Thank you for joining us here today in Dallas. Every month or so we try to hold an event outside of Washington, DC with the purpose of learning first-hand about how consumer financial products and services are affecting people around the country. Today, we are here to talk about arbitration, which is a way to resolve disputes outside of the court system. Rather than take the issue before a judge and perhaps a jury, the two parties turn to a third party, known as an arbitrator, to decide the dispute.
Many business contracts contain a “pre-dispute arbitration clause,” which states that once the contract is agreed to, the parties will resolve all future disputes through arbitration. More recently, many contracts for consumer financial products and services have been written with such arbitration clauses as well.
Arbitration is often described by supporters as a “better alternative” to the court system – more convenient, more efficient, and a lower-cost way of resolving disputes. Opponents argue that arbitration clauses deprive consumers of certain legal protections available in court, and may serve to quash a dispute rather than provide an alternative way to resolve it.
There is a long and interesting history in this country of the relationship between arbitration and the judicial system as alternative means of resolving disputes. In 1925, Congress first enacted the Federal Arbitration Act to make written agreements to arbitrate certain disputes, including those arising out of contracts, enforceable in the courts. Rather than obtaining a legal judgment from a court, parties to an arbitration agreement would be bound by an arbitration award, which could be confirmed, but generally not reviewed or overturned, by a court.
The new federal law was explicitly enacted to address previous judicial hostility to arbitration agreements, which had been held by many courts to be revocable at any time by either party. Indeed, some courts had sought to protect their own jurisdiction by rejecting arbitration clauses outright and finding them to be void in violation of public policy.
For four decades after the Federal Arbitration Act was adopted, the federal courts maintained a skeptical and restrictive view of arbitration. In 1953, for example, the Supreme Court held that arbitration clauses could not be used to waive the right to a federal judicial forum granted under substantive federal statutes such as the securities laws. The heart of the Court’s position was that the buyer of a security was being required to give up an advantage granted to him under the statute at a time when he was at a disadvantage in terms of knowledge.
Starting in the late 1960s, however, the law took a dramatic turn, and over the next couple of decades the Supreme Court expressly overruled much of the prior case law in this area. During this period, which extends to the present day, the Court revised its previous views of the Federal Arbitration Act. In fact, it has now determined that the statute evinces a core policy favoring arbitration as a means of resolving disputes, including where the matters at issue are governed by various other substantive federal and state laws.
As judicial doctrine on arbitration has evolved, though, one basic premise of that doctrine has become clear: it is Congress that has the authority to adopt laws to regulate dispute resolution procedures in the manner that it deems most conducive to the administration of justice. Where Congress addresses arbitration as a method of dispute resolution, either generally or in particular federal statutes, then the courts must follow its lead.
The Dodd-Frank Act is one such statute in which Congress diverged from the general policy of favoring arbitration as expressed in the Federal Arbitration Act. In section 1414 of the Act, Congress expressly prohibited the inclusion of arbitration clauses in most residential mortgage loan contracts. In section 921, Congress gave the Securities and Exchange Commission authority to prohibit or restrict use of such clauses for certain disputes, if it finds that doing so would be in the public interest and for the protection of investors. And in section 1028, Congress expressly addressed the applicability of pre-dispute arbitration clauses “in connection with the offering or providing of consumer financial products or services.”
The statute establishes a clear procedure to be used to determine whether such agreements should be prohibited, conditioned, or limited in any way. First, the Consumer Financial Protection Bureau is to conduct a study and provide a report to Congress concerning the use of such agreements. Second, the Bureau may adopt regulations that “prohibit or impose conditions or limitations” on the use of such agreements if it finds such measures to be “in the public interest and for the protection of consumers” and such findings “are consistent with the study” that the Bureau has conducted.
That is what brings us to the subject of today’s discussion. In the world of consumer financial products and services, these clauses are quite common. If you were to look in your wallet right now, the chances are high that one or more of your credit cards, debit cards, or prepaid cards would be subject to a pre-dispute arbitration clause. The clauses are contained in standard-form contracts, where the terms are not subject to negotiation. Like the other terms of most consumer financial products, they are essentially “take-it-or-leave-it” propositions. Consumers may open a new account or take on a new product without being aware of what the contract says or without fully understanding its implications.
We have begun the arbitration study mandated by Congress and we now have a first round of preliminary findings to present for general consideration. We also have narrowed and specified many of the remaining areas on which we are most likely to focus as we complete our work to issue the required report to Congress. Although we have more work ahead of us, we know this is an important topic in the realm of consumer finance. So we wanted to share some of our initial research in order to facilitate a broader discussion about issues such as where these clauses are found, what they say, and what we have learned about arbitration filings by consumers.
To date, we have focused on a few key consumer markets, including credit cards and checking accounts. One of our most notable findings about arbitration clauses in these markets is the stark contrast in the types of institutions that use them. On the whole, larger institutions are more likely to include an arbitration clause in consumer contracts than community banks or credit unions. That raises interesting questions about why smaller institutions and credit unions do not use arbitration clauses as frequently in these markets.
While arbitration clauses are more common from larger credit card or checking account issuers, the same cannot be said about prepaid cards. Perhaps because it is a newer and more highly concentrated market, we found that arbitration clauses are very common across all prepaid card contracts – regardless of whether they are offered by a larger or smaller player. In fact, smaller players are much more likely to use arbitration clauses in prepaid card contracts than they are in credit card or checking account contracts.
Our study looked not only at which institutions use arbitration clauses, but also at what these clauses say. Regardless of who was using them, arbitration clauses in credit card agreements were almost always more complex and written at a more demanding grade level of readability than the other parts of the contracts we studied. In fact, in every case, the rest of the credit card contract scored better in terms of readability than did its arbitration clause considered alone.
More than ninety percent of the arbitration clauses we looked at explicitly bar consumers from participating in class arbitrations. The few clauses without this express limitation were in smaller bank contracts, meaning that almost all of the consumers who are subject to arbitration provisions are effectively precluded from participating in class proceedings – whether in court or in arbitration. We plan to spend more time analyzing and considering class actions in the second phase of our study.
About one-quarter of the clauses contained in checking account and credit card contracts allow consumers to opt out of the arbitration requirement. For those that allow it, consumers usually have to submit a signed document by mail within a set time frame – usually thirty or sixty days from when the account was opened or the agreement was mailed.
A consumer who wants to resolve a dispute through arbitration generally must file with the private arbitration organization that is named in the clause. For the consumer financial products we have reviewed, the named organization is typically the American Arbitration Association (or AAA). We have obtained records on all consumer arbitration cases filed with the AAA between 2010 and 2012. There were about 1,250 such filings about credit cards, checking accounts, payday loans, and prepaid cards.
About 900 of these were filed by consumers: the rest were filed by companies or, in some instances, the consumer and the company filed together. The vast majority of these filings were about credit cards. In most cases the consumers were represented by counsel; in virtually all cases the companies were. Almost all filings involved individual consumers; only two class arbitrations were filed for these product markets.
Although we have some way to go in looking at litigation alternatives, we have identified more than 3,000 federal court cases filed by consumers over the same period from 2010 through 2012 – about credit card issues alone. That includes more than 400 class actions, in which one or more individuals may seek relief on behalf of many other consumers as well, sometimes even millions of other consumers.
For those consumers who do use arbitration, we observed that very few of them filed arbitration claims for small-dollar amounts. For example, there are almost no disputes over amounts less than $1,000. A number of arbitration clauses come with a carve-out for small claims – meaning that both the company and the consumer retain the option to use small claims courts, rather than the arbitration process, to resolve such matters. So those carve-outs could explain why there are very few small-dollar arbitration filings. Yet our preliminary analysis casts doubt on this hypothesis, for it indicates that, at least when it comes to credit card disputes, consumers do not appear to file many cases in small claims court. Indeed, we found the cases filed in small-claims court are much more likely to be brought by banks than by consumers.
As an initial step in comparing the benefits to consumers from arbitration and class action litigation, we have identified a number of class actions involving credit cards, deposit accounts, or payday loans that were settled since July 2009 and where the contract at issue allowed for arbitration before the AAA. Consumers who were members of the classes in these cases had the option of opting out of the class settlement and bringing their own case through arbitration.
In such cases as we have identified thus far, more than 13 million class members made claims or received payments under these settlements, whereas 3,605 individuals opted out. At most, only a handful of these individuals who opted out chose instead to file an arbitration claim.
One significant takeaway from these various points is that few consumers use arbitration at all, at least when compared to the number of consumers involved in lawsuits and class actions. In the second phase of our study, we will seek to obtain a better understanding of what explains the incidence and nature of arbitration claims, including small-dollar claims. We will look to see what happens to arbitration filings and endeavor to compare what we see happening in arbitration to what we see happening in litigation, including class litigation.
Those are challenging comparisons to make for a variety of reasons, but we intend to engage in a thoughtful process in order to understand how arbitration clauses affect both consumers and businesses. We also are proposing to conduct a survey of consumers in the credit card marketplace to determine such matters as: whether they are aware of the terms of arbitration clauses; whether they make assumptions about their legal rights under the terms of these clauses; and whether they factor the existence of these clauses into their decision-making process about obtaining or using particular consumer financial products and services.
These are only some of the areas we will be pursuing before submitting our report to Congress. We recognize that Congress intends the results of this study to be the basis for important policy decisions that the Consumer Bureau will have to make in this area.
And so today we invite you to share your thoughts on that process and about these issues. Tell us about any experiences you have had with arbitration clauses and share your input on these issues. 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. We also envision a marketplace where educated consumers can make well-informed decisions about their financial affairs. 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.