Rule on Arbitration Would Restore Right to Sue Banks

The nation’s consumer watchdog is unveiling a proposed rule on Thursday that would restore customers’ rights to bring class-action lawsuits against financial firms, giving Americans major new protections and delivering a serious blow to Wall Street that could cost the industry billions of dollars.

The proposed rule, which would apply to bank accounts, credit cards and other types of consumer loans, seems almost certain to take effect, since it does not require congressional approval.

In effect, the move by the Consumer Financial Protection Bureau — the biggest that the agency has made since its inception in 2010 — will unravel a set of audacious legal maneuvers by corporate America that has prevented customers from using the court system to challenge potentially deceitful banking practices.

Honing their plan over decades, credit card companies, banks and other lenders devised a way to use the fine print of their contracts to push consumers out of court and into arbitration, where borrowers must battle powerful companies on their own. Without the ability to pool resources, most people abandon their claims and never make it to arbitration.

The new rules would mean that lenders could not force people to agree to mandatory arbitration clauses that bar class actions when those customers sign up for financial products. The changes would not apply to existing accounts, though consumers would be free to pay off their old loans and open new accounts that are covered.

And while those rules are not final yet — there will be a 90-day public comment period — financial industry lawyers say they are tough to derail.

“It’s going to spell the end of arbitration,” said Alan S. Kaplinsky, a lawyer with the firm Ballard Spahr in Philadelphia, who pioneered the use of arbitration clauses to thwart class-action lawsuits and thus opposes the proposed rule. “It will lead to a huge upsurge in litigation and take away a benefit to consumers.”

Mr. Kaplinsky and other backers of arbitration argue that the private legal system is a more expedient way to resolve disputes. Class actions, they say, are primarily a boon to plaintiffs’ lawyers.

For years, that assertion was largely anecdotal, since there is no federal database that tracks arbitrations.

But in a yearlong investigation, The New York Times created its own database showing that despite the industry’s claims, few people ever go to arbitration once their effort to build a class-action case is blocked.

The numbers are particularly stark when they involve disputes for small amounts, like questionable bank fees and overcharges. The Times found that from 2010 to 2014, only 505 consumers went to arbitration over disputes of $2,500 or less.

That is a minuscule fraction of the tens of millions of Americans whose financial contracts include arbitration clauses.

Among the class actions quashed was a case brought by Citibank customers, who accused the bank of duping them into buying insurance that they were never eligible to use. And another, against American Express, was brought by a group of merchants who challenged the company’s high processing fees.

Richard Cordray, director of the Consumer Financial Protection Bureau, pointed out what a major change his agency was poised to bring about. “Many banks and financial companies avoid accountability by putting arbitration clauses in their contracts that block groups of their customers from suing them,” he said in a statement.

Richard Cordray

The rule would apply only to the consumer financial companies that the agency regulates. It would not apply to arbitration clauses tucked into contracts for cellphone service, car rentals, nursing homes or employment.

“It is a good start,” said Berle M. Schiller, a federal judge in Philadelphia who has been critical of arbitration clauses that dismantle class actions and tip the scales in favor of companies. “Class actions are the only way that companies can be brought to heel.”

The agency’s proposed rule would be the first significant check on arbitration since a pair of Supreme Court decisions in 2011 and 2013 blessed its widespread use. Those decisions signaled the culmination of an effort by a coalition of credit card companies to stop the tide of class-action lawsuits.

The group dusted off a federal law dating to 1925 that formalized arbitration as a means for companies to resolve their disputes with one another. Starting in the early 2000s, the credit card companies began widely using arbitration for disputes with their customers.

As arbitration spread, it drew the ire of prosecutors, judges and officials like Senator Elizabeth Warren, Democrat of Massachusetts, who championed the creation of the consumer protection bureau. The Dodd-Frank law, which overhauled Wall Street and created the bureau, specifically charged the agency with the task of studying arbitration.

Last March, the agency released a 728-page report detailing how few consumers followed through with arbitration once their class actions were blocked.

For the few who did go through with the process, the report also showed the lopsided nature of the rulings. Businesses won bigger judgments against consumers in arbitration — a total of $2.8 million in 2010 and 2011, largely for debt payments — than the consumers obtained in relief, according to the agency’s analysis.

During that period, only 78 arbitration claims resulted in judgments in favor of consumers, who received less than $400,000 in total relief.

The financial industry disputed the findings, arguing that on an individual basis, consumers fare better in arbitration than in class actions. On average, awards in arbitration are 166 times as great as the sums received by individuals participating in a class action, according to the industry’s analysis.

But judges and law professors say that class actions, by their very nature, are meant to help large groups of people recoup small amounts of money — a $35 overdraft fee or a mysterious $5 late fee, for example.

And more broadly, class actions can force companies to change their business practices.

Banks — not all of which use mandatory arbitration clauses — may understand that concept better than most. Banks had to pay more than $1 billion to settle class-action lawsuits, beginning in 2009, that accused them of manipulating their checking account policies to maximize the number of overdraft fees.

Since then, seven of the banks involved in the class actions have adopted mandatory arbitration clauses.

The new rules giving borrowers access to class actions are likely to draw vigorous opposition from the U.S. Chamber of Commerce and other business groups, though they may not be able to do much about them. Their position has been that the consumer agency’s study does not support its conclusions about mandatory arbitration.

“The proposed rule is a wolf in sheep’s clothing,” the U.S. Chamber of Commerce said in a statement. “Now the agency designed to protect consumers is proposing a rule that will end up hurting them.”

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