CFPB Report Claims Arbitration “Less Beneficial To Consumers” than Individual or Class Litigation, Foreshadows Attempt to Impose Restrictions in Future
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.
Deepa J. Zavatsky is a Senior Litigation Associate in Reed Smith’s Financial Industry Group in Princeton and New York. She represents lenders and financial institutions in consumer-facing individual and class actions in state and federal courts.
"Abusive” further defined by court as CFPB case against ITT Tech moves forward
On March 9, District Judge Sarah Evans Barker issued her long-anticipated order on the motion to dismiss in CFPB v. ITT Educational Services, Inc., No. 1:14-cv-00292 (S.D. Ind.). Judge Barker denied ITT’s motion to dismiss the Bureau’s unfairness and abusiveness claims but granted it on the Bureau’s TILA claim. At 67 pages, the order provides one of the longest and most thorough judicial opinions about the Bureau’s abusiveness authority to date.
CFPB complaint alleged that ITT coerced students into taking on private loans In its complaint, filed in February 2014, the CFPB alleged that ITT Tech, a for-profit college, pressured students into enrolling by using high-pressure sales tactics and offering no-interest loans, called “Temporary Credit,” which were good for the student’s first academic year. Students needed these loans to fill the “tuition gap” between what federal loans and grants covered and the cost of ITT’s tuition. The Bureau alleged that ITT knew from the outset that many students would not be able to repay their Temporary Credit balances at the end of the first year or fund their next year’s tuition gap. Instead, according to the Bureau, ITT’s financial aid staff rushed students through a process of refinancing the no-interest loans and paying for the gap with high-cost private loans that ITT had designed and helped manage. It alleged that ITT knew as early as May 2011 that more than 60 percent of the students who received the private loans would default.
Creating oppressive circumstances for consumers satisfies the “abusive” standard The order helps put some meat on the bones of the Bureau’s authority to prevent “abusive” acts and practices. The CFPB’s complaint alleged abusive practices under two of the four prongs of 12 U.S.C. § 5531(d), highlighted below:
(d) ABUSIVE.—The Bureau shall have no authority under this section to declare an act or practice abusive in connection with the provision of a consumer financial product or service, unless the act or practice—
- materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or
- takes unreasonable advantage of—
- a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;
- the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service; or
- the reasonable reliance by the consumer on a covered person to act in the interests of the consumer.
First, CFPB alleged that ITT took unreasonable advantage of the inability of consumers to protect their interests in selecting or using a consumer financial product or service. The judge rejected ITT’s argument that it did not take “unreasonable” advantage because ITT’s conduct is similar to the conduct of college financial aid offices across the country. She wrote, “the Bureau has alleged conduct that—we hope—is not simply par for the course; at any rate, the ‘everyone else is doing it’ defense does not support a motion to dismiss absent an argument that the allegations are legally invalid or factually implausible.” On the meaning of “inability of the consumer to protect” her interests, the judge wrote, a “reasonable reading of the statutory language . . . is that it refers to oppressive circumstances,” which the Bureau sufficiently alleged. Interestingly, she cited a law review article that suggests that this prong of the abusive standard “is a statutory codification of the common-law doctrine of unconscionability.”
Second, the CFPB alleged that ITT took unreasonable advantage of the reasonable reliance of consumers to act in the consumers’ interests. Judge Barker wrote, “‘Reasonable reliance’ is a familiar concept in tort law, and it is a question of fact generally not appropriate for resolution on a motion to dismiss, or even summary judgment.” To the extent that future courts follow Judge Barker’s lead, this position could mean that the Bureau in the future will only need to sufficiently plead that the defendant took “unreasonable advantage” to withstand a motion to dismiss.
Abusiveness captures conduct that may not be unfair or deceptive In rejecting ITT’s argument that the CFP Act’s prohibition of abusive practices is unconstitutionally vague, the judge wrote that the legislative history “suggests that the term was added, in part, to enable the Bureau to reach forms of misconduct not embraced by the more rigid, cost-benefit standard that had grown up around the terms ‘unfair’ and ‘deceptive.’” She wrote that the statute itself provides “significant guidance” as to the term’s meaning.
The Bureau’s authority and structure are not unconstitutional Judge Barker rejected ITT’s arguments that the Bureau and its investigation of ITT and/or its authorities were unconstitutional, noting that two other district courts have also rejected arguments that the Bureau is unconstitutional.
The Bureau has jurisdiction over ITT as both a provider of financial advisory services and as a service provider to the private lenders ITT argued in its motion that the Bureau lacked jurisdiction over it because it was merely an educational institution, and that the financial aid counseling ITT provided did not fall within the CFP Act’s definition of “financial advisory services.” The judge disagreed, writing that, at a minimum, the Bureau had pleaded conduct that “would fall within the realm of ‘credit counseling’ and ‘assist[ing] a consumer with debt management,’” two of the activities in the Act’s definition of financial advisory services. The judge also held that the Bureau had alleged conduct that would qualify ITT as a service provider to the private lenders, citing ITT’s involvement in operating and maintaining the loan program, including its payment of credit union membership fees for students and the stop-loss guarantee it provided the private lenders.
The Bureau has sufficiently pleaded unfair practices The judge applied the three-part unfairness test to the CFPB’s complaint, holding that: (1) allegations that ITT coerced 8,600 students into private loans with interest rates as high as 16.25 percent and origination fees as high as 10 percent adequately described a substantial financial injury; (2) allegations that ITT threatened to withhold transcripts or expel students if they failed to make up their “tuition gap” described a situation that was not reasonably avoidable; and (3) whether the harm is outweighed by countervailing benefits is a factual question and that the Bureau’s detailed allegations of the harm were sufficient to state a claim.
The TILA statute of limitations for civil actions bars the CFPB’s TILA claim The only silver lining for ITT and its lawyers is that Judge Barker dismissed the Bureau’s TILA claim as time-barred. This ruling may make the Bureau reluctant to bring federal district court claims under TILA for conduct that is not continuing. However, the order does not limit the Bureau’s ability to bring such claims in an administrative proceeding.