Consumers who are wrongly nickeled and dimed by banks, credit card issuers, debt collectors and other financial service concerns could soon regain the right to band together and sue, thanks to a new rule announced by the Consumer Financial Protection Bureau.
The CFPB announced final rules on Monday that will bar companies that extend credit and collect debt from forcing consumers to give up their right to pursue class actions by contractually obligating customers to binding arbitration agreements. These arbitration agreements, once used primarily for disagreements between businesses, are now pervasive in the financial services industry, covering roughly half of all credit card and banking relationships.
The CFPB's new, are expected to go into effect next March.
"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," said CFPB director Richard Cordray at a press conference on Monday. "The real effect of mandatory arbitration clauses is to insulate companies from most legal proceedings altogether."
The reason is practical: If you were improperly charged a $35 overdraft or late fee, you're unlikely to spend thousands of dollars to hire an attorney and take the matter to court. Only 2 percent of consumers said they'd take their credit card company to court over a small-dollar dispute, according to a CFPB study. However, this same consumer might join a "class" of thousands of other individuals, who claim they were ripped off in the same way by the same company.
Indeed, consumer groups commonly refer to mandatory arbitration agreements as "rip-off clauses," because they bar group arbitration, as well as class actions. By keeping small-dollar disputes out of court, consumer advocates contend that wrongdoers are able to perpetuate with impunity nagging rip-offs that affect millions. However, bankers maintain that arbitration agreements can provide a low-cost way to resolve disputes.
"I have been drafting arbitration provisions for a long time, and most of the companies we deal with make sure that the consumer doesn't have to spend anything in the way of a filing fee," says Alan Kaplinsky, an attorney with Ballard Spahr, which has represented the American Bankers Association and Wells Fargo (WFC), among others. "If you go through arbitration, hire an attorney and win, the company will have to pay your attorney's fees as well."
The American Bankers Association also argues that individual consumers are likely to win more in arbitration than they would in a class action. Consumers who won in arbitration collected an average of $5,389 in arbitration versus an average of $32.35 via class actions, said Rob Nichols, president and CEO of the ABA, citing a CFPB study.
However, in the same study, the CFPB noted that only 78 consumers made it through theand they won a cumulative total of $360,000. Class action, on the other hand, returned over $1 billion to millions of aggrieved consumers.
Systemic problems that would otherwise be the subject of class actions are better addressed by regulators than the courts, Kaplinsky said. However, consumer advocates maintain that class actions are necessary to protect consumers in an era of limited regulatory resources.
"Class actions are a vital source of consumer protection," said Linda Sherry, director of national priorities for Consumer Action.
Added Christine Hines, legislative director of the National Association of Consumer Advocates: "Restoring customers' ability to band together in class actions will ensure that American consumers are empowered to help themselves when they are cheated or ripped off by bad actors."
Notably, the CFPB's rule would not bar all arbitration agreements. It simply would prevent financial services concerns from stopping group actions that are the basis of most class action claims. Kaplinsky maintains that this is likely to ring a death knell for all arbitration agreements because banks won't bother to use them if they aren't an efficient way to block class actions.
He predicts "an avalanche" of additional class actions, which could cost financial services concerns between $2.6 billion and $5.2 billion in just the next five years, if the rule becomes law.
However, he and other experts agree that the rule is a long way from being effective. The CFPB's process provides a 240-day period before new rules go into effect. In the meantime, financial services companies have vowed to fight the change in the courts and the legislature.
Also, the Republican-controlled Congress could theoretically upend the rule with a simple majority vote using a '90s-era law known as the Congressional Review Act. The GOP has been using the CRA to roll back regulations issued in the final months of Obama's administration. The law doesn't require the 60-vote filibuster threshold in the Senate to override an agency's recently issued rules within 60 legislative days of it being finalized.
"The rule should be thoroughly rejected by Congress," said Republican Congressman Jeb Hensarling of Texas, the CFPB's biggest foe in Congress and chairman of the House Financial Services Committee. The White House declined to comment on the CFPB's announcement.
Some members of Congress are also attempting to legislatively curtail the CFPB's authority and replace Cordray with a less consumer-friendly chairman.
The new rule doesn't retroactively apply to existing contracts. So if your bank or credit card company's terms-of-service agreement currently demands binding arbitration, it's grandfathered under previous law. You would be covered under the new rule only if you severed your ties to that bank or credit card company and opened a new account after the rule's effective date, said Lauren Saunders, associate director of the National Consumer Law Center.
It's worth mentioning that some big financial services concerns don't demand binding arbitration today. Capital One (COF), for example, doesn't include arbitration agreements in its banking contracts, neither does Bank of America (BAC). Chase (JPM) doesn't demand arbitration for credit card customers, but it does for bank account customers, said Saunders.
If you want to know whether your bank imposes binding arbitration, you need to read the terms-of-service agreement. They're commonly posted on financial institution websites. However, most banks also will provide them in writing at your request.
Cordray acknowledged that the rule is likely to face political scrutiny. However, Congress has passed laws that ban arbitration clauses outright in other forms of financial products, notably mortgages and loans to servicemen and women.
"I am, of course, aware of those parties who have indicated they will seek to have the Congress nullify this new rule," Cordray said in prepared remarks. "My obligation as the director of the Consumer Bureau is to act for the protection of consumers and in the public interest. In deciding to issue this rule, that is what I believe I have done."
The Associated Press contributed to this story.