American companies have spent a decade convincing judges that consumers should keep complaints out of the courts and use arbitration instead. Now business has to persuade a potentially more skeptical group: regulators.
Two U.S. agencies -- the Consumer Financial Protection Bureau and the Securities and Exchange Commission -- are studying whether to take steps to limit or ban so-called mandatory arbitration clauses from financial contracts with consumers.
“The action on mandatory arbitration has shifted to the agencies,” Deepak Gupta, a former lawyer for the bureau who also argued a 2011 Supreme Court case on arbitration, said in an interview.
Alan Kaplinsky, head of the consumer finance practice at Ballard Spahr LLC, said a regulatory rollback of mandatory arbitration has the potential to impose new litigation risks and costs on providers of checking accounts, credit cards and payday loans. They can also be found in contracts for employment, mobile phones and rental equipment.
“These clauses are utterly ubiquitous in financial services,” Kaplinsky said in an interview.
The regulator push-back has been evident in at least two recent actions. In February, the SEC forced The Carlyle Group LP to remove from its proposed public offering documents a clause that would have required its new shareholders to use arbitration. The consumer bureau, established by the same Dodd-Frank Act that gave it the power to regulate the clauses, has started a study to determine if arbitration does consumers more harm than good.
Companies have portrayed arbitration as a tool to avoid frivolous but expensive-to-defend class-action lawsuits that only benefit trial lawyers. Consumer groups charge it limits redress, especially in cases where the individual damage is small but the collective cost is large.
Recent class-action cases over overdraft fees on checking accounts hint at the potential impact on banks. A federal judge in 2010 ordered Wells Fargo & Co. to pay more than $200 million to customers who paid higher fees due to how the bank posted transactions to checking accounts.
The Supreme Court found in favor of mandatory arbitration in a 2011 case, AT&T Mobility v. Concepcion, the case that Gupta argued. After the decision, Wells sought to terminate the class-action case.
The judge has not yet ruled on the bank’s argument that the individual consumers should be compelled to seek arbitration, as required under their checking account contracts, Wells spokeswoman Richele Messick said in an e-mail.
In a report published in April 2011, the Pew Charitable Trusts found that 94 percent of checking accounts at the 10 largest U.S. banks include a clause waiving the right to bring a class-action suit. Also, 71 percent explicitly require arbitration in case of disputes, according to Pew.
Class-action suits make financial sense for plaintiffs when they can aggregate small amounts -- in the case of Concepcion, a $30 payment per person -- into a large group complaint, often worth millions. By obligating customers to arbitrate, companies can stop class-action cases before they start.
Elizabeth Warren, the Obama administration adviser who set up the consumer bureau and is now running for the U.S. Senate from Massachusetts, was a strong opponent of mandatory arbitration. In a September 2007 blog post, she said the idea has a “folksy, cheap and fair” image.
“The data suggest, however, that it is Darth Vader’s Death Star -- the Empire always wins,” Warren wrote.
In the investment arena, regulators have sanctioned arbitration in disputes between consumers and brokers, while forbidding its mandatory use by shareholders.
In February, Carlyle abandoned a clause in its prospectus for an initial public offering that would have required shareholders to submit disputes to arbitration. The SEC told the company it would not sign off on a waiver that allows underwriters to price the IPO shortly before the stock’s introduction unless the clause was dropped.
Brian Fitzpatrick, a professor of law at Vanderbilt Law School, said the SEC could be vulnerable to a court challenge on forcing shareholders to arbitrate. The SEC relies on longstanding practice, not a specific regulation or law, to stamp out arbitration clauses for shareholders.
“It’s only a matter of time,” Fitzpatrick said in an interview. “Someone is going to test the practice, and that will open up a whole new door for arbitration.”
The Financial Industry Regulator Authority, a private-sector self-regulatory agency overseen by the SEC, uses arbitration to settle disputes between investors and their brokers.
The Dodd-Frank law of 2010 directs the SEC to study the issue of mandatory arbitration as part of a broader look at what information investors should have about their brokers. The study was completed in January 2011.
Dodd-Frank also gives the commission explicit authority to regulate mandatory arbitration. The provision was included amid “concerns over the past several years that mandatory pre-dispute arbitration is unfair to the investors,” according to a Senate Banking Committee report from April 2010. No action is currently planned for rules on arbitration, according to the SEC’s Dodd-Frank rulemaking calendar.
The consumer bureau began its study on April 24 with a call for public comment on how it should conduct the research. Battle lines are now forming around the issue, with the U.S. Chamber of Commerce and the trial lawyers group, the American Association for Justice, gearing up for a regulatory fight.
Matt Webb, senior vice president at the Chamber’s Institute for Legal Reform, asserted that if the agency “does an even-handed and robust study of how arbitration is used in the real world,” it will support the industry’s side.
“It will be difficult for the CFPB to go down the road to rulemaking on this front,” Webb said in an interview.
Christine Hines, a lawyer with Public Citizen, a consumer advocacy group, predicted the bureau would probably oppose arbitration because class-action suits buttress the rest of its work.
“If I were the CFPB, I’d want consumers to be able to enforce their own rights so the agency does not have to do everything itself,” Hines said in an interview.
Will Wade-Gery, an official in the bureau’s division of research, markets and regulations, is handling the study directly, according to a Federal Register notice published April 27. Wade-Gery is a former lawyer with Morrison Foerster LLC and advocated in favor of arbitration in Ross v. Bank of America, a case involving the use of antitrust laws to trump arbitration clauses, according to court documents.
Richard Cordray, the bureau’s director, spoke out against mandatory arbitration while he was attorney general of Ohio from 2008 to 2011. In an undated circular, he advised Ohioans not to sign home improvement contracts if they contained such clauses.
Attorneys general are generally critics of mandatory arbitration because they have regarded the practice as contrary to consumer interests, said Paul Bland, an attorney with Public Justice, an advocacy group.
“Republican and Democratic attorneys general have joined hands on this issue for 15 years,” Bland said in an interview.
“We’re in the business of reading tea leaves here in Washington,” said L. Richard Fischer, a lawyer with Morrison Foerster in Washington. “The tea leaves do not bode well for mandatory arbitration clauses.”
Jen Howard, a spokeswoman for the bureau, said that the bureau is committed to doing the study without prejudice to its outcome.
“We have not pre-judged this issue -- our analysis will be based on facts and data,” Howard said in an e-mail. “We look forward to receiving robust public input on the inquiry to help identify the best available evidence to evaluate.”