Consumer Financial Protection Bureau to Put End to Mandatory Arbitration for Consumer Loans, Credit Cards

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It looks like a pervasive abuse is about to bite the dust.

A major way that financial firms have tipped the playing field even further in their direction is the inclusion of mandatory arbitration clauses in their contracts. The argument has been that this feature is beneficial to consumers, since arbitration is cheaper that litigation in the event of a dispute. But studies have repeatedly found that to be bollocks. The arbitrators that are chosen to serve are not only screened to be big institution friendly; arbitrators that wind up ruling in favor of customers have this funny way of being moved to the bottom of the selection list, while hanging arbitrators get regular assignments. For instance, from a 2009 report by the Center for Responsible Lending:

Arbitration cases can be unfair not only because consumers have no choice in the matter, but also because prior results from Public Citizen research suggests that consumers may win only 4% of the time. The relationship as currently structured gives arbitration forums and arbitrators a strong incentive to side with “repeat players” that control the flow of ongoing business, rather than a consumer seen only once. In the credit card context as well as many other consumer transactions, it is very difficult to find a product without a forced arbitration agreement hidden somewhere in the fine print.

And a New York Times investigation found that individuals almost never avail themselves of arbitration for amounts under $2500; they found only 505 examples from 2010 to 2014.

Similarly, the forced arbitration clause means class action attorneys cannot take up these cases. Despite the regular demonization of their efforts, banks find it profitable to engage in penny-ante grifting which is just not worth it for a customer to pursue, like charging undisclosed fees, or timing and ordering deposits and check clearing during the day so as to maximize the amount of consumer fees. While consumers don’t net much from these lawsuits, the bigger point is to stop this behavior going forward and to put financial firms on notice that if they engage in small scale ripoffs across large numbers of customers, they face good odds of being caught out and having to pay back a lot of their ill-gotten gains. The New York Times series also identified consumer abuses that class action lawyers had targeted but were stymied by the presence of mandatory arbitration clauses, such as Citibank selling consumer insurance they could not actually use, and merchants who disputed American Express’ hefty processing charges.

The New York Times today reports that the Consumer Financial Protection Bureau will soon bar mandatory arbitration clauses in consumer financial products. Even though the rule is not final and is subject to a comment period, the tone of the Times report is that the provision becoming final is close to a certainty. From the account:

The nation’s consumer watchdog is unveiling a proposed rule on Thursday that would restore customers’ rights to bring class-action lawsuits against financial firms, giving Americans major new protections and delivering a serious blow to Wall Street that could cost the industry billions of dollars.

The proposed rule, which would apply to bank accounts, credit cards and other types of consumer loans, seems almost certain to take effect, since it does not require congressional approval.

In effect, the move by the Consumer Financial Protection Bureau — the biggest that the agency has made since its inception in 2010 — will unravel a set of audacious legal maneuvers by corporate America that has prevented customers from using the court system to challenge potentially deceitful banking practices.

“It’s going to spell the end of arbitration,” said Alan S. Kaplinsky, a lawyer with the firm Ballard Spahr in Philadelphia, who pioneered the use of arbitration clauses to thwart class-action lawsuits and thus opposes the proposed rule. “It will lead to a huge upsurge in litigation and take away a benefit to consumers.”….

“It is a good start,” said Berle M. Schiller, a federal judge in Philadelphia who has been critical of arbitration clauses that dismantle class actions and tip the scales in favor of companies. “Class actions are the only way that companies can be brought to heel.”

The agency’s proposed rule would be the first significant check on arbitration since a pair of Supreme Court decisions in 2011 and 2013 blessed its widespread use. Those decisions signaled the culmination of an effort by a coalition of credit card companies to stop the tide of class-action lawsuits.

Note that the rule will apply only to new accounts and loans, but consumers can cancel existing ones and sign up again.

I’ve been generally critical of Dodd Frank as delivering much less than it promised, but this is an important exception. Dodd Frank not only established the Consumer Financial Protection Bureau, but also tasked the agency to investigate arbitration. Its 2015 report showed how the process was skewed in favor of bigger players. Again from the Times”

For the few who did go through with the process, the report also showed the lopsided nature of the rulings. Businesses won bigger judgments against consumers in arbitration — a total of $2.8 million in 2010 and 2011, largely for debt payments — than the consumers obtained in relief, according to the agency’s analysis.

During that period, only 78 arbitration claims resulted in judgments in favor of consumers, who received less than $400,000 in total relief.

It’s rare to see a clean win for consumers versus banks, particularly given that the Consumer Financial Protection Bureau has tended to be cautious. However, previous research and reporting and the agency’s own analysis showed that forced arbitration was a clear-cut abuse, paving the way for action. And the Administration generally has been pursuing various bank settlements and fines to burnish Obama’s “tough on bank” claims, even though these actions are rounding error compared to the massive wealth transfer represented by the stealth bailouts. But even though this is a comparatively small step, it will still over time curb a lot of misconduct, particularly the type that hits low-income customers disproportionately hard. The howling by the Chamber of Commerce and bank allies says that the financial services industry expects this measure to hurt them where they care most, in their wallets. About time.

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  1. sleepy

    Wow, this is such a pleasant surprise to wake up to! Good news is hard to come by in this depressing world.

  2. YankeeFrank

    The fact that it applies to only new accounts is ridiculous. What is the reasoning there? That contracts between banks and customers are sacrosanct even if they (with questionable legality) take away significant rights from people? The vast majority of people won’t even know about this and won’t be closing accounts and opening new ones (not to mention what a pain or impossibility that can be) so I don’t see much reason for the victory lap here. Sure its a move in the right direction, but come on people. If we’re settling for this as some kind of great win its due to Stockholm Syndrome and nothing else. And gauging its import by how loudly banksters wail is an inaccurate measure as they strategically deploy their outrage, shamelessly pretending to be the world’s biggest whiners and cry-babies screaming when anyone removes even their least favorite toy from the pram.

    1. Yves Smith Post author

      The existing accounts are legal agreements. The regulators don’t have the authority to change those. The Supreme Court did rule that terms like that were kosher. Plus the banks would have a very strong argument if someone were to try that it amounted to a taking under the 5th Amendment and they needed to be paid for the value of the change in terms.

      First, you can inform people you know. Second, people can and do change banks and get new credit cards. So this is more significant than you assert.

      1. sd

        My credit card can at any time announce new terms for my account and I have no say except to close the account which will of course hit my credit rating.

        1. Clive

          You do not need to close your account. If you simply do not use your “old” account it will remain active for a while (depending on the card issuer), then it will be flagged as dormant (still open but any transactions will likely get queried) until finally it will get — usually — force-closed. Force-closing of a facility by a card issuer for reasons of low usage cannot be recorded as a detriment by a credit reference agency unless your account it delinquent. Not using credit does of course, perversely, reduce your credit score but if you merely substitute one card with another this is on balance neutral.

          Another credit card product application may have some affect on your score, but if this is the first application you’ve made in, say, 24 months or so, it will almost certainly be discounted.

          If your FICO is really bad then when you apply for a new card product you may be declined or offered only a high-rate facility. In this case, you should try as far as possible to operate the card product writhing the agreed facility for 12 months until your credit score improves. Usually 13 months without an overlimit excess is enough to improve the score sufficiently to move you from a straight decline for a prime card product to an acceptance.

          If, sadly, you’re seriously underwater with your personal finances then you might be stuck with a card account on legacy terms. But if is genuinely does apply, it is probably a wake-up call that you can’t earn your way out of the situation and it isn’t going to just sort itself out with time. In my experience far too many people end up spending far too long trying to use a thimble to bail out a sinking boat. Bankruptcy carries a stigma (it shouldn’t do) and is not a consequence-free option but for some people it is far and away the best one. That is an extreme scenario in the context we’re discussing here; the vast majority of people can — and should — switch once products start appearing with the new Terms and Conditions.

            1. Clive

              Said in (part) jest I’m sure, but you’re spot on. Corporations use BK procedures all the time. I remember when so many U.S. airlines were trading in Chapter 11, the smattering of those who weren’t complained that it was unfair competition (I think the rules were changed a little in response but I didn’t follow up on the story to find out the nitty-gritty details).

              A good friend of mine was a runaway spender in her twenties and amassed huge CC debts — far more than she could ever realistically repay. For well over 10 years she’s been playing the lender’s games, trying to be a “good” person, entering IVAs (an arrangement here in the UK which is supposed to be only for those with some possibility of paying back what they owe), not meeting them, paying off bits and bobs here and there which are just enough to allow the lenders to claim the debt isn’t completely written off but never actually getting out of the hole. There is a smidge of equity in her property which all the lenders are angling to get but the round-robin of part payments stops her getting repossessed (“foreclosure” as you guys call it).

              She still gets calls from collection agencies for debts that must be coming up to 15 years old. Then there’s the junk fees. She really needs to go bankrupt (I’ve advised her on a plan — basically, stop paying everyone, save enough for a deposit on a rental place plus a modest sinking fund, go BK and once the court approves it she’d be free and clear with enough cash-in-hand to cover contingencies plus freedom from the constant worry over her precarious situation. Plus she’d then be able to tell the creditors to take a hike, after her BK, they’d be history). Luckily she has no student loans so that really would be that.

              But no, she keeps worrying what “people would think of her”. I will cite your example ! And in so doing, quite possibly be the first recorded use of Donald Trump as being of benefit to anyone.

              1. Skip Intro

                I’ve been trying condition myself to find positive things about the likelihood of a Trump Clinton match, and the concomitant Trump presidency…

                Do you think we can reach single-digit turnout?

      2. YankeeFrank

        The legal agreements should be for current balances, not for the duration of the account. After all, and as sd points out, the companies can change terms on existing accounts going forward if THEY choose. Once again we see the courts giving rights to corporations they don’t give to people. If the banks don’t like it they have a remedy: they can close the account.

        The corporations and corporate friendly courts have skewed our legal system such that it really only responds to their interests in almost every case. As one egregious example, somehow when a bank steals a home through fraud that’s okay, but courts are loathe to give a family a “free house” in order to punish the bank for its numerous frauds in that one case alone. Even class action suits skew towards corporate interests because courts rarely seek to compensate plaintiffs in full for clear corporate malfeasance, let alone compensating them beyond the economic damages to actually provide some punitive punishment that MAY deter future thefts. And why, if I steal from a cash register, do I go to jail when a corporation pays a tiny fraction of their theft and then walks?

        The fact is our “justice” system treats corporate criminals (and all the tricks they play amount to theft in any fair definition of the word) as above the law. Is it going to take a literal revolution for this to change? Celebrating a victory is fine, but let’s not forget this is a mere rearguard action in a war we are losing badly.

        1. Clive

          It is impractical to have contracts lapse when a credit card debt is settled. A credit agreement needs a contractual framework for both the lender’s and the borrower’s benefit. If simply paying off a debt which was originally accrued as part of a rolling facility (like a credit card debt it) ends the agreement, you’d have to sign a new agreement each time your credit card balance reached zero. This is a nuisance for those who routinely maintain a hard-core debt on their card account and only repay it outright periodically, completely untenable for those who settle the debt in full monthly.

          While I am the last person to say that courts do not, on occasions, act in ways that favour big corporations over individuals, contract law is very well settled in the U.S. jurisdiction. Meddling with established precedents risks unintended consequences. If a court ruled that contracts could be retrospectively changed when they’d not been broken (as is the case here, the contracts are valid even if they are stinky) all contracts would have grounds to ask for the same privileges. Like it or not, that is the way justice works and rightly so.

          Mandatory binding arbitration should never have been allowed to be hardwired into credit card agreements. But the fact that they have been ruled impermissible is a huge step. If I ruled the world, I’d mete out restorative judgements differently than the system we have at the moment. But I don’t and you don’t want a dictatorship or a system of inconsistent rules either. We have to take our victories as we find them and be emboldened for the next round. You don’t waste your energy sitting there asking for jam on it too.

          1. YankeeFrank

            Yeah, the sanctity of contracts again. This is about power, not contracts. The power to steamroll people, buy judges and make laws that have no relation to justice or even common sense. The SC may have decided that mandatory arbitration agreements are legal, but they are not ethical and they break the spirit of the law if not the actual letter.

            I understand the CSFB doesn’t have the power to nullify contract terms. But again, that’s another power decision. If government can create secret courts to grant it unaccountable power as we now have in the USA, don’t preach to me about the law. The law no longer exists as anything other than a cudgel for the powerful.

            1. Clive

              It’s not just that the CSFB can’t nullify or forcibly amend the contracts. A court could, but if a court modified the credit card contracts in the way you’re proposing then a precedent is set which could be used — by the same corporations we’re so castigating — to similarly modify other contracts and make them more to their liking.

              You don’t have a justice system worthy of the name by letting it be arbitrary, capricious and tyrannical.

              Social reform, I’m all in favour of that. Anarchy in the USA is a recipe for collective misery.

              1. reslez

                if a court modified the credit card contracts in the way you’re proposing then a precedent is set which could be used — by the same corporations we’re so castigating — to similarly modify other contracts and make them more to their liking.

                The point is that the CC companies already can and do modify the contracts to their liking at any time. When that occurs the customer’s only recourse is to cancel their account. I don’t disagree with you, I think we’re just boggling at how unfair the situation already is.

                1. Clive

                  Yes and the CFPB has recognised the power disparity inherent when you might have a captive customer and set limits on how much the CC issuers can leverage that. This is why the CFPB’s move is so important.

                  I’d agree that the redress isn’t perfect. But it is as good as can be achieved if we accept that the principe of Do The Least Harm is a valid one.

          2. Nathanael

            “Contracts of adhesion” are not respected by the courts the way real, negotiated, signed contracts are respected. And they shouldn’t be.

            There are no credit card agreements, bluntly. There’s just a spew of text which the credit card company is trying to claim that you have to comply with. Legally speaking, the credit card companies are on very thin ground when they claim that I’ve agreed to anything. Common law rules over such “contracts of adhesion”; the courts have great power to smash and rewrite such “contracts”.

            Completely invalidating such “contracts” would have no effect whatsoever on *real* contracts, which are negotiated and signed in ink by both parties.

            (The corruption in the Supreme Court is another matter. Obviously the Scalia Court would happily rule in favor of the banksters no matter what the issue was.)

      3. Dave

        Yankee Frank, how is it that corporate “persons” get to write off interest charges against “their”, really should be “its”, taxes, while meat-and-sauce humans cannot?

        Patriots pay cash to small businesses and individuals.

        If you have credit cards for things like gasoline or hotel bookings, call up and cancel your cards. Tell them that you are out of the country for a few years.

        Then, call up and ask for a new card(s) which will have the new protections.

        Be careful about doing this all at once as it can affect your credit rating-if you give a damn about that.

        Why do I think “Papal indulgences” when I hear “credit rating”?

        1. Nathanael

          Reagan eliminated the interest deduction which individuals used to be able to take.

    2. Chris

      Encouraging additional account churn is a way to hit the banks’ cost bases. I’m sorry that I don’t have U.S. industry figures, but for the UK, processing a new account application is c. £10-15 depending on the product. Producing and sending out the account goods, credit checks, doing the admin etc. are not huge costs individually but in bulk they start to add up. Maintaining an unused account is £5-10 per year (the card issuer will most likely eventually force-close it, but too late to avoid taking a loss on the customer for that period of low activity).

      If we take, say, 10 million accounts switching at maybe $20 cost ea. that’s a non-trivial hit.

  3. Tony Sturgis

    The arguements being made by industry schills like Kapinsky and the Chamber of Commerce are so disingenuous and misleading that they would make Joseph Goebbels proud. It is amazing that the banks continue to pay these attack dogs and propogandists but seem to be mystified as to why Americans view bankers as basically evil.

  4. Mark K

    I don’t suppose the CFPB has jurisdiction over phone companies, cable companies, and all the others who write mandatory arbitration clauses into consumer contracts? Or that the changing zeitgeist will somehow drive the clause out of those contracts as well?

    1. Tony Sturgis

      The phone companies started to enter the finance realm by leveraging their monthly billing and ability to shut off people’s phones for non-payment. They sold their services to sleezy slammers who tricked (usually children) into downloading ringtones and charging four or five bucks a month into perpetuity. The phone companies took a big chunk of the revenue for enabling what was essentially fraud. Most people paid the fees for months or years before noticing and then had to spend an hour on the phone trying to get the charges removed which the phone companies claimed were “third party” charges they had no control over.

      They are now providing financing when you buy a new smart phone. I would hope that this would be enough for the CFPB to assert juristiction in at least some instances.

  5. Paul Tioxon

    Congrats on government regulation helping the people out.
    Protection from arbitrary authority, at the whim of the banks, yes!
    Intervention into the market place by CFPB, PRICELESS!

  6. ke

    The system is now so artificially complex that the majority are handing their kids over to the communists at birth, for a 25 year indoctrination period, teaching them to chase debt with ever more arbitrary and shifting rules, breeding as if genetic modification will save the day, in a positive feedback loop with genetic degeneration.

    The psychologists hook them up on drugs, drop them in the street for heroin distribution, and collect again on rehab, a vicious cycle coming to a community near you soon. The credit card companies are drug dealers, charging whatever rate is necessary at the bottom to cover defaults from the top. Income inequality is growing, surprise.

    Thank goodness that gal from Mass is on the job, offering free healthcare and education for EVERYONE.

  7. Toyota

    some for profit colleges ripped off students by loading them into tons of debt, I would wonder if they can benefit from the new changes in laws?

  8. Felix_47

    A secondary benefit is that this will be a windfall for defense and plaintiff attorneys. If anyone thinks these class action cases are going to make the consumer better off they are crazy. The banks will just boost their fees overall so this is a benefit that will simply make credit more expensive. And low income people, generally the ones with issues, should not have credit cards based on what I have seen over the years. If people lived within their means there would be a lot less stress and if income is not adequate they might unite and agitate for a better system and perhaps vote for a socialist.

    1. diptherio

      And low income people, generally the ones with issues, should not have credit cards based on what I have seen over the years.

      The best thing is to find a Credit Union that offers over-draft and/or a credit card. Either way is likely to be the cheapest credit available for low-income people. And sometimes we do need that credit, due to our low income.

      If people lived within their means there would be a lot less stress and if income is not adequate they might unite and agitate for a better system and perhaps vote for a socialist.

      Have you not been paying attention? Fight for 15, Sanders…hell, even the TEA Partiers were agitating for a better system (most of the ones I’ve talked to got involved because of the bailouts).

      But I am also pessimistic about this having major effects. It’s a step in the right direction, but taking one step forward for every twenty steps back isn’t something to get too excited about. The score is still Customers: 1, Banksters: 300 Billion….

    2. ke

      So long as prices are determined by arbitrary debt compliance to the FILO, the so impoverished have little choice but to enter the debt trap serving the so shrinking middle class.

      Females vote for immigration, playing one off against the other, sophists print, males rise against, and the conquerors breed in the vacuum, what’s new.

    3. armchair

      An arbitrator who always decides in favor of the institution is way more efficient than a judge. No contest. Even an industry friendly judge will slow things down with their concern for giving the appearance of a fair hearing. Think of the efficiency that will be lost.

  9. Tony Butka

    Nice to hear some good news. In California, most of the “arbitrators” under these agreements are retired judges with seriously outrageous fees and ‘I love my financial institution’ bumper stickers :-).

  10. Enquiring Mind

    Modern life seems to have more moral hazard elements over the past few decades. The arbitration example is one of many that the average citizen may cite in the course of traversing a day, week or month.

    If you accept, or even entertain that premise, what are the likely causes of the trend?

    My admitted bias includes a reference to the Powell Memo. While defense of one’s position, industry or whatever is reasonable, at what point does that defense cross some normative lines into manipulation, misconduct or generalized misanthropy? Was there some high water mark of decency that passed, and if so, why?

  11. FluffytheObeseCat

    This is great news on the face of it.

    The proposed rule is 2-fold. The second part of it constrains covered providers to give the CFPB “specified arbitral records“. Which may be as valuable in the long run as the ban. Patterns of abuse have been seen even in the spotty records that the CFPB and others have obtained to date.

    The first part: “would prohibit providers from using a pre-dispute arbitration agreement to block consumer class actions in court and would require providers to insert language into their arbitration agreements reflecting this limitation”

    The summary doesn’t suggest that providers will be prohibited from offering arbitration as an option, and then giving customers incentives to use it. It’s not clear (p. 4) if they might be allowed to induce consumers to sign away their rights in return for upfront incentives, like a .25% higher rate, say, on a CD, or a .1% lower rate on a loan.

    There are people reading this proposed rule as we write, looking for ways to blunt its effect. Ideally it would be written so as to discourage covered providers from indulging in end-runs. The enacted rule should be written in such a way that customers have maximum access to the courts when facing disputes.

  12. joey

    FYI from Louisville, purchasing tickets to the Kentucky Derby requires signing a forced arbitration/ class action exempting agreement with Churchill Downs Inc. Is that becoming a broad corporate policy?
    As if paying $250 for $3 seats wasn’t already an acknowledgement that they like to screw consumers.

  13. The Derivative Project

    It is my understanding the CFPB proposed rule only permits class actions lawsuits. Contracts will still call for binding arbitration. From the Wall Street Journal:

    “The CFPB aims to prohibit financial companies from using mandatory-arbitration clauses as a way to block class-action lawsuits, in which a large number of plaintiffs with similar complaints band together. Companies would still be able to require consumers to enter arbitration to resolve individual disputes.”

    The industry knows most of the issues are small insidious issues that still will remain behind the cloak of secrecy and the consumer will still have no access to the court system. Only true change can come about by allowing arbitration to be optional, as is currently the case in contracts with real estate firms for home purchases, for example. These legal breaches cost thousands of losses to the average consumer who has no access to recoup their losses, when laws are broken. The industry knows this.

    Dodd Frank also ordered the SEC to consider banning mandatory arbitration, a significant issue for retirement accounts, holding over $5 trillion in IRAs, all subject to mandatory arbitration. Rep Keith Ellison (D-MN) introduced a bill to ban last Fall– it went no where most obviously, with a Republican controlled House FS Committee.

    The most costly pre-dispute arbitration clauses are with Wall Street firms, with broker dealer accounts, where every IRA is subject to mandatory arbitration. These broker dealer account agreements may still permit clauses with the new fiduciary DOL ruling, that permit mandatory arbitration by FINRA’s kangaroo court. Again, it is the small losses that do not give rise to class action status that are harming the individual retirement investor. As the February 2015 White House report indicated, retirement investors are losing over $17 billion annually to conflicted advice.

    Most legal experts state the new DOL fiduciary rule will have to be argued in the courts, for example what is “best interests” for retirement investor., which will take a decade or more to determine. This decade Wall Street knows will usher in an unprecedented trillions of dollars of wealth transfer from 401k account to IRA’s, by aging boomers. Wall Street knows this and is pleased to have another decade to continue breaches of existing securities laws. All the small, insidious claims, will continue to prevent the small retirement investor to a fair justice system. The real issues will never make it to the courts and will be hidden by Wall Street’s avenue to prevent true transparency on their ongoing monstrous breaches of securities rules, their SRO FINRA. Wall Street has created a brilliant business model which has allowed the theft of $17 billion annually due to conflicted advice that breached Investment Advisers Act of 1940 to be hidden behind their right to limit retirement investor’s access to courts.

    It should be noted that FINRA did allow the right to class action law suits in IRA accounts, challenging Charles Schwab’s clause that banned them. Yet they know very well how to get around that. If there is any doubt on how pleased FINRA was with the recent DOL ruling on “fiduciary” for retirement investors and the ongoing right to control the legal process for another decade, read here:

  14. Nathanael

    So I’m going to explain something important.

    This type of ripoff hits the upper middle class. They get nickel-and-dimed on these damn fees and it’s not worth their time to fight it, but they hate it.

    The elite has gotten so greedy and nasty that they’re ripping off people who… well, *who get appointed to the CFPB*, to be blunt. This was pretty dumb of the elite, wasn’t it? They’re ripping off judges, too. And white shoe lawyers. And so on. Every one of the professionals who the elite rely on to keep them out of prison was ripped off by this sort of fee fraud.

    That’s a situation which is hard for them to maintain. That’s why this CFPB rule is going to go into effect.

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