CFPB Shines a Light on Inequities in Forced Arbitration; Congress Opts to Keep Consumers in the Dark

November 17, 2017

Massive corporate scandals have become all too familiar in America’s finance industry. Wells Fargo and Equifax offer two prominent examples that are still seared in our collective memories.

Last year, the Consumer Financial Protection Bureau (“CFPB”) revealed that Wells Fargo bank opened almost 1.5 million unauthorized customer accounts. Since then the scope of fraud has expanded to include an additional 2.1 million bogus accounts, bringing the current total to 3.5 million. As if that were not enough, Wells Fargo admitted in July 2017 that it charged over 500,000 customers for car loan insurance they no longer needed, resulting in tens of thousands of customers having their vehicles wrongfully repossessed.

Consumers who discovered these fake accounts tried to sue Wells Fargo back in 2013, but, pointing to fine-print clauses in its customer contracts, the bank successfully sent those matters to private arbitration. As a result, Wells Fargo was able to conceal the scandal from regulators and the public, and it continued to profit off customers from similarly injurious behavior for three additional years. In the class actions that were filed after the scandal became public in 2016, Wells Fargo tried to have those cases tossed out of court and into private, non-class arbitration as well. It was only after facing political and public backlash that Wells Fargo stepped back from its arbitration argument and agreed to settle one of the class actions for $142 million.

More recently, the consumer credit rating agency Equifax exposed 145 million Americans’ sensitive information, including social security and drivers’ license numbers, to increased risk of identity theft when it failed to have adequate security measures in place to prevent hackers from stealing the data. Equifax’s proposed remedy was to offer consumers one year of free credit monitoring and identity theft protection. But there was a catch: to sign up, consumers had to agree to arbitration and give up their right to sue the company. Facing public outcry, Equifax retracted that requirement.

Class Action Litigation versus Individual Arbitration

When consumers find themselves on the losing end of egregious corporate failures, filing a class action lawsuit is often the only feasible means to seek redress. That is because the cost of litigation far surpasses the damages to each individual consumer. And yet, many financial institutions, similar to Wells Fargo and Equifax, deny consumers access to the courts with arbitration clauses. These provisions are often buried in the terms of service and include class action waivers, which prevent consumers from joining together to bring claims collectively in open court. Instead, each individual, if he or she chooses to proceed, is required to independently go into private arbitration. Arbitration occurs behind closed doors (where wrongdoing can be concealed from the public), the rules of evidence often do not apply, and companies can steer matters to friendly arbitrators who wield unfettered power to issue decisions that are not subject to judicial oversight. While companies that provide arbitration services tout themselves as neutrals, there is a financial incentive for arbitrators to side with the companies that are their repeat customers.

The harsh reality is that once blocked from going to court collectively, most consumers do not pursue their claims individually. Former Judge Richard Posner explains, “[t]he realistic alternative to a class action is not 17 million individual suits, but zero individual suits, as only a lunatic or a fanatic sues for $30.” In other words, the difference between a class action and individual arbitration is often the difference between getting something and getting nothing at all. When consumers can sue collectively, facing significant class action damages, companies are more likely to change their bad practices in order to avoid future costly lawsuits. Forcing people into private arbitration and taking away the class action device effectively removes one of the few tools everyday people have to fight predatory and deceptive business practices and keep corporate defendants honest.

The Consumer Financial Protection Bureau Takes on Arbitration

Recognizing that arbitration clauses were becoming common in consumer contracts and concerned about the impact, the CFPB was specifically mandated to study arbitration following the Great Recession. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act created the agency to provide a single point of accountability for enforcing federal consumer financial laws and protecting consumers in the financial marketplace. It is authorized not only to enforce existing federal laws, but also to issue new regulations that are in the public interest and for the protection of consumers, and which are based on findings that are consistent with its studies.

In accordance with its mandate, in March 2015, the CFPB issued a report showing that hundreds of millions of contracts for consumer financial products and services have mandatory arbitration clauses, yet three out of four consumers surveyed did not know they were subject to them. In addition to being common and unknown, the study found arbitration leads to worse outcomes for consumers compared to class action litigation. According to the study, group lawsuits succeed in bringing hundreds of millions of dollars in relief to millions of consumers each year. Conversely, in the roughly one thousand cases in the two years that were studied, arbitrators awarded a combined total of about $360,000 in relief to 78 consumers.

Following the release of its report, the CFPB convened a Small Business Review Panel; sought feedback from the public, consumer groups, industry, and other stakeholders; and drafted an arbitration rule. A final version of that rule was issued July 2017. The rule banned financial companies–including student loan providers, payday lenders, credit card companies and banks–from using mandatory arbitration clauses that deny groups of people their day in court. Companies could still include arbitration provisions, but they would need to use specific language provided under the rule. The rule also sought to increase transparency by requiring companies to report to the CFPB each time a matter was sent to arbitration, so the agency could monitor the fairness of those proceedings and publish its findings. Financial institutions would have until March 19, 2018, to become compliant.

The CFPB’s Arbitration Rule Receives Instant Blowback

Wall Street was quick to condemn the CFPB’s rule. The American Bankers Association, the American Financial Services Association, and the U.S. Chamber of Commerce expressed strong disapproval of the rule asserting it was based on incomplete research. The U.S. Chamber of Commerce also issued a notice to representatives that it would consider their position on repealing the rule as a key vote to be published in its annual pro-business bona fides scorecard. The House of Representatives wasted no time and voted to rescind the rule at the end of July. Representatives justified the decision stating that they believed the rule benefited trial lawyers, not consumers.

Some believed the Senate would reach a different conclusion in light of vocal support from a wide array of groups including consumer advocates, the American Legion, the Military Coalition, the Tea Party, and the NAACP. And many Republican Senators were undecided in the weeks leading up to the vote. But a U.S. Treasury Department report may have sealed the rule’s fate. The U.S. Treasury Department, led by the former Goldman Sachs banker Steve Mnuchin, issued a report critical of the CFPB’s rule the day before the Senate vote occurred, indicating it could “impose extraordinary costs” on businesses. On October 24, 2017, the Senate narrowly voted to repeal the rule, with Vice President Mike Pence casting the deciding vote after the Senate tied 50-50. Senator Elizabeth Warren described the decision as “a giant wet kiss to Wall Street.” On November 1, 2017, the CFPB’s rule was officially killed by the stroke of President Trump’s pen.

California Sets its Own Path

While the CFPB’s arbitration rule was being crushed by Congress, California’s legislature was passing its own arbitration regulation. California Senate Bill 33 was introduced in response to the Wells Fargo scandal. Co-sponsored by California State Treasurer John Chiang, the legislation creates a new exception to mandatory arbitration within the California Arbitration Act and permits an existing bank customer to sue a depository bank when a fraudulent account is opened unknowingly in the consumer’s name. Banks are prohibited from requiring that disputes related to the fraudulent accounts be sent to private binding arbitration. The law applies to both federally and state-chartered banks. Governor Brown signed the bill into law on October 4, 2017, and it goes into effect on January 1, 2018.

Supporters of the legislation are optimistic that California consumers have secured their right to be able to pursue fraud and identity theft cases in public courts instead of secret arbitration hearings. Critics of the California bill predict the law will be short-lived as it will be invalidated as conflicting with the Federal Arbitration Act.

*    *    *

Regardless of the long-term viability of California’s new law, advocates will continue to fight to restore consumers’ right to bring class actions and have their day in court when they are the victims of predatory banking practices at the federal level. For now, however, companies like Wells Fargo and Equifax remain free to conceal their bad acts by forcing consumers into private arbitration. What’s past is prologue, and where claims fail to reach the light of a courtroom, justice tends to die in the dark.