The Consumer Financial Protection Bureau, the best new federal agency in decades (and, yes, I have a ranking order), just did something so simple, so intuitive and yet so rare in modern policymaking. It banned a harmful activity.
It didn’t force disclosure, empowering consumers to be smart shoppers through awareness of the harmful activity. It didn’t limit the damage from the harmful activity by allowing only a portion of it, or restricting it to a certain consumer class. It just got rid of it. And that could and should be a model for the rest of the federal bureaucracy to follow.
CFPB’s new proposal concerns mandatory arbitration clauses, a sneaky way that corporations protect themselves legally. In many consumer contracts — from your mobile phone to your credit card — companies add fine print that prevents consumers from suing individually or participating in class-action lawsuits over unfair and deceptive practices. Instead, disputes go to an arbitration panel, comprised of mediators paid for by the lenders.
Consumers often don’t even know about this until they try to take their claims to court. Even if companies engage in a systemic practice of ripping off millions of customers $100 at a time, thanks to the arbitration clause, everyone harmed must fight it on their own. Stripped of the ability to pool resources and trapped in an extra-judicial process tilted toward big business, they usually don’t even bother to file the case.
Last March, CFPB released a report on arbitration, finding these clauses in nearly all private student loan contracts as well as those for prepaid cards and payday lenders. In a random sample of 1,060 arbitration cases, corporations received seven times as much in financial rewards as consumers. By contrast, while individual lawsuits didn’t fare much better, class-action lawsuits were successful in obtaining hundreds of millions of dollars in annual relief and changing corporate behavior.
Corporations have tried hard to restrict class-actions through the judiciary — and they’ve been successful, though a new Supreme Court majority could change that. But even in their crippled state, class-actions do far better than arbitration in giving consumers a fair shot.
The results of the study were clear: Arbitration is a tremendous tool for corporations to stop consumers from banding together. Only banning arbitration clauses that prevent class actions could end this inequitable situation. Amazingly, that’s precisely the proposed rule that CFPB came out with today.
While companies could still use arbitration clauses, they would explicitly not be able to prevent class-action cases. In fact, CFPB would provide the proper language for the clause. This gives a chance for wronged consumers to actually stop the abuse, and it provides a deterrent to companies, because they would be liable in a class action if they ripped off their customers.
The rule applies only to consumer financial products and services — but when you include bank accounts, credit cards, personal loans, payday or auto title loans, money transfers, private student loans and prepaid cards, it would affect hundreds of millions of consumer contracts. It only applies to new accounts and loans, but consumers can cancel existing ones and sign up for new ones that incorporate the arbitration changes. This is a proposed rule, but it’s very likely to go into effect after a 90-day public comment period, as CFPB has been working on it for years.
There’s a transparency element to the proposed rule as well: Companies with arbitration clauses would have to submit full information about those cases to CFPB, and that information may be presented for public review. But the main thing here is an outright ban on using arbitration to avoid class actions. “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,” said CFPB Director Richard Cordray at a field hearing in Albuquerque, New Mexico.
We don’t use prohibitions often enough in regulatory actions. Congress had already banned arbitration clauses in loans to servicemembers in 2007, and in mortgages as part of the Dodd-Frank Act. But a lot of CFPB’s work has been around disclosure in consumer financial contracts. The bureau created the “Know Before You Owe” rule for mortgages to help borrowers understand what they’re signing. It forced more disclosure from lenders about interest rates and prepayment penalties, and from student loan servicers about available repayment options.
But sometimes it’s not enough to just get companies to disclose. After all, the arbitration clause was written right into consumer contracts — the consumers just overlooked it most of the time, or had no choice because the entire industry instituted them. In this instance, CFPB asked whether arbitration clauses that prevented class-action lawsuits had any value for consumers, or if they were merely used as a tool to do them harm. And they decided there was no good reason for them to exist.
Sadly, this is not yet the end of arbitration clauses. They’re often stuck into contracts for nursing homes, cable television, cell phones, broadband, appliances and dozens of other agreements between consumers and sales agents, where CFPB doesn’t have jurisdiction. They’re even in many employment contracts, preventing lawsuits against workplace discrimination or hazardous conditions.
Sen. Al Franken of Minnesota, who’s been on top of the arbitration scheme for years, has introduced legislation to ban arbitration clauses in telecommunications contracts, and a broader bill to get rid of them altogether. “I believe that all Americans have a fundamental right to seek justice when they’ve been wronged, and that’s why we need to limit the unfair practice of forced arbitration,” Franken said in a statement today.
He’s right. Lawmakers and federal agencies should learn from today’s CFPB action. And they shouldn’t limit it to just arbitration. We’ve gotten too far away from this idea that some innovations are only useful to the people who came up with them, and should therefore be prohibited. We can ban financial derivatives that do nothing but magnify risk for the benefit of a few financiers. We can ban usurious interest rates that impoverish borrowers. We can ban for-profit colleges that bankrupt students in exchange for worthless diplomas. For that matter, we can ban these arbitration clauses outright, for all consumer and worker contracts.
That said, CFPB’s proposed rule is an excellent start toward providing corporate accountability and protecting ordinary consumers. The government should build on it and make sure it’s not just an oasis in the desert.