Is the process rigged against the consumer?
by Timothy BernsteinMr. Bernstein is affiliated with New Oak, a financial advisory and consulting firm providing clients with strategic insight, transparency and risk management. Reprinted with permission. Visit here.
A new rule proposed by the Consumer Financial Protection Bureau (CFPB) is about to make it considerably harder for companies to divert customers into arbitration, a process CFPB believes is unfairly rigged against the consumer.
With the rule almost certain to take effect next year, the question going forward is whether the proposed reforms are the most effective method by which to tackle this problem.
Released on May 5, the proposed rule would not, as has been reported in certain places, ban arbitration as a means to resolve disputes. What it would do is prevent financial companies regulated by the agency from including mandatory arbitration clauses in any contracts with consumers; such contracts effectively force their customers to negotiate with them privately as opposed to joining class-action lawsuits.
Very few consumers actually enter arbitration
Two investigations over the past year, one by the New York Times and one by the CFPB itself, have concluded that very few customers actually end up entering arbitration, either because they were unaware of the option or do not wish to go to the trouble for a small claim. Moreover, the ones that do rarely have anything to show for it; the Bureau, looking at1 158 cases between 2010 and 2011, found that “consumers won an average of 12 cents for every dollar they claimed,” and they rarely claimed all that much to begin with.
The rule—widely expected to take effect next year after a 90-day public comment period and final drafting—has been heralded as a victory for the consumer, and it may well turn out to be. If nothing else, it seeks to limit the influence of an undeniably flawed system in mandatory arbitration, which is frequently geared toward the interests of businesses over the interests of consumers. The Times report described incidents in which companies paid employees to testify in their favor, supposedly independent arbitrators frequently handle multiple cases for the same company, and their decisions are nearly impossible for the plaintiffs to appeal.
It is just as undeniable, however, that the primary result of this new regulation will be to significantly increase the volume of class-action litigation, a blunt instrument that is sometimes effective, always protracted, and extremely beneficial to the litigators themselves. Certain arguments for class-action suits have more merit than others—consumers now have more tools to challenge widespread malfeasance by companies, such as predatory lending or discrimination, and the appeal and transparency processes are much improved from arbitration as it currently stands. These benefits do not alter the fact that the vast majority of plaintiffs in class-action lawsuits end up receiving very little money, and that many companies will wind up passing along any costs of litigation to consumers in general.
A deterrent for unethical practices?
On the other hand, the notion that a restoration of class-action can act as a deterrent against future unethical practices is precarious at best, especially when considering the realities of the class litigation process.
As law professor Linda Mullenix, writing last year in the Emory Law Journal, points out:
Defendants, typically, will aggressively challenge plaintiffs’ class certification motions. If defendants succeed in opposing class certification, then the class action rule served no use (other than a nuisance purpose). If, however, a court certifies a class action, defendants usually bargain for the most financially advantageous settlement terms (i.e., a cheap settlement), and punitive damages are typically removed from the negotiation process. In addition, defendants admit no liability. Consequently, the combination of these settlement factors (cheap settlement funds, no punitive damages, no admission of liability)…significantly undercut the deterrence rationale for class litigation.
All the same, it is certainly true that class action settlements, whether or not an admission of liability occurs (and there is never any admission of liability in settlements between private litigants) provide a blueprint for future litigation if the questionable conduct continues. Even if that happens, though, the fact remains that the structure of the involved lawyers’ compensation does not necessarily incentivize the most aggressive negotiation on behalf of the plaintiffs.
These defects of the class-action process should not prevent regulators from trying to hold businesses accountable for dishonest practices.
While the CFPB’s new rule may wind up helping in this regard, it is worth considering whether efforts to improve the arbitration system would be a more efficient way to assist consumers. To begin, regulators could compel businesses not to hide the relevant clauses concerning arbitration deep in consumer contracts; for example, most of these agreements include an opt-out clause for arbitration (often lasting between 30 and 60 days from purchase), but the vast majority of consumers are not even aware of this.
They might also bar or otherwise limit how much repeat business an arbitrator can receive from one company or industry, thereby mitigating a clear incentive for arbitrators to rule in favor of corporate defendants. Arbitrators could also be limited from working on too many cases at a time, which might provide both parties with a greater sense that they are being heard.
Reforming the arbitration appeal process is complicated
The question of reforming the arbitration appeal process, meanwhile, is more complicated; appeals in arbitration are virtually nonexistent (by design), but one of the signature advantages arbitration—even in its current form—has over class-action is its relative speed and efficiency (though the process has grown longer over time).
A potential solution lies in improving the access both parties have to information concerning the quality of the arbitrator involved, as well as the transparency surrounding that arbitrator’s eventual decision. A task force assembled by FINRA last year offered possible solutions, including a requirement by the Authority to train arbitrators to explain their decisions in writing. The task force even suggested mandating a raise in arbitrators’ per-session compensation, referencing “concerns that the below-market-rate arbitrators’ compensation acts as a disincentive in the recruitment of arbitrators and in the commitment of substantial time by arbitrators in executing their responsibilities.”
Any or all of these reforms could go a long toward making sure that a consumer is explaining her case in front of the best possible audience. In addition, they would avoid the potential explosion of expensive class-action litigation and the passed-on costs they will incur for the public at large. Only time will tell whether the CFPB’s new rule achieves the ambitious reforms it has set out to, but a more nuanced approach with less of an emphasis on litigation is an alternative worth considering.
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