What happened? The Senate voted last week (October 24th) to overturn a regulation designed to protect consumers from a financial industry practice known as “forced arbitration” – a way to force consumers to resolve disputes through a private arbitration company rather than using the traditional legal system. Millions of Americans have signed contracts that include these mandatory “forced arbitration clauses” in the fine print of credit card applications, student loans, checking accounts, and other financial products. In the case that a consumer is wronged by a large financial company, these clauses prohibit them from suing a company in a traditional court of law before a public judge and jury.
Why is it important? The decision is part of a larger conversation about the role of government in consumer protection. Does government have the right and/or responsibility to protect average people from the predatory practices of credit card providers, banks, loan servicers, and other businesses? Those opposed to regulating the financial services industry argue that government should not play a significant role in consumer protection. The most recent vote not only strikes down the “forced arbitration” rule, but also suggests impending limitations on the broader power of the Consumer Financial Protection Bureau, an organization designed with the specific intent of protecting consumers from harmful practices of large companies providing credit cards, checking accounts, debit cards, payday loans, private student loans, and auto loans. When thinking about the policy considerations of consumer protections legislation, it’s critical to think about why and to what extent protecting consumers is important:
- Does the average American consumer have the adequate support, tools, and resources to respond when harmed by a large corporation?
- What are the financial demands placed on businesses by a new regulation? Are these demands realistically achievable and fair?
- Every decision has trade-offs: what are the trade-offs of a new rule or regulation?
- If government is not responsible for protecting people against unfair business practices, faulty products, fraud, etc, then who in society should bear this responsibility?
Why was there a regulation in the first place? Following the financial crisis of 2008, a new government agency – The Consumer Financial Protection Bureau (CFPB) – was created to investigate abusive and predatory practices by financial companies. Many of these practices, such as predatory lending, hidden fees, and misleading interest rates, contributed directly to the financial crash and collapse of the housing market.
There was no sole federal agency responsible for consumer protection prior to the creation of the CFPB in 2010. The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010, gave the Consumer Financial Protection Agency power to study business practices and implement policies designed to protect consumers from harmful business practices.
The Federal Arbitration Act, passed in 1925, created an alternative form of dispute resolution that ran parallel to the court system: arguments between private parties could instead be resolved by a private “arbiter” rather than by a court of law. Many financial firms use a business practice known as “forced arbitration,” often in the fine print of a contract, that require consumers to resolve disputes via private arbitration rather than through the traditional court system.
For instance, when signing up for a credit card, the fine print might dictate that you cannot sue the credit card company in a class action lawsuit. Let’s say that your credit card provider charged you excessive, unadvertised fees. You then chose to sue the company. The paperwork you signed when you applied for the card might prohibit you from bringing a lawsuit against them in a traditional court system. Instead, your contract might mandate that any dispute must be handled by a private “arbitration company” that would examine the case. Your contract might also prohibit you from joining other affected credit card customers in a joint class-action lawsuit. Consumer protection advocates argue that class-action lawsuits give people the power and tools to challenge large businesses for injustices – something that is less feasible for just one person working alone. Does the average person have the money to hire a legal team to take on a credit card company? Unlikely.
The director of the CFPB, Director Richard, explains: “Arbitration clauses in contracts for products like bank accounts and credit cards make it nearly impossible for people to take companies to court when things go wrong…These clauses allow companies to avoid accountability by blocking group lawsuits and forcing people to go it alone or give up. Our new rule will stop companies from sidestepping the courts and ensure that people who are harmed together can take action together. ”
The agency studied forced arbitration, solicited feedback from consumers and business, and issued a 700-page report in support of a new regulation that would prohibit mandatory forced arbitration clauses. The report found that:
- Approximately half of banks and credit card companies use mandatory arbitration clauses
- 75% of consumers were unaware that they had agreed to forced arbitration
- Very few arbitration cases were resolved in favor of the consumer with only a combined total of $360,000 in relief to 78 consumers over a period of two years of study
Concluding that forced arbitration denies average consumers the tools to protect themselves against predatory business practices, the CFPB advocated for new limitations on the use of these clauses. The new rule was designed to make the following changes:
- Prohibited companies from using arbitration clauses to stop class action lawsuits
- Required companies to use specific language to describe arbitration in their contracts
- Increased transparency by requiring companies to submit additional records to better understand and study private arbitration settlements
- Specified future areas of study to assess effectiveness and fairness of the regulatory changes
What are arguments against the regulation? Businesses who oppose the new rule argue that arbitration is a fast, cheap, and fair way of resolving disputes. Opponents have focused on a few key arguments, legitimacy nonwithstanding:
- Class action lawsuits predominantly benefit trial lawyers rather than consumers
- New regulations will place burdensome requirements on businesses; as a result, legal expenses to defend against class action lawsuits will rise, and these excess costs will be passed on to consumers in the form of decreased credit and higher interest rates
- Research done by the CFBP does not make a strong enough argument that the new regulation will have any positive benefits for consumers
- The new rule will encourage frivolous, meritless lawsuits
What are the political dynamics? Republicans in the Senate ideologically oppose government regulation and are seeking to dismantle the legacy of the Obama Administration. Democrats have argued that the new rule protects consumers against the predatory practices of large companies that led to the 2008 financial crisis. Vice President Mike Pence cast the 51st – and deciding vote – against the new regulation. Two Republicans voted against the reversal: (1) Louisiana Senator John Kennedy (2) and South Carolina’s Lindsey Graham. Kennedy explained: “Just about every adult in my state had his or her data stolen. I am not going to tell my people they cannot have their day in court.”
The Senate used a rarely used mechanism, known as the Congressional Review Act, to overturn the rule by simple majority. It is only the second time in the 21-year-history of the Congressional Review Act that the Senate has used this legislative tactic. The last time it was used was under George W Bush to reverse a rule designed to prevent ergonomic injuries in the workplace.
The detailed breakdown of the vote count can be found here.
If not this rule, what are other alternatives? The Department of the Treasury, led by Trump appointee Steven Mnuchin, issued a highly critical report on October 24th, arguing that the regulation limited consumer choice and encouraged costly litigation. This report – as well as other critics – argued that other, more effective, strategies would better protect consumers, including:
- Measures designed to better inform consumers about arbitration clauses
- More prominent disclosure requirements by firms using forced arbitration
- Limited regulation in selected markets designed to test efficacy before broader implementation
Some who oppose the regulation argue that there are more effective strategies for consumer protection. Others are entirely opposed to any government regulation in the private market, regardless of how this effects consumers. However, opponents have also done little to demonstrate how alternative proposals would solve the problem of abusive business practices.
What should we make of this: the evidence presented by the Consumer Financial Protection Bureau is imperfect; however, the study was conducted over many years with broad input from consumer advocates, the business community, and the lay public. The concerns raised by opponents – particularly arguments that the regulation will not ultimately achieve the stated goal of protecting consumers – have legitimacy and should be taken seriously. To justify regulatory change, there must be constant reevaluation to confirm that stated goals are being achieved.
However, it is difficult to believe that opponents are acting in good faith to protect consumers. Republicans are unlikely to support legislative changes based on the very proposals that they suggest: increased reporting requirements, enhanced transparency in arbitration proceedings, and increased funding to support further study of these issues. Many opponent who voted to revoke the rule also argued vigorously against the very existence of the CFPB when it was created in 2010, and nearly all have been staunch opponents of any measure, however incremental, to regulate predatory business practices. If those who voted against the bill are serious about enhancing consumer protections, this commitment has not been evidenced by their legislative actions. Opponents do not seem serious about the alternative proposals to which they give lip service.
Imperfect as this rule was in design, it was a thoughtful proposal by an agency tasked with protecting average consumers. Those who oppose the rule do not seem serious about offering legitimate alternatives and translating those ideas into real legislative change.
Sources and further reading:
Ackerman, Andrew, and Yuka Hayashi. “Banking & Finance: Lobbying Beats Back New Rule for Banks — Securing Votes of a Handful of Republicans Proves Key to Blocking Consumer Measure.” Wall Street Journal, Eastern Edition; New York, N.Y. October 27, 2017.
“CFPB Issues Rule to Ban Companies From Using Arbitration Clauses to Deny Groups of People Their Day in Court.” Consumer Financial Protection Bureau. Accessed October 29, 2017. https://www.consumerfinance.gov/about-us/newsroom/cfpb-issues-rule-ban-companies-using-arbitration-clauses-deny-groups-people-their-day-court/.
Consumer Financial Protection Bureau. “Arbitration Study: Report to Congress, pursuant to Dodd–Frank Wall Street Reform and Consumer Protection Act § 1028(a).” Accessed October 29, 2017. http://files.consumerfinance.gov/f/201503_cfpb_arbitration-study-report-to-congress-2015.pdf.
Hayashi, Yuka. “Treasury, CFPB Clash Over Arbitration Rule.” Wall Street Journal, Eastern Edition; New York, N.Y. October 24, 2017.
Lazarus, David. “By a Single Vote, Republicans Throw out Years of Work on Consumer Protection.” Los Angeles Times, October 27, 2017. http://www.latimes.com/business/lazarus/la-fi-lazarus-senate-arbitration-rule-20171027-story.html.
McKinney, Darren. “Richard Cordray’s Surprising Admission.” Wall Street Journal, Eastern Edition; New York, N.Y. October 26, 2017.
“Richard Cordray’s Bad Numbers.” Wall Street Journal, Eastern Edition; New York, N.Y. October 23, 2017.
Sovern, Jeff. “Why We Need to Save the Consumer Financial Protection Bureau.” Salon, October 28, 2017. https://www.salon.com/2017/10/28/why-we-need-to-save-the-consumer-financial-protection-bureau_partner/.
U.S. DEPARTMENT OF THE TREASURY. “LIMITING CONSUMER CHOICE, EXPANDING COSTLY LITIGATION: AN ANALYSIS OF THE CFPB ARBITRATION RULE,” October 23, 2017. https://www.treasury.gov/press-center/press-releases/Documents/10-23-17%20Analysis%20of%20CFPB%20arbitration%20rule.pdf.
Yacik, George. “How the CFPB Rule Was Killed; Wells Hung out to Dry by Storm.” American Banker; New York, N.Y. October 30, 2017.