DS: What is the current status of arbitration clause use in consumer financial products?
MC: With few exceptions, arbitration agreements for consumer financial products have become incredibly common over the last 20 years. It’s a relatively recent phenomenon, though. Twenty years ago, the practice of barring consumer access to the courts just didn’t exist.
There are a few exceptions. Beginning in the early 2000s, Fannie Mae and Freddie Mac began refusing to purchase mortgages with mandatory arbitration clauses, believing that arbitration clauses were unfair to consumers and enabled lenders to avoid public accountability. Dodd-Frank confirmed that practice; it prohibits arbitration clauses in mortgage agreements. So in large part, mortgages don’t have arbitration clauses in them.
And in the middle part of the decade, there was antitrust class action credit card litigation, the settlement of which barred arbitration clauses in credit card agreements for a period of time, which has now expired. So there was a period of time in which credit cards were not subject to arbitration requirements, but that sector has largely reverted to mandatory arbitration. Many banks have now reverted to having arbitration clauses in their credit card agreements.
EF: How did we get here?
MC: It all results from the evolution of the Federal Arbitration Act (FAA), which was passed in 1925 and which preempted the ability of states to limit the use of arbitration clauses. For many years, based on the legislative history and judicial application of the FAA, it applied only to commercial contracts—so consumers were unaffected.
Then, in the 1980s, there was a string of Supreme Court rulings that ignored the legislative context and held that the FAA applied to all contracts. Attorneys for the lenders took these decisions and created an industry out of writing anti–class action arbitration clauses for businesses, marketing them as “immunity clauses” so that consumers wouldn’t be able to bring class actions in the courts.
There was litigation for the next 20 years over the standards to be applied to these expansive arbitration clauses. Many states applied unconscionability standards to void anti-class clauses, citing the impact on consumer access to justice.
In 2010 and 2011, the Supreme Court severely limited these efforts. In Rent-a-Center West, Inc. v. Jackson (2010), the Court held that questions of arbitrability should be decided by an arbitrator—not the courts—which created an obvious pro-arbitration bias, and in AT&T Mobility v. Concepcion (2011), the Supreme Court closed the door to unconscionability defenses. Those rulings led to an explosion of arbitration clauses in all kinds of everyday transactions. The clauses can be ridiculous. Sometimes the defendant alone gets to appoint the arbitrator. Or the arbitration is even set in an international location, making it impossible for the consumer to bring the proceeding. Generally, there is no public record or appeal. A belief I share with many others in the field is that these agreements undermine the rule of law because even if there is a law on the books to protect the consumer, there is no fair way to adjudicate whether the law has been complied with.
EF: What about arbitration class actions?
MC: There was a time when plaintiffs were asking—and occasionally getting—arbitrators to certify classes in arbitration. Those efforts were ultimately shut down by the expansion of anti-class clauses written into mandatory agreements and by industry lobbying pressure on the AAA. Industry has a lot of influence over the arbitrators because they are repeat players, whereas your typical consumer isn’t going to appoint an arbitrator more than once in his or her life.
DS: What was the genesis of the CFPB’s rule? Why is it being implemented now?
MC: When Dodd-Frank was enacted, it had two provisions related to arbitration: (1) Following the practices of Fannie and Freddie, it banned arbitration clauses for mortgages, and that ban has been in effect since 2011; and (2) it directed the CFPB to study whether arbitration clauses should be banned or limited for other consumer financial transactions.
The CFPB undertook that study, gathering evidence for more than two years, and, in 2015, published a lengthy report, which showed that though there were tens of millions of consumers subject to financial product arbitration agreements, there were—on average—only about 400 arbitrations filed by individuals each year.
The CFPB looked at class actions, specifically, which account for something like 98 percent of the liability imposed in the consumer world, given the economics of bringing a small individual claim. There, the CFPB found that where claims were litigated in court on a class basis, there were hundreds of millions of financial consumers affected each year, nearly $2 billion in cash relief granted between 2008 and 2012, and another $600 million of “in-kind” relief. Looking at the numbers involved, and the economics, the agency concluded that regulation to prohibit restrictions on class actions was a good idea.
EF: Who have been the champions and the detractors of this proposed rule, and are they making any interesting arguments for or against it?
MC: It has largely been the usual industry sources lining up against the rule, while consumer advocates are for it. Business sees this as a test case that may have broader impact beyond consumer financial services and as a threat to the protections they’ve built for themselves over the last 20 years. So even parties outside the consumer financial sector are weighing in—the Chamber of Commerce has come out strongly against the new rule. The fear is that if you ban arbitration clauses here and there are favorable results, it will be an important step toward banning arbitration clauses in other areas of the economy. In a lot of ways, this is a test case for what should be done about arbitration.
We’ve seen some interesting arguments against it. There was a bit of a brouhaha when the acting comptroller of the currency came out with a statement that this rule could be the “proverbial straw on the camel’s back” to destroy the availability of financial services for consumers. He initially asked the Financial Stability Oversight Council to block the rule as a threat to the overall banking system. He has since backed off that position, which was ridiculous on its face. There have been long stretches of time where the consumer financial services market was not laden with arbitration clauses and yet showed record profits.
Industry sources also say that individual consumers do better in individual arbitrations than on a class-wide basis or that this is “taking away choice” from consumers by invalidating contractual provisions. I don’t think those are very serious arguments, though. Comparing an individual claim—which might be worth a couple thousand dollars at the most—to class action liability imposing tens or hundreds of millions of dollars of liability on a defendant is misleading, given the very few individual cases that occur. And consumers can always opt out of a class action and take their individual claim to arbitration if for some reason they want to do that.
DS: How does this rule fit in with broader concerns about arbitration clauses and class actions?
MC: There is definitely a growing awareness that the pervasiveness of arbitration agreements has removed significant areas of our economy from the oversight and accountability that is provided by public proceedings. Enforcement resources are limited, but we’ve seen renewed interest in the area of for-profit colleges, for example, which have historically avoided scrutiny because they have uniformly included binding arbitration clauses and been largely exempt from litigation (other than by the Department of Education and state attorneys general) over student loan abuses. The Obama administration tried to limit the use of arbitration clauses by executive order or regulation—focusing on Medicaid, for example, and the prohibition of arbitration clauses that involved the abuse of nursing home patients. Those efforts have recently been blocked or rolled back.
Ironically, there was a bill enacted, about 15 years ago, to ban arbitration clauses entirely in one specific area: The Automobile Arbitration Fairness Act (AAFA) was enacted at the request of car dealers, to ban arbitration clauses in agreements between car dealers and manufacturers. The legislative findings are interesting. Congress found arbitration agreements to be contracts of adhesion and noted the problems involved in a lack of public oversight, etc.—all of the concerns that consumer advocates have articulated over the years. Ironically, in subsequent years after the AAFA was enacted, the auto dealers turned around and put mandatory arbitration clauses into all of their contracts with consumers.
EF: What other opposition will the rule face before or after it goes into effect?
MC: Under the Congressional Review Act (CRA), Congress can overturn a regulation that has been issued, by a simple majority vote in both houses and a resolution signed by the president. The CRA passed in the 1990s, but it has generally not been used because there generally hasn’t been the single-party control necessary to pass and sign the required legislation. Prior to this administration, the CRA was used only once, a number of years ago, to overturn an Occupational Health and Safety Administration rule regarding repetitive injuries.
Since the election, the CRA has been used 13 or 14 times. The House recently voted to overturn the CFPB arbitration regulation. If the Senate also voted to overturn, the president would presumably follow. So the issue is currently pending in the Senate. A number of Republican senators have expressed concerns on this issue, though, and indicated that they are not inclined to overturn the CFPB regulation. My own view is that the Senate probably does not have the votes to overturn it right now.
If it goes into effect, we will certainly see industry challenges in the courts, and there is always the possibility that when CFPB Director Cordray leaves, the new head of the agency will try to roll back this and other consumer protection regulations, though that will be difficult if Congress rejects the CRA resolution to overturn the rule.
DS: Do you want to make any predictions on where we’ll be in 5 or 10 years on this issue?
MC: We’ve polled on the issue—using very fair questions—and the public strongly supports efforts to roll back mandatory arbitration provisions. Something like 66 percent support our position. So, long term, the support is there. But industry has a structural advantage because there are very significant benefits to them in avoiding public lawsuits and they are focused and unified in advancing their interests toward arbitration. The provision on mortgages is written into the Dodd-Frank statute, so I think it’s unlikely that will be changed. But I think arbitration will continue to be a significant issue, and it’s not really decided yet how it will come out.