On September 29, 2017, some Texas business groups sued the Consumer Financial Protection Bureau (CFPB) and CFPB Director Richard Cordray in the Northern District of Texas U.S. District Court. Alan Kaplinsky, chairman of the Consumer Financial Services Group of Ballard Spahr helps Lending-Times unpack this lawsuit and shed some light on how it might impact the alternative lending industry.
Summary of the Complaint
Plaintiffs in this case include the U.S. Chamber of Commerce, American Bankers Association, American Financial Services Association, Consumer Bankers Association, Financial Services Roundtable, Texas Association of Business, Texas Bankers Association, and chambers of commerce for the city of Grand Prairie, Irving-Las Colinas, Grapevine, Lubbock, Bay City, New Braunfels, Longview, McAllen, North San Antonio, Paris-Lamar, and Port Arthur, all within the state of Texas.
The CFPB issued a mandatory ban on arbitration clauses in July 2017. The ban is designed to allow consumers to join class action lawsuits against financial services companies instead of being forced to use arbitration that financial services companies put into their contracts.
“The outcome is extremely important because if it goes into effect, it’s going to cost the financial services industry billions of dollars in the first five years alone,” Kaplinsky said. All types of financial service companies, including online lenders, will likely have to defend new class action lawsuits filed against them by consumers. Some of that cost will get passed on to consumers, he said.
According to the complaint filed in federal district court, plaintiffs are suing the CFPB for ban arbitration clauses for four specific reasons:
- Plaintiffs claim the CFPB itself is structured unconstitutionally, therefore the ban cannot stand;
- and further claim the “arbitration rule,” as it is called, violates the Administrative Procedure Act because the CFPB “failed to observe procedures required by law when it adopted the conclusions of a deeply flawed study that improperly limited public participation, applied defective methodologies, misapprehended the relevant data, and failed to address key considerations;
- plaintiffs further claim the rule violates the APA because it runs counter to the record set prior to the CFPB’s formation and doesn’t take into account important aspects of the problem the agency is trying to solve;
- and, finally, they claim it violates the Dodd-Frank Act for failing to advance public interest and consumer welfare.
Who Are Ballard Spahr and Alan Kaplinsky?
Kaplinsky heads the group at law firm Ballard Spahr that specializes in consumer finance issues. The Ballard Spahr Consumer Financial Services Group employs 100 lawyers that specialize in various types of consumer services from banking services to online lending. He has been practicing law since 1970 and has spent his entire career focused on consumer financial services and involved in disputes regarding a variety of asset classes including auto loans, payday loans, credit cards, mortgages, and more.
Arbitration is a special interest of his because he is known for pioneering the arbitration provision in consumer contracts.
“When the CFPB got involved in rule making pertaining to arbitration, it was natural that I would be heavily involved in that,” he said.
Kaplinsky, along with several other lawyers, authors the Consumer Finance Monitor, a blog that keeps its eye on CFPB activities and comments on them. He is not representing the plaintiffs in this case, but he has a strong interest in it due to the nature of his practice and where it intersects with the legal ramifications of the final outcome.
Is the CFPB Unconstitutional?
Regarding the first complaint, that the CFPB’s structure is unconstitutional, Kaplinsky said, “I think they have a very good argument.” He cited the PHH case in the DC Circuit Court of Appeals that came to the same conclusion with a 2-1 vote.
The argument is based on the separation of powers clause in the U.S. Constitution that federal agencies cannot be structured in such a way to assess too much power in the hands of one individual. The CFPB is currently structured so that the director of the agency can not be removed by the president without just cause as opposed to directors of other federal agencies that allow for a sitting president to remove and replace them for any reason at his discretion. Kaplinsky also said the bureau is not subject to Congressional appropriations. Rather, it is funded from the Federal Reserve system “with very few limitations.”
The Administrative Procedure Act
The Administrative Procedures Act (APA) is a law that applies to all rules issued by the federal government.
According to the Act, any rule that is arbitrary, capricious, or contrary to other laws is invalid. Kaplinsky said it’s relevant in this case because the entire process used by the CFPB was “tainted and flawed.”
Reasons cited for the flawed procedures include not using comments received from members of the public throughout its proceedings and ignoring data gathered from its own study regarding the effectiveness of class action lawsuits and arbitration.
“They conducted a study,” he said, “then drew conclusions to propose the rule that is contrary to what the study in fact showed. The study demonstrated unequivocally that arbitration was a good process for consumers and very effective, speedy, and fair. And it’s a much better process for consumers than having to go to court.”
Kaplinsky also said the CFPB’s study showed that class action lawsuits were not beneficial to consumers. Of 562 class action suits looked at, only 12.3 percent produced any settlement benefit to the class action participants, he said. While attorneys litigating class action lawsuits received more than $400 million in attorneys fees, class action plaintiffs received an average of $32 in settlements.
“That’s a paltry amount by anybody’s standards,” Kaplinsky said, and he went on to note that class action settlements typically require consumers to fill out paperwork to receive a claim but only 4 percent of them bother to do so.
The CFPB also didn’t consider whether consumers who go through the arbitration process were pleased with the experience. and ignored other studies, as well, he said.
Does the Arbitration Rule Solve the Problem it Seeks to Solve?
When it comes to getting vindication, do consumers have a choice? The CFPB says arbitration clauses take their choice away. Kaplinsky disagrees.
“If the CFPB thinks wrongdoing was involved, the consumer can get relief,” he said. “There are actually very few arbitrations, so the CFPB concludes erroneously that arbitration isn’t working.” Kaplinsky said the reason there are few arbitrations is because companies often choose instead to settle with consumers. “Companies don’t want arbitration. It costs them money.”
In fact, it costs $3,000 just to initiate the arbitration process. And, according to Kaplinsky, the CFPB didn’t even consider how many companies opt to settle with consumers without going through the arbitration process.
“Companies don’t win all the time,” Kaplinsky said. “They can lose in arbitration. But they try to resolve the matter even if they have to pay out more.”
One reason for this is because lawsuits and settlements can be a public relations negative for a company. If they can settle a dispute in arbitration, the result of which is typically private, then it saves them in the long run on public image.
The Dodd-Frank Act
In 2010, Congress passed and President Obama signed the Dodd-Frank Act, a sweeping piece of legislation that created the CFPB and other financial services regulatory agencies. One of the provisions of the Act is purportedly to advance public interest and protect consumer welfare. Plaintiffs suing the CFPB say the arbitration rule does neither, and Kaplinsky agreed.
“Arbitration is working well,” he said. “The CFPB is saying they don’t care if companies get rid of the process. They want to preserve class action lawsuits, which aren’t working well for consumers.”
Citing Section 1028 of the Dodd-Frank Act, Kaplinsky said any rule passed by the CFPB must be consistent with the results of its own study. Since the CFPB’s study shows that arbitration is working well and class action lawsuits aren’t, and the CFPB came to the opposite conclusion, the arbitration rule is therefore in violation of the Dodd-Frank Act.
The Impact to Alternative Lenders
If Congress doesn’t override the arbitration rule and it is allowed to stand, Kaplinsky predicted that every alternative lender will have to conduct a cost-benefit analysis to determine if they should abandon arbitration clauses altogether and stick to individual disputes or run the risk of class action litigation.
“Most will come to the conclusion that to get rid of the clause altogether and change of their forms will be the best course of action,” he said. “They’ll have to prepare for an onslaught of class action lawsuits.”
Of course, many alternative lenders are pre-funded startups. Some never see venture capital funding even in early seed rounds. One class action lawsuit could put them out of business even if the company isn’t found to be guilty of violating consumer rights because of the high cost of litigation. This is one case everyone in the industry should keep an eye on.