Thank you for joining us for this field hearing of the Consumer Financial Protection Bureau. We are here in Newark today to discuss the subject of arbitration. At its most basic level, arbitration is a way to resolve disputes outside of the court system. Parties can agree in their contract that if a dispute arises between them at a later time, rather than take it before a judge and perhaps a jury as part of a public judicial process, they will be required to turn instead to a non-governmental third party, known as an arbitrator, to resolve the dispute in private. These contractual provisions are referred to as “pre-dispute arbitration clauses.”
Arbitration clauses were rarely seen in consumer financial contracts until the last twenty years or so. Arbitration is often described by its supporters as a “better alternative” to the court system – more convenient, more efficient, and a faster, lower-cost way of resolving disputes. Opponents argue that arbitration clauses deprive consumers of certain legal protections available in court, may not provide a neutral or fair process, and may in fact serve to quash disputes rather than provide an alternative way to resolve them.
Long ago, prior to the Great Depression, Congress provided a general framework that located the role of arbitration in federal law. Court decisions over the years refined the relationship between private arbitration and formal judicial proceedings under a number of federal business statutes, including the antitrust laws and the securities laws as well as under the labor laws. More recently, however, Congress has taken an increased interest in arbitration clauses in consumer financial contracts. In 2007, Congress passed the Military Lending Act, which prohibited such clauses in connection with certain loans made to servicemembers. That was the first occasion on which Congress expressed explicit concern about the effect such clauses may have on the welfare of individual consumers in the financial marketplace.
In the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Congress went further and prohibited the inclusion of arbitration clauses in most residential mortgage contracts. Another measure in that same law is of special interest because it leads directly to our discussion today. In section 1028 of the Dodd-Frank Act, Congress directed the Consumer Bureau to conduct a study and provide a report to Congress on the use of pre-dispute arbitration clauses in consumer financial contracts. Further, Congress provided 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 findings in such a rule are “consistent with the study” performed by the Bureau.
We have set about this mandatory task to study the use of arbitration clauses with conscious care. We began our study almost three years ago, when we issued a Request for Information seeking public input on the appropriate scope, methods, and data sources for this work. We received dozens of written comments in response and held a series of stakeholder meetings to gather more informal input. In December 2013, we released preliminary results from our study. We wanted to provide a progress report to the public on our work, while also eliciting further comments on the work plan that we had developed. In those results, we found that arbitration clauses are commonly used by large banks in credit card and checking account agreements. We also found that these clauses can be used to prevent any litigation, including class litigation, from moving forward. In addition, we observed that roughly nine out of ten such clauses barred arbitrations on behalf of a class of consumers.
Today we are releasing the results of our study and we are providing our arbitration report to Congress as the law requires us to do. As far as we are aware, this is the most comprehensive empirical study of consumer financial arbitration ever conducted. We looked at over 850 consumer finance agreements to examine the prevalence of arbitration clauses and their terms. We have reviewed the following categories of disputes: over 1,800 consumer finance arbitration disputes filed over a period of three years; a sample of the nearly 3,500 individual consumer finance cases we identified that were filed in federal court over the same time frame; and all of the 562 consumer finance class actions we identified that were filed in federal court and in selected state courts. We also looked at over 40,000 small claims filings over the course of a single year.
We have supplemented this research by assembling and analyzing a set of more than 400 consumer financial class action settlements in federal courts over a period of five years and more than 1,100 state and federal public enforcement actions in the consumer finance area. We also conducted a national survey of 1,000 credit card consumers to learn more about their knowledge and understanding of arbitration and other dispute resolution mechanisms.
Needless to say, simply assembling – let alone analyzing – all this information was a substantial undertaking. But at the Consumer Bureau, we are committed to data-driven decision-making. With limited exceptions, the debate that has taken place over arbitration clauses has not been informed by actual empirical research into the facts “on the ground” about arbitration generally or consumer finance arbitration specifically. So we believed this was an investment well worth making, even though the process took longer than it otherwise might have taken.
It is not possible in the space of a few minutes to do justice to the depth and richness of the Consumer Bureau’s report. But I want to discuss a few key findings that shed light on some of the major questions that have been much debated by various stakeholders.
In discussing these findings, it is important to bear in mind that when it comes to consumer finance, arbitration clauses are contained in standard-form contracts, where the terms are not subject to negotiation. Like the other terms of most contracts for consumer financial products or services, they are essentially “take-it-or-leave-it” propositions. Consumers may open a new account or procure a new product without being aware of what the contract says or without fully understanding its implications. As part of the study we are releasing today, we looked at arbitration clauses in at least six different consumer finance markets.
In order to understand the effects of arbitration clauses, we wanted to know how many people use consumer products or services where the standard customer agreements include such clauses. In the credit card market, we found that credit card issuers representing more than half of credit card debt have arbitration clauses. In the checking account market, we found that banks representing almost half of insured deposits have arbitration clauses. Given the size of these markets, we can safely say that tens of millions of consumers are covered by one or more such arbitration clauses. Indeed, for credit card accounts alone, the number could be as high as 80 million consumers. Sometimes consumers are given a one-time chance to opt out of these clauses, but our research showed that consumers were generally unaware of this.
A key question we asked is to what extent individual consumers use arbitration procedures or individual litigation to challenge company behavior that they believe to be wrongful. The answer is: not very often. We looked at disputes where an arbitration case is filed with the American Arbitration Association, or AAA – the largest administrator of consumer finance arbitration disputes in the country – between 2010 and 2012. Across six consumer finance product markets covering tens of millions of Americans, just over 1,800 arbitration disputes were filed with the AAA – an average of about 600 per year. And over twenty percent of these cases may have been filed by companies, rather than consumers. Moreover, almost all of these disputes involved matters where more than $1,000 was at stake; that is, in this data consumers seem to be indicating that it rarely makes sense for them to bring an individual claim with only a small amount at stake.
We sought to study what happened in these arbitration cases, but we learned that for the cases filed in 2010 and 2011, approximately two-thirds ended without a decision from an arbitrator, either as the result of a settlement or some other informal resolution. In the cases that were decided, arbitrators awarded consumers a combined total of less than $175,000 in damages and less than $190,000 in debt forbearance. Arbitrators ordered consumers to pay $2.8 million, predominantly on debts that were disputed.
We also found that individual consumers are much more likely to bring a lawsuit in a court instead of pursuing a dispute in arbitration. During the same three-year period, we found nearly 3,500 individual consumer finance lawsuits were filed in federal court in five of the six consumer finance markets covered by the arbitration data we studied – an average of under 1,200 per year. We studied all of the cases in four markets and a random sample of credit card cases and found very few that were resolved by a court. In those that were resolved by a court, consumers won under $1 million and more than half of that total came from a single case. We also looked to small claims courts, but found little evidence of extensive consumer filings from the limited information available about those proceedings. Instead, small claims courts seemed to be used mostly by companies filing debt collection lawsuits against consumers.
The survey we conducted reflects these findings. In that survey, we asked consumers what they would do if they were charged a fee by their credit card issuer that they knew to be wrong and they had already exhausted all possible efforts to obtain relief from the company. Only two percent of consumers said they would consider bringing formal legal proceedings or would consult a lawyer. That is almost the same percentage of consumers who said they would simply accept responsibility for the fee. Most people, in fact, say they would simply cancel their card. The research thus indicates that consumers are very unlikely, acting alone, to even consider bringing formal claims against their card issuers – either through arbitration or through the courts.
Another question our study addresses is the extent to which consumer finance class actions enable consumers to get financial redress. We focused our research on class action settlements because that is generally the way consumers obtain relief in class actions. These cases rarely go to trial. (The same is generally true of individual court actions and to a lesser extent of arbitration cases as well.)
For the period from 2008 through 2012, we identified about 420 federal class action settlements in consumer financial cases. We found that those settlements totaled $2.7 billion in cash, in-kind relief, and fees and expenses. Of this, 18 percent went to attorneys’ fees and litigation and administration expenses. That means approximately $2.2 billion was available as monetary and in-kind relief for the benefit of affected consumers. Further, these figures do not account for the benefits to consumers from lawsuits or settlements that led to changes in company behavior; this value is considerable but difficult to quantify. And of course, the numbers do not include the potential benefit to other consumers from any deterrent effect associated with these settlements.
In over 100 of these settlements, payments were made to affected consumers automatically without those consumers having to submit claims forms. For those cases where numbers were available, over $700 million was paid to consumers. We were able to obtain data on payments in another 125 or so settlements in which consumers were required to file claims in order to get their money. In those cases, we found that approximately $325 million was paid to consumers. In another 25 or so cases, a combination of automatic distributions and a claims process was used, and in those cases roughly $60 million was paid to consumers. In other words, the total cash payout – excluding in-kind relief – was, at a minimum, in excess of $1.1 billion, or at least $200 million per year. These payments were provided to a minimum of 34 million consumers, which works out to an average of 6.8 million consumers annually.
The contrast between the class action system as a means of addressing consumer claims as compared to arbitration and individual litigation can be especially stark if we focus on particular markets. Consider, for example, the checking account market. Over 90 percent of all American households – roughly 114 million of them – have a checking account, making this perhaps the single largest consumer market. Between 2010 and 2012, there were a total of 72 arbitration disputes filed with the AAA and 137 individual cases filed in federal courts involving checking accounts. Yet during those same three years, six class settlements were approved involving the overdraft practices of five banks. The settlements totaled close to $600 million and covered more than 19 million consumers. The cases also resulted in changes to overdraft practices going forward – changes that brought material benefit to consumers.
A further question we studied is the extent to which arbitration clauses stand as a barrier to class actions. By design, arbitration clauses can be invoked to block class actions in court. We studied how often arbitration clauses are, in fact, used in this way. We found that it is rare for a company to try to force an individual lawsuit into arbitration. But it is quite common for arbitration clauses to be invoked to block class actions. For example, we found that when credit card issuers with an arbitration clause were sued in a class action, companies invoked the arbitration clause to block the action in nearly two-thirds of the cases. And, in the overdraft litigation to which I just referred, five banks were able to get the class actions against them dismissed because of arbitration agreements.
We also examined how often consumers seek to file class actions in arbitration. The AAA has a process that allows a consumer to pursue a dispute on behalf of a class of other consumers just as one can do in court. However, under the AAA rules, a class action arbitration can only proceed if it is permitted under the arbitration clause. We found that nearly all arbitration agreements include a provision which says that arbitrations may not proceed on a class basis. Perhaps not surprisingly, we found that only two class action arbitrations were filed with the AAA between 2010 and 2012 in the markets we studied. One of these was not pursued after it was filed and the other was pending on a motion to dismiss as of September 2014.
In addition, we looked at whether companies that include arbitration clauses in their contracts are able to offer lower prices because they are not subject to class action lawsuits. Our methodology here centered on a real-world comparison of companies that dropped their arbitration clauses and companies that made no change in their use of arbitration clauses. This was possible because in 2009, four large credit card issuers had settled an antitrust lawsuit by agreeing to drop their arbitration clauses. Meanwhile, other card issuers had either retained their arbitration clauses or continued to refrain from using arbitration clauses.
Using de-identified, account-level information from credit card issuers that represent about 85 percent of the credit card market, we compared the total cost of credit paid by consumers of some of the companies that dropped their arbitration clauses and of some of the companies whose use of arbitration clauses was unchanged. We looked at whether the elimination of arbitration agreements led to an increase in prices charged to consumers. We found no statistically significant evidence of such a price increase. We likewise found no evidence that issuers which dropped their arbitration clauses reduced access to credit relative to those whose use of arbitration clauses was unchanged.
Finally, our study examined the extent to which consumers are aware of, and understand the implications of, arbitration clauses. In our survey of 1,000 consumers with credit cards, we found that of those consumers who said they knew what arbitration was, three out of four did not know if they were subject to an arbitration clause. Of those who thought they did know, more than half were wrong about whether their agreements actually contained arbitration clauses. In fact, consumers whose agreements did not contain an arbitration clause were more likely to believe that the agreements had a clause than consumers whose agreements actually did have such a clause.
The confusion did not stop there. More than half of the consumers who were subject to an arbitration agreement and who said they knew what a class action was believed that they could participate in a class action nonetheless. Forty percent were unsure whether they could, leaving relatively few consumers who recognized that they could not participate in class actions.
We also asked consumers if they recalled being asked whether they wished to “opt out” of their arbitration clause so that they could retain their right to sue in court or to participate in class actions. Over a quarter of the credit card arbitration agreements we reviewed permit individual consumers to opt out. However, only one consumer whose current agreement permitted him to opt out recalled being asked whether he wished to do so.
In our governing statute, Congress specified that the results of this arbitration study are to provide the basis for important policy decisions that the Consumer Bureau will have to make in this area. So people are right to be interested in digesting these results and considering how we intend to fulfill the objectives established by Congress. We will be meeting with stakeholders after they have had a chance to read our report, and we are here today to invite you to share your thoughts on these issues in general and on that process in particular.
At the Consumer Bureau, we are dedicated to a marketplace characterized by fair, transparent, and responsible business practices. We believe that strong consumer protection is an asset to honest businesses because it ensures that everyone is playing by the same rules, which supports fair competition and positive treatment of consumers. We look forward to a robust and vigorous discussion today, which will bring us one step closer to achieving that vision.
The Consumer Financial Protection Bureau (CFPB) 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 www.consumerfinance.gov.