Leaving Consumers High and Dry

With the completion of its study of forced arbitration, the Consumer Financial Protection Bureau now has the authority to prohibit the practice in the financial markets it oversees. The bureau has made a compelling case for doing so.

Forced arbitration clauses, widely found in take-it-or-leave it contracts for checking accounts, prepaid cards, credit cards and other financial services, require consumers to give up the right to go to court in the event of a dispute. Instead, you are forced to bring your case to a private arbitration firm that has been chosen by the company – your opponent in the dispute.

The CFPB’s data show how unfair this increasingly common corporate practice is, and how damaging it can be to the financial marketplace. Contracts that require arbitration generally also forbid class actions; in other words, rather than being allowed to band together in an effort to resolve similar complaints, consumers must pursue their claims individually, through arbitration or (as some such contracts also allow) in small-claims court.

This is especially problematic in the financial services markets, where most individual consumer losses are low-dollar amounts as a result of such things as usurious interest rates, predatory fees or potentially illegal charges. Individual consumers typically cannot pursue these small claims alone. Forced arbitration clauses with class-action restrictions essentially shield companies from being held accountable for systemic misconduct where the damage to any one consumer is too small to justify the trouble and expense of legal action.

So the real story behind forced arbitration, as the bureau’s data confirm, is that it prevents consumers from complaining in any forum. Of the millions of financial consumers governed by such clauses, fewer than 500 a year participated in arbitration between 2010 and 2012, the agency found. And even more startling is that only about 25 consumers a year filed claims in arbitration worth under $1,000.

The bureau’s report also showed that when consumers can join together to pursue claims for harm against financial institutions, the results are much better. In a series of cases several years ago, consumers sought accountability from banks that had adopted a practice of manipulating the sequence of checking account transactions that resulted in overcharging consumers for debit overdrafts, bringing the banks millions in illicit fees. The CFPB found that a set of 18 class-action settlements involving this practice provided $1 billion in cash relief to some 29 million people. On the other hand, five banks that invoked arbitration against their customers escaped accountability and largely did not have to answer to their customers for the overdraft charges.

Further, the bureau found that between 2008 and 2012, 419 class actions in federal court, covering mostly debt collection, checking and savings products, credit card and credit reporting, resulted in a total of $2.7 billion in awards to 160 million people. Meanwhile, in 341 arbitration claims filed by consumers in 2010 and 2011 where the CFPB could actually determine the arbitration outcome, consumers received a remedy for their claims in only 32 disputes for total awards of about $170,000 in cash and $190,000 in debt forbearance. No wonder banks prefer to avoid class actions.

Forced arbitration clauses, according to the bureau’s research, now cover about half of all credit-card holders and between 80 and 90 percent of those with prepaid cards, private student loans and payday loans. But very few consumers – fewer than 7 percent – realize that the terms and conditions for these services require them to surrender their access to the courts.

When consumers can join forces in a single suit over a common pattern of conduct, the company involved can be made to return a share of its illegal profits, sometimes even a really meaningful share, as happened in the overdraft cases. Class actions are far more likely to lead to a change in corporate behavior; and even the threat of a lawsuit can act as a deterrent, motivating companies to think twice before they resort to harmful or deceptive practices.

That’s why consumers must have the benefit of choice in the financial sector – not just the ability to choose from an array of financial products and services, but also to choose how to resolve disputes once they arise. The bureau’s study shows that consumers’ access to courts ultimately leads to better results for them and the marketplace as a whole.