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Financial regulators move to restrict forced arbitration

Suing your bank or debt collector might be getting a whole lot easier.

The Consumer Financial Protection Bureau is considering new regulations that would severely curtail a contentious practice called mandatory arbitration, which is when consumers are forced to take their disputes to a third-party mediator instead of a court of law. It is something consumer advocates have long argued does a disservice to people who have disputes with banks, credit card issuers and other financial service providers.

Many Americans don’t know that, buried in the fine print, they’ve agreed not to bring lawsuits against banks or other financial institutions if they have complaints over issues such as disputed charges on their checking accounts or credit card bills.

Instead, they’re required to go through a binding arbitration process. Consumer advocates say these arbitrators are often biased and routinely rule against consumers. If a customer loses an arbitration ruling, oftentimes it cannot be appealed.

The goal of forcing disputes to be arbitrated instead of litigated was to streamline and lower the cost of resolving disputes that customers had with financial service providers.

But what started off as a good idea became corrupted over time, critics say. Companies who did not like how an arbitration firm would rule could shop around, giving arbitration companies a reason to rule in favor of the companies who hired them. Arbitration rulings were also not transparent.

The proposal, which the agency announced Wednesday, follows years of scrutiny by financial regulators, state attorneys general and consumer financial advocates.

“Companies can sidestep the legal system, avoid big refunds, and continue to pursue profitable practices that may violate the law and harm countless consumers,” said Richard Cordray, director of the CFPB, in a statement.

The proposal is the first step toward restricting the practice. The regulator is likely to face stiff resistance from the financial industry and the CFPB’s critics in Washington.

“Forcing consumers to hire expensive lawyers and go to trial rather than use a low-cost dispute resolution system harms the very low and middle income consumers the CFPB should be helping,” said Rep. Jeb Hensarling, R-Texas, who is chairman of the House Financial Services Committee.

Not surprisingly, consumer advocates cheered the announcement.

“This proposal is a tremendous step toward cleaning up a system that has heavily favored companies over consumers who were wronged,” said George Slover with Consumers Union, the public policy and advocacy arm of Consumer Reports magazine.

The CFPB’s proposal does not create a blanket ban on arbitration, which is legal in the U.S. under the Federal Arbitration Act of 1925. Instead, the CFPB’s new rules would allow disgruntled customers to sue banks or other financial companies as a group through a class-action lawsuit, should they choose to, even if they’re subject to arbitration agreements. Financial companies will still be able to force individuals to settle disputes through arbitration, however those cases are less common. Many disputes are also resolved outside of the formal arbitration process.

Another proposal would force companies that continue to use arbitration to submit those claims to the CFPB, so the agency can monitor the process and make sure it’s fair to customers.

Roughly 20 years ago, arbitration began to become a common way for financial companies to resolve disputes with customers without having to go to trial. Over the years, the practice ballooned to the point that many financial services, ranging from checking accounts to private student loans have incorporated arbitration clauses in the fine print of their customer agreements.

In one notorious case in 2009, Minnesota Attorney General Lori Swanson found out that a debt collection company and the National Arbitration Forum, at the time one of the largest arbitration companies, were owned by the same investors. National Arbitration Forum was also involved in helping writing arbitration clauses into contracts.

“The Forum presented itself as this neutral party like our court system, but consumers didn’t know they were affiliated with same companies bringing the claims against them,” Swanson said in an interview.

Shortly after Swanson’s lawsuit was filed, National Arbitration Forum agreed to get out of the business of arbitrating consumer financial disputes.

If a group of bank customers found they were victims of unfair practices at their bank, under the new rules they would be able to pursue a class-action lawsuit against the bank.

Under current rules, customers can be bound to use individual arbitration to resolve disputes, even in cases where many individuals were victims of the same practice. For consumers, pursuing individual lawsuits is typically a drawn-out and expensive process.

“It is simply impossible to have an effective group claim where the vast majority of consumers have all lost their right to have their day in court,” Cordray said.

While it is only a partial ban in writing, arbitration experts say that by allowing class action lawsuits to go forward, the CFPB’s proposal is in essence a de-facto ban on arbitration because the service, which is typically paid for by the bank, becomes less cost-effective.

“If I was a consumer advocate against arbitration, and I was looking at what the CFPB proposed, I would be popping those champagne corks right about now,” said Alan Kaplinsky, a consumer financial services lawyer with Ballard Spahr LLP.

The Dodd-Frank Act required the CFPB to study forced arbitration and submit a report to Congress. In its final report, released in March, the CFPB found companies widely used arbitration clauses to dismiss class action lawsuits and, despite being on the majority of financial products, three out of four Americans did not know they were subject to arbitration.

The CFPB held an open meeting on the proposal in Denver on Wednesday. While there were some critics of the plan, the overwhelming majority of audience members and participants were in favor of the CFPB weighing in on the issue.