The Consumer Financial Protection Bureau (CFPB) proposed a new rule that could dramatically increase the frequency of class action litigation in the area of consumer finance and have a profound impact on the E&O market for financial institutions.
On May 5, 2016, the Bureau announced plans to end the mandatory arbitration clauses that have become a mainstay of most financial institution consumer contracts over the last decade. This announcement does not come as a surprise; these wheels were put in motion in 2010 with the passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act, which mandated a study of such clauses and gave the CFBP the power to issue rules consistent with the results of the study.
Who Will Be Affected?
Any financial institution that is engaged in consumer finance is likely to be affected by the new rules. The CFPB has direct authority over banks and credit unions with over $10 billion in assets, as well as non-banks such as mortgage lenders and payday lenders. If instituted, the rules will apply to all of the consumer financial products and services that the CFPB oversees: credit cards, checking and deposit accounts, prepaid cards, money transfer services, certain auto loans, payday loans, private student loans and installment loans.
In addition, while the bureau does not have supervision and enforcement authority over community banks and most credit unions, they can notify a regulator if it believes that a bank or credit union has violated a federal consumer law and the regulator must respond to the CFPB within 60 days.
The Potential Impact on Insurance
There is no question that class actions can be a powerful tool for consumers, allowing injured parties to bring causes of action for smaller infractions than would be available to them on an individual basis. But is giving consumers the ability to file class action lawsuits against banks and credit card lenders a big deal for financial institutions? The chairman of the House of Representatives Financial Services Committee, Jeb Hensarling, called it a “big, wet kiss to trial attorneys.” The CFPB’s proposed rules, if implemented, will drive a significant increase in consumer class action litigation in the financial institutions sector—something to which the insurance market may have an adverse response on the line that provides coverage for client-drive claims: E&O or professional liability insurance.
Mandatory Arbitration Became the Norm
The debate regarding mandatory arbitration dates back to a 2005 California case where the state Supreme Court ruled that an arbitration clause was unenforceable because a class-action waiver within it would exculpate the institution from liability for wrongdoing involving small sums of damages. Then in 2011, the US Supreme Court determined that the Federal Arbitration Act of 1925 preempts state law barring class action prohibitions. In this case (AT&T Mobility LLC v. Conception), the Court determined there was nothing stopping financial institutions from amending consumer contracts that prohibited class action lawsuits and required arbitration. Around the same time, Dodd-Frank issued its charge to the newly formed CFPB regarding mandatory arbitration clauses.
The CFPB’s Argument for Banning Mandatory Arbitration
Released in March 2015, the CFPB’s study showed that very few consumers ever bring individual actions against their financial service providers either in court or in arbitration. The study opined that class actions provide a more effective means to challenge unfair practices by financial institutions and those class actions succeed in bringing hundreds of millions of dollars in relief to millions of consumers each year and cause companies to alter their legally questionable conduct. The study also showed that at least 160 million class members were eligible for relief over a five-year period.
The Case for Arbitration
Opponents of the proposed rules argue that class action lawsuits convey a significant benefit to the lawyers bringing the action but in actuality do little good for consumers. They cite the CFPB’s own study, which found that 87% of class actions provide no benefit at all to class members. In the remaining 13% that do settle on a class-wide basis, only 4% of the class members submit the necessary paperwork to get paid and even then the payouts averaged a mere $35. Plaintiffs’ lawyers, however, received an average of $1 million per settled case.
In light of the CFPB’s proposal, affected financial institutions should work with their risk advisors to monitor the outcome of the rulemaking and communicate clearly and early with their E&O insurers regarding the potential impact of the change on their programs, if any. It may also be beneficial for insureds to proactively convey to the insurance market any business practices that they have undertaken to mitigate the incidence of consumer class actions against them.
This post was co-authored by Ryan Wenzel, Willis Towers Watson’s Banking Industry Leader, based in New York. Ryan’s previous post was Guide to Directors & Officers Liability Insurance for Financial Institutions, published April 28, 2016.