Delamaide: CFPB fires first salvo against arbitration racket

WASHINGTON — The new consumer finance watchdog agency is now tackling one of the biggest tricks the financial services industry plays on customers.

The Consumer Financial Protection Bureau this month proposed rules that would limit a company's ability to deny customers their day in court when disputes arise.

Most financial service providers include an arbitration clause in their contracts with consumers, which makes it mandatory to submit eventual disputes to an arbitrator rather than taking them to court.

But the dirty little secret in the industry is that these arbitration forums are effectively rigged against consumers.

The CFPB documented the fact in a study of arbitration disputes published in March, even though it didn't directly accuse the industry of rigging the process.

In an analysis of arbitration cases affecting the products it supervises — credit cards, bank accounts, payday loans and other consumer products — the agency found that arbitration proceedings overwhelmingly came down in favor of the provider.

In 341 cases resolved by an arbitrator in 2010 and 2011 which had a clear outcome, consumers obtained relief regarding their affirmative claims in just 32 disputes. Consumers obtained debt forbearance in 46 cases. The total amount of affirmative relief awarded was $172,433 and total debt forbearance was $189,107.

During the same period, by contrast, in 244 cases studied in which companies made claims or counterclaims that were resolved by arbitrators, companies obtained relief in 227 disputes. The total amount of such relief was $2,806,662.

You see the pattern?

It is the reason lawmakers mandated the CFPB, when they created it as part of the 2010 Dodd-Frank financial reform, to study mandatory arbitration clauses and to take appropriate steps to protect consumers.

In its proposed new rules, the agency is targeting specifically the provisions in arbitration clauses requiring customers to waive their right to recourse in a class-action lawsuit or in a group arbitration action.

"Consumers should not be asked to sign away their legal rights when they open a bank account or credit card," CFPB Director Richard Cordray said in a statement announcing the rules. "Companies are using the arbitration clause as a free pass to sidestep the courts and avoid accountability for wrongdoing."

Companies, in short, have been free to pursue a divide-and-conquer approach that allows them to settle or arbitrate any number of individual disputes without changing the practices that gave rise to the dispute.

The proposed rules would require companies to explicitly state that the arbitration clauses don't apply to potential class-action lawsuits, unless a judge denies class certification or dismisses the underlying claims.

The proposal raised the predictable howls of protest from the U.S. Chamber of Commerce, which trotted out the standard industry objections that class-action lawsuits increase costs to consumers and only enrich plaintiffs' lawyers while consumers receive just a pittance.

What the Chamber's protest conveniently ignores is the deterrent aspect of allowing class-action lawsuits.

However much trial lawyers make from the cases, or however little victims actually receive, a successful lawsuit costs the companies a lot more than the few arbitration cases they lose. This should deter them from engaging in predatory or illegal practices to begin with, the CFPB feels.

"The proposals under consideration would incentivize companies to comply with the law to avoid lawsuits," the agency said in announcing the proposed rules. "When companies can be called to account for their misconduct, public attention on the cases can affect or influence their individual business practices and the business practices of other companies more broadly."

The CFPB rules would also require companies that use arbitration clauses to submit claims and awards under arbitration to the agency, so that it can monitor the procedure and increase transparency.

Mandatory arbitration clauses are not confined to the services CFPB supervises, but the agency so far is the only regulator willing to act.

The Securities and Exchange Commission had the same mandate from Dodd-Frank to examine the issue in the brokerage and financial adviser firms it supervises, but it has dragged its feet on all the Dodd-Frank measures and this is no exception.

Whether the CFPB rules end up undermining the arbitration clauses altogether, as the Chamber of Commerce predicts, or whether it will have any spillover effect on the SEC or other agencies remains to be seen.

But at least the CFPB has taken the first step to limit what consumer advocates have long seen as a racket favoring the industry against consumers.

Columnist Darrell Delamaide — @ddelamaide on Twitter — has reported on business and economics from New York, Paris, Berlin and Washington for Dow Jones news service, Barron's, Institutional Investor and Bloomberg News service, among others.