The CFPB’s Ban on Mandatory Arbitration – Betting Better Behavior by Banks Will Offset Considerable Consumer Costs

It’s been getting tougher for anyone to mount strong opposition to the Consumer Financial Protection Bureau’s (CFPB) rule banning mandatory arbitration clauses after news broke of more misdeeds at Wells Fargo, which has admitted to forcing borrowers to pay for auto insurance they didn’t need. Although Senate approval of the rule remains uncertain, banks and other lenders should prepare for it to take effect. If that’s a benefit to consumers, it’s one they are going to pay for. Indeed, consumers should prepare for higher costs as a consequence of that preparation and the uncertainty deregulation might fuel.

In many respects, complying with the rule will be relatively straightforward. Financial institutions will need to amend consumer contracts so that they do not prohibit class action litigation and ensure compliance with new reporting requirements regarding transparency in arbitration. They should also monitor changes that affect existing contracts and may in turn trigger an obligation to issue amendments.

But there is another layer of complexity, for which it is much more difficult to prepare. The CFPB rule would lead to the filing of more class actions in any economic or political environment, but in this era of deregulation, it could have a combustible effect. The president intends to reduce the CFPB’s enforcement powers as part of his larger deregulatory effort. As we’ve noted in several publications, including Asset Securitization Report, Inside the CFPB and Inside MBS & ABS, if that occurs, then plaintiffs may have a better chance of getting courts to agree their class action, versus government action, is the superior method of prosecuting claims. Further, as banks self-regulate according to their own standards in a deregulated environment, they create market inconsistencies and consumer uncertainty that itself can trigger more legal action. This greater legal exposure, in turn, leads to greater uncertainty for banks and, in an unfortunate boomerang effect, increased costs to consumers.

To be sure, the rule would serve a worthy goal for consumers, expanding the weapons available to them and allowing them, in theory, to choose the option best suited to their particular claim. But on closer inspection, it’s unclear that the “deterrence” argument used to support the rule would have prevented the Wells Fargo insurance fiasco, had the rule been in place. According to Wells Fargo, it was a case of one hand not knowing what the other was doing, and it has announced plans to refund affected consumers. Deterrents work against purposeful conduct, but not the kind of incompetence that apparently took place at Wells Fargo.

Given the prospect of increased litigation and less regulation, banks’ attention will need to shift to whether their actions can be defended, rather than merely whether they are lawful. Litigation is likely to fill the void left by deregulation, leaving the universe of legal theories limited only by the creativity of plaintiffs’ counsel. This makes the CFPB’s arbitration rule an expensive proposition for banks and consumers alike.

James Serritella, a partner in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert, contributed to this post.