Controversial CFPB Rule Exposes Financial Services Companies to Greater Class Action Risk

This article previously appeared on the Holland & Knight Consumer Protection Defense & Compliance blog and is re-published here with permission. The post was co-authored by Peter P Hargitai, Josh H Roberts, and Laura B Renstrom.

Under a controversial new final rule issued by the Consumer Financial Protection Bureau (CFPB) on July 10, 2017, banks and credit card companies are prohibited from forcing consumers into arbitration to avoid class action lawsuits. The rule, if it becomes effective, will make it easier for consumers to bring class action lawsuits against financial companies. However, as discussed below, the CFPB has been targeted by the current administration, and Congress is empowered to override the rule.

A Brief Overview of Arbitration Clauses and the CFPB

Banks and credit card companies regularly insert mandatory arbitration clauses into their contracts with consumers. These clauses require consumers to bring their disputes against the company before a private arbitrator and generally prohibit a consumer from pursuing a class action claim in arbitration. In arbitration, both the evidence and the arbitrator's final decision are typically confidential among the parties.

While consumer rights organizations have long argued that arbitration denies consumers their day in court, financial institutions view arbitration as an efficient and cost-effective way to quickly resolve legal disputes. Further, the U.S. Supreme Court has repeatedly recognized that class action waiver provisions in arbitration agreements are fully enforceable, and cannot be ignored simply because the cost of proceeding on an individual basis outweighs any potential recovery.¹

The CFPB was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Since its inception, the CFPB has been tasked with reviewing arbitration clauses in financial contracts. In Dodd-Frank, Congress mandated that the CFPB study pre-dispute arbitration clauses and, if warranted, issue regulations to restrain them. In March 2015, the CFPB issued an arbitration study concluding that, although credit card issuers representing more than half of all credit card debt used mandatory arbitration clauses, three out of four consumers were not even aware they had agreed to an arbitration clause. The study, which was cited by CFPB Director Richard Cordray in rolling out the CFPB's new rule, reported that nearly 34 million consumers received payments totaling approximately $1 billion as a result of consumer class actions over a five-year period. Meanwhile, over that same period, 78 consumers participated in arbitration, recovering a total of $360,000.

Although Cordray used the study to insinuate that consumer class actions are more effective, the study also illustrates that the benefit to individual consumers who participate in arbitration is greater than the benefit to those who are members of a class action. While the award to an individual consumer in a class action averages $29 per consumer, the award to an individual consumer in an arbitration averages $4,615 per consumer. If the CFPB's mission is to protect the consumer (rather than punish financial institutions), Cordray's reliance on the study seems counterintuitive.

The CFPB's New Rule

The CFPB's final rule will be codified at 12 C.F.R. part 1040 to Chapter X in Title 12 of the Code of Federal Regulations. The rule sets forth two primary limitations on the use of pre-dispute arbitration agreements by financial companies.

First, the rule prohibits financial companies from including class action bans in their arbitration clauses. The rule is not an outright ban on arbitration clauses. The rule also does not apply to existing contracts, and only applies to pre-dispute arbitration agreements entered into after the effective date of the new rule. While companies may still include arbitration clauses in their contracts, these clauses may not prohibit consumers from being part of a group action. If companies do choose to include an arbitration clause in a contract for a consumer financial product or service, the contract must include the following language:

"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."

Second, the rule creates a significant reporting burden by requiring financial companies involved in an arbitration to submit specified arbitral and court records to the CFPB. These records include initial claims and counterclaims, answers to initial claims and counterclaims, and awards issued in arbitration. The CFPB intends to use the information it collects to monitor arbitral and court proceedings. Further, the agency intends to publish these redacted materials on its website beginning in July 2019.

Challenges to the CFPB's New Rule Appear Imminent

The CFPB's new rule is effective 60 days following publication in Federal Register and applies to all contracts entered into more than 180 days after that. Cordray believes that the new rule "throws open [courtroom] doors," allowing "harmed consumers to band together and seek justice." On the other hand, affected companies and many lawmakers believe the new rule will open the floodgates to frivolous and exceedingly costly litigation.

In the coming months, the rule is likely to face significant pushback from the financial services industry and a Republican-controlled Congress. The American Banking Industry released a statement expressing disappointment in the CFPB's new ruling, stating that "[b]anks resolve the overwhelming majority of disputes quickly and amicably, long before they get to court or arbitration. Arbitration is a convenient, efficient and fair method of resolving disputes at a fraction of the cost of expensive litigation."

Further, under the Congressional Review Act, Congress may override the rule by a simple majority vote within 60 legislative days of its finalization. Thereafter, once passed and signed by President Donald Trump, the affected agency is prohibited from revisiting the subject regulation for an extended period of time. The Congressional Review Act, a 1996 law, was used by a Republican-dominated Congress 14 times in the final months of the Obama Administration.

Last year, shortly before the election, the U.S. Court of Appeals for the District of Columbia found the structure of the CFPB, which is led by a single director, to be unconstitutional.² However, rather than shutting down the CFPB, the court ordered that the agency be restructured so that the Director could be removed at the will of the President. The decision was a response to a petition from mortgage lender that challenged an enforcement action from the agency and called for the CFPB to be eliminated. In May 2017, the D.C. Circuit reheard the case en banc, and no en banc decision has been issued.

Meanwhile, the Trump Administration has proposed to significantly curb the authority of the CFPB. President Trump has criticized Dodd-Frank's impact on lending, hiring and the overall economy. Just last month, the U.S. Department of the Treasury issued a report calling for a complete overhaul of the CFPB and urging Congress to remove the agency's authority to supervise banks and financial companies. In addition, consistent with the ruling of the U.S. Court of Appeals for the District of Columbia, the report called for the President to be able to remove the CFPB Director at will and without cause. In light of the foregoing, it remains in doubt whether the CFPB's new rule, banning arbitration clauses that limit class actions, will become effective.