must provide CFPB with:
- The initial claim and any counterclaim
- The answer to any initial claim and/or counterclaim, if any
- The pre-dispute arbitration agreement filed with the arbitrator or arbitration administrator
- The judgment or award, if any, issued by the arbitrator or arbitration administrator and
- If an arbitrator or arbitration administrator refuses to administer or dismisses a claim due to the provider’s failure to pay required filing or administrative fees, any communication the provider receives from the arbitrator or an arbitration administrator related to such a refusal
- Any communication the provider receives from an arbitrator or an arbitration administrator related to a determination that a pre-dispute arbitration agreement for a consumer financial product or service covered by § 1040.3 does not comply with the administrator’s fairness principles, rules, or similar requirements, if such a determination occurs.
If a financial services provider asserts a pre-dispute arbitration clause in court in connection with a new contract, it must provide CFPB with:
- Any submission to a court that relies on a pre-dispute arbitration agreement in support of the provider’s attempt to seek dismissal, deferral, or stay of any aspect of a case and
- The pre-dispute arbitration agreement relied upon in the motion or filing.
This information must be provided to CFPB within 60 days of filing (or of being served, if the financial services company is the defendant).
The result of these new obstacles is likely to be a wholesale abandonment of arbitration provisions by banks and financial services companies, as they will no longer be able to rely on class action waivers, pushing consumer disputes into already congested state and federal courts as class actions.
Necessary actions and potential pitfalls under the new rule
As noted earlier, the rule takes effect 60 days after publication in the Code of Federal Regulations and applies to contracts entered into 180 days after that date. This means that, unless the proposed rule is sidetracked by the Congressional Review Act (CRA) or by judicial action, financial services providers have about eight months to revise their standard customer agreements and terms to comply with the new rule for new customers after the rule becomes effective.
Existing consumer contracts are grandfathered in under the rule, but these contracts must also be reviewed for compliance with the new rule because it applies to pre-dispute arbitration agreements initially entered into between a consumer and “a covered person other than the provider.” The example given in CFPB’s “Supplement I to Part 1040 – Official Interpretations” is a pre-dispute arbitration agreement in a consumer’s motor vehicle installment sales contract with an auto dealer that existed prior to the rule’s compliance date. An auto dealer is a “covered person” under Dodd-Frank, but is excluded from the definition of “provider” under the new rule. If a “provider” under the rule, such as a “servicer or purchaser or acquirer of the automobile loan,” or a debt collector, has a dispute with the consumer arising after the compliance date, that provider is now prohibited from relying on the arbitration agreement in the earlier contract with the dealer.
Banks and financial services companies must also beware of requirements triggered by routine business activities after the compliance date, such as acquiring loans from other providers. Acquiring a covered consumer financial product or service that is subject to a pre-dispute arbitration agreement (such as an older loan) will be considered “entering into a pre-dispute arbitration agreement after the compliance date.” This requires the acquiring financial institution to amend the contract to include the following specific language prescribed by the CFPB, or to notify all consumers to whom the agreement applies in writing: “We agree not to rely on any pre-dispute arbitration 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 filed by someone else.”
The practical result is that every time a new bank or financial services provider becomes a party to an older contract containing an arbitration agreement, the clock is reset and that agreement becomes “new” and subject to the Arbitration Agreements Rule. Not only will this requirement gradually result in elimination of grandfathered in arbitration provisions, but it may chill formerly routine inter-bank or debt buying transactions. Banks can also likely expect an uptick in customers paying off old loans and opening new ones to “reset” and avoid arbitration clauses.
The Bureau’s decision to press forward with this controversial rule despite active challenges to the constitutionality of its structure and robust criticism of the rule itself may prompt a response from Congress or the White House on this and other issues surrounding the Bureau. In fact, both the House Banking Committee chairman, Senator Michael Crapo (R-ID) and House Financial Services chairman Jeb Hensarling (R-TX) have expressed grave reservations about the wisdom of the rule; Senator Crapo and Senator Tom Cotton (R-AR), another member of the Senate Banking Committee, have expressed support for using the CRA to rescind the rule. Since January, 14 rules have been rescinded via the CIA.
In the House, Representative Blaine Luetkemyer (R-MO), chairman of the House Financial Services Subcommittee on Financial Institutions and Consumer Credit, has promised hearings on the possibility of erasing the rule via the CRA. In addition, Keith Noreika, the Acting Comptroller of the Currency, has formally requested Director Cordray to delay the rule and provide the Office of the Comptroller with data and analysis that justifies its issuance and which addresses its possible adverse effect on bank safety and soundness. Specifically, Acting Director Noreika asked the Bureau to delay the rule pending an OCC independent review of the data behind the rule to confirm that it does not create financial risks for banks that could affect safety and soundness. Three letters have passed between Noreika and Cordray since the rule was announced on July 10, 2017, wherein the OCC asserted the importance of allowing it to assess potential safety and soundness consequences to banks arising from the rule, but the rule was published anyway. The objections of the OCC may also shore up Congressional opposition to the rule and delay implementation.
These developments are likely just the beginning. It has also been rumored that Director Cordray, whose term expires in July 2018, may resign by the fall to prepare to run for governor of Ohio, at which point an acting director could be designated and an active review of the rule could result. Additionally, banks and financial services providers will likely mount legal attacks against the rule, including challenges under the Federal Arbitration Act.
Last, a constitutional challenge against the Bureau’s very existence is pending before the full US Court of Appeals for the District of Columbia. If the court should overrule its earlier panel decision finding the Director’s standing to be unconstitutional, the case will undoubtedly be appealed to the US Supreme Court. If, on the other hand, the court should uphold the panel’s decision, the case will likely end there; as a practical matter, the Bureau will be unable to appeal.