The Consumer Financial Protection Bureau recently proposed a rule that would regulate the use of pre-dispute arbitration provisions in agreements for many types of consumer financial products and services. The proposed rule would effectively ban class action waivers in arbitration agreements for credit cards, personal loans, remittances, and mobile wallets, among others. While the proposed rule would permit the use of pre-dispute arbitration provisions without class action waivers, it would require the financial product or service provider involved in arbitrating such a claim to timely file with the Bureau information about the claim and how it was resolved.
This rulemaking is remarkable because of the wide range of products and companies it would affect, the significant political response that has already begun, and the expansion of class actions that would likely result. In this article we describe the context in which the proposed rule was developed and analyze the rule’s technical components, including who is covered and the intricacies of when the rule would apply. For example, while the rule is generally prospective in application, in some cases it would apply to existing agreements that are sold to a new party. We discuss the CFPB’s stated policy reasons for the rule and their responses to industry arguments in favor of arbitration. We conclude with commentary on the path ahead, including potential challenges to the rule, how arbitration agreements in contracts for consumer financial products and services might be viewed by courts in the interim period until a final rule is issued, and how companies might respond to the proposal.
Many contracts for consumer financial products and services include a “pre-dispute arbitration” clause that requires any dispute related to the contract be resolved through private arbitration rather than litigation. In addition, a significant number of those pre-dispute arbitration clauses include “class action waivers” that prohibit consumers from banding together with other similarly situated persons to file claims as class actions rather than as individual claims. Consumer advocates have challenged these pre-dispute arbitration clauses with class action waivers as unfairly restricting basic consumer rights while industry representatives have argued that arbitration represents a better, faster, and cheaper means of resolving disputes than the court system.
Section 1028(a) of the Dodd-Frank Act requires the Bureau to study and provide Congress with a report on the use of pre-dispute arbitration clauses in contracts for consumer financial products and services. The Dodd-Frank Act further authorizes the Bureau to issue regulations prohibiting or imposing conditions on the use of pre-dispute arbitration provisions in connection with consumer financial products and services, provided that such regulations are in the public interest and consistent with the findings of the Bureau’s study. See 12 U.S.C. 5518.
As we discussed in a previous post, the Bureau initiated a public inquiry in 2012 as a “preliminary step” in its study of consumer arbitration, seeking comments on the appropriate steps, methods, and data sources for the required study. The Bureau released preliminary results of its study on December 12, 2013, focusing on three types of agreements: cardholder agreements for credit cards, deposit account agreements for checking accounts, and cardholder agreements for general purpose reloadable prepaid cards. The preliminary report included findings with respect to the incidence and substance of arbitration provisions (including their complexity and inclusion of class action waivers), and the incidence and types of consumer disputes filed with the American Arbitration Association and in small claims courts. In that report, the Bureau indicated it would conduct additional empirical research, including a telephone survey of consumers, to assess the use of litigation and arbitration to resolve disputes about consumer financial services and products, and the impact of pre-dispute arbitration clauses on the price of consumer financial services and products, among other things.
Early last year, the Bureau released its final report on pre-dispute arbitration clauses (the Study), which we discussed here. The Study compared aggregate arbitration outcomes with aggregate class action outcomes and concluded that, over a five-year period, at least 160 million consumers were eligible for relief in consumer class actions, and that settlements in those cases totaled $2.7 billion in cash, in-kind relief, expenses and fees. By contrast, over a two-year period, consumers obtained relief in only 78 arbitrations (out of 1,060 filed with AAA), and obtained less than $400,000 in relief and debt forbearance in those cases, which was outweighed by the $2.8 million consumers were ordered to pay companies in some 263 other arbitrations where decisions were reported.
Additionally, the Bureau highlighted the following key findings from the gathered data:
- Arbitration agreements affect a large number of consumers, including 80 million consumers in the credit card market alone;
- Consumer understanding of arbitration is significantly lacking—three in four consumers did not know if they were subject to an arbitration provision and only 7 percent recognized such a provision meant they could not sue their card issuer in court;
- Consumers are reluctant to bring small individual claims against companies, while roughly 32 million consumers on average are eligible for relief through consumer finance class action settlements each year; and
- Arbitration clauses have not produced lower prices for consumers.
The Study’s conclusions have been disputed by members of the financial services industry. For example, the American Bankers Association, Consumer Bankers Association, and Financial Services Roundtable submitted a joint comment letter to the CFPB in July 2015 stating that the “data reported in the Study clearly demonstrate that arbitration is more beneficial to consumers than class action or individual litigation.” The trade associations noted that “[a]rbitration is faster, less expensive, and more effective than litigation” and that “customers who prevailed in arbitration recovered an average of $5,389, compared to the $32.35 obtained by the average class member in class action settlements.” Finally, the trade associations concluded that it “would be premature for the Bureau to promulgate any regulation at this time….”
The Study has also been criticized by members of Congress. 85 members of the House of Representatives signed a letter claiming that a “flawed process produced a fatally-flawed study” and that “[r]ather than focusing on the critical question – whether regulating or prohibiting arbitration will benefit consumers – and devising a plan to address the issues relevant to resolving that question, the Bureau failed to provide even the most basic of comparisons needed to evaluate the use of arbitration agreements”, such as between the transaction costs associated with federal court claims and with arbitration.
Small Business Review Panel
On October 7, 2015, the Bureau announced that the agency was considering a proposal regarding the use of class action waivers in arbitration agreements for consumer financial products and services. As the first step in any Bureau rulemaking having a “significant economic impact on a substantial number of small entities,” a small business review panel was formed with representatives from the Bureau, Small Business Administration, and Office of Management and Budget’s Office of Information and Regulatory Affairs (known as a “SBREFA panel”). The SBREFA panel met with a number of small entity representatives to discuss the Bureau’s outline of proposals on arbitration, along with a series of discussion issues surrounding the proposal.
The SBREFA panel submitted its final report to the Bureau on December 11, 2015 and the Bureau released the SBREFA panel’s report on May 5, 2016 in conjunction with the proposed rule. According to the SBREFA panel report, small entity representatives expressed concern that the Bureau’s proposal could result in increased costs of litigation that could potentially limit an entity’s product offerings or ultimately force an entity out of business. The panel recommended that the Bureau conduct additional cost analyses regarding the disparate litigation costs for small entities compared to larger entities.
The Proposed Rule
The proposed rule consists of two major components: (1) a ban on the use of arbitration agreements containing class action waivers, and (2) reporting requirements for covered providers that continue to require arbitration pursuant to a pre-dispute arbitration clause. The scope of the rule depends on whether a “provider” is offering a “covered consumer financial product or service”, which covers a broad range of products including loans, deposit accounts, remittances, and mobile wallets.
Ban on Class Action Waivers
The proposed rule would prohibit providers from relying on a pre-dispute arbitration agreement “with respect to any aspect of a class action” related to a covered financial product or service, “including to seek a stay or dismissal of particular claims or the entire action, unless and until the presiding court has ruled that the case may not proceed as a class action” and the time for an interlocutory appeal has lapsed or such a review has been resolved. As a practical matter, this provision prohibits pre-dispute arbitration agreements for covered financial products and services from including class action waivers. A provider still would be allowed to use a pre-dispute arbitration agreement so long as the provider does not seek to limit a consumer from addressing any dispute via a class action.
“Pre-dispute arbitration agreements” are defined in the proposed rule as “an agreement between a provider and a consumer providing for arbitration of any future dispute between the parties”, regardless of whether the agreement is mandatory or optional (e.g. subject to an opt-out or opt-in construct).
Continued Use of Pre-Dispute Arbitration Without a Class Action Waiver
The proposed rule permits providers to include a pre-dispute arbitration agreement in a covered consumer financial product or service agreement, but requires such providers to include in the agreement specific language clearly stating that the consumer is permitted to participate in a class action. For example, a pre-dispute arbitration agreement would be required to state that it will not be used “to stop you from being part of a class action case in court”. For existing agreements that subsequently become subject to the rule, the proposal would require that either the agreement be amended to include this notice or that this notice be provided separately from the agreement in “any way that the consumer communicates with the consumer, including electronically.” In the event that a provider offers multiple products or services to a consumer and only some of those products or services are covered by the proposed rule, the provider could elect to provide an alternative disclosure stating that the class action waiver only applies to consumer financial products or services covered by the rule (only by reference to the rule and without identifying the specific covered products or services).
Providers that continue to use pre-dispute arbitration agreements would also be required to submit certain arbitral records to the Bureau, including: (1) the initial claim and counterclaim; (2) the pre-dispute arbitration agreement filed with the arbitrator or arbitration administrator; (3) the judgment or award, if any, issued by the arbitrator or arbitration administrator; and (4) any communication the provider receives from the arbitrator or an arbitration administrator refusing to administer or dismissing a claim due to the provider’s failure to pay required filing or administrative fees. Providers would also be required to disclose any communications related to a determination that a pre-dispute arbitration agreement “does not comply with the administrator’s principles, rules, or similar requirements, if such a determination occurs.” Providers would be required to disclose these materials to the Bureau within 60 days of filing or receiving such a record. The CFPB has indicated it intends to publicly publish the arbitration data that it receives.
Scope of the Proposed Rule
As noted above, the proposed rule would apply to “providers” offering “covered consumer financial products and services”. The technical definitions of these terms are important because they ultimately determine the scope of the rule’s application.
“Covered consumer financial products and services” are intended to broadly capture the “consumer financial markets of lending money, storing money, and moving or exchanging money.” This subset of “consumer financial products and services” (as defined under the Dodd-Frank Act) that would be subject to the proposed rule includes:
- Consumer credit, such as credit cards, auto loans, and personal loans. These products are defined by reference to ECOA’s definition of “credit”, which also captures:
- Persons that “regularly participate in a credit decision”; and
- Others whose primary business activity involves referring consumers to creditors without participating in credit decisions, including accepting applications and either referring applicants to creditors or selecting creditors to whom credit requests can be made, such as real-estate brokers, auto dealers, home builders, and home-improvement contractors.
- Deposit accounts and remittances. These products are defined by reference to an “account” under Regulation E. Given the CFPB’s pending rulemaking on prepaid cards, when that definition is amended it will expand the scope of the arbitration rule.
- Auto leases;
- Debt management or debt settlement;
- Consumer reporting;
- Check cashing;
- Money transmission, including such activities conducted by mobile wireless third-party billing services;
- “[A]ccepting financial or banking data… directly from a consumer for the purpose of initiating a payment… except when the person accepting the data… is selling or marketing” the good or services being paid for, which would include a telecommunications provider or other entity that provides a platform for consumers to initiate payments to third parties; and
- Collecting debt arising from any of the above consumer financial products and services.
A “provider” would be defined as a subset of a “covered person” under the Dodd-Frank Act, namely “a person  that engages in offering or providing any of the consumer financial products or services covered by [the rule] to the extent that the person is not [otherwise] excluded.” “Provider” would also include affiliates of providers when the affiliate is acting as a service provider to the covered provider.
The proposed rule exempts certain persons providing covered financial products and services, including broker dealers and federal, state, local, and tribal governments and any affiliates of those governments. It also exempts providers that offer or provide any covered financial product or service to no more than 25 consumers in the current calendar year and no more than 25 consumers in the preceding calendar year.
In the Public Interest
The Bureau offers a number of reasons for its conclusion that the proposed rule is in the public interest and for the protection of consumers. According to the Bureau, the proposed rule would protect consumers by incentivizing providers to more fully comply with consumer protection laws by facilitating the use of class action lawsuits to bring private enforcement actions against providers. The Bureau argues that the ban on class action waivers and resulting increase in class action lawsuits will serve as a deterrent, encourage compliance, and enhance accountability, including increased consumer redress for non-compliant behavior. To that end, the proposed rule estimates that over the next five years it will result in an additional 514 federal class action settlements with total additional payments of over $1.7 billion (not including attorneys’ fees).
In releasing the proposed rule, the CFPB attempts to refute a number of potential negative consequences that were raised in response to its earlier Study. For example, the Bureau acknowledges certain costs arising out of the proposed rule, including increased compliance costs, class action defense costs, and costs to revise contracts, and the possibility that these costs may be passed to consumers, but concludes that the cost would not be noticeable to consumers. The proposal also states that potentially negative impacts on innovation and windfalls for certain class action participants are likely to be limited and do not outweigh the benefit to consumers.
The proposed rule would become effective 211 days after a final rule is published in the Federal Register and generally apply prospectively to agreements “entered into” after that day. The proposed commentary clarifies that a provider “enters into” a pre-dispute arbitration agreement when it: 1) provides a new product or service to a consumer and is a party to the pre-dispute arbitration agreement; 2) “acquires or purchases” a covered financial product or service and becomes a party to a pre-dispute arbitration agreement; or 3) adds a pre-dispute arbitration agreement to an existing product or service. For example, if a credit agreement that was originated before the rule becomes effective includes a pre-dispute arbitration agreement with a class action waiver, it would not be subject to the rule. But if the creditor is purchased by a third party after the effective date, and the purchaser becomes a party to the credit agreement, the rule would apply at the time the agreement is amended to include the purchaser, and the purchaser would be required to amend the agreement by either eliminating the class action waiver or providing specific notice that the pre-dispute arbitration provision would not be used to prevent a class action. However, an amendment to an existing agreement that contains a pre-dispute arbitration agreement with a class action waiver that was entered into before the effective date would not trigger application of the rule, as long as a new party is not added to the agreement.
An exception would apply for certain pre-packaged general-purpose reloadable prepaid card agreements packaged before the compliance date. The exception would essentially give additional time for a prepaid card issuer to amend the pre-dispute arbitration agreement in writing within 30 days after the issuer has the ability to contact the consumer, for example, by mail or email, even if the consumer is identified well after the effective date of the rule.
Comments on the proposed rule were due by August 22, 2016. While comments were requested on all aspects of the proposed rule, the CFPB specifically sought comments on the following issues, among many others:
- Scope of the proposed rule. The Bureau sought comments on whether any products or services that the Bureau has proposed to cover should not be covered, and whether any types of consumer financial products or services that it has not proposed to cover should be covered. Specifically, the Bureau sought comments on the inclusion of credit counseling services, debt collection services, stored value products and services, and persons subject to the Securities and Exchange Commission’s jurisdiction. Additionally, the Bureau sought comments regarding its approach to cross-referencing terms in enumerated consumer financial protection statutes and regulations and how changes to those laws may affect the scope of the proposed rule.
- The Bureau sought comments on whether the proposed definition of class action would be appropriate and whether the term arbitration should be defined, and, if so, how and why.
- Insurance costs. The Bureau sought comments on whether and, if so, how the rule would affect class action litigation defense insurance costs for covered entities. The Bureau also sought comments on whether and to what extent commercial lenders inquire in the course of underwriting a loan about a potential borrower’s exposure to class actions or ability to rely on pre-dispute arbitration agreements to reduce exposure to class actions.
- Benefits of submission of arbitral records. The Bureau acknowledges that the proposed rule would provide “limited insight into how and whether arbitration agreements discourage filing of claims” and sought comment on whether the proposed collection of the arbitral records would allow the Bureau to monitor potential harms in providers’ use of arbitration agreements as well as the underlying legal claims.
- Confidentiality of arbitral records. The Bureau sought comments on the publication of the arbitral records submitted to the Bureau, including whether it should limit publications based on consumer privacy concerns or if providers would have other confidentiality concerns. Additionally, the Bureau sought comments on whether consumers should be able to opt-out of the Bureau’s publication of documents related to the arbitrations in which they participate.
- Temporary exception for prepaid cards. The Bureau sought comments on whether the temporary exception for prepaid cards is necessary, and if so, whether the scope of the exception should be extended to other types of covered products.
- Public interest and the protection of consumers. The Bureau sought comments on whether the proposed rule would be in the public interest and for the protection of consumers.
Over 6,200 comments were submitted on the proposal from various participants, including trade associations, consumer advocates, potentially affected companies, and consumers.
Our Take: Reactions and Challenges Ahead
Below are a series of potential consequences that could stem from this rulemaking.
- Spur or chill the use of arbitration agreements with class action waivers. The proposed rule could chill the use of class action waivers by financial institutions, even before the Bureau issues a final arbitration rule. On the other hand, since a final rule will generally not be retroactive, it may provide an incentive for providers to include class action waivers in arbitration agreements before the proposed rule becomes effective.
- Increased litigation challenging pre-dispute arbitration agreements with class action waivers. The Bureau or other law enforcement bodies, namely state attorneys general and regulators, could consider bringing enforcements actions against providers that do not elect to revise their arbitration agreements using their authorities to prohibit unfair, deceptive, or abusive acts or practices. And although the Bureau does not intend the proposed rule to apply retroactively to existing arbitration agreements, the rationale and data behind the proposed rule could give courts a reason to start invalidating class action waivers or finding entire arbitration agreements unconscionable, including as to providers who do not fall within the proposed rule’s scope. For providers that are subject to the rule and attempt to use a class action waiver in a class proceeding when expressly prohibited by the rule, penalties under the Dodd-Frank Act could likely be pursued by the CFPB or state attorneys general or regulators for a violation of a “Federal consumer financial law” (e.g. $5,000 per day for a violation of law, $25,000 per day for a reckless violation, or up to $1 million per day for a knowing violation).
- Increased class action litigation. If finalized as proposed, the proposed rule will likely increase the number of private class action lawsuits filed seeking to enforce technical aspects of federal statutes, including the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act, and state unfair and deceptive laws (where, in many cases, a violation of federal law is deemed a violation of state UDAP law). Indeed, this is one of the Bureau’s explicitly desired outcomes of the proposed rule.
- Consumer gaming. Consumers could be incentivized to close accounts with agreements that contain class action waivers and re-open the account after the compliance date. Companies could consider countering this activity by offering sign-up incentives before the effective date of a final rule.
- Lack of clarity in federal policy surrounding arbitration. The proposed rule mirrors recent actions taken by other federal agencies to regulate the use of pre-dispute arbitration agreements in consumer agreements in other industries, including broadband Internet access service providers by the Federal Communications Commission and long-term health care facilities by the Centers for Medicare and Medicaid Services. Nonetheless, the proposed rule is arguably inconsistent with the strong federal policy supporting arbitration, as reflected in the Federal Arbitration Act and recent Supreme Court precedent. The political and legal consequences of this conflict are yet to be seen.
- Disclosure of arbitration pleadings and awards conflicts with a core tenet of arbitration. The submission and publication of information about arbitrations, which are typically private proceedings and are often subject to non-disclosure agreements, would be a significant departure from current practice.
- Legal and political challenges to the proposed rule. There is a possibility that one or more consumer financial services providers that would be impacted by the proposed rule could file a lawsuit to prevent the rule from becoming effective. Among other things, the challenge could be based on allegations that the CFPB’s arbitration study was flawed, that the CFPB’s reliance on the study data to conclude that the rulemaking is in the public interest is unsound, or that the rulemaking is beyond the CFPB’s statutory authority. Assuming the data in the study is valid, the conclusions drawn from the data could be disputed. For example, proponents of arbitration have argued that the study data indicates that arbitration is in fact in consumers’ best interests when compared to class actions.
- Concerns about abusive class actions remain unsolved. The proposed rule bolsters the class action system without recognizing or attempting to solve any of its flaws. Class action waivers have arguably become prevalent in pre-dispute arbitration agreements because of their effectiveness in limiting companies’ liability from abusive or frivolous class action lawsuits. Absent the inclusion of a class action waiver, however, the value of a pre-dispute arbitration agreement is diminished. Companies may consider including stand-alone class action waivers in their agreements (e.g. without pre-dispute arbitration), though the enforceability of these waivers varies by jurisdiction and would provide uncertain protection.
We hope PLA readers find this information helpful and welcome your feedback. We’ll continue to write about developments in arbitration.