The rule (pdf) just proposed by the Consumer Financial Protection Bureau to regulate arbitration agreements is not a surprise: the Bureau has said for months that it was developing such a rule.
This post examines the details of the proposal—how it would regulate arbitration, its scope, and its effective date. We also discuss the course of the rulemaking process, including potential judicial review of any final rule. In a future post, we’ll evaluate the CFPB’s purported justifications for the regulation.
The bottom line: The CFPB’s proposal is effectively a blanket ban on the use of arbitration by companies in the consumer financial services arena. It is an attempt to overrule by regulation the Supreme Court’s landmark decision five years ago in AT&T Mobility LLC v. Concepcion (in which we represented AT&T). Businesses that are concerned about the ramifications of this proposal will have 90 days from the date the proposal is published in the Federal Register to submit comments to the agency, and if a rule is adopted in the present form of the proposal, parties are certain to seek judicial review.
The CFPB’s Proposal
Exclusion from arbitration of all class actions filed in court. The principal restriction on arbitration agreements is as far-reaching as it is easy to explain: a flat prohibition on invoking an arbitration provision to require arbitration with respect to claims asserted in a class action filed in court (§ 1040.4(a)(1)). Indeed, the proposal requires that the arbitration agreement state: “We agree that neither we nor anyone else will use this agreement to stop you from being part of a class action case in court. You may file a class action in court or you may be a member of a class action even if you do not file it” (§ 1040.4(a)(2)(i)). The sole exception to the Bureau’s prohibition is if a court has already held that class treatment is improper (and immediate appellate rights exhausted), which is like saying it’s okay to close the barn door only after the horse has long been gone.
Reporting requirements. The proposal also would require companies to submit information to the CFPB regarding each arbitration conducted under agreements covered by the rule—such as the claim and any counterclaim, the arbitrator’s award, a copy of the arbitration agreement, and any communications relating to a company’s failure to pay arbitration fees or with the designated arbitral forum’s fairness principles (such as the American Arbitration Association’s Consumer Due Process Protocol).
Scope. The Bureau states that its intent is “to cover a variety of consumer financial products and services that the Bureau believes are in or tied to the core consumer financial markets of lending money, storing money, and moving or exchanging money.” The following consumer products and services would be subject to the arbitration regulation (§ 1040.3(a)(1)-(10)):
- Extending “consumer credit” as defined in Regulation B, or acting as a “creditor” under the Regulation by participating regularly in consumer credit decisions or referring applicants to creditors or selecting creditors to whom requests for credit may be made—note that this broad provision includes extensions of credit by merchants and sellers of nonfinancial products and services, but that some such businesses are excluded by the merchant exclusion described below;
- Extending or brokering auto leases (although auto dealers are excluded);
- Debt management or settlement services relating to an extension of consumer credit that would be covered by the rule;
- Providing consumers with credit reports, credit scores, or other information from a consumer report (except if the report is provided in connection with an adverse credit action with respect to a product or service not subject to the arbitration rule);
- Providing accounts subject to the Truth in Lending Act;
- Providing accounts or remittance transfers subject to the Electronic Fund Transfer Act;
- Transmitting or exchanging funds for consumers, unless with respect to products and services not covered by the proposed rule;
- Accepting financial data from a consumer, or providing a product or service to accept such data, for purpose of initiating a payment or credit or charge card transaction for the consumer—unless the person accepting the data is selling the nonfinancial product or service that is the subject of the transaction;
- Check cashing, check collection, or check guaranty services;
- Collection of a debt arising from the above financial products or services by the entity providing the product or service giving rise to the debt, its affiliate, or one acting on behalf of the entity or affiliate; an entity purchasing the debt or its affiliate or one acting on its behalf; or a debt collector as defined in the Fair Debt Collection Practices Act.
(Note that each of these categories is described in greater detail in the Bureau explanation published in conjunction with the proposed rule. Notably, the CFPB is proposing to cover creditors as defined by Regulation B instead of Regulation Z. The definition of a creditor under Regulation B is broader than the definition under Regulation Z.)
Expressly excluded from the proposed regulation are (§ 1040.3(b)(1)-(5)):
- Merchants, retailers, and other sellers of nonfinancial goods and services that provide an extension of credit directly to a consumer for the purpose of allowing the consumer to purchase the nonfinancial good or service from the merchant, retailer, or other seller—unless the credit extended significantly exceeds the market value of the nonfinancial good or service (or the sale of the nonfinancial good or service is a subterfuge to avoid regulation) or the merchant or seller regularly extends credit and the credit is subject to a finance charge, in which circumstances the arbitration regulation would apply;
- Persons who provide the specified product or service to no more than 25 consumers in the current and prior years;
- Activities falling within the statutory exclusions from the CFPB’s authority set forth in Sections 1027 and 1029 of the Dodd-Frank Act, that provide protection (often subject to significant limitations) for—among others—real estate brokerage, accounting, legal, and insurance services and (as noted above) for auto dealers;
- Broker-dealers subject to regulation by the Securities and Exchange Commission;
- The federal government and its affiliates; and
- State, local, and tribal entities to the extent they provide the consumer financial product “directly to a consumer who resides in the government’s territorial jurisdiction.”
Importantly, an affiliate of a company providing a financial product or service is subject to the proposed regulation when the affiliate is acting as a service provider to that company. That means that activities of the affiliate not subject to the arbitration regulation—either because the affiliate’s activity does not qualify as providing a financial product or service or because it falls within one of the exclusions—would nonetheless be subject to the arbitration regulation (§ 1040.2(c)(2)).
Finally, when a business’s relationship with a consumer includes some products or services covered by the regulation and some that are not, the arbitration regulation applies only to those covered by the regulation. The “Official Interpretations” appended to the proposed rule state that a business that is subject to the proposed rule “must comply with this part only for the products or services that it offers or provides that are covered” by the rule. (Official Interpretations, Section 1040.2(c).1). The proposal permits the arbitration agreement to state, in relevant part, “[w]e are providing you with more than one product or service, only some of which are covered by the Arbitration Agreements Rule issued by the Consumer Financial Protection Bureau,” and that the ban on applying the arbitration agreement to class actions in court “applies only to class action claims concerning the products or services covered by that Rule” (§ 1040.4(a)(2)(ii)).
The Bureau’s proposal provides an illustrative list of the businesses likely to be subject to the rule:
banks, credit unions, credit card issuers, certain automobile lenders, auto title lenders, small-dollar or payday lenders, private student lenders, payment advance companies, other installment and open-end lenders, loan originators and other entities that arrange for consumer loans, providers of certain automobile leases, loan servicers, debt settlement firms, foreclosure rescue firms, certain credit service/repair organizations, providers of consumer credit reports and credit scores, credit monitoring service providers, debt collectors, debt buyers, check cashing providers, remittance transfer providers, domestic money transfer or currency exchange service providers, and certain payment processors.
Effective date. The Dodd-Frank Act provides (in Section 1028(d)) that any arbitration regulation issued by the CFPB may apply only to arbitration agreements entered into 180 days after the effective date of the regulation. Recognizing this limitation, and the general rule that regulations do not take effect until 30 days after their promulgation, the proposed rule states that it would apply to contracts entered into 211 days after the date the final rule is published in the federal register (§ 1040.5(a)).
The delayed effective date means that all arbitration agreements in effect 210 days after the rule’s effective date can continue to be enforced—and any class waiver in those agreements can continue to be enforced—for the agreement’s duration. Significantly, moreover, the Official Interpretations state that a business does not enter into an arbitration agreement, and therefore the regulation is not triggered, if it “[m]odifies, amends, or implements the terms of a product or service that is subject to a pre-dispute arbitration agreement that was entered into before” 211 days after the rule’s effective date. This appears to mean that businesses can change the terms of service governing an existing consumer relationship without invalidating the pre-existing arbitration clause (including any class waiver) (see Official Interpretations, Section 1040.4.a.ii).
But if a business with an existing relationship with a consumer provides that consumer with a new product or service 211 days or more after the rule’s effective date, any arbitration agreement with respect to that new product or service will be subject to the limitations in the Bureau’s regulation (see Official Interpretations, Section 1040.4.a.i.A). And if, 211 days or more after the effective date, an entity subject to the rule acquires or purchases a product that is covered by the rule and subject to an arbitration agreement, that arbitration agreement becomes subject to the Bureau’s restrictions (see Official Interpretations, Section 1040.4.a.i.B.).
The Rulemaking Process and Judicial Review
The Bureau’s issuance of a proposed rule is just the beginning of the rulemaking process. The Bureau has established a ninety-day period for any interested party to file comments (the period begins on the date the proposed rule is published in the Federal Register, which has not yet occurred).
The CFPB then is obligated to study the comments, decide whether to modify any provisions of the proposed rule—or terminate the rulemaking without issuing a rule—and, if a rule is issued, explain its provisions and respond to the public comments. That process typically requires at least several months following the close of the comment period.
The Dodd-Frank Act specifies (in Section 1028(b)) that the Bureau may promulgate a regulation governing arbitration only if it finds that the regulation “is in the public interest and for the protection of consumers”; in addition, the findings underlying the rule “shall be consistent with” the arbitration study required by the statute. The Act also requires the Bureau to consider (a) “the potential benefits and costs to consumers and [regulated businesses], including the potential reduction of access by consumers to consumer financial products or services resulting from” the proposed rule; and (b) the impact of proposed rules on smaller financial institutions and on consumers in rural areas (Section 1022(b)(2)(A)).
To the extent the Bureau’s final rule fails to satisfy these statutory requirements, or is otherwise arbitrary and capricious or contrary to law, anyone adversely affected by the rule may seek judicial review—invoking the applicable provisions of the Administrative Procedure Act—and obtain an order invalidating the rule. (There already have been substantial criticisms of the CFPB’s arbitration study (pdf), for example here (pdf) and here (pdf), which may lead a court to conclude that the study is an inadequate predicate for issuance of the arbitration rule.)
Finally, the questions about the constitutionality of the CFPB’s structure raised by the D.C. Circuit prior to oral argument in the PHH Corp. v. CFPB case, and the focus on that question at the oral argument, cast a shadow on the proposed arbitration rule. A holding in PHH that the Bureau’s structure confers too much unconstrained authority on a single individual—the Bureau’s Director—and therefore violates the Constitution could provide grounds for invalidating the arbitration rule. And if the issue is not addressed by the PHH Court, it is likely to be raised in any judicial challenge to a final arbitration rule.
Although the arguments supporting judicial review are powerful, many businesses are nonetheless engaging in contingency planning to address the possibility that the rule will be finalized and implemented. Certainly businesses that make use of (or are interested in using) arbitration programs will want to consider a variety of steps aimed at addressing the impact of the CFPB’s proposed rule.