Thank you to Albuquerque for the warm welcome you have given us. This is our 34th field hearing since the Consumer Financial Protection Bureau first opened its doors and started traveling the country to listen to the everyday concerns of American consumers. Each one of these field hearings has been valuable for us. They give us insight and substance to inform our work, and they humanize the challenges posed in the financial marketplace. So we thank you all for joining us today. Hearing people’s stories, as told by them, sometimes in voices of steely determination, other times through tears as they recount their difficulties and frustrations, leaves an indelible mark on us as we turn back to analyze and address the issues they raise. Let there be no doubt that these sessions motivate us to keep moving forward in our efforts to help make consumer finance markets work better for consumers.
Today we are proposing a new regulation for public comment and further consideration. If finalized in its current form, the proposal would ban consumer financial companies from using mandatory pre-dispute arbitration clauses to deny their customers the right to band together to seek justice and meaningful relief from wrongdoing. This practice has evolved to the point where it effectively functions as a kind of legal lockout. Companies simply insert these clauses into their contracts for consumer financial products or services and literally “with the stroke of a pen” are able to block any group of consumers from filing joint lawsuits known as class actions. That is so even though class actions are widely recognized to be valid avenues to secure legal relief under federal and state law.
We have investigated arbitration, and our research found that very few consumers know anything about these “gotcha” clauses. Even fewer consumers know how they actually work. Based on our research, we believe that any prospect of meaningful relief for groups of consumers is effectively extinguished by forcing them to fight their legal disputes as lone individuals. These battles – frequently over small amounts of money – would often have to be fought against some of the largest financial companies in the world. When faced with the daunting prospect of spending considerable time and effort to recoup a $35 fee or even a $100 overcharge, it is not hard to see why few people would even bother to try.
The fact is that certain corporate policies and practices can be lucrative to businesses but harm large numbers of individuals only on a minor basis. There was a long time in the history of this country where the legal system struggled for a solution to this problem. Courts and legislative bodies sought to develop a workable mechanism whereby people could band together and aggregate their claims into a single action that could provide accountability and justice within the legal system. Some of these efforts go back hundreds of years, but about a half-century ago, the concept of the modern class action came to fruition in the American civil justice system. As this procedure was refined to allow the courts to handle and process such cases efficiently and fairly, both Congress and the federal courts embraced and approved this approach. So did legislatures and courts in nearly every state. It has proved particularly meaningful in the arena of consumer finance, where companies that violate the law may do small amounts of harm to thousands or even millions of consumers.
It is important to recognize that the legislative and judicial branches of government not only have recognized and validated this mechanism for group lawsuits, but they also tightly control its use in particular cases. Congress and state legislatures have the authority to determine whether any violation of law can give rise to a private lawsuit in the first place, under what conditions, and for what types of relief. If a class action lawsuit is filed, the courts have specific processes for determining whether the claims can proceed in that format or not.
This is notable because for some provisions of the consumer financial laws, Congress has in fact authorized private lawsuits. Thus, over many years of enacting federal consumer financial laws (all of which post-date the adoption of the modern class action procedures in the federal courts), Congress has explicitly determined that such actions further the purposes of those particular statutes. And in so doing, Congress has permitted consumers to bring lawsuits (including class actions) to seek meaningful relief for the harm done them by such violations of law.
These provisions of the consumer financial laws thus provide a right to sue for relief, with one consumer representing the interests of a group who have all been harmed in the same way. If the lawsuit is successful, the company can be made to rectify the problem for all affected customers. It also can be required to clean up its practices moving forward. Yet a mandatory arbitration clause can negate all of this, leaving consumers with few practical avenues to secure adequate relief when they are harmed by violations of the law.
The justification for this approach is found in the Federal Arbitration Act, a statute that dates from 1925. Over time, its application has evolved. At the outset, its primary and virtually sole focus was on business-to-business disputes, in cases where the parties negotiated and agreed that it was in their mutual interest to have their disputes resolved by an arbitrator rather than by the courts. Over the years, arbitration came to be used in other types of disputes as well, such as those between unions and employers. It is generally recognized as one of several methods of “alternative dispute resolution.”
More recently, many businesses have sought to use arbitration clauses not simply as an alternative means of resolving disputes, but effectively to insulate themselves from accountability by blocking group claims. For many years, courts wrestled with the question of whether to allow arbitration clauses to be used in this way. Several years ago the Supreme Court concluded that arbitration clauses could in fact block class actions even though the state courts in that case had deemed that result to be unconscionable under state law.
In the past decade, however, Congress has expressed growing concern about whether mandatory arbitration is appropriate in the realm of consumer finance. First in the Military Lending Act, passed in 2007, Congress barred arbitration clauses in connection with certain loans made to servicemembers. In 2010, in the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress went further by barring arbitration clauses in mortgages, which make up the largest consumer finance market. In so doing, Congress expanded on a ban that Fannie Mae and Freddie Mac had imposed several years earlier on mortgage contracts they purchased.
Similarly, in the Dodd-Frank Act Congress authorized the Securities and Exchange Commission (SEC) to regulate the use of arbitration clauses in contracts between investors and brokers and dealers. Here Congress was building on work by the Financial Industry Regulatory Authority (FINRA), which has long required that arbitration clauses adopted by its broker-dealer members cannot be used to block class actions by customers. Each of these measures reflects concern about how mandatory arbitration clauses may undermine the welfare of individual consumers (or, in the case of the SEC, investors) in the financial marketplace.
Congress also spoke to our subject today by directing the Consumer Bureau to conduct a study and provide a report to Congress on the use of mandatory arbitration clauses in other consumer financial contracts. Once this work was completed, Congress stated that “[t]he Bureau, by regulation, may prohibit or impose conditions or limitations on the use of” such arbitration clauses in consumer financial contracts if the Bureau finds that such measure “is in the public interest and for the protection of consumers,” and such findings are “consistent with the study” we performed. We finished that work a year ago and heard from stakeholders about our findings and analysis. We then put forward an initial framework, subject to further review through our small business review panel process and with others as well. All of this leads up to our proposal today for a potential new rule that would address this issue.
To explain what we are proposing, it is useful to recap the results of our extensive study and report to Congress, which spans 728 pages of findings and analysis. Perhaps the most striking finding from our study is that consumers rarely file individual disputes involving financial products or services in any forum. We believe in part this is because consumers often do not recognize when their rights have been violated. It can be difficult for consumers to know, for example, when they have received inadequate or even misleading information or when they have been subject to discrimination. Even when consumers do feel aggrieved by something their financial service provider has done – for example, by charging an unwanted back-end fee – consumers rarely know whether the company’s conduct is unlawful. And for the overwhelming majority of consumers, we believe it simply does not make sense to try to find a lawyer to take issue with a small fee or other such practices.
Our study further found that when individual consumers choose to step forward and bring a class action on behalf of all similarly-situated consumers, such group lawsuits can be an effective way to provide relief when they are allowed to proceed. This includes those who may not realize that their rights have been violated or those who may have felt they simply had to resign themselves to the way they were treated. Indeed, by examining five years of data on several distinct markets, the study found that group lawsuits delivered, on average, about $220 million in payments to 6.8 million consumers per year in consumer financial services cases. Customers were also able to obtain substantial prospective relief by forcing companies to improve compliance and adopt more consumer-friendly practices. Of course, the class action lawsuit is by no means a perfect mechanism for addressing such issues. But class actions do happen to be the most practical solution that has been worked out to date. And the precise parameters of class action procedures have remained constantly subject to further critique, reform, and improvement over time.
The study showed that many companies use mandatory arbitration clauses to block consumers from ever securing any meaningful relief from violations of the law. Tens of millions of consumers use financial products or services that are subject to arbitration clauses. Those clauses deter class action lawsuits from being filed and often prevent those that are filed from moving forward. Yet without group lawsuits, those consumers who feel they may have been wronged are often left with very limited options. They can pursue their dispute with the company individually in arbitration, in small claims court, or sometimes in state or federal court, yet our study showed they rarely do so. They can simply accept the unlawful terms and absorb the harmful treatment, as is too often the case for many consumers. They can pursue some type of informal dispute resolution with the company through complaint lines, which will lead to relief in some instances as a matter of good customer service, but falls far short of any systematic resolution that eradicates unlawful practices. Or they can “vote with their feet” by moving on to another provider, though this is not always possible. Even when it is, there may be less incentive to do so if other companies have also inserted arbitration clauses in their own contracts.
So our study indicated that simply by inserting the magic words of an arbitration clause, financial companies can avoid being held directly accountable for their actions affecting their customers. Of course, the laws may empower certain government officials, such as those of us at the Consumer Bureau, to bring actions to enforce their terms. Yet public resources devoted to this purpose are limited, to the point where we cannot hope to cover the waterfront of consumer financial harm by such means. Indeed, the study found that class actions supplement government enforcement actions and seldom overlap with them. And several state attorneys general have told us they favor limitations on arbitration clauses because their enforcement resources are also limited.
Under the proposed regulation we are releasing today for public comment, companies could still include arbitration clauses in their contracts. For new contracts, however, these clauses would have to say explicitly that they cannot be used to stop consumers from grouping together in a class action. As noted previously, this is the same approach FINRA has taken in regulating similar provisions in certain investor contracts and it does not go as far as Congress did for mortgage contracts or certain credit contracts for servicemembers. In our study, we found that individual arbitrations are not commonly filed in consumer finance matters, and we do not believe we have enough data to justify restricting them further at this time.
If arbitration truly offers the benefits that its proponents claim, such as providing a less costly and more efficient means of dispute resolution, then it stands to reason that companies will continue to make it available. If they do, then companies which retain these more limited arbitration clauses would have to submit claims, awards, and other information to the Bureau. This would enable better monitoring of consumer finance arbitrations to ensure that the process is fair for individual consumers. It would also enable further review of the substantive allegations raised in these arbitration processes to see if they warrant action by the Bureau. Finally, we are considering publishing these materials on our website to promote transparency and enable the public to learn more about the arbitration process.
So the essence of the proposal issued today is that it would prevent mandatory arbitration clauses from imposing legal lockouts to deny groups of customers the right to pursue justice and secure meaningful relief from wrongdoing. From the results of our study, we believe that doing so would produce three general benefits, about which we seek further comment.
First, consumers would have a more effective means to pursue meaningful relief after they have been hurt by violations of consumer financial laws. At the same time, it would stop the same prohibited practices from harming consumers in the future. Many of these laws confer the right to an effective remedy to redress harms consumers suffer from violations of the law. This reflects an important element of personal liberty, that people should have the ability to protect themselves by acting to pursue their rights. But as we have already noted, it may not be practical or worthwhile for consumers to undertake the burden and cost of bringing an individual case just to challenge small fees and charges. Without the opportunity to pursue group claims, they may be effectively cut off from having their grievances addressed.
Second, another important benefit that would potentially flow from our proposal is that it would deter wrongdoing on a broader scale. Although many consumer financial violations impose only small costs on each individual consumer, taken as a whole these unlawful practices can yield millions or even billions of dollars in aggregate harm. Mandatory arbitration clauses that bar group actions protect companies from being held accountable for their misdeeds. Thus, companies have less reason to ensure that their conduct complies with the law. We plainly recognize that this may cause financial companies to incur higher compliance costs and forgo some revenue from engaging in risky behaviors. But we believe that is exactly how accountability should change company behavior.
Put differently, it matters if companies are aware that group lawsuits can lead to relief to thousands or even millions of victims of unlawful practices. The likely result is to create a safer market for current and future customers of that company. That is because the potential for a substantial monetary award often leads a company to rethink its practices by reassessing its bottom line. And the public spotlight on these cases can influence business practices at other companies as well.
Third, by requiring companies to provide the Bureau with arbitration filings and written awards, which we might end up making public in some form, the proposal would enable the Bureau to monitor and assess the pros and cons of how arbitration clauses affect resolutions for individuals who do not pursue group claims. We believe this would improve our understanding and enable policymaking that is better informed. The Bureau would also collect correspondence from administrators about a company’s non-payment of arbitration fees and its failure to adhere to the arbitration forum’s fairness principles. The purpose here would be to provide insight into whether companies are abusing arbitration or whether the process itself is unfair.
In short, we believe our proposal would promote consumers’ ability to pursue claims, bring greater accountability, and enhance the transparency and fairness of arbitrations.
Our democracy allows, encourages, and indeed depends on citizens who band together to demand political or legislative change. Many consumer financial laws likewise presuppose that groups of customers can join together in our legal system to demand changes in unlawful practices that affect them all in common. But our study shows that an important avenue for reform can be cut off by mandatory arbitration clauses that affect millions of consumers. Our proposal would reopen that avenue by ensuring that consumers can take action together if they have been hurt together.
Under our proposed rule, companies would not be able to deny consumers their day in court. Companies would not be able to evade responsibility by blocking groups of consumers from the legal system and reaping the favorable consequences. Everyone benefits from a marketplace where companies are held accountable for treating their customers fairly and in accordance with the law.
Our proposal will be open for public comment for the next three months. We will carefully consider the comments we receive before issuing a final rule. We have found this process is always instructive and enables us to reach sounder conclusions in the end. We look forward to the public comments as well as the initial feedback we will hear today. Thank you.
The Consumer Financial Protection Bureau is a 21st century agency that helps consumer finance markets work by making rules more effective, by consistently and fairly enforcing those rules, and by empowering consumers to take more control over their economic lives. For more information, visit consumerfinance.gov.