By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in India and other parts of Asia researching a book about artisanal textile workers but also writes regularly about law, political economy, and regulatory topics for various consulting clients and publications. She also writes occasional travel pieces for The National (http://www.thenational.ae).
Business interests have launched a pre-emptive broadside against the Consumer Financial Protection Bureau’s (CFPB) long-awaited regulations covering the use of forced arbitration clauses in consumer financial contracts. Financial institutions use such clauses to require consumers to use arbitration procedures to resolve a dispute, rather than allowing them bring class action or other types of lawsuits.
The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act mandated that the CFPB study the use of such clauses. This task was one of many slowed by the two-year stalemate over confirmation of CFPB director Richard Cordray. The CFPB arrived at its proposed rule after extensive study of the issue, first releasing public preliminary results in December 2013 and culminating in its May 2015 Arbitration Study. The bureau published its rule in May and solicited public comments. Now the bureau must wade through the more than 13,000 largely duplicative comments received before the comment period closed last week.
The rule contains two key parts. The first would prohibit financial companies from using an agreement that would bar a consumer from participating in a class action concerning a financial product or service covered by the agreement. The second would introduce a modicum of greater transparency into arbitration proceedings, and require financial firms to submit records of arbitration proceedings to the bureau.
Consumer advocates and others concerned about openness have long considered arbitration proceedings problematic as there’s little transparency, records are not made public, past decisions have little precedential value, and there are limited grounds for appeal. In addition, since parties on one side of transactions tend to be repeat customers, this pattern may skew decisions to one side. The lack of transparency in the system means it is impossible to evaluate how fair an arbitration system is.
The CFPB notes that although tens of millions of consumers enter into agreements using such clauses, little empirical research has been conducted on the subject. Nearly all the arbitration clauses it examined disallow class arbitration; 75% of consumers it surveyed were unaware that their consumer and financial contracts contain such clauses; and fewer than 7% of consumers understand that these clauses eliminate any right to litigate.
About 50% of credit card debt is subject to such clauses, as is 44% of insured deposits, and upward of 85% of other types of financial contracts (e.g., mobile wireless services, prepaid cards, payday loans, and private student loans).
The American Banker quotes a joint letter from the U.S. Chamber of Commerce, the American Bankers Association, the Financial Services Roundtable and 26 other national and state industry groups calling for the CFPB to withdraw the proposed rule, claiming this proposal “would have the practical effect of eliminating the availability of low-cost, efficient, and fair arbitration programs for consumers.”
Class Action Lowdown
Class actions get a bad press, partly due to the extensive efforts that have been made by business interests to tout the defects of the US legal system, especially laws, regulations, and procedures that allow consumers to recover for harms they have suffered. From the perspective of potential plaintiffs, class actions allow pooling of resources, making it economically viable to bring claims that individually may be too small to pursue. From the perspective of courts, class actions allow numerous similar claims to be combined and thus save court resources as claims are litigated together rather than separately. And from a systemic perspective, class actions allow private actors– entrepreneurial plaintiffs’ attorneys, incentivised by the large potential fees they can reap from contingent fee arrangements, to act as private attorneys general. In what can be called a regulation by litigation model, these lawsuits impose de facto constraints on dangerous, fraudulent, or predatory behaviour that in other national systems might be controlled by effective upfront regulation by the nation state (and at one time in the US, were addressed by some public regulators).
Supreme Court and Arbitration Clauses
The use of arbitration clauses in consumer financial contracts has been on the increase since the 1990s. Financial institutions like such clauses because they limit their potential exposure to large jury awards. And over this period, the business-friendly Supreme Court has generally interpreted the Federal Arbitration Act of 1925 (FAA) to allow enforcement of standard form pre-dispute arbitration clauses in consumer, employment and other types of contracts.
The CFPB’s pending rule-making would supersede the Supreme Court’s 2011 AT&T Mobility v. Concepcion decision holding that the FAA pre-empted state law that would have prohibited the enforcement of a consumer arbitration clause with a “no-class” provision. Prior to this decision, courts were split on the issue of state law challenges to the enforceability of no-class provisions in arbitration clauses. The Supreme Court extended this decision later that year in American Express v. Italian Colors Restaurant , upholding an arbitration agreement that checked merchants from bringing class action lawsuits against the company.
Constraints on Class Actions
Over the last couple of decades, the US class action system has been significantly constrained, partly by political decisions, but also by a series of judicial opinions. Let’s start with the political actions. Many of the same business interests arrayed behind the latest attempted squeeze on the CFPB were architects of the so-called ‘legal reform’ or ‘tort reform’ movements, such as the 1994 Contract With America. Both houses of Congress in 1995 passed the Common Sense Legal Reform Act, which, among other provisions, would have imposed “loser pays” rules and limitations on punitive damages; this legislation was vetoed by President Bill Clinton. Another bill, the Private Securities Litigation Reform Act, was ultimately enacted in 1995, over a Clinton veto, and made it more difficult to bring securities fraud claims (and in the opinion of some, made “bubble-era” abuses possible). Consumer advocates largely opposed such measures. In addition, trial lawyers, who at times have been the Democratic Party’s single largest source of campaign funds, also opposed the initiatives.
Moving forward a decade, in February 2005, the Senate passed the Class Action Fairness Act, with votes from 53 Republicans, one independent, and 18 Democrats– including then-Senator Barack Obama. The House had previously passed the bill and President George W. Bush signed it into law. This legislation helped make it more difficult for plaintiffs to prevail in consumer class action lawsuits. The bill shifted most class actions from state to federal courts, the latter of which are usually considered to be less open to creative class action claims. Similar legal reform measures were also mounted at the state level, and these included state statutory changes, as well as efforts to elect Republican state attorneys general (or others supportive of similar pro-business measures). The 2005 federal legislation eased procedures for a defendant to appeal against an unfavourable class certification decision, and one intended effect, now especially apparent a decade later, has been to relax pressure on (corporate) defendants to settle, out of fear of losing a class action trial.
Another major impediment to class actions has been a series of decisions the Supreme Court has made that restrict the award of punitive damages on constitutional grounds. Beginning with BMW v. Gore and including State Farm v. Campbell and Philip Morris v. Williams, these cases have steadily ratcheted down the amount of overall damages plaintiffs can hope to recoup..
These Court decisions are not as widely known as they should be. But they have had a major effect in reducing class action lawsuits because of the way such lawsuits are financed and developed. Plaintiffs’ attorneys frequently function as entrepreneurs in pioneering new areas of legal recovery. To develop successful such lawsuits can take years, and cost millions of dollars.
Plaintiffs’ attorneys usually bear the upfront costs of what can often be speculative litigation, with recovery uncertain; they in turn, are largely compensated by contingency fee arrangements. Such fees can seem exorbitant– they may stretch to as much as 1/3 of the total costs of a successful judgement or settlement. But the situation is more complicated than it appears on its face. Fees are contingent on success and are only earned if the lawyers recover money. In the event of a loss, plaintiffs’s attorneys receive nothing. It requires investment of considerable money up front to develop these claims to the point where plaintiffs’ attorney have leverage to secure a settlement (for virtually none of these cases ultimately goes to trial). Not every case results in a win or settlement, and if the expected benefits were not outsize when money is actually recovered, these attorneys would have insufficient incentives to bring claims in the first instance. (Just how outsize these fees need to be to achieve these results should of course be a topic for discussion and debate.)
The U.S. Chamber of Commerce is one group that has spotlighted the level of attorneys’ fees, especially relative to the amounts that the class action plaintiffs themselves ultimately receive. Some courts have also increased their scrutiny of consumer class action settlements. Judge Richard Posner of the United States Court of Appeals for the Seventh Circuit in 2014 authored three opinions overturning district court’s approval of settlements, over objections, of consumer class actions. Posner examined issues relating to attorney’s fees, and also examined the collusive effects of some typical settlement structures, which lower settlement costs for class action defendants.
Posner’s decisions are only legally binding as precedent in the Seventh Circuit. While they attracted substantial commentary, the impact of these decisions outside of the Seventh Circuit has been muted. Courts will continue to lean toward approving such settlements, except in the most extreme cases, as these reduce pressure on court resources.
But there’s a larger point that these critics miss. If the major benefit of class actions is their deterrent effect on the behaviour of corporate defendants, then the distribution of monetary rewards between plaintiffs and their attorneys is beside the point. Regardless of who receives what proportion of a successful judgement or settlement, a robust class action system imposes real costs on businesses, as partly demonstrated by the intensity of their lobbying efforts against the class action system. The net effect of tilting the class action playing field in a business-friendly direction is only to reduce pressure on firms to police their behaviour.
The current private litigation system overwhelmingly relies on entrepreneurial plaintiffs’ attorneys to bring lawsuits against corporate defendants that engage in practices that hurt consumers. If these attorneys are not incentivised to bring private lawsuits, few lawsuits whatever will be brought. We’ve certainly seen the sad reality of an overwhelming lack of effective Department of Justice enforcement actions against corporate defendants, especially financial institutions, during the Obama administration. The CFPB lacks resources to enforce consumer rights effectively and is dependent on private enforcement mechanisms. And so overriding existing legal precedent and thereby making it possible for attorneys to bring class actions is one of the limited tools the CFPB has at its disposal to shape the practices of financial institutions.
Such a move will not be unopposed. If the CFPB follows through and implements its proposed class action-friendly agenda, the U.S. Chamber of Commerce and its allies have already served notice that they will mount a legal challenge to the new rules. The Chamber sent a 103-page comment letter to the CFPB outlying some of the legal challenges it will raise. And depending on the electoral result, Congress, and maybe the incoming president, may make their own attempts to reign in the CFPB.