Many credit card and loan agreements these days have in the small type what's called a "mandatory arbitration clause." Most people don't even know what that means. But by signing, customers agree not to sue the financial firm in a class action lawsuit. Instead, they agree to work out any problem with an arbitrator hired by the bank.
"The company can sidestep the legal system, avoid accountability, and continue to pursue profitable practices even if they may violate the law and harm thousands or even millions of consumers," says Richard Cordray, the director of the Consumer Financial Protection Bureau.
The CFPB on Thursday proposed a rule that would ban a range of financial firms from using this tactic to avoid lawsuits.
Restoring The Power Of The Class Action
Suppose you notice that your credit card company charged you a $50 fee you think is unfair. And it turns out the company is doing this to a million people. A class action lawsuit can band you together with them and make it worth some lawyers' time to go after the company for $50 million.
And if the lawsuit is successful, "the company then is under significant compulsion by the courts to change their practices going forward," Cordray says. And he says there's a deterrent effect. "If companies know that they can be held accountable for these kinds of violations, then they're less likely to engage in them and more likely to be more careful about what they're doing," he says.
Class action lawsuits of course aren't new. Consumer advocates say they have played an important role for decades. But, in recent years, and especially after a Supreme Court decision in 2011, mandatory arbitration clauses have become widespread across all kinds of industries. So consumers in many instances have signed away their right to seek restitution through a class action.
But now, the CFPB is basically saying to big banks: If 1,000 or 1 million customers want to get together and sue you, they can do it.
Industry Warns Of Frivolous Lawsuits
The financial industry does not like this proposed rule. Travis Norton, with the U.S. Chamber of Commerce, says the rule could bring a flood of frivolous class action lawsuits. "The Consumer Financial Protection Bureau in this rule is really turning into the plaintiff's lawyer protection bureau," he says.
Norton worries that many lawyers won't bring lawsuits to protect consumers but will sue to unfairly shake down companies to line their own pockets.
Norton says the proposed rule would raise legal costs for companies, which in turn would increase prices for consumers.
He cites a recent class action lawsuit in which the issue was "whether Subway restaurant 'foot-long' sandwiches were actually 12 inches." Norton says some consumers measured them and thought they were only 11 1/2 inches. "There was a $525,000 settlement," Norton says. "Consumers, they got $5,000 and the trial lawyers who brought the case got $520,000."
But consumer advocates say class action lawsuits do help consumers.
Julia Duncan, a lawyer with the American Association for Justice, says that in a class action, the court can tell a bank or lender to hand over a list of thousands of customers that might have been affected. In arbitration, she says, the bank is in control.
"Corporations get to pick the arbitration provider, they choose all of the rules of the process and there is virtually no right to appeal," Duncan says. And, she says, "amazingly, corporations also usually insist that arbitrations remain completely secret, so the public is not able to ever find out what a lender or a bank is doing to thousands of its customers."
The CFPB is now seeking public comment on the proposed rule. One point of contention between consumer and industry groups is likely to be whether the rule would grandfather in existing arbitration clauses. If a final rule is issued, it will likely go into effect next year.