[co-author: Charles Davis - Summer Associate]

On May 5, 2016, the Consumer Financial Protection Bureau (“CFPB”) held its fourth field hearing on Arbitration and issued a proposed Rule that would prohibit the use of arbitration clauses that block consumers’ participation in class actions in contracts for consumer financial products and services. The Rule would also require providers who use pre-dispute arbitration agreements to submit certain records relating to arbitral proceedings to the CFPB. The Rule is expected to take effect during the summer of 2017.

Upon issuance of the Final Rule, companies will have 210 days to comply. After this time, companies will have to include disclaimer language in any agreements containing arbitration clauses and submit information concerning their arbitration clause, claims, etc., to the CFPB.

This Rule will impact hundreds of millions of consumer contracts. The CFPB estimates that over 53,000 providers will be affected by the Rule. In terms of costs, the CFPB believes that there will be $103 million in additional class action settlements annually, $342 million in additional settlement proceeds to consumers, $66 million for plaintiffs’ attorneys, and $39 million in defense costs to providers.

The reduction of the reliance on arbitration provisions will slow the completion of litigation, making class actions more common. Litigation on the whole will likely increase and defense costs will rise. Fewer arbitrations and more class actions will have a tangible impact on how lenders and other impacted consumer financial services businesses allocate resources. Businesses are wise to plan ahead and ensure they have the operational and legal compliance steps in place as well as a strong litigation attorney network ready to take on the changes that lie ahead.

What to do Now

• Operations: Impacted businesses should immediately conduct an operational analysis to determine what resources they have and what level of flexibility there is in re-allocation. Construct a flexible plan as to how they will get the necessary pieces in place. Ensure employees are cross-trained and ready to be mobilized.
• Legal: Assess their attorney network to ensure each line of business has the right litigation and legal compliance teams in place to manage an increase in class actions.
• Financial: Budget for the potential changes and conduct a cost-benefit analysis to determine at what point the savings from continued use of arbitration may not offset the cost.

What to do when the Final Rule is Issued

• Operations: Implement the resource allocation plan. Develop procedures, training, and operational controls related to the arbitration reporting and disclosure requirements.
• Legal: Revise the contract language to reflect the requirements of the Final Rule. Mobilize the attorney network and advise them of the business’s relevant procedural updates and strategy.
• Compliance: Audit procedures related to new arbitration reporting and disclosure requirements, document retention, training, and test operational controls.

Background

This Rule is the culmination of over a year of research by the CFPB. On March 11, 2015 it delivered its Report to Congress regarding its study of consumer arbitration. The CFPB says the study supports its contention that arbitration clauses restrict consumers’ potential for relief. On December 11, 2015, the CFPB issued a Final Report from the Small Business Review Panel on the CFPB’s Potential Rulemaking on Pre-Dispute Arbitration Agreements.

This reflects the broadening of a trend emerging from the securities and mortgage wings of the financial services industry. The Financial Industry Regulatory Authority (“FINRA”) prohibits its members from enforcing arbitration agreements against any member of a certified or putative class unless and until the class treatment is denied or decertified.[2] In 2004, the Government Sponsored Enterprises stopped purchasing mortgages that contain arbitration agreements and the 2010 Dodd-Frank Act prohibited the use of arbitration agreements in mortgage contracts, imposed conditions on their use by investment advisers, and invalidated their use in certain whistleblower proceedings.[3]

Unsurprisingly, there have been strong reactions to the Rule. The U.S. House Financial Services Committee’s Subcommittee on Financial Institutions and Consumer Credit criticized the Rule on the grounds that it increases costs for business and will “perpetuate a justice gap by taking away a legal forum for low-income individuals and those with small and individualized claims.”[4] The U.S. Chamber of Commerce has argued that the Rule’s practical effect will be to eliminate arbitration altogether because companies will be unable to finance arbitration and class action costs, resulting in the loss of ability to resolve individualized claims. The Association of Credit and Collection Professionals also came out against the Rule, and The Consumer Bankers Association criticized the CFPB’s study on the grounds that it failed to show that prohibiting arbitration is beneficial to consumers.

In the immediate future, Congress may try to block the Rule and various groups have threatened to litigate against it. Regardless, it is not safe to assume the Rule will substantively change before it is finalized. Impacted businesses must start planning now, remaining flexible, and getting all the pieces in place ahead of time. Proactive development of legal compliance and operational plans will distinguish the businesses with the foresight to plan ahead from those who will be reactively scrambling to comply.

[1] Co-author Charles Davis is a 2016 Summer Associate in the Tampa office of Burr & Forman LLP. He is a law student at University of Notre Dame Law School. Thanks to Gennifer Bridges, Ben Coulter, and Tala Amirfazli for contribution to the research.

[2] FINRA Code of Arbitration Procedure for Customer Disputes 12204(d).

[3] See Kenneth Harney, Fannie Follows Freddie in Banning Mandatory Arbitration, Wash. Post., Oct. 9, 2004, available here. See Dodd-Frank section 1414(a) (codified as 15 U.S.C. 1639c(e)(1)); Dodd-Frank section 921(b); Dodd-Frank section 922(c)(2).

[4] Press Release, The Office of Congressman Randy Neugebauer, Neugebauer: Examining the CFPB’s Proposed Rulemaking on Arbitration, (May 18, 2016), available here.

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